Lifting the Corporate Veil: An Exceptional Concept of the Shareholders’ Limited Liability Principle
Introduction
One of the main motivations to form a legal entity is to limit the liability of its members and controllers for the obligations of the business of the legal entity. As a separate entity, a company is set up to shield the shareholders of a company from personal liability for the debts or negligence of the business. Thus, shareholders are not liable for the company’s debts beyond their initial capital investment, and have no proprietary interest in the property of the company[1] as per the limitation of liability and separation principle. Such principle is that the shareholders are held liable only toward the legal entity and not toward third parties, virtually creating a “veil” between the shareholders and third parties. However, in certain circumstances, such veil may be lifted by a court order where a fraudulent and misleading use is made of the legal entity as an exception of the principle of a separation and limited liability principle. While this view appears in the Anglo-American Law, it has also been adopted in civil laws, including Turkish Law. This article examines the grounds upon which the corporate veil can be pierced under Turkish law.
Being Held Liable by Lifting the Corporate Veil
The majority of legal systems distinguish the corporate entity wholly from its members with the rationale to separate the company’s legal personality from the shareholders’ as the company is independent and distinct from its shareholders. Similarly, the Turkish legal system provides clear distinction between the liabilities of the equity companies and their shareholders’ personal assets, where the company is the sole beneficiary of the credits it is owed as it is solely liable for the debts. Thus, the company has been shielded from its shareholders’ personal liabilities and vice versa. In this respect, under Turkish Law, limitation of shareholders’ liabilities is subject to certain exceptions as (i) the obligations vis-à-vis the government and (ii) a legal doctrine accepted by the Turkish case law, “lifting the corporate veil” as a judicially imposed exception to the separation principle where a shareholder is responsible for the company’s action.
As explained above, while the shareholders’ limited liability resulting from the separation principle under Turkish law, the Turkish Courts of Appeals advanced the doctrine of veil lifting due to the occurrence of companies that have been set up for fraudulent purposes, and/or to avoid existing obligations. By this exception, the courts shall disregard the separation principle[2] of the corporation, and hold the shareholders responsible for their actions of the corporation as if it were the actions of the shareholders. Under Turkish law, the shareholders (natural or legal entity shareholders) may be held liable by veil lifting (i) in case of fraud committed against the law or (ii) breach of a contractual obligation by hiding behind the corporation or (iii) breach of good faith as per Articles 2 and 3/II of the Turkish Civil Code.
The Grounds to Lift the Corporate Veil
The necessity to lift the corporate veil may occur in situations related to (i) deficiency of shareholders’ equity; (ii) serious misconduct, such as abuse of the corporate form and (iii) intermingling the assets of the shareholder and entities.
Deficiency of Shareholders’ Equity
Deficiency of shareholders’ equity might result in holding the shareholders liable for the obligations of the legal entity by lifting the corporate veil. The deficiency must be determined objectively by taking the purposes and activity size of the legal entity into account.
According to the Turkish Commercial Code (“TCC”), a certain amount of shareholders’ equity is required to be determined and allocated to the company so that the creditors can be protected. In such respect, the shareholders are liable to fund the subscribed amount of capital to the company. However, such right must be exercised according to the good faith principle, and the amount so allocated must be determined in accordance with the good faith principle[3] considering the activities of the company and underlying risks likely to arise therefrom. The capital amount must be sufficient to cover the possible risks likely to occur, not only in the company itself, but also through the conduct of its activities. Then, in the event a company with insufficient equity enters into legal transactions without rectifying its equity deficiency, it may be required to lift the corporate veil and hold the shareholders liable for the obligations of the legal entity.
Lifting the Veil in the Companies with a Controlling Shareholder
The fact that one or more shareholders having the authority to represent and manage the company in capital companies (holding the majority of the share capital or voting rights) is referred to as the controlling shareholding. The control over a company can also occur by holding the majority of shares by another company or person. The Turkish courts attempt to pierce the corporate veil and make the controlling shareholder(s) liable for the debts of the company in the case of controlling shareholder(s) abuse of its controlling rights to the detriment of the creditors for the sake of their own interests. As an example, the courts may pierce the veil of a parent company if the parent company used its subsidiary for the purpose of fraudulent transactions.
Intermingling of Funds and Assets of Shareholders and Entities
Shielding personal assets from corporate liabilities is generally one of the primary purposes of incorporation. However, failing to keep corporate and personal assets distinct with the purpose of misleading third parties, whereby a shareholder aims to keep its identity disguised with respect to ownership of the assets, may lead to lifting the corporate veil. Lifting may apply where a parent or holding company fails to ensure the necessary distinction between its own assets and those of its subsidiary (horizontal intermixing of the assets).
Conclusion
One of the major goals behind the concept of the limited liability of shareholders is to protect shareholders from being liable for the company’s debts and other obligations. As an exception to this general limited liability principle, lifting the corporate veil is an instrument that protects the interests of third party creditors.
The necessity to lift the corporate veil may occur in situations related to insufficient capital (deficiency of shareholders equity), shareholders’ abuse of the corporate entity, and intermingling of the assets contrary to the good faith principle. In fact, under certain circumstances likely to occur in practice, the “separateness principle” may result in unjust results, and lifting the corporate veil thus assures the legal certainty.
[1] Çamoğlu Ersin, Piercing the Corporate Veil, Banking and Corporate Law Journal, June, 2016, Volume XXXII No. 2.
[2] “Single debt principle” is set forth under Article 480/1 of the Turkish Commercial Code. Save for exceptions stipulated under the TCC, no obligation shall be conferred upon the shareholders by the articles of association, other than the premium exceeding the share price or nominal value of the share.
[3] Yanlı Veliye, Piercing the Corporate Veil for Joint Stock Companies, May, 2009, p 111.
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