A company, as it currently stands, assumes a separate legal personality from its shareholders, using this metaphor to ‘hide’ its directors behind the ‘corporate veil.’[1] The purpose of this structure is to encourage entrepreneurship through the shifting of risks of business failure to the company’s creditors.[2] The courts are reluctant to lift this ‘corporate veil’, often leaving creditors in a disadvantaged position should the company fail.

The concept was outlined in Salomon v Salomon & Co Ltd [1897] AC 22 HL, and is often described as a fundamental principle of modern company law.[3] In Australia the courts have only strayed from this concept of a separate legal entity in exceptional circumstances, which has produced the impression of unprincipled and random results.

Occasions arise though where the court is prepared to lift the corporate and find individuals liable. This was perhaps best put by Lord Denning in Littlewood Mail Order Stores Ltd v McGregor [1969] 3 All ER 855, where he stated; “[the doctrine] has often been supposed to cast a veil over the personality of a limited company through which the courts cannot see. But that is not true. The courts can, and often do, pull off the mask to see what really lies behind.”

It is worth noting that in piercing the veil the courts are not violating the doctrine of a separate legal personality, with doctrines such as that of limited liability remaining preserved.[6] The circumstances in which the court will find directors personally liable all stem from one category, that being the prevention of injustice.

The Corporations Act 2001 (Cth) includes several statutory provisions relating to when the separate legal entity of the company may be disregarded and in these circumstances the court is prepared to lift the corporate veil.[8] The relevant sections are as follows.

Section 588G covers the personal liability of directors for debts incurred by a company whilst it is insolvent.[9] This principle has been designed as a mechanism to protect unsecured creditors, as when a company is threatened by insolvency consideration of the effect on creditors is taken into consideration.[10] In Spies v R (2000) 201 CLR 603 at 636 the court stated that when a company is,[11] or is near, insolvency creditors gain a direct interest in the company as a “duty of imperfect obligation owed to creditors,” comes into effect.[12] Directors can be found personally liable for debts owed to creditors for trading whilst insolvent.

The separate legal entity doctrine may also be disregarded in relation to; invalidating charges granted to officers of a company in certain circumstances, s 267,[13] the requirement of consolidated financial statements in respect of group companies ss 292 and 295,[14] where a holding company may be held liable for debts incurred by its subsidiary while it is insolvent s 588V to 588X,[15] and invalidating uncommercial transactions entered into between a company and officers in certain circumstances s 588FE(3).

The structure of a company as we know it is a legal person, separate from its shareholders.[17] As a separate entity it can be sued, however this separation also means that shareholders will not be liable for the company’s debts.[18] A creditor can only take action against the company itself, and not its shareholders or directors unless the court is prepared to lift the corporate veil, but this will only occur if one of the situations outlined above is present.

This leads to the doctrine of limited liability, which states that shareholders are only liable to the amount unpaid on their shares.[20] Therefore if the company fails it is the creditor who will suffer the losses, as shareholders will not be liable for any debts the company may owe.

Whilst disadvantaged by the company structure, where there has been wrongdoing by the company’s directors in the form of trading whilst insolvent, the presence of fraud, deception, or attempts to avoid a legal duty, to the detriment of creditors of the company, the law will intervene and lift the corporate veil.

In Walker v Wimborne (1976) 137 CLR 1, the High Court expressed an obligation on directors to have regard to creditor’s interests,[22] however this obligation cannot be extended to a duty as this is inconsistent with the idea of a company having a separate legal personality, which is why the lifting of the corporate veil remains the exception, not the rule.[23] As no duty is said to exist there is no remedy available to creditors against the company, and only if the court is willing to find the individual directors liable will they be able launch an action to recover what is owed to them.[24] In Ring v Sutton (1979) 5 ACLR 546 the court held the directors of a company liable as they had breached their duties and disregarded the interests of creditors after causing the company to lend money at rates below market value.

In 2005-2006 less than five percent of companies that lodged an insolvency report with ASIC were able to pay 10 cents or greater in the dollar to unsecured creditors, leaving creditors facing a huge loss, receiving little, if anything, of what they are owed by the company.

Thus the law is only willing to look behind the company and find individuals liable where creditors are disadvantaged by the improper behavior of company directors.[27] The law will not lift the corporate veil every time a company fails and creditors are unable to recover what is owed to them.

 

Originally published on - Teddington Legal Gold Coast


[1] Nicholas James ‘Separate Legal Personality: Legal Reality and Metaphor’ (1993) 5(2) Bond Law Review 217, 218.

[2] Mohammad Rizal Salim, ‘Corporate Insolvency: Separate Legal Personality and Directors’ Dutires to Creditors’ (2004) 90(2) UiTM Law Review, 1.

[3] Salomon v Salomon & Co Ltd [1897] AC 22 HL.

[4] James, above n 1, 218.

[5] Littlewood Mail Order Stores Ltd v McGregor [1969] 3 All ER 855

[6] James, above n 1, 223.

[7] Ibid 225.

[8] Corporations Act 2001 (Cth).

[9] Corporations Act 2001 (Cth) s 588G.

[10] Justice Simon Whelan and Leon Zwier, Employee Entitlements and Corporate Insolvency and Reconstruction [10] < http://cclsr.law.unimelb.edu.au/research-papers/Protection%20of%20employee%20entitlements%20_final_1.pdf> at 4 April 2012.

[11] Spies v R (2000) 201 CLR 603, 636.

[12] Whelan and Zwier, above n 10, 10.

[13] Corporations Act 2001 (Cth) s 267.

[14] Corporations Act 2001 (Cth) ss 292, 295.

[15] Corporations Act 2001 (Cth) s 588.

[16] Corporations Act 2001 (Cth) s 588FE(3).

[17] Salim, above n 2, 1.

[18] Ibid 2.

[19] Ibid 1.

[20] Ibid 1.

[21] Ibid 2.

[22] Walker v Wimborne (1976) 137 CLR 1.

[23] Salim, above n 2, 6.

[24] Ibid 6.

[25] Ring v Sutton (1979) 5 ACLR) 546.

[26] Christine Brown and Kevin Davis, The Sons of Gwalia Judgment [3] < http://www.camac.gov.au/camac/camac.nsf/byHeadline/PDFSubmissions_3/$file/CBrown_&_KDavis.pdf> at 7 April 2012.

[27] Salim, above n 2, 13.

[28] Ibid 13.

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