A company is liable for its obligations with its property, i.e., the company’s property is separate from the property of its members. Except in the case of partners in a general partnership and general partners in a limited partnership, the members of the company are not liable with their property for the obligations of the company. This rule is not without exception, which brings us to the topic of this article, namely the institute of piercing the corporate veil. 

What is piercing the corporate veil? 

This concept, regulated by our Companies Act refers to a situation where the principle of separation of the company’s assets and its members is deviated from, allowing creditors to be satisfied not only from the assets of the company which is their debtor but also from the assets of its members and founders. 

The name originates from the English term ‘piercing the corporate veil’; thus, imagine a curtain separating the company from the personalities of its founders and members. When this curtain is pierced or lifted, we move from the realm of limited liability to the territory of unlimited liability of the company’s founders and members. 

Where does the name originate? 

The institute of piercing the corporate veil originates from the case law of the United States, where the term ‘piercing the corporate veil’ is associated with Professor Wormster from the University of Illinois, who mentioned this concept in his article in 1912, although the practice regarding this institute appeared in earlier years. In American case law, other terms such as ‘lifting the corporate veil,’ ‘mere instrumentality’, and ‘alter ego’ are also used as narrower definitions covering specific examples where piercing the corporate veil occurs. 

It is considered that the case of Salomon v A Salomon & Co Ltd from 1897 is the first one that raised questions regarding the potential abuse of limited liability companies. The British House of Lords ruled in favor of Mr. Salomon at the time because it considered that once a company is established, it becomes a separate legal entity, distinct from its members. 

As for the continental legal system, we can highlight Germany. In Germany, similar to the American practice, several terms are used for the institute of piercing the corporate veil, such as ‘Durchgriffshaftung’, ‘Durchgriff’, or sometimes ‘Haftungdurchgriff’. German legal theory accepts the division of this institute into a narrower and broader sense. 

Who can be held liable for piercing the corporate veil of a company? 

Article 18 of the Companies Act states that the obligations of the company are borne by the limited partner, the member of a limited liability company, and the shareholder of a joint-stock company, as well as the legal representative of that person if it is a legally incompetent natural person, who abuses the rule of limited liability. 

Piercing the corporate veil does not apply if the Law itself prescribes the liability of founders and members as a regular form of liability; for example, members of a general partnership are jointly and severally liable for the obligations of the company – such liability is prescribed by law. 

Conditions for piercing the corporate veil 

The first condition is related to the members – founders or members of the company are not, by the Law itself, jointly liable with the company nor have they committed to being jointly liable. 

The second condition concerns the unlawful behavior of the members or founders of the company or a manner for which the Law prescribes piercing the corporate veil as a consequence. In practice, unlawful behavior is most often encountered, but there are situations where piercing the corporate veil may occur even without the condition of unlawfulness. 

Since piercing the corporate veil is based on the behavior of the founders or members of the company, it can be said to be based on their fault; although certain legal systems accept the concept of piercing the corporate veil without fault in some situations, our legal system closely ties this institute to fault or the intention of damaging creditors or gaining unlawful benefit. 

By the decision of the Court of Appeals in Belgrade Gž 2239/19, it was established that the institute of piercing the corporate veil can be applied only to companies that exist in the legal order; i.e., it is not applied to companies in bankruptcy where bankruptcy creditors can file their claims and realize their rights. 

Some laws in the region mention bankruptcy in the legal text on piercing the corporate veil; for example, Article 10, paragraph 5 of the Companies Act of the Republic of Croatia states that if bankruptcy proceedings have been opened against a company, claims against responsible persons can be pursued only by the bankruptcy administrator. 

How is piercing the corporate veil determined? 

Whether piercing the corporate veil has occurred or not is determined by the court. It is necessary for the creditor to file a lawsuit with the competent court for the collection of claims from the legal entity. In other words, piercing the corporate veil is not determined in a separate procedure but is always an integral part of the procedure for the collection of claims. The competent court determines whether the conditions for piercing the corporate veil are met and orders the members to jointly fulfill the obligations with the legal entity. 

It is important to note that only creditors can request such an extension of liability, and the court does not consider piercing the corporate veil ex officio. The Law provides a subjective deadline of 6 months from the knowledge of the abuse and an objective deadline of 5 years from the date of the abuse. If the creditor’s claim has not matured at the time of knowledge of the abuse, the subjective deadline begins to run from the maturity date of the claim. 

Our case law has taken the standing that the founder and member of a company cannot be held liable for damages under Article 172 of the Law on Obligations but only based on piercing the corporate veil regulated by the Companies Act. The Commercial Appellate Court stated in the judgment Pž 926/2015 that the founder of a company cannot be held liable under Article 172 of the Law on Obligations, which prescribes that a legal entity is liable for the damage caused by its organ to a third party in the performance or in connection with the performance of its duties, but only based on piercing the corporate veil. 

When does the abuse of the limited liability rule occur? 

Our Law specifies 4 different situations. We will briefly explain each situation in a few sentences. 

A member of the company uses the company to achieve a goal that is otherwise prohibited. 

Article 2 of the Companies Act defines a company as a legal entity that conducts business activities for profit. The purpose of establishing a company or making a profit is achieved by performing activities; the company has a predominant activity that is registered in accordance with the legal regulations on registration, and it can also perform all other activities that are not prohibited by law. 

This leads us to the conclusion – if someone establishes a company that has a different goal instead of performing the predominant activity and activities that are not prohibited by law, piercing the corporate veil occurs. Money laundering is often cited as an example – a company is established with the intention of channeling money from illegal activities into legal channels. 

A member of the company uses the assets of the company or deals with them as if they were his personal property. 

Many examples can be cited where a member of the company deals with the assets of the company as if they were his personal property. For example, the Court of Appeals in Belgrade determined in the judgment Gž 5394/2014 that failing to deposit money into the account of the company but retaining that money for oneself constitutes dealing with the assets of the company as one’s personal property. 

There are many other actions that theoretically could constitute piercing the corporate veil, such as using the company’s official vehicle for personal purposes and paying bills that are not the company’s bills but personal bills of a member of the company. 

A member of the company uses the company or its assets to harm creditors. 

This situation is considered rare in practice because it involves solely the intention to cause harm to creditors by using the company itself or its assets. 

For example, the Court of Appeals in Belgrade in case Gž 1364/2021 determined that piercing the corporate veil involves committing fraudulent acts that must be proven, and that activating personal liability by piercing the corporate veil is not possible based on passive behavior, along with the fact that the burden of proof lies with the plaintiff. 

The legal veil of the company is not always an impenetrable barrier to creditors, but only when the company is not used to harm creditors, commit fraudulent acts, commingle assets with the assets of a member of the company, and the like. In such cases, the veil is lifted, and the owner of the company becomes liable without limitation. 

The Supreme Court also stated in case Rev 2494/2017 that the abuse of the business company or piercing the corporate veil involves committing fraudulent acts that must be proven. 

A member of the company, for the benefit of themselves or third parties, diminishes the assets of the company, knowing or ought to have known that the company will not be able to fulfill its obligations. 

In this situation, various actions of ‘siphoning off’ the assets of the company for the benefit of members or third parties occur, such as, for example, granting loans, paying out profits when there are no conditions, credit indebtedness, and similar things. A member of the company is liable in this case if they were aware that, due to the diminishment of assets, the company would be unable to fulfill its obligations. 

From the wording of the law itself, i.e., that the member ‘knew or ought to have known,’ we can see that the member’s awareness here encompasses intent and conscious negligence, as well as unconscious negligence but only in the form of gross negligence. 

Please note that this piece does not offer legal advice but rather represents the author’s standpoint.