Hiding behind the veil

October 1st, 2013
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By Rehana Cassim

The vexed topic of piercing the corporate veil under s 20(9) of the Companies Act 71 of 2008 (the Act) was discussed by the author in De Rebus in August 2012 (2012 (Aug) DR 22). Section 20(9) of the Act gives the courts a general statutory discretion to pierce the corporate veil. It was submitted in that article that there are some uncertainties regarding the interpretation and the scope of s 20(9) of the Act, such as –

  • the meaning of the term ‘unconscionable abuse’;
  • whether s 20(9) overrides the common law instances of piercing the corporate veil;
  • whether piercing of the veil is still to be regarded as an exceptional remedy that may be used only as a last resort; and
  • who an ‘interested person’ would be under s 20(9).

In the recent case of Ex parte Gore NO and Others NNO (in their capacities as the liquidators of 41 companies comprising King Financial Holdings Ltd (in liquidation) and its subsidiaries) [2013] 2 All SA 437 (WCC) the Western Cape High Court handed down the first judgment on s 20(9) of the Act. This judgment gives valuable insight into the questions raised above, concerning the interpretation of s 20(9) of the Act. The issue in Gore was whether the court should pierce the corporate veil in a group of companies. This article will discuss the Gore case, as well as the court’s approach to piercing the corporate veil in company groups and, finally, will examine the court’s dicta on the interpretation of s 20(9) of the Act.

Section 20(9) of the Act states:

‘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).’

The Gore case

In the Gore case the applicants were the liquidators of 41 companies that had formed part of a group of companies, referred to as ‘the King Group’. The holding company was King Financial Holdings Limited (KFH), which was also in liquidation. The three King brothers were directors of KFH and most of its subsidiaries, and held a majority of the KFH shares, which enabled them to exercise control of the King Group.

The companies in the King Group provided financial services by way of marketing investments in commercial and residential immovable properties. Investments solicited by the King Group were structured in the form of a purchase by an investor of shares in a member of the group. The acquisition of the shares was coupled with an extension of a loan by the investor concerned to the company of which he was to be a shareholder.

The affairs of the King Group had been conducted in a manner that did not maintain any distinguishable corporate identity between the various companies in the group. Some examples of how the group’s affairs were conducted are as follows:

  • The documentation purporting to evidence an investment was ineptly prepared and failed to identify the company in which the particular investment was being made. The invested funds were in fact ‘allocated’ by the management of the King Group into whichever company it saw fit, and this had occurred without any properly kept accounting record. The court described the record keeping of the companies as ‘grossly inadequate’ (at para 8).
  • Funds solicited from investors were transferred at will by the controllers of the holding company between the various companies in the group, with no regard to the individual identity of the companies concerned.
  • The flow of funds within the King Group appeared to have been materially determined by the need of the King brothers to sustain their scheme by finding money to pay existing investors who wished to withdraw their investments.
  • Shares in KFH were marketed and sold directly to the public even though, at the relevant time, the company had not been converted from a private company into a public company and could consequently not issue shares to the public.
  • A greater number of shares were issued than had been authorised.

As a consequence of the dishonest and chaotic administration of the affairs of the King Group, the liquidators of the constituent companies were unable to identify the relevant corporate entities against which the individual investor-creditors had claims. The question before the court was whether it should in these circumstances pierce the corporate veil and disregard the separate corporate personality of the various subsidiary companies, so that the assets of the subsidiary companies could be regarded as the assets of the holding company for purposes of the investors’ claims. The application was brought under the common law, alternatively in terms of s 20(9) of the Act.

Court’s findings

The court found that the entire group had in effect operated as one entity through the holding company, and that the King brothers had ‘treated all their companies as one’ (at para 8). It found that there was no distinction for practical purposes when it came to dealing with investors’ funds between KFH and the subsidiary companies. The court found that the disregard by the King brothers of the separate corporate personalities of the companies in the King Group was so extensive as to impel the conclusion that the group was in fact a ‘sham’ (at para 15).

The court appears to have decided that there was an unconscionable abuse by the controllers of the juristic personalities of the subsidiary companies as separate entities and that this had brought the case within the ambit of s 20(9) of the Act.

Court’s decision

The court declared that, in terms of s 20(9) of the Act, the subsidiary companies, with the exception of KFH, be deemed not to be juristic persons in respect of any obligation by such companies to the individuals or entities that had invested in the King companies. It held further that the King companies were to be regarded as a single entity. Their separate legal existence was ignored and the holding company, KFH, was treated as the only company.

Under s 20(9)(b) of the Act a court may declare that a company is deemed not to be a juristic person in respect of any right, obligation or liability of the company. The court in Gore stated that an order made in terms of s 20(9)(b) will always have the effect of fixing the right, obligation or liability in issue of the company somewhere else (at para 34). The court found that the right involved in this case was the property held by the subsidiary companies in the King Group and the obligation was that which any of them might actually have to account to and make payment to the investors (at para 34).

The applicants (other than the liquidators of KFH) were directed to transfer all monies that might remain in each of the King companies after payment of all liquidation costs, bondholders’ claims and claims other than claims by investors to the liquidators of KFH to be administered as a single pool of assets available for distribution to the investors.

The approach adopted by the court to piercing the corporate veil in company groups

The Act defines a ‘group of companies’ as meaning a holding company and all its subsidiaries (s 1). Each company in a group of companies is in law a separate legal entity with its own separate legal personality and its own rights, privileges, duties and liabilities separate and distinct from those of the other subsidiary companies. The fact that a group of companies effectively forms one economic unit does not necessarily mean that the separate identity of each company is ignored and that the group is treated as one entity. It follows that the acts of a holding company are not per se the acts of its subsidiary companies, or conversely, since the holding company is a separate legal entity from its subsidiary.

The court in Gore, referring to Contemporary Company Law with approval, acquiesced in the point made there that courts have struggled with the correct approach to adopt in determining whether or not to pierce the corporate veil (see para 21 of the judgment and FHI Cassim, MF Cassim, R Cassim, R Jooste, J Shev and J Yeats Contemporary Company Law 2ed (Cape Town: Juta 2012) at 42). This difficulty is more acute in the context of groups of companies, where the courts have been divided in their approach whether, and in what circumstances, the corporate veil may be pierced so that the group is in fact treated as a single entity as opposed to a collection of different corporate entities.

The courts have adopted either a liberal approach (see, eg, DHN Food Distributors Ltd v London Borough of Tower Hamlets [1976] 3 All ER 462 and Ritz Hotel Ltd v Charles of The Ritz Ltd and Another 1988 (3) SA 290 (A)) or a conservative approach to piercing the veil in company groups. The stricter, conservative view holds that courts are not entitled to disregard the separate legal personality of a company in a group simply because it is just to do so. This was spelt out in Adams and Others v Cape Industries Plc and Another [1991] 1 All ER 929 (CA) as follows:

‘… save in cases which turn on the wording of particular statutes or contracts, the court is not free to disregard the principle of Salomon v A Salomon and Co Ltd [1897] AC 22, [1895–9] All ER Rep 33, merely because it considers that justice so requires. Our law, for better or worse, recognises the creation of subsidiary companies, which though in one sense the creatures of their parent companies, will nevertheless under the general law fall to be treated as separate legal entities with all the rights and liabilities which would normally attach to separate legal entities.’

This dictum was approved in Wambach v Maizecor Industries (Edms) Bpk 1993 (2) SA 669 (A) and Macadamia Finance BK en ’n Ander v De Wet en Andere NO 1993 (2) SA 743 (A) where both courts adopted the conservative view. They refused to pierce the corporate veil and to view the companies in the group as a single economic entity. It thus seems that, while South African jurisprudence had initially adopted the liberal approach, in recent years there has been a trend in South Africa leaning towards the conservative approach. The approach of the courts is nevertheless unpredictable.

Even though the court pierced the corporate veil in Gore, the court seemed to have adopted the conservative approach, since it pierced the corporate veil on the basis that the King Group was a sham, and found that this had brought the activities of the group within the meaning of ‘unconscionable abuse’ in s 20(9). The court drew attention to the recent case of VTB Capital Plc v Nutritek International [2013] UKSC 5 where the UK Supreme Court, in declining to pierce the corporate veil, implied that the existence of pertinent statutory provisions could determine a different conclusion on the question of whether, and in what circumstances, a court could pierce the corporate veil (see para 130).

In Gore, Binns-Ward J commented that the UK Supreme Court in VTB Capital may not have refrained from piercing the corporate veil if a statutory provision such as s 20(9) of the Act had been applicable (para 24). It seems that the applicability of a statutory provision on piercing the corporate veil may counter the judicial hesitancy to pierce the corporate veil, including in instances of company groups.

The court’s interpretation of s 20(9) of the Act

The court’s dicta on the interpretation of s 20(9) of the Act is set out below. These dicta answer some of the questions raised by the author in the previous article (supra).

What is ‘unconscionable abuse’?

The phrase ‘unconscionable abuse’ is not defined in s 20(9) and the section fails to provide any guidance on the facts or circumstances that would constitute an ‘unconscionable abuse’ of the juristic personality of the company as a separate entity (see 2012 (Aug) DR 23).

In Gore the court stated that the words ‘unconscionable abuse’ are less extreme than the words ‘gross abuse’, which are used in s 65 of the Close Corporations Act 69 of 1984 in a similarly worded provision to s 20(9) of the Act (see 2012 (Aug) DR 23 for a discussion of the conduct that may constitute ‘gross abuse’). The court asserted that the words ‘unconscionable abuse of the juristic personality of a company’ used in s 20(9) postulate conduct in relation to the formation and use of companies that is diverse enough to cover all the descriptive terms such as ‘sham’, ‘device’, ‘stratagem’, and conceivably much more. The court stated that this indicates that the remedy may be used whenever the illegitimate use of the concept of juristic personality adversely affects a third party in a way that reasonably should not be countenanced (at para 34).

Does s 20(9) override the common law?

The question was raised whether s 20(9) of the Act overrides the common law instances of piercing the corporate veil (2012 (Aug) DR 24). It was contended that s 20(9) did not override the common law instances of piercing the corporate veil, and that the principles developed at common law with regard to piercing the corporate veil would serve as useful guidelines in interpreting s 20(9) of the Act.

In Gore the court found that the language of s 20(9) is very wide, which it stated indicates an appreciation by the legislature that s 20(9) would apply in widely varying factual circumstances (para 32). The section broadens the bases on which the South African courts have till now been prepared to pierce the corporate veil (at para 33). The court noted that s 5 of the Act enjoins a court to interpret the Act and apply it in a manner that gives effect to the purposes of the Act set out in s 7 and to the extent appropriate, to consider foreign law.

Approaching the interpretation of s 20(9) of the Act from this perspective, the court stated that it was unable to identify any discord between s 20(9) and the approach to piercing the corporate veil evinced in cases decided before it came into operation (at para 32). In light of the fact that there are no set categories of instances when a court will pierce the corporate veil at common law (Cape Pacific Ltd v Lubner Controlling Investments (Pty) Ltd and Others 1995 (4) SA 790 (A)), the court held that it is appropriate to regard s 20(9) as supplemental to the common law, rather than substitutive (at para 34).

Is s 20(9) a remedy of last resort?

At common law, piercing the corporate veil is regarded as a drastic remedy that must be resorted to sparingly and as a last resort in circumstances where justice will not otherwise be done (see for example Hülse-Reutter and Others v Gödde 2001 (4) SA 1336 (SCA) at para 23 and Amlin (SA) Pty Ltd v Van Kooij 2008 (2) SA 558 (C) at para 23). The question was raised whether the same principle would apply to s 20(9) of the Act and whether reliance could be placed on s 20(9) despite other remedies being available (2012 (Aug) DR 24). It was suggested that reliance may well be placed on s 20(9) despite other remedies being available.

In Gore, the court stated that s 20(9) introduces a firm and flexible basis for piercing the veil, and that it will erode the foundation of the philosophy that piercing the corporate veil should be approached with ‘à priori diffidence’ (at para 34). The court stated that the unqualified availability of the remedy in terms of s 20(9) militates against an approach that the remedy should be granted only in the absence of any alternative remedy. Section 20(9) is available as a remedy simply when the facts of a case justify it, which detracts from the notion that the remedy should be regarded as exceptional or drastic to be used only as a last resort (at para 34).

Who is an interested person under s 20(9)?

Section 20(9) of the Act permits any ‘interested person’ to bring an application to court requesting the court to deem a company not to be a juristic person, but the section does not define the term ‘interested person’.

The court stated in Gore that no mystique attaches to the meaning of the term ‘interested person’. The standing of any person to seek a remedy in terms of s 20(9) of the Act should be determined on the basis of well-established principles (see Jacobs en ’n Ander v Waks en Andere 1992 (1) SA 521 (A) at 533 – 534) and, if the facts implicate a right in the Bill of Rights, s 38 (enforcement of rights) of the Constitution (at para 35). The court found that the liquidators had a direct and sufficient interest in the relief sought so as to qualify as ‘interested persons’.

Conclusion

The judgment in the Gore case is highly significant not only because it is the first case in which the statutory remedy of piercing the corporate veil was considered, but also because of the useful and thorough analysis of the authorities on piercing the corporate veil. The judgment sends a clear warning to directors, shareholders and controllers of company groups that the corporate veil will be pierced where unconscionable abuse of the juristic personality of the company is found, including in company groups and that the remedy will not be regarded as an exceptional one to be used only as a last resort. It appears that the statutory remedy of piercing the corporate veil would be applied by the courts with less reticence than the common law remedy of piercing the corporate veil. It remains to be seen how this statutory remedy will be further developed by the courts in the future.

 

Rehana Cassim BA (cum laude) LLM (cum laude) (Wits) is an attorney at Rooth & Wessels Inc in Pretoria.

This article was first published in De Rebus in 2013 (Oct) DR 34.