What is the definition of Corporate Veil and its historical background? Corporate veil is a legal term for the fundamental rule that assets & liabilities of a corporation are separate from the assets and liabilities of its shareholders.
This rule protects shareholders from being liable personally for the company's debts and other obligations . This concept has its exceptions though. For shareholders this means that the worst fate that can befall them, if the company becomes insolvent, is that they lose the entire value of their investment. However, their personal assets or funds will not be affected if the company goes bust, unless of course they have signed personal guarantees.
The historical origins of the concept of corporate veil or the separate legal personality of legal entities, i.e. companies and corporations, traces its roots back to the Roman law (known now as the Civil Law System, as opposed to the Common Law System). It was subsequently developed under the English legal system in the second half of the nineteenth century when the House of Lords of England delivered its judgment in Salomon v Salomon & Co (1897).
The creation of a separate legal personality is just that, a separate legal personality potentially capable of suing and being sued in its own name, of holding property in its own name, and logically, therefore, of making profits and losses that are of its own and not those of its members - the members have no direct claim on the assets and no exposure to its losses beyond the share capital they invested. The limited liability of shareholders in companies is the logical sequence of the concept of separate legal personality of companies.
How would a third party know that he is dealing with a company whose partners have a limited liability?
Companies’ names usually end with the letters “LLC”. This abbreviation refers to a Limited Liability Company and indicates that the liability of its shareholders or partners is limited to their proportional shareholding subscription in the issued capital of the company. So, the main reason of the existence of the abbreviation “LLC” is to warn all third parties who may be dealing with that company that the liability of its members is limited to their contribution in the company’s capital. But the abbreviation “LLC” refers only to the limitation of liability of such company’s shareholders or partners rather than the liability of the company itself. In other words, the company is liable for all its debts, with no limitation, but once its assets are exhausted, its creditors cannot pursue the personal assets of its shareholders.
Although joint stock companies, either public or private, do not have the abbreviation of “LLC” attached to them, the liability of their shareholders is also limited to their shareholding subscription in the issued share capital of the company in question. The concept of limitation of liability of shareholders in public joint stock companies has had a positive impact on encouraging public stock market investment and has boosted the concept of the initial public offering as an indispensable source of corporate finance.
Are all types of entities conferring their members a limited liability?
No; according to the UAE Federal Commercial Companies Law No. 8 of 1984 (“CCL”) there are various types of legal entities, namely:
• General Partnership;
• Simple Limited Partnership;
• Joint Participation (Venture);
• Public Joint Stock Company;
• Private Joint Stock Company;
• Limited Liability Company; and
• Company Limited by Shares
Partners in general partnerships are jointly liable for the company liabilities to the extent of all of their assets. That is why the name of general partnerships must consist of the names of all the partners. The partnership’s name may be confined to the name of one or more of the partners with the insertion of an indication as to the existence of a company. The partnership may, however, have a special trade name.
It happens that partners in general partnerships may use a name of a third party (which is usually a famous family name). In this case, if such third party knows that the general partnership in question will use his name, such an individual shall be jointly liable for the company's liabilities. The knowledge of the third party whose name is used in a general partnership can be proved by all means of evidence.
Limited partnerships are a hybrid partnership whereby one or more general partners are liable for the company liabilities to the extent of all their assets, while one or more limited partners are liable for the company liabilities to the extent of their respective shares in the capital only. Similarly, companies limited by shares are companies which are formed by general shareholders who are jointly liable to the extent of all their assets for the company liabilities and other participating shareholders whose liability is only limited to the extent of their shares in the capital.
With respect to joint participation (venture) partnerships, third parties have no right of recourse except towards the partner with whom he had dealt with. If the partners act in a manner that might inform a third party of the existence of the partnership, it may be considered a real existing in which all its partners will be jointly liable towards third parties.
The liability of partners or shareholders in the remaining legal forms of companies (Public Joint Stock Company; Private Joint Stock Company; and Limited Liability Company) is limited to their proportional contribution in the issued share capital of the company.
What are the statuary rules of limitation of liability and companies’ separate legal personality?
Article 64 of the CCL defines a public joint stock company as any company whose capital is divided into equal value negotiable shares and whose shareholders are only liable to the extent of their share in the capital of the company. It is also worth noting that Article 216 of the CCL provides that the provisions of public joint stock companies (including the limited liability of shareholders) are applicable to private joint stock companies.
As for limited liability companies, paragraph 2 of Article 218 of the CCL states that:
“Each partner shall only be liable to the extent of his share in the capital….”
Article 256 of the CCL also provides that the liability of the limited shareholders in companies limited by shares is only limited to their contribution in the share capital of the company.
It is to be noted also that Article 166 of the CCL provides that the assets of the company may not be attached for debts incurred by one of the shareholders. However, creditors of the shareholder may attach the shares and dividends accrued from those shares.
Also, Article 288 of the CCL provides that a limited liability company will not be dissolved upon the withdrawal or death of a partner or the court order for sequestration, bankruptcy or insolvency of one of the partners. It has its separate legal personality. This rule is subject to any express term to the contrary in the company's memorandum.
Are there any exceptions to the limited liability of shareholders or cases where the corporate veil is to be lifted?
Yes; there are exceptions to the limited liability of shareholders in LLCs and joint stock companies. In particular situations, the separation of the personality of a company and its shareholders is not to be maintained. The veil of incorporation is thus said to be lifted. Legal practitioners often use metaphors to describe a legal process, so in common law jurisdictions they describe the situations where the limitation of liability of shareholders are not maintained by “lifting”, “piercing” or “parting” the veil of a company.
Under the CCL, there are a number of exceptions to the concept of limitation of liability of shareholders and the separate legal personality of companies. Below are examples of statutory exceptions:
What are other grounds on which a shareholder can be sued?
In practice, shareholders in SMEs typically assume management roles in their companies. It is not unlikely that a major shareholder in a limited liability company assume the role of the general manager or the executive manager of such company. In this case, the shareholder who assumes a management role in his company can be sued by other shareholders or third party for all acts of fraud, abuse of power, violation of the law or the company articles, in addition to mismanagement. It is also to be noted this is a mandatory rule and any agreement to limit or exclude such liability will be void. He will be sued in this case in his capacity as a member or the head of the management team, rather than as a shareholder whose liability is limited.
On the other hand, a shareholder may agree to provide the creditors of his company with a surety (i.e. personal guarantee) to guarantee full payment of the company’s debts if it fails to do so. Such shareholder can be sued on the basis of the guarantee(s) that he provides.
Having relayed the above legal concepts and provisions, it is clear that a company has a separate legal personality from its members. A company’s property is owned by the company as a separate person, not by the members of such company; and the company’s business is conducted by the company as a separate person not by its members. It is the company as a separate person that enters into contracts in relation to the company’s business and property.
One of the major aims and drives behind the concept of the limited liability of shareholders and having a separate legal personality of companies (either conferred by the CCL or under other companies law in other different jurisdictions) is to enable business people to incorporate their business and to limit their personal exposure by avoiding incurring further personal liability.
Apparently, there are common grounds between the common law legal system and the civil law legal systems. One can even argue that the roots of particular concepts in the common law system have originated from the civil law system, and vice versa.
It is also worth noting that each rule has its exceptions; either statutory exceptions or exceptions generated by the legal practice. All exceptions, however, must not conflict with other mandatory rules and should be applied prudently.