THE PRINCIPLE OF LIMITATION OF LIABILITY IN A LIMITED LIABILITY COMPANY

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A. INTRODUCTION

The protection provided by a limited liability company is an important aspect of the business structure as it allows shareholders of a company to not be personally liable for the debts of the company.

However, in this regard, the following questions should be considered:

1. What if the shareholders or the directors of a limited liability company misuse the principle of limitation of liability?

2. Does the principle of “separate corporate personality” of a company safeguard the shareholders and directors of a limited liability company?

3. Would the creditors of a limited liability company be able to go after the shareholders’ personal assets to recover the company’s debts?

All of the above questions are considered and addressed by the Dubai Court Of Cassation in Dubai Cassation Court’s Judgment dated 19/01/2009 on the Appeal No. 75/2008 – Commercial Appeal, wherein the Court ruled as follows:

“It’s established under the provision of Articles 111 and 237 of the Commercial Companies Law (1) that a director of a limited liability company shall be liable toward the company, the shareholders and third parties for acts of fraud and misuse of powers and for any act of default with regard to the law or the company regulations and for maladministration…. Whereas it’s established under the doctrine of Dubai Cassation Court that the principle, as per the provision of Article 218 of the Commercial Companies Law (2), stipulates that a partner in the limited liability company may be liable only to the extent of its share in the capital, however the liability limitation principle of a partner in the limited liability company, to the extent of the share of such partner in the company’s capital, may not apply whenever the partner takes advantages of the principle of the independency of limited liability company’s debt from the debt of the partners therein as a means or cover for illegal activities breaching the company’s MOA, which activities shall inflict damages to other partners or creditors, as long as such activities include fraud, deception, or gross negligence; in this event, the principle of the partner’s liability to the extent of its share in the capital shall be ineffective; yet the partner shall be liable in its personal capacity for such acts to the extent of its own monies”.

In order to fully understand the aforementioned judgment let’s discuss the following aspects in turn:

1. Definition of a limited liability company.

2. The concept of a separate and independent legal personality of a limited liability company (the Corporate Personality of a company).

3. The possibility of personal liability of the partners and the legal representatives of a limited liability company against their personal assets to cover the company’s debts, upon the establishment of gross negligence and fraudulent acts.

B. DISCUSSION IN LIGHT OF THE RELEVANT PROVISIONS OF FEDERAL LAW NO. 2 OF 2015

I. Definition of a limited liability company and the concept of limitation of liability

A limited liability company is the most common form of business structure in the UAE. Article 71(1) of the Federal Law No. 2 of 2015 (“Companies Law”) defines a limited liability company as follows:

“A Limited Liability Company is a company where the number of partners is at least two (2) but shall not exceed fifty (50). A partner shall be liable only to the extent of its share in the capital.”

The above-mentioned article 71(1) of the Companies Law codifies the principle of “limitation of liability” of the shareholders and specifically provides that the liability of the partners/ shareholders of a limited liability company shall be limited to the extent of their share in the share capital of the company.

II. The concept of separate and independent legal personality of a limited liability company (the Corporate Personality of a company).

In general, this concept stipulates that a limited liability company is considered to have its separate legal personality, which is independent from the legal personality of its partners . Therefore, as a general principle, the company’s partners or directors may not be held personally liable for the company’s debts. This is because a limited liability company is recognized as a legal entity distinct from its members, and has its own independent legal existence separate from its shareholders, directors, officers, and creators etc. Consequently, assets attributed to the associated individuals cannot be seized in an effort to repay debt obligations attributed to the company. This principle is enunciated in Article 21(1) of the Companies Law, which states:

“The company shall, from the date of entry in the Commercial Register with the competent authority, acquire a corporate personality in accordance with the provisions of this Law and the Resolutions issued hereunder”.

Dubai Cassation Court’s Judgment dated 26/03/2013 on the Appeal No. 202/2012 – Labour Appeal states:

“A limited liability company shall have its independent legal entity from the date of its commercial registration; which entity shall remain until legally expired, hence the legal entity of the LLC company shall be independent of the entity of the partners thereof and the entity of its legal representative, and the company shall continue to reserve such independent entity even if one of the partners or the manager thereof is the owner of another company, or even if such company itself is the owner or a partner in another company, and even if the director of the two companies is the same person”.

III. The liability of the partners and the legal representatives of a limited liability company against their personal assets for the company’s debts upon the establishment of gross negligence and fraudulent acts

Notwithstanding the foregoing, the general concepts of the limitation of liability and separate legal personality of a company (discussed in Point I and II above respectively), may be disregarded in certain exceptional circumstances.

For example, in the event, there is a serious fault committed by the company’s manager (with the participation of the partners) which results in the smuggling and/or misappropriation of the company’s money/assets, with the intention to cause damage to the company’s creditors, and whereas such default is established, being embodied in hiding the company’s money, whether its profits or assets, which constitutes a security for the creditor, then such act shall be deemed a breach by the company’s manager/director and partners of the relevant provisions of the Companies Law.

Therefore, as an exception to the general concepts discussed in Point I and II above, legal proceedings may be initiated against the partners (in their personal legal capacity) and the directors (in their personal legal capacity), if they commit serious fraud or other wrongful acts with the intention to hide the company’s assets to inflict damages against the company’s creditors. Consequently, the relevant partners and directors shall be personally and jointly liable for the company’s debt (as applicable). In this regard, the liability of the partners shall also not be limited to the extent of their contribution to the share capital of the company and can exceed to cover the actual debts of the company.

Generally, proving the said fraudulent acts of the manager and/or partners requires the claim to be referred to an accounting expert who shall conduct an in-depth examination of the company’s documents and audited reports, as well as conduct an inventory on the company’s assets, review the bank accounts of the company and examine the financial transfers and basis thereof to establish whether the company’s directors and partners have collaborated to smuggle, hide and/or misappropriate the company’s assets to cause damages to the company’s creditors.

Please see below the relevant articles of the Companies Law that are relevant in this regard.

Article 22- Duties of the Managing Director of the Company

“A person authorized to manage the company shall preserve its rights and extend such care as a diligent person such person shall do all such acts in agreement with the objective of the company and the powers granted to such person by virtue of an authorization issued by the company in this respect.”

Article 23- Liability of the Company for the Acts of its Managing Director

“The company shall be bound by any act or behaviour arising out of its Managing Director upon conducting the affairs of management in a usual manner. The company shall also be bound by any act of any of its employees or agents authorized to act on behalf of the company, and whereby a third party relies thereon upon its transaction with the company.”

Article 84(1)- Liability of the Managers of the Company

“Every director in a Limited Liability Company shall be liable against the company, the partners and the third parties for any fraudulent acts by such Manager and shall also be liable for any losses or expenses incurred due to improper use of the power or the contravention of the provisions of any applicable Law, the Memorandum of Association of the company or the contract appointing the Manager or for any gross error by the Manager. Any provision in the Memorandum of Association or the contract appointing the Manager in conflict with the provisions of this Clause shall be deemed void”.

Article 90- Liability of the Members of the Supervisory Board

“The Members of the Supervisory Board shall not be held liable for the acts of the Managers or the results of such acts unless such members were aware of the errors committed and omitted to state such errors in their report presented to the General Assembly of the partners.”

The above-mentioned articles of the Companies Law codify the duties and liabilities of the managers of a company. Based on these provisions and the Dubai Court of Cassation judgements quoted in this article, it can be concluded that in the event the managers/directors act contrary to their duties (with the participation of the shareholders), then the Courts may not conform strict compliance to the principles of limitation of liability and the separate corporate personality of a company and, subject to the establishment of a fault/ fraud in this regard, render such shareholders/ directors personally liable for the company’s debts.

The rationale for the same is to ensure that the partners/ shareholders of a limited liability company are deterred from taking unjust advantage of this principle and refrain from conducting illegal and wrongful activities in reliance of the same. As stated by the Dubai court of cassation:

“the liability limitation principle of a partner in the limited liability company, to the extent of the share of such partner in the company’s capital, may not apply whenever the partner takes advantages of the principle of the independency of limited liability company’s debt from the debt of the partners therein as a means or cover for illegal activities breaching the company’s MOA, which activities shall inflict damages to other partners or creditors, as long as such activities include fraud, deception, or gross negligence; in this event, the principle of the partner’s liability to the extent of its share in the capital shall be ineffective; yet the partner shall be liable in its personal capacity for such acts to the extent of its own monies”.

C. CONCLUSION

As a general principle, a limited liability company has a separate and independent legal personality from the entity of the partners. Furthermore, as a general rule, the liability of the shareholders of a limited liability company is limited to the extent of their shares in the share capital of the company.

Notwithstanding the same, to offer protection to the third party transactions with the company and to refrain the shareholders and directors/managers of the company from misusing these concepts in bad faith, the UAE legislature and the legal precedents allow for exceptional circumstances, whereby the partners and the legal representatives of a company can be personally held liable to secure the debts of the company by their personal assets, in the event of the commitment of a serious fault of fraud by such individuals.

Written by: Abourassm Gaber – Executive Associate

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