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NEWS May 04 2020

Piercing the Corporate Veil

By Danielle O'Brien, Junior Associate

 
This article discusses an increasingly relevant query; namely, to what extent does the UAE law recognise a Limited Liability Company’s1 (“LLC”) separate legal personality, and under what circumstances can the corporate veil can be pierced?

Piercing the corporate veil occurs when a Court holds a LLC’s shareholders, managers and directors personally liable for the debts of the LLC.

Article 21 of Federal Law 2 of 2015 (the “Companies Law”) states that upon incorporation, a company shall “acquire a corporate personality”. Accordingly, once a LLC is incorporated, it obtains an independent legal personality from its shareholders and managers.

The UAE affords shareholders and managers of an LLC a certain degree of protection. Under ordinary circumstances, the debts of a company are attributable to its shareholder and managers only to the value of their shareholding in the LLC. In other words, creditors cannot generally pursue shareholders and managers beyond their shareholding in the LLC (such as their personal assets).

Article 218 of the Companies Law states:

“1- The company may not discharge a shareholder from his obligation to pay the value of a share. Such obligation may not be set off against any rights of the shareholder from the company.

2- Any of the creditors of the company may file a lawsuit against the shareholder to demand him to pay the value of the share.”

This demonstrates that on a strict application of the law, shareholders and managers cannot be held liable for the acts or omissions of the LLC (beyond their shareholding). Accordingly, theoretically, the corporate veil cannot be pierced, and the shareholders and/or managers of a LLC cannot be held personally liable for the LLC’s debts.

That said, Article 24 of the Companies Law prohibits and renders void any stipulations in the company’s memorandum of association exempting personal liability.

“Subject to the provisions of this Law, any provision in the Memorandum of Association or Articles of Association of the company authorizing it or any of its subsidiaries to agree to exempt any person from any personal liability that such person bears in his capacity as a current or former officer of the company shall be void.”

The circumstances in which personal liability does arise, are discussed here below.
 
1. Improperly Incorporated Companies

Article 9 of the Companies Law states that:

“1- The company shall take one of the following forms:
a- Joint Liability Company.
b- Limited Partnership Company.
c- Limited Liability Company.
d- Public Joint Stock Company.
e- Private Joint Stock Company.
 
2- Any company which does not adopt one of the forms referred to in the preceding Article shall be considered null and void, and the persons concluding contracts in its name shall be individually and jointly liable for the obligations arising from such contracts.
 
3- Every company established in the State shall bear the nationality thereof, but this does not entail that said company shall necessarily enjoy the rights exclusive to UAE Nationals.”
 
Pursuant to the Companies Law, the corporate veil may only be pierced in the following limited circumstances:
 
a. If the company was improperly incorporated in accordance with the Companies Law, or has been declared void by a court order; and

b. If the Memorandum of Association of the LLC contains false provisions regarding a shareholder’s contribution to the LLC.
 
2. Exceptions For Shareholders
 
There are two notable further exceptions that permit creditors to pierce the corporate veil and hold the shareholders accountable for the debts of the LLC:

1. Where the shareholders use the LLC to drive a personal agenda; and

2. Where the shareholders distribute fictitious profits.
 
Driving a Personal Agenda

The Dubai Court of Cassation (Case No. 69, 70/2007) found that if a creditor has established that a shareholder used the LLC to conduct his/her own personal business, to the detriment of the LLC, then he/she shall be personally liable to the full extent of any potential liability, i.e., beyond his/her shareholding in the LLC.

Furthermore, jurisprudence illustrates that Courts require a creditor to demonstrate the existence of additional circumstances before piercing the corporate veil, namely that:

1. The acts of the shareholder/LLC resulted in harm to third parties; and

2. The acts were deceitful or culminate in what could be characterized as a gross mistake.

Similar principles have been reflected in jurisprudence whereby shareholders were held liable when abusing the legal separation between the LLC and themselves, by using the LLC’s entity as a veil to cover their fraudulent acts2.

The best way to pierce the corporate veil is to prove the existence of fraud. The Dubai Court of Cassation (Case No. 92/2012) has held that when a shareholder abuses the legal separation of the LLC and its shareholders to conduct fraudulent activity, it is regarded as not only a breach of the LLC’s memorandum of association, and a shareholder’s duty to act in the best interests of the LLC, but a clear violation of the law.
 
Distribution of Fictitious Profits

Another exception, recognized by the Companies Law, occurs when shareholders of a LLC distribute ‘fictitious profits’.

Article 30 of the Companies Law states:

“1- No fictitious profits may be distributed to the partners or shareholders. The Board of Directors or any similar body shall be liable towards the partners or shareholders and the creditors of the company for such procedure.

2- If the company distributes any profits in violation to the provisions of this Law and the Decisions issued hereunder, such partner or shareholder shall return any profits received by him in violation to such provisions. The company's creditors may request such partner or shareholder to return what he has received thereof, even if done in good faith.” [emphasis added]

When partners or shareholders receive money from the LLC before paying off the LLC’s creditors, the creditors, pursuant to Article 30(2) of the Companies Law, have a right to claim compensation from the shareholders beyond their interest in the LLC.

In the event that shareholders, managers, directors, and even auditors, provide false statements as to the LLC’s finances, the corporate veil will be pierced, leading to criminal liability.

“Any manager, board member, auditor or liquidator who deliberately provides false statements in the balance sheet or the profits and losses account or in a financial report or omits material incidents in such documents for the purpose of concealing the true financial position of the company shall be punished by imprisonment for a period between six months and three years and/ or a fine between AED 100,000 (one hundred thousand) and AED 500,000 (five hundred thousand)”
 
By proving a criminal offence, the corporate veil can be easily pierced.
 
3. Exceptions for Managers & Directors

Managers of an LLC have a statutory duty of care3.  In the event that a manager abstains from his/her duty of care, the Courts are willing to pierce the corporate veil, and hold the manager personally liable.

 “Article 84 - Liability of the Managers of the Company
1- Every Manager in a Limited Liability Company shall be liable against the company, the partners and the third parties for any fraudulent acts by such Manager and shall also be liable for any losses or expenses incurred due to improper use of the power or the contravention of the provisions of any applicable Law, the Memorandum of Association of the company or the contract appointing the Manager or for any gross error by the Manager. Any provision in the Memorandum of Association or the contract appointing the Manager in conflict with the provisions of this Clause shall be deemed void.

[…]

Article 162- Liability of the Board of Directors
1- The members of the Board shall be liable towards the company, the shareholders and the third parties for all acts of fraud, misuse of power, and violation of the provisions of this Law or the Articles of Association of the company or an error in management. Every provision to the contrary shall be invalid.” [emphasis added]

Accordingly, managers and directors can be held personally liable if: (i) they fail to act within the statutory duty of care, (ii) they act fraudulently, or (iii) they abuse the protection afforded by the principle of legal separation between an LLC and its shareholders and managers. The Companies Law does not specify what constitutes “an error in management”, and therefore one must look to the UAE Courts to interpret, and apply these provisions.

The Dubai Court of Cassation has held that:

“every partner in a Limited Liability Company should be liable against the company, the partners and the third parties for any fraudulent acts by such Manager and should also be liable for any losses or expenses incurred due to improper use of the power or the contravention of the provisions of any applicable Law, the Memorandum of Association of the company or the contract appointing the Manager or for any gross error by the Manager.”

[Dubai Court of Cassation Case No. 346/2019]

These rules have been applied by UAE Courts pursuant to their direct and simple interpretation of the law. Managers have been held liable for their actions if it is established that:

- Their acts resulted in a harm4

- They acted in breach of their obligations; or

- Their actions are classified as gross mistake or negligence, or abuse of right, or any other breach of the law, such as fraud5.

Finally, and perhaps the most common example of piercing the corporate veil within the UAE, is the personal liability of a signatory to a cheque6


While a signatory is not always a manager of the company (as this is not necessarily required), a payee may initiate civil and criminal proceedings against the signatory and/or the LLC – amounting to personal or joint liability. The Dubai Court of Cassation has stated that, when attempting to hold a signatory liable for a cheque, the burden of proof is effectively reversed. The mere existence of a cheque serves to prove the presence of the underlying debt, and the debtor’s attempt to pay. It is therefore for the debtor to prove bad faith on the part of the creditor7

 
4. Conclusion

The Companies Law and the Courts’ application of the law have provided for limited exceptions whereby the companies’ managers and shareholders can be held personally liable for the debts of an LLC.

It is worth pointing out that the key element that a creditor must prove to establish unlimited liability, particularly against the shareholders, is that the shareholders’ actions were tortious, because tortious liability cannot be limited pursuant to the general principles of UAE.
 
 
End Notes
 
1 - Article 71 of the Companies Law defines a Limited Liability Company as a:
“(1) company in which the number of partners is no less than two and no more than 50 partners and the liability of each partner shall only be in proportion to his share in the capital.
(2) the owner of the company capital shall not be liable for its obligations unless to the amount of capital that appears in the memorandum of association thereof and the provisions of the limited liability company, as stipulated by this Law, shall apply to such person, providing that there shall be no conflict with its [the Company’s] nature.”

2 - Dubai Court of Cassation Case No. 279/2009.
 
3 - Article 22 of the Companies Law sets out a manager’s duty of care:
“A person authorized to manage the company shall preserve its rights and extend such care as a diligent person. Such person shall do all such acts in agreement with the objective of the company and the powers granted to such person by virtue of an authorization issued by the company in this respect.”
 
4 - Dubai Court of Cassation Case No. 14/2008.
 
5 - Dubai Court of Cassation Case No. 336/2019.

6 - Article 401 of Federal Law 3 of 1987 (the “Penal Code”) as amended, states:

“Shall be subject to a jail sentence or to a fine, whoever draws in bad faith a cheque without sufficient funds or who, after giving the cheque withdraws all or part of the funds, so that the remaining balance is insufficient to cover the amount of the cheque, or gives order to the drawee to stop payment, or if he deliberately writes or signs the cheque in such a manner as to make it non payable.
Shall be sentenced to the same penalty whoever endorses to another or delivers to him a bearer draft knowing that it has no available sufficient funds in consideration thereof or that it is not drawable.
The penal action shall be precluded in case of payment or its withdrawal subsequent to the perpetration of the crime but prior to the settlement of the case by a decisive judgment otherwise stay of execution shall be ordered
In case the court orders the withdrawal of the check book from the condemned person and the prohibition to give him new check books, according to the provisions of Article 643 of the Commercial Transactions Law, the public prosecution shall notify this order to the Central Bank in order to generalize it on all banks.
Should any bank violate this order, it shall be liable to pay a fine amounting to one hundred thousand Dirhams.
Shall be liable to the same penalty whoever endorses to another or deliver a bearer draft knowing that against the deed there are no available sufficient funds to pay its amount or that it is not drawable.''
 
7- Dubai Court of Cassation Case 465/2019.
 
 
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