In certain corporate legal cases where the substance behind the entity needs to be assessed, the court has the right to ‘pierce the corporate veil’, removing the usual protection provided to shareholders and directors but when is this the case, writes Johann Krynauw, Manager - Estates of BDO Business Restructuring for BDO South Africa.
One of the most important concepts in company law is the fact that a company is seen as a separate “legal person”. This means that a company, like a human being, is able to acquire legal rights and incur legal obligations.
This concept has been central to the rapid economic development experienced all over the world over the past few centuries, as it allows groups of people to invest in a company as shareholders, but their liability is limited to the amount of their investment. As a separate and distinct legal person, the company can take on risks and obligations including lending money which its shareholders’ may not be willing to take on.
Of course, the separate legal personality of a company is open to abuse. We have all heard of “shell companies” and their nefarious uses to, among other things, evade tax. Groups of companies can be set up to avoid liability towards creditors where, for instance, an agreement is set up with one entity which borrows money from a creditor but does not actually own any assets or conduct any business.
Such an “entity” then spends the money to the benefit of another entity, either its shareholder or a related company.
In such cases, when the creditor asks for repayment of the debt, it transpires that the company owns nothing and is unable to pay. The creditor is left with no recourse and their only option is to liquidate the company which owns nothing. In other instances, someone may have signed a restraint of trade preventing themselves from carrying on a certain type of business but then will find a company to get around this context.
There are many more examples in which companies can be used to get out of legally binding obligations.
For this reason, Section 20(9) of the Companies Act enables a court to disregard the separate legal personality of a company when there has been an “unconscionable abuse of the juristic personality of a company as a separate entity”. This is known, rather poetically, as “piercing the corporate veil” and courts have been able to do so even before the Companies Act expressly provided for it.
The piercing of the corporate veil is an exception to the separate legal personality of a company such that when the corporate veil is pierced, the form of the company is disregarded, and a court looks at the substance behind the entity, removing the usual protection provided to shareholders and directors of a company due to the concept of separate legal personality.
By doing so the court can then hold the person (it could be a human being or another legal person) who has abused the company’s separate personality liable for the obligations they have tried to evade.
In situations where a company is liquidated and creditors of the company are not repaid, there may be instances where the shareholders had improperly used those funds across various entities forming part of a group of companies, but then the creditor only has a claim against the entity with which they have an agreement.
This happened in the renowned liquidation of the King Group and the court case, Ex Parte Gore NO and Others where the liquidators successfully applied in terms of Section 20(9) of the Companies Act to have the assets of the group be regarded as being owned by a single entity. In a more recent case, Centaur Mining South Africa (Pty) Ltd v Murray NO and Others the Johannesburg High Court also considered some principles related to piercing the corporate veil.
The applicants in that case, Centaur Mining South Africa (Pty) Ltd (CMSA), had applied to rescind an order granted by the court in which the court had ordered that various companies in the Gupta-associated Trillian group be collapsed into a single entity and that their separate legal personalities be ignored. CMSA had argued that because they claimed to be a creditor of one of these entities, the order affected them and that they therefore had the right to participate in the original court case, which they had not been cited in. Furthermore, CMSA claimed that the court did not have the jurisdiction to make the order it had made.
In its judgment, the court held that CMSA was not a creditor of any of the entities in the group, as the loan claim it had relied on was tainted by fraud. Based on this fact alone, CMSA’s application fell to be dismissed. However, the court went further and considered whether CMSA’s argument that the court did not have the jurisdiction to make the initial order was a valid argument.
CMSA had relied on a recent judgment in Barak Fund SPC Ltd v Insure Group Managers Limited and Another to argue that the court did not have the power to collapse companies that were not in liquidation into another company that was already in liquidation because, among other things, the liquidators of the company already in liquidation would not have the power to assume control of the assets of the companies that were collapsed into it.
This was a rather technical argument, which, on the facts of the Barak case had resulted in an application in terms of section 20(9) to pierce the corporate veil being dismissed. In the case under discussion however, the court rejected this argument. The court confirmed that section 20(9) provides a court with broad powers to make any order it considers appropriate in the circumstances and that this includes collapsing a non-liquidated company into a liquidated company.
The takeaway point from this case is that where a company is in liquidation, there is nothing preventing a court from piercing the corporate veil in terms of section 20(9) of the Companies Act in respect of cases of solvent companies being collapsed into the liquidated entity. The court would then, as it had done in the initial order, order the Companies and Intellectual Property Commission and the Master of the High Court to amend their records to reflect the consolidation of the companies into a single entity.
In business, we must remain committed to integrity and compliance, staying true to an imperative of a totally transparent corporate veil – one that need never be pierced.