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As the director of a company, you have certain duties and obligations that you must meet. While directors usually enjoy limited liability, there are certain circumstances where this will not be the case. Removing this wall of protection is referred to as piercing, or lifting, the corporate veil.
To help you better understand the corporate veil, this article will explore:
- the concept of the corporate veil;
- when it can be pierced;
- the consequences of piercing it; and
- how you can avoid it.
What Is The Corporate Veil?
One of the benefits of incorporating your business is the ability to protect your liability. By incorporating, you create a divide between the directors and members of the business and the business itself. This wall of protection is referred to as the corporate veil.
However, in certain circumstances, the courts can hold directors and members of a company personally accountable. This is referred to as piercing the corporate veil, whereby the law will step in to remove the barrier between the company and its members.
When Can the Corporate Veil Be Pierced?
There are specific instances in which the court may pierce the corporate veil. The following section outlines these circumstances.
Fraud or Improper Conduct
If a director sets up their company for fraudulent purposes, the court may pierce the corporate veil. Fraudulent purpose can mean a director creates a company to take advantage of the corporate veil. For example, this might include if the company has been established not to conduct business but instead to effect false transactions to ensure debts are not payable.
Improper conduct also includes when directors knowingly breach their fiduciary duties or fail to deter actions that will detriment the company or its stakeholders. This includes a duty to avoid insolvent trading. Indeed, where a director knows or should know that a company is insolvent, they must prevent it from incurring any further debts.
Avoiding a Legal Obligation
The court may pierce the corporate veil when a company is using the veil to avoid its obligations. For example, a company might owe money to a creditor and seek to avoid paying their debt. In this case, the company might transfer their assets to a separate corporate entity to avoid paying its debts before winding up the company. In this instance, the court may pierce the veil and order the company to repay the money.
Agency
Another way the court might pierce the corporate veil is in circumstances of agency. Notably, it is common for companies to be part of large corporate structures where a parent company oversees subsidiaries. Thus, in the instance that a subsidiary company acts as an agent for a parent company’s fraud or avoidance of a legal obligation, the courts can hold the parent company liable.
If you are a company director, complying with directors’ duties are core to adhering to corporate governance laws.
This guide will help you understand the directors’ duties that apply to you within the Australian corporate law framework.
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Consequences of Piercing the Corporate Veil
Once a company pierces the corporate veil, its obligations and duties fall to the directors. These obligations and duties may include debts or ongoing legal disputes. If the company cannot pay its debts, your personal assets, such as your home or personal accounts, will be at risk. In the instances of fraud, there is also the risk of criminal liability.
While this is a worst-case scenario, the court rarely pierces the corporate veil. However, if the court does do so, they will only impose personality liability on the directors who breached their obligations or duties.
How to Avoid Piercing the Corporate Veil
There are some key things you can do to avoid the courts piercing the corporate veil. Some of these include:
- ensuring you comply with your directors’ duties;
- ensuring you do not engage in insolvent trading;
- maintaining separate finances and bank accounts for you and the business;
- observing the required corporate formalities, such as holding shareholder and directors meetings; and
- maintaining detailed records of the business’ finances and corporate strategy.
Key Takeaways
Although the court will rarely pierce the corporate veil in Australia, it is crucial that companies understand the corporate veil and what it means for them. Some key things to be aware of include:
- understanding what the corporate veil is;
- knowing when the corporate veil can be pierced;
- consequences of piercing the corporate veil; and
- how to avoid piercing the corporate veil.
If you need assistance understanding your duties and obligations as a company director, LegalVision’s experienced business lawyers can help. You can contact them on 1300 544 755 or by filling out the form on this page.
Frequently Asked Questions
When you incorporate your business, you create a divide between the directors and members of the business and the business itself. This wall of protection is referred to as the corporate veil. Likewise, the veil protects the directors and members of a company from the company’s actions.
There are specific instances in which the court may pierce the corporate veil, with it being quite rare for the court to do so. This includes when directors engage in fraud or improper conduct, when companies use the veil to avoid obligations or when a subsidiary company engages in such activity on behalf of a parent company.
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