The Salomon principle and the corporate veil

Chapter 2

The Salomon principle and the corporate veil

Chapter Contents

2.1      Introduction

2.2      Lifting the veil – exceptions to the Salomon principle

2.3      Companies – torts and crimes


Self-test questions

Further reading

2.1  Introduction

As has been noted, a key feature of the company is that it is a legal person with a separate existence from the company’s members (i.e. shareholders where the company has shares) or its directors. From this separate personality flow many consequences.

The House of Lords’ decision in Salomon v A Salomon & Co Ltd established the separate identity of the company.

Aron Salomon and his boot and shoe business have done for company law what Mrs Carlill and her smoke ball did for the law of contract and what Mrs Donoghue and her adulterated ginger beer did for the law of tort.

Mr Salomon transferred his business to a limited company and he and six other members of his family subscribed the company’s memorandum; the purchase price was £38,782. Salomon took 20,001 shares and the six other family members took one share each. Debentures (loan stock) of £10,000 and £8,782 cash were paid to Salomon as the balance of the purchase price. The business foundered and was wound up with liabilities in excess of its assets by £7,733. The company’s liquidator claimed that the company’s business was still Salomon’s, in that the company was merely a sham to limit Salomon’s liability for debts incurred in carrying it on, and the repayment of Salomon’s debenture should be postponed until the company’s other creditors were satisfied. At first instance, Vaughan Williams J agreed with the liquidator. He held that Salomon’s sole purpose in forming the company was to use it as an agent to run his business for him.

The Court of Appeal reached the same conclusion but for different reasons. It took the view that the principle of limited liability was a privilege conferred by the Companies Acts only on genuinely independent shareholders and not on ‘one substantial person and six mere dummies’.

The House of Lords unanimously reversed the Court of Appeal decision. Lord Halsbury LC in Salomon v A Salomon & Co Ltd said:

I must pause here, to point out that the statute enacts nothing as to the extent or degree of interest which may be held by each of the seven [subscribers] or as to the proportion of influence possessed by one or the majority of the shareholders over the others. One share is enough. Still less is it possible to contend that the motive of becoming shareholders or of making them shareholders is a field of enquiry which the statute itself recognises as legitimate. If there are shareholders, they are shareholders for all purposes; and even if the statute was silent as to the recognition of trust, I should be prepared to hold that if six of them were the cestuis que trust of the seventh, whatever might be their rights inter se, the statute would have made them shareholders to all intents and purposes with their respective rights and liabilities, and dealing with them in their relation to the company, the only relations which I believe the law would sanction would be that they were corporators of the body corporate.

This case thus established one of the basic articles of faith of British company law, indeed of company law of all common law systems, that a company is a legal person independent and distinct from its shareholders and its managers.

This, at least, was the theory. However, the principle in Salomon’s case has not been without its detractors. Otto Kahn-Freund in ‘Some Reflections on Company Law Reform’ in (1944) MLR 54, was critical of the principle in the case. He says:

However, owing to the ease with which companies can be formed in this country, and owing to the rigidity with which the courts applied the corporate entity concept ever since the calamitous decision in Salomon v Salomon & Co Ltd, a single trader or a group of traders are almost tempted by the law to conduct their business in the form of a limited company, even where no particular business risk is involved, and where no outside capital is required.

This state of affairs would not necessarily call for reform, if it were not for the fact that the courts had failed to give that protection to the business creditors, which should be the corollary of the privilege of limited liability.

Kahn-Freund continues (page 57):

What can be done? How is it possible to check the one-man company and other abuses of company law for purposes which it was never meant to serve? Is it conceivable that Salomon’s case can be abrogated by legislation? Could the interests of outside creditors be protected by a general clause under which persons owning a controlling interest in a company would be liable for its debts? Or could there be a provision according to which a company would be deemed to act as agent for the owners of controlling interests?

Nor is Kahn-Freund alone. Clive Schmitthoff in ‘The Wholly Owned and the Controlled Subsidiary’ [1978] JBL 218, considers problems that present themselves in connection with wholly owned and controlled subsidiaries (see section

Schmitthoff looks at the decision in Salomon in the narrower context of subsidiary companies, although he analyses the decision and points out some difficulties that it presents.

He looks specifically at two separate problems; one concerns the problem of jurisdiction where the courts of the host country (of a subsidiary) may wish to exercise jurisdiction over the parent company in the home country. He also considers the separate problem of the liability of the parent for the debts of subsidiaries.

As regards jurisdiction, the courts and authorities of the host country should assume jurisdiction over the parent company if it carries on substantial business in the host country by means of wholly owned or controlled subsidiaries, or by means of branch offices.

As regards liability, the parent company should be liable for the debts of wholly owned and controlled subsidiaries if it employed these dependent companies as agents, and it should be rebuttably presumed that it used these subsidiaries in that manner.

Schmitthoff continues:

If the subsidiary is wholly owned, there should be a conclusive presumption that it is controlled by the parent, and if the parent holds more than 50% of the voting power of the subsidiary, but does not own the subsidiary wholly, there should be a rebuttable presumption to the effect that the subsidiary is controlled.

(p 229]

Notwithstanding such statements and occasional exceptional judicial instances apart, the principle of separate identity has been consistently applied.

In the New Zealand case of Lee v Lee’s Air Farming Ltd [1961] AC 12, which went to the Privy Council, Lee owned all the shares but one in the company that he founded. His wife held the other share. Lee was governing director of the company, whose business was spraying crops from the air. When he was killed in a flying accident while on company business, his widow was held to be entitled to recover compensation from the company for his estate as the company was quite separate and distinct from her husband, its employee.

It has sometimes been said that the American Realist school in jurisprudence explains far more about how judicial decisions are made than the system of precedent. Thus decisions may be put down to whether the judge has a fondness for, or aversion to, redheads, and what the judge has had for breakfast. This may explain some of the cases in this area of law, which are notoriously difficult to reconcile one with another.

It is proposed to contrast some cases here. The case of Lee v Lee’s Air Farming Ltd can be contrasted with Malyon v Plummer [1964] 1 QB 330. Here the claimant’s husband had been killed in a fatal accident. This had been caused by the admitted negligence of the defendant. The husband owned all but one of the shares in a company. He worked a six-day week for the company and was the only breadwinner. The claimant owned the other share and received a substantial salary for a limited amount of part-time work, which she performed on a casual basis. The wife sought to claim for the loss of her livelihood, asserting that when the husband was killed, the company was also effectively killed.

In the Court of Appeal, Sellers LJ said,

In my opinion, the inter-position of FP Malyon Ltd, if that is how it should be regarded, does not prevent the court assessing truly the loss which the wife has suffered. The husband’s business, FP Malyon Ltd, has been destroyed by the loss of the husband, and it is clear that the revenue was, in substance, derived from him. The decision in Salomon v Salomon Co need not blind one to the essential facts of dependency and require a finding of fact that is contrary to the true financial position as distinct from an artificial or fictitious one.

The common feature in Lee v Lee’s Air Farming Ltd and Malyon v Plummer is that, in a loose sense, justice can be seen to have been done in both cases. In Lee, by asserting the separate identity of the company, the widow was able to benefit from the New Zealand Workman’s Compensation Act and obtain compensation. In a similar way, by destroying the corporate facade in Malyon v Plummer, the widow was able to assert that when the husband died the company also died, and that they were one and the same thing, and thus she was able to recover compensation for the loss of livelihood. Two widows recovering compensation by opposite legal arguments. Judges of a certain age may well have an instinctive sympathy for widows!

It is often difficult to reconcile the cases and to find a coherent body of doctrine in this area.

Two further cases may be contrasted: Buchan v Secretary of State for Employment and Ivey v Secretary of State for Employment [1997] 1RLR 80, on one hand and Secretary of State for Trade and Industry v Bottrill [2000] 1 All ER 915 on the other hand.

In Buchan v Secretary of State for Employment and Ivey v Secretary of State for Employment, the Employment Appeal Tribunal distinguished the Privy Council decision in Lee in two joined appeals. The two directors involved held a half and a controlling interest respectively in their companies. It was held that they were not employees for the purpose of making a claim against the National Insurance Fund.

The tribunal considered that such directors could block decisions at board level, including decisions relating to their dismissal, and that this was not consistent with being an employee. No doubt, the context of the dispute influenced the decision as the directors were seeking compensation as employees for dismissal. The Employment Appeal Tribunal took the view that it is not the purpose of the legislation to fund compensation for those whose businesses have failed.

However, in Secretary of State for Trade and Industry v Bottrill, the veil was not lifted. Bottrill was managing director of Magnatac UK Ltd. He held the only share. There was one other director. Bottrill had a contract of employment which set out all his duties, his hours, sick pay, etc. He paid tax and national insurance. The company became insolvent and he applied for a redundancy payment. It was held by the Court of Appeal, with Lord Woolff MR presiding, that it was a question of fact whether Bottrill was an employee or not. The fact that he was a controlling shareholder was not decisive. The question was whether there was a genuine contract. In the instant case the tribunal had been entitled to conclude that there was a genuine contract.

Two further cases may be contrasted.

In Macaura v Northern Assurance Company Ltd [1925] AC 619, where the owner of a timber business incorporated the business but continued to insure the property in his own name, it was held when the property was destroyed that he had no insurable interest and so could not claim on the policy. The property was no longer his; it now belonged to the company. It may well have been relevant in this case that the fire occurred soon after the insurance policy had been renewed. There was at least a hint in the case that this may have been a relevant factor in the decision. Is this a hint of arson?

Nevertheless, the case may be contrasted with the Supreme Court of Canada decision in Constitution Insurance Co of Canada v Kosmopoulos (1987) 34 DLR (4th) 208. Kosmopoulos was the sole shareholder and director of a company, Kosmopoulos Ltd, which carried on a retail business. He conducted the business as a sole proprietorship (as it had formerly been), and was himself the lessee of the business premises. He took out insurance in his own name. Damage was caused by fire to the assets of the company, and the insurers denied liability. Kosmopoulos’s action succeeded at trial and in the Ontario Court of Appeal. On further appeal by the insurers to the Supreme Court of Canada, the appeal was dismissed. It was held that it was not necessary that the insured should have a legally enforceable interest in the property. It was sufficient if he had a relation to, or concern in, the subject matter of the insurance, whereby he would suffer a loss upon the occurrence of the insured risks. Wilson J in the Supreme Court said that:

Mr Kosmopoulos, as a sole shareholder of the company, was so placed with respect to the assets of the business as to have benefit from their existence and prejudice from the destruction. He had a moral certainty of advantage or benefit from those assets but for the fire. He had, therefore, an insurable interest in them, capable of supporting the insurance policy and is entitled to recover under it.

There is no suggestion that the law in Canada is materially different from the law in the United Kingdom. Common law countries all seem to suffer from the same confusion of clinging to the Salomon principles of the basic separation of the company from its controllers, while at the same time undermining it with a variety of exceptions and qualifications which are considered in this chapter. Those hoping for a clear and consistent message in this area will hope in vain, as the above cases demonstrate.

Demonstrating the separate nature of the company in R v Buxton and others [2010] All ER 215, the Court of Appeal held that a restraining order could be issued to safeguard a company from harassment.

While the decision in Salomon’s case has certainly been open to criticism, and the cases are far from consistent, in Adams v Cape Industries plc [1990] Ch 433, the Court of Appeal held that an English company, whose business was mining asbestos in South Africa, was not present in the United States through another member of the corporate group. Slade LJ had said: ‘… save in cases which turn on the wording of particular statutes or contracts, the court is not free to disregard the principle of Salomon v A Salomon & Co Ltd merely because it considers that justice so requires.’

In fact, Adams identified two further areas where the veil may be lifted, namely where the company is a ‘facade’ such as a fraudulent construct, and also where there is an agency express or implied.

However, the Court of Appeal’s view in Adams v Cape Industries plc has not always been followed faithfully. In Creasey v Breachwood Motors Ltd [1993] BCLC 480, Richard Southwell QC, sitting as a deputy High Court judge, allowed the substitution of one company for another as defendant holding the second company liable for the debts of the first. This decision, however, was itself disapproved in Ord & Another v Belhaven Pubs Ltd [1998] 2 BCLC 447 by the Court of Appeal. The defendant, Belhaven Pubs Ltd, appealed against a decision of Judge Alton whereby the deputy judge ordered that the claimants be granted leave to substitute Ascot Holdings plc as the defendant in an action brought by the claimants against Belhaven Pubs Ltd, claiming damages for misrepresentation and breach of warranty. The Court of Appeal held that, in the absence of any impropriety, sham or concealment in the restructuring of the Group, it would be wrong to lift the corporate veil in order to make the shareholders of the defendant company liable instead of the company itself.

The principle of separate identity was also restated by Lightman J in Acatos and Hutcheson plc v Watson [1995] 1 BCLC 218. He considered that the principle of separate identity should be upheld unless there was a specific statutory provision or some other contractual term or established common law principle to the contrary. He said that ‘outside these exceptions [the company] is entitled to organise and conduct its affairs in the expectation that the court will apply the principle of Salomon v A Salomon & Co Ltd in the ordinary way’. The case concerned the company acquiring all the issued share capital of a company called Acatos Ltd and Acatos and Hutcheson plc sought a declaration that the proposal did not fall foul of the provision prohibiting a company from purchasing its own shares, where Acatos Ltd’s sole asset was a 29 per cent holding in Acatos and Hutcheson plc. It was held that there was no breach of the provision.

2.2  Lifting the veil – exceptions to the Salomon principle

However, the principle in Salomon’s case does give way to exceptions where the veil of incorporation is lifted. These are of two types: statutory and judicial.

2.2.1  Statutory exceptions

It was formerly the case that if an officer of the company did not use the company name in full on any letter, order for goods or money, etc., then that company officer was liable to the other party and also liable to a fine (s349 (4) CA 1985). However, the Companies Act 2006 alters this provision. Section 82 CA 2006 provides that the Secretary of State may make regulations requiring companies to display specified information at specified locations, on documents, and on request to those with whom they deal. This information would include the name of the company. If the company then sought to enforce contractual rights against the other party, then these proceedings would be dismissed if the other party had a claim against the company which he was unable to pursue by reason of the company’s breach of regulations, or if he had suffered some financial loss by reason of the company’s breach of the regulations unless the court considered it just and equitable to permit the proceedings to continue (s 83 CA 2006). Breach of the regulations under s 82 would also amount to a criminal offence on the part of the company and on the part of every officer in default (s 84 CA 2006) (see in general section 6.2).

If the company’s business has been carried on with intent to defraud creditors or for any fraudulent purposes, the court, on the application of the liquidator, may declare that the persons who were knowingly parties to the fraud are liable to make such contributions (if any) to the company’s assets as the court thinks proper (s 213 of the Insolvency Act 1986). Whatever contributions the court orders will be distributed among the company’s creditors and should therefore compensate for the loss caused to creditors by the fraudulent carrying on of the business (Morphitis v Bernasconi [2003] Ch 552). This section has a criminal counterpart in s 993 of the Companies Act 2006. The section is applicable not merely to directors but to other persons who are trading through the medium of the company. By contrast, s 214 of the Insolvency Act 1986, which deals with wrongful trading, empowers the court to make a declaration in the situation of insolvent liquidation against a person who was a director or shadow director who knew, or ought to have known, that there was no reasonable prospect of the company avoiding insolvent liquidation (see section 25.3).

In Re Produce Marketing Consortium (No 2) [1989] BCLC 520, Knox J drew attention to two material differences from s 213:

First, the requirement for an intent to defraud and fraudulent purpose was not retained as an essential, and with it goes what Maugham J called ‘the need for actual dishonesty involving real moral blame’.

He continued:

The second enlargement is that the test to be applied by the court has become one under which the director in question is to be judged by the standards of what can reasonably be expected of a person fulfilling his functions, and showing reasonable diligence in doing so.

On the facts of the case, two directors of a fruit-importing business were held liable. The directors of the company had been warned by the company’s auditors of the company’s serious financial plight.

In this case, the judge ordered that the directors should contribute to the company’s assets the amount by which they had been depleted by the directors’ conduct, i.e. once again the aim is compensatory.

In Re Purpoint Ltd [1991] BCLC 491, the judge decided that the right measure of liability for wrongful trading was the increase in the net liabilities of the company which had been occasioned by the continuance of trading after the director should have known that the company was destined for liquidation (see wrongful trading, section 25.3).

There are some other situations in respect of insolvency where the veil is lifted. Section 216 of the Insolvency Act 1986 makes it an offence for a person who is a director, or shadow director, of a company that has gone into insolvent liquidation to be in any way concerned in the next five years in the formation or management of a company with a name similar to that of the original company. Section 217 makes such persons personally liable in such a situation.

A further provision applicable in situations of insolvency is s 15 of the Company Directors Disqualification Act 1986, which provides that a person who has been disqualified from acting in the management of a company is personally liable for the company debts if he acts in contravention of this order.

In the case of a public limited company, if it acts before it has obtained its trading certificate, then the company and its officers are liable to fines. Furthermore, if the company fails to comply with its obligations within 21 days, the directors of the company are jointly and severally liable to indemnify any other party to the transaction in respect of any loss or damage suffered by reason of the company’s failure to comply with its obligations (s 767(3) CA 2006).

Group accounts have to be filed where companies are in a group. This is in addition to the separate sets of accounts that have to be filed for each of the constituent companies. In order to determine if a company is part of a group, clearly the veil is being lifted. To determine if a holding/subsidiary relationship exists, it is necessary to examine ownership of the shares, membership of the board of directors, or control of the board or company in general meeting (s 399 CA 2006) (see section 17.2.2).

There are many other statutory examples. For example, under s 6 of the Law of Property Act 1969, it is provided that an individual landlord is able to resist the renewal of a tenancy if he can show that he needs the premises for his own commercial purposes. This is extended to cover the situation where he needs the premises for the purposes of a company which he controls. See Tunstall v Steigmann [1962] 2 QB 593.

2.2.2  Judicial lifting of the veil

It is difficult to identify a consistent thread running through the decided cases indicating when the veil will be lifted. It seems to be, as the American Realists (commenting on the nature of legal decisions) indicate, dependent on the particular judge and what the judge has had for breakfast! However, it is possible to identify certain consistent themes in the cases.

As Murray Pickering in ‘The Company as a Separate Legal Entity’ (1968) 31MLR 481 has demonstrated, there is a remarkable range of judicial descriptions used where difficulties are experienced by the courts in separating the company as a legal entity from its members. These include, as Pickering notes, for example, ‘a mere nominee’, ‘a mere fraud’, ‘an agent’, ‘a trustee’, ‘a mere device’, ‘a myth and a fiction’ (Broderib v Salomon [1895] 2 Ch 323), ‘a pretended association’ (Salomon v Salomon & Co [1897] AC 22), ‘a bubble’ (Re Carl Hirth [1899] 1 QB 612), ‘an unreal’ procedure (Attorney General for Dominion of Canada v Standard Trust Co of New York [1911] AC 498), ‘an alias’, ‘a name’ (Re Darby [1911] 1 KB 95), ‘an artificial legal thing’, ‘a legal abstraction’ (Continental Tyre & Rubber Co (GB) Ltd v Daimler Co Ltd [1915] 1 KB 95), ‘mere machinery’ (Daimler Co v Continental Tyre & Rubber Co [1916] 2 AC 307), ‘a metaphysical conception’ (Lennards Carrying Co Ltd v Asiatic Petroleum Co Ltd [1915] AC 705), ‘a sham or bogus’ (R v Grubb [1915] 2 KB 683), ‘an abstract conception’ (Houghton & Co v Nothard Lowe & Wills Ltd [1928] AC 1), ‘a simulacrum’ (EBM Co Ltd v Dominon Bank [1937] 3 All ER 555), ‘a cloak’ (Gilford Motor Co Ltd v Horne [1933] Ch 935), ‘a mere alter ego’ (Pegler v Craven [1952] 2 QB 69), ‘an abstract being’ (Austin Reed Ltd v Royal Assurance Co Ltd [18 July 1956 CA] unreported), ‘a creature’ (IRC v Lithgows Ltd (1960) 39 TC 270), ‘a screen’ (Barclays Bank v IRC [1960] 3 WLR 280) and even ‘a blacksheep’ (IRC v Sansome [1921] 2 KB 492).  Fraud situations

The court will lift the veil to prevent fraud or sharp practice. In Jones v Lipman [1962] 1 All ER 442, a vendor of land sought to evade a decree of specific performance of a contract for the sale of a piece of land by conveying the land to a company which he had purchased for the purpose of side-stepping the obligation.

The court held that the acquisition of the company and the conveyance of the land to it was a mere ‘cloak or sham’ to evade the contract of sale. The veil was lifted.

By contrast, in the Australian case of Electric Light and Power Supply Co Ltd v Cormack