Piercing the corporate veil
In certain circumstances, the law will “pierce the veil” of incorporation. But what are those circumstances and what does “piercing the veil” actually…
In certain circumstances, the law will “pierce the veil” of incorporation. But what are those circumstances and what does “piercing the veil” actually mean?
As you will be aware, a company is a separate legal entity with all the rights and liabilities which apply to natural legal persons, or humans as they are better known. For the individuals behind the company, its directors and shareholders, this separate personality is a key reason for setting up the company, as it allows them to trade without incurring personal liability. The company is, in effect, a “corporate veil” which shields the individuals behind it.
Companies’ legislation requires details of directors and shareholders to be made public, as one of many conditions of the benefits brought by separate legal personality. These conditions are necessary as, on occasion, these individuals abuse their position and use their company as a device to perpetrate their misdemeanours, whilst protecting themselves from liability. As you will see from the article below “Company controllers: greater transparency in 2016”, the introduction early in 2016 of a requirement to create a Register of People with Significant Control (PSC) is intended to assist further those dealing with the company (including its creditors) to identify and pursue the company’s owners where it is appropriate to do so.
It is worth noting before we proceed that sometimes the law will hold the individuals involved directly liable for their actions in the name of the company, particularly the directors. In these cases, there will be no need to “pierce the veil” or, to put it another way, disregard the separate legal personality of the company. The company may here continue to be recognised as separate and may even, in some cases, be directly liable jointly with its directors and/or shareholders.
When is it necessary to 'pierce the veil'?
As noted above, if the legal objective can be achieved without needing to cast aside the separate corporate personality, no “piercing” is involved.
True piercing of the veil occurs where a person who owns and controls a company is identified in law with the company. It is well known that “fraud unravels all”.
Does this mean that in any case where a company is used for fraudulent purposes or commits an act that may amount to the criminal offence of fraud or even some lesser form of wrongdoing under the civil law, the shareholders are liable?
There are two circumstances in which true piercing may be necessary and therefore appropriate. The first is where a company is being used as a means of evading the law. In this case, the company is commonly referred to as a “sham”. The second is where a company is being used to conceal the true facts, where it acts as a “façade”. These two circumstances trigger operation of the true rule, namely piercing the veil to prevent the abuse of corporate legal personality, and are illustrated by the following examples:
- A former employee is restricted under his contract of employment from setting up in competition with his former employer. He incorporates a company and carries on the business through the company. He cannot personally be liable because he is not carrying on the competing business. The company is. The company cannot be liable because it was not party to the contract of employment with the former employer which prohibits the competing business. Here, the interposition of a corporate entity is to evade the contractual legal obligation and the veil would be pierced allowing direct action against the individual behind it. Of course, careful drafting of the non-compete covenant would avoid the need to invite the court to pierce the veil.
- After exchanging contracts for the sale of a plot of land, the seller changes his mind and transfers the land to a corporate entity to avoid an action for specific performance against him. As in the previous example, the corporate structure would be pierced to permit action directly against the individual.
- To illustrate the façade aspect, a director misappropriates company funds by procuring payments due to the company from a third party, by requiring instead that these are paid to an offshore company controlled by him. The veil of the offshore company would be pierced to get to the individual who interposed the company to conceal the true facts, namely that company money had been diverted to the director.
If you feel that you may be a victim of a sham corporate arrangement or circumstances where a company is used as a façade, we would encourage you to get in touch.
If you are interested in finding out more about this or any other issue of corporate fraud, please contact Mark Surguy, a Partner in the Commercial Dispute Resolution team, on 0121 616 6587 or email firstname.lastname@example.org.