Salomon transferred his business of boot making, initially run as a sole
proprietorship, to a company (Salomon Ltd.), incorporated with members
comprising of himself and his family. The price for such transfer was paid to
Salomon by way of shares, and debentures having a floating charge (security
against debt) on the assets of the company. Later, when the company’s business
failed and it went into liquidation, Salomon’s right of recovery (secured
through floating charge) against the debentures stood a prior to the claims of
unsecured creditors, who would, thus, have recovered nothing from the
liquidation proceeds.
To avoid such alleged unjust exclusion, the liquidator, on behalf of the
unsecured creditors, alleged that the company was sham, was essentially an
agent of Salomon, and Salomon being the principal was personally liable for its
debt. In other words, the liquidator sought to overlook the separate
personality of Salomon Ltd., distinct from its member Salomon, so as to make
Salomon personally liable for the company’s debt as if he continued to conduct
the business as a sole trader.
The issue was whether, regardless of the separate legal identity of a
company, a shareholder/controller could be held liable for its debt, over and
above the capital contribution, so as to expose such member to unlimited
personal liability.
The Court of Appeal, declaring the company to be a myth, reasoned that
Salomon had incorporated the company contrary to the true intent of the then
Companies Act, 1862, and that the latter had conducted the business as an agent
of Salomon, who should, be responsible for the debt incurred in the course of
such agency.
The House of Lords, held that, as the
company was duly incorporated, it is an independent person with its rights and
liabilities appropriate to itself, and that “the motives of those who took part
in the promotion of the company are absolutely irrelevant in discussing what
those rights and liabilities are”.