As a general rule, companies enjoy what the law calls, legal personality, which, under a fiction of the law, provides the company with a distinct personality from its shareholders, management or Board. This way, when shareholders do set up a company1, they seek to be responsible only up to the amount of their contributions, thus their only assets at risk would be the equity contributions that they have funded in the company’s incorporation, and/or have provided through the life of said entity. Likewise, members of Management or of the Board of Directors, expects that in their conduct of company’s business, they do not end being personally responsible, and that the company, by having a distinct legal personality, should be liable before third parties.
Nonetheless, it could happen that in being established, a company does not follow proper corporate formalities, or it is later found that the shareholders formed it with intent to defraud third parties, or that the Board (or other controlling body), uses it to commit certain illegal conducts. In those, and other cases that we will refer below, the responsibility attributed to the company as an autonomous entity may fall to the shareholders or any other party acting on behalf the company, and actions may be instituted against them.
When the law allows a party to pursue direct remedies against the shareholders or management or the Board, for actions conducted by the company itself, it is said that such party is piercing the corporate veil or disregarding the corporate fiction.
The piercing of corporate veil has been evolving in the Dominican Republic, but we lack of a strong and consistent jurisprudence and doctrine on the subject. This article aims to provide basic notions on the concept, while addressing what in our opinion there are certain inconsistencies within law 479-08 (the “Companies Act”), in regard with (i) which cases where a party may seek the lifting of corporate veil, and (ii) the courts powers in allocating responsibilities among the individuals, being shareholders, managers or directors, as the case may be.
Cause for piercing the corporate veil
Originally, our Commercial Code established the presumption of a corporate veil and did not create any possibilities for piercing it. The only case that our former commercial code authorized a claimant to go after the founders of a company, had to do with the company not complying with legal formalities in its charter (in these cases, one may easily conclude that such direct actions is a mere reflection on the fact that the company did not complete legal requirements to create the corporate veil). Outside the commercial code, the Dominican Republic also followed a long tradition of piercing the corporate veil for tax obligations, thus allowing the tax administration to pursue the assets of the shareholders and administrators, in case of the companies’ default.
By adopting the Companies Act, the Dominican Republic not only confirmed that failure to comply with formalities for the incorporation of a company might trigger damages claims against founders, administrators and managers, but also introduced important modifications on the matter, by expressly setting forth for the first time the concept of “piercing the corporate veil2.”
Accordingly, article 12 of the Companies Act admitted that the corporate veil could be taken in certain specific cases: (a) when it is used in fraud against the law; (b) when it violates public order; and (c) and when it operates in detriment of the rights of partners, shareholders or third parties.
The law does not say it, and one first loophole to deal with is whether the above conducts are intended to be limited and exclusive; or whether there are other merits within the Companies Act to pierce the veil. In principle, article 12 is drafted to reflect a limitation on the cases, but one can find, nonetheless, multiple provisions at the Companies Act that without referring to article 12 or to the concept of piercing of corporate veil, would lead to the same results. As such, once the case is presented, the courts will have to conclude that in addition to article 12, the Companies Act has foreseen other events conducting towards lifting the corporate veil.
Also, we should note that the conducts that would pierce the corporate veil are described in general terms and neither article 12 nor any other disposition of the Companies Act does provide clear principles that would guide the courts in determining whether a company falls within any of them.
Allocation of liabilities: conflictive provisions
Besides the determination of whether the list of conducts set forth in article 12 is intended to be exclusive and limited, the Companies Act generates another conflict on the allocation of liabilities among agents (be a shareholder, a director or a manager). A combined lecture of paragraphs III and V of article 12 seems to require the courts to distinguish who are the ultimate responsible for the misconducts leading to piercing the corporate veil. Paragraph III says that the court shall “determine who or whom, pursuant to the law, correspond… the obligations of the company,” while paragraph V, reiterates the personal responsibility of individuals in such misconducts, with an express caveat: responsibility must be allocated among agents pursuant to their “level of intervention or knowledge.”
Based on such provisions, one may conclude that in an action seeking to pierce the corporate veil, it will not be enough for plaintiffs just to name the complete Board of Directors or Management, or all Shareholders of a single company, as jointly and severally liable, but it is necessary that based on evidence plaintiffs must identify the “level of intervention or knowledge” among defendants.
However, many other provisions of the Companies Act seem to bring different conclusions. To just name a few, articles 27, 28, 105, 124, 165, 212, 234, 369-3 pa IV of the Companies Act consistently establish that there will be a jointly and severally liability for either Shareholders, Board or Management, in certain conducts that affect third parties. That wording is in clear contradiction with paragraph V of article 12, which expressly provides that they must be only responsible based on their “level of intervention or knowledge.” Because of this inconsistency, if dealing with an action seeking to pierce the corporate veil, a director, manager or shareholder, may validly compel a plaintiff to identify his/her level of involvement in any claim, instead of just being named as a jointly and severally defendant without asserting his/her particular and individual liability.
There are some additional provisions that we consider worth mentioning. For instance, as one might expect, the burden of the proof relies on the plaintiffs, and article 12 clearly express that plaintiffs have to present “faithful evidence” that the corporation has been effectively used to reach the above illegitimate conducts, in order to be admitted in their claim. This mostly to discourage frivolous claim and preserve the strong principle of the company’s legal personality.
Also, regarding the effects of the action, article 12, pa II, does clearly establish that remedy will only be provided in respect of the particular wrong that has been committed, meaning that the company would continue to be a legal entity for all intent and purposes in its dealing with other parties outside the conflict. As such, another individual cannot rely on the court decision in a particular case, to pursue any action against company’s Shareholders, Board or Management.
Finally, bona fide third parties will be entitled to preserve their acquired rights in their dealing with the company, for those cases where the corporate veil is lifted, which is a sound provision to protect those third parties that have validly and in good faith negotiated with the company, from the uncertainties of the litigation brought by other parties.
As the companies are most frequently used to develop personal strategies, be it for assets planning, or to conduct one specific business, etc., outside of the regular trade and traditional commercial practices, we expect plaintiffs using the Companies Act to prove that certain corporate vehicles are mere alter egos of their owners and seeking to pierce the corporate veil. It would be the role of the courts to supervise that in pursuing those remedies the core principles of the companies’ legal personality are not lightly harmed.
1 While for this article it is not relevant the type of structure (corporation, Limited Partnership or simplified corporation), it should be understood that there are certain structures where owners are also liable with the entity, by mandate of the law. We are not referring to those type of personal structures.
2 While not using the term “pierce of the corporate veil”, the text leads to the same concept.