In general, companies enjoy the benefit of limited liability. This is because the company is a seperate legal entity. The enjoyment of this limited liability is known as the ‘corporate veil’. For larger companies, this means that shareholders and directors 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. However, circumstances may arise where the directors or members of the company are liable for the companies actions.
The Liability of Company 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. Alternatively, running a company means you have limited liability. This is because companies enjoy the benefit of being a seperate legal entity. In most circumstances, the company directors won’t be responsible if things go wrong.
What is the Corporate Veil?
Corporations are separate legal entities from their members. Thus, 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 for a companies actions and debts. 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 or Breaking the Corporate Veil
The courts have stated that the courts are able to lift the corporate veil if:
- A company is used as a vehicle for fraud,
- When a company is used as a sham,
- When directors knowingly and fraudulently breach their fiduciary duties.
This means that if a company engages in any of the above conduct, the courts will intervene, lift the veil and effectively extend the companies liability and actions onto its directions, members or agents responsible.
According to the Corporations Act 2001 (Cth), there a few circumstances in which the corporate veil. Therefore, legislation states that the corporate veil must lift if:
- Directors engage in insolvent trading,
- Directors fail to prevent insolvent trading.
Now, even thought there are different routes or origins surrounding the corporate veil, the court-made law and legislation do work together. Therefore, if the director acts in any of the above ways, they will not receive protection or immunity. The director will be open to the liability and consequences of his or her actions.
Some different types of conduct will now to delved into:
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. Agency can also occur where a member of the company is acting as the director. Thus, the agent is acting as a company. Where this occurs, the court may lift the corporate veil in order to hold the parent company, or director 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.