Directors duties

1. Introduction

Malaysia’s economy depends on the drive and efficiency of the companies. Therefore, the

effectiveness of the board of directors in discharging their duties and responsibilities

determines Malaysia’s competitive position. In other words, Company directors must be free

to drive their companies forward, but they have to exercise that freedom within a framework

of effective accountability.

According to Section 4 (1) “director” has been defined as, any person occupying the position

of director of a corporation by whatever name called and includes a person in accordance

with whose direction or instructions the directors of a corporation are accustomed to act and

an alternate or substitute director.

In other word, director is the person who is responsible in the business operation, by making

the best decision for the company. The appointment of a director is a must in incorporating a

business. Therefore, when signing Form 48A, they have to be witnessed by a Commissioner

of Oaths, Sessions Court Judge, Magistrate or any other officer authorized by the Statutory

Declarations Act 1960.

It is immensely important that directors must be aware of their responsibilities towards the

business, shareholders or investors, government and public. Those who failed to fulfil the

requirements according to Companies Act 1965 may have to pay heavily.

In Great Eastern Ry v Turner (1872), Lord Selbourne aptly said this about directors:

“Directors are the mere trustees or agents of the company, trustees of the company’s

money and property; agents in the transactions which they enter into on behalf of the

company.”

The minimum number of directors in a company has been dictated in the Companies Act

1965. Section 122 (1) and (1A) provides that, “every company shall have at least two

directors, who each has his principal or only place of residence within Malaysia”; and that the

alternate or substitute director should not be included in the calculation of this statutory

minimum number of directors.

Therefore, a company must have minimum two directors, whose only place of residence or

principal place of residence is in Malaysia.

Who can be appointed as a director?

An individual can be a director as long as he is :

      i.        18 years old;

     ii.        must not be an undercharged bankrupt

    iii.        must not have been convicted of criminal offence involving fraud or dishonesty

   iv.        must not have been imprisoned for an offence under S132, S132A or under S303 of

Companies Act

    v.        must consent to act as director

All these conditions have been set in order to ensure that the director understand their

responsibilities to the company after the appointment. A director is under a duty to ensure

that any act he undertakes is with a view to enhancing the interest of the company either by

enhancing profits, reducing costs or even positive publicity of the company, Bursa Securities

Listing Requirement, Securities Commission Act 1993 and Securities Industry Act 1983.

Mainly, there are three types of director duties.

      i.        Statutory duty

     ii.        Fiduciary duty

    iii.        Duty of reasonable care, skill and diligence.

Therefore, we will discuss in details regarding the duties of director.

Statutory duty

S131 CA provides that:

“every director of a company who is in any way, whether directly or indirectly, interested

in a contract or proposed contract with the company shall, as soon as practicable after

the relevant facts have come to his knowledge, declare the nature of his interest at a

meeting of the directors of the company.”

These provisions are designed to achieve a modification of the ‘no conflict rule’ by allowing a

company to enter into transactions with directors provided their interest is disclosed to the

board.

Section 132 (2) provides that the duty not to misuse information or position. Under S132 (2),

an officer or agent of a company or officer of the Stock Exchange shall not make improper

use of any information acquired by virtue of his position as an officer or agent of the

company or officer of the Stock Exchange to gain directly or indirectly an advantage for

himself or for any other person or to cause detriment to the company. Hence, it is applicable

to directors

The statutory duties of the directors include:

1. Act honestly at all times and use reasonable diligence in the discharge of duties.

2. Not to make improper use of information obtained by virtue of office to gain

advantage personally or to cause detriment to company.

3. Not to make improper use of unpublished price-sensitive information to gain personal

benefit.

4. Seek approval of the company in general meeting before dispose of or execute any

transaction for the disposal of a substantial portion of the company's undertaking or

property.

5. Disclose/give notice to the company disclosing his shareholdings and any changes

thereof.

6. Disclose interest in any contract or proposed contract made by the company.

7. Make sure registers and statutory books are kept updated.

Fiduciary Duty

At the time of a company is incorporated, the first two directors of the company has been

appointed as it is one of the conditions. Thus, in company law, a director owes his company

a fiduciary duty when exercising his powers. However, the question is what is fiduciary duty?

What is fiduciary duty?

A fiduciary is a person who is expected to act in the interest of another person. The fiduciary

cannot use their knowledge or position to benefit themselves rather than the person on

whose behalf the fiduciary is required to act. A director is a fiduciary and must act in the

interest of the director’s company. Therefore, fiduciary duty is responsibility or duty of the

person who is expected to act in the interest of another person.

A director is required to act bonafide and in the interest of the company. The first element of

this duty is, it requires directors to exercise the powers not only in the manner which has

been set by the law, but also it must be beneficial to the company as a whole. This duty is

also known as good faith. The duty of good faith can be distinguished from other general

duties imposed upon directors.

First, the duty applies to directors when they make decision to exercise powers were

Corporation, or perform some function as individuals which has been designated to them by

the board. In other word, they have to exercise corporate powers and acting in a corporate

rule.

Secondly, the duty of good faith permits a challenge to be made to a particular decision will

have taken or transaction entered into by directors; remedies for breach of a duty include

orders setting aside the decision or transaction in appropriate cases. 

In Re Smith & Fawcett Ltd [1942] Ch 304, [1942] 1 All ER 542, CA, the directors refused

to transfer a deceased man’s shares to his son, exercising their 'absolute and uncontrolled

discretion without assigning reasons and offered a lesser amount instead.

Lord Greene MR stated that: 'A wide and comprehensive power to directors by their passing

a particular transfer the transferee would obtain too great a weight in the councils of the

company or might even perhaps obtain control.' Thus the directors had acted in the best

interests of the company. The court stated that directors must act 'bona fide in what they

consider - not what the court may consider - is in the interests of the company’. However

many cases have held that directors may breach their duty to act in the interests of the

company, even if they are acting in what they genuinely consider to be an honest manner.

Furthermore, a director is needed to use powers for their proper purposes. A director must

not use his powers for a purpose other than he has been assigned. By doing against his

duty, there will be a breach of duty for abusing the director’s power. As Hoffman LJ has

stated,

...He must exercise the power solely for the purpose for which it was conferred.

Therefore, it is important to ask what are the things that a director must do or must not do

and what are the consequences?

In Section 132(2) of the Companies Act 1965, some illustrations were given.

A director or officer of a company shall not, without the consent or ratification of a general

meeting –

a)    Use the property of the company;

b)    Use any information acquired by virtue of his position as a director or officer of the company;

c)    Use his position as such director or officer;

d)    Use any opportunity of the company which he became aware of, in the performance of his

functions as the director or officer of the company; or

e)    Engage in business which is in competition with the company,

to gain directly or indirectly, a benefit for himself or any other person, or cause detriment to

the company.

As in the case of Re W & M Roith Ltd , a company director had entered into a

service contract with his company for  the purpose of providing a pension for his wife in

the event of his death and without taking into consideration whether the contract was for the

benefit of the company. The court held that the whole object of the contract was not to be

binding on the company as it was to benefit Mrs Roith and not the company. By analyzing

this case, it can be seen that as Roith did not act  for the best interest of  the

company as he acted for the interest of his wife, he had breached his fiduciary

duty that is duty to act in the best interest of the company. That is why in this case, the court

held that the contract was not binding to the company.

A director is also responsible to avoid conflict of interests. Section 131 requires a director to

notify or declare to other directors any material interest he may have in a contract or

proposed contract with the company. He must not allow his duty to the company to come into

his personal interests.

It is not a breach of duty per se for a director to allow such a conflict to occur but he is under

disability from entering into any transactions where such a conflict exists.  Therefore, a

transaction which a director makes on behalf of the company from which he obtains a

personal benefit may be treated as a void transaction and can be set aside at the option of

the company.

Conflict of interest can be described as in the situation where the director makes a secret

profit. In Cook vs Deeks [1916] 1 AC 554, the directors diverted business of the company to

themselves, and attempted to ratify their dealings by voting their shares at a general meeting

in their own favour. The Privy Council held that ratification was not possible because the

directors were using their votes to expropriate the minority shareholders.

In Regal Hastings v Gulliver, where Regal was a business that operated cinemas. The

directors of Regal formed a subsidiary, HAC. HAC acquired two new cinemas and two weeks

later the company was sold producing profits per share. Regal took proceedings, under its

new management, against the ex-directors, seeking an account on the profits they had made

on the sale of their shares in the HAC. House of Lords held that the ex-directors were liable

to Regal for these profits on the ground that they had obtained their shares by reason of their

position as directors of Regal and in the course of office as directors. The court further held

that without their position as directors they will never have the opportunity to gain such

profits.

Similarly in the case of Industrial Development Consultants Ltd v Cooley [1972] 1 WLR

443. Mr. Cooley was an architect and the managing director of IDC. He was asked to

negotiate with The Eastern Gas Board for a contract. During the negotiation, Mr Cooley

found out that The Eastern Gas Board was not prepared to give the contract to IDC.

However, they were ready to give Mr Cooley the contract instead. He came back to IDC and

told them that the negotiation was failed. Soon after the negotiation, he resigned from IDC on

the ground of ill-health. He successfully obtained the contract from The Eastern Gas, and

made substantial amount of profit. On the same time, IDC was informed about the contract,

and they sued Mr Cooley for the profit he made to himself from The Eastern Gas contract.

The court held that, he must return the profit to IDC because when he negotiated with The

Eastern Gas, his position was the managing director of IDC, where he has abuse the power

as a director by entering into the contract for his personal interest.

Nevertheless, in Peso Silver Mines Ltd v Cropper, the owner of mineral claims offered to

sell their claim to Peso Silver Mines Ltd. The board of directors of Peso rejected the offer.

Mr. Cropper, a member of the board, purchased the claim for himself. Learning of this, Peso

sued Cropper for breach of his fiduciary duty towards the company for "seizing the corporate

opportunity".

The Court found that Cropper was not in breach of his fiduciary duty to Peso. The directors

had acted in good faith and in the best interests of the company in rejecting the offer. The

information that Cropper received as a board member was in no way confidential that was

unavailable to any prospective purchaser. The company received offers to sell on a regular

basis and the offer at issue was not different from any other. The offer was made to Cropper

as a private individual and was entirely separate from his role as a director. Consequently,

for all these reasons there was no breach found.

However, making a secret profit is not the only interest that should be avoided by directors.

In Thomas Marshall v Guinle (1979) 1 Ch 227, the managing director had resigned before

the end of the contractual term. There was an express covenant in his contract against using

or disclosing the company’s confidential information during or after his employment. Megarry

VC suggested that four elements were necessary when considering the 'quality of

confidence'. First, the release of the information would be injurious to the owner of it or of

advantage to rivals; secondly, that the owner must believe that the information is confidential,

for example not in the public domain; thirdly, the owner's belief in the above is reasonable;

and, fourthly, the information must be judged in the light of the usage and practices of the

industry concerned.

The above fiduciary duties are based on the concept that a director is in a special position of

responsibility in relation to the company. He is therefore held to a higher standard of

responsibility than most, which can lead to liability even where he has acted honestly. 

Fundamentally, a director must act in good faith in the best interests of the company,

irrespective of the fact he may have a substantial shareholding in that company.  In essence,

just because he is the boss, he may not take unauthorised advantage of his position. A

director has a duty not to profit from his position, for example by taking a business

opportunity that came to him through the company, even if the company does not want to

take  it  itself. If  a  director  wishes  to  benefit  personally outside what has already been

accorded to him in the Articles of Association he must declare such benefit and have  it 

approved  by  the  members.  In short, if a director gains any form of unauthorised benefit, he

must offer it to the company or alternatively indemnify the company for its loss.

Duty of care, skill and diligence

 Section 132(1A) of the companies Act 1965 provides that

A director of a company shall exercise reasonable care, skill and diligence with –

a)    The knowledge, skill and experience which may reasonably expected of a director

having the same responsibilities and

b)    Any additional knowledge, skill and experience which the director in fact has.

Directors owe the company duty of care, skill and diligence. The applicable case in Malaysia

is Re City Equitable Fire Insurance Co. Ltd (1925) CH407. In this case, the chairman of

the company committed frauds by purporting to buy Treasury Bonds just before the end of

the accounting period and selling them just after the audit. By this method a debt due to the

company from a firm in which the chairman had an interest was reduced on the balance

sheet by increasing the assets. The liquidator of the company attempted to make the other

directors liable for failing to discover the fraud. (They had left the management of the

company entirely in the hands of the chairman). The liquidator failed. Romer J held that a

director need not exhibit in the performance of his duties a greater degree of skill than may

reasonably be expected from someone of his knowledge and experience.

There are no specific standards for a director. It is a subjective issue to define. However, one

thing is clear that, a director do not presently have to meet a high standard. The duty of care

arises under the general law and may also arise under a contract of service that exists

between a director and the company.

Daniels v AWA Ltd (1995) 13 ACLC 614 (CA) removed any lingering doubts on this point. 

In at least some of these recent cases especially Rogers CJ’s judgment in AWA the courts

have also set out realistic and useful guidelines for directors to follow to ensure that when

exercising their powers and carrying out their duties they are not breaching their legal or

statutory obligations. In this case, AWA, a large listed company in Australia, employed a

young foreign exchange manager, Andrew Koval, for its foreign exchange dealings. Andrew

concealed losses from management as there were neither adequate internal controls in

place nor proper records in place. The company suffered loss of A$ 50 million. They

dismissed Koval and sued auditors in contract, alleging negligence in audit. Auditors

counter-claimed against the company for contributory negligence on ground.

The court held that, the auditors are negligent but also held that the company to be twenty-

percent contributory negligent. None of the directors were found liable on ground that they

we ignorant of failure to adhere foreign exchange of the company. It is important not to

overreact to these decisions.  However, it is equally important for members of the governing

bodies of non-profit associations to be aware of the fact that they have an obligation to

ensure that the operations of the association are managed properly and that they may be

personally liable for breaches of this obligation.

Directors have both collectively and individually, a continuing duty to acquire and maintain a

sufficient knowledge and understanding the company’s activities to enable them to discharge

their duties as a director. Detailed inspection of the day-to-day activities is not required but

what is required is a general monitoring of the company’s business affairs. A director should

attend board meetings regularly. Although directors are not required to make an audit of the

company’s books directors should be familiar with the financial status of the company which

includes conducting regular reviews of financial statements.

In other words, a non executive director did not need to have any skill or qualification

suitable for his office. This affirmed the decision of the court in Re Brazilian Rubber

Plantation & Estate Ltd where the directors did not have knowledge of the rubber industry

and made losses from rubber speculation. The court held that they were excused of liability.

In the case Re Brazilian Rubber Plantations and Estates Ltd (1911), three individuals were

appointed as directors of a multinational undertaking. They behaved with extreme

incompetence and caused the company to suffer prodigious losses. However Neville J

refused hold any of the directors liable to the company for the consequences of their gross

ineptitude. The court found that the individuals were inexperienced, unqualified and poorly

skilled. Paraphrasing the reasoning of the court it was held that if a company decides to

appoint idiots to directorial posts, it should not later be permitted to complain if those

individuals behave and perform like idiots in discharging their responsibilities.

However, this benchmark of competence proved far too lax and excessively forgiving as it

was applied in cases throughout the twentieth century. In plain English, the subjective test for

care and skill featherbedded generations of negligent directors. Towards the end of the

twentieth century Lord Hoffman became the standard-bearer for reform in this field and in

decisions including Norman v Theodore Goddard [1991]. The court held that when

performing his functions as an executive director, an executive director is to exercise his

knowledge, skill and experience which he actually has and which a person carrying his

function should be expected to have.

Conclusion

When discussing the duties of director, we will be questioning ourselves to whom do

directors owe their duties?

Directors owe a duty to the company and not its individual shareholders. In many

instances, the distinction is not significant, since what is good for the corporation will also

benefit its shareholders. Maximising the return to shareholders (or creating “shareholder

value”), in many cases, does not conflict with the interests of the company. But there

may be situations where the interests of the company and shareholders may conflict.

The interests of shareholders may lie in realizing a short-term gain on their investment,

something which the directors may decide is not the in the interest of the company in the

long term.

In a number of corporate and commercial transactions directors will be put in a special

position of reliance. We have already noted the case where financial certificates have to

be provided under a loan stock instrument, but a more common example is where

directors are asked to warrant or give undertakings in relation to information about a

company when it is being bought or sold.

Where directors are made separate parties to a sale and purchase agreement, they will

clearly have a separate liability, whether or not there is a right of recourse or indemnity

against the company. But if the agreement is simply between buying and selling

shareholders, and warranties are given ‘to the best of the directors’ knowledge,

information and belief’ or ‘after due and careful inquiry’, it seems likely that an

independent duty arising into the person relying on an appropriate degree of care being

applied, will exist.

It appears that the task of clarifying and reformulating director duties to promote

accountability is not an easy one but it has to be done so as to ensure that our corporate law

framework remains effective and can facilitate business. The confidence of the investors

should not be derogated by poor performance of the directors.

Company Law In Malaysia by Chan Wai MengCommercial Applications of Company Law in Malaysia, 3rd Editionhttp://www.law-essays-uk.comCompany Law in Malaysia by Chan Wai Menghttp://swarb.co.uk/thomas-marshall-exports-ltd-v-guinle-chd-1979/

Posted 4th March 2013 by Nurafiza Tali 0

Add a comment 2.

Feb11

Company Law in Malaysia - Separate Legal Entity

Nur Afiza Tali

Introduction

In a modern capitalist market economy, companies are a familiar part of everyday life.

Companies own supermarkets, supply water, gas, electricity and petroleum products we are

depending on. They publish the newspapers and provide our Internet services. We deal with

companies so often as purchasers and users of their products and services that the image

‘company’ brings to mind is usually of an organisation concerned with marketing and

collecting payment for products which the company has made (or bought in) or services it

has provided. It is necessary to go behind this image to get to the company which is the

subject of company law.

 As we all know in Malaysia there are different types of business entities. Local or foreign

investors are coming to Malaysia to start a business. Company has been defined as any

formal business entity for profit which may be a corporation, a partnership, association or

individual proprietorship. Often people think the term "company" means the business is

incorporated, but that is not true. In fact, a corporation usually must use some term in its

name such as "corporation," "incorporated," "corp." or "inc." to show it is a corporation. In

Malaysia, a "company" is a business organisation that is registered (or "incorporated") under

the Companies Act, 1965 or its predecessor legislation, Section 14(1) two or more persons, if

they agree to become associated for any lawful purpose may incorporate a company. In

reality, a company or a corporate person is an association of persons who have agreed to

undertake their lawful undertakings through a company.

In order to incorporate a company, there are two stages that we have to go through, which

are, pre-incorporation and post incorporation. In the pre incorporation stage, the promoter is

responsible to bring the company into the legal existence and ensure its successful running,

and in order to accomplish his obligation he may enter into some contract on behalf of

prospective company. Promoters are the persons involved in formation of a company. They

will undertake the initiative to prepare necessary documents and do other significant works in

order to register the company. Sometimes they become the first directors of the company

once the company has been registered or they might find new directors.

While in the post incorporation stage, we have to ensure that all the things that have been

stated in memorandum and article of association will be exercised. A company is also

required to maintain the statutory books such as, Register of Members as has been provided

in Section 158, Register of Substantial Shareholders as in Section 69L, Books of Accounts

Section 167 etc. The responsibilities will increase once the company is incorporated.

A company is an artificial person, which is capable of owning property. Who owns the

company and benefits from the wealth which the company has, and who controls what the

company does with its assets? Therefore, we will discuss more regarding the duties of the

promoters and the effects of incorporations in Malaysia.

Promoters

Before a company can be formed, there must be some persons who have an intention to

form a company and who take the necessary steps to carry that intention into operation.

Such persons are called ‘promoters’. According to Cockburn CJ in Twycross v Grant (1877),

a promoter is a “person who undertakes to form a company with reference to a given object

and set it going and takes the necessary steps to accomplish the purpose”. While in Tengku

Abdullah v Mohd Latiff bin Shah Mohd, [1996] 2 MLJ 265 Gopal Sri Ram JCA said, "A

promoter is one who starts off a venture-any venture-not solely for himself, 

but for others, but of whom, he may be one." The promoter lays the foundations for a

Company in terms of negotiations, registration of the Company, obtaining directors and

shareholders and preparing all the paperwork.

However, because the promoter is such an important person in the formation of the

company, the law places several responsibilities on him. These are known as fiduciary

duties. The promoters have fiduciary relationship with the company meaning that the

promoters have a very close relationship with company and they acted as trustee of the

company. The fiduciary obligations arise automatically once a person identified as a

promoter.  Therefore, promoters have fiduciary duties towards company which is not to make

any secret profit without company’s consent and to give full disclosure to the company any

interest promoters have in any transaction to be entered into by the company.  The

promoters must make full disclosure of the profit made to the independent board of directors.

If the promoters or some of the promoters are in the board of the directors, the board would

not be considered as an independent board of the directors. If that’s the case, the disclosure

of interest of promoters should be made to the members of the company.

Cotton LJ in Re Cape Breton Co (1885) said that his duty as a promoter may arise even at

the time he purchases a property with the property with the intention of selling it to the

company he is going to incorporate. Therefore, his role as the company’s promoter does not

end immediately once the company is incorporated, as in Erlanger v New Sombrero

Phosphate Co (1878). In this case a syndicate purchased a lease of an island in the West

Indies. The island contained deposits of phosphate of lime. Mr. Erlanger was the chief in the

syndicate. The syndicate purchased the lease of island for £55,000. Subsequently a

company was formed by the syndicate and it sold the island to the new company for

£110,000 through a nominee. As a result the syndicate earned £55,000 secret profit. The

articles of the company empowered the directors to adopt the purchase of the lease, which

was ultimately done. A prospectus was issued by the company giving a very favourable

account of the scheme and many people bought shares. The real circumstances of the

purchase were not disclosed to the shareholders despite being questioned by the

shareholders. Later an investigation committee was formed to investigate the incidence and

it recommended the removal of the original directors and appointment of a new board of

directors. The new board of directors was appointed and it rescinded the purchase contract

and claimed for repayment of the money and shares which had passed to the syndicate. The

House of Lords held that the purchase contract could be rescinded. He may continue to be a

promoter even after the company has been incorporated, for the purpose of procuring capital

for the company. A promoter can be compelled by the company to hand over any secret

profit which he has made without full disclosure to the company. The company can also sue

for the rescission of the contract of sale by the promoter where the promoter has not

disclosed his interest therein.

In the case where the secret profit is recoverable, the company decides not to rescind the

contract as in Gluckstein v. Barnes.  A company was able to recover the sum of £20,000

made as secret profit which was not fully disclosed by the promoters. In this case a syndicate

consisting of four persons bought a property known as ‘Olympia’ for £140,000 from a

liquidator. Then it sold the property to a company which it promoted for £180,000 and made

£40,000 profit. The syndicate made another £20,000 profit by buying securities on the

property at a discount. A prospectus was issued by the company to the public to raise

capital. In this prospectus the promoters disclosed £40,000 profit but not the other £20,000

profit. The company went into liquidation within four years of its incorporation. The liquidator

sued the syndicate to recover £20,000 undisclosed profit. House of Lords held that the

disclosure of secret profit was not full and allowed the liquidator to recover £20,000

undisclosed profit from the syndicate.

A promoter is subject to the following liabilities under the various provisions of the companies

act. The liability of promoters is stated in Section 130 of Companies Act 1965.  This Section

provides that if a person is convicted of any offence in connection with the promotion,

formation or management of a corporation, he shall be disqualified automatically from being

a director or promoter for five years from the date of conviction or from the date of release

from jail if he was imprisoned. However, the person can be appointed for such a position if

he has obtained the leave of court. If a person is convicted on allegations of an offence in

connection with the promotion of a company, he might be disqualified by the court to become

a director in the company.

Effect of incorporation

According to Companies Act 1965, Section 16(5) – On and from the date of incorporation

specified in the certificate of incorporation but subject to this Act, the subscribers to the

memorandum together with such other persons as may from time become members of the

company shall be a body corporate by the name contained in the memorandum capable

forthwith of exercising all the functions of an incorporated company and of suing and being

sued and having perpetual succession and a common seal with power to hold land but with

such liability on the part of the members contribute to the assets of the company in the event

of its being wound up as is provided by this Act.

The principle of separate legal entity which is, after the incorporation of a company, it is

regarded as an artificial person or juridical person, who has the rights and responsibilities

similar to a living person, has been widely accepted and applied in the world of business,

trade and industry. Once it is incorporated by complying with the prescribed procedure, it

comes into being and is a separate legal entity from its members and officers. This principle

differ a company from a partnership. A company as a separate person has members, who

are effectively its owners, and it has directors, who control what it does and manage its

business. But only the company as a separate person is responsible for the debts incurred in

carrying on its business. It will be qualified to sue or being sued by others for any wrongs

committed against it.

The principle that company is a legal entity separate from its members once it is incorporated

was asserted in the case of Salomon v Salomon & Co Ltd (1897).

The facts in this case disclosed that a company had been incorporated by Mr. Salomon in

which he and members of his family were the only shareholders. The case came into

limelight when the company’s business turned out to be a failure. The value of the assets

was insufficient to pay out both Mr. Salomon and the company’s other creditors.

Consequently, the creditors raised an issue whereby they argued that Mr. Salomon should

not have received the payment from the company because the degree of control he

exercised over the company. It was held by the House of Lords that despite Mr. Salomon

having the control over the company, it was neither his agent nor trustee. This is because a

company was treated as operating the business in its own right, and as being separate from

its controller, for example like in this case of Mr. Salomon. Therefore, the charge given by the

company to Mr. Salomon was valid and he was entitled to be paid his debt even though

other creditors of the company would not be paid because the company had insufficient

assets to pay all its creditors.

The decision confirms that a company upon its incorporation is a separate legal entity from

its members. It is immaterial that the company bought over the business from its subscribers,

and operated it as before; that third parties dealt with the same personnel; and that the same

persons received the profits generated by the business, previously as the partners and now

as members of the company running that the business.

As the debts were incurred by the company, the creditors can look  only to the company, and

not its members for repayment. Since the company and its members are separate legal

entity, the liability of the members only limited to the amount of whatever they still owe the

company.

In the case of Salomon, Lord Macnaghten also commented that “there is nothing in the Act

requiring the subscribers to the memorandum should be independent or unconnected, or

that they or any of them should take substantial interest in the undertaking, or that they must

have a mind and will of their own.” Therefore the fact that all the shares held for the benefit

of one person will not affect the status of the company as a separate legal entity. It does not

cause the company and the sole beneficial owner of the shares to be one legal person.

The principle was strengthened by the Privy Council in the case of Lee v Lee’s Air Farming

Ltd (1961). This case was about the veil of incorporation and separate legal personality. Mr

Lee is the owner and sole working director of a company engaged in the business of aerial

crop spraying. Mr Lee held 2999 of 3000 shares was the sole director and employed as the

chief pilot. He also took insurance for his employees. While he was performing his duties as

a pilot, he was killed in an accident. His widow, the plaintiff, attempted to collect what was

rightfully due to a widow of a man killed on the job. The actual defendant was an insurance

company. The company was insured (as required) for worker compensation. The Lee's Air

Farming case confirmed the Salomon principle. Lee's Air Farming Ltd. was not a mere sham.

It was a legitimate corporation, established for legitimate purposes, and had carried on a

legitimate business. His employment by the corporation was well-documented  through

government records of tax deductions, workmen’s' compensation contributions, etc., and

was not something his widow had attempted to piece together after the fact of his death.

There was no reason in law why a person could not perform corporate functions and

employee functions within the same corporation. Mrs. Lee won the case and the

compensation was paid.

In another case, Macaura v. Northern Assurance Co. Ltd. [1925], Mr Macaura, had formed

an estate company. Then he sold his owned timber estate for £42,000 to the estate

company, whereby the purchase money was paid by the company in the form of issuance of

42,000 fully paid shares of £1 each. Macaura had affected an insurance policy on the timber

in his own name, and not in the company’s name. On 23 February 1922, most of the timber

was destroyed by fire. Thus, Macaura claimed under his insurance policies. However, it was

ruled by the court that Macaura had no insurable interest. The insurance policy effected by

him could only be on the basis of a creditor or a shareholder of the company, which neither

two has an insurable interest in the assets of the company based on the principle that a

company is an independent entity.

As was mentioned earlier, once a company is incorporated it will be a separate legal entity,

which would qualify it to sue and being sued for any wrongs committed against it. The

members are not permitted to take legal action on behalf of the company against the wrong

doer. If a wrong has been committed against the company, the member cannot take action

on behalf of the company as in the case of Foss v Harbottle (1843). Certain burghers in

Manchester purchased park land to dedicate to the then heiress of the throne Princess

Victoria. The park opened to great acclamation but difficulties soon followed. It was alleged

by some of the company’s members that some directors had misapplied company’s property.

The case was heard by Wigwram VC. He held that the action could not proceed as the

individual shareholders were not considered as proper plaintiff. He held that a wrong was

committed against the company, and only the company could take the legal action. The

members did not have legal standing to sue the wrongdoers because the members and the

company were separate legal entities.

In the case of Newborne v Sensolid (GB) Ltd (1954) 1 QB 45 a  consignment of tinned ham

was sold to Sensolid under a contract  headed "Leopold Newborne (London) Ltd" and ending

"Yours faithfully”, Leopold Newborne (London) Ltd" and signed by Leopold Newborne.

Sensolid refused to take delivery of the ham. It was held that neither the then unincorporated

company nor Mr Newborne personally could sue on the contract. Lord Goddard held that this

contract purports to be a contract by the company; it does not purport to be a contract by Mr

Newborne. He does not purport to be selling his goods but to be selling the company's

goods. The only person to have any contract here was the company, and Mr Newborne's

signature merely confirmed the company's signature...In my opinion,

unfortunate though it may be, as the company was not in existence when the contract was

signed there never was a contract, and Mr Newborne cannot come forward and say: "Well, it

was my contract."

Upon the incorporation of the company the persons whose names appear in the

company’s register of members from time to time shall be the members of the company

(Section 16(6)) and together they shall be a body corporate. As in Section 16(5), the

body corporate shall enjoy a separate legal entity with an existence that does not

depend on the identity of its members. Members come and go but the company will

remain exist.

 In the case of Abdul Aziz Bin Atan & 87 ORS vs Ladang Rengo Malay Estate SDN BHD

(1985) 2 MLJ 165, where all the shareholders of the company sold and transferred their

entire share holdings to a certain buyer. Therefore, the court had to determine whether a

change of employer took place. The court held that an incorporated company is a legal

person separate and distinct from its shareholders. The company, from the date of

incorporation, has perpetual succession and did not change its identity or personality

even though the entire share holding of the company changed hands.

In another case, Re Noel Tedman Holdings Pty Ltd. (1967) QdR 561. The company had

a husband and a wife as its only shareholders. They were also the company’s directors.

They died in an accident, leaving behind an infant child. After their death the company

was still in existence. The problem that arose was, as the shareholders and directors

had died, the shares could not be transferred according to the will of the deceased to the

infant child. The court thus allowed the personal representative of the deceased to

appoint directors of the company, so that these directors could allow the transfer of the

shares to the child. Therefore, the company may even continue to exist despite the

death of all its shareholders and directors. It will last until it is deregistered or ‘wound up’.

Another effect of the incorporation is the common seal. A Company is an Artificial

Person in eyes of Law, it has no soul, and it takes birth by the operation of law and ends

its life by the operation of law. Like a natural person, it cannot sign on its own. As still it’s

an artificial person and as it operates in the world market, there arises some situation

where law asks a company to sign by putting its common seal on the documents.

Section 121(1) (a) of the Companies Act 1965 requires every company to have a

common seal with its name and company number appearing on it. The common seal is

affixed on contracts made by the company (Section35 (4(a)). The manner of affixation is

prescribed in the company’s articles of association. Usually, a board of directors’

resolution is required and it may be affixed in the presence of one director and secretary

or another director.

A company is also entitled to hold land. However such power is to be read subject to

Section 19(2) of the Companies Act 1965 which provides that a company formed for the

purpose of providing recreation or amusement or promoting commerce, industry, art,

science, religion or any other object not involving trading for profit, shall not acquire land

unless it has obtained the prior approval of the minister charged with the responsibility

for companies. Therefore, the property will be treated as the company’s own and not the

shareholder’s even if a person owns all the shares in the company. He does not own the

company’s property nor does he have any legal or equitable interest in that respect.

Here the case of Macaura Vs Northern Assurance Co. Ltd 1925 can be mentioned as an

example. Here the court held that no share holders have any right to any item of

property owned by the company.

As in the case of Nicoll v. New York & Erie R. R. Co, Nicoll gave a deed to the New York

and Erie Railroad Company of a strip of land across his farm for the right-of-way of the

railroad. Later, he wished to regain it from the railway company and brought this action

to have the corporation ejected from the possession, on the ground that it did not have

power to purchase land, nor to take a deed to the fee. The company was chartered for

fifty years, and this, it was claimed, made it impossible for it to take more of a title than a

fifty-year interest, while the deed purported to convey the whole ownership, for all time,

to the corporation and its successors.

It was held that the company was entitled to retain the land. The Court said, in an

opinion by Mr. Justice Parker: "The power to purchase lands, where it is necessary for

the other purposes of the corporation, is a power incident at common law to all

corporations, unless they were specially restrained by their charters or by statute. It is

true, that corporations are in most states, expressly prohibited from holding land that is

not used for the corporate business, and corporations, for the purpose of buying and

holding real estate, are not often permitted. But one of the general powers of any

corporation is the holding, purchasing, and conveying of such real estate as the

purposes of the corporation require."

Section 16(5) of the Companies Act 1965 also states that members of the company shall

be liable to contribute to the assets of the company in the event of being wound up. The

liability of the members depends on whether the company is a limited company or an

unlimited company and Section 18(1) requires the company’s memorandum of

association to stipulate so. A limited company does not mean that the company’s liability

is limited; it is still liable to fulfil all its obligations. It means that its members’ liability to

pay the company’s debts and obligation is limited.

A member of an unlimited company is liable for all debts of the company. Whether a

member of a limited company is liable for the debts of the company depends on the

whether he has fully paid up on his shares or otherwise, he may be called upon at any

time by the company to pay up the unpaid portion. If the company should suffer losses,

the shareholder is not liable to contribute any more to the company if he has fully paid

for his shares. His actual loss would be the amount he has paid for the shares.

Creditors of the company cannot take any action against the members, because the

members are separate from the company. In the case of Re Application by Yee Yut Ee

(978)2 MLJ 142, Yee was the secretary of a company that was a wholly-owned

subsidiary of an American corporation. The company had retrenched their staff and

dispute arose as to the retrenchment benefits. The matter was brought to the Industrial

Arbitration Court where an award was made in the company’s absence. As the company

did not comply with the award, the Arbitration Court ordered that Yee be personally liable

as he had been appointed director by then. The High court held that a director is not

liable for the company’s debts.

In Fairview Schools Bhd v Indrani Rajaratnam & Ors, Mahadev Shanker J said that,

“Limited companies are formed so that its shareholders are not exposed to unlimited

liability for the company’s debt. In exchange for this immunity, share capital is pumped

into the company which thus becomes available to the company’s creditors.”

Veil of Incorporation

Most people decide to create a company rather than holding a sole proprietorship or

partnership due to the liability protection factor. This is because a “company veil” will be

created between the personal assets of members and shareholders with the company.

The veil can also be described like a wall between the company and the members.

Anton Behr said that, “Stand behind the veil of incorporation is the principle of limited

liability that the court will use to prescribe that a company will be responsible for all the

debts that have been incurred instead of its shareholders or members.”

This company veil is one of the main advantages of establishing a company as it will

provide a liability protection against lawsuits and creditors. In addition, members and

shareholders can enjoy limited personal liability up to the capital invested in the

company when the company was winding up.

However, it is crucial to remember that there are  times where there are some

exceptional circumstances where the court would ignore the company principle of

separate legal entity  and strip the company members’ and shareholders’ limited liability

that they  enjoy. This is   called the “lifting veil of incorporation”.

Lifting the veil of incorporation is a legal decision which will treat the rights and

obligations of a corporation as the rights or liabilities of its owner. The members will be

responsible in carrying out their fiduciary duties towards the company. If they act in bad

faith, the court will lift the company veil and they shall have a personal liability. There are

two factors that can be shown, whether there is fraud/injustice or there must be a lack of

separate existence.

Related cases where the court have lifted the company veil

i.        In cases where national emergency involved.

Referring to the  case of Daimler Co. Ltd v Continental Tyre & Rubber Co    happened

during the time when England was at war with Germany, Continental sued Daimler for

money due in respect of goods supplied. Daimler claimed that the Company was

actually owned by German Nationals and paying them was illegal under the Trading with

the Enemy Act. The Court lifted the corporate veil to discover if this was so, and found

as a fact that it was the Germans who were operating the business. D was therefore

successful in its defence.

ii.        In order to prevent a fraud from being committed

In Gilford Motors v Horne [1933], Horne was at one time the Managing Director of Gilford

Motors. One of the terms of his employment contract was that, in the event that he

leaves the Company, he will not solicit the customers of the Company. Eventually Mr.

Horne left the Company and setup his own Company by the name of JM Horne & Co

Ltd. through which he had business dealings with the previous Company’s clients.

Gilford Motors sued Mr. Horne. Horne’s claimed that it was not him that was doing the

business but the Company and that under Company Law they were two different people.

However the Court was not convinced and lifted the veil of incorporation. In this

instance, Mr. Horne was just trying to hide behind a corporate veil to steal business from

his former employer. It was held that the Court could lift the veil to determine whether the

assets of the company were really owned by them or whether there was an abuse of the

principal that a company is a separate legal entity.

In the case of Jones v Lipman 1962, Lipman sold Jones a house by a written contract but

later refused to complete the sale and wished out of the contract. He formed a company,

transferred the house to avoid the transaction to claim that he could no longer sell the house

to Jones. The court held that this company was formed as a ‘device or sham’ to frustrate the

sale contract, and an order of specific performance of the sale contract was granted to

Jones.

The veil of incorporation has been considered in Trustor AB v Smallbone [2001]. The

significance in this case lies in the way counsel for the claimant invited the Court of

Appeal to lay down rules as to when the veil of incorporation may be lifted. Smallbone

was a director of Trustor AB, a Swedish registered company. Without the consent of the

other directors, he transferred large amounts of corporate funds into a company

controlled by him, Introcrom Ltd. He then removed some of these funds from Introcrom

Ltd’s bank account into his own name. Being aware of all the circumstances, Smallbone

was found to be jointly  liable with Introcrom Ltd for those sums received by him from its

bank account. The court then had to consider whether Smallbone was liable for sums

paid from that account to other persons.

Summary

In forming a company, promoters will take all the responsibilities to ensure that the process

runs smoothly. Promoter owes a fiduciary to the company as long as he is a promoter. He

may be one of the directors of the company. The company may sue him if he is making any

secret profits.

A promoter cannot also claim for reimbursement for his expenses incurred to promote the

company unless the company has agreed to do so.

Incorporation of a business   may bring benefits. As had been mentioned, once the company

is incorporated, it shall become an artificial legal person which is recognized by the law as a

separate and distinct entity from its members and shareholders and capable of having its

own rights, duties and obligations and it will be able to sue or be sued in its own name.

However the strict application of the separate legal entity principle does have its

disadvantages. We have seen in Macaura’s case where the application of the separate legal

personality principle caused hardship to the one who owned almost all the shares of the

company and who could not claim for insurance taken under his own name. There are also

cases where third parties suffer. Where a company is limited liability company, the creditors

will suffer if the company incurs debts, as the shareholders are not liable beyond the amount

they have contributed in full for their shares. 

Due to some of the undesirable consequences of incorporation, company law recognizes a

number of exceptions to the principle of veil of incorporation. Under these exceptional

circumstances, the law looks at the situation and will ignore the separation between the

company and its members or officers. This is called lifting the veil. When the court lifts the

corporate veil, the members or officers will be made liable for the company’s obligations. The

corporate veil is lifted under situations provided by statue, and also according to the judicial

decision under the common law.

Definition as in legal dictionary

Company Law in Malaysia by Chan Wai MengPrinciple of Company Law by Nicol Burnelaw-essays-uk.comlawyersnjurists.com Company Law in Malaysia by Chan Wai MengCompany Law in Malaysia by Chan Wai Menghttp://chestofbooks.com/business/lawhttp://www.lawteacher.net/Pamela Hanrahan, Ian Ramsay, Geof Stapledon http://vijayhighcourt.blogspot.comhttp://vijayhighcourt.blogspot.comhttp://www.cfbutlerandassociates.comBusiness law: Jon Rush and Michael Ottley

Posted 11th February 2013 by Nurafiza Tali