Piercing the Corporate Veil

Piercing the Corporate Veil

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 Piercing the Corporate Veil is the judicial act of imposing personal liability on otherwise immune corporate officers, directors, and shareholders for the corporation’s wrongful act.[1] Piercing Corporate Veil shows that the Limited Liability Company (“Company”) often cannot be separated from the parties’ interest such as the Shareholders of that Company. In this context, the Shareholders’ interest is the Company’s interest. Piercing Corporate Veil Concept stipulates that when “the separation condition” of Company with the Shareholders does not exist then the limited liability responsibility of the Shareholders should be absent. Therefore the Shareholders must be liable personally upon the loss of the Company.

Piercing Corporate Veil also applies to the corporate officers such as director and/or commissioner if it shows that loss of company because of the corporate officers’ wrongful act. Therefore director/commissioner of company must be liable to Company upon the loss of the company. In case of insolvency, they must be liable to the Creditors. This article will only discuss the Piercing Corporate Veil by the Shareholders. Piercing corporate veil by the shareholders The purpose of establishment of Company is to conduct the business activities that the respective founders (Shareholders) are not liable personally besides the assets that they put in the Company. In order to have a limited liability status, the Company must fulfill the formal requirements based on the prevailing laws and regulations. The founders must fulfill the requirements from pre-establishment to post-establishment of company. If the founders do not conduct their duty related to the fulfillment of legal status of the Company, the founders clearly do not want to have limited liability from the Company. With regard to the limited liability of Company, the Company owns at least the minimum required capital so that the Company can operate.

As a legal entity, the Company must be rendered the sufficient capital to conduct its activities. Moreover, the respesctive capital must be used based on the purpose of the Company and the Company’s interest. The misuse of the Company assets is not allowed by law. The purpose of the Company’s assets that were separated by the Shareholders, is to ensure only the respective separated assets will be liable, not all the assets of the Shareholders. The intermingling of assets of the Company and of the shareholders shows that it is difficult to separate the liability from the existing assets. As a consequence, the characteristic of limited liability of Company is absent because of law. In general the Company is established in order to have profits. That profit will be distributed among the Shareholders unless otherwise stipulated. The dividen given to the Shareholders every year is mandatory. If dividen is not given to the Shareholders every year, it shows that there is misuse of company for the Shareholders’ interest particularly the majority Shareholders.

In this scenario, the Piercing Corporate Veil can be applied. If the Shareholders transfer the assets of the Company to each Shareholder improperly, then the Piercing Corporate Veil can be conducted in this case. Theory of Piercing Corporate Veil With regard to the piercing corporate veil, there are five (5) theories e.g. agency, fraud, sham or façade, group enterprise and unfairness/justice. In the Agent theory, the Company is agent of the Shareholders. It shows that as an agent, the Company is not liable upon the acts that were conducted by itself based on the purpose of the Shareholders. Therefore there is no limited liability that applies to the Shareholders. In the Fraud theory, the particular action is conducted by the Company in order to avoid the personal liability. For example: the Shareholders treats the assets of the Company as their own personal assets, the respective Shareholders use the Company’s assets for his personal interest, and the Shareholders’ act emerges the transfer of Company’s assets to each Shareholders improperly. Furthermore, a ‘sham’ or façade will be applied as piercing the corporate veil if the corporate form was incorporated or used as a mask to hide the real purpose of the corporate controller. While a façade will be used as a category of illusory reference to express the court’s disapproval of the use of the corporate form to evade obligations, although the court has failed to identify clear test based on pragmatic consideration such as undercapitalization or domination.[2]

The purpose of the Shareholders to establish a company is only to avoid the limited liability; however they do not fulfill their obligations. For example: the intermingling of assets of the Company and Shareholder. Furthermore, the group enterprises theory will be applied as piercing the corporate veil because a corporate group is operating in such a manner as to make each individual entity indistinguishable, and therefore it is proper to pierce the corporate veil to treat the parent company as liable for the acts of the subsidiary. For example: the Board of Director (“BoD”) cannot take any action without considering the regulations of Parent Company with regard to the Company. In this case, BoD will take action only for the interest of the Parent Company as the Company’s shareholders. The Shareholder in a Company may also seek to pierce corporate veil to get the underlying reality of the situation, in order to avoid an unfair outcome. In that condition, the unfairness/justice theory can be applied for the piercing corporate veil.

For example: The majority shareholder also involves in making decision for the Company. Because of his respective action, the party that has legal relationship with the Company gets unfair outcome. If the respective party files a suit against the Company, his claim to Company will make the Company’s loss bigger. In this case, it would make it possible for the direct claim to the majority of shareholders to be made. Piercing the corporate veil based on Indonesia company law Company Shareholders are not personally liable for agreements entered into on behalf of the Company and are not liable for Company losses exceeding the nominal value of the shares individually subscribed.[3] The condition above will not apply if: The requirements for [a Company’s existence as]a legal entity have not been or are not fulfilled; Shareholder, either directly or indirectly, in bad faith, uses the Company solely for personal purposes; A shareholder is involved in unlawful acts committed by the Company; or A shareholder, either directly or indirectly, unlawfully uses the Company’s assets, which causes the Company assets to be inadequate to settle the Company’s debts. Point (1), it is clear that the Shareholders are not serious to obtain the status of limited liability.

This status can only be obtained after the Company has gained the Ministry of Laws and Human Rights (“MoLHR”) approval. If the Shareholders neglect the formal procedure of the establishment of the Company, it can be interpreted that the Shareholders do not really want to establish a limited liability company. The request to obtain MoLHR legalization must be submitted to the Ministry at the latest of 60 (sixty) days after the Deed of Establishment (“DoE”) is signed, together with the information about the supporting documents.[4] If the request to obtain the Ministry’s legalization is not submitted within this period, the Article of Association becomes void as from the passage of that period and the Company that has not obtained the legal entity status is dissolved by law and its settlement shall be carried out by the founders.

The Company cannot obtain the legal status not only because the Company has no MoLHR’s approval but also for other reasons such as the founders have not placed the capital as agreed before, founders do not give their authority to the Company’s officers to conduct the Company’s activities because the founders wishto conduct activities on behalf of the Company, etc. Point (2), the Shareholders in bad faith uses the Company for their own interest. The Company implements only the purposes and objectives of the Shareholders. This is in line with the Agent Theory. Therefore, the Shareholders in bad faith can not be protected by law. Piercing Corporate Veil can be applied in this case. Point (3 ) shows that a shareholder is involved in unlawful acts committed by the Company based on the Fraud theory. Anyone who causes loss to others, must be liable upon that loss. As an artificial person, the Company does not have objectives. In the event that the objective of Company is the same as the Shareholders’, the Shareholders will become liable. Point (4) related to the use of the Company’s assets illegally, in the event the Shareholders use the Company’s assets and losses exceeding the Company’s assets, which cause the Company can not settle its debts to Creditors, then the piercing corporate veil can apply to this case. Parties that are being protected by the principle of the piercing of corporate veil Article 3 (2) Law 40/07 does not explain explicitly the parties that are being protected by the Principle of the Piercing of Corporate Veil.

However, Article 3 (2) Law 40/07 may give protection to the Creditors of the Company. Moreover, Article 61 and Article 62 Law 40/07 may give protection to the Minority Shareholders. Article 61 and 62 Law 40/07 stipulate the followings: Each shareholder is entitled to file a lawsuit against the Company in the District Court, if [that Shareholder] suffers losses by the Company’s actions which are considered unfair and without reasonable ground as a result of a resolution of the General Meeting of Shareholders (“GMS”), BoD and/or Board of Commissioners (“BoC”). The lawsuit shall be filled in the District Court whose jurisdiction covers the Company’s seat. Each shareholder is entitled to demand the Company to purchase his shares at a reasonable price, if that shareholders does not approve of the Company’s action which is detrimental to the shareholder or the Company, namely:

  1. An amendment to the Article of Association;

  2. A transfer, or a change of the Company’s assets that have a value of more than 50% (fifty percents) of the Company’s net assets; or

  3. A Merger, a Consolidation, an Acquisition or a Separation.

Where the shares requested to be purchased in the abovementioned condition exceed the limit for the provision regarding share repurchase by a Company, the Company must make an effort that the remaining shares be purchased by a third party. Those Articles show that the Shareholders only have rights to sue the Company, if the respective actions/or acts of the Company are taken based on the prevailing mechanism, and/or have been ratified by the Company based on the prevailing laws and regulations.

Case Example: We may see the Bank Summa’ case on 1992. Whether Mr. Edward Soeryadjaya as a shareholder as well as the Corporate officer of Summa Bank must responsible for Summa Bank’s debts. Summa Bank had loss and could not pay its debts to its Creditor. Mr.Edward’s father, Mr. William Soeryadjaya (“Om William”) acted as a personal guarantor of Summa Bank. Bank Indonesia gave warnings to Bank Summa because they could not fulfill their obligation. Bank of Indonesia has stipulated the period time for Bank Summa to pay its debts. When the time was lapsed, Mr. Edward Soeryadjaya could not pay its debts.

Because of this, Om William had to sell his shares in PT Astra International to pay Summa Bank’s debts that managed by his son. In this case, the Shareholders may loss its immunity upon the limited liability subsequently the Shareholder will be personally liable. Also the limited liability principle may be absent when the Corporate Officers (“Board of Directors or Board of Commissioners”) are at fault or negligent in carrying out their duties according to the principle of good faith (Article 97 (3) Law 40/07).

-Mary Osmond-

[1] Blacklaw dictionary

[2] Widjaja,Gunawan, Risiko Hukum sebagai Direksi, Komisaris & Pemilik PT, Forum Sahabat, 2008, page 31.

[3] Art.3(1) Law No. 40 of 2007 regarding Limited Liability Company (August 17, 2007) (“Law 40/07”)

[4] Art.10 (1) Law 40/07

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