As a company director, you will likely want to protect yourself and your personal assets from risks. One main concern is your liability and whether you may be personally liable if a claim is brought against the company.
One of the key appeals of running your business through a company structure is the protection it offers through limited liability. As a company is a separate legal entity distinct from its owners and managers, it is liable for any debts, obligations, or legal actions against the business. Creditors or plaintiffs cannot directly pursue the personal assets of the company’s shareholders or directors, providing them with a layer of protection.
However, it’s important to note that this limited liability is not absolute, and there are circumstances where directors or shareholders may be personally liable. This article will outline the concept of limited liability and explore situations where the corporate veil can be pierced.
What is the Veil of Incorporation?
The phrase means a company has a separate legal identity from its directors. The law regards a company as its legal person (or entity). This refers to the company’s capacity to:
- enter into a contract;
- open bank accounts;
- be sued; and
- sue someone else.
As the company is a legal person in its own right and can be sued, the suing action will generally not expose the directors or shareholders. The directors are protected from the suing action because they are ‘behind’ the company. The ‘veil’ that is the company, in effect, protects them.
This means the company only bears any liabilities resulting from the suing action. Therefore, as a director, you are not personally liable. In most cases, your personal assets will not be available to meet any claim.
How Do You Pierce the Veil?
Limited liability is a key principle that underpins company structures. It refers to the limitation of a shareholder’s or director’s personal financial liability for the debts and obligations of the company.
Specifically, limited liability means that shareholders are only liable for the company’s debts up to the amount of capital they have invested in the company (i.e. the value of their shares). Their personal assets beyond their share capital contribution are protected from creditors if the company becomes insolvent or bankrupt.
However, there are some cases where this “veil” can be “pierced”. This allows a court to hold the shareholders or directors personally responsible for the company’s actions. The “veil” will often be “pierced” when a court regards the company as an agent of the directors or shareholders and instead holds them accountable for the company’s actions.
Often, this will occur when its directors have:
- Breached their director duties: Directors fail to fulfil their legal obligations to the company, such as acting in good faith, exercising due care and diligence, or avoiding conflicts of interest. This can include actions like trading while insolvent or misusing company funds;
- Acted illegally: Directors or shareholders use the company as a vehicle for unlawful activities. This might involve fraud, tax evasion, or other criminal acts. The court may hold individuals personally responsible to prevent them from hiding behind the corporate structure; and
- Given personal guarantees: Directors provide personal assurances for company debts or obligations. This often occurs when securing loans or entering into contracts where the director explicitly agrees to be personally liable if the company cannot meet its obligations.
Phoenix Companies
Another common reason for piercing the veil is tax. Some companies try to avoid tax by declaring bankruptcy and winding up. This means that the company will not have to pay the taxes that it owes. The company then reopens with a new name and a clean slate. This is referred to as a ‘Phoenix Company’. Whether the new company is a Phoenix Company will depend on several subjective factors, mostly relating to the similarities between the previous entity and the new one. To prevent the incorporation of Phoenix companies, the law allows the tax office to go directly after the directors for the tax bill.
If you are a company director, complying with directors’ duties are core to adhering to corporate governance laws.
This guide will help you understand the directors’ duties that apply to you within the Australian corporate law framework.
What happens when the Veil is Pierced?
As a director, there may be severe consequences if the corporate veil is pierced. You may be required to provide compensation to the affected parties, including:
- creditors;
- customers;
- employees; or
- other third parties who have incurred losses due to the company’s actions.
You may also risk being disqualified as a director as the Australian Securities and Investments Commission (ASIC) holds the authority to disqualify directors from managing companies if they have breached their duties and responsibilities under the Corporations Act 2001 (Cth). This means you could be banned from managing companies temporarily or permanently.
As a director, you must be aware of your obligations and duties under the Corporations Act 2001 (Cth). For example, you must:
- act in good faith in the best interests of the company;
- exercise their powers with care and diligence;
- ensure that the company maintains proper books and records;
- complies with all relevant laws and regulations; and
- does not trade while insolvent.
Key Takeaways
The fact that your company is facing a lawsuit does not necessarily mean you will lose your house. The company is liable, not you. The only time that you could be liable yourself is if, as a director of the company, you did something that allows the suing party to ‘pierce the corporate veil’.
If you need advice on what you can and cannot do as a director, our experienced business lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.
Frequently Asked Questions
As a separate legal entity distinct from its owners and managers, the company is liable for any debts, obligations, or legal actions against the business. Creditors or plaintiffs cannot directly pursue the personal assets of the company’s shareholders or directors, providing a layer of protection.
It’s important to note that this limited liability is not absolute, and there are circumstances where directors or shareholders may be personally liable.
This means the company only bears any liabilities resulting from the suing action. You, as a director, are therefore not personally liable. Your personal assets will, generally speaking, not be available to meet any claim.
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