Salomon v. A. Salomon & Co.

Aron Salomon was a leather merchant and boot maker in London who ran his business alone for many years. He then converted it into a company. The law of that time required at least seven members, so the members were Salomon, his wife, his daughter and his four sons.

The company bought his business for about thirty-nine thousand pounds. It paid him partly in shares, so he held 20,001 of the 20,007 shares issued. Each family member held one share. The company also gave him debentures worth ten thousand pounds. A debenture is a written acknowledgement of a loan. These debentures were secured by a charge on all the company's assets.

The business soon ran into trouble and the company went into liquidation. Its assets were not enough to pay even the debentures in full. If Salomon, as a secured debenture holder, was paid first, the unsecured creditors would get nothing.

1. Was the company validly formed when six of its seven members were Salomon's own family members, each holding just one share?

2. Was the company only a sham, an agent or a trustee for Salomon, so that Salomon had to pay its debts personally?

3. As a secured debenture holder, could Salomon be paid before the unsecured creditors of the company?

The liquidator argued that the company was a sham, only Salomon under another name, and so Salomon should pay its debts.

The trial judge and the Court of Appeal accepted this view. They held that the company was merely an agent or trustee for Salomon.

The House of Lords unanimously reversed the decisions of the trial judge and the Court of Appeal.

It held that the company had been validly formed. The Act asked only for seven members holding at least one share each. It did not ask that they be independent of one another.

Lord Macnaghten said that the company is at law a different person altogether from the subscribers. Even if the business is the same as before, with the same managers and the same hands receiving the profits, the company is not the agent of the subscribers or a trustee for them.

So Salomon was not liable for the company's debts. As a secured creditor, he was entitled to be paid before the unsecured creditors.

The company law statute in force at that time (the lecture does not name it), which required at least seven members, each holding at least one share; Concept of debentures secured by a charge on the company's assets

This case is the foundation of modern company law. The lecture tells students to quote it in every answer on corporate personality.

It establishes the following rules:
- Separate legal personality.
- The company owns its own property and owes its own debts.
- A member can lend money to his own company as a secured creditor.
- Creditors must normally sue the company, not its shareholders.

The lecture also notes that the same principle can work against the shareholder. In Macaura v. Northern Assurance Company Limited, a shareholder holding almost all the shares had no insurable interest in timber owned by the company.

Hypothetical: Prince holds ninety-nine per cent of the shares of a private company. The company buys goods from Farhan on credit and fails to pay. Farhan cannot seize Prince's house to recover the money, because Prince and the company are two different persons in law. Farhan must sue the company.

Similarly, if Prince had also lent money to the company against a secured charge on its assets, Prince could be paid as a secured creditor before unsecured creditors like Farhan.