Piercing the Corporate Veil under the UAE Companies Law – When can Shareholders be Responsible?
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:
- Article 77 of the CCL provides that during the course of inviting the public to subscribe in a pubic joint stock company, the founders of the company in question have to issue a prospectus and publish it in two local daily newspapers. The prospectus has to include all the financial and business related information of the company in question, as well as, any other matters affecting the rights or obligations of the shareholders. The founding members are jointly liable for the accuracy of the particulars mentioned in the prospectus. In other words, the founding members may not rely on their limitation of liability if they are sued by one of the public subscribers for inaccuracies in the prospectus.
- Article 84 of the CCL obliges the founding members jointly to reimburse the paid-up value of the shares back to the subscribers if they decide to rescind the incorporation of the company in question. This is a logical consequence as there will be no company to be sued and therefore its founders will be exposed in their personal capacities and will be jointly liable vis-à-vis public subscribers.
- Article 156 of the CCL provides that the creditors of a company have the right to sue any of such company’s shareholders directly in his personal capacity to oblige him to pay up any unpaid amount due for his shares in the company. Although any defaulting shareholder is only liable to pay the unpaid balance of his shareholding participation in the company, the corporate veil is lifted in the sense that creditors have the right to go after the shareholder directly in his personal capacity.
- Article 223 of the CCL provides that if a partner in an LLC presents a share in kind, it must be valued in the company memorandum, specifying its kind, the name of its contributor and the amount it represents in the capital. The contributor of the share in kind shall be liable towards third parties for the accuracy of the estimate of its value in the memorandum. If it is established that the share was valued at more than its real value, the contributor of the share must pay the difference in cash to the company and the founding members shall be jointly liable with their private assets for the payment of this difference.
- Article 226 of the CCL provides that if, at any time after incorporation of an LLC, the number of partners exceeds the statutory limit (i.e. 50 partners), the competent authority will notify the company to rectify its situation. If the company does not rectify its position within six months subsequent to the date of the notice, the company shall be deemed dissolved and the partners shall be personally and jointly liable for the debts and liabilities incurred by the company as from the date of exceeding the statutory limit of the number of partners. However, the partners ignorant of such excess are exempted from that provision.
- Article 316 of the CCL provides that if a foreign company or its office or branch practices activities in the UAE before applying the formalities stipulated in the CCL, all the persons who performed this activity shall be personally and jointly liable for their actions.
- It is also to be noted that Article 322 of the CCL sets out the applicable penalties on those who violate the provisions of the CCL. Among these penalties, this Article provides that without prejudice to a more severe punishment provided in another law, a prison sentence for a period of not less than three months and not more than two years, or a fine of not less than ten thousand Dirhams and not more than one hundred thousand Dirhams, or either of these penalties, will be imposed on:
- Every founding member who extends the public invitation for the subscription to shares or stocks for the account of a limited liability company and whoever offers these documents on behalf of the company; and
- Whoever (including partners) evaluates in bad faith the shares in kind contributed by the partners at more than their real value.
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.