1.What is “Piercing the Corporate Veil”?
The general rule in Turkish Commercial Code No. 6102 and Bankruptcy and Enforcement Law No. 2004 is that a legal entity is responsible for legal transactions as an independent person, separately from its shareholders. Shareholders or affiliated companies cannot be held responsible for the company debts with their personal assets. The principal that the shareholders and affiliates have limited liability to the debtor company and are not responsible towards third party creditors forms a veil between the shareholders and third-party creditors. However, some shareholders abuse this principal in violation of the principle of good faith and cause detriment to third party creditors. At this point, the theory of “Piercing the Corporate Veil” is discussed.
If certain conditions are fulfilled, the law will prevent the shareholders acting in bad faith from gaining unfair benefit from the legal entity or hide behind it in order to clear their debts by lifting the veil between the legal entity and its shareholders or affiliated companies.
The foundation of “Piercing the Corporate Veil” theory, which is fairly recent but gradually gaining grounds in Turkish case law is the principle of good faith. Preventing the shareholders who violate the principles of good faith and equity from dissolving or emptying the company assets, and causing the creditors to incur damages is only possible by piercing the corporate veil. As the name of the theory suggests, if the conditions that will be mentioned below exist, the corporate veil may be pierced, and the shareholder or the parent company may be held responsible. In the case of a proper causal connection between the incurred damage and the action, the corporate veil is pierced and the real or legal entity that caused the damage by their wrongful act may be held liable.
In practice, especially the creditors of the subsidiary that is used as a cover in parent – subsidiary relationship, may have recourse to the parent company when the corporate veil is lifted.
2.Circumstances in which “Piercing the Corporate Veil” Theory is Applicable
2.1.Deficiency of Equity
Deficiency of equity may occur in situations related to insufficient capital due to failure to take measures to meet the commercial needs of the company and the interests of the creditors. However, in such a case, certain conditions are required in order to lift the corporate veil and hold the shareholders liable.
The primary condition is the existence of a reasonable causal connection. If a reasonable causal connection exists, the third party creditor who is unable to collect receivables due to deficiency of equity may demand the company debt to be covered by its shareholder. The reasonable causal connection in question refers to situations in which the creditor is able to hold a person (shareholder or separate legal entity) liable when they cannot obtain their receivables due to wrongful act of such person who emptied the company assets.
For instance, when the property of a company that is unable to pay its debts due to deficiency of equity is transferred to the majority shareholder to the detriment of the creditor, such a transaction is considered to be contrary to the principle of good faith. In this case, it is accepted that there is a reasonable causal connection between the company debt and the transfer transaction and the shareholder that acquired the property may be held responsible to the creditor of the company.
Shareholders who act in violation of the principle of good faith and empty the company assets with the intention of debt evasion or make the company equity deficient may be held responsible for the company debts.
2.2.Piercing the Veil in Companies with a Controlling Shareholder (Parent – Subsidiary Relationship)
It is accepted that there is a parent – subsidiary relationship between the companies that have two different legal entities, but one of which is affiliated to the other. In the doctrine, subsidiary undertaking is defined as the pocket, puppet, tool, attachment or division of the parent undertaking. The parent undertaking is dominant, and the legal independence of the subsidiary undertaking is not taken into consideration. In this relationship, when the corporate veil is lifted, the parent company may be held liable for the debts of the subsidiary.
In the event that the parent company acts in contradiction with the principle of good faith by using its dominance in such a way as to harm the subsidiary or the creditors of the company, the veil between the subsidiary and the parent company may be pierced and the company may be held liable for the detrimental transactions made on behalf of the subsidiary.
2.3.Intermingling of Assets
Company assets and shareholders’ assets are separate from each other and the shareholders responsibility is limited to the amount of capital committed to the company. However, in practice, the company’s assets and shareholder’s assets may be intermingled. Even though there is no harm in using the company assets within the principle of good faith and without harming the interests of the company and the creditors, if the company assets are used to the detriment of creditors against good faith, the corporate veil may be pierced and the shareholders may be held liable.
For instance, if a shareholder is the controlling shareholder in two different companies and uses a motor vehicle belonging to one of the companies for the activities of the other without any proper act of disposal, this indicates that the two companies’ assets have been intermingled and that there is an organic link resulting in reasonable causal connection between the companies. In such a case, when one of the companies whose assets are intermingled with each other is emptied to the detriment of creditors and the company cannot pay their debts due to insufficient equity, the other company may be held liable with its assets.
3.What Can Be Done When the Need to Pierce the Corporate Veil Arises?
Shareholders or other companies that empty the company assets in violation of the principle of good faith are jointly liable to the company creditors they have damaged in this way. In this case, the third-party creditor who is prevented from collecting the debts may have recourse to the shareholder’s or the parent company’s assets. Lawsuits that may be directed to the debtor company may also be directed to real or legal persons who have emptied the company. If the court establishes that a shareholder or the parent company have emptied the principal debtor company’s assets, the court will rule for the collection of debts from these persons.