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In most cases, you will not be liable. However, 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 means that a company has a separate legal identity from its directors. The law regards a company as its own legal person (or entity). This refers to the company’s capacity to:

  • enter into a contact;
  • open bank accounts; and
  • 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. 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. 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
  • 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 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, the original suit may occur because a director has done 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 knows that the company 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 to ‘pierce the veil’. In this case, the directors may be personally liable.

Phoenix Companies

Another common reason for piercing the veil has to do with 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 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.

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, contact LegalVision’s business lawyers on 1300 544 755 or fill out the form on this page.

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