Trading in Turbulent Times – When Will Courts Pierce the Corporate Veil?

By Ben Grillo and Alexandra Vrdoljak

Separate legal personality and limited liability are characteristics which make the company the most widely used business structure in Australia.

The term ‘corporate veil’ refers to the way a company is treated as separate from its owners by the law. The ‘corporate veil’ allows companies to have their own, separate legal personality and allows them to acquire and dispose of property, take legal action, be sued, incur liabilities, and enter into contracts.

This separation protects owners by limiting the extent to which they can be personally liable for any debt incurred by the business. Although it is important to remember that this protection is not all encompassing, and courts have the power to pierce the corporate veil in order to hold owners personally liable for the actions and debts of the company in certain circumstances.

Determining the exact circumstances in which the ‘corporate veil’ is set aside is made difficult by the court’s tendency to adopt a case by case approach rather than follow any general principles. While the use of a company as a vehicle for fraud, or as a sham to avoid legal obligations has proved to be persuasive indicia in the past, these factors are mostly valuable as a guide for when courts may consider it appropriate to pierce the veil, and are not necessarily determinative on their own. However, owners questioning the security of their personal assets as a result of this ambiguity, should take comfort in the court’s rigorous implementation of the separate legal personality principle and its general reluctance to engage in veil piercing under common law.

Despite this, courts are much more likely to disregard limited liability in instances where doing so is mandated by statute. For example, section 588G of the Corporations Act 2001 (Cth) imposes personal liability on directors who know, or reasonably suspect, that their company is insolvent and fail to prevent it from incurring further debts. Section s 95A(1) provides that a company is insolvent if it is unable to pay all of its debts as and when they become due and payable.

Clearly sensitive to this heightened risk, the Australian Securities and Investment Commission (ASIC) introduced the ‘National Insolvent Trading Program’ (NITP) which allows it to review companies to ensure compliance with insolvent trading provisions. This proactive approach which attempts to assist directors by preventing them from trading while insolvent, is mirrored by the ‘Duty to Prevent Insolvent Trading: Guide for Directors’ which ASIC released in 2010. 

This existing support framework was varied during the COVID-19 pandemic by the Coronavirus Economic Response Package Omnibus Act (2020) (the Covid Act) providing a temporary safety net which limits the extent to which directors can be held personally liable where they have failed to prevent their company from trading while insolvent.

The Covid Act restrict the court’s ability to pierce the corporate veil (providing that certain conditions are met), directors are afforded relief from personal liability and are given an opportunity to trade out of financial difficulties. The Covid Act, which seeks to complement the pre-existing ‘safe harbour’ legislation introduced in 2017, will provide directors with relief until the end of the year, after having been extended from its original six month period which expired on 25 September 2020.

Notwithstanding the protections afforded by separate legal personality, limited liability and the court’s general reluctance to pierce the corporate veil, business owners should be aware of the circumstances where a court may find them personally liable for the actions and debts of their company. In an insolvency context, where this risk is arguably greater, directors have the option to utilise the existing support frameworks, and should obtain immediate professional advice if they have concerns about the solvency of their company.