Piercing the corporate veil: when directors can be held responsible for losses

One of the oldest and most well-established principles of South African corporate law, and throughout the world, is that of separate juristic personality.

In essence, the concept of separate juristic personality means that when a corporate entity (more commonly referred in the legal fraternity to as a juristic person) such as a company or a close corporation has been properly incorporated in terms of the relevant company laws, the law recognises that that entity concludes transactions in its own name.

This means that where a company concludes a contract with another party, even though it must by necessity be represented by a natural person (i.e., a human being), the law recognises that the contract was concluded by the company and the third party – not the person that represented the company.

Company versus person

The significance of this is that, in the ordinary course, it will be the company who will be held responsible for complying with the obligations arising from the contract and not the person who represented it in concluding the contract, or the people who hold shares or a member’s interest in the company.

There are, however, exceptions to the principle of separate juristic personality, in terms of which a Court will disregard the principle and look to the people behind the juristic entity– its directors and shareholders or members – which are provided for both in terms of the common law and by legislation or statutes.

Piercing the corporate veil

The common law exception to the principle of juristic personality is known as the process of “piercing the corporate veil”. The concept of “piercing the corporate veil” is somewhat contentious and the legal fraternity is not entirely in agreement regarding the circumstances which justify its application or what the extent of the consequences should be.

What is not contentious is that the above concept will apply when it is clear to a Court that the natural person seeking to rely on the principle has not been giving effect thereto in their daily interactions with the company by, for instance, settling personal debts with company funds or using company property for personal gain. However, the application of this exception is narrow as it does not provide for instances in which the relevant natural person(s) were reckless and/or negligent and/or fraudulent in their dealings with, and on behalf of, the company, unless their conduct also satisfied the above condition of not giving effect to the principle of separate juristic personality.

Directors can be held liable for the conduct of a company

The legislative exception to the principle of juristic personality has a broader application and is contained both in the Companies Act 61 of 1973 (“the Old Act”) and the Companies Act 71 of 2008 (“the New Act”). I shall focus on the application of the New Act (which repealed the majority of the Old Act). The New Act contains various provisions in terms of which directors can be held liable by the company, or its shareholders, for losses which those parties suffered as a result of the directors’ conduct. This does not, however, protect the creditors of the company, when they are unable to enforce their rights against the company.

The New Act also provides that a company must not, inter alia, carry on business recklessly, with gross negligence, with intent to defraud any person or for any fraudulent purpose or trade under insolvent circumstances. Directors are responsible for the conduct of a company and they determine how a company conducts itself.

Finally, the New Act also provides that any person who contravenes any provision thereof is liable to any other person for any loss or damage suffered by that person as a result of that contravention.

Although there are numerous aspects which will have to be proven by a creditor to succeed in a claim against the directors of a company, and although these provisions of the New Act are yet to be thoroughly tested by the Courts, the New Act appears to provide for a mechanism by which creditors of a company can hold the directors of that company liable, in their personal capacity, for loss which the creditors have suffered as a result of the directors’ conduct when such conduct also constitutes a breach of the provisions of the New Act. In the circumstances, where it can be shown that directors of the company were party to a decision to conduct the business of the company in contravention of the above provisions of the Act, those directors can be held personally liable for loss suffered by any party as a direct result of the aforementioned conduct.

This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your legal adviser for specific and detailed advice. Errors and omissions excepted (E&OE)