2015 EDITION 15 INSIDE: Aron Salomon v A Salomon Ltd A Stern Result Reasonable Force? PG 1 PG 3 PG 6 The Disestablishment of the Kiwisaver Cluster A Lesson in Capital Maintenance Doctrine Bomb Litigation Risk PG 2 PG 5 PG 8 Reasonable Force. How far will the law let you go? 1 Waterline Edition 15, 2015 0800 CLOSED Aron Salomon v A Salomon Limited (in liquidation) The case of Salomon and Salomon has been passed down like an heirloom, with Aron Salomon A Salomon Limited each generation of law and commerce students understanding its significance less. It is hard, from this perspective of a century and a quarter, to appreciate Aron's wife, the case’s importance. After all, the daughter, decision was prosaic. A company and four was a separate legal entity from its sons shareholders. This is obvious, isn’t it? Aron Salomon So why was the case so important? The 1856 and 1862 Companies Acts The case needs to be seen in context of the slow emergence of shareholder’s limited liability. The Crown or Parliament restricted who could form a company as we might understand it today. Business was instead done through a complex form of partner- ship called a Deed of Settlement Company. The business was sold for £39,000; £29,000 and he isn’t liable for the losses of Being a partnership, any investor faced the in cash and £10,000 was vendor financed the business prospect of being held personally liable for secured by a floating charge over the busi- the entire losses of the enterprise. ness. High Court and the Court of Appeal Adding to the complexity, such companies Sadly, the company fell on hard times. Aron Both the High Court and the Court of Appeal were entirely contract based, not having any had to borrow £5,000 and assigned his agreed with the liquidators and unsecured legal identity separate from their owners. security to a gentleman named Edmund creditors. The Court of Appeal declared Similar to partnerships still in use. Broderip. This wasn’t enough and Broderip that Salomon was abusing the limited liabil- appointed a receiver who successfully ity protection provided for in the 1862 Act. In 1844 a law change allowed these busi- recovered sufficient assets to repay his Further, the company was a proxy from him, ness entities to be registered but they were loan, at which point the security and the the shareholders were not independent and still partnerships and limited liability wasn’t £5,000 balance reverted to Aron Salomon. the company was; available. This was a common complaint and Parliament responded with the 1856 The receivers became liquidators. …a trustee improperly brought into and 1862 Companies Act that did allow an existence by him to enable him to do incorporated company’s shareholders to It was at this point that things became inter- what the statute prohibits. It is manifest have limited liability. esting. The company had; that the other members of the company have practically no interest in it, and The new legislation also provided that a Assets £6,000 their names have merely been used by company must have seven sharehold- Unsecured Creditors £7,000 Mr. Aron Salomon to enable him to form ers, amongst a number of other specified Salomon Security £5,000 a company, and to use its name in order restrictions. If a company didn’t meet these Shortfall £6,000 to screen himself from liability. criteria then the protections afforded under the Act, including Limited Liability for share- There was a court case with three protago- This view reflected that of the commercial holders, would not apply. nists. community. Companies did not automati- cally provide for limited liability. To appreciate Despite this excellent piece of legislation Liquidators: their thinking consider how we view trusts most small enterprises preferred the status The company is a sham. The busi- today. A trust, if formed for improper pur- quo of the Deed of Settlement Company ness was in truth Aron Salomon pose, will fail if challenged. A company regime. and he should be liable for the total then, considered the Victorian businesses losses of the company as if he was community, would fare no better. Aron Salomon; Cobbler a sole trader This is why the case of Salomon and Into this uncertain stage stumbled Unsecured Creditors: Salomon matters. The House of Lords were Aron Salomon, a cobbler operating in Aron Salomon’s security was based emphatic in their judgment. Lord Halsbury Whitechapel. He had a good business and on a nonsense, you can’t sell your wrote; his sons wanted to get involved. Aron, being own business to yourself and his a family man, obliged. Following the law at security should rank behind the I have no right to add to the require- the time Aron incorporated his business. unsecured creditors ments of the statute, nor to take from The new company had the required seven the requirements thus enacted. The shareholders. Aron issued 20,001 to himself Aron Salomon: sole guide must be the statute itself… and one each to his wife, daughter, and The company was incorporated their four sons. according to the 1862 Act. It was Either the limited company was a legal a separate legal entity, not a sham, entity or it was not. If it was, the business 2 Waterline Edition 15, 2015 belonged to it and not to Mr. Salomon…. the extent and in the manner provided Both Lord Halsbury and Baron Macnaghten If it was not, there was no person and by the Act. were politicians. Both had been elected to no thing to be an agent at all; and it is the House of Commons before being ele- impossible to say at the same time that By means of a private company…. a vated to the House of Lords and Halsbury there is a company and there is not. trade can be carried on with limited lia- served three times as Lord Chancellor bility, and without exposing the persons (similar to the Attorney General). Parliament Another Lord, Baron Macnaghten, wrote; interested in it in the event of failure to meant what it said and judges, especially the harsh provisions of the bankruptcy lower court judges, shouldn’t second guess The company is at law a different per- law. parliament. son altogether from the subscribers to the memorandum; and, though it may The unsecured creditors of A. Salomon However, the Salomon case did not deal be that after incorporation the business and Company, Limited, may be entitled with any liability that Mr Salomon had to is precisely the same as it was before, to sympathy, but they have only them- his business. There was no allegation that and the same persons are managers, selves to blame for their misfortunes. he was reckless or had acted with financial and the same hands receive the prof- They …had full notice that they were no irresponsibility; only that he should not be its, the company is not in law the agent longer dealing with an individual, and allowed to hide behind that the plaintiffs of the subscribers or trustee for them. they must be taken to have been cog- held was the fiction of his company. Nor are the subscribers as members nisant of the memorandum and of the liable, in any shape or form, except to articles of association. The Disestablishment of the Capital Maintenance Doctrine Once upon a time, before the Solvency Dividends could only be paid if the com- The company was James Product Limited Test, there existed a strange custom in pany would pass the Solvency Test after the (JPL) and it had two shareholders. The the commercial community called the dividends were paid. Directors who voted minority 25% shareholder was the plain- Capital Maintenance Doctrine. for the dividend are required to sign a sol- tiff and had issued a statutory demand vency certificate declaring this. because a dividend had been authorised Shares, when they were issued, had a by the board but the director was refusing capital value; the par value. Shareholders Paying dividends is a two-step process. to pay it out. were required to pay this to the company First the board must authorise the payment for their shares. Sometimes this was done and then the company must actually pay the The director defended his position. Between immediately but sometimes it remained an cash. The 1993 Companies Act has a provi- the board resolution and the time to pay the obligation that could be called on. This pro- sion, Section 52(3), that if the board ceased firm’s solvency situation had changed. JPL vided the company with the working capital to think that the company would be solvent imported clearing products from France. needed to trade. Before a dividend could between the authorisation and the payment The French supplier had changed the terms be paid the level of capital in the firm must then the authorisation was deemed not to of trade and effectively stripped JPL of cash; be no less than the level of capital originally have happened. leaving the company in a delicate position. set. This level of capital was supposed to To pay out the $80k the minority shareholder provide a buffer for creditors and must be This matter came before the High Court and wanted would cause JPL to fail the solvency maintained. Thus; the Capital Maintenance Justice Heath in 2002. test. So he didn’t and Justice Heath agreed Doctrine. he was right to do so. There were many issues with this Doctrine and measuring the level of capital, espe- cially when dealing with depreciating fixed assets, gave plenty of scope for creative accountants.