Avoiding the use of legal entities to commit fraud

One of the most important elements of company law is the limitation of the liability of the partners or shareholders.

It is of course permissible to articulate business activities through a company, so that the personal assets are protected from the eventual outcome of the company. However, this separation of assets must not be used in a fraudulent manner, amounting to what is known under Spanish law as “abuse of legal personality”.

Spanish case law has constructed its own mechanisms to combat possible abuses of legal personality, making use of the lifting of the corporate veil doctrine, first developed in Spain by a Supreme Court ruling of 28 May 1984 that has been used and developed ever since in virtually all areas of law.

It is generally understood that this inappropriate use occurs when the purpose of the company is not that which is proper to it (the exercise of commercial activities) but the mere avoidance of personal liabilities.

Requirements of the Spanish “piercing the corporate veil” doctrine

The doctrine will be perfectly applicable when the requirements for assessing such possible fraud are met, namely: (i) control of several companies by the same person; (ii) related-party transactions between those companies; (iii) lack of economic and legal justification for those transactions.

When this type of situation arises, in which intra-group transactions serve no purpose other than fraud, diverting for example the funds of the company that has debts to another company that does not, to the obvious detriment of the creditors of the former, the courts apply the doctrine of piercing the veil, thus rendering ineffective the apparent transactions that have constituted the abuse.

Once this first judicial formulation of the doctrine was carried out in Spain, a significant number of decisions, both by the Supreme Court and the Courts of Appeal, as well as by the Courts of First Instance, have led to its full confirmation and progressive use until it can be said that it has become an institution of judicial creation fully integrated into all areas of Spanish law.

Piercing the veil in civil-commercial and insolvency matters

It is in the civil-commercial sphere where the doctrine of lifting the corporate veil has had its confirmation and development through a body of case law that has been shaping and delimiting it.

One of the guidelines that Spanish jurisprudence has always been clear about this doctrine has been its necessarily restrictive application.

On the other hand, having clarified its restrictive nature, the doctrine cannot be applied “ex officio” by the judge.

Although there have been different attempts made by Spanish doctrine to classify the cases in which it is understood that the doctrine could be used, it is understood in case law that these are not “numerus clausus”.

It is frequently used, for example, in cases of misuse of the legal personality to the detriment of creditors, when the sole or majority shareholder normally empties the debtor company of its business and assets to continue with the same business and operations by setting up a new company and thus evade liability for the obligations assumed by the first entity. An example of fraudulent succession of companies can be found in the Supreme Court ruling of 20 December 2017, which condemns a company that formally did not contract the debt to pay it.

In insolvency matters, the doctrine is also applicable, among others, in: (i) claw-back actions (ii) for credit-ranking purposes (iii) determination of personal liabilities for the causation or worsening of the insolvency (iv) opening of joint insolvency proceedings (v) To resolve third-party claims, particularly when denying the status of third party to the company “confused” with the foreclosed company.

The Supreme Court Judgment of 30 January 2018 goes a step further by extending the application of the doctrine to consumer matters, by extending the contractual liability of the developer to the construction company against individual owners in a claim for construction defects.

Piercing the veil in criminal matters

In criminal law we can find frequent use of the doctrine of lifting the corporate veil, mainly in matters of economic criminal law, tax offences, as well as in the claim for civil damages caused by the criminal offence, where the perpetration of the crime occurs precisely by means of the interposition of “apparent” companies.

In terms of tax avoidance, we can cite the Supreme Court ruling of 8 June 2018, according to which, through a different company, income was concealed that belonged to another. Or the most recent ruling of the same Court dated 18 September 2018 on the avoidance of the special tax on hydrocarbons.

We can also apply it to crimes of embezzlement of public funds to clarify whether we are dealing with a public official or not. Thus, the Supreme Court ruling of 8 February 2018 states:

Or in matters of crimes of misappropriation as in the judgement of the same Chamber dated 21 February 2017 or 30 November 2016.

And the lifting of the veil has been applied with similar forcefulness in money laundering offences. Thus, by way of example, the Supreme Court ruling of 22 October 2013.

In short, we can say that in criminal law, we have seen an increasing use of the doctrine of lifting the veil, mainly for the prosecution of crimes committed using front companies.

The Spanish State General Prosecutor’s Office instructed Spanish public prosecutors to invoke the piercing of the corporate veil, notwithstanding the also available criminal liability of legal entities (Circular Letter 1/2011, dated 1 June 2011).

Piercing the corporate veil in employment matters

Special mention should be made of the doctrine of lifting the veil in the employment law sphere, as here its justification is given by the specific need to identify the true centre of business management, especially in those cases in which the employer is a group of companies, as well as in those in which the employer hides behind the screen of a company that acts as an apparent employer.

It can be said that, although it was created by commercial doctrine and formulated in case law in the civil sphere, for some years now in Spain there has been a consolidated line of case law by labour courts.

In addition to the cases of groups of companies, the doctrine of lifting the veil is also fully effective in cases of company succession, i.e., those cases in which the intention is to circumvent the employee’s employment rights by means of a transfer of ownership of the company carried out with abuse of the legal personality by the employer.

Piercing the corporate veil in tax matters

In the field of taxation, it was regarding the personal income tax from work concealed by certain sportsmen and sportswomen -by means of interposed special purpose vehicles- that the courts resorted to the use of the doctrine of lifting the veil during the 1990s.

However, it was not until the decision of the Supreme Court of 19 April 2003 that the latter accepted the application of the doctrine to resolve a case of tax evasion using shell companies.

Since that date, there have been frequent cases in the tax sphere, whether in liquidation or collection matters, in which the Spanish Courts have resorted to the use of the lifting of the veil doctrine.

In fact, it could be said that the doctrine has gradually become part of tax legislation itself. Thus, the current wording of section 6 of Article 170 of the General Tax Law is inspired by the doctrine when, in precautionary measures, it ignores the legal personality of the company in cases where the taxpayer “exercises effective control, total or partial, direct or indirect, over the company of the owner of the property“. In addition, Article 43 of the same Law, sections g) and h), in listing subsidiary liable parties, includes the case that “it is proven that the legal persons have been created or used abusively or fraudulently to evade the universal patrimonial liability to the Treasury and there is a single person or economic sphere, or confusion or diversion of assets“.

In terms of case law, Courts recognise the doctrine of lifting the veil as a “complementary” technique to combat tax avoidance, in a case in which taxation on corporate income tax was avoided by charging high interest on a debt to one of the non-resident group of companies; or the case where a company was set up to provide professional consultancy services actually rendered on a personal basis.

Piercing the corporate veil in administrative litigation

In the administrative litigation sphere (i.e., litigation by private individuals/companies against the State), the application of the lifting of the veil doctrine is accepted without objection, based on the same arguments offered by the civil jurisdiction. Thus, the judgement of the Supreme Court of 16 April 2008, regarding the reimbursement of a public subsidy, states that “the legal figure of lifting the veil has been used to overcome the abusive use of the legal personality of companies”.

However, despite this admission of the doctrine, in general, it has been scarcely used by this jurisdiction, which prefers to resort to the generic institutes of “fraud of law” and/or “abuse of rights”, mainly in cases of extensions of liability for public debts, sanctions or the patrimonial liability of the State.