Discuss the consequences of incorporation of a limited company.
For several years Salomon had carried on a business as a boot repairer and manufacturer. He formed a limited company and sold his business to the company for slightly over £39000. As money came into the
company, it paid the purchase price by issuing Salomon with 20000 £1 shares, by regarding him as having
loaned the company £10000, by paying off the existing debts of the business at the time of incorporation
and by making up the balance in cash. Salomon’s wife and five children each took one £1 share. Salomon
took all of the company’s assets as security for the £10000 loan which he had made to the company.
Unsecured creditors later loaned the company further substantial sums of money. Shortly after the company
was incorporated, it got into financial difficulty and was wound up. When the company’s assets were
realised there was not enough money to repay all of the £10000 loan which Salomon had made to the company. Creditors who have been given security for their loan are entitled to be repaid before unsecured
creditors. Salomon therefore claimed all of the money which was realised. The company liquidator claimed
that Salomon should personally pay all of the company’s debts, in the same way as he would have been
liable to pay all of the business debts if he had carried on his business as a sole trader.
Held. The company had been formed properly and without any fraud. Although Salomon owned all but six
of the issued shares he was one person and the company was another. Salomon therefore had no obligation to pay the company’s debts.
COMMENT (i) When the High Court heard the case, Salomon was held liable for the company’s debts, on the
grounds that the company had acted as Salomon’s agent. In the Court of Appeal Salomon was held liable on the grounds that the company had run the business as a trustee for Salomon. Both of these arguments
were rejected by the House of Lords.
Lord MacNachten said:
‘The company is at law a different person altogether from the subscribers to the memorandum [the
people who take the first shares]; and, though it may be that after incorporation the business is precisely the same as it was before, and the same persons are managers, and the same hands receive
the profits, the company is not in law the agent of the subscribers or trustee for them. Nor are the
subscribers as members liable, in any shape or form, except to the extent and in the manner provided
by the Act.’
(ii) Salomon’s case is regarded as one of the most important in English law, mainly because of the protection which it offers to the shareholders and the officers of companies. However, the decision that a
company has a legal identity of its own has many other consequences, as the following two cases show.
(iii) The value of Salomon’s unincorporated business, which was sold to the company, was overvalued. Lord
MacNaghten said: ‘The price on paper was extravagant. It amounted to over 39000 [pounds], a sum which
represented the sanguine expectations of a fond owner rather than anything that could be called a businesslike or reasonable expectation of value.’ However, there was no fraud and the unsecured creditors
knew that they were lending the money to a limited company. They should have taken out some kind of
security to protect their loans.
In Salomon v Salomon it was held that following a proper incorporation, the company becomes a legal entity separate from its members. Request: Discuss the consequences of incorporation of a limited company.
Step by step
Solved in 3 steps
