Limited liability protects the personal assets of individuals forming and investing in companies.
Limited liability creates a barrier around the personal assets of the shareholders and directors: this is called the corporate veil.
The corporate veil enables people to incorporate a business and avoid incurring further liability by
- ring-fencing personal assets of the shareholders i.e. cash held in bank accounts, cars, houses, shares owned in other companies – from those of the legal entity in which they own shares.
When “piercing the corporate veil” the limited liability is no longer available to the shareholders and their personal assets are then at stake to pay the debts of the company.
Piercing the Corporate Veil
When it is lifted by the creditors it:
- makes the shareholders liable for the debts of the company
- gets at the personal assets of the shareholders,
- to use those assets to recover the debts of the company to creditors.
An exception allows creditors to get at the shareholders to establish personal liability against the shareholders: unlimited liability.
Piercing the corporate veil has the net effect (legally speaking) of treating the company and the shareholders as one, single legal entity.
The exceptions apply in limited circumstances. They’re exceptions to the rule in Salomon v A. Salomon and Co Ltd.
Evasion of Legal Duty
In Petrodel Resources Ltd v Prest (2013) the Supreme Court decided that the corporate veil will not protect shareholders where:
there is a legal right against the person in control of it which exists independently of the company’s involvement, and a company is interposed so that the separate legal personality of the company will defeat the right or frustrate its enforcement.
In those cases, courts can disregard the corporate veil.
When a company’s separate legal person is abused for some relevant wrongdoing, court are more likely to be justified piercing the corporate veil.
It’s known as the evasion principle. It’s when companies are used by those in control of it to evade a legal liability that the individual would otherwise have had (if it weren’t for the corporate veil).
The corporate structure must be abused by those controlling the company to pierce the corporate veil and lose the benefit of limited liability. That usually takes the form of:
- such misuse of the company,
- fraud, such as wrongful trading and insolvent trading
- malfeasance or
- evasion of legal obligations
Piercing the corporate veil is a remedy of last resort, because personal liability of the individual abusing the corporate veil can usually be established by other means.
It has a limited application, because, as the Supreme Court said in Prest:
in almost every case where the test is satisfied, the facts will in practice disclose a legal relationship between the company and its controller which will make it unnecessary to pierce the corporate veil.
It’s this availability as a last resort that’s explained by the concealment principle.
Concealment of Wrongdoing
This is usually the first port of call for attempts to establish liability against shareholders.
It is personal liability in the sense that the individual – being a shareholder or directors has committed a wrongful act which attracts personal liability in its own right.
Contrasted with evasion are attempts to conceal wrongdoing with use of corporate structures.
The concealment principle […] does not involve piercing the corporate veil at all. It is that the interposition of a company or perhaps several companies so as to conceal the identity of the real actors will not deter the courts from identifying them, assuming that their identity is legally relevant. In these cases the court is not disregarding the “facade”, but only looking behind it to discover the facts which the corporate structure is concealing.
So when a separate legal entity is used to attempt to find shelter from liability (such as doing an act through a company rather than through the same company or as an individual), the pre-existing legal obligation can’t be avoided by using a separate legal entity. Limited liability does not come into it, because the legal liability is personal to the actor involved.
The classic example is fraud. In Standard Chartered Bank v Pakistan National Shipping Corporation  UKHL 43, Lord Hoffman said:
No one can escape liability for his fraud by saying “I wish to make it clear that I am committing this fraud on behalf of someone else and I am not to be personally liable.”
So in the case of a shareholder behaving fraudulently, the shareholder is personally liability for the fraud. The corporate veil doesn’t come into it to protect the shareholder, because liability for the fraud arises independently of ownership of any shares in a company.
Other common examples for establishing personal liability include – which usually results in the company and the individual being sued:
- contracts made by the shareholder in question with a third party, such as a personal guarantee:
- personal guarantees give rise to personal liability because a direct legal relationship is made between a lender and the guarantor
- restrictive covenants to avoid anti-competition agreements
- joint liability for a tort: such as infringement of intellectual property rights or the tort of conversion (roughly speaking, the civil law of theft)
- conspiracy with third parties, and perhaps where the company is a joint tortfeasor
- assumption of responsibility, where the shareholder takes on responsibility for a particular risk in the course of providing professional services
The expressions “lift the corporate veil”, “lift the curtain of incorporation” and “pierce the veil of incorporation” describes the:
- legal effect of getting past the shelter given to the shareholders and directors of companies; and
- means by which a court will disregard the separate personality of the company.
It’s establishing personal liability against a director or shareholder for some sort of unlawful behaviour done in the name of the company. The unlawful behaviour disentitles them to the protection of limited liability.
The unlawful behaviour requires (1) dishonest conduct of some degree, or (2) conduct so reprehensible that the person should not have the benefit of limited liability.