|Sweden: Landmark Case on Shareholder and Director Liability|
Gärde Wesslau Advokatbyrå
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A limited company is a type of business entity which is defined by the fact that its shareholders' liability is limited to the capital invested in the company. The Company Act sets out certain exceptions, primarily that directors – and in some cases shareholders – may be held personally liable for debts incurred by negligently continuing to do business when shareholder equity in the company is less than one-half of the registered share capital. However, this personal liability does not help creditors of bankrupt or insolvent companies in cases where the debt amounted rapidly or in one stroke (eg, damages for a major oil spill or other damages in tort).
In order to mitigate this problem, the Swedish courts have established a doctrine of 'piercing the corporate veil' – that is, disregarding the 'limited' nature of a limited company and treating the duties of the company as the duties of its shareholders or owners. Notable rulings in this respect were made in 1947 and 1975, but few decisions regarding the doctrine have been made in recent times and those decisions that have been rendered have upheld the limited company structure. During the most recent major revision of the act, the question was raised as to whether the doctrine should be included, although it was eventually decided that it should not. Nevertheless, it was stressed that the decision to exclude the doctrine from the act was not a negative statement on the viability of its use. A recent case from the Scania and Blekinge Court of Appeal confirms this.
A company acquired a potential claim from a bankrupt company and brought an action against a former board member, arguing that he was personally liable for actions committed in the bankrupt company. That action was dismissed by both the district court and the court of appeal, with the result that the plaintiff was ordered to pay compensation to the former board member for his legal costs. However, the plaintiff lacked the funds to pay the costs and subsequently went into bankruptcy that ended without any dividends to the creditor.
With the tables turned, the former board member brought action against those behind the bankrupt plaintiff, claiming that they should be liable for plaintiff company's debts to him because they had forced him into a costly process in the knowledge that the company was insufficiently solvent to pay the legal costs of a case that they were likely to lose.
The former board member was able to show that the plaintiff company had been acquired for the sole reason of the lawsuit, that the company lacked any other revenue-generating business and that steps hade been taken to conceal the ownership of the company. The registered share capital of the company was Skr100,000, while the former board member's legal costs had amounted to more than Skr500,000.
The court of appeal, like the district court, held that such behaviour constituted abuse of the act (ie, the basic principles of shareholder freedom from personal responsibility). The persons behind the company were therefore found to be jointly and severally liable in person in accordance with the principles of piercing the corporate veil.
The Scania and Blekinge Court of Appeal's ruling is in line with the case law from 1947 and 1975. From those cases, general principles were established that the corporate veil may be pierced where:
·A limited number of the owners of a business entity have failed to maintain arm's-length relationships with the owners' business;
·The limited liability arrangement has been used in a scheming way in order to minimise the owner's potential liability; and
·The business entity is significantly undercapitalised (capitalisation requirements may vary based on the nature and location of the business).
All three of these factors were relevant in this case, and therefore the court's decision was to be expected. Nevertheless, the case represents the first time since 1975 that the courts have ruled in favour of piercing the corporate veil. Given the recent reduction of the required minimum share capital for private limited companies from Skr100,000 to Skr50,000, which in historical terms is very low, one can expect the question of whether to pierce the corporate veil to be asked more frequently in future.
The opinions expressed do not constitute investment advice and specialist advice should be sought about your specific circumstances.
Published on our website on Oct.14, 2010