Aaron Salomon, ran a profitable business as sole trader as a leather and boot manufacturer in Whitechapel, London and on advise decided to register a company and sell to it, his business for the sum of ₤39,000 sterling. He received payment by way of 20,000 ₤1 shares, which he divided among his family, issuing one each to his five children and another to his wife. He kept the remaining shares. The outstanding sum was issued to Salomon by way of a debenture and the company was in debt to him. This placed Salomon in the position of principal shareholder and creditor of Salomon & Co. Ltd.
Due to a downturn in the business at the time the company experienced some difficulties and Salomon took out a further mortgage to help keep the company afloat. But when this loan fell into arrears an action was brought by the liquidator Mr. Broderip against the appellant, Aran Salomon, which was tried before Mr. Justice Vaughan Williams.
The liquidator tried to maintain that the original debenture issued to Salomon was invalid as Salomon and Salomon & Co. were in fact the same person and he was operating as he had done so in the past, that the company was merely an agent of Salomon and therefore he was personally liable for the debts of the company. Vaughan Williams said that the company “…had been some servant of Mr. Salomon’s to whom he had purported to sell his business,” In fact the Court of Appeal held that Salomon had perverted the incorporation of the company in so far as it was a “wholly unwarranted perversion of the companies’ legislation.” The company was a sham. Salomon appealed to the House of Lords and they unanimously rejected the decision of the Court of Appeal and held that the company had been properly formed and was a legal person in its own right separate from its members and legally had to be treated as such. Creditors had to respect the legal parameters of incorporation, as the company was different to the subscribers or members of the memorandum even though at first glance it may seem that the company is as one with them, the company is in fact separate and not liable for any debts incurred but for those that exist under the Companies Act. Lord MacNaghten stated that “The company is at law a different person altogether from the subscribers to the Memorandum, and although 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 at law the agent of the subscribers or a trustee for them. Nor the subscribers as members liable, in any shape or form, except to the extent and in the manner provided by the act.” And thus was borne the Salomon Principles, forever more to be the bedrock of Company Law, or was it?
While the Court of Appeal’s decision was reversed the House of Lords held that the company in its privileged position of having separate legal personality, it could only do so if ‘there was no fraud and no agency and if the company was a real one and not a fiction or a myth’. And so from this point on right up to the 1970’s, the segregation of the company from its shareholders became firmly embedded as a fundamental principle of Company Law...