Explain and discuss the importance of the House of Lords’ judgment in Salomon v. Salomon & co. [1897] in developing the principle of separate corporate personality and the exceptions to that principle in UK Company Law.
The landmark case of Salomon v A. Salomon and Company [1897] A.C. 22 saw the House of Lords firmly uphold the principle of separate corporate personality which has been the starting point for any discussion on the topic ever since.
Mr Salomon controlled a boot-making business as a sole trader. He incorporated a company called A Salomon and Co Ltd to which he sold his business. Complying with The Companies Act of 1862 which specified that there be a minimum of seven members for a company to be properly formed, Mr Salomon held the majority of the shares while six members of Mr Salomon’s family held one share each. Mr Salomon continued to exercise dominant control over the company as he had done while he was a sole trader. Unfortunately, the company went in to liquidation and Mr Salomon was the only secured creditor. The company’s liquidator fought on behalf of the other creditors to impose personal liability on Mr Salomon for the company’s debts.
In both the High Court, where Vaughan Williams J found that the company was a mere alias or agent of Mr Salomon, and the Court of Appeal, where it was found that the company was Mr Salomon’s trustee, Mr Salomon was held liable to indemnify the company against the creditors’ claims. However, when the case came to the House of Lords, the views of the lower courts were rejected and it was held that Mr Salomon was not personally liable. In giving judgment, Lord Halsbury stated that once a company had been legally incorporated, it must be ‘treated like any other person with its rights and liabilities appropriate to itself’, and further, that Mr Salomon’s motives for forming the company were ‘for the purposes of establishing those rights and liabilities’.[1] Indeed, as Lord Herschell stated: ‘The Company is ex hypothesi a distinct legal persona’.[2]
The significance of the principle of separate corporate personality is that the company, as a separate legal entity, can be in a legal relationship. Accordingly, a company can own property, enter into contracts and be a party to legal proceedings. As persons separate from the company, the members do not own the company’s property, do not carry on its business and do not owe its debts. The advantages of incorporating a company are numerous with perhaps the most important of these being limited liability which allows companies to raise vast amounts of capital. This is seen as promoting entrepreneurship. In addition, a company can issue transferable shares and securities and is able to create a floating charge over the company’s assets. Companies also gain perpetual succession once incorporated.
The principle has subsequently been upheld in many different contexts. In Macaura v Northern Assurance [1925] A.C. 619, Mr Macaura was the sole owner and controller of a company, but insured the company’s timber in his own name. After a fire, Northern Assurance refused to pay out to Mr Macaura, as he did not own the timber. In the House of Lords, it was found that Mr Macaura had no legal or equitable interest in the property owned by the company, as it was a distinct legal entity, despite suffering economically by its destruction. In Lee v Lee’s Air Farming [1961] A.C. 12, it was found that the wife of a deceased owner of a company was entitled to compensation under the Workers’ Compensation Act 1922 as her husband was an employee of that company. Lord Morris found that: ‘…a man acting in one capacity can make a contract with himself in another capacity. The company and the deceased were separate legal entities’.[3]
However, there are instances where the separate corporate personality of a company will be ignored. This is often referred to in metaphorical terms as ‘lifting the veil’ or ‘piercing the veil’ of incorporation. This term can be used in a broad sense to refer to a divergence from the general principle of separate legal personality but, as Lord Sumption noted in Prest v Petrodel Resources Ltd [2013] UKSC 34, it should most accurately be used in the narrow sense of disregarding the corporate veil and the separate corporate personality of a company.
A court may attribute certain characteristics or knowledge to a company in order to make companies subject to laws that are only applicable to persons who have knowledge or intention. This may be referred to as lifting the veil of incorporation in its broadest sense. In fact, such imputation of knowledge or intention takes into account the artificial nature of the company without disregarding its separate existence as a legal person. As such, it can be viewed as an affirmation of the separate legal personality of a company.
In the case of statutory provisions, the principle of separate corporate personality may be diverged from. For example, Section 213 of the Insolvency Act 1986 provides for the offence of ‘fraudulent trading’.[4] Under this provision, directors and others may be held liable for the company’s debts if its business has been carried on with the intent to defraud creditors. The principle of fraudulent trading is complemented by Section 214 of the Insolvency Act 1986, which provides for the concept of ‘wrongful trading’, a liability which applies to a director or shadow director if they ‘knew or ought to have concluded that there was no reasonable prospect that the company would avoid going in to liquidation’ at some time before it did.[5] In addition, Section 216 of the Insolvency Act 1986 restricts the use by a director of a company known by a prohibited name.
Besides statutory provisions, there is one instance where the limited liability the members gain from incorporation may be nullified. This is when the parties contract around such arrangements. It is common that members of an owner-managed company make contracts agreeing to guarantee its obligations. Indeed, this is often insisted upon by major creditors or suppliers. However, it is vital that the member or director of the company accepts an express legal obligation to be liable on this basis as by not formalising such arrangements, the consequences for the other party can be severe.[6]
Furthermore, there is nothing in company law to prevent a person from agreeing to a company being their agent. This makes that person liable for what that company does within the agency. As was established in Salomon, the fact that a person is a member of the company does not make the company that person’s agent in the absence of a specific intention to create an agency relationship. In Smith, Stone & Knight Ltd v Birmingham Corporation [1939] 4 All ER 116, it was found that a parent company which incorporated a wholly owned subsidiary company nominally operating a waste-paper business was entitled to compensation on the compulsory purchase of the land on which the business was conducted. This was because the parent company had never formally transferred ownership of the waste-paper business to that subsidiary and retained ownership of the land on which the business was operated. This case differs crucially from Salomon in that Mr Salomon formally transferred the business to A Salomon and Co Ltd. By contrast, the business operated by the subsidiary company in the instant case was never transferred to it and remained the property of its principal member. Since an agency relationship demands two legally recognisable parties, rather than being an example of disregarding the separate corporate personality of a company, treating a company as an agent of its controllers is in fact a complete affirmation of the principle.
Another exception to the principle of separate corporate personality may be found in trusteeship and liability in equity. In Petrodel, Mr Prest was found to have procured the transfer of various residential properties to companies which he owned and controlled and in so doing, had received no consideration from the companies. Based on the evidence available, the Supreme Court held that the companies must be presumed to hold the properties on resulting trust for Mr Prest. Therefore, the properties could be treated as the personal assets of Mr Prest for the purposes of matrimonial proceedings. Lord Sumption found that this did not involve piercing the corporate veil, but was an example of the ‘concealment principle’. Rather than piercing the veil, the court was simply looking behind it to discover the true facts.
In Petrodel, the Supreme Court recognised a limited power to pierce the corporate veil and to disregard the separate personality of a company in carefully defined circumstances. In giving leading judgment, Lord Sumption articulated the principle as a very narrow one. Indeed, he found that ‘most cases in which the corporate veil was pierced could have been decided on other grounds’.[7] Lord Sumption drew a distinction between the concealment principle and the evasion principle. For his lordship, the first was ‘legally banal’ and did not involve piercing the veil, as the courts in these cases were not disregarding the ‘façade’ but were looking behind it to discover the true facts. However, the second principle was different. It existed so that a court could disregard the corporate veil where there was a legal right against the person in control of it which existed independently of the company’s involvement and where this legal right was defeated or frustrated by the interposition of a company and its separate corporate personality.
In his extensive judgment, Lord Sumption examined two cases most often associated with piercing the corporate veil in the narrow sense, where the evasion principle was engaged. In the first, Gilford v Horne [1933] CH 935, the defendant attempted to evade a covenant not to compete with the claimant by arranging for his wife to form a company for the purpose. As Lord Hanworth MR stated in the case, the company was a ‘device, a stratagem’ utilised to mask the effective carrying on of the business by Mr Horne. The company was restrained in order to deprive Mr Horne of the benefit he would have derived from the company’s separate legal personality. However, Lord Sumption went on to speculate that even this case might have been decided on different grounds. This would not have involved piercing the corporate veil, such as the imputation of knowledge to the company so as to make their conduct unconscionable or tortious.[8] In Jones v Lipman [1962] 1 WLR 832, the defendant entered into a contract to sell his house. He sought to escape his obligation by conveying the property to a company in which he and a nominee of his controlled all the shares and were the directors. Russell J found that the company was ‘a mask which [Mr Lipman] holds before his face in an attempt to avoid recognition by the eye of equity’ and that the company had the same obligation to convey the property to the plaintiff as Mr Lipman, despite not being a party to the contract of sale.
Lord Sumption concluded that there was a limited principle which applied when a person was under or subject to an existing legal obligation, liability or restriction which that person deliberately evaded by interposing a company under their control. In these circumstances, the court may pierce the corporate veil for the express purpose of depriving the controller or the company of the advantage which they would otherwise have obtained by the company’s separate legal personality.[9]
Although Lady Hale and Lord Mance were less willing than Lord Sumption to draw sharp distinctions between cases of concealment or evasion or to foreclose all possible future situations, the Petrodel judgment brings much needed limitations and clarity to the doctrine of piercing the corporate veil.[10] Indeed, Lord Walker stated that it was not a doctrine at all, but merely a label that has been used to describe the disparate occasions where the court disregards or makes an exception to the principle of separate corporate personality. Petrodel may signal a more conservative use of the term by the courts in future.
Finally, a possible exception to the principle of separate corporate personality has been considered in the context of groups of companies. In DHN Foods v Tower Hamlets [1976] 1 WLR 852, the Court of Appeal, led by Lord Denning, treated a group of companies as a single entity to justify an entitlement to full compensation for the compulsory purchase of land, which one company owned and on which another company carried on a business. Unlike Smith, Stone and Knight, where an agency relationship was established, this case was decided on the basis of ‘enterprise theory’. Lord Denning felt that on the facts, the three companies involved should be treated as one. DHN Foods was not enthusiastically received, and in Adams v Cape Industries [1990] CH 433 (CA), the case was confined to being a decision on the relevant statutory provisions of compensation. The Court of Appeal stated that a court was not free to disregard the Salomon principle because it considered that justice so required.[11] Furthermore, it was held that structuring a group of companies in such a way so as to shield the group’s assets from future potential liabilities and ensuring these liabilities would be incurred by one company was a legitimate use of the corporate veil. In Bank of Tokyo v Karoon [1987] AC 45, Lord Goff summed up the approach of UK law to groups of companies, stating that the court was interested not with economics, but with law; in law the distinction between parent and subsidiary is fundamental. In Petrodel, Lord Sumption went further, adding that the distinction was also economically fundamental, since ‘limited companies have been the principal unit of commercial life for more than a century’.[12]
The Salomon principle has survived for over 100 years and has shaped UK Company Law. Following the judgment in Petrodel, it is clear that this principle will only be ignored or disregarded by a court in carefully defined circumstances. In most cases where the corporate structure is utilised to conceal the reality, the court will merely establish the true facts of the case in order to reach a decision. This decision may be reached on the basis of established legal principles such as agency or trusteeship. However, this should not be mistaken for the court piercing the veil or ignoring the fundamental principle. Rather, these cases involve the affirmation of the doctrine of separate corporate personality since the application of such principles requires two or more distinct legal persons.
[1] Salomon v A. Salomon and Company [1897] A.C. 22, dicta of Lord Halsbury.
[2] Ibid, dicta of Lord Herschell.
[3] Lee v Lee’s Air Farming [1961] AC 12, dicta of Lord Morris.
[4] Section 213, Insolvency Act 1986; http://www.legislation.gov.uk/ukpga/1986/45/section/213
[5] Section 214 (2) (b); http://www.legislation.gov.uk/ukpga/1986/45/section/214
[6] Carlton Communications and Grenada Media v The Football League [2002] EWHC 1650.
[7] Prest v Petrodel Resources Ltd [2013] UKSC 34, Lord Sumption at [27].
[8] Ibid at [29].
[9] Ibid at [35].
[10] Ibid at [92] and at [100].
[11] Adams v Cape Industries [1990] CH 433 (CA),
[12] Prest v Petrodel [2013] UKSC 34 at [8].