The Theory of Piercing the Corporate Veil in Capital Companies

ABSTRACT

A legal personality is a structure that emerges in areas where individual effort falls short and is defined as a legal existence independent of the person. In capital companies, the principles of limited liability and separation apply; within this framework, shareholders are liable only to the extent of the capital they have committed and only toward the company. However, despite these principles, legal personality is sometimes abused and instrumentalized in a manner that harms third parties.

In such cases, pursuant to Article 2 of the Turkish Civil Code[1] numbered 6427 ("TCC"), the principle of good faith and the prohibition of abuse of rights come into play, and the corporate veil is pierced to hold the real persons behind the personality directly liable. In this study, the concept of legal personality will be explained, and the procedures for piercing the corporate veil, as well as how and under what circumstances it occurs, will be examined in detail together with the theory of organic connection and its differences.

Keywords: Legal Personality, Principle of Limited Liability, Principle of Separation, Piercing the Corporate Veil, Abuse of Rights, Principle of Good Faith, Organic Connection

I. INTRODUCTION

In modern legal systems, the concept of personhood includes not only real persons but also legal personalities that are established for specific purposes and recognized as independent legal existences. Real personality is an important legal tool that enables the collective execution of economic and commercial activities. However, this structure may sometimes be abused by shareholders or managers to serve the purpose of harming third parties.

In such cases, it becomes possible to circumvent the boundaries of separation and non-liability recognized by the legal order and to avoid responsibility by hiding behind the corporate personality. In situations that constitute an exception to the principle of separation and non-liability between the legal personality and its shareholders, namely, when the structure of the legal personality is abusively used in violation of the legal order or when the distinction between the company and the shareholders clearly contradicts the principle of good faith, the theory of "piercing the corporate veil" is invoked.

II. THE CONCEPT OF LEGAL PERSONALITY

When evaluated from a legal standpoint, the concept of "person" refers to entities that have the capacity to hold rights and assume obligations. Although real persons come to mind at first in line with this definition, due to the inadequacy of individual effort in achieving certain goals and the compulsion of social needs, some groups of persons and assets have also been recognized as "persons" by the legal order. These collectives, referred to as legal persons, are entities formed through contracts and are defined as legal personalities separate and independent from the real or legal persons who execute such contracts[2].

Legal personality can be defined by reference to the first paragraph of Article 47 of the TCC. A legal person is a group of persons or assets that is organized to achieve a specific and continuous objective, and is independent from the individuals who have established it[3].

III. CERTAIN PRINCIPLES GOVERNING LEGAL PERSONALITY

A. The Principle of Limited Liability

In general, what is meant by limited liability in partnership law is the limitation of partners' liability to creditors for partnership debts[4]. The principle of limited liability in capital companies expresses that shareholders are liable only to the extent of the capital they have committed or actually brought into the company; third parties may resort solely to the assets of the company to satisfy company debts. For joint stock companies, it is explicitly regulated that shareholders are liable only with their committed share capital and only towards the company[5].

Additionally, due to the company’s debts to third parties, a shareholder bears no liability whatsoever toward the company’s creditors; nor does the shareholder have any obligation to fulfill these debts. In other words, since companies are liable for their debts only with their own assets, company creditors may not make any personal claim against shareholders, whether directly or indirectly. A shareholder is deemed to have fulfilled their obligation by paying the committed share capital to the company, and upon such payment, their liability toward the company ceases.

B. The Principle of Separation

The principle of separation refers to the legal personality's possession of capacity to hold rights and undertake obligations independently from both its members and third parties, and in this context, to its ownership of a distinct and separate estate. In this regard, capital companies are liable for partnership debts only with their own assets. Accordingly, real or legal persons who come together under the roof of a legal personality are not held liable for the debts of the partnership, thanks to the principle of separation[6].

In this respect, the principle of separation can be examined under two subcategories. Under the scope of personal separation, legal personalities are permanent organizations that are distinct from their founders, members, and shareholders, and are unaffected by the lifespan of those individuals meaning that the persons forming the legal personality and the legal personality itself are different from one another.

Asset separation means that the legal personality possesses a property that is separate and independent from the persons who constitute it. Thanks to the principle of asset separation, the legal personality becomes directly liable for the legal transactions to which it is a party, and in principle, the individuals forming the legal personality do not bear liability. Accordingly, legal personalities are liable only to their own creditors and are fully liable with all of their assets. As a rule, shareholders cannot be held liable for the debts of the legal personality, and likewise, the debts of shareholders cannot be claimed from the legal personality[7].

The principle of separation establishes a legal distinction and distance between the legal person and the real persons who constitute it. This is a natural consequence of the separation principle and essentially aims to limit the personal liability of shareholders toward third parties. However, in certain exceptional circumstances, this distinction may be breached, and the individuals behind the legal personality may be held directly liable.

IV. PIERCING THE CORPORATE VEIL

Piercing the corporate veil, in its most basic sense, refers to the disregard of the principle of separation of the legal person in a concrete case, thereby allowing third-party creditors of the legal personality to hold the individuals constituting that legal personality liable[8].

Circumventing legal rules to commit fraud against the law; individuals using a separate legal personality as a shield to avoid fulfilling contractual obligations they are party to through that legal personality, or causing harm to third parties and subsequently hiding behind such a structure, these are incompatible with the principle of good faith and the prohibition of abuse of rights and cannot be protected by the legal order. In such cases, as the second paragraph of Article 2 of the TCC stipulates that the abuse of a right shall not be protected, the corporate veil must be pierced, and the real persons behind the personality must, where necessary, be held directly liable.

Circumstances such as the mixing of the legal personality's assets and organizational structure with those of the shareholders, the shareholders acting as if there is no legal separation between them and the legal person, or failing to observe a boundary between their personal property and the company’s property, or continuing operations with insufficient capital, especially when the legal personality is intentionally used in a manner that causes harm to third parties, are among the primary grounds for piercing the corporate veil.

In legal doctrine, the theory of piercing the corporate veil is addressed in three distinct forms: direct (straight), indirect (reverse), and lateral (cross) piercing. In the case of direct piercing, the controlling or sole shareholder who abuses the legal personality to avoid liability is held personally liable toward the creditors of the legal personality. The Court of Cassation decisions also acknowledge and apply the concept of direct veil piercing[9]. In reverse piercing, however, the creditors of a shareholder are permitted to pursue claims against the legal personality over which the shareholder exercises control, holding both the shareholder and the legal personality jointly liable[10]. Cross piercing of the veil arises not only between parent and sister companies but also among sister companies within a corporate group or holding structure.

If a decision is made to pierce the corporate veil, the legal personality and those who constitute or control it are treated as if they were the same person. In the case of direct veil piercing, the debts of the legal personality are extended to the shareholders, making them personally liable for satisfaction of such debts[11].

V. THE THEORY OF ORGANIC CONNECTION

Alongside the theory of piercing the corporate veil, another theory that must be discussed is the theory of organic connection. In corporate law, the term organic connection refers to relationships between different companies. It can be said that the term denotes the execution of commercial transactions and dealings among related persons, such as in cases of ownership or creditor relations, without establishing a formal company partnership or corporate group structure, thereby concealing the actual owners and transactions behind different companies, persons, or representatives and disguising the economic and commercial activities accordingly[12]. Organic connections reveal that although companies appear to be independent personalities, they are in fact part of a network managed by the same individuals or organizations.

The concept of organic connection is not regulated under Turkish law by statute, but has emerged through customary practice and case law of the Court of Cassation. It may be said that proving the existence of an organic connection requires a lesser evidentiary burden compared to piercing the corporate veil[13]. The Court of Cassation recognizes that organic connection can be identified through similarities in companies' addresses, fields of activity, shareholders, and representatives, as well as by establishing the legal relationships between them[14].

The concepts of piercing the corporate veil and organic connection are closely related but nonetheless distinct theories within corporate law. Both theories ultimately aim at broadening the scope of liability. Piercing the corporate veil typically enables a creditor to reach beyond the company to the real person shareholders behind it and to hold them liable. By contrast, the theory of organic connection allows different legal personalities to be held jointly and severally liable if a relationship between them exists. The fundamental difference between the two theories is that piercing the veil targets the liability of real persons, whereas the organic connection theory assigns liability to another legal personality.

VI. CONCLUSION

The concept of legal personality is a fundamental building block in the regulation of complex economic and social relations within modern legal systems. Legal persons, which are recognized as legal personalities independent of real persons, operate as collectives organized for a specific purpose; and thanks to the inherent principles of separation and limited liability, the personal assets of shareholders are protected and risks are confined within defined limits.

However, particularly in cases where legal personality is abused with the intent to harm third parties, such conduct is clearly contrary to the principle of good faith, and in such circumstances, the piercing of the corporate veil comes to the fore. Although the principles of limited liability and separation constitute the foundational elements of legal personality, when these principles are abused, the legal order may pierce the corporate veil and impose direct liability on the real persons behind it. This mechanism serves the administration of justice by preventing the abuse of rights.

REFERENCES

1. Prof. Dr. Hasan PULAŞLI, Şirketler Hukuku Şerhi Volume I, Edition 4, Adalet Yayınevi, Ankara, 2022

2. Fahri Erdem KAŞAK, Tüzel Kişilik Kavramı ve Tüzel Kişilik Perdesinin Kaldırılması, Marmara Üniversitesi Hukuk Fakültesi Hukuk Araştırmaları Dergisi, Edition 26, December 2020

3. Dr. Emrullah KERVANKIRAN, Sermaye Ortaklıklarında Sınırlı Sorumluluk İlkesine Karşı Önemli Bir İstisna: Tüzel Kişilik Perdesinin Kaldırılması, Erzincan Üniversitesi Hukuk Fakültesi Dergisi, Edition 11, Issue 3-4, December 2007

4. Dr. Namık Kemal UYANIK, Tüzel Kişilik Perdesinin Kaldırılması ve Organik Bağ, Edition 3, Seçkin Yayınevi, Ankara,

[1] Official Gazette dated 21.11.2001 and numbered 24607