Author(s): Rekha Panchal

Piercing the Corporate Veil

“Nothing can be so unjust as for a few persons abounding in wealth, to offer a portion of their excess for the formation of a company, to play with that excess—to lend the importance of their whole name and credit to the society, and then, should the funds of the incorporated body prove insufficient to answer all demands, to retire into the security of their un-hazarded fortune, and leave the bait to be devoured by the poor deceived fish.”

- The editorial from ‘The Times of London’ dated 25 May 1824

Introduction

The principle of limited liability has come under the scanner to meet the ends of justice. The general rule of a corporation being a separate legal entity and distinct from its shareholders has proved fatal while administering justice. The corporate veil enables the companies to maintain separate corporate personalities from the shareholders and bear limited liability to protect the shareholders from being personally liable for the company's debts and other obligations. The principle of limited liability has come under the scanner to meet the ends of justice. The general rule of a corporation being a separate legal entity and distinct from its shareholders has provedwhile administering justice. The corporate veil enables the companies to maintain separate corporate personalities from the shareholders and bear limited liability to protect the shareholders from being personally liable for the company's debts and other obligations.

The courts have however unveiled the corporate structures. Piercing the corporate veil of the aforementioned separate legal entity is an open-ended concept and flexible, based on the specific facts concerning the relevant case.

This is a very well-established principle in common law as evidenced by the plethora of judgments being referred to as precedents. The predictability of the doctrine of corporate veil remains to be challenged, however, hence we attempt to augment the predictability of the subject in view of UAE law. We also seek to illustrate the circumstances in which the corporate veil may be lifted by UAE courts. The scope of this article is limited to the personal liability of shareholders and directors against third party.

The UAE Federal Law Number 2 of 2015 concerning Commercial Companies Law (the CCL ) provides for the principle of establishment of corporate personality distinct from its shareholders under article

Corporate Personality Ensuring Limited Liability to the Shareholder

Various articles in CCL endorse the principle that the company is considered a distinct corporate personality. The following are the instances of the same:

The CCL under article 21 states that ‘The Company shall, from the date of entry in the Commercial Register with the competent authority, acquire a corporate personality’.

Liability limited to share capital (LLC) : Article 71(1) under chapter 1 of title 3 for incorporation of Limited Liability Company (the LLC ) provides definition of company and further provides that ‘a partner shall be liable only to the extent of its share in the capital’. This article goes on to provide for the establishment of sole proprietorship with limited liability.

Sole Proprietorship (LLC) : Article 71(2) provides that a single natural or corporate person may incorporate and hold a LLC. It further states that ‘The holder of the capital of the company shall not be liable for the obligations of the company other than to the extent of the capital as set out in its Memorandum of Association. The provisions of the Limited Liability Company contained in this Law shall apply to such person to the extent not in conflict with the nature of the company’.

Liability limited to share capital (PJSC): Article 105 under title 4 of the CCL states similar provision in respect of public joint stock company which states ‘A shareholder shall be liable only to the extent of his share in the capital of the company.’

Sole Proprietorship (PJSC): Article 255 (3) of the CCL provides that the single legal person may incorporate and hold a Private Joint Stock Company. It limits the liability of corporate entity up to the extent of the capital as set out in its Memorandum of Association.

Personal Liability of Shareholders

The shareholders can be held personally liable most often on the basis of personal guarantees granted by them. However, the CCL provides for the articles which seek to render the shareholders or company representatives personally liable for their acts. The instances of the same are set out below:

Exceeding Statutory Number of Partners: The number of partners must be limited to 50 pursuant to article 71(1). However, if number of partners exceed the statutory limit of 50, such situation must be rectified in three months from the date of notice send by manager of company to the competent authority. The company shall rectify and comply with the limitation on partner’s number within six months as extended by authority failing which the company shall be deemed terminated and the partners shall be personally and jointly liable from their assets for the debts and obligations of the company from the date the statutory limit of partners was exceeded.

Valuation of Contributions in Kind: Article 78 provides that partner may agree on the value of share in kind and if a partner of LLC presents a share in kind, such partner shall be liable to third parties for the evaluation of its value and accuracy of the estimated value of such share in kind. If it is established that the share was evaluated above their true value, the partner providing such contributions shall pay the difference in cash to the company and are personally liable for such contribution.

Foreign Company’s Activities: Article 328 restrains foreign companies or its branch offices from conducting activities in UAE mainland prior to the completion of required process of law for carrying out branch activities. Article 328(2) states that the persons acting in contravention of above shall be held personally and jointly liable for the acts.

Invitation to Public Subscription : Article 121 holds the parties involved in the incorporation procedures and their representatives jointly and personally liable for the validity of the information set out in prospectus .

Providing False Statements or Statements in Violation of the Law: A person shall be punished by imprisonment for a period between six months and three years and/ or have a fine imposed on them between AED 200,000 (two hundred thousand) and AED 1,000,000 (one million) under article 361 if any false statements or such statements are made in constitutive documents of the company including Memorandum of Association/Articles of Association/the prospectuses of shares or bonds or in any other documents of the company, in violation of the provisions of the CCL. The above provision also any penalizes any other person that may, knowingly, signs or distributes such documents.

Overvaluation of the Contributions in Kind: Article 362 provides penalty for any person assesses the contributions in kind provided by the founders or shareholders in excess of their actual value in bad faith, shall be punished by imprisonment for a period between six months and three years and/ or a fine between AED 500,000 (five hundred thousand) and AED 1,000,000 (one million).

Personal Liability of Directors/Managers

Fraudulent Acts Fraudulent Acts : The manager/director of the company is liable for the losses incurred : The manager/director of the company is liable for the losses incurred to the company, partners and the third parties for any fraudulent acts, misuse of authority, contravention of any applicable law or the memorandum of association (the MOA ), the contract appointing the manager and any mismanagement by the manager under article 51 and 84(3). The provision in MOA contracting out of this statutory liability will be void. The equivalent provision is available for the PJSC wherein the directors are liable for the fraudulent acts under article 162. It is not uncommon for the partner of the LLCs in UAE to assume the managerial position. The manager is usually held liable to company and third party for his acts in contravention of law. The Dubai Court of Cassation in case number 69/2007 held that ‘ where a shareholder has exploited the principle of the independent liability of the company as a means to conceal fraudulent acts or misappropriation of the funds of the company in order to cause harm to his partners or creditors, the protection bestowed by law for a shareholder in an LLC will not be upheld. In these circumstances, it may be possible for a shareholder to be held liable in their personal capacity for such dispositions, and such liability will extend to their personal assets ’.

Further, article 6(2) states that the Board of Directors of a company or its managers, depending on the circumstance, shall be responsible for the application of the rules and criteria of governance. The precedents have been scanty in the matter.

The principles of sharia law such as unjust enrichment and using the company as facade for carrying out fraudulent acts along with the civil and commercial code governing the contractual relations between the parties pursuant to the commercial and civil transactions laws also plays important role while adjudicating the contention of whether the corporate veil must be pierced or not.

Conclusion