Piercing the Corporate Veil: Approach by Various Jurisdictions

13 December 2024

Experts consider the development of the corporate veil notion to be one of the most significant corporate breakthroughs. Well-established nations have accepted the idea of limited liability, leading to the rise of multinational corporations with affiliates in various jurisdictions. To achieve equity, courts may “pierce” or “lift” the veil, making the parent company liable for the activities of its affiliates, stakeholders, and other interested parties. However, the means of lifting the veil vary among nations. Let us now understand the concept, its significance, and how it is dealt with in numerous countries.

Understanding the Concept of Corporate Veil

The notion of “lifting the corporate veil” lies at the intersection of corporate regulations, morality, and transparency. It permits an invasion of the protective barrier differentiating an entity from its investors or founders under certain conditions. This theory is critical in company law because it governs whether persons or corporations responsible for a business can be deemed personally accountable for its activities. Contemporary law provides for veil piercing in certain instances. If investors are involved in corrupt business practices, courts may overlook the corporate personality and find them individually accountable. The corporate veil is inextricably tied to the growth of corporate governance in contemporary legislation. With a growing emphasis on transparent corporate behaviour, investors are eager to ensure ethical businesses.

Significance in Modern Legislation

The corporate veil matters massively in the evolving legal environment. This idea has a multidimensional role, encompassing themes of governance, economic backing, leadership, and transparency. At its root, the corporate veil is an effective motivator for building entrepreneurial spirit and multiplying investments. It allows people to engage in flourishing companies with less uncertainty since the limited liability aspect boosts trust, enabling them to take measured risks and engage in new initiatives. The corporate veil acts as a cover, reducing the chances of loss that stakeholders bear. This is crucial for businesses that experience considerable monetary losses. The corporate veil improves corporate governance, guarantees concentrated administration, and promotes efficiency in corporate affairs because investors are unable to engage in the everyday affairs of the firm, so they recruit qualified executives to run its affairs. The corporate veil facilitates the change of leadership. The stock of publicly listed corporations may be easily traded in stock markets, thereby increasing market flexibility and avoiding volatility.

Overview Across Jurisdictions

Germany

In Germany, a corporation’s legal personality and shareholders remain completely distinct. Stockholders are not deemed personally responsible for the business’s commitments or actions. The lifting of the veil here is rare and occurs only when the legal identity is exploited. German courts think that the coherence of the corporate framework must be preserved. The major factors used in Germany to determine whether or not the veil should be pierced include whether there are severely inadequate financial methods, the use of the business framework for illicit purposes, or intolerable disrespect for organisational procedures.

United States

In the US, the veil can be lifted occasionally, such as in cases of deception, capital mergers, or insufficient financing. In Walkovszky v. Carlton [1], the New York Court of Appeals ruled that the veil might be lifted where the company and its shareholders have a common interest and that continuing within the organisational framework of governance can be unjust. In Sea-Land Services, Inc. v. Pepper Source [2], the court emphasised the necessity of following business procedures, stating that failing to do so might result in lifting the veil.

To lift the veil in the US, courts often need proof of inappropriate behaviour, deception, or misuse of the company structure. Courts evaluate aspects such as:

The Alter Ego Doctrine empowers courts to lift the veil when a firm is considered the ‘alter ego’ of its proprietors. Founders may be deemed accountable whenever unification between motives and control disregards the firm’s independent personality.
Courts can lift the veil if a firm is purposefully underfunded to deceive investors and does not have enough capital to pay its commitments.
When a company conducts deception or is involved in unlawful activities, courts may overlook its organisational framework and consider the culpable parties individually accountable.
If a company struggles to operate with separate funds, have meetings with shareholders or members, or register necessary documents, the veil can be lifted.

It is vital to take into account that the applicability of these principles differs by state, as business law is predominantly governed by state legislation in the USA. In this regard, penetrating the veil is currently highly complex in the United States, as many judges struggle to clarify the legal basis of their rulings, resulting in uncertainty and unpredictability.

China

Chinese law recognises that an enterprise is an independent legal person from its founders, thus preventing them from becoming personally accountable for the company’s conduct. However, in line with recommendations provided by China’s Supreme People’s Court, the corporate veil could be pierced when members misuse the corporation for misconduct or to avoid compliance with laws. Chinese courts consider the following factors: the extent of leadership involvement, the degree of dishonest endeavour, and whether the company is only a cover.

Japan

Under Japanese law, it is a widely recognised notion that the parent company and its subsidiaries have distinct legal personalities, and the lender of one cannot sue the other. Since there is no formal section in the company law, the corporate veil notion has evolved via case law. In the Apex Court Judgement of 1969 [3], the court stated that the corporate veil can be lifted where a juridical identity has no legal basis or is used improperly to prevent legal enforcement. Governance techniques, misuse of privileges, and unfair advantage are all aspects to be evaluated before cutting through the corporate veil.

United Kingdom

Courts in the UK frequently seek evidence of fraudulent or unlawful exploitation of the company’s framework, policies, or working to penetrate the corporate veil. The core concept that a company is an independent juridical person emerged in the UK’s historic “Salomon v. Salomon & Co. Ltd” [4] case. In “Presto v. Petrol Resources Ltd” [5], the UK Supreme Court emphasised that the veil covering a company could potentially be pierced where the company is a pretence or is used to conceal something.

Australia

The Australian Courts may lift the corporate veil if the entity was employed for fraudulent activity to shield the parent entity from statutory responsibilities or if the parent business has full authority over the subsidiary’s decisions. The absence of defined rules allows courts to assess each case independently. Australian courts are willing to breach the veil in situations concerning privately owned firms having only one or two executives. The argument for such breaches is that in closely held corporations, stakeholders often lack limited liability to attract them to participate in the firm. The courts may pierce the corporate veil in cases of misconduct to allow involuntary tort lenders to seek recourse.

Maldives

The new companies act (Act no. 7/2023) [6] elaborates on the rules related to piercing the corporate veil. Article 65(a) of the act states that if a director acts fraudulently or acts only in his self-interest, the company’s corporate veil can be pierced by the courts. Article 65 outlines this further by stating the criteria that must be fulfilled for the courts to do so. This includes:

The company and the owners are the same entities
The acts of the company are fraudulent and have been used to hide from the responsibilities associated with the fraudulent act
The fraudulent act caused direct harm to a party and the company is used to hide from the legal responsibilities related to the act

According to the Article, the following acts can be considered fraudulent acts by the court.

Any act that can be deemed fraudulent conduct
Use of company’s assets negligently
Knowingly using the company negligently for your self-interest or the interest of others, causing damage to the company
Deciding to distribute profit to shares without considering the company’s debt

If such a case is in court, the courts can decide that the company’s owners, directors, and officers are responsible for the act together or separately. The courts can also decide whether to dissolve the company or give orders to run the company in a specific manner.

Aside from Article 65 of the Companies Act, the rulings in Sharu Launch Service Pvt Ltd & others v Fenaka Corporation Ltd [7] can still be applied. In the case of Sharu Launch Service Pvt Ltd & others v Fenaka Corporation Ltd, the court decided that the corporate veil of a parent company can be pierced if a subsidiary company is used by the parent company for fraudulent acts. The Ruling also states that if a person controlling the company is using an asset registered as a trustee for fraudulent acts, the person controlling the company can be made responsible as well.

Conclusion

We can summarise that the lifting of the corporate veil permits courts to overlook the legally binding barrier between corporations and the involved parties. This concept is not constant in today’s dynamic commercial conditions and is recognised somewhat differently across nations. It continually experiences amendments due to emerging company procedures and standards and technological advances. Removing the corporate veil is more than just a statutory notion; it symbolises shifting societal views and perceptions of business transparency. Legal scholars and legislatures must have honest and clear motives, as it is crucial for uncovering transgressions and ensuring fairness. Ultimately, in this ever-changing landscape, the corporate veil must remain a versatile and adaptable instrument that finds equilibrium between corporate responsibility and minority security and safeguards.

John Walkovszky v William Carlton [1966] NY 18, [1966] 223 NE 2d 6
Sea Land Services Inc v Pepper Source [1991] 7th Cir, [1991] 941 F.2d 519
Saiko saibansho minji hanreishū (MINSHŪ) [SC Reporter], V. 23, P. 511.
Salomon v A Salomon and Co Ltd [1897] UKHL AC 22
Prest v Petrodel Resources Ltd & Ors [2013] UKSC 34
Companies Act (Act no. 7/2023)
Sharu Launch Service Pvt Ltd & others v Fenaka Corporation Ltd (2022)