Piercing the Corporate Veil
The term ‘piercing the corporate veil’ describes cases in which exceptions to the independence of a legal person are made. The terminology of veil piercing displays a pictographic character in many European legal systems. In the English legal language ‘lifting the corporate veil’ is commonly used besides ‘piercing the corporate veil’. In Spain the term levantamiento del velo de la persona juridíca has become generally accepted. Similarly, in the French legal terminology the expression levée du voile social is prevalent. In the Netherlands, one speaks of doorbraak, and its etymologic sibling Durchgriff is used in Germany.
The metaphors ‘piercing’, ‘lifting’ and ‘reaching through the veil’ illustrate the substantive problem: The strict separation of the legal relations of the legal person from the legal position of its members may become intolerable under exceptional circumstances. However, in order to develop rational solutions for such cases it is advisable to analyse the problem from a functional point of view first and then apply a stringent legal methodology.
Functionally piercing the corporate veil cases can be classified into two categories: liability piercing and attribution piercing. Liability piercing completely or partially removes the separation of the assets of the legal person and the private assets of its members. Attribution piercing suspends the separation of the legal person and its members insofar as circumstances affecting the legal entity become relevant for the legal position of its members (and vice versa). Both categories—understood from a functional perspective—have in common that the general separation of legal person and members (separation principle) is abandoned under certain conditions. Liability piercing affects the separation of assets while attribution piercing concerns the separation of legal relations and their underlying circumstances without affecting the separation of assets.
The discussion on piercing the corporate veil centres around the question if and—if so—under which conditions the members of a private limited company (private company limited by shares (private limited company (England and Wales), Gesellschaft mit beschränkter Haftung (GmbH), Société à responsabilité limitée (SARL), etc) should be personally liable for the debts of the company in insolvency. While this constitutes the most important constellation of liability piercing it is not the only one. Sometimes creditors of a shareholder want to tap into the company’s assets. According to a decision of the Hungarian Supreme Court the creditors of a shareholder can enforce their claims against the assets of the legal person if the shareholder transfers private assets to the company under a contract, harming the interests of creditors and withdrawing assets necessary to service the shareholder’s personal debts (§ 203 Hungarian Civil Code, decision 1/2002 PJE of 25 June 2002).
In contrast, a typical attribution piercing case is Re FG (Films) Ltd  1 WLR 483, where a US company founded an English limited company in order to benefit from advantages only granted to British movie producers. The funding of the movie, however, was still provided by the American company. Also, the English company did not directly contract with the actors and other employees. The Chancery Division declined registration of the movie as British. The court interpreted the Cinematograph Films Acts 1938 and 1948, basing its construction on the fact that the US company—and not the British company—was in charge of the funding and production of the movie.
While the functional analysis of piercing the corporate veil considers the economic consequences of piercing the veil, the method of veil piercing is about the legal technique used to override the separation principle. A comparison of laws reveals a heterogeneous picture in this respect. Additionally, many European legal systems, among them England, France and Germany, are still in the process of developing and calibrating the legal theory of piercing the corporate veil. A good example is provided by the doctrinal changes in the decisions of the German Federal Supreme Court (Bundesgerichtshof) regarding shareholder liability for interferences destroying the existence of the company to the detriment of creditors (Existenzvernichtungshaftung) in recent years. While the German Federal Supreme Court initially based the liability on objective control structures within corporate groups, the liability for destroying the existence of the company is now understood as a form of tortious liability under § 826 German Civil Code (Bürgerliches Gesetzbuch (BGB)) featuring a subjective element (BGH 16 July 2007, BGHZ 173, 246).
Besides statutory law providing for a piercing of the corporate veil, commonly used methods to pierce the veil are the extensive or restrictive interpretation of legal norms (statutes, contracts) as well as the complete or partial disregard for the independence of the legal person in case law. An instance of statutory norms concerning piercing the corporate veil is the new liability of the shareholders of an insolvent private limited liability company where there are no directors to take care of creditors’ interests according to § 823(2) German Civil Code (BGB) in conjunction with § 15a(3) Insolvency Code (InsO). Gilford Motor Company Ltd v Horne  Ch 935 (CA) is an example for an extensive interpretation of a contract. The court extended the application of a non-competition clause in a service contract to a company owned and managed by nominees of the person obliged under the contract not to compete. From a functional point of view, the Gilford Motor judgment constitutes an attribution piercing case. The French doctrine on the confusion of assets (confusion des patrimoines) illustrates how courts disregard the independence of the legal entity and thus bring about a functional piercing of the corporate veil. According to this doctrine a shareholder is liable for the debts of the company if his or her private assets are inseparably intermingled with the assets of the company.
d) Piercing the veil of partnerships
Up to now, the concept of piercing the veil was only used in the context of legal persons and their shareholders. However, the issue of piercing the veil is relevant for all legal subjects that are not physical persons, among them especially commercial partnerships enjoying legal capacity (rechtsfähige Personenhandelsgesellschaften). In 1984, the German Federal Supreme Court (BGH 12 November 1984, BGHZ 93, 146) heard a case in which the members of a GmbH & Co KG (a limited partnership with a limited company as general partner) had intermingled their private assets with the assets of the KG (the limited partnership). In the interest of clarity of presentation, however, the following text will concentrate on piercing the veil in connection with legal persons only.
e) Piercing the corporate veil in relation to directors?
English and French law—as opposed to German law—are familiar with the notion of piercing the corporate veil in relation to directors. Considering the principle according to which directors acting for the company only bind the company and not themselves personally, the notion of piercing the veil to hold directors accountable is a helpful analytical category. From a functional perspective, the liability of a director for a company’s debts seems to be as much of a piercing of the corporate veil as the liability of a shareholder for company liabilities.
This background elucidates why directors’ liability for wrongful trading under s 214 English Insolvency Act 1986 in the 8th edition of Gower & Davies’ textbook on Company Law is dealt with in the chapter ‘Statutory Exceptions to Limited Liability’ and why the French liability of de jure and de facto directors, according to Art L 651-2 Code de commerce (responsabilité pour insuffisance d’actif), is understood as an exception to limited liability.
However, the idea that both statutory rules referred to above constitute a piercing of the corporate veil in relation to shareholders where they are held liable as de facto directors needs clarification. Rather, from a functional perspective such instances are a piercing of the corporate veil in order to hold directors accountable. This understanding is a better explanation of the application of rules dealing with managerial liability and facilitates a straightforward identification of the basic condition for liability: Liability is triggered if the shareholder functionally acts as a director. Due to space restrictions, the piercing of the veil in relation to directors is not further dealt with here.
2. Liability piercing
a) Functional definition
Considering the various legal techniques existing in the European legal systems for holding a shareholder liable for the debts of a limited liability company, the question arises which rules to include in a comparison of laws. Here it is suggested to use a functional definition of piercing the corporate veil in order to hold shareholders liable.
From a functional perspective a piercing of the corporate veil to hold a shareholder liable occurs if the following two conditions are met: a person is obliged (1) in his or her capacity as a shareholder (2) to contribute more risk capital than the maximum amount promised ex ante.
The first part of the definition ensures that only the rules functionally concerned with shareholder behaviour are taken into account. Such behaviour is to be identified using the classical financial and administrative rights (and duties) of shareholders. Some examples include the participation in the annual profits and the liquidation surplus as well as voting and information rights. Therefore, a shareholder held liable as de facto director for insolvent trading is—from a functional perspective—liable not as a shareholder but as a director. Liability for insolvent trading is based on carrying out the function of a director rather than exercising shareholders’ rights.
The second part of the definition reflects the economic consequences of limited liability and liability piercing. The financial effect of limited liability is that a shareholder cannot be compelled to contribute more capital to a company than promised before becoming a member. The purpose of limited liability is to appease the empirically evidenced worries of equity investors about losing their private fortunes as a consequence of entrepreneurial risk taking in order to encourage equity investments. Exceptions to this principle—viz a functional liability piercing—are cases in which the legal system forces shareholders to contribute more risk capital than the limited amount promised ex ante.
When applying this definition of functional liability piercing to liability rules relevant for shareholders, the following picture emerges. No functional piercing of the corporate veil takes place in cases in which the legal system forces shareholders to return value received. Thus, when s 847(3) English Companies Act 2006, § 83(1) Austrian Private Limited Company Act (GmbHG) and § 31(1) German Private Limited Company Act (GmbHG) require shareholders to repay unlawful distributions, there is no functional piercing of the corporate veil. The shareholders only have to give back what they had received. A risk capital contribution exceeding the sum initially envisaged by the shareholder does not take place. In contrast, the liability for damages in cases of existence-destroying interferences of shareholders under § 826 German Civil Code (BGB) and the possibility for creditors of an insolvent company to tap into the private assets of shareholders in cases of an intermingling of assets (confusion des patrimoines) in French law are examples of a functional liability piercing of the corporate veil. In both cases, the law forces shareholders to contribute more risk capital in total than promised ex ante.
b) Evolution of European company laws
The history of the legal person and the liability of shareholders in Europe demonstrate that the concept of the legal person does not necessarily coincide with the principle of limited liability. The English Joint Stock Companies Act 1844 allowed for the formation of a company enjoying both legal capacity and legal personality. Nevertheless, the Act did not provide for an explicit limitation of the shareholders’ liability. It was only the Limited Liability Act 1855 that introduced a codified liability limitation of shareholders.
Looking at the legal history, it is remarkable that the statutory introduction of limited liability had as a consequence that the exemption of the liability of shareholders in insolvency was not questioned for a considerable time. In England, it took more than forty years until the demand of a creditor to tap into a shareholder’s assets came before the House of Lords in 1896 (Salomon v Salomon & Co Ltd  AC 22). In Germany, in the Tivoli-Theater case, the Supreme Court (Reichsgericht) had to decide in 1934 for the first time whether a creditor whose claims could not be satisfied in insolvency proceedings could instead—in spite of § 13(2) German Private Limited Company Act (GmbHG) of 1892—demand that a shareholder settle the claims (RG JW 1935, 52).
In the Europe of today, common patterns of piercing the corporate veil can neither be distinguished from a technical nor from a functional point of view. In particular, no consensus regarding methodology can be discerned between the legal systems. Some jurisdictions try to solve the problem rather by way of a true piercing of the corporate veil developed in case law, viz to disregard the independence of the legal person. The leading case Salomon v Salomon & Co Ltd  AC 22 (HL) as well as the judgment of the Tribunal Supremo of 28 May 1984 show that England and Spain belong to this category. In other countries, the courts also employ the method of truly piercing the corporate veil but additionally solve liability issues by way of extensive or restrictive application of legal rules. This is the case in France and Germany, where—considering the development of the liability for existence-destroying interferences depicted above—one can observe a tendency to favour the application of statutory norms (here § 826 BGB) over a true piercing of the corporate veil ultimately based on case law.
The legal systems also feature differences in the area of liability related to groups of companies which are often at the centre of attention. Broadly speaking, structural liability in terms of the coincidence of control and liability is not recognized in Europe. Correspondingly, the courts in England, France and Germany establish the liability of the parent company for the debts of its insolvent subsidiary not in a generalizing way but through the application of specific legal norms on a case-by-case basis. In contrast, in Spanish law, a uniform approach can be found according to which group companies can be liable for the debts of other group companies if the group displays a certain degree of consolidation and integration.
Additionally, the European legal systems differ in the field of liability piercing from a functional perspective. Limited liability is not equally reliable throughout Europe if both statutory law and case law are considered. In England, until today, the restrictive approach towards piercing the corporate veil formulated by the House of Lords more than 100 years ago in Salomon v Salomon and extended by the Court of Appeal to groups of companies in Adams v Cape Industries Plc  Ch 433 in 1989 is good law. A functional piercing of the corporate veil to hold shareholders liable on the grounds of statutory or case law is unknown in English law to this day. Differing assessments in legal literature do not reflect legal reality. First, these opinions can be explained by the fact that the term ‘piercing the corporate veil’ is also used for attribution piercing in English legal terminology. Second, it needs to be considered that, so far, the concepts of de facto and shadow director have only been applied in order to disqualify shareholders from directorship and not in order to establish a liability for company debts in insolvency. The English lending practice reacts to this legal background by relatively frequently demanding securities from shareholders.
In contrast, in German law there are numerous instances of a functional (as defined above) piercing of the corporate veil to establish shareholder liability based on statutory or case law. Sources are, for example, the liability for existence-destroying shareholder interference according to § 826 Civil Code (BGB), the subordination of shareholder loans according to § 39(1) no 5 Insolvency Code (InsO), the liability for a delayed filing for insolvency according to § 15a (3) Insolvency Code (InsO) and the liability to cover losses the company suffers before incorporation (Verlustdeckungs- and Vorbelastungshaftung). The greater willingness of the German legislature and courts to hold shareholders liable in spite of the generally codified limited liability is also reflected in German lending practice. Banks require comparatively fewer personal securities when extending credit to German GmbHs than when doing so to English limited companies. Empirical research shows that the ratio is 1 (German GmbHs) to at least 2.5 (English limited companies).
3. Attribution piercing
The technical approaches to attribution piercing in Europe exhibit similar differences between the legal orders as discovered regarding liability piercing. The approach to apply legal norms extensively or restrictively (such is the tendency in Germany) contrasts with the concept of a true attribution piercing of the corporate veil (employed by contrast in Spain). However, both approaches are frequently combined within one legal system. Traditionally, attribution piercing draws less attention than liability piercing. This is also true for comparative and empirical research. Nevertheless, it can be said that one may not automatically assume that the structures of attribution piercing mirror the structures of liability piercing. As illustrated by the English case Re FG Films above, attribution piercing is well known in English law while—from a functional perspective—liability piercing on the basis of statutory or case law does not occur.
4. ECJ decision Idrima Tipou
So far there is only one ECJ decision on the issue of piercing the corporate veil: Idrima Tipou (C‑81/09, 21 October 2010, submitted by the Greek Council of State). In this case the court had to decide whether European law precludes national legislation according to which the fines for infringement of the rules of good conduct governing the operation of television stations are imposed jointly and severally, not only on the company which holds the licence to operate the television station but also on all shareholders with a holding of over 2.5 per cent. The ECJ held that while such a rule was not precluded by the First Company Law Directive (Disclosure Directive) it did violate Art 49 TFEU (freedom of establishment) and 63 TFEU (free movement of capital).
First, the ECJ argues that the Disclosure Directive does not predefine essential characteristics of limited liability companies and, hence, allows exceptions to limited liability. Second, the ECJ holds Arts 49 and 63 TFEU to be applicable and qualifies the Greek shareholder liability rule as a restriction of both the freedom of establishment and the free movement of capital. Investors from Member States other than Greece—so the ECJ argues—are at a disadvantage to ally themselves with other shareholders in order to be able to influence the decisions of the company’s management. Since the Greek liability rule was—in the eyes of the ECJ—neither suitable nor appropriate to secure compliance by television companies with the rules of professional conduct, the restrictions on the freedom of establishment and the free movement of capital could not be accepted.
The essential conclusion to be drawn from Idrima Tipou is twofold: European secondary law does not contain a rule according to which limited liability may not be subjected to exceptions. European primary law, however, may preclude shareholder liability rules if their effect is to put investors from other Member States at a disadvantage compared with national investors. In this regard the ECJ approaches the issue of limited liability from the perspective of the capital market and not from the perspective of corporate organizational law.
5. Harmonization attempts
In the past years, a few attempts were undertaken to standardize the law in respect of piercing the corporate veil in some areas on the European level. Among these initiatives were the draft of the 9th Company Law Directive of 1984 (Group Directive), the proposals of a Corporate Group Law for Europe of the Forum Europaeum Konzernrecht, the draft version of the Single-Member Companies Directive (the liability of a sole parent company according to Art 2(3) of the draft version was removed before the final version of the directive was adopted), the proposal of the High Level Group of Company Law Experts on a Modern Regulatory Framework and the Action Plan of the European Commission for Modernising Company Law and Enhancing Corporate Governance in the European Union. However, neither directly nor indirectly binding rules have been passed up to now, and they are not to be expected in the foreseeable future.
The proposal of the Institute of International Law titled ‘Obligations of Multinational Enterprises and their Member Companies’ dates from 1995. It deals with liability issues within groups of companies and proposes liability of the controlling companies for debts of subsidiaries of the same group under certain circumstances.
6. Piercing the corporate veil in international private law
The Rome II Regulation on the law applicable to non-contractual obligations (Reg 864/2007) does not apply to the personal liability of members as such for the obligations of the company according to Art 1(2)(d). Against this background, the draft of the German Federal Ministry of Justice for an international company law of 7 January 2008, which can be traced back to the proposal of the Special Commission of the German Council for International Private Law (Spezialkommission Internationales Gesellschaftsrecht des Deutschen Rates für Internationales Privatrecht), provides for new rules in the German Introductory Law to the Civil Code (EGBGB). According to Art 10(1), (2) no 7 of the draft, the law applicable to the liability of members of a legal person is the law of the state in which it is registered. If it is not registered, the law of the state according to which it is organized shall be applicable. Concerning liability piercing the draft did not connect the applicable law to the place of the member’s action which could have resulted in a separation from the law generally applicable to the company’s affairs.
A systematization of the law on attribution piercing in international private law has not yet been attempted and would be fraught with considerable challenges due to the various approaches in the substantive national laws.
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