Salomon and the Recession

That the recession has a real bad effect on the economy is not a scare that we aren’t aware of. Companies incur huge losses, workers are laid off, and the poor keep getting poorer. However, while all this suffering is going on, the directors and owners of these corporations have billions of dollars stacked away in bank accounts and deluxe properties; and this money is enough to cater for many succeeding generations of theirs.

The single most important legal principle coming to the aid of such a director in this context is that of a ‘separate legal personality’ of the corporation as laid down in Salomon v. Salomon. This basically meant that the corporation is a separate ‘person’ in law whose rights and liabilities cannot be read in conjunction with the directors and share holders. Evolving from this decision is also the idea that corporations have liabilities different from that of the directors save in exceptional circumstances. As a result, while the Corporations have incurred huge losses and affecting millions of workers and their families, the huge assets of the directors cannot be touched as they don’t represent the corporation. At the same time, it is these directors who created this recession.

Kahn-Freund in an article in the Modern Law Review titled “Some reflections on company law reform” (1944] 7 MLR 54) analyses the decision in Salomon from a social perspective with its economic impact in mind. He talks of the problem of the impact on the society by a failing economy and corporations and uses two main approaches whilst at this; first that the interests of the community itself in the distribution, investment of profits of the concern, the prevention of fraudulent transactions affecting the community at large and the measure of publicity should be taken into consideration. The second by the abuse of the principle of a corporate entity and undermining of the company’s capital as a ‘guarantee fund’ by the issue of shares and buy outs in exchange for over valued assets.

The recession today is a result of Kahn’s idea of the mismanagement of a guarantee fund and over valued transactions. A lot of these companies put in their capital in over-valued assets and generated mortgage money to the common people resulting in the sub-prime. While some of these transactions may even be fraudulent, it is only the directors who made money of them while everyone was at a loss. The recession started showing with the downfall of Fannie and Freddie May and now perhaps the whole world economy. But the directors of these companies are still sitting on their assets and money. Such a recession does not call for a legal remedy but an economic one. But if there were the possibility of looking at a legal solution, it would have been countered by the decision in Salomon.

I am not asking for Salomon v. Salomon to be reconsidered. The above is just to point out one of the consequences of this decision. Many of the directors in America have now decided to take a pay cut in order to combat the recession; but this should be considered a pro bono measure and strictly non legal in nature. While economics has an explanation for the disappearance of all the money, there may not be any possibility of pinning liability on some ‘private person’ because Salomon does not allow it to do so.

PS: copyright issues bar me from putting up Kahn- Freund’s article. Apologies !!