Critically assess the historical development of the limited liability doctrine in light of the House of Lords calamitous decision

in Salomon v. A.Salomon & Co Ltd in 1897; critically analyse how this judgment influenced the judicial orientation on this topical matter.

A company is a means to an end, in English company law a company is a distinct legal person separate from its members. A company may own its own property, create contracts, sue and be sued and do much of what a human being can do. In the early companys traders would form a contract between themselves which is what we would now term as a partnership. One of the key growths of companys was the development of limited liability which means the investor as a shareholder is not personally liable for the companys debts if it fails. In 1855 an act of parliament allowed limited liability to companies with more than 25 members, this number was reduced to 7 in the 1862 Companies Act. In 1897 the leading case of corporate separate personality was acknowledged by the House of Lords in Salomon v Salomon which changed company law forever. Aron Salomon was a merchant who had traded successfully as a sole trader, one day he decided to create a company. The Companies Act 1862 required for there to be at least 7 members in a company. Aron organised the members as himself, his wife and five children. Once Aron created the company he transferred all his personal assets ownership as a sole trader to the new company. Aron Salomon granted debentures to the company in return for loans. When the company failed the liquidators sought to recover the debt from Aron personally and argued the company and Salomon was effectively the same person. When the case came before the High Court the judge was concerned that allowing Aron Salomon to rely on limited liability would rob the creditors of the chance of recovering their money. The judge in the High Court held that Aron Salomon should not be able to rely on the limited liability provision. When the case reached the Court of Appeal the court considered that not only what Aron Salomon was doing was not in the spirit of the companys act but that there was also something immoral about it. The judge considered the company was merely a sham designed to protect Mr Salomon from liability of his business. The House of Lords ignored the moral arguments and held that the result of the company acting as an agent logically meant that the company was itself a person and if the company was a person it should treat all the assets and liabilities of the business as belonging to the company as a separate legal person distinct from Aron Salomon. The decision in Salomon was built on a logic which was itself built on an ideology of the company as a conscious artificial economic actor. The corporate separate personality is now known as the Salomon principle. One of the advantages of this principle is it encourages economic activities by giving entrepreneurs limited liability when incorporating a company. Another advantage of the Salomon principle is that it makes trading simpler and quicker for commercial organisations. However, it can also be argued the principle allows clever capitalist to hide behind the Salomon principle and escape liability. It also contributes to reckless business behaviour where innocent creditors bear the loss. The decision by the House of Lords was criticised by Professor Khan-Freund and described as being a calamitous decision. At times the courts may set aside the Salomon Principle and lift the corporate veil. The expression means ignoring the fact that an act has been performed by a company which is generally a distinct legal person and instead holding the human beings behind the company as personally liable. The general principle is that the veil will rarely ever be lifted. The first category of cases in which the veil was lifted is known as the one man companies. In Lee v Lees Air Farming Ltd, Lee formed a company and was the governing shareholder and controlling director. He was killed when flying one of the companys aircraft. His widow tried to claim compensation under the workers compensation act on the basis that her husband was a worker. In this case it was held Lee was a separate legal person and there was no prohibition on the wife claiming compensation as a worker. As we can see in this case the Salomon principle was used in a fairly manner.

There have been historical instances where the Salomon principle has resulted in unjust rulings. One of these cases was related to group companies. Companies can be organised into groups where by the parent company owns all of the shares in a subsidiary company. Each subsidiary company is considered by company law to be a distinct legal person even though they have common ownership in the real world. One of the troubling cases of the Salomon principle was in Adams v Cape Industries. The defendant company was part of a group of companies that operated mines in different countries. The holding company was located in the UK. One of the subsidiary companies operated in South Africa. Mineworkers developed serious illness and tried to bring a claim. However, the South African subsidiary had insufficient funds to meet the claim. The miners proceeded to take the claim to the parent company which was a separate legal person. The court held the liabilities of one company could not be imposed on another company and recognised a subsidiary company will be treated as separate legal entity and has the rights which is normally attached to separate legal entities. One of the questions raised in this case was whether the parent and subsidiary company could be considered a single economic unit however this contention was rejected. One of the troubling decisions mentioned in this case is that the court is not free to disregard the Salomon Principle merely because it considers that justice requires so. The use of the principle constituted an unconceivable denial of human liability for harm caused to other people and therefore the veil should have been lifted. There are certain exceptions to the Salomon principle relating to wrongful and fraudulent trading. Under s213 of the Insolvency Act 1986 if in the course of a wind up it appears the business has been carried on defraud creditors, the court may hold knowing parties liable to make contribution to the companys assets. It was held In Re Patrick Lyon Ltd that the term fraud meant actual dishonesty which constitutes real moral blame. The provisions dealing with wrongful trading is to discourage abuses of limited liability stemming from negligent rather than fraudulent conduct. Among the cases in which the veil has been lifted are those companies which have been created solely to defraud claimants or avoid the terms of a contract. In the case of Gilford Motors v Horne, the defendant signed a contract where he agreed not to solicit the claimants clients. Instead of soliciting the defendant instead created a company which he set up in direct competition with the claimant. Horne tried to argue it was not him who breached the terms but the company. The argument was rejected and the court held the creation of the company was a sham to elude Hornes contractual obligations. The corporate veil was therefore lifted. Similarly in the case of Jones v Lipman the defendant agreed to sell land to the claimant but later decided to try and avoid the contract. He created a company and transferred the land to the company. The court held again that the contract was being solely as a sham so the defendant can avoid his contractual obligations after it had already come into existence. These cases and among others are some of the positive developments in which the courts disregarded the Salomon principle. To conclude the Salomon principle and the development has its benefits as a foundation of economic activity in many parts of the world. The principle encourages economic activities by giving entrepreneurs limited liability when incorporating a company, it also makes trading and creating contracts quicker, simpler and easier than it would have been had the principle not existed. However, the central problem with the principle is an ethical one. If an entrepreneurs personal property and assets are protected from liability they may give less importance in dealing honestly, fairly and with care giving less attention to third parties because they face no great personal risk of loss.