The principle of limited liability. A reminder on Salomon v A Salomon & Co Ltd

In Salomon v A Salomon & Co Ltd, the House of Lords famously upheld the principle that creditors of an insolvent company cannot sue the company’s shareholders for any of the company’s outstanding debts. In the words of Lord Herschell:

The very object of the creation of the company and the transfer to it of the business is, that whereas the liability of the partners for debts incurred was without limit, the liability of the members for the debts incurred by the company shall be limited.

Creditors of the company aren’t creditors of the shareholders. Therefore, they cannot reach the personal assets of the shareholders. This is the essence of the principle of limited liability, one of the inventions that helped create the modern world.

The strenght of the principle of limited liability is determined by its exceptions. One of these exceptions is the so-called piercing of the “veil” of incorporation. The relationship between principle and exception was described as follows by Easterbrook and Fischel:

Limited liability is a fundamental principle of corporate law. Yet liability has never been absolutely limited. Courts occasionally allow creditors to “pierce the corporate veil,” which means that shareholders must satisfy creditors’ claims. “Piercing” seems to happen freakishly. Like lightning, it is rare, severe, and unprincipled. There is a consensus that the whole area of limited liability, and conversely of piercing the corporate veil, is among the most confusing in corporate law

In a recent judgment (Persad v Singh (Trinidad and Tobago) [2017] UKPC 32), the Judicial Committee of The Privy Council, strongly confirmed the principle determined in Salomon v A Salomon & Co Ltd. In the words of Lord Neuberger:

The fact that CHTL was a “one man company” is also irrelevant: see Salomon v A Salomon and Co Ltd [1897] AC 22, which famously established the difference between a company and its shareholders. That case also exposes the fallacy of the notion that the court can pierce the veil where the purpose of an individual interposing a company into a transaction was to enable the individual who owned or controlled the company to avoid personal liability. One of the reasons that an individual, either on their own or together with others, will take advantage of limited liability is to avoid personal liability if things go wrong, as Lord Herschell said at pp 43 to 44. If such a factor justified piercing the veil of incorporation, it would make something of a mockery of limited liability both in principle and in practice.

Caveat creditor.

 

Author: Arie Van Hoe

Lawyer (NautaDutilh), voluntary scientific collaborator (University of Antwerp)

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