Piercing the corporate veil using personal guarantees
While the term ‘veil of incorporation’ may not be familiar, for those companies that have extended credit to their customers only to have them default when it comes time to pay, its consequences are all too familiar. Ultimately the veil prevents a creditor from enforcing a debt against an individual person within a company, and forces them to go up against the company itself.
It is well understood that a key motivation, indeed often the key reason, for setting up a company and incorporating is to limit the risk to the owners (shareholders) of that company. This is true regardless of whether the company is a smaller proprietary company or a larger publicly traded one.
In part, this ‘risk limitation’ results from a fundamental principle of incorporation, that upon incorporation the company itself gains legal personality. This means that in the eyes of the law the company is the entity that enters into agreements with other parties, and as result, is ultimately liable under those agreements. In comparison, the liability of the shareholders (in most instances) will be limited to the amount of money they have paid for their shares, often as little as a $1.
It has been a well-established principle for more than one hundred years that there is nothing improper about setting up a company just for this purpose. This benefit is known as the ‘veil of incorporation’, and ever since its inception lawyers have attempted (with varying degrees of success) to pierce this veil or find a way around it.
With the above in mind, an essential question you need to consider is whether your ability to collect a debt owing to your business will be stopped dead by the effects of incorporation. In the worst cases this can leave you with no recourse but to try and recover a debt from a company in liquidation.
One way around this situation is through personal guarantees. In short, a guarantee expands the number of persons you can enforce the debts of the company against. It does so by creating an agreement with an officer of the debtor company (generally a director) that they will be liable for the company’s debts. As directors will often have personal assets and real property, these can be invaluable in ensuring that the debt is paid.
A key mistake often made is failing to get the guarantee signed. We have seen horror stories where clients are owed a substantial sum of money by a customer and has a great personal guarantee document. Unfortunately, the guarantee not being signed leaves the client’s only recourse for recovery against the (often) insolvent company.
How we can help
We can help you protect your business by ensuring that your agreements and process incorporate strong personal guarantees. This will ensure the debtor finds it much more difficult to hide behind the corporate veil. Contact us on (07) 3667 8966 today to assist you in drafting the appropriate documentation.
Matthew Foster – Solicitor