Lawyers
Piercing the corporate veil - What is it and in what cases is it used?
Each limited liability company (limited liability company) is considered a separate legal personality, which means that the company’s debts cannot be imposed on its shareholders. The almost complete separation between the company’s personality and its shareholders is called the “corporate veil” and is intended to encourage shareholders to take initiatives and risks, thus bolstering the economy on a societal level, leading to economical growth and productivity. Piercing the corporate veil is the exception to the rule of separate legal personality, in which the court pierces the veil that separates the company and its shareholders and obliges the shareholders personally to repay the company’s debts.
By Igal Mor, Adv. & Notary
Accuracy in Legal Advice. Excellence in legal support.
What is piercing te corporate veil?
This is a very unusual step, in which the court removes the protection given to shareholders and imposes on them, personally, the obligations of the corporation. Why is this step so unusual? Because it contradicts one of the central rationales of the principle of separate legal personality. Within the framework of this principle, which is reflected in companies Ltd., the maximum financial risk of the shareholders is up to the level of their investment in the company, and not beyond that, therefore, they are not indebted to its debts. Piercing the veil violates this basic and important rule and therefore, the Companies Act has established the extreme cases in which the court would order that a piercing of the veil is neccessary. The burden of proving that one of these exists rests with the creditors seeking the piercing of the curtain.
When can a court lift the veil of incorporation and expose shareholders?
Section 6 of the Companies Act provides for two categories in which the court may, if it finds in the circumstances of the case that it is just and proper to do so, attribute a company’s debt to a shareholder in it. In both situations, it is due to improper use of the separate legal personality of the company. The first is when the corporate veil is used to deceive a person or deprive a creditor of the company. The second is when the corporate veil is used in a manner that is detrimental to the purpose of the company while taking an unreasonable risk as to the ability of the company to repay its debts. Examples of these situations – when a shareholder uses the company’s resources for his personal needs, thereby depriving shareholders, or for example in the case of “thin financing” – a situation in which shareholders do not invest the money themselves, or alternatively invest small amounts, leading to a situation where most of the company’s activity relies on leverage. The shareholders do not take any risk at all and only endanger the creditors’ money. It will be emphasized that this responsibility will be imposed on a shareholder only if he suspected, or was aware of the possibility of the existence of the circumstances that caused such misuse. That is, as long as the shareholder is a passive shareholder, he is likely to be protected from personal liability in the corporation’s debts.
Piercing the veil in a family company
As stated above, piercing the veil of incorporation is considered an exceptional step. The legislature, therefore, determined in specific situations where the court would be entitled to order this and also gave it the power to decide whether it was right and proper to do so. Indeed, the approach of the courts in this matter is that it is an extreme action reserved for cases where the limitation of the liability of the shareholders will lead to a very unjust result. At the same time, when it comes to a family company, there is a greater chance that the creditors’ request for a piercing of the veil will be granted. Why? Since in many cases, in family companies the shareholders are also the directors of the company, it is, therefore, easier to claim that there is a uniformity of sorts between them and the separate legal personality of the company. Of course, the court does not order a piercing of the veil of incorporation unless the creditors have proved that one of the cases in section 6 of the Act exists.
Employer liability for company debts
Discrimination against workers’ rights is a common phenomenon. in such cases’ employees often file their claims against the company and not against the actual employer. However, when it has been proven that the employer has exploited the separate legal personality of the company, in matters of workers’ rights, the court may also order a piercing of the veil of incorporation. It can be said that in these cases the court may order more easily to pierce the veil, due to the clear public interest in safeguarding workers’ rights, especially in cases where the employer has acted in bad faith. Bad faith is a broad term that may apply to an array of situations, among them: deduction of pension provisions from the employee without transferring them to the insurance company (which is also a criminal offense), non-payment of wages, withholding of employees’ wages, and more.
In conclusion
Our offices accompany dozens of businesses at different stages of their business lives, we perform a risk survey and, among other things, examine the shareholders’ exposure to personal claims and the possibility of lifting the veil of association against them.
Are you are considering starting a company or joining as a shareholder in an existing company? You have received a claim in which you appear personally as a shareholder? We invite you for legal advice to examine your personal exposure as a shareholder in the company and to advise you on how to avoid raising the veil of incorporation towards you.
Shareholder? We invite you to consult with us on matters related to your holding of company shares.
Adv. Mor & Co.’s commercial law department has experience in representing various entrepreneurs, businesses, and corporations from Israel and abroad in a wide variety of legal areas.
