Can a shareholder be held liable for the company’s debt?
The popularity of the limited liability company structure in conducting business is largely based on the fact that the shareholders of a limited liability company are not responsible for the company’s debts. This has been stated in the general principles of the Companies Act, which states that “A limited liability shall be a legal person distinct from its shareholders” and “The shareholders shall have no personal liability for the obligations of the company”. Limited liability companies therefore differ from open companies, for example, in that in open companies the partners are liable for the obligations of the company even with their personal assets.
However, despite the clear wording of the Companies Act, there are situations in which a shareholder of a limited liability company or an external entity to the company can be held liable for the obligations of the company. This is called piercing the corporate veil in legal terms. The term refers to a situation in which the group structure, the relationships between the companies or the power of the shareholder has clearly been used in an artificial and reprehensible manner, which has, for example, caused damage to the company’s creditors or circumvented statutory liability. A shareholder may also be held liable for the company’s debts on the basis of special legislation. For example, on the basis of the Tax Procedures Code, the Bankruptcy Act or the Enforcement Code, the company may be overlooked if it is considered to be an artificial arrangement and liability assigned to the person who has actual authority in the company, such as the owner.
The principle of the separation of assets and liabilities in the Companies Act is very strong and cannot be easily overlooked. For example, the use of authority alone in another company is not enough to justify piercing the corporate veil. In the relatively few cases oregarding this, the Supreme Court has always made a decision on the basis of a comprehensive review.
A few years ago, the Supreme Court ruled (2015:17) that a Finnish limited liability company was jointly liable for the obligations of an Estonian company. The case concerned a situation in which a Finnish e-commerce company sold CDs and other storage devices through an Estonian company, owned by the Finnish company, without paying a compensation fee to Finland. Teosto, which was responsible for collecting the fee, demanded in court that the Finnish and Estonian companies are held jointly liable for paying the compensation fee. Both the Finnish and Estonian companies disputed their payment obligations. The District Court sentenced the Estonian online store to pay the fee to Teosto, but dismissed the action against the Finnish company. The proceedings continued at the Court of Appeals, which decided that the Finnish online store was also liable for paying the fee to Teosto, even though the products had been sold by the Estonian company. The Supreme Court also came to the same conclusion in its decision.
The Court of Appeals and the Supreme Court justified their decisions as follows:
the Finnish company exercised authority over the Estonian company;
the activities of the Estonian company were completely dependent on the Finnish company;
the decisive reason for starting the operations of the Estonian company had been to avoid the obligation to pay compensation under Finnish copyright law;
the products were marketed on the Finnish company’s website as if they were the seller, although the seller was actually the Estonian company;
the Finnish online store actually conducted their business in the form of the Estonian company
Both the Court of Appeals and the Supreme Court stated that none of the above considerations alone would have been sufficient to overlook the principle of separation for limited liability companies, but the facts as a whole demonstrated such reprehensible behaviour on the part of the Finnish online store that the criteria for equivalence existed.
The Supreme Court came to a similar decision just before Christmas, in which shipping company A was found liable for the debts of shipping company B. In the case, shipping company A’s staff were transferred to shipping company B, who at the same time leased the staff back to shipping company A. The vehicles and contracts were in the name of A. The companies had the same ownership. Company B went bankrupt and its employees were paid outstanding salaries from pay security. The ELY Centres demanded in court the payment of salaries paid by shipping company A, even though the salaries had been paid to B’s employees. All the courts came to the same conclusion; shipping company A was liable for the pay security debts of shipping company B due to equivalence. In its arguments, the Supreme Court stated that A and B had formed a functional entity and that the companies had the same owner, who effectively exercised authority over each of the two companies. The arrangement whereby staff were transferred to one company and then leased back to the other was considered artificial by the Supreme Court, as it had no acceptable commercial justification.
Nevertheless, the shareholders of limited liability companies are not in principle liable for the company’s debts. Only in very exceptional circumstances may liability be transferred to a shareholder or an external entity. Before you make extensive corporate arrangements, you should find out from a lawyer that there is no risk of being held liable.