The Iron Curtain ? How Difficult is it to Pierce the Corporate Veil

The Iron Curtain ? How Difficult is it to Pierce the Corporate Veil

Written by

Gilad Bar-Ami
June 21, 2023

As happens once in a while, in the beginning of 2023 we woke up to discover that yet another well-known corporation with a successful image is about to collapse. This time it was the “SHER fitness” chain of gyms, with thousands of subscribers, owner that radiates success and a business that appeared, to the outside observer, to be glamorous, successful and profitable. Immediately, as per a well-known script, commentators, experts and self-declared experts stood and announced that there should be a "corporate veil piercing" and the owner should be personally liable.

Unlike a private business which debts are directly attributed to its owner, between the creditors/claimants against a limited liability company and the company's owners there is an invisible "corporate veil". This "veil" results from the definition of a company as a separate legal entity which exist independently of its owners as well as the limitation of the owner's liability for company debts in accordance with the limitations set forth in the articles of association. The corporate veil is what allows the company the freedom to operate independently from a business and economic point of view without any shareholder acting to prevent this due to fear of exposure to damage of an unknown amount. At the same time, in order to prevent situations of extreme abuse of the corporate veil, the Courts are given the tool of piercing the corporate veil and attribution liabilities to shareholder(s).

The law itself establishes the following closed list of cases in which the corporate veil can be pierced due to its abuse: (a) fraud against a person or a creditor of the company; (b) harming the purpose of the company and taking an unreasonable risk regarding its ability to pay its debts. But even these cases are contingent on proof of the shareholder's awareness and also on the prerequisite (in the law itself) that these are only "exceptional cases". But does the Court act to assist the victims or does it try to minimize the use of this tool as much as possible.

In the case discussed in the Jerusalem District Court in May, 2023, it was determined that the plaintiffs are not entitled to piercing the corporate veil. Although it was not disputed that the company owed a debt that was not paid in full, the shareholder's very attempt to heal the company and even pay off the debt does not meet the basic condition of abuse of the corporate veil which is required in order to pierce it. Moreover, when the plaintiffs did not demand a personal guarantee from the shareholder in the contracts with the company, piercings the corporate veil will become a tool to change the terms of the agreement retroactively and illegally. The Court even noted that economic failure or mismanagement are not sufficient grounds for piercing the corporate veil and a manager who takes risks in order to save the company is not obliged to disclose company’s status to creditors and such non-disclosure is not a reason to pierce the corporate veil, because the imposition of such an obligation could ultimately prevent companies from being saved.

However, in another case, discussed in Lod in January, 2023, the Court decided to pierce the corporate veil. In that case it was a company which condition was deteriorating for a long time despite the owners' attempts to save it and company owners who continued to purchase goods even when the possibility of saving it from insolvency was clearly improbable. It wasfound that even though the decision to begin insolvency proceedings has not yet been made, not disclosing to the suppliers that the company is facing certain collapse is not reasonable, and therefore the corporate veil should be pierced in relation to the debts created starting from this point.
From this, as can be seen, unlike experts in the media, the Courts will not be inclined to easily pierce the corporate veil and will require from those who seek it evidence that the case meets the limited conditions established by law. Moreover, even when the plaintiffs met the burden and proved that the shareholders abused the corporate veil and harmed the creditors, the Court will tend to limit the piercing of the veil as much as possible and will apply this only in connection with the period and the debts in which the actions of the shareholders amount to fraud or close to it, and not to cases in which risks were taken (and even risks beyond those that a reasonable or average manager would have taken) as long as these risks were not extremely unreasonable.

In any case, as it is a complex issue and creating personal liability may have large economic value, it is recommended that for any question or doubt, not to skimp on receiving professional advice from a lawyer with experience in the field of companies and contracts with companies, whether one is a shareholder in a company or wish to sign a contract with a limited company.