MrAron Salomon made leather boots and shoes in a large Whitechapel High Street establishment. His sons wanted to become business partners, so he turned the business into a limited company. His wife and five eldest children became subscribers 5 and two eldest sons also directors. Mr Salomon took 20,000 of the company’s 20,006 shares. Transfer of the business took place on June 1, 1892. The company also gave Mr Salomon £10,000 in debentures6 (i.e., Salomon gave the company a £10,000 loan, secured by a charge over the assets of the company). Soon after Mr Salomon incorporated his business a decline in boot sales, exacerbated 7 by a series of strikes which led the Government, Salomon’s main customer, to split its contracts among more firms to avoid the risk of its few suppliers being crippled 8 by strikes. Mr Salomon assigned 9 Edmund Broderip his debenture, the loan with 10% interest and secured by a floating charge. But Salomon’s business still failed, and he could not keep up with the interest payments. In October 1893 MrBroderip sued to enforce his security. The company was put into liquidation. Broderip was repaid his £5,000, and then the debenture was reassigned to Salomon, who retained the floating charge over the company.
At first instance, the case entitled Broderip v Salomon Vaughan Williams J said MrBroderip’s claim was valid. It was undisputed that the 200 shares were fully paid up. He said the company had a right of indemnity against Mr Salomon. He said the signatories 10 of the memorandum were mere dummies11, the company was just Mr Salomon in another form, an alias12, his agent. Therefore it was entitled to indemnity from the principal. The liquidator amended the counter claim, and an award was made for indemnity. Court of Appeal
The Court of Appeal confirmed Vaughan Williams J’s decision against Mr Salomon, though on the grounds that Mr. Salomon had abused the privileges ofincorporation and limited liability, which Parliament had intended only to confer on “independent bona fide14 shareholders, who had a mind and will of their own and were not mere puppets15”. Lindley LJ (an expert on partnership law) held that the company was a trustee for Mr Salomon, and as such was bound16 to indemnify the company’s debts. “
The incorporation of the company cannot be disputed. (See s. 18 of the Companies Act 1862.) Whether by any proceeding in the nature of a scirefacias the Court could set aside the certificate of incorporation is a question which has never been considered, and on which I express no opinion; but, be that as it may, in such an action as this the validity of the certificate cannot be impeached17. The company must, therefore, be regarded as a corporation, but as a corporation created for an illegitimate 18 purpose. Moreover, there having always been seven members, although six of them hold only one 1l. share each, Mr.Aron Salomon cannot be reached under s. 48, to which I have already alluded19. As the company must be recognised as a corporation, I feel a difficulty in saying that the company did not carry on business as a principal, and that the debts and liabilities contracted in its name are not enforceable against it in its corporate capacity. But it does not follow that the order made by Vaughan Williams J. is wrong.
A person may carry on business as a principal and incur debts and liabilities as such, and yet be entitled to be indemnified against those debts and liabilities by the person for whose benefit he carries on the business. The company in this case has been regarded by Vaughan Williams J. as the agent of Aron Salomon. I should rather liken the company to a trustee for him – a trustee improperly 20 brought into existence by him to enable him to do what the statute prohibits. It is manifest 21 that the other members of the company have practically no interest in it, and their names have merely been used by Mr.Aron Salomon to enable him to form a company, and to use its name in order to screen himself from liability. This view of the case is quite consistent with In re George Newman & Co. In a strict legal sense the business may have to be regarded as the business of the company; but if any jury were asked, Whose business was it? they would say Aron Salomon’s, and they would be right, if they meant that the beneficial interest in the business was his. I do not go so far as to say that the creditors of the company could sue him. In my opinion, they can only reach him through the company.
Moreover, Mr.Aron Salomon’s liability to indemnify the company in this case is, in my view, the legal consequence of the formation of the company in order to attain a result not permitted by law. The liability does not arise simply from the fact that he holds nearly all the shares in the company. A man may do that and yet be under no such liability as Mr.Aron Salomon has come under. His liability rests on the purpose for which he formed the company, on the way he formed it, and on the use which he made of it. There are many small companies which will be quite unaffected by this decision. But there may possibly be some which, like this, are mere devices to enable a man to carry on trade with limited liability, to incur debts in the name of a registered company, and to sweep 22 off the company’s assets by means of debentures which he has caused to be issued to himself in order to defeat the claims of those who have been incautious 23 enough to trade with the company without perceiving 24the trap which he has laid for them.
It is idle 25to say that persons dealing with companies are protected by s. 43 of the Companies Act, 1862, which requires mortgages of limited companies to be registered, and entitles creditors to inspect the register. It is only when a creditor begins to fear he may not be paid that he thinks of looking at the register; and until a person is a creditor he has no right of inspection. As a matter of fact, persons do not ask to see mortgage registers before they deal with limited companies; and this is perfectly well known to every one acquainted with the actual working of the Companies Acts and the habits of business men.
Mr.Aron Salomon and his advisers, who were evidently very shrewd people, were fully alive to this circumstance. If the legislature thinks it right to extend the principle of limited liability to sole traders it will no doubt do so, with such safeguards, if any, as it may think necessary. But until the law is changed such attempts as these ought to be defeated whenever they are brought to light. They do infinite 26 mischief27; they bring into disrepute 28 one of the most useful statutes of modern times, by perverting 29its legitimate use, and by making it an instrument for cheating honest creditors. Mr.Aron Salomon’s scheme is a device 30 to defraud creditors. ”
Lopes LJ and Kay LJ variously described the company as a myth and a fiction and said that the incorporation of the business by Mr Salomon had been a mere scheme to enable him to carry on as before but with limited liability.