Direct Responsibility Of The LLC’s Founder

Did you know that the founder of a limited liability company can be held liable for the obligations of his company?

 

Of course, the essence of the mentioned liability should not be tied to the phrase “limited liability”.

 

This refers to the possibility of unlimited liability with personal property of a member of a company.

WHAT IS LLC?

In order to understand the above-mentioned possibility of unlimited liability of a member of the company, it is first of all necessary to define the LLC.

 

Of course, like other modern legislations, ours does not dare to determine a specific definition of a limited liability company.

 

The reasons are very clear.

 

A limited liability company, as the most common form of legal form of a company in Serbia, was created as a need to combine typical characteristics of other legal forms of companies and typical characteristics of capital companies, and therefore has the characteristics of both companies, which makes it difficult to define.

 

Due to the mentioned attributes, it is often also called incorporated partnership, quasi-partnership, limited partnership without general partners, etc.

 

It is most often a company with a small share capital, a small number of members, but also with a feature that specifically interests us, that its members are not responsible for the company’s obligations, but bear the risk of doing business to the extent of its role (a member of the company can lose only what he invested during the establishment, but also later when increasing the share capital and nothing more).

 

Only the company is responsible for the assumed obligations towards third parties with all its assets.

However…

LIFTING THE VEIL – PIERCING THE CORPORATE VEIL

One of the reasons why LLC is the most common legal form of a company in the Republic of Serbia is the “protection” of the founders and other members of the company, i.e. the fact that the company is responsible for its business and obligations to third parties with its property while the personal property of the founders is out of reach for the creditors.

 

However, observed in the described way, we come to the situation of witnessing numerous abuses by members of the LLC, for which reasons the need to suppress them arose. In other words, the legal subjectivity of capital companies is not always an impenetrable wall for creditors. In fact, this wall is impenetrable if the legal personality of the company is not used for illegal purposes.

 

Otherwise, the institute of “Piercing the Corporate Veil” becomes relevant, which enters the field of unlimited liability of the company’s owners for the company’s obligations, where the comparative advantages of legal forms of capital companies (LLC, SC) over other forms of companies (GP, LP) disappear.

 

The origin of the institution of “Piercing the Corporate Veil” can be found in court practice, i.e. the court precedent of the English judiciary, and it is about the dispute of Salomon v. Salomon and Co. Ltd. from 1897.

PIERCING THE CORPORATE VEIL ACCORDING TO THE SERBIAN LAW ON COMPANIES

The institution, as a creation of court practice, still does not have an adequate legal regulation.

 

However, there are certain solutions.

 

Thus, the Serbian Law on Companies prescribes (joint and several) liability of members of LLCs for the obligations of the company who abuse the limited liability rule in which case they are liable for the obligations of the company with their personal property. An obligation is considered to exist when that person:

 

  • Uses the company to achieve a goal that is otherwise forbidden to him;
  • Uses the company’s assets or disposes with them as if they were his own;
  • Uses the company or its assets for the purpose of damaging the company’s creditors;
  • In order to procure personal gain or gain for third parties reduces the company’s assets, although the person was aware or had to be aware that the company would not be able to fulfill its obligations (negligence).

 

The legislator did not define this list as “numerus clausus“, but points out the mentioned cases as frequent, which means that it is possible for the legal personality of the company to break through in situations and ways other than mentioned.

 

What is quite clear is that by “Piercing the Corporate Veil” obligations are avoided and creditors who are misled and kept in error are cheated and damaged.

 

These are most often companies that have one member or companies without employees in which there is a close relationship with members, who are usually related by family, as well as in highly undercapitalized companies.

 

Furthermore, with the amendments to the Law on Companies, the legislator additionally opened the possibility of encroaching on the field of personal asset of the owner of the LLC. Namely, Article 548, paragraph 3 of the Serbian Law on Companies stipulates that the controlling member of the LLC, in case of forced liquidation, is jointly and severally liable for the obligations of the company for three years after deletion of the company from the register.

 

Theoretically, the intention of the legislator is very clear… To prevent the abuse of the legal form of the capital company. However, things are somewhat different in practice.

 

First of all, the application of this institute is achieved by filing a lawsuit to the competent court according to the registered office of the company by an authorized person – the creditor.

 

Although this phenomenon is relatively common in business it is not particularly present in practice in Serbia. Moreover, the application is unjustifiably and for insufficiently clear reasons rare and restrictive in the practice of commercial courts.

 

It is certainly a difficult task for the creditor and that is the fact that the burden of proof is on his side. The courts do not dare to take an additional step because they follow the “trodden paths” of decision-making and thinking on the issue of responsibility and are obviously not ready to enter into the separation of legal entities of companies and their founders. This is evidenced by the judgments of the Commercial Court of Appeals, Pž 2111/2014 from 19 November 2015, as well as Pž 926/2015 (1) from 12 April 2017, but also the Judgment of the Supreme Court of Cassation Rev 2494/2017 of 6 June 2018.

 

This behavior of courts is especially unclear because in practice there are many situations when the “Piercing of the Corporate Veil” is more than clear, especially in cases when the founder of an over-indebted LLC or a member of his family founds a new company that often has a very similar business name.

IS THERE AN ALTERNATIVE?

  1. “Piercing the Corporative Veil” as a criminal offense

 

Earlier provisions of the Criminal Code, i.e. its Article 238, provided for the criminal offense of Abuse of Authority in the Economy, both in basic and qualified form. However, with the amendments to the Criminal Code this criminal offense ceased to exist, but from the majority position of the courts, we find that the previous criminal offense was not decriminalized, because its important features are contained in the criminal offense of Fraud in performing economic activities under Art. 223 of the Criminal Code.

 

  1. Responsibility of the founders according to the Law on Tax Procedure and Tax Administration

 

From the point of view of tax law, it should be noted that, if the company has due and unsettled obligations based on public revenues, the Tax Administration, ex officio, confiscates TIN to the newly established company, whose founder is a person who also owns due and unsettled obligations based on public income. It is a mechanism of protection of the state from unscrupulous business of taxpayers, however, creditors, who do not have the status of public entities are not protected by this mechanism.

 

  • Responsibility of the founders according to the Bankruptcy Law

 

Bankruptcy, as one of the ways to terminate the existence of a company, occurs in a situation when the company’s assets are less than liabilities, i.e. when the company is not liquid, i.e. it is not able to fulfill its obligations.

 

The Bankruptcy Law specifically regulates the reasons for initiating bankruptcy proceedings, as well as the authorized proposers, including the bankruptcy debtor (company). In this regard, Article 56, paragraph 2 of the Bankruptcy Law, in the part relating to the form and content of the proposal, provides that the proposal for initiating bankruptcy proceedings to the competent court contains a list of bankruptcy and other creditors stating the amount and basis of claims, as and the names and residences of the members of the company who are liable for the obligations of the bankruptcy debtor with their personal property, if the proposer is the bankruptcy debtor.

CONCLUSION

The institution of Piercing the Corporative Veil slowly and shyly enters our legal life. The credit for this certainly belongs to the timid and hesitant legislator, as well as to the confused and irresponsible court practice.

 

We can only hope that the institute will play a more significant role in the law of Serbian companies and that, in that way, the creditors of unscrupulous founders of capital companies will have greater security and the possibility of settling their claims.

 

What should be especially emphasized is the fact that the legal subjectivity of capital companies is the rule and that “Piercing the Corporative Veil” is an exception, the application of which must not be absent when the appropriate legal preconditions are met.