Piercing the Corporate Veil: When Can a Court Look Behind a Company?

As mentioned in our previous article titled Director’s duties and Personal Liability, one of the most important principles in company law is that a company is a separate legal person.

This means that a company exists separately from its directors and shareholders. It can own property, enter into contracts, sue and be sued, and incur debts in its own name.

This principle is one of the main reasons people register companies. It allows business owners to trade through a separate legal entity and, as a general rule, limits their personal liability to the company’s debts and obligations.

However, this protection is not absolute.

Where a company is abused, the court may, in appropriate circumstances, disregard the company’s separate legal personality and look into the liability of the directors in their personal capacity. This is commonly referred to as “piercing the corporate veil”.

What does it mean to pierce the corporate veil?

Piercing the corporate veil means that a court looks beyond the company as a separate legal person and considers the people or entities behind it.

In ordinary circumstances, the company is treated as separate from its shareholders, directors and related companies. However, where the company structure is used improperly, the court may refuse to allow those behind the company to hide behind its separate legal personality.

This may result in the rights, obligations or liabilities of the company being attributed to another person or entity.

In simple terms, the court may say: although the company appears to be separate, it has been used in such an abusive manner that the law will not allow that separation to protect wrongdoing.

The legal position in South Africa

Section 20(9) of the Companies Act 71 of 2008 (“the Companies Act”) allows a court to pierce the corporate veil where there has been an unconscionable abuse of the company’s juristic personality.

The section provides that, where the incorporation, use, or conduct of a company constitutes an unconscionable abuse of its separate legal personality, a court may declare that the company is to be deemed not to be a juristic person in respect of certain rights, obligations or liabilities.

The court may also make any further order it considers appropriate to give effect to that declaration.

This is a powerful remedy, but it is not granted lightly. The court must be satisfied that there has been more than ordinary business failure, poor management or commercial difficulty.

There must be an abuse of the company’s separate legal personality.

When may a court pierce the corporate veil?

A court may consider piercing the corporate veil where, for example:

• the company is used to commit fraud;

• the company is used to avoid existing legal obligations;

• company funds are moved improperly to frustrate creditors;

• the company is used as a façade or device to conceal wrongdoing;

• personal and company affairs are deliberately mixed;

• related companies are used as a single abusive structure;

• the company is used to defeat the rights of creditors;

• assets are shifted between companies without proper commercial justification;

• the separate corporate structure is used in an unconscionable manner.

Each case depends on its own facts. The mere fact that a company cannot pay its debts does not automatically justify piercing the corporate veil.

Similarly, the fact that a company forms part of a group of companies does not, on its own, mean that the separate legal personality of each company will be ignored.

The focus is on whether the company structure has been abused.

Lessons from the Constitutional Court

The Constitutional Court recently considered the scope of section 20(9) of the Companies Act in Centaur Mining South Africa (Pty) Ltd v Moodliar N.O. and Others.

The case involved various companies in the Trillian group.

The evidence showed that the affairs of the companies were heavily intermingled. Funds were moved between different companies, invoices were allegedly used to disguise the movement of money, and certain entities were found not to have conducted legitimate business.

The liquidators sought relief under section 20(9) of the Companies Act on the basis that the companies had been used in a manner that amounted to an unconscionable abuse of their separate legal personalities.

The Constitutional Court confirmed that separate legal personality remains the foundation of company law. A company is ordinarily treated as an independent legal person, separate from its shareholders, directors and related companies.

However, the Court also confirmed that section 20(9) gives courts a discretion to disregard separate legal personality where there has been an unconscionable abuse of that personality.

Importantly, the Court clarified that section 20(9) is not a general liquidation mechanism. In other words, the section does not, by itself, empower a court to liquidate a company. Its purpose is to address the abuse of separate legal personality by allowing the court to disregard that separate personality in respect of specific rights, obligations or liabilities.

The judgment is significant because it confirms that courts will protect the principle of separate legal personality, but will not allow that principle to be used as a shield for abuse.

Practical example

Assume Company A owes money to creditors.

Its directors then transfer its assets to Company B, a related company controlled by the same people, for no proper commercial reason. Company A is left empty and unable to pay its debts, while Company B continues trading with the transferred assets.

In those circumstances, a creditor may argue that the company structure has been abused to avoid payment. Depending on the facts, a court may consider piercing the corporate veil or granting other appropriate relief.

By contrast, if Company A simply fails because it loses a major client, suffers cash flow problems, or makes a bad commercial decision, that alone will usually not be enough. Honest business failure is not the same as abuse of corporate personality.

Why this matters for directors and shareholders

Directors and shareholders should not assume that the use of a company will protect them in all circumstances.

The protection of limited liability is available where the company is used properly. It becomes vulnerable where the company is used to perpetrate fraud, avoid obligations, conceal wrongdoing, or frustrate creditors.

This is particularly important in group structures, family businesses and small private companies, where the same individuals often control multiple entities.

Directors and shareholders should ensure that:

• each company has a legitimate commercial purpose;

• company funds are kept separate;

• inter-company transactions are properly documented;

• loans between related entities are recorded;

• company assets are not moved without proper authority and value;

• financial records are accurate and up to date;

• creditors are not misled;

• the company is not used to avoid existing legal obligations.

Proper corporate governance is not only an administrative requirement. It is a safeguard against personal exposure and future litigation.

Conclusion

Separate legal personality is a fundamental protection in company law. It allows businesses to trade, contract and grow through a legal entity that is distinct from the people behind it.

However, that protection is not absolute.

Where a company is used dishonestly, fraudulently or in a manner that amounts to an unconscionable abuse of its separate legal personality, a court may pierce the corporate veil.

The lesson for directors, shareholders and business owners is simple: use the company structure properly. Keep proper records, respect the distinction between personal and company affairs, and avoid using companies as vehicles to escape obligations or frustrate creditors.

At Le Roux Vivier Attorneys, we advise directors, shareholders, companies and creditors on corporate governance, personal liability, shareholder disputes, debt recovery and commercial litigation.

Ezekiel Dikio

LLB

Associate at Le Roux Vivier Attorneys

Disclaimer: The views expressed in this article are those of the author(s) and do not necessarily reflect the views of the firm. This content is provided for general information only and does not constitute legal advice. While every effort is made to ensure accuracy, the law may change and its application depends on the specific facts of each matter. Readers should seek professional legal advice before acting on any information contained herein. The firm and the author(s) accept no liability for any loss or damage arising from reliance on this content.