Piercing the Corporate Veil

Piercing the Corporate Veil is the judicial act of imposing personal liability on otherwise immune corporate officers, directors, and shareholders for the corporation’s wrongful act.[1] Piercing Corporate Veil shows that the Limited Liability Company (“Company”) often cannot be separated from the parties’ interest such as the Shareholders of that Company. In this context, the Shareholders’ interest is the Company’s interest. Piercing Corporate Veil Concept stipulates that when “the separation condition” of Company with the Shareholders does not exist then the limited liability responsibility of the Shareholders should be absent. Therefore the Shareholders must be liable personally upon the loss of the Company.

Piercing Corporate Veil also applies to the corporate officers such as director and/or commissioner if it shows that loss of company because of the corporate officers’ wrongful act. Therefore director/commissioner of company must be liable to Company upon the loss of the company. In case of insolvency, they must be liable to the Creditors. This article will only discuss the Piercing Corporate Veil by the Shareholders. Piercing corporate veil by the shareholders The purpose of establishment of Company is to conduct the business activities that the respective founders (Shareholders) are not liable personally besides the assets that they put in the Company. In order to have a limited liability status, the Company must fulfill the formal requirements based on the prevailing laws and regulations. The founders must fulfill the requirements from pre-establishment to post-establishment of company. If the founders do not conduct their duty related to the fulfillment of legal status of the Company, the founders clearly do not want to have limited liability from the Company. With regard to the limited liability of Company, the Company owns at least the minimum required capital so that the Company can operate.

As a legal entity, the Company must be rendered the sufficient capital to conduct its activities. Moreover, the respesctive capital must be used based on the purpose of the Company and the Company’s interest. The misuse of the Company assets is not allowed by law. The purpose of the Company’s assets that were separated by the Shareholders, is to ensure only the respective separated assets will be liable, not all the assets of the Shareholders. The intermingling of assets of the Company and of the shareholders shows that it is difficult to separate the liability from the existing assets. As a consequence, the characteristic of limited liability of Company is absent because of law. In general the Company is established in order to have profits. That profit will be distributed among the Shareholders unless otherwise stipulated. The dividen given to the Shareholders every year is mandatory. If dividen is not given to the Shareholders every year, it shows that there is misuse of company for the Shareholders’ interest particularly the majority Shareholders.

In this scenario, the Piercing Corporate Veil can be applied. If the Shareholders transfer the assets of the Company to each Shareholder improperly, then the Piercing Corporate Veil can be conducted in this case. Theory of Piercing Corporate Veil With regard to the piercing corporate veil, there are five (5) theories e.g. agency, fraud, sham or façade, group enterprise and unfairness/justice. In the Agent theory, the Company is agent of the Shareholders. It shows that as an agent, the Company is not liable upon the acts that were conducted by itself based on the purpose of the Shareholders. Therefore there is no limited liability that applies to the Shareholders. In the Fraud theory, the particular action is conducted by the Company in order to avoid the personal liability. For example: the Shareholders treats the assets of the Company as their own personal assets, the respective Shareholders use the Company’s assets for his personal interest, and the Shareholders’ act emerges the transfer of Company’s assets to each Shareholders improperly. Furthermore, a ‘sham’ or façade will be applied as piercing the corporate veil if the corporate form was incorporated or used as a mask to hide the real purpose of the corporate controller. While a façade will be used as a category of illusory reference to express the court’s disapproval of the use of the corporate form to evade obligations, although the court has failed to identify clear test based on pragmatic consideration such as undercapitalization or domination.[2]

The purpose of the Shareholders to establish a company is only to avoid the limited liability; however they do not fulfill their obligations. For example: the intermingling of assets of the Company and Shareholder. Furthermore, the group enterprises theory will be applied as piercing the corporate veil because a corporate group is operating in such a manner as to make each individual entity indistinguishable, and therefore it is proper to pierce the corporate veil to treat the parent company as liable for the acts of the subsidiary. For example: the Board of Director (“BoD”) can not take any action without considering the regulations of Parent Company with regard to the Company. In this case, BoD will take action only for the interest of the Parent Company as the Company’s shareholders. The Shareholder in a Company may also seek to pierce corporate veil to get the underlying reality of the situation, in order to avoid an unfair outcome. In that condition, the unfairness/justice theory can be applied for the piercing corporate veil.

For example: The majority shareholder also involves in making decision for the Company. Because of his respective action, the party that has legal relationship with the Company gets unfair outcome. If the respective party files a suit against the Company, his claim to Company will make the Company’s loss bigger. In this case, it would make it possible for the direct claim to the majority of shareholders to be made. Piercing the corporate veil based on Indonesia company law Company Shareholders are not personally liable for agreements entered into on behalf of the Company and are not liable for Company losses exceeding the nominal value of the shares individually subscribed.[3] The condition above will not apply if: The requirements for [a Company’s existence as]a legal entity have not been or are not fulfilled; Shareholder, either directly or indirectly, in bad faith, uses the Company solely for personal purposes; A shareholder is involved in unlawful acts committed by the Company; or A shareholder, either directly or indirectly, unlawfully uses the Company’s assets, which causes the Company assets to be inadequate to settle the Company’s debts. Point (1), it is clear that the Shareholders are not serious to obtain the status of limited liability.

This status can only be obtained after the Company has gained the Ministry of Laws and Human Rights (“MoLHR”) approval. If the Shareholders neglect the formal procedure of the establishment of the Company, it can be interpreted that the Shareholders do not really want to establish a limited liability company. The request to obtain MoLHR legalization must be submitted to the Ministry at the latest of 60 (sixty) days after the Deed of Establishment (“DoE”) is signed, together with the information about the supporting documents.[4] If the request to obtain the Ministry’s legalization is not submitted within this period, the Article of Association becomes void as from the passage of that period and the Company that has not obtained the legal entity status is dissolved by law and its settlement shall be carried out by the founders.

The Company cannot obtain the legal status not only because the Company has no MoLHR’s approval but also for other reasons such as the founders have not placed the capital as agreed before, founders do not give their authority to the Company’s officers to conduct the Company’s activities because the founders wishto conduct activities on behalf of the Company, etc. Point (2), the Shareholders in bad faith uses the Company for their own interest. The Company implements only the purposes and objectives of the Shareholders. This is in line with the Agent Theory. Therefore, the Shareholders in bad faith can not be protected by law. Piercing Corporate Veil can be applied in this case. Point (3 ) shows that a shareholder is involved in unlawful acts committed by the Company based on the Fraud theory. Anyone who causes loss to others, must be liable upon that loss. As an artificial person, the Company does not have objectives. In the event that the objective of Company is the same as the Shareholders’, the Shareholders will become liable. Point (4) related to the use of the Company’s assets illegally, in the event the Shareholders use the Company’s assets and losses exceeding the Company’s assets, which cause the Company can not settle its debts to Creditors, then the piercing corporate veil can apply to this case. Parties that are being protected by the principle of the piercing of corporate veil Article 3 (2) Law 40/07 does not explain explicitly the parties that are being protected by the Principle of the Piercing of Corporate Veil.

However, Article 3 (2) Law 40/07 may give protection to the Creditors of the Company. Moreover, Article 61 and Article 62 Law 40/07 may give protection to the Minority Shareholders. Article 61 and 62 Law 40/07 stipulate the followings: Each shareholder is entitled to file a lawsuit against the Company in the District Court, if [that Shareholder] suffers losses by the Company’s actions which are considered unfair and without reasonable ground as a result of a resolution of the General Meeting of Shareholders (“GMS”), BoD and/or Board of Commissioners (“BoC”). The lawsuit shall be filled in the District Court whose jurisdiction covers the Company’s seat. Each shareholder is entitled to demand the Company to purchase his shares at a reasonable price, if that shareholders does not approve of the Company’s action which is detrimental to the shareholder or the Company, namely:

a. An amendment to the Article of Association;

b. A transfer, or a change of the Company’s assets that have a value of more than 50% (fifty percents) of the Company’s net assets; or

c. A Merger, a Consolidation, an Acquisition or a Separation.

Where the shares requested to be purchased in the abovementioned condition exceed the limit for the provision regarding share repurchase by a Company, the Company must make an effort that the remaining shares be purchased by a third party. Those Articles show that the Shareholders only have rights to sue the Company, if the respective actions/or acts of the Company are taken based on the prevailing mechanism, and/or have been ratified by the Company based on the prevailing laws and regulations.

Case Example: We may see the Bank Summa’ case on 1992. Whether Mr. Edward Soeryadjaya as a shareholder as well as the Corporate officer of Summa Bank must responsible for Summa Bank’s debts. Summa Bank had loss and could not pay its debts to its Creditor. Mr.Edward’s father, Mr. William Soeryadjaya (“Om William”) acted as a personal guarantor of Summa Bank. Bank Indonesia gave warnings to Bank Summa because they could not fulfill their obligation. Bank of Indonesia has stipulated the period time for Bank Summa to pay its debts. When the time was lapsed, Mr. Edward Soeryadjaya could not pay its debts.

Because of this, Om William had to sell his shares in PT Astra International to pay Summa Bank’s debts that managed by his son. In this case, the Shareholders may loss its immunity upon the limited liability subsequently the Shareholder will be personally liable. Also the limited liability principle may be absent when the Corporate Officers (“Board of Directors or Board of Commissioners”) are at fault or negligent in carrying out their duties according to the principle of good faith (Article 97 (3) Law 40/07).

-Mary Osmond-

[1] Blacklaw dictionary

[2] Widjaja,Gunawan, Risiko Hukum sebagai Direksi, Komisaris & Pemilik PT, Forum Sahabat, 2008, page 31.

[3] Art.3(1) Law No. 40 of 2007 regarding Limited Liability Company (August 17, 2007) (“Law 40/07”)

[4] Art.10 (1) Law 40/07

Learning from Temasek Case

On 19 November 2007, the Commission for Business Competition Supervision (“KPPU”) declared that Temasek Holdings, a holding company owned by the Singapore Government, along with eight other firms namely Singapore Technologies Telemedia Pte. Ltd. (“STT”), STT Communications Ltd., Asia Mobile Holding Company Pte. Ltd, Asia Mobile Holdings Pte. Ltd., Indonesia Communication Limited, Indonesia Communication Pte.Ltd., Singapore Telecommunications Ltd. (“SingTel”), Singapore Telecom Mobile Pte. Ltd, breached the Anti Monopoly Law. Temasek Holdings is considered to have violated Article 27 of the Law No. 5/1999 regarding the Prohibition of Monopoly Practice and Unfair Competition (“Law No. 5/1999”). This Article prohibits business players from owning majority shares in several companies of the same type and the same market or to establish several companies owning the same type of business activity in the same respective market if these ownerships create a business player or a group of business players owning a total of more than 50% market share of a certain type of goods or services.

In 2002 STT, a 100%-subsidiary of Temasek Holdings, won the right to buy a 40,77% stake in state-owned telecommunications company, Indosat. Before its acquisition another Temasek subsidiary, SingTel, has bought a 35 % share in Telkomsel, the biggest cellular operator in Indonesia. Therefore, at the moment, Temasek Holdings owns 35 % of PT Telkomsel through its subsidiary SingTel and 40,77 % of Indosat through STT.

Even though Temasek Holdings is not the majority shareholder, KPPU was convinced that with this structure, Temasek Holdings had the capability to control both Telkomsel and Indosat and that this control caused unfair business competition. According to KPPU’s press release, this caused a slower development in comparison with Telkomsel and therefore the entire mobile telecommunications in Indonesia became uncompetitive. This condition is also shown by the development of Indosat’s Base Transceiver Stations (“BTS”) which, according to the KPPU, developed slower than Telkomsel and XL; the other two big operators in Indonesia.

Furthermore, KPPU found that Temasek’s’ ownership of shares violated Law No. 5/1999, which bars monopolistic practices and unfair business competition. In its decision, KPPU stated that the ownership structures owned by Temasek Holdings through its subsidiaries SingTel and STT in Telkomsel and Indosat respectively caused price leadership in the telecommunication industries. In KPPU’s opinion, Telkomsel, as market leader, had fixed the price of cellular telecommunication service at an excessive level, causing losses to the consumers between Rp 14.3 trillion and Rp 30.8 trillion during the period 2003 to 2006. Therefore, KPPU decided that Telkomsel had violated article 17 paragraph (1) Law No. 5/1999 regarding monopoly practices.

The KPPU decision has triggered controversy and some commentators believe that the decision will affect the investment climate in Indonesia. Potential investors believe that the KPPU decision shows that law enforcement is negatively biased against foreign investors in Indonesia. In addition, the decision still left some important questions for all stakeholders. Temasek, together with its subsidiaries, is stated to have violated article 27 (1) Law No. 5/1999 which states that a business player is prohibited from having majority shares in several companies of the same type which create market share control.

In this case actually, Temasek is not the majority share holder in Telkomsel. Temasek through SingTel has only 35% shares. Apparently, KPPU has interpreted majority shares as having control shareholdership even though the shareholdership is less than 50%. In the case of Indosat this interpretation is understandable because STT is the largest shareholder. However, in the case of Telkomsel this decision is difficult to understand since the majority shareholder in Telkomsel is PT Telkom. Temasek denies having control or influence or having any say in the policies, operations or decisions of Indosat or Telkomsel, whether directly or indirectly through STT and SingTel respectively. Temasek states that the Indonesian Government holds a Series A Share (commonly known as a golden share) in Indosat which gives it special powers including veto rights. The government’s interest in Indosat is only about 14.3%, but it nominates the majority of Indosat’s directors (including the President Director). STT states that it has no special rights or privileges.

Telkomsel is controlled by its majority shareholder Telkom, which has 65% of the shares and which nominates 3 out of 5 of the Telkomsel directors as well as 3 out of 5 of the Telkomsel commissioners.

Another interesting fact in this case is that Temasek is not the owner of the shares in either Telkomsel or Indosat. The owner of the 40,77 % shares in Indosat and the 35% shares in Telkomsel are subsidiary companies of Temasek, namely STT and SingTel. In running their business, STT and SingTel are technically independent, even though there are indications that they are acting in a coordinated way. Apparently, in this case the KPPU has considered that Temasek and its subsidiaries as 1 (one) business player. Temasek denies that it directs, controls, coordinates or materially influences STT and SingTel. It states that each subsidiary of Temasek is run and managed independently by its respective board and management.

The joint market share of both Telkomsel and Indosat is around 90% and has increased in the recent years as shown below. So has profitability. It is however still unclear what were the references of prices and profitability to determine that they are excessive.

Temasek argues Indosat’s market share in terms of subscribers has fallen by six percent since 2004, while Telkomsel's has gone up approximately two percent, with the remaining market share going to Excelcomindo and Mobile-8. Thus the joint market share of the two companies at the focus of the allegations is actually declining.

Temasek points at the fact that the other operators have been making significant investments in the market to deny that market power was being exercised by Telkomsel and Indosat. ‘Consumers, have been the beneficiaries of competition in the market, with falling prices, increased penetration and usage, increased coverage, and new services being made available’, says Temasek.

The KPPU has taken a stance at perceived efforts to exercise market control, even though its considerations appear somewhat difficult to understand from a legal point of view. The Indonesian anti-trust law also gives the opportunity to the investor to challenge the decision made by KPPU. The investor still has the right to appeal before the district court and the Supreme Court so there is still a long way for this case to a final and binding decision.

Based on this case, foreign investors that are willing to invest in Indonesia should be very careful not to go near situations that can be perceived as efforts to control the market. As the Temasek case shows, a substantial shareholding, even if it is not a majority shareholding, can be regarded a controlling share. If a company has two such stakes in two different big companies in the same market, each with large market shares, this can be considered an effort to exercise undue influence on the market. Therefore, a legal opinion from an Indonesian legal expert in anti monopoly law, taking into account this decision, is worth wile. The KPPU can give decisions which can annul any business transaction in Indonesia that violates Law No. 5/1999. The decision can however still be appealed , before the District Court and of course before the Supreme Court.

That is what will happen in the Temasek case. It will be very interesting to see whether the District Court, and ultimately maybe the Supreme Court, will uphold KPPU’s judgment of the facts and the alleged intentions of Temasek. It will define the legal framework for companies with large market shares.

Elmar Bouma, Muqthi Ali, Maria Ardyaningtyas.
Indonesia Netherlands Association Bimonthly Magazine