Salomon v. Salomon & Co. Ltd (1897) A.C.22
The principle of separate legal entity was explained and emphasized in the famous case of Salomon v. Salomon & Co. Ltd.
Fact of the case
Salomon was a leather merchant, he was sole proprietor of his business. In 1892, he decided to convert his business into a limited company. He formed the company with the help of his wife, his daughter and four sons fulfilling the statutory requirement of at least 7 members. Salomon, with his 2 sons, constituted the board of directors.
Salomon sold his leather merchant business to Salomon & co ltd, the purchase consideration was paid by the company by the allotment of 20,000 shares of £1 each and £10,000 debentures which gave Salomon charge over all the assets of the company, and the rest balance was paid in cash to Salomon.
After few months the company business ran into difficulties and a year later the current debentures holder appointed a receiver and the company went into liquidation.
The position on liquidation of the company was as following:-
Debentures issued to Salomon £10,000
Unsecured creditors £7,000
And the assets of company – £6,000
Thus, it was found that after paying debenture holder( Salomon) nothing was left for unsecured creditor.
The unsecured creditor argued before the court that Salomon and Salomon & co are one and the same. Salomon could not owe money to himself. The company was a mere sham and an agent or nominee for Salomon who remains the real proprietor of the business.
But it was held by the court that, once the company was Incorporated under the Act it had separate legal entity independent from its member. Salomon who was holding substantially the whole share of the company could also be a creditor of the company. In this case Salomon was a secured creditor and was entitled to be repaid at priority over the unsecured creditor of the company.
Separate legal entity– A company is a legal person having a Juristic personality entirely distinct from and independent of its members. (Kathiawar Industries Ltd. C.G. of Evacuee Property A.I.R (1966) Punj.337)
It means that the creditor of the company can sue only the company to recover their debt not the members. Similarly, the company is not liable in any way for the individual debts of its members.
With the incorporation of the company, the company is separated or a separate new person is born in the eyes of law, now for every liability incurred by company, company will be responsible but the member.
Now the company has right to own and transfer the title of the property, way it likes. No member or person can claim joint ownership of the company property. It can be sued and can sue in its own name.
Separate legal entity of the company is also recognized by the Income Tax Act, where a company is required to pay Income Tax on its profits and when these profits are distributed to shareholders in the form of dividend, the shareholders have to pay income tax on their dividend income. This proves that a company and its shareholders are two separate entities.
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