Separate corporate personality

Meaning and origin

 Legal Doctrine maintains that
Incorporation is the source of
separate legal personality
• Classically attributed to Salomon v Salomon
(1897)
• Aron Salomon sole trader in boot making
registered his business as a co. in 1892.
• Purchase price £38,782 19s. 7d. Nominal capital
40,000 £1 shares
• Wife, daughter and sons subscribed to
memorandum
•
•
• Shares and Debentures issued to Mr Salomon.
• Debentures of £10,000 issued to Mr Broderip
creditor for £5000
•
• Salomon Co. Ltd defaults on interest
• Mr Broderip initiated proceedings to enforce
debentures
• Official receiver appointed: order to wind up co.
October 1893
•
Broderip v Salomon (1895) 2 Ch 323
• Liquidator had contended that the co. was a
fraud on the creditors and should be set aside
and money’s removed from Salomon
• Or, that co. should be indemnified by Salomon
the amount of outstanding debts and have no
other claim until creditors paid.
Vaughan Williams
• Rejected the contention that the valuation
• was a fraud but.
•
• “He took the whole of the profits, and his
• intention was to take the whole of the profits
• without running the risk of the debts and
• expenses…….one must consider the
• position of the unsecured creditor”
“The company was the mere nominee of Mr


Salomon’s and it does not seem to me to make the

slightest difference whether the nominee is a
company or a person; and therefore I wish, if I
can, to deal with this case exactly on the basis that
I should do if the nominee, instead of being a
company, had been some servant of agent of Mr
Salomon to whom he had purported to sell his
business.”
•
“ to allow a man who carries on business
under another name to set up a debenture

in priority to the claims of the creditors of

the company would have the effect of

defeating and delaying his creditors.

There must be an implied agreement by him

to indemnify the company”

“It is clear that the relationship of principal

and agent existed between Mr Salomon and

the company”
Court of Appeal (1895)
Appeal by Mr Salomon against an order to
indemnify the company Salomon Ltd against

the unsecured debts and liabilities incurred in

the name of the company whilst it carried on

business.
Lindley LJ:

“The legislature contemplated the

encouragement of trade by enabling a

comparatively small number of persons-

namely, not less than seven- to carry on

business with a limited joint stock or capital,

and without the risk of liability beyond the

loss of such joint stock or capital. But the

legislature never contemplated an extension of

limited liability to sole traders or to a fewer

number than seven”

•
“ Although in the present case there were, and are,
seven members , yet it is manifest that six of them

are members simply in order to enable the seventh

to carry on business with limited liability. The object

of the arrangement is to do the very thing which the

legislature intended not to be done; and, ingenious

as the scheme is, it cannot have the effect desired so

long as the law remains unaltered”

 Co. existed as a trustee

Lopes LJ.

•
•
 “The incorporation of the company was perfect- the
machinery by which it was formed was in every
respect perfect, every detail had been observed: but
the business was, in truth and in fact, the business of
Aron Salomon”


“It would be lamentable if a scheme like this could

not be defeated”

•
Salomon v Salomon (1897) **
House of Lords
Lord Herchell
Qu- Co. Agent carrying on business on behalf of

Mr Salomon?

“a company may in every case be said to carry on

business for and on behalf of its shareholders; but

this certainly does not in point of law constitute the

relation of principal and agent between them or

render the shareholders liable to indemnify the

company against the debts which it incurs”


Creditors interest?
Division of ownership of shares irrelevant if the
conditions of the Act have been complied with.

How “does it concern the creditors where the capital of the

company is owned by seven persons in equal shares,

with the right to an equal share of the profits, or

whether it is almost entirely owned by one person,

who practically takes the whole of the profits? The

creditor has notice that he is dealing with a company

the liability of the members of which is limited, and

the register of the shareholders informs him how the

shares are held, and that they are substantially in

the hands of one person, if this be the fact”..

•
Lord Halsbury.

•
“It seems to me impossible to dispute that once the
company is legally incorporated it must be treated

like any other independent person with its rights and

liabilities appropriate to itself, and that the motives

of those who took part in the formation of the

company are absolutely irrelevant in discussing

what those rights and liabilities are”.

HOUSE OF LORDS UNANIMOUS IN

UPHOLDING ARON SALOMONS APPEAL

•
Origins of separateness
• Contextual and historical analysis refutes legal
doctrine that incorporation is the source of
separate corporate personality.
• Historically incorporated companies were not
originally conceived as existing as completely
separate from its members
• eighteenth and early nineteenth century cases
incorporation did create an entity but not one that
was conceived as completely separate from
members
• entities composed of those members merged into
one legally distinguishable body.
•
Evidence
• Linguistic
• Until late nineteenth century, cases referred to
the company as ‘they’. Indivisible from the
individuals not ‘it’ an autonomous legal being.
• Section 3 of the 1856 Act stated that:
• “Seven or more persons may form themselves
into an incorporated company”,
• 1862 Act (section 6) the words form themselves
were omitted.
•
•
Member’s property interest
• not divisible from the companies interest
• throughout the eighteenth and early nineteenth
centuries, the term share was used in its natural
sense, namely as an appreciable part of a whole
undertaking
•
Samuel Williston (1888)
• ‘old law’ a share was an equitable interest in the
whole undertaking. SH were in equity ‘co-
owners’
• Child v Hudson’s Bay Co (1723),
 Lord Macclesfield ‘the corporation held its
assets as a trustee for the shareholders, who were
in equity co-owners’.
•
•
• Share realty or personalty according to the
nature of company assets
• ‘if the shareholders have in equity the same
interest which the corporation has at law, a
share will be real estate or personalty,
according as the corporate property is real or
personal’.
• Fraudulent transfer of shares were upheld for
bona fide purchaser for value because shares
were equitable not legal rights
• Shareholders connected in equity to the debts of
the company. Their obligation was part of the
company’s assets ie Naylor v Brown (1673)
Held true for all companies
• incorporated companies: the legal interest in the
property was vested in the corporation
• unincorporated companies, constituted through
deeds of settlement, the legal title was vested in
trustees.
• Both held the property on trust for their
shareholders.
•
Reconceptualisation of members’
property interests (the share).

• In the course of the middle part of the nineteenth

century, the legal nature of the share
underwent a change.
•
• It began to be understood as a piece of personal
property, distinct from the property of the
company
•
Bligh v Brent (1837). 2 Y. & C. 268

•
• Could shares be bequeathed in a will not
executed?
• Issue depended on whether shares were realty or
personalty
• Shares in Chelsea Waterworks, assets of
company real estate.
•
BARON ALDERSON:

“It is of the greatest importance to look carefully at the nature

of the property originally entrusted, and that of the body to
whose management it is entrusted: the powers that body has
over it, and the purposes for which these powers are given.
The property is money- the subscriptions of individual
corporators. In order to make it profitable, it is entrusted to a
corporation who have an unlimited power of converting part of
it into land, part of it into goods; and of disposing of each from
time to time; and the purpose of all this is the obtaining of a
clear surplus from the use and disposal of this capital for the
individual contributors.”
“It is this surplus profit alone which is divisible


among the original incorporators.



The land and chattels are only the instruments



(and those varying and temporary instruments),

whereby the joint stock of money is made to
produce profit.”
Crucially, Alderson

Distinguished between a claim against the

product of the assets, and a claim against the assets
themselves and recognised that the typical investor
was interested in the end product of the production
process (profit) rather than in the process itself.

By investing in the company they gave up the right

to recover their investment directly and could only
recover it by transferring the shares or by the
liquidation of the company.
The case of an unincorporated company

Sparling v Parker (1840)

A share was not a right attached to

“an interest in land ……..share transferable
only for money”
However.....A.B.DuBois
• No general law
• Corporations determined by individual charter
• Bligh v Brent- wording of charter made assets the
right to lay piping, land assets purchased later.
• Refers to company as ‘they’
• Gradual process of separation
why was the character of shares
reconceptualised?
• Capital hungry nature of first infrastructure and
then industry
• Overcoming barriers that inhibited the
circulation of capital and the need to overcome
them
• i. developed law
• Ii. developed market
Capital needs
• Up until the middle of the nineteenth century,
British capitalism was characterised by high
profits and labour intensive methods.
• Money for reinvestment was generated
internally, profits were ploughed back into the
business.
• The dominant legal form taken by business was
the partnership.
(cont)
• Increased mechanization required substantial
capital investment,
• Joint stock company, facilitated investment.
• Increasingly became the dominant legal form
taken by business.
• Railway development had already taken the
capital route and incorporated under private
Acts (Bubble Act)
•
1770-1850-----manufacture/ labour intensive---
discipline/long hours low pay-----high profits but
objective limitations-----internal plough back
Partnership form

1850 --> machinofacture---capital intensive---

--need to raise capital to remain competitive
Joint Stock Company Form
• Conditions under which the share could become
distinct and separate from the activities of the
company. A piece of property.
•
• 1. Law enabling the freely transferable share.
•
• 2. A developed market in shares.
•
The Law: Transferabiltiy and limited
liability
• Transferability
• Bubble Act prohibited free transferability,
• Deed of Settlement companies contained
• restrictions.(although of diminishing
consequence)
• 1723-1808 no prosecutions (life imprisonment)
•
Companies Act 1867
• Reduced capital
• ‘£30,000,000, which has been invested in the
shares of limited liability companies, is
rendered practically unmarketable in
consequence of the impossibility of reducing
the denomination of the shares’
 1867 Select Committee on the Limited
Liability Acts, City banker W.Newmarch
Limited Liability Act 1855

•
• 1844 Act- liability continues three years
• after transfer-
• 1844-56, 994 co.s registered 1856-62, 2,479
registered
• Encouraged small non managerial investor
• Today synonymous with companies
•
HA Shannon
• Not significant effect on business activity
• Between 1856-83 only 6% maintained an
ongoing trading record.
• Limited liability associated with sharp practice
Law and markets
• Originally, titles to revenue were categorised in common law
as ‘choses in action’ and covered bills, notes, cheques and
government stock .They were conceptualised as rights,
personal to the parties bound by the obligation.
• non assignable and incapable of being independent forms of
property.
•
• Developed markets for ‘ titles to revenue’, had been rapidly
developing thoughout the eighteenth century,
• they permitted money to preserve its flexibility and liquidity.
Shares as “choses in action”( Early
C18th)
• “Shares on stock are in their Nature Choses in
Action and are not assignable or transferable by
the common-law; perhaps in equity they may”
• Tied to asset
•
• Treasury commissioners on the incorporation by
royal charter of the Bank of Ireland (1721)
Railway shares
• Created a market in shares
• Issued in small denominations
• Sold in local markets and popularised
• London Stock Exchange reorganised rooms and
brokers around share sales
• Facilitated concept of share as a transferable
asset
•
•
The Railway: growth and capitalisation
• 1832- 166 miles of steam operated railway
• 1838- 742 miles
• 1844- 2,200 miles
• 1848- 5,000 miles
•
• Share and loan capital raised on railway companies
• 1830-£1.82 million
• 1837- £37.54 million
• 1844- £79.59 million
• 1849- £230 million
•
Law, market and capital
• the joint stock company share emerged as a new
form of ‘right to revenue’
• investment in shares appeared to be separate
from investment in industry.
• new economic form of the share determined
judicial understanding of it’s legal nature.
Doctrine of separate personality
• Doctrine expressed the ‘real’ state of things
• Circulating in different markets, with a value
distinct from the assets - a tradable piece of
property owned in law and equity, the share was
separate from the company
• Thus the shareholder’s interest was separate from
the company
• Thus the company was independent, a separate legal
being
• The doctrine describes the space between owner and
corporation
 44

Key.
• M= investment
• C= purchases of investment, raw materials,
labour, land
• P= production
• C1= products made for sale in P
• M1= money made from sale of products,
expectation that M1 will be greater than M
1. Early Capitalism- Partnerships.
M ------>C------------------>P--------->C1------------->M1
Collectively held Collectively shared

2. Credit system enabling market development

I(Interest)
(M-------+M--------->C--------->P----------C1-----------M1

PE (Profits of
industry)
2. Later developments- Joint Stock Companies.

M------------->M1
Money, in the form of shares, appears to create profits
independently.
 46

Governance implications(term 2)
 M-C-P-C1-M1 Investor or money capitalist are
one person-partnership.
 M-M1 Increased capital demands, company form
facilitates investment. Investors widely drawn
and unconcerned with the running of the
company.
 C----P------C1 process distinct from investors
(owners)
 Empirically encapsulated in BERLE & MEANS
‘The Modern Corporation and Private Property’
(1932)

Implications for limited liability
debate?
•
•
• C-P-C1 process- unlimited liability
•
• M-M1 process- limited liability
Problems with limited liability?
Salomon: A calamitous decision?
• Kahn-freund ‘the company has become a means
of evading liabilities and concealing the real
interests behind the business’ (1944) Immoral
to have a claim to profit without a responsibility
for debts?
• But enables the investment of large numbers of
non controlling investors to contribute to the
development of industry?
• Manne(1967). Limited liability enables an
efficient capital market as enables small
investment. Unlimited liability would make
these equally liable as controlling investors.
Creditors aware an cost the possibility of
insolvency
• But Landers (1975) transfers the cost of business
failure form shareholders to creditors without
compensation
Posner (1967)
• Lender of limited liability companies are paid
higher interest rates which compensate.
• Lenders assess risk, including default.
• Unlimited liability would be costly as it would
involved monitoring the personal wealth of
investors
• May involve increased and costly participation by
investors
• Share value easier to quantify if detached from
corporate liabilities
•
Conclusion: Separation and Limited
Liability
• Development of share-origins of SCP- accounts for
protection of investor via limited liability
• A fact of a developed market. Concepts intertwined.
• C-P-C1 process- unlimited liability
• M-M1 process- limited liability
• Creates faceless entities with no responsibilities- ‘ no
soul to damn, no body to kick’- but some
exceptions especially for small company
• Real issue of accountability? Responsibility lies not
with outsider/passive shareholders but with the
entity.