In this paper, an analysis on the advantages of forming a company is made with reference to the case of Salomon v Salomon & Co. Ltd. The specific advantages to be analyzed are those arising out of a company being accorded the status of a corporate legal person and the limited liability status. A company is defined as an entity formed by a group of persons who are desirous of engaging in some trade. It is formed with an objective of limiting personal liability to the founders or shareholders in case of any externalities. The company thereby formed exists as a legal entity that has its own name and exists as legal person. It does business independently of the persons who founded it or who hold any stakes in it.
In any form of business, there is always analysis as to which form of enterprise to constitute. Others may prefer sole proprietorship, partnerships, or companies. Under companies, there are limited liability ones. Majority of company establishments are of course the limited liability. This means that incase of financial constraints in the company, what is at stake is the amount of investment made to the company and not the personal property of the shareholders. The liability is only restricted to what the members have contributed to the company in capital or shares held. This is one of the reasons for the popularity of the limited liability companies.
In the subject case, Salomon v Salomon & Co Ltd, Mr. Aron Salomon, had established a business enterprise for the manufacture of leather shoes and boots. His family members showed their interest in the business and he thereby converted it into a limited liability company. He held a vast majority of the shares while the rest of the six members only held one share each. He sold the business to the company, Salomon & C. Ltd. The price at which he sold the business to the company is termed as too extravagant. It was deemed as an unfair selling price. He then lent some money to the company to help enhance its operations through a more robust financial base. The company was later to suffer financially due to the government’s initiative to widen the supply base to protect other suppliers from losses due to strikes. This negatively did a blow to Salomon & Co. Ltd since their supplies were curtailed. Their stores therefore remained full of unsold stock. The company needed more money, so they borrowed £ 5,000 from Mr. Edmund Broderip. Mr. Salomon assigned to their creditor his debentures and interest secured by a floating charge. The company still failed and was unable to meet the interest rates at 10%.
The Advantages of Corporate Personality and Limited Liability
In 1983, the creditor, Mr. Broderip sued to enforce his security. Salomon & Co Ltd was put into liquidation. Broderip was repaid his money and the debentures were reassigned to Salomon who retained the floating charge over the company. The liquidator met Mr. Broderip’s claim with a counter claim for the return of the full amount and cancellation of the transfer of the business to the company. He claimed that the debentures were issued for fraud. It was however ruled in favor of the creditor by the court of appeal. The decision was however overturned by the House of Lords who held that, once the entity was formed into a limited liability company, it acquired new status of being a distinct legal entity different from the shareholders who formed it. There cannot be a way by which any of such persons can be an agent for the other. The claims that Salomon acted as an agent of the company were therefore dismissed. That his actions constituted fraud, no evidence was adduced to support such an allegation. The creditors ought to know when they decide to deal with a company, of the legal effects of their engagement. Mr. Salomon could therefore not be held liable for any wrongs whether to repay any money owed to creditors since he is a different person from the company although he owns a majority of the shares. The company to meet its liabilities and the shareholders theirs. What remains at stake is only the amount held in shares.
From the above case, the advantages of corporate personality and limited liability are thereby contained. They are discussed as follows; once a company has achieved its registration, it becomes an artificial legal person. This means that it can sue on its own name and likewise be sued. The effect of this is that, shareholders are protected from civil suits resulting from the acts or omissions of their company. They cannot be dragged into cases of the company just because they are the shareholders. The company faces the law on its own. The shareholders are thereby protected from cases, some of which may have immense financial repercussions were they to be enjoined. This is captured in the ruling by the House of Lords in their overturning of the earlier decisions of the Court of Appeal. They observed that Salomon is a different person from Salomon & Co Ltd and could therefore not be held liable for the ills facing the company.
A company as a legal entity can raise funds using debentures (Lowry, 2006). This is unlike sole proprietorship, which cannot use the means. This is a provision of the law to help companies raise funds with a guarantee that the money borrowed would be repaid to the debenture holders. In our case, the company used debentures to get a loan from Mr. Broderip. This is held on a security of the floating balance. This is therefore another advantage of forming a limited company as opposed to sole proprietorship. The concept of independent legal entity also allows companies rights to own, lease, or transfer any interests in their land. Any of their land cannot also be taken away from them without following the due process of the law. The autonomy accorded to companies therefore is such that they are free to engage in any business that they so wish. They can borrow money in their names just like Salomon & Co Ltd borrowed from Mr. Aron Salomon. The securities used to secure such loans are the property of the company thereby limiting the members’ liability.
The Concept of Limited Liability
The concept of limited liability shields the shareholders against any malpractices of the company that may cause financial harm to them. Activities of the company have no effect on the personal property of the shareholders other than the amount held in shares and the interests, which may be contained as dividends. In case of losses due to poor or bad leadership in the company or huge debts owed to creditors, the company can only afford to pay less or not pay at all any dividends to the shareholders. In case the company is sued for the recovery of debts, the company property would then be at stake. The shareholders can only be called upon to share the remaining part on liquidation after creditors have gotten their debts repaid. The important point here is that, the company conducts its affairs as an artificial legal person and held liable as so.
A company, as an entity with corporate personality, also enjoys the benefit of holding a perpetual life. In the case of Salomon v Salomon & Co Ltd, Salomon’s life does not have any effect upon the life of Salomon & Co. Ltd. Since they are all different persons, no one person depends on the other for their lives. Shareholders are therefore assured of their interests in the company regardless of who is available or who exits. It offers continuity in the operations of the company unless limited from liquidation.
In conclusion, the subject case offers important lessons. It remains vital that creditors are aware of these facts so that they make informed decisions before they enter into any agreements with companies. This is because; they are mostly involved in legal tussles whenever the company runs bankrupt. Investors are also called upon to be informed on the forms of business to set up. Understanding of the legal consequences is paramount. This is mainly because the different sets of businesses would attract varying interests accruing to the parties concerned. For instance, the rights and liabilities to a sole proprietor are different from those of a shareholder in a limited company. This therefore presents opportunities and risks, which should be analyzed before a decision is made.