Separate Legal Personality: what does it mean for companies and what are the limits?
The concept of separate legal personality has long existed in our law and is fundamental to company law. A company is defined in section 1 of the Companies Act as a juristic person incorporated in terms of the Act and in terms of section 19(1)(b) of the Companies Act, a company is a legal person with separate legal personality. The Act has therefore given recognition to the fact that a company possess its own legal personality to acquire rights and incur obligations that are distinct from those of the directors and shareholders. This concept of separate legal personality exists from the date and time that the incorporation of a company is registered and from that point, the company will have all the legal powers and capacities of an individual, except to the extent that a juristic person is incapable of exercising any such power or having any such capacity, or except to the extent that the Memorandum of Incorporation provides otherwise. Although fundamental, developments in common law as well as by the legislature have indicated that this privilege is not absolute and will not be upheld in instances of abuse. However, it will be argued that the courts development of these exceptions has safeguarded against the threat of destroying this foundation of company law and is a necessary tool to ensure that separate legal personality is respected.
The concept of separate legal personality results in a number of legal consequences for companies which affirm the position that the company and the directors and shareholders are distinguishable from one another. Firstly, separate legal personality results in limited liability in the sense that the liability of shareholders for the company’s debt is limited to the amount that they have paid the company for its shares and cannot be held personally liable for the debts of the company. This is confirmed by section 19(2) of the Act which states that a person is not, solely, by reason of being an incorporator, shareholder or director of a company, liable for any liabilities or obligations of the company, except to the extent that the Act or the Memorandum of Incorporation provides otherwise. Another element of separate legal personality is that the property and assets of the company belong to the company and not the shareholders or directors and following this, the debts and liabilities are that of the company and the shareholders cannot be compelled to pay the debts of the company. Separate legal personality also enables a company to enjoy perpetual succession which means that notwithstanding any changes in membership, the company will retain its legal identity and continue to exist. In Foss v Harbottle, the Court upheld the principle of separate legal personality and held that in the event that the company is involved in legal proceedings, it must be initiated in the name of the company, and not in the name of the shareholders or directors as it is the company, which exists as its own legal person, itself being sued or suing. It is clear from this that the concept of separate legal personality has important legal consequences for a company incorporated in terms of the Companies Act, particularly with regards to debts and liabilities of the company and lies the foundation for company law. Separate legal personality affords greater protection for shareholders and directors in the sense that they cannot be held liable for the debts and liabilities which belong to the company. It can be said that metaphorically, once a company has been formed, a veil is drawn between the company and its shareholders and directors, which separates the company from its shareholders and directors and protects them from liability for the debts and wrongful acts of the company. As is evident from the legal consequences of such a distinction, this concept is the cornerstone of South African company law and has existed in our law years before the introduction of the Companies Act.
Salomon v Salomon was the first case to establish the principle that a company is a separate legal person quite distinct from its shareholders and directors and that because of this, the directors and shareholders cannot be liable for the debts and liabilities of the company. Upon the liquidation of Mr Salomon’s validly registered company, of which he happened to be a secured creditor, the liquidator objected to the payment of Mr Salomon and argued that as he owned all but six of the issued shares in the company, he and the company were one and the same person and therefore the debts of the company were his debts. The House of Lords found in favour of Mr Salomon and affirmed the concept of separate legal personality which affords a privilege that enables shareholders and directors to be protected in their personal capacity from any potential liability arising as a result of the actions of the company. This case illustrates the courts reluctance to resort to such a drastic remedy and the importance of upholding separate legal personality.
However, the courts began to recognise that instances existed whereby there has been some form of abuse of this privilege of separate legal personality by directors or shareholders whereby it then becomes necessary to create exceptions to the fundamental principle of separate legal personality. One exception to this principle of separate legal personality exists in the remedy of ‘piercing the corporate veil’ which developed through common law and empowers the court to ‘pierce the corporate veil’ and as a result, remove the protection that is afforded to shareholders and directors and examine the substance of the company, rather than the form under which it has been incorporated. This removes the distinction between the company as a separate legal person and the shareholders of the company and as a result, attributes liability to a natural person who misuses or abuses the principle of corporate personality. It is necessary to further distinguish between ‘piercing the veil’ and ‘lifting the veil.’ In instances where the court pierces the corporate veil, the court will completely disregard the separate legal personality of a company and as a result, attribute the liabilities of the company on the shareholders or directors and remove the protection afforded by separate legal personality. This is a drastic remedy and the courts have warned about the importance of upholding the concept of separate legal personality and only resorting to this remedy when there are compelling reasons to do so. Where a court simply ‘lifts the corporate veil’, there is no removal of the protection that is afforded to shareholders and directors and the court merely takes into consideration who the shareholders and directors of the company are, rather than attributing liability to these natural persons. This remedy is less drastic and has been used in instances where it is necessary for legislative purposes to know who the people controlling the company are for example, for purposes of BBEE compliance.
The common law remedy of piercing the veil has not always been consistent in our law with regards to when exactly the courts will resort to piercing the corporate veil but it is clear from case law that the courts will not resort to this remedy easily and the court will look for some kind of abuse of separate legal personality. This can take the form of separate legal personality being used as a device by a director to evade his or her fiduciary duty and where separate legal personality has been used to overcome a contractual duty. This reluctance to use such a drastic remedy was evident in the case of Dadoo where the court noted that this is exceptional remedy which goes against the cornerstone of commercial law enterprise and erodes the confidence in the idea of a corporation and the privileges it brings. In the case of Botha v Niekerk, the court held that the test to pierce the corporate veil was where there had been ‘unconscionable injustice’ of the separate legal personality and that all other potential remedies had been exhausted. This indicates a high threshold that must be proved in order for the court to disregard the separate legal personality of a company.
However, the case of Cape Pacific Limited v Lubner Controlling Company is known as the leading case in our common law with regards to this remedy and provides a number of general principles which guide the court in an application to pierce the corporate veil. The court in Cape Pacific rejected the test in Botha and favoured a more flexible approach which was based on the facts of each case. The court held that there was no closed listed of categories in which a court will pierce the corporate veil and that the court has no general discretion to disregard a company’s separate legal personality whenever it chooses to do so. The court affirmed that importance of separate legal personality as a cornerstone in our law and the fact that this should not be disregarded lightly and that where there is fraud or abuse present, the court is required to perform a balancing act between the need to uphold separate legal personality, in the interests of the commercial world, with the need of remedying the harm that has been caused by the abuse of this privilege. This case indicates the courts recognition of the importance of upholding separate legal personality as a fundamental principle in our law and the framework provided by the court in Cape Pacific has created safeguards against a general discretion to disregard the principle. This case has ensured that the privilege of separate legal personality is not removed from our law, or threatened by the remedy of piercing the corporate veil.
Following from numerous case law, a novel provision in the Companies Act 71 of 2008 was introduced to give recognition of the courts ability to disregard a company’s separate legal personality. It is important to note however, that this provision has not replaced the common law piercing the veil remedy but rather that they run in tandem. Section 20(9) of the Act allows an interested person to approach the court for an application to declare the company not to be a juristic person, thereby attributing liability to shareholders or directors, where there has been an ‘unconscionable abuse’ of separate legal personality. Section 20(9) also empowers the court to make any further order that the court considers appropriate and does not require, as the common law, that the remedy is of last resort. This is the first time in our law that there has been statutory recognition of the remedy to pierce the corporate veil of a company. The Act has however failed to define what constitutes an ‘unconscionable abuse’ of separate legal personality and therefore, the common law principles which have been developed serve as a useful guideline for the courts. In the case of Ex Parte Gore, the court decided to pierce the corporate veil in terms of section 20(9) of the Act and confirmed that this section is much wider than the common law remedy and allows an application to be brought in relation to any abuse relating to the incorporation of the company, use of the company or any act by or on behalf of the company which leads to an unconscionable abuse of separate legal personality which must be in respect of a particular right, obligation or liability. The court furthermore confirmed the balancing act approach taken in Cape Pacific which requires weighing up the importance of giving effect to juristic personality against the adverse and moral effects of countenancing an unconscionable abuse of the separate legal personality. It is clear from this that under the statutory remedy, the court will not pierce the veil where the company has not yet done anything or carried out its purpose. Moreover, the courts have retained a balancing act in order to ensure the fundamental principles of separate legal personality is protected and only disregarded when the balance tips in favour of mitigating the abuse of this privilege.
It is submitted that the courts recognition of the extremity of this remedy and the guiding principles from Cape Pacific of a balancing act approach based on the facts of the case will place no threat to the principle of separate legal personality unless the court is certain that the harm that has been caused overrides the need to uphold the principle. Companies who act in conformity with the law and who do not abuse the privilege of separate legal personality are under no threat from the development of exceptions to this principle and the safeguards that have been put in place by the courts and the legislature have ensured that the solid foundation on which company law has rested is not threatened. An absolute privilege of separate legal personality opens the floodgates to all types of abuses by directors and shareholders who use companies as a guise for protection from personal liability and exceptions by the court and legislature to this principle does not threaten to destroy the foundation on which company law has rested but rather to ensure that this foundation is respected and not abused. Despite the fact that the Act allows the remedy whenever it is justified, the courts must maintain the drastic extent of the remedy and the importance of upholding separate legal personality except in instances where policy considerations demand a piercing of the veil.
By Hannah Delit