MBA I - Legal Aspects - Understanding Salomon vs. Salomon Case (Contract Act)

Salomon vs. Salomon

The concept is nothing else but A COMPANY IS SEPARATE FROM ITS MEMBERS (SHAREHOLDERS). It simply means that the company is independent and separate from any other entities who are related to it (company).

Mr. Salomon had his own business of boot manufacturing, etc. It's not the main issue here.

Since his children wanted to be a part of the business as owners, Mr. Salomon sold his business to the New Company (the company, he was planning to form) for a certain amount of money ( Rs.40000 ).

He was selling his business to the new company as he knew that the COMPANY IS SEPARATE LEGAL ENTITY.

He needed 7 members (shareholders) to form that company. Fortunately or unfortunately, he had 5 children. 7 members were found: 5 children, 1 wife, and Mr. Salomon himself.

So, he gave himself 20000 shares (1 Rupee each), 1 share to each child (total 5 shares for 5 children) and 1 share to his wife.

He elected his two children together with him to be the Directors of the company.

Let me refresh the case so that you get the points mentioned above. Mr. Salomon became a SHAREHOLDER, right? Yes. But the company still owes Mr. Salomon 20000 Rupees, right? Yes ...

So, The company gives him debentures of Rs.10000 and rest Rs.10000 were paid in cash, etc.

Let me remind you ... Figures are not that important here. But remember that he is a SHAREHOLDER in the company, and now, a DEBENTURE HOLDER too.

Can you look back so that you get another point? He was a DIRECTOR also. So, He was SHAREHOLDER, DIRECTOR & DEBENTURE HOLDER.

He was an ORDINARY SHAREHOLDER who would be paid after all the creditors are paid IF THERE IS LIQUIDATION OF THE COMPANY.

But He was a Debenture Holder too.

Ok.... We are in the main part now ...

After 1 year, the company went into Liquidation (because the liabilities were more than assets by certain amount) and the creditors needed to paid.

The LIQUIDATOR asked Mr. Salomon to pay all the creditors since Mr. Salomon was the OWNER of the company.

Salomon did not agree with that. Because He (Salomon) was supposed to paid for his DEBENTURES. But the Liquidator asked him to pay to Other Creditors!!!!!

TRIAL JUDGE VAUGHAN WILLIAMS agreed with Liquidator and asked SALOMON to pay on behalf of the company since Salomon was the owner, but Salomon didn't agree.

He appealed to COURT OF APPEAL so that he (Salomon) didn't have to pay the debts owed to creditors by the company. COURT OF APPEAL said that Salomon just found 6 people (his 5 children & wife) to form the company. Those 6 people are mere nominees of Mr. Salomon. COURT OF APPEAL also asked Mr. Salomon to pay.

NOW PLEASE CONCENTRATE .....

This time Salomon appealed to the highest court "HOUSE OF LORDS".

HOUSE OF LORDS rejected all the judgments made by TRIAL JUDGE VAUGHAN WILLIAMS, COURT OF APPEAL.

HOUSE OF LORDS said that there is neither fraud in the manner which Mr. Salomon formed the company, nor Mr. Salomon formed the company for Fraudulent purpose.

So, Mr. Salomon did not have to pay to the COMPANY'S Creditors since Mr. Salomon and The Company are two Separate (Legal) Entities.The company is separate from its members!


For more details on the Contract Act kindly refer -
http://www.vakilno1.com/bareacts/indiancontractact/indiancontractact.html

Note: A report on Salomon vs. Salomon Case has to be submitted on the 22nd of Sept. 2006.

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Cheers,
MBA I - Study Circle Team