Piercing the corporate veil (Lifting the veil)

The golden rule and one of the basic principles when it comes to the issue of a capital company is that members i.e. founders of the company are not liable for the debts of the same. Therefore in such companies the capital (stake) determines the company and sets limits of liability of its members, where the same will be liable only if the entire contracted stake is not entered or paid and then liability is up to the amount of unpaid (not-entered) stake.

This principle is one of preconditions that should serve as protection of founders i.e. it is so-called protective veil, but the same also has to protect the company from the misuse by its owners. At a time in which transparency is one of the most common terms in the public sector, this golden rule gets another important meaning. However, quite often are mentioned possibilities of misuse of this principle which, acting vice versa, can be used for circumvention of creditors and can lead to the lifting the veil, which represents a significant novelty.

If assets of the company are being used for personal purposes and personal gain, along with a false presentation of the situation in terms of assets in company’s business books and records, then the situation is called piercing the corporate veil. In practice this is quite often manifested in avoiding obligations, then it also tricks and damages the creditors who are then being brought and held in fallacy, since it creates a false presentation and image of the company i.e. it significantly hampers determination of the actual situation with regard to the company and its assets.

All authorized persons of the company are responsible within the company in relation to all decisions, all disposals of assets and also all contracts where all have to be made with a purpose of achieving the main goal of the company i.e. increase of the company’s property, so any violation of this principle presents piercing the corporate veil.

Piercing the corporate veil would enable that, due to actions by which creditors are being damaged and the company misused, the owners would  be liable without any limits. However, it should be noted that the piercing the corporate veil is also possible in cases of related companies in a way that the parent company can pierce the corporate veil of the subsidiary company, and that in general there are various ways that can lead to piercing the corporate veil.

Although this issue is more elaborated in Western countries (Eng. Lifting the veil – piercing the corporate veil), especially in the United States, the United Kingdom and Germany, where there are judgments in such cases in which the court has ruled in favor of persons who were damaged in this way, this issue is also well known in our legal practice, although did not yet find its place officially.

The Law on Companies of the Republic of Srpska indeed provides that: Limited partners of a limited partnership, as well as members of limited liability companies and joint stock companies may be liable to third parties for obligations of the company if they misuse the company for unlawful or deceptive purposes or if they dispose assets of the company as their own assets and act as the company as a legal entity does not exist at all.

The responsibility for these actions shall be determined by the competent Court, where the same will take into account all relevant circumstances. However, this formulation in the law is not adequate to fully and properly address the issue of piercing the corporate veil nor the existing provisions are applied in practice.

In neighboring Serbia and Croatia this issue is also receiving more attention as a result of recent years, business practices and opportunities that have opened up with increased participation of private capital. We are witnessing, unfortunately, increased number of bankruptcies and companies that are unable to pay their obligations, As well as very common situation where the debt of the company  is determined with a judgment, but there is no way of settlement of creditors simply because the company does not have any assets. What happens in these cases? Unfortunately quite often nothing happens. It is particularly interesting that the issue of piercing the corporate veil is closely related to cases of a limited liability company with only one member i.e. the founder at the same time is also the director of the company and then misuse of the company gets its full meaning. The question that remains open is how to prevent such misuse and what would be the best protection mechanism. The Criminal Code of the Republic of Srpska lists a series of crimes against the economy and payment system, and in this context worth of attention are particularly acts such as misuse of fraudulent bankruptcy, misuse of authority in economy, then the business fraud. The sanctions provided for in the Criminal Code cannot provide adequate protection in these cases. Namely, the law for legal entities provides a fine, seizure of property and the dissolution of a legal entity. However, this method does not solve the fundamental problem – a legal entity shall be sanctioned, their property will be seized (if still available) and will be determined the termination of that legal entity, but what will then happened with damaged parties? Separation of assets of a legal entity from its owner / founder still protects those who have misused the above mentioned principle for misconduct, especially in cases where the offense does not include responsible persons and their actions or where the person responsible in the legal entity is not considered as liable. In other countries where this issue is much more elaborated, a crucial role is played by the courts in deciding whether there has been a case of piercing the corporate veil following claims of those who have a legitimate interest. In these cases, if a court determines that there has been a case of piercing  the corporate veil the court will remove the “veil” of separation and determine the responsibility of the founders of the company and eliminates the effect of the principle of separation of their property from  the property of the legal entity.

If we follow the example of the Law on Companies of the Republic of Serbia and the way it is regulated there, then the law should also define liable persons i.e. specify who may act contrary to imperative legal provisions and thus suffer the consequences of entering into the field of personal responsibility, as well as specify cases of misuse of companies and protection mechanisms.

The effort to provide as much legal certainty and stability in the business and all economic flows is certainly reason to approach this issue seriously, with an aim of finding better and more practical solutions that would instill confidence to all participants.

Author: Tijana Milacic

E-mail: [email protected]

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