Lifting the corporate veil
The term “corporate veil” is a legal phrase that refers to a company being treated by the law as a separate entity to its owners.
The corporate veil enables companies to conduct business activities such as buying and selling property or assets, taking legal action, acquiring debt and signing contracts.
What is the purpose of the corporate veil?
Over the course of history, companies have had to balance two competing interests: encouraging business growth while shielding individuals from undue possible damage arising from taking legitimate, calculated business risks.
The corporate veil is in place to protect business owners by limiting the extent to which they can be held personally liable for any debts or legal troubles encountered by the business.
Company directors not held liable for business activities
Because directors of a company have limited liability, it can be better to run your business as a company, rather than as a sole trader. As a sole trader, you are responsible if the business goes into debt. Not so for company directors, who in most circumstances won’t be held financially responsible if the business goes belly up.
Can the corporate veil also be used to hide dirty deeds?
Separating the legal identities of business and owner was framed in English law in 1897 as the “corporate veil”. When you register a company, you receive limited liability protection under the “veil”.
But often, the veil is used not so much to provide shielding, but to hide foul play. (For more information please see Illegal phoenix activity – government determined to expand crackdown efforts and Company directors on a deadline to get their director ID number.)
The challenge for corporate regulators is to strike a balance between legitimately shielding investors from losses in the ordinary course of business and hiding skulduggery.
Corporate veil makes it easier to place a company into administration than save it
The key sin for company directors is to allow the company to keep trading while insolvent. Because company directors don’t have personal liability, they may be deterred from taking action to help a struggling company recover. Instead, it’s often easier to place the company into administration.
In 2017, “safe harbour” provisions were introduced under section 588GA of the Corporations Act. These allow a director to place their company in administration, in specified circumstances, without risking prosecution for trading while insolvent.
In 2020 further “COVID safe harbour” provisions were introduced.
What does it mean to pierce the corporate veil?
Piercing the corporate veil refers to a circumstance where an action pursued against a company leads to the owners, members and shareholders being held personally liable.
The corporate veil can be pierced by courts, or at least lifted for a peek at what’s underneath, if a company is deemed to have been used as a cloak for fraud or a sham, or if directors knowingly and fraudulently breached their fiduciary duties.
In 2001, Melbourne University published an article on piercing the corporate veil. Some findings from a study they’d undertaken indicate there has been a large increase in the number of “piercing” cases heard by courts over time, and that courts are more prepared to pierce the veil of a proprietary company than a public company. (See Piercing the corporate veil in Australia, Company and Securities Law Journal, 2001.)
If you’re a director, it’s important to understand your level of liability and legal obligations. This will ensure the corporate veil isn’t lifted in a cold puff of ill wind which could result in you losing your shield.
If in doubt, it’s best to obtain advice from a business lawyer.
For more information please see Warning – directors duties still apply when touting for business overseas.