The ”veil of incorporation” is a term used when a company separates legal responsibility from its directors and shareholders. This partition protects directors from being personally liable for a companies bad debts and obligations. In 1862 this law was established and has rarely been lifted in UK company law.
The ‘veil of Incorporation’ was used as a defence in the Salomon v Salomon & Co case in 1897. Salomon sons wanted to become a partner within his business thus led to Salomon incorporating his business as a limited company. At this time the legal requirement was to have at least seven people subscribe as shareholders. Mr Salomon mad himself the director owning 20,001 shares of the companies 20,007. The remaining 6 shares were split between his wife, daughter and four sons. Mr Salomon sold his business to the corporation for an excessive amount of £39000 and £10000 of this were debentures for him. In less than a year after becoming a limited company the business ran into financial difficulties and the liquidation process had to start. The assets of the company weren’t enough to cover the debt owed to Salomon as well as debts owed to creditors. The liquidator who worked on behalf of the creditors claimed that the debentures were invalid as the company was an agent to Mr Salomon and therefore Mr Salomon should be personally liable for the debts of the company.
At first the high court agreed with the liquidators claim and ruled that Mr Salomon had full responsibility for the debts owed. This was then taken to the court of appeal, which confirmed the original ruling, and claimed Mr Salomon had abused the privileges of incorporation and limited liability. The court of appeal also claimed Mr Salomon was using other shareholders as mere puppets and after there incorporation he ran the business like a sole trader. At first the judge agreed this was a valid claim and ruled there is a right of indemnity against Mr Salomon. This was taken to the court of appeal, which confirmed the original decision that Mr Salomon is personally liable for the company’s debts. However the House of Lords unamously over turned the decision as they considered the previous ruling to be indecisive and incorrect. The reason for there descision was because Mr Salomon set up the incorporation following regulations. The Hose of Lords held the company was a legal entitity and therefore Mr Salomon was protected by the veil of incorporation meaning that Mr Salomon as shareholder was not legally responsibly for the debts of the company.