Summary: The requirements of correctly constituting a limited company
The concept of Separate Legal Personality (SLP) is the fundamental principle upon which company law is based. It lays the foundation for how a company operates and is considered to be one of the most important and steadfast rules in corporate jurisprudence. However, the application of this principle has been met with much controversy throughout history and is a commonly litigated topic both within and across different legal jurisdictions. Despite this, the rule established in the landmark case of Salomon v Salomon, still holds significant weight and is widely recognized as the central foundation of not only English company law but also of the global commercial legal system.
Commonly known as: Salomon v Salomon
Salomon transferred his boot making business, which was originally run as a sole proprietorship, to a company called Salomon Ltd. The company was made up of himself and his family members. The transfer was paid for by giving Salomon shares and debentures, which had a floating charge on the assets of the company as a security for debt. Later, when the company’s business failed and it went into liquidation, Salomon’s right to recover the debt through the floating charge was prioritized over the claims of unsecured creditors, meaning they would receive nothing from the liquidation proceeds. To prevent this perceived injustice, the liquidator, acting on behalf of unsecured creditors, claimed that the company was a sham and was essentially acting as Salomon’s agent. Therefore, they sought to disregard the separate legal identity of Salomon Ltd. and make Salomon personally liable for the company’s debt, as if he were still conducting the business as a sole trader.
The case dealt with the claims of unsecured creditors in the liquidation process of Salomon Ltd., a company in which Salomon was the majority shareholder. The question at hand was whether, despite the separate legal identity of a company, a shareholder/controller could be held liable for its debt beyond their capital contribution, resulting in unlimited personal liability.
The Court of Appeal had ruled that Salomon Ltd. was a sham, as Salomon had set up the company in violation of the true intent of the Companies Act, 1862, and that Salomon had conducted the business as an agent of the company and should be held responsible for its debt. However, the ruling was overturned by the House of Lords on appeal. They held that as the company was properly incorporated, it is a separate legal entity with its own rights and liabilities, and the motives of those involved in setting up the company are irrelevant in determining those rights and liabilities. This established the legal principle of the “corporate veil” between the company and its owners/controllers, known as the Salomon principle.
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