Corporations are separate legal entities from their members. However, circumstances may arise where the members are liable. This is known as ‘piercing’ the corporate veil.
Registering a company means that you are also establishing a separate legal entity. For larger companies, this means that shareholders (owners) are not responsible if the company gets into debt or if anything else goes amiss. Similarly, Court actions will be against the company itself, not its directors.
The extent to which you can be held liable as a company owner is limited. This is one of the most attractive features of starting a company, rather than running your business as a sole trader. As a sole trader, this means that you’re responsible if the business gets into debt. Similarly, being a sole trader means you will be taxed at individual rates.
Alternatively, running a company means you have limited liability. This is because your company is considered a legally distinct entity from you. In most circumstances, you won’t be responsible if things go wrong.
What is the Corporate Veil?
When you register a company, you receive limited liability protection known as the ‘Corporate Veil’. This analogy stems from the fact that being the owner of a company effectively ‘shields’ you from liability. However, there are times when the Courts will hold directors or owners responsible. Doing this ‘lifts’ or ‘pierces’ the veil. This effectively opens up creditors and third parties to the assets of directors and members of the corporate entity.
Piercing the corporate veil
Generally, they can be split into two common categories where it may be possible. However it should be noted, besides these two categories, directors may still be held liable. These include where there is a breach of directors duties, insolvent trading, and corporate crime.
Fraud and Improper Conduct
If you register a company to take advantage of the veil, then the Court may lift it. Further, if the company is a ‘mere cloak or sham’, this may be tantamount to fraudulent or improper conduct. Usually, this occurs when there is a company set up with the purpose of not trading.
Often, companies will act as a parent company for others. Where a subsidiary company acts as an agent for the parent company, the parent company can be liable. Where this occurs, the court may lift the corporate veil in order to hold the parent company liable.
Avoiding a legal obligation
The Court may lift the veil if the company concerned is ‘using’ the veil to avoid fulfilling legal obligations. For example, if a company owes a creditor money but transfers their assets to another entity to avoid payment, the Court can lift the veil.
Kevin is the director of Company X and Company Y. Company X is indebted to Company Z in the amount of $750,000. Kevin has transferred the assets from Company X into Company Y and wound up Company X. The Court pierced the corporate veil when they ordered that Kevin pay back the money.
Courts in Australia are somewhat reluctant to enforce these provisions. However, it is important to understand your level of liability whilst running a registered company. Lawpath can help you register a company through a variety of different packages. If you are a director and want to know more about your legal obligations, LawPath can help you find a business lawyer.
If you are currently running a registered company or looking to register a company, it is important to understand the liability that you hold to individuals and businesses you contract and work with everyday.
Don’t know where to start? Contact one of our consultants on 1800 529 728 to learn more about customising legal documents and obtaining a fixed-fee quote from Australia’s largest legal marketplace.