There are almost 1.4 million companies registered in Hong Kong. 95% of them are private limited company which offers several benefits. One of them is the protection of the personal assets of the shareholders from business risks and liabilities. With that in mind and the fact that opening a company in Hong Kong takes less than 2 days, we often hear from company founders that the best protection in case of a claim against the company is … to simply close it and reopen a new one. Well not really. In this article, we will explain that closing your company to avoid legal action is probably not your best option.
1. Minimising the personal liability of the shareholders
A limited company is treated as a separate legal entity with its own legal existence and its own right. The business is separated from the person who owns and manages it so that it offers protection of personal assets from business risks and liabilities. As a shareholder, the liability is limited to the nominal value of the shares.
A loss or an incident that occurs in relation to the business will therefore not result in exposure to the personal finance and assets. If an insolvent company is unable to pay its creditors, shareholders will only be required to contribute the nominal value of the unpaid shares. Beyond that, the personal assets will be protected.
Same with a claim from a third party in relation to the business activity, the product, or the service. If the company does not have the sufficient resources to indemnify the third party, it will be closed. Again, the personal assets of the shareholders will be protected.
This separation is known as the ‘corporate veil’. Any debt, losses, or legal claims associated with the company are the responsibility of the company itself – not its owners (shareholders/guarantors) or directors.
However, this is not bulletproof.
2. Piercing the corporate veil
When ‘piercing the corporate veil’, the individuals associated with the entity can be held personally accountable of the debt, losses or legal actions arising from the company’s wrongdoing. The third parties will be able to go after the owners’ home, bank account, investments, and other assets to satisfy the company’s debt
Circumstances where the shield of a registered legal entity may be pierced are limited but they exist. It could be:
- Absence or inaccuracy of corporate records
- Failure to keep business funds separate from personal funds (commingling assets)
- Paying for personal purchases with the business credit card
- Personally, guaranteeing a business loan or using personal property as collateral for a business loan
- Not meeting compliance obligations
- Conducting fraudulent activities under the business
If cases where the courts ‘pierce’ the corporate veil in Hong Kong are rare, courts do not hesitate to lift the corporate veil especially in presence of “fraud and evasion of existing legal obligations” such as in this example. In this study from 2011, in 1 case out of 2 courts have agreed to lift the corporate veil when the doctrine has been invoked.
3. Buying an insurance will certainly be less expensive and troublesome
In case a third party sues a company in Hong Kong, closing it and reopening a new one could be a solution that some founders would choose to avoid the financial impact of the litigation. However, taking all the assets lodged under the company and transferring them to a new corporation then shutting down the old one, all to avoid responsibility to the plaintiff might not only be stressful but this might be considered by the courts as a fraud.
To avoid this potentially damaging and risky solution, founders of private limited companies could buy an appropriate liability coverage. Setting up a public liability insurance, a product liability insurance or a professional liability insurance is not expensive. It will then bring the following advantages:
- Mitigation of the financial impact of the claim
- Reimbursement of the defence costs, investigation costs and other cost necessary to defend your situation
- Compliance with your commercial agreement with clients. Liability insurance is more and more often part of the contractual requirements.
And last not least, this will avoid the headaches of you having to close your company
Having question about liability insurance
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