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The separate legal personality of a company or close corporation

In legal parlance, the term “person” connotes an entity which is capable of having legal rights and incurring legal obligations. Every individual is a legal person – a so-called “natural person”. A company or close corporation is also, in law, a person (a “juristic person”), for it is capable of having legal rights and incurring legal obligations in its own right, which vest in the company or close corporation itself, not in the shareholders, directors or members.

Generally, members and directors are not personally liable for the company’s or close corporation’s debts

As a general principle, the shareholders and directors of a company and the members of a close corporation are not personally liable for the debts of the company or close corporation. Creditors of the company or close corporation can usually enforce their claims only against the company or close corporation itself. Of course, if a person has signed a suretyship for the debts of the company or close corporation, then he or she is personally liable on the basis of that suretyship.

However, there are a number of situations in which the law “lifts the veil of incorporation” and holds the members or directors liable for the debts or other liabilities of the company or close corporation.

One of the most important situations in which the law imposes such personal liability is where the company or close corporation has carried on business with intent to defraud its creditors, or has carried on business recklessly
by incurring debts without reasonable grounds to believe that it will be able to pay those debts as and when they fall due.

Consequently, no director of a company or member of a close corporation has a cast-iron guarantee that he or she will never be held liable for the company’s or the close corporation’s debts.

Personal liability for a company’s or close corporation’s VAT

Another important situation in which personal liability for a company or close corporation’s debts can arise is in terms of section 48(9) of the Value Added Tax Act, 1991, which reads as follows:

“Where a vendor is a company, every shareholder and director who controls or is directly involved in the management of the company’s overall financial affairs shall be personally liability (sic) for the tax, additional tax, penalty or interest for which the company is liable.”

The VAT Act defines a “company” as including a close corporation; hence this provision applies to close corporations as well.

This particular sub-section is particularly draconian, as it imposes personal liability on shareholders and directors who actively participate in the company’s or close corporation’s financial affairs even if there was no personal wrongdoing on their part or complicity in the wrongful act of others.

Personal wrongdoing by a director or member may expose them to being sued personally

If a director of a company or member of a close corporation has been guilty of wrongdoing when acting on the company’s or close corporation’s business, they may well incur personal liability to an outsider.

In some overseas jurisdictions, there is an increasing trend, when a lawsuit is brought against a company, for the plaintiff to join the directors – and even sometimes the employees – as co-defendants with the company. For example, if a company is being sued for failing to fulfil a contract, the plaintiff may sue as codefendants the directors or employees of the company who negotiated the contract on its behalf on the grounds that they made some misstatement regarding a significant fact relevant to the contract and have therefore incurred personal liability for the financial loss occasioned to the plaintiff by that misstatement.

This “joinder” of directors and employees as co-defendants with the company may be done for (sometimes dubious) tactical reasons in the litigation process. No-one relishes being personally involved in a lawsuit and a director or employee, who is joined as a co-defendant with the company may feel under great pressure to compromise and settle the suit, rather than be personally embroiled in litigation which can be damaging to one’s reputation and hard on the bank balance.

Sometimes the reason why individual directors or employees are joined as co-defendants with the company is to circumvent some contractual provision which binds the company. For example, if a company has signed a contract which has a clause saying that disputes must be settled by arbitration and not by litigation, the plaintiff may try to sue the directors and employees personally, so as to circumvent the arbitration clause and force those directors or employees to submit to cross-examination in a court of law, with all the attendant publicity and expense.

In short, the “veil of incorporation” does not shield employees and directors of companies or the members of close corporations who have been guilty of personal misconduct. Either their own company or close corporation can take action against them for that misconduct, or in certain circumstances, an outside party may be entitled to take action against them.

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