In most cases, you won’t be liable, but there are some exceptions to that rule. As most owners of companies know, one of the reasons to operate through a company is to benefit from the generally lower company tax rate. Outside of the tax benefit, the other most significant factor is what we business lawyers refer to as the “corporate veil” or “veil of incorporation”. If a director has not upheld his or her duties as a director, he or she may be personally liable.
What is the veil of incorporation?
The phrase is actually a metaphor for the concept that a company has a separate legal identity from its directors. The law regards a company as its own legal person (or entity). No, this doesn’t mean a company can sing and dance. It refers to the company’s capacity to enter into a contact, open bank accounts and do many other things that a “normal” person can do. Another thing they can have done to them is to be sued.
This is where the “veil” metaphor comes into play. Because the company is a person and can be sued, the suing action will generally stop once it gets to the company. It won’t go any further. The directors are protected from the suing action because they are ‘behind’ the company. The “veil” that is the company, in effect, protects them. Therefore, any liabilities that result out of the suing action are borne only by the company. You, as a director, are not personally liable, and your personal assets will, generally speaking, not be available to meet any claim.
How do you pierce the veil?
Sometimes, however, that “veil” can be “pierced”. This occurs when its directors have acted illegally or they have otherwise assumed personal liability for a certain debt or contract. A small business lawyer will be able to look at the circumstances in place when the relevant contract or relationship was formed to help determine if there is any potential liability.
Generally, when a company being sued loses, the company will then become liable for any order of damages and costs and the matter will come to an end. The company will have to pay whatever the amount is and the matter is finished.
Sometimes, however, a reason why the original suit may occur is that a director will go and do something illegal or otherwise assume personal liability for a particular debt. A very common example is continuing to trade and acquire additional debt in circumstances where the director actually knows that the company is in such a bad way that it will never be able to pay the money back. This is referred to as ‘trading while insolvent’. Alternatively, a director may have made certain promises or representations that form, at law, a personal guarantee. In these sorts of situations, there can be an order made that the veil be “pierced”, in which case the directors may be personally liable.
Another common reason for why the veil gets “pierced” has to do with tax. Some companies try to avoid tax by declaring bankruptcy and winding up. This means that the company won’t have to pay the taxes that it owes. The company then reopens with a new name and a clean slate, which is referred to as a ‘Phoenix Company’. Whether the new company is a Phoenix Company will depend on a number of 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.
The fact that your company is being sued doesn’t necessarily mean you’ll 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 corporate veil to be “pierced”. It always pays to have us, the best small business lawyers around, give you the right advice on what you can and can’t do as a director to make sure that you won’t ever be in that position.
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