Piercing the Corporate Veil

By Liad Hadar, Director at Hadar Incorporated, Specialist Property Law Firm
This article first appeared in Asset Magazine’s July 2024 edition

In an ideal world, landlords sign lease agreements with tenant companies with deeds of suretyships or guarantees from directors or shareholders of the tenant.

For several reasons, these security instruments are not always obtained, leaving landlords exposed as they can only theoretically pursue legal action against the tenant company. This however does not take into consideration that a landlord may have an alternative method of pursuing directors or shareholders in their personal capacities.

In the intricate landscape of South African company law, the principle of limited liability serves as a cornerstone, shielding company directors and shareholders from personal liability for the company’s debts.

In certain circumstances however, the law permits the “piercing” or “lifting” of what is known as the corporate veil, thereby holding directors and even shareholders personally liable for the company’s obligations.

For landlords dealing with tenant companies that fail to meet their rental commitments and for such companies to then not be in any financial position to pay the landlord despite any legal action undertaken, understanding the nuances of this legal doctrine can be crucial in seeking recourse and securing owed payments in alternative ways.

The Principle of Limited Liability and Its Exceptions

The South African judiciary is composed of several tiers, namely the Small Claims Courts, Magistrate Courts, High Courts, Supreme Limited liability is a foundational principle of company law, providing that the personal assets of directors and shareholders are generally protected from the company’s creditors. This principle encourages entrepreneurship and investment, as well as a willingness to hold directorship positions, by mitigating personal financial risk. However, the law recognizes that this protection can be misused, leading to unjust outcomes for creditors, including landlords.

To address potential abuses, South African law includes provisions for piercing the corporate veil. This legal remedy however is not applied lightly and is reserved for cases where it is just and equitable to do so. The courts may pierce the corporate veil to prevent directors or shareholders from using the company as a shield for fraudulent or dishonest behaviour.

Circumstances Warranting Piercing the Corporate Veil – Directors

For a landlord seeking to hold directors personally liable for a tenant company’s unpaid rent, it is essential to understand the circumstances under which the courts may be willing to pierce the corporate veil. These circumstances typically include:

  1. Fraud or Dishonesty: If the director/s have engaged in fraudulent activities or have dishonestly used the company entity to evade their obligations, the court may decide to pierce the corporate veil. This includes situations where the company was simply used as a vehicle to commit fraud, mislead creditors, or siphon assets away from the company to avoid paying debts.
  2. Improper, Reckless or Negligent Conduct: The courts may also pierce the corporate veil in cases where director/s have conducted business recklessly or with gross negligence. If the director/s knew or should have known that the company could not pay its debts and continued to incur liabilities, they could be held personally liable for those debts.
  3. Alter Ego Theory: When a company is merely a facade for the personal dealings of its directors, the courts may treat the company and its director/s as one and the same. This typically occurs when there is no real separation between the company’s activities and the personal activities of its director/s, indicating that the company is simply an alter ego of the director/s.

The New Companies Act and Case Law

Section 20(9) of the Companies Act 71 of 2008 (known as The New Companies Act) empowers the South African courts, through legislation, to pierce the corporate veil. It provides that if, in any proceedings, it is shown that the incorporation or use of a company constitutes an unconscionable abuse of the juristic personality of the company, the court may declare that the company is not to be treated as a juristic person, thus holding the director/s personally liable.

Notable cases, such as Hülse-Reutter v Gödde, have shaped the judicial approach to piercing the corporate veil in South Africa. In this case, the court emphasized the need for a just and equitable basis for piercing the veil and highlighted that mere ownership of a company or involvement in its business does not automatically lead to personal liability. Although it is possible to pierce the corporate veil, the threshold is relatively high and not easily achieved.

Strategies for Landlords

For landlords dealing with tenant companies that have defaulted on their rental obligations and with whom there have been no deeds of suretyships, guarantees or other such security, pursuing personal liability against the directors can be a daunting process. However, several strategic steps can enhance the likelihood of success:

  1. Gather Evidence: Collecting evidence of fraudulent or improper conduct by the directors is crucial. This may include financial records (often landlords have a right to demand financials and other accounting documents in terms of a particular clause in lease agreements), communications, and any other documentation that demonstrates the misuse of the company’s separate legal personality.
  2. Legal Advice: Engaging lawyers with expertise in corporate law is essential. An experienced attorney can help assess the viability of piercing the corporate veil and guide the landlord through the complex legal proceedings.
  3. Litigation: After receiving professional and expert input from a lawyer, initiating legal proceedings to pierce the corporate veil requires a well-prepared case. The landlord must present a compelling argument that the conduct of director/s justifies disregarding the company’s separate legal identity.

Conclusion

Piercing the corporate veil is a significant legal remedy that allows landlords to hold directors and shareholders personally liable for the debts of a tenant company in specific circumstances. While the principle of limited liability generally protects directors, the courts recognize that there are instances where justice and equity demand a different approach.

For landlords facing the challenge of unpaid rent from insolvent tenant companies, understanding the legal grounds for piercing the corporate veil and seeking appropriate legal advice is essential but also an extremely effective alternative remedy to pursue recovery of debts.

By navigating this complex legal landscape effectively, landlords can enhance their prospects of recovering owed payments and ensuring that directors are held accountable for their actions. Ultimately, the ability to pierce the corporate veil serves as a crucial safeguard against the misuse of corporate structures, promoting fairness and integrity in the commercial world and repercussions for gross mismanagement of corporate entities to the detriment of creditors, including landlords.

Contact the Hadar Incorporated Team to assess whether you have good prospects of success in pursuing directors or shareholders of a tenant company in arrears despite not having a deed of suretyship or guarantee to rely on.