A company is a separate legal entity, and its actions, assets, rights and liabilities are distinct from individuals who are members or directors. The company, and not its members, is liable for any breaches flowing from its contracts. The court, however, can in exceptional circumstances disregard this principle, and “lift the corporate veil” to hold member(s) liable. Below, we explain the purpose of the corporate veil and in what situations the court will look behind the business’ separate legal personality.
Separate Legal Entity Doctrine
An incorporated company is a separate legal entity, wholly distinct from its shareholders and directors, as such:
- A company debt is distinct from a private debt;
- A company asset is not a private asset;
- A company can be liable in tort to a shareholder; and
- A company can contract with its members.
Creditors cannot typically access the personal assets of the company’s directors or members to satisfy any outstanding debts – an important factor when the company accrues substantial liabilities or enters liquidation.
Piercing the Veil
A court in particular circumstances can pierce the corporate veil, meaning creditors and other third parties can access the assets of its directors or members. In a corporate group, creditors can potentially access the assets of a subsidiary’s parent company. Also, the court can attribute to the company the knowledge and intentions of its directors and shareholders.
It’s difficult to provide clear guidance as to when the court will lift the corporate veil as it does so in such rare and exceptional circumstances. Typically, a court will pierce the corporate veil where a person uses the company to further a dishonest and improper purpose – namely, as a sham or to avoid an existing legal duty.
As a sham, to mask the true purpose of its controller(s)
The court may lift the veil when members use a company with the specific intent of not giving effect to transactions such as contracting and trading through a network of sham companies to ensure that a party never pays their debts.
To avoid an existing legal duty:
The court may also lift the veil if the controller(s) use the company to avoid an existing legal duty. For example, if a company that is involved in an action with a former employee for wrongful dismissal ceases trading and transfers its assets to another related company. If the employee was to succeed and receive damages against their former employer, that company could, in reality, pay nothing. Other examples could include:
- Using the company as a vehicle for fraud;
- Using the company to assist a director to breach their fiduciary duties;
- Evading tax;
- In the case of a corporate group, if a subsidiary is an agent of the parent company;
- For a corporate group, if a parent company is a shadow director of a subsidiary in liquidation; and
- If the court considers that it is in the wider public interest.
Although the court rarely looks behind the company’s separate legal personality to hold members personally liable, its important to understand what type of conduct could give rise to piercing the veil. If you are a director and have any questions about your obligations to the business, get in touch with out commercial lawyers on 1300 544 755.