PIERCING THE CORPORATE VEIL

PIERCING THE CORPORATE VEIL IN TERMS OF THE NEW COMPANIES ACT

Article by listed attorney: NICOLENE SCHOEMAN

Introduction

With the enactment of the new Companies Act earlier this year, there has been much debate on various platforms about the liability of corporates and that of their officers, servants and directors.  

Because the officers, servants and directors of a corporate entity act and think on its behalf, there is a need for the individuals and corporates to be held accountable for their actions. The director’s duties and liabilities have been significantly expanded under the New Companies Act. But does this expansion represent a lifting or piercing of the corporate veil?

What is piercing the corporate veil?

At this point it is worth noting the unique relationship and distinction between ownership and management in a company. Under the company’s memorandum of incorporation and also company legislation, the company’s directors are mandated to act in the best interests of the company — which is deemed to be a separate legal person from its shareholders. Although this mandate is owed to the company, it is also owed on behalf of the company shareholders who share in the company’s profits.

When directors’ decisions are influenced by the threat of personal liability, a specific challenge arises. How to balance the interests of creditors and directors by legislative provision? If the directors’ decisions favour the interests of creditors more than the interests of the company — and therefore shareholders’ interests — this may amount to a breach of directors’ fiduciary and other duties.[1]

This issue is separate from piercing the corporate veil (see our article on directors’ duties). Traditionally, the common law notion of piercing the corporate veil is applied when the interests of creditors must be balanced with the right and duty of the company’s directors and officers to run the business in the best interests of its shareholders. When the veil of incorporation is pierced or lifted, the court acts to strip away the protective covering of the limited liability presented by the company structure[2]. This mostly happens when shareholders are involved in fraudulent activity.

In Kurt Robert Knoop NO and others v Birkenstock Properties (Pty) Ltd, and in The Shipping Corporation of India Pty Ltd v Evdomon Corporation and Another 1994 1 SA 550 A, the court held that: “The corporate veil may be pierced where there is proof of fraud or dishonesty or other improper conduct in the establishment or the use of the company or the conduct of its affairs and in this regard it may be convenient to consider whether the transactions complained of were part of a “device”, “stratagem”, “cloak” or a “sham””.

There have been cases where the doctrine of lifting the veil of incorporation has been applied outside instances of commercial abuse. In these instances, the application has extended to eliminating the use of the corporate form to avoid legitimate obligations.[3] It will not be applied lightly. This notion was further amplified by the court in Cape Pacific Ltd v Lubner Controlling Investments Pty Ltd and others.[4]

“This reluctance is said to exist because of the deeply seated notion of fair play in our law.

When there is fraud, dishonesty or some other improper conduct, policy dictates that the court engages in a balancing exercise. The court considers the circumstances and facts of each case to determine whether in the appropriate case, it is proper to disregard the corporate personality and apportion liability where it belongs.”

Historic legislative provision

It should be noted that unlike the company structure, the close corporation does not automatically separate ownership and management. Under Section 64 of the Close Corporations Act 69 of 1984, members could be held liable for mismanagement of the corporation. Although this was successful in one instance, it was clearly contradicted by a later case of the South African Supreme Court of Appeal.[5]

The court held that where the company was actually able to meet the debt, the provision should not be available. If the person who acted on behalf of the company has been reckless or even fraudulent, this should be of no concern to the creditor, whose only interest is to recover the debt. It would seem that the purpose of the legislation as applied by our courts is to protect creditors rather than punishing errant management.

New Companies Act

In terms of section 20 (9)  of the Companies Act of 2008 the court may “on application by an interested person or in any proceedings in which a company is involved, a court finds that the incorporation of the company, any use of the company, or any act by or on behalf of the company, constitutes an unconscionable abuse of the juristic personality of the company as a separate entity” Moreover in terms of section 218 of the Companies Act of 2008, the locus standi[6] is that any interested party such as creditors, employees, trade unions, shareholders and so on, may now claim losses, damages and costs. Section 218(2) states that: “Any person who contravenes any provision of this Act is liable to any other person for any loss or damage suffered by that person as a result of that contravention. “

This implies that the statutory classification of piercing the corporate veil is now defined in statute (to some extent)  and has become much broader. Piercing the corporate veil does not just protect the interests of creditors.

Conclusion

The imperative remains to not disturb the delicate balance between encouraging entrepreneurial initiative and protecting creditors against far-fetched, outlasting and fraudulent conduct by the entrepreneur. It remains to be seen whether or not the new Companies Act will create the correct environment conducive to maintain that balance.

Nicolene Schoeman, Schoeman Attorneys (Cape Town)

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