One-man company, or a sham?

Law student gives his views on one-man companies

Posted by Lawrence Li
More than 110 years ago the House of Lords in SALOMON V A SALOMON &
CO LTD [1897] AC 22 (SALOMON) confirmed the doctrine of separate legal
entity that a company is distinct from its shareholders and is not the
shareholders agent. This doctrine is now adopted as the law of most
countries. However, what makes Salomon a landmark case is not only
because of the doctrine of separate legal entity, which was already there for
more
than
200
years
before SALOMON was
decided
(see,
for
example, SALMON V THE HAMBOROUGH CO (1671) 1 CH CAS 204). It is also
because of the recognition of one-man company, which is later described
by Lord Denning MR inWALLERSTEINER V MOIR (NO 1) [1974] 1 WLR 991 at
page 1013 as a company under the control of the one man who owns all the
shares and is the chairman and managing director.
In arriving at such decision, Lord Macnaghten in SALOMON (at page 53)
noted that it does not matter whether the power to control the company is
within only the hands of one person as long as the shares are fully paid up.
His Lordship further observed that the conclusion was not contrary to the
true intention of the COMPANIES ACT, or against public policy, or detrimental
to the interests of creditors. However, some scholars observed that it is a
struggle between form and substance (A Hicks and S H Goo, Cases and
Materials on Company Law (6th ed Oxford University Press, Oxford 2008),
96). So, are one-man companies genuinely companies?
Lord Macnaghtens Three Observations
The intention of the COMPANIES ACT will firstly be considered. Under the
COMPANIES ACT 1862 SECTION 6, which was applicable to SALOMON, an
incorporation should have seven or more persons associated for any lawful
purpose, but in SALOMON the company in question only had one true
owner, which was Mr Salomon himself. The English Court of Appeal held that
the legislature did not intend to allow a company of such kind to be created,
but this view was rejected by the House of Lords. Lord Watson (at page 38)
adopted a literal approach and held that there was nothing in the
COMPANIES ACT supporting the Court of Appeals interpretation that the
seven businessmen must be genuine. It therefore appeared the legislative
intent Lord Watson in mind was that there need not be seven or more
persons running the company; it would suffice so long as there were seven or
more persons being responsible. In such case, one-man companies were not
contrary to the legislative intent of the COMPANIES ACT.

The next observation is about public policy. To understand the whole picture
it is necessary to mention the business practices in relation to family
business, which may be a more appropriate label for Mr Salomons company
as it was transferred from a business run by his family. The facts
in SALOMON in fact reflected the common practice during the 1890s when
the concept of private company was developing and individuals were
selling their business to new companies for cash, shares and debenture (R
Tomasic, S Bottomley and R McQueen, Corporations law in Australia (2nd ed
Federation Press, Leichhardt 2002), 30). After SALOMON, family businesses
may also enjoy perpetual succession through incorporation, which allows
transfer of ownership by generation (for a detailed discussion, see S P Ville,
Judging Salomon: Corporate Personality and the Growth of British Capitalism
in a Comparative Perspective (1999) 27 FLR 203, 211). As observed by Lord
Buckmaster in RAINHAM CHEMICAL WORKS LTD (IN LIQUIDATION) V
BELVEDERE FISH GUANO CO LTD [1921] 2 AC 465, this encourages
enterprise and adventure by allowing individuals to limit their liability
through incorporation. The case presented an excellent opportunity for the
House of Lords to establish the doctrine of separate legal entity and to
recognise private companies, even at the price of ignoring, if any, the
substantive statutory requirement. Hence, the decision, from this
perspective, is favourable to public policy.
The last observation concerning detriments to the creditors interests,
however, is more controversial, and one of the moot points is whether
private individuals could be benefited from limited liability by incorporation
as this benefit is not available to sole proprietorship or general partnership. It
may lead to people forming companies to generate profit for themselves but
leaving liabilities to the companies. This appears to be unfair to creditors, but
one of the views is that creditors should be aware of the fact that they are
trading with a limited company instead of an individual. This view received
some support from in a New Zealand case TREVOR IVORY LTD V
ANDERSON [1992] 2 NZLR 517 where Hardie Boys J held that [t]he use of a
company to carry on a one-man business may be seen as itself a personal
disclaimer. Furthermore, the use of one-man company can also be a twoedged sword. For example, the House of Lords held in MACAURA V
NORTHERN ASSURANCE CO LTD [1925] AC 619 that the plaintiff, operating
an one-man company and having insured his timber being the property of
the company, lacked insurable interest in the timber as the timber belonged
to his company instead. Although this decision was said to be representing a
fairly narrow view for economically and factually [the plaintiff] was
undoubtedly interested in the timber (see S Barber, Company Law:
Textbook (4th ed Old Bailey Press, London 2003), 6), this is a trade-off for the
benefit of limited liability. One-man companies are therefore prima facie not

detrimental to creditors if the creditors approach one-man companies with a

cautious attitude.
Forming Subsidiary
The concept of one-man company can further be extended to corporate
groups, and the separate legal entity shields parent companies from liability.
A classic example is ADAMS V CAPE INDUSTRIES PLC[1991] 1 ALL ER 929,
where Slade LJ explicitly stated that subsidiary companies, while they seems
to be creatures of their parent companies, are separate legal entities from
their parents companies. Similarly, in ATLAS MARITIME CO SA V AVALON
MARITIME LTD (NO 1) [1991] 4 ALL ER 769, Staughton LJ noted that although
it may not be the most honest way to do business by forming subsidiaries
but running under the directions from the parent company, implying an
agency relationship between them would be revolutionary.
This allows companies to set up subsidiaries to run risky business with
minimal liability. As held by Bokhary JA (as he then was) in CHINA OCEAN
SHIPPING CO V MITRANS SHIPPING CO LTD [1995] 3 HKC 123, setting up
company to evade future liability is perfectly acceptable at law. Hence, a
parent company may just form subsidiaries to avoid itself, which usually has
more asset, being liable, especially when the required registration capital is
low. ORD V BELHAVEN PUBS LTD [1998] BCC 607 also illustrates that the
possibility that a parent company may even remove assets from subsidiaries
through ordinary restructuring so to make the plaintiffs action worthless.
Problem of Fraud
Nevertheless, one-man companies may also be abused to conduct fraudulent
business. This is partly reflected by the fact that private companies
registered with a capital of less than 5000 rose from 20% to 33% from 1897
to 1901 in the England (P L Cottrell, Industrial Finance 1830-1914: The
Finance and Organisation of English Manufacturing Industry (Methuen,
London 1980), 163). Opposing to Lord Macnaghtens view, Kahn-Freund
believed that [the] clash between law and truth and substance is
detrimental to the creditors (O Kahn-Freund, Some Reflections on Company
Law Reform (1944) MLR 54, 57). Lord Jenkins Report of the Company Law
Committee in 1962 also highlighted the problem of fraud in relation to oneman companies.
It seems that fraud committed through one-man companies has been a
problem for ages. While most frauds one-person companies may commit can
also be committed by genuine companies, the lack of balance in powers and
interests within an one-man company makes it easier for the one-man to
commit fraud for his personal benefit. For instance, the one-man may avoid

liability by setting up numerous one-man companies, and transfer the

property belonging to a problematic company to another company quickly as
the companies are under the control of a single person (cf. PEPPER V LITTON,
308 US 295 (1939)). It may even be a sham for criminal activities, such as
drug trafficking or money laundering.
In response to the possibility of abuse, creditors are now more prudent and
take more steps to verify the creditability of a company. This makes the
individuals creditability, instead of that of the one-man company, to be more
material. There is also an increasing demand of disclosure of documents for
investigating the true financial status of a company. Creditors may further
demand personal guarantee or fixed or floating security (Helen
Anderson, Piercing the Veil on Corporate Groups in Australia: The Case for
Reform (2009) 33 MELULR 333, 339-340).
The law also responds to the possibility of abuse by piercing the corporate
veil, which is the most common weapon against the shield of separate legal
entity. In general, if a person sets up a company for committing fraud or
using it as a sham to evade existing legal obligations, the corporate veil
between the person and the company will be pierced. Having pierced the
veil, rights, liabilities and activities of the company and the one-man behind
the veil will be equated (ATLAS MARITIME CO, supra). A company may be
liable for the one-mans act as in GILFORD MOTOR CO LTD V HORNE[1933]
CH 935 where injunction was granted against the wrongdoers company, or
vice versa as in RE DARBY [1911] 1 KB 95 where two persons were
personally liable for using a company to commit fraud. Situations where the
courts pierce the veil are however rare. This is so even when acts of an oneman company can easily be attributed to the one-man. In GRAMOPHONE &
TYPEWRITER LTD V STANLEY [1908] 2 KB 89, Buckley LJ (at page 105-6) held
that the corporate veil will not be pierced even the parent company owns all
shares in the subsidiary if the directors are empowered by the articles of
association to control the business.
However, the law is moving forward. Since DHN FOOD DISTRIBUTORS LTD V
TOWER HAMLETS LONDON BC [1976] 3 ALL ER 462, the courts have been
more willing to see what is behind the corporate veil within a corporate
group, and in that case the veil between the parent company and its whollyowned subsidiary was pierced for both companies being one economic entity
and having the same directors. In ATLAS MARITIME CO SA (supra), Staughton
LJ (at page 779) further distinguished the terms "piercing" and lifting a
corporate veil. It was suggested that while piercing the corporate veil
follows the traditional meaning, lifting the corporate veil allows the court to
see the master behind the corporate veil, which may go beyond directors
and shareholders (Kevin Wardman, The Search for Virtual Reality in

Corporate Group Relationships (1994) 15(6) Comp Law 179, 179-180). If it is

the case, the veil of an one-man company will be lifted in more cases as it is
quite obvious that the company is actually being controlled by the one-man.
Apart from that, the one-directing-mind nature makes one-man companies
easier to be criminally liable. In SECRETARY FOR JUSTICE V LEE CHAU
PING [1999] 2 HKC 103, the convicted defendant used her company to traffic
in drugs, and Lugar-Mawson DJ (as he then was) found no difficulties to also
confiscate the property of her one-man company as the company was prima
facie controlled by her for her personal benefit.
Conclusion
One-man company is by itself not a bad thing as it can encourage business
venture and makes better use of market resources. Many jurisdictions have
already recognised private one-man companies. For example, it is recognised
by the European Economic Community in the 12th Company Law Directive
89/667/EEC of 21 December 1989. Following the Companies (Amendment)
Ordinance 2003 becoming effective on 13 February 2004, one-man private
company is also now recognised in Hong Kong under the COMPANIES
ORDINANCE SECTION 153A(1).
After all, it is impossible to reverse the development of one-man companies.
Instead, it is more important to think of measures to prevent it being used as
a sham. One may expect more restrictions to be imposed on one-man
companies. For example, while China started recognising one-man company
in 2005, there are different restrictions, including ARTICLE 64 OF THE
COMPANY LAW OF THE PRC, which requires shareholders to prove that their
assets are distinct from the company or otherwise they are vicariously liable.
The recognition of one-man companies in SALOMON has changed the
substantially and reshaped the economy, but at the same time it gives
to different problems. While the conflict between separate legal entity
protection of creditors of one-man company may be solved only in
future,SALOMON still remains to be a turning point of the common law.

law
rise
and
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