Corporate Liabilities in Malaysia [Part 1]: Doctrine of Separate Legal Personality

It is a common misconception among many Malaysians that as company directors, they are absolutely immune from any liabilities or obligations arising from the acts or omission of the company as well as its debts due to the concept of separate legal personality where a company is a legal person separate from its members (directors, shareholders and employees) in the eyes of law. Thus, it could be said that there is an invisible “corporate veil” drawn between the company and its directors and shareholders and this article seeks to examine more on this common misconception and the circumstances where this corporate veil can be pierced to hold the company’s directors personally liable.

1. What is the Doctrine of Separate Legal Personality?

A company is bestowed a corporate, separate legal personality when it is incorporated in accordance with the Companies Act 2016 (hereafter referred to as the ‘CA 2016’), as enshrined in Section 20 of the aforementioned Act.

This means that a company is treated as a separate legal person with its own rights, liabilities, and obligations distinct from its directors or shareholders and as for any existing corporate debts and liabilities, creditors will have no recourse against the directors but can only go after the company itself. This fundamental principle was established in the landmark English case of Salomon v Salomon [1897] AC 22 and remains unchallenged up to the date of this article as the ruling of Salomon had intended to provide a powerful incentive for investors to invest in a business without attracting any further risks. The Salomon principle has since been adopted within Malaysian jurisprudence, but it is not without criticisms where many lamented that the century-old principle had lost relevance in modern company law as this doctrine is often abused by unscrupulous corporate players to conveniently hide behind the corporate veil and to escape liability.

2. Cirumcstances where the Doctrine of Separate Legal Personality can be disregarded

However, this does not mean that this doctrine is absolute, and directors and shareholders are not to be liable in every situation. The Courts may still exercise its discretion to disregard the doctrine of separate legal personality and to “lift or pierce the veil of incorporation”, thus essentially imposing personal liability on the company’s directors and shareholders but only in limited circumstances.

1. Where the company is being used as a façade to conceal the true facts of the matter.

In the Court of Appeal case of Perman Sdn Bhd & 6 Ors v European Commodities Sdn Bhd & Anor [2006] 1 MLJ 97, Gopal Sri Ram JCA held that “a litigant who seeks the court’s intervention to pierce the corporate veil must establish special circumstances showing that the company in question is a mere façade concealing the true facts.”

2. Where it is in the interests of justice to lift the veil of incorporation.

The Court of Appeal in Law Kam Loy & Another v Boltex Sdn Bhd & Others [2005] 3 CLJ 355 held that the court could no longer lift the veil of incorporation solely on the ground of interests of justice as it is “too inherently vague nor does it provide the courts or the business community with guidance as to when normal company rules should be displaced.” However, the court can still exercise its discretion to lift the veil of incorporation in the interests of justice but only in exceptional circumstances, such as in a situation where actual fraud at common law or some evidence of inequitable or unconscionable conduct amounting to fraud in equity exists. This was confirmed in the High Court case of Chanel v Melwani2 International [2017] 10 MLJ 592.

FRAUDULENT TRADING – SECTION 540 OF THE CA 2016

Company directors and shareholders cannot hide behind the corporate veil and escape liability if they are found guilty of “fraudulent trading” under Section 540 of CA 2016 as Section 540 is a “specific statutory provision which allows the corporate veil to be lifted in the limited situations specified.” This was confirmed by the Court of Appeal in Lama Tile (Timur) Sdn Bhd v Lim Meng Kwang & Anor [2015] 4 MLJ 85. To successfully establish fraudulent trading under Section 540, the plaintiff would need to show on (the lower civil standard of proof) of on a balance of probabilities that:

In the course of the winding up of a company or in any proceedings against the company that the business of the company has been carried on:
- with the intent to defraud creditors of the company or creditors of any other person; or
- for any fraudulent purpose;
that the defendant was knowingly a party to the carrying on of the business in that manner; and
that there was dishonesty.

Further guidance on Section 540 is provided in the Federal Court judgement of Lai Fee & Anor v Wong Yu Yee & Ors [2023] 3 MLRA:

On the meaning of “intent to defraud”
1. The phrase ‘with intent to defraud creditors’ is in general a proper inference that the company is carrying on business with intent to defraud the creditors of the company if the company continues to carry on business to incur debts at a time when there is to the knowledge of the directors no reasonable prospect of the creditors ever receiving payment of those debts. (R v. Grantham [1984] BCLC 270). It has also been interpreted to include an intent to deprive creditors of an economic advantage or inflict upon them some economic loss (Coleman v. The Queen [1987] 5 ACLC 766). The word ‘intent’ is being used in the sense that a man must be taken to intend the natural or foreseen consequences of his act (Re Cooper, (supra) at 267);

On establishing dishonesty:
- It must be shown that:
  - what was done was dishonest according to the ordinary standard of reasonable and honest people, and
  - the actor himself must have realised that the act was by those standards – dishonest.

3. Illustrative case on the operation of Section 540

Lai Fee & Anor v Wong Yu Yee & Ors [2023] 3 MLRA 495

Facts: In this case, the plaintiff(s) were partners of a timber logging business named Fave Enterprise and the plaintiffs had entered into a Sale and Purchase Agreement (SPA) with Centennial Asia Sdn Bhd for a purchase price of RM7 million that is to be paid in three (3) tranches. It is pertinent to note that the defendant(s) were merely involved with the negotiations with the purchase of the Fave Enterprise and was never named in the aforementioned SPA, but they were in fact directors of Centennial Asia Sdn Bhd. Once the SPA had been executed, the plaintiff(s) relinquished and transferred their interests in Fave Enterprise, but in a surprising turn of events, it was the defendant(s) and not Centennial Asia Sdn Bhd (who was named on the SPA) who had registered themselves as the new partners of Fave Enterprise. Whilst the first two tranches of payment had been made to the plaintiff(s) through a company procured by the defendant(s) – (Westhill Equity Sdn Bhd), however problem arose following the default of the payment of the final balance price amounting to RM2.5 million. The plaintiff(s) then brought a suit under Section 540 of the CA 2016 against the defendant(s) for fraudulent trading and to declare the defendant(s) personally liable for the payment of the final balance price of RM2.5 million due and owing the plaintiff(s) and Fave Enterprise.

Decision: the Federal Court held that the following arrangements as devised by the Defendant(s):

Having procured a dormant company (Westhill Equity Sdn Bhd) that is not a party to the SPA to effect payment of the purchase price of the timber logging business. Furthermore, it was subsequently discovered that there is no prospect of Westhill Equity Sdn Bhd fulfilling its obligations to make the payment of the purchase price to the plaintiff(s) as the company does not have any assets nor income.
That the plaintiff(s)’ interest in Fave Enterprise is to be transferred to the defendant(s) and not to Centennial (to whom is named as the designated buyer of Fave Enterprise under the SPA).
The provision of immediate transfer of ownership of Fave Enterprise upon the execution of the SPA but before the full purchase price of RM7.5 million has been settled.

was in fact, all a dishonest scheme (according to the standards of reasonable and honest people) to insulate themselves against any personal liability for the purchase of timber logging business as the plaintiff had been induced into the agreement by the Defendant’s representation that the full purchase price will be paid by the dormant company – but in reality, there was no prospect of one of the dormant companies paying the balance purchase price and the other was not a party to the sale and purchase agreement. It was held that the defendant(s), as directors of Centennial Asia Sdn Bhd, had used Centennial Asia with the intention to defraud the plaintiff(s) and were thereby ipso facto personally liable under Section 540 of the Companies Act 2016 for the payment of the balance purchase price amounting to RM2.5 million.

4. Conclusion

In conclusion, company directors are not absolutely immune from all liabilities or obligations arising from the acts or omission of the company. Case laws over the years such as Lai Fee & Anor v Wong Yu Yee & Ors has shown the Court’s willingness to lift the corporate veil and impose personal liability on unscrupulous company directors that seeks to take advantage hide behind the façade of the company’s separate legal persona. Therefore, company directors are reminded to exercise their powers and control in the operation and management of the company prudently and with due diligence; whilst bearing in mind of their statutory duty to act in good faith and the best interest of the company at all times.

“Stay tuned for Part 2, where we will delve into corporate liabilities, with a focus on the legal obligations surrounding employee wages.

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