South Africa: Piercing The Corporate Veil When Holding Companies Act As Operators

Last Updated: 19 July 2017
Article by Rurik McKaiser and Samantha Bradshaw

Outline: Abstract – What is a corporate veil? – Piercing the Corporate Veil with §20(9) of the New Companies Act – 1. What is 'unconscionable abuse'? – 2. Who may invoke and use §20(9)? – 3. How is §20(9) to be invoked? – 4. What orders may be made under §20(9)? – 5. Does §20(9) override the common law? – 6. Is §20(9) to be used as a remedy of last resort?

Abstract: We attempt to clarify Section 20(9) of the Companies Act through Stephen Malcolm Gore N.O. case

Three brothers each established a trust for the benefit of themselves and their families and each trust was a shareholder in a holding company with more than 40 subsidiaries. This group provided financial services through marketing investments in real estate with little to no regard to the distinction between that company's legal personality and that of its subsidiaries, going so far as to misrepresent its status as a licensed financial service provider on its letterhead. The court even said that the "flow of funds within the Group appears to have been materially determined by the need of the King brothers to sustain their scheme by finding money to pay out existing investors who wished to withdraw their funds." When the Financial Services Board in South Africa investigated the group, they found consistent fraud, misrepresentation, a severe lack of bookkeeping, and that "entire group was operated, in effect, as one entity through the holding company."1

This gave the South African judicial system its first chance to apply a new provision of its updated company law, Section 20(9) of the Companies Act, 2008, which was meant to provide significantly more certainty and indeed visibility to the doctrine of piercing the veil.

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What is a corporate veil?

The idea of the corporate veil was first codified nearly 30 years ago under the Close Corporations Act (now partially repealed by the 2008 Companies Act) in South Africa, albeit in a much different form that exists today. Today, the directors and shareholders of a company enjoy extensive protection against personal liability for the actions of the entity because the entity enjoys a fictionalized legal personhood. However, such protection is not absolute as the court has the power – in certain exceptional circumstances to pierce or lift or pull aside the corporate veil and to hold the directors and others personally liable for the debt of the company.2

Piercing the Corporate Veil with §20(9) of the New Companies Act

While there are many ways to pierce the corporate veil under both common and statutory law, we will look specifically at §20(9) of the New Companies Act:3

'If, on application by an interested person or in any proceedings in which a company is involved, a court finds that the incorporation of the company, any use of the company, or any act by or on behalf of the company, constitutes an unconscionable abuse of the juristic personality of the company as a separate entity, the court may –

(a) declare that the company is to be deemed not to be a juristic person in respect of any right, obligation or liability of the company or of a shareholder of the company or, in the case of a non-profit company, a member of the company, or of another person specified in the declaration; and

(b) make any further order the court considers appropriate to give effect to a declaration contemplated in paragraph (a).'

What this effectively means is that interested parties can now approach the court, by motion, for an order that the incorporation, use or any act by or on behalf of the company constitutes an unconscionable abuse of juristic personality and to pierce or lift the corporate veil. However, the new statutory basis for piercing the corporate veil also raised new questions.

  1. What is 'unconscionable abuse'?
  2. Who may invoke and use §20(9)?
  3. How is §20(9) to be invoked?
  4. What orders may be made under §20(9)?
  5. Does §20(9) override the common law?
  6. Is §20(9) to be used as a remedy of last resort?4

We look to the case of Stephen Malcolm Gore N.O. and 37 Others N.N.O WC Case Number 18127/2012, the first case to fully contemplate §20(9) to answer these questions.

1. What is 'unconscionable abuse'?

As §20(9) does not define 'unconscionable abuse', we must look to case law for guidance.

In the Stephen Malcolm Gore case summarized in the beginning of this article, the court stated that "term 'unconscionable abuse of the juristic personality of a company' postulates conduct in relation to the formation and use of companies diverse enough to cover all the descriptive terms like 'sham', 'device', 'stratagem' and the like used in that connection in the earlier cases, and - as the current case illustrates - conceivably much more." The judge went on to list certain actions the King Group had taken that constituted unconscionable abuses such as those that "involved the controllers of the companies treating the group in a way that drew no proper distinction between the separate personalities of the constituent members and in using the investors' funds in a manner inconsistent with what had been represented. The first mentioned category of impropriety, in my view, constituted an unconscionable abuse by the controllers of the juristic personalities of the relevant subsidiary companies as separate entities and brought the case within the ambit of the statutory provision." This means that the subsequent improprieties simply added fuel to the piercing lance of the learned Judge when, in his wisdom, he applied §20(9).

2. Who may invoke §20(9) of the Companies Act?

Section 20(9) permits any 'interested person' to bring an application to court requesting the court to deem a company not to be a juristic person. However, the section also does not define the term 'interested person'.

In TJ Jonck BK t/a Bothaville Vleismark v Du Plessis 1998 (1) SA 971 (O), the court found that term 'interested person' under the Close Corporations Act, was not to be interpreted too restrictively, but at the same time it is not to be interpreted too widely as to include an indirect interest. The court further stated that the interest is limited to a financial or monetary interest. A creditor of a corporation, for instance, would be an interested person.5

In the instance of the King Group, the learned Judge explains his interpretation of 'interested person'.

"I do not think that any mystique should be attached to ['interested person']. The standing of any person to seek a remedy in terms of the provision should be determined on the basis of well-established principle; see Jacobs en 'n Ander v Waks en Andere 1992 (1) SA 521 (A), at 533J-534E, and, of course, if the facts happen to implicate a right in the Bill of Rights, s 38 of the Constitution. There can be no doubting that the applicants have a direct and sufficient interest in the relief sought so as to qualify as 'interested persons' within the meaning of the provision."

Earlier in the judgement, at paragraph 34, the Judge states that "The provision brings about that a remedy can be provided whenever the illegitimate use of the concept of juristic personality adversely affects a third party in a way that reasonably should not be countenanced"

(underlined for emphasis). Thus §20(9) can be evoked by what the Judge's refers to as a third party, further qualified by the explanation that is given to the term interested person, as set out above.

At footnote 36 of the judgement, the Judge makes the following remark, reminding us of the very subtle, yet clear distinction between the remedy that is borne out of the Act, on the one hand, and the manifestation of a consequence within the conduct of the offending party on the other hand "The expression in the statute relates to the conduct giving rise to the remedy, whereas that used in the judgments related to the consequences of the conduct."

3. How is §20(9) to be invoked?

A declaration by the court in terms of §20(9) that a company is deemed not to be a juristic person may be sought by way of application or through action proceedings. The court may also act on its own initiative in deeming a company not to be a juristic person should it find in any proceedings in which a company is involved that there has been an unconscionable abuse of the juristic personality of the company as a separate entity.6

The Judge further states "By expressly establishing its availability simply when the facts of a case justify it, the provision detracts from the notion that the remedy should be regarded as exceptional, or 'drastic'."

In conclusion to this question, note that this case was brought to court in the form of an Application. Section 20 is to be read with section 218 of the Act. Where the Act is contravened, the provisions of section 218 of the Act may serve as a bridge between this heavier onus to pierce the corporate veil and personal liability for damages resulting from contravention of the Act. Legal practitioners may find themselves in a position where they will have to plead these remedies in the alternative to one another in legal process.7

4. Orders that may be made under §20(9)

A court may declare a company not to be a juristic person in respect of certain rights, obligations or liabilities of the company; or of a shareholder of the company; or, in the case of a non-profit company, a member of the company, or of another person specified in the declaration. A court does not have the power to intervene under §20(9) where the unconscionable abuse is not in respect of any such right, obligation or liability.

In declaring that a company is deemed not to be a juristic person, a court is given a wide discretion by §20(9) of the Act to make any further orders that it considers appropriate to give effect to such declaration.8

At paragraph 34, the learned Judge confirms the very wide ambit of §20(9) (b):

"The unqualified availability of the remedy in terms of the statutory provision also militates against an approach that it should be granted only in the absence of any alternative remedy. Paragraph (b) of the subsection affords the court the very widest of powers to grant consequential relief. An order made in terms of paragraph (b) will always have the effect, however, of fixing the right, obligation or liability in issue of the company somewhere else. In the current case the 'right' involved is the property held by the subsidiary companies in the King Group and the obligation or liability is that which any of them might actually have to account to and make payment to the investors."

5. Does §20(9) override the common law?

Where the requirements of §20(9) are not met and the section cannot be relied on, the common law remedy of piercing the veil would probably apply, since the section does not override the common law instances of piercing the corporate veil.9 The principles developed at common law with regard to piercing the corporate veil would certainly serve as useful guidelines in interpreting §20(9) of the Companies Act.10

The learned Judge confirms that

"The introduction of the statutory provision has given rise to some debate on whether the subsection has replaced the common law on piercing the corporate veil. Certainly there is no express intention apparent to that effect, as for example to be seen in s 165(1) of the Act (concerning derivative actions), but, equally, there is no express indication that the intention is not to displace the common law, like that to be found in s 161(2)(b) (concerning remedies available to protect the rights of the holders of securities in companies)."

The Judge further states,

"The statute enjoins that its provisions be construed with appropriate regard to subsections 5(1) and (2) read with s 7 of the Act (including, to the extent appropriate, a consideration of foreign company law). Approaching the interpretation of s 20(9) of the Companies Act in that manner I am unable to identify any discord between it and the approach to piercing the corporate veil evinced in the cases decided before it came into operation."

Thus it can be said that §20(9) is more of a codification of the common law as it has been evolving over the years, particularly since the Salomon case,11 to date.

The Judge in his wisdom comes to the following conclusion. "Having regard to the established predisposition against categorisation in this area of the law and the elusiveness of a convincing definition of the pertinent common law principles, it seems that it would be appropriate to regard s 20(9) of the Companies Act as supplemental to the common law, rather than substitutive." (underlined for emphasis)

6. Is §20(9) to be used as a remedy of last resort?

At common law, the remedy of piercing the veil is to be used only as a last resort according to the Hülse-Reutter case. In Amlin (SA) Pty Ltd v Van Kooij 2008 (2) SA 558 (C) the court stated that "piercing the veil is a rather drastic remedy. For that reason alone, it must be resorted to rather sparingly and indeed as the very last resort in circumstances where justice will not otherwise be done between two litigants."

Judge Binns-Ward confirms in his ruling that the he thinks the court should have wider discretion to pierce the corporate veil under §20(9) in comparison to the common law. The judgement states "The unqualified availability of the remedy in terms of the statutory provision also militates against an approach that it should be granted only in the absence of any alternative remedy."

This remedy is thus NOT one of last resort.

Footnotes

1 Stephen Malcolm Gore N.O. and 37 Others N.N.O WC Case Number 18127/2012

2 Dennis Davis (Ed.) Companies and other Business Structures 2 ed (2011) p 24

3 Act 71 of 2008

4 R Cassim 'Piercing the corporate veil "Unconscionable abuse" under Companies Act 71 of 2008' (2012) De Rebus August 2012

5 R Cassim 'Piercing the corporate veil "Unconscionable abuse" under Companies Act 71 of 2008' (2012) De Rebus August 2012

6 R Cassim 'Piercing the corporate veil "Unconscionable abuse" under Companies Act 71 of 2008' (2012) De Rebus August 2012

7 N Schoeman 'Piercing the corporate veil under the New Companies Act' (2012) De Rebus June 2012

8 R Cassim 'Piercing the corporate veil "Unconscionable abuse" under Companies Act 71 of 2008' (2012) De Rebus August 2012

9 Cassim et al Contemporary Company Law (2011) p 58

10 R Cassim 'Piercing the corporate veil "Unconscionable abuse" under Companies Act 71 of 2008' (2012) De Rebus August 2012

11 Salomon v Salomon & Co Ltd [1897] AC 22

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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