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‘Unconscionable abuse’ under the Companies Act 71 of 2008

Piercing the corporate veil ‘Unconscionable

abuse’ under the Companies Act 71 of 2008
August 1st, 2012

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By Rehana Cassim
Until recently, South Africa did not have a provision in the Companies Act that gave a
court general discretion to pierce the corporate veil.
Now, under the Companies Act 71 of 2008 (the Act), for the first time, a statutory
provision has been enacted that permits a court to disregard the separate juristic
personality of a company and pierce the corporate veil.
Such a provision is not new in respect of close corporations as s 65 of the Close
Corporations Act 69 of 1984 permits a court, in certain circumstances, to deem a close
corporation not to be a juristic person.
An advantage of the new statutory provision on piercing the corporate veil is that it gives
more certainty and visibility to the doctrine of piercing the veil, but a danger is that it may
result in the doctrine becoming inflexible, particularly if the courts interpret the provision
in a technical way (FHI Cassim, MF Cassim, R Cassim, R Jooste, J Shev and J
Yeats Contemporary Company Law 2ed (Cape Town: Juta 2012) at 58). This new
provision, as embodied in s 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).’
Section 20(9) raises many questions and creates some uncertainties. For instance, the
term ‘unconscionable abuse’ is not defined, nor is any guidance provided on the
circumstances that would constitute an ‘unconscionable abuse’ of the juristic personality
of the company as a separate entity. Another question that arises is whether s 20(9)
overrides the common law or judicial instances of piercing the corporate veil. Is piercing
the veil still an exceptional remedy that may only be used as a last resort? Who would
constitute an ‘interested person’ referred to in s 20(9)? These and other issues are
discussed below.
First, it is useful to examine the approach generally adopted to piercing the corporate
veil in the common law.
The common law approach to piercing the corporate veil
The position has not been reached in the common law where it is possible to state with
any degree of certainty the circumstances in which a court would pierce the veil. The
courts have not followed consistent principles in determining when to do so. As the
Supreme Court of Appeal (SCA) in Hülse-Reutter and Others v Gödde 2001 (4) SA 1336
(SCA) acknowledged, the circumstances in which a court would pierce the veil are far
from settled and much depends on a close analysis of the facts of each case,
considerations of policy and judicial judgment. Some useful guidelines to the approach
of the courts to piercing the veil may be obtained from the leading case of Cape Pacific
Ltd v Lubner Controlling Investments (Pty) Ltd and Others 1995 (4) SA 790 (A), in which
the then Appellate Division laid down a few general principles relating to the common
law instances of piercing the veil, namely:
o It is a fundamental principle that the courts should not lightly disregard a company’s
separate personality, but should strive to give effect to and uphold it. Thus, a court has
no general discretion to simply disregard a company’s separate legal personality
whenever it considers it just to do so.
o The court stressed that it was not formulating any general principles with regard to when
the corporate veil should or should not be pierced, and that each case must be decided
on its own facts. Thus, there are no set categories of instances governing when a court
will pierce the veil.
o The court stated that, as a general principle, where there is fraud, dishonesty or other
improper conduct, a balancing approach must be adopted that requires the concept of
separate legal personality being weighed against those principles and policies in favour
of piercing the veil. In adopting such an approach, a court would be entitled to look to
substance rather than form. This balancing approach is based on the United States case
of Glazer v Commission on Ethics for Public Employees 431 So.2d 752 (La 1983).
o The court stressed that, even if a company had been formed for a legitimate purpose but
was later misused, the corporate veil may nevertheless be pierced.
In the Hülse-Reutter case (at para 20) the SCA emphasised that, as a matter of
principle, there must at least be some misuse or abuse of the distinction between the
corporate entity and those who control it that results in an unfair advantage being
afforded to those who control the corporate entity.
It is clear from the common law approach to piercing the veil that this remedy is an
exceptional procedure to be used as a remedy of last resort (discussed further below)
and that there must be a compelling reason for a court to ignore the separate legal
existence of a company (see Airport Cold Storage (Pty) Ltd v Ebrahim 2008 (2) SA 303
(C) at para 9).
Piercing the veil under the 2008 Companies Act
According to s 20(9) of the Act, the corporate veil will be pierced when a court finds that
there was an unconscionable abuse of the juristic personality of the company as a
separate entity. Unconscionable abuse of the juristic personality of a company may
occur in three instances, namely –
o on the incorporation of the company;
o as a result of any use of the company as a legal entity; and
o as a result of any act by, or on behalf of, the company.
The wording of s 20(9) makes it clear that the section may be invoked not only where a
company is formed as a sham, but also where a company has initially been legitimately
established but is subsequently misused. This accords with the position in the common
law, as discussed above. There is much scope for the courts to interpret the words ‘any
use of’ a company widely should they choose to do so (Cassim et al (op cit) at 59).
What is ‘unconscionable abuse’?
Of major concern is that the phrase ‘unconscionable abuse’ is not defined in s 20(9). The
section also 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. Some guidance may perhaps be obtained from the jurisprudence that
has thus far been developed in respect of s 65 of the Close Corporations Act, which is
worded similarly to s 20(9). However, an important difference between s 20(9) of the
Companies Act and s 65 of the Close Corporations Act is that s 65 deems a corporation
not to be a juristic person in instances of a ‘gross abuse’ of the juristic personality of the
corporation as a separate entity, whereas s 20(9) of the Act deems a company not to be
a juristic person where there is an ‘unconscionable abuse’ of the juristic personality of
the company as a separate entity. It may be useful to consider some previous cases in
the common law in which the courts have regarded the abuse of the juristic personality
of a close corporation as a separate entity to be a ‘gross abuse’ under s 65 of the Close
Corporations Act.
In Haygro Catering BK v Van der Merwe en Andere 1996 (4) SA 1063 (C) the court held
that the members of a close corporation were, together with the close corporation, jointly
and severally liable for the debts of the close corporation where the name of the close
corporation had not been displayed anywhere on the corporation’s business premises,
documents or correspondence, in contravention of s 23 of the Close Corporations Act.
The court found that this failure had constituted a gross abuse of the juristic personality
of the corporation as a separate entity under s 65 of the Close Corporations Act.
In TJ Jonck BK h/a Bothaville Vleismark v Du Plessis NO en ’n Ander 1998 (1) SA 971
(O) a member of a close corporation who had made large loans to the close corporation,
despite knowing that it was insolvent, had given written authorisation for the registration
of a notarial bond over the movable property of the corporation as security for his loans
to it. A few months later he obtained an order entitling him to take possession of all the
movable assets of the corporation in terms of the notarial bond. He thus acquired
ownership of the business in his name, without any creditors, and continued to conduct
business from the same premises under a new name, using the equipment and stock
that had previously been that of the close corporation. The court found that he had
conducted the business of the close corporation fraudulently or recklessly under s 64 of
the Close Corporations Act, but it observed that, in terms of s 65 of the Close
 Corporations Act, the member’s actions had also constituted a gross abuse of the juristic
personality of the close corporation.
A further instance of gross abuse of juristic personality arises from the Airport Cold
Storage case. Some of the factors that the court considered relevant in coming to the
conclusion that there had been a gross abuse of the juristic personality of the
corporation included the following –
o the close corporation had formed part of a conglomerate of associated family businesses
that had been conducted with scant regard for the separate legal personalities of the
entities concerned;
o the close corporation had not kept proper books of account;
o the close corporation had operated without appointing an accounting officer; and
o the close corporation had voluntarily assumed a debt owing by the family business when
it was incorporated and had acquired significant debts since commencing business,
which had amounted to reckless trading.
The court observed that, when it suited the defendants, the members of the close
corporation chose to ignore the separate juristic identity of the corporation. They could
not ‘now choose to take refuge behind the corporate veil’ of the corporation in order to
evade liability for its debts (para 52). The court accordingly granted a declaratory order
in terms of s 65 of the Close Corporations Act to the effect that the corporation was
deemed not to be a juristic person, and held the defendants jointly and severally liable to
the plaintiff for the amounts owing to the plaintiff by the corporation. On appeal, the SCA
(Ebrahim and Another v Airport Cold Storage (Pty) (Ltd) 2008 (6) SA 585 (SCA)) found it
unnecessary to consider the application of s 65 of the Close Corporations Act as it found
that the appellants had ‘recklessly’ conducted the business of the close corporation.
They had consequently contravened s 64 of the Close Corporations Act. The decision of
the court a quo nevertheless provides guidance on the scope of s 20(9) of the Act.
The courts will have to grapple with a number of issues in giving meaning to the phrase
‘unconscionable abuse’. For example, is there a difference between gross abuse and
unconscionable abuse? How far does the abuse have to extend before it is considered
to be unconscionable? One might argue that any abuse of the juristic personality of a
company would be unconscionable (Cassim et al (op cit) at 62). The principles
developed with regard to piercing the corporate veil in the context of s 65 of the Close
Corporations Act and at common law generally may serve as useful guidelines in this
regard.
Note that the test for piercing the corporate veil envisaged in s 20(9) of the Act focuses
only on the abuse of the juristic personality of the company as a separate entity and on
whether that abuse constitutes unconscionable abuse. It is not a requirement under s
20(9) that the abuse result in an unfair advantage being afforded to those who control
the company, as was laid down in the Hülse-Reutter case discussed earlier. To this
extent, the test for piercing the corporate veil under s 20(9) of the Act has been
simplified (Cassim et al (op cit) at 60).
Who may invoke s 20(9) of the Companies Act?
Section 20(9) permits any ‘interested person’ to bring an application to court requesting
the court to deem a company not to be a juristic person. However, the section does not
define the term ‘interested person’. In the TJ Jonck BK h/a Bothaville Vleismark case the
court stated, at 986, with reference to the meaning of the term ‘interested person’ in s 65
of the Close Corporations Act, that the term is not to be interpreted too restrictively, but
at the same time it is not to be interpreted too widely as to include an indirect interest.
The court further stated that the interest is limited to a financial or monetary interest. A
creditor of a corporation, for instance, would be an interested person.
It is submitted that this interpretation of the term ‘interested person’ would be relevant to
s 20(9) of the Companies Act.
How is s 20(9) to be invoked?
A declaration by the court in terms of s 20(9) of the Act that a company is deemed not to
be a juristic person may be sought by way of application or through action proceedings.
The court may also act on its own initiative in deeming a company not to be a juristic
person should it find in any proceedings in which a company is involved that there has
been an unconscionable abuse of the juristic personality of the company as a separate
entity.
Orders that may be made under s 20(9)
A court may declare a company not to be a juristic person in respect of certain rights,
obligations or liabilities 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. A court does not have the power to intervene under s 20(9) of the Act
where the unconscionable abuse is not in respect of any such right, obligation or liability.
In declaring that a company is deemed not to be a juristic person, a court is given a wide
discretion by s 20(9) of the Act to make any further orders that it considers appropriate to
give effect to such declaration.
Does s 20(9) override the common law?
Where the requirements of s 20(9) are not met and the section cannot be relied on, the
common law remedy of piercing the veil would probably apply, since the section does
not override the common law instances of piercing the corporate veil (Cassim et al (op
cit) at 58). The principles developed at common law with regard to piercing the corporate
veil would certainly serve as useful guidelines in interpreting s 20(9) of the Companies
Act.
Is s 20(9) to be used as a remedy of last resort?
At common law, the remedy of piercing the veil is to be used only as a last resort
(the Hülse-Reutter case, at para 23). In Amlin (SA) Pty Ltd v Van Kooij 2008 (2) SA 558
(C) the court stated, at para 23, that ‘piercing the veil is a rather drastic remedy. For that
reason alone, it must be resorted to rather sparingly and indeed as the very last resort in
circumstances where justice will not otherwise be done between two litigants.’
It is not clear if the same principle is to be applied to s 20(9) of the Companies Act. It
may well be that reliance may be placed on s 20(9) of the Act despite other remedies
also being available.
Courts may now also have a wider discretion to pierce the corporate veil under s 20(9) of
the Act compared to their common law discretion (Cassim et al (op cit) at 58).
Consideration must, however, be given to the fact that piercing the veil is an exceptional
remedy that must be used cautiously. Perhaps the balancing approach envisaged in
the Cape Pacific Ltd case ought to be applied to the interpretation of s 20(9); that is, the
need to preserve the company’s separate legal personality must be balanced against
those policy considerations in favour of piercing the veil (Cassim et al (op cit) at 62).
Conclusion
Section 20(9) embodies a statutory provision in the Companies Act that gives courts a
general authority to pierce the corporate veil. There are, however, uncertainties
regarding the interpretation of the scope and ambit of this provision. It remains to be
seen how the courts interpret s 20(9) and, in particular, the meaning they will attribute to
the phrase ‘unconscionable abuse’ of the juristic personality of the company as a
separate entity. A flexible and sensible, instead of a rigid, approach is essential to the
proper application of s 20(9).
Rehana Cassim BA (cum laude) (Wits) LLM (cum laude) (Wits) is an attorney at
Rooth & Wessels Inc in Pretoria.
This article was first published in De Rebus in 2012 (Aug) DR 22.