Separate Legal Entity CA2016.pptx

Separate Legal Entity
Companies Act 2016

Objectives of this unit
After the completion of this chapter, you should be
able to:
 Explain the concept of separate legal entity between the company and
its officers and members.
 Discuss the statutory exceptions to the doctrine of separate legal
entity as prescribed in the Companies Act 2016 and other statutes in
Malaysia.
 Discuss the common law exceptions to the doctrine of separate legal
entity.
2

Introduction
 A company is an artificial person. 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.
 One of the underlying principles of an incorporated company is it is a separate
legal entity from its members and officers. This principle distinguishes a company
from a partnership and a sole-proprietorship.
 The importance of the principle of separate legal entity was established in the
landmark case of Salomon v Salomon & Co Ltd (1897). In Malaysia, the courts have
also applied this principle. In Sunrise Sdn Bhd v First Profile (M) Sdn Bhd (1996),
the Federal Court held that:
We are in complete agreement with the basic principle of the fundamental attribute of corporate
personality, i.e. that the corporation is a legal entity distinct from its members, be they individuals
or corporate bodies under a principle firmly established since Salomon v Salomon & Co Ltd.
3

Principle of separate legal entity under s.20
of CA 2016
A company incorporated under this Act is a body
corporate and shall
1. (a) have legal personality separate from that of its
members; and
2. (b) continue in existence until it is removed from the
register.
In addition, section 192(1) also expressly provides that “a
member shall not be liable for an obligation of a company by
reason only of being a member of the company”.
4

Statutory exceptions to principle of separate legal
entity to avert adverse situations
 However, the law recognises that there may arise circumstances when this
principle of separate legal entity may lead to adverse positions.
 Fraudsters may incorporate a company to commit fraud and hide behind
the veil of incorporation.
 Similarly, officers who carry out wrongful deeds in the name of the
company are protected by the veil of incorporation and are thus, not liable.
 In view thereof, statutory exceptions are enacted to lift the veil of
incorporation under specified situations and render the members or officers
liable for the wrongful deeds
5

Separate legal entity enunciated in
Salomon v Salomon
The principle that a company upon incorporation is a legal
entity separate from its members, was affirmed by the House
of Lords in Salomon v Salomon & Co Ltd (1897). It is
immaterial whether the company has the minimum number
of members (under the CA 2016, the minimum number of
members is only one) or has a large number of members.
6

Salomon v Salomon
 Mr Salomon was a sole-proprietor, manufacturing boots. The business was successful. Mr
Salomon incorporated a company and sold his business to the company in consideration
for 20,000 shares and debentures of £10,000 issued in favour of Mr Salomon. Mr
Salomon ended up holding 20,001 of the 20,007 shares issued. The other six shares were
held by his wife and five children as nominees of Mr Salomon.
 Unfortunately, the company experienced financial difficulty and despite efforts by Mr
Salomon, the company became insolvent and was compulsorily wound up.
 An action was brought against Mr Salomon for a court order to postpone his priority under
the debentures to rank after the company’s unsecured creditors and also to indemnify the
company for all the debts due to its unsecured creditors. If it had been approved by the
court, not only the company’s unsecured creditors would have priority over the debentures
issued in favour of Mr Salomon but Mr Salomon would also have been liable to the
company’s creditors.
7

Salomon v Salomon
Fortunately for Mr Salomon, Lord Macnaghten on behalf of the
House of Lords held that:
The company is at law a different person altogether from the subscribers to the
memorandum; and though it may be that after incorporation the business is
precisely the same as it was before, and the same persons are managers, and
the same hands receive the profits, the company is not in law the agent of the
subscribers or trustee for them. Nor are the subscribers as members liable, in
any shape or form, except in the manner provided by the Act.
8

Implications of decision in Salomon v Salomon
 The decision confirms that a company upon its incorporation, is a separate legal entity from
its members
 As the debts were incurred by the company, the creditors can look to only the company, and
not its members, for repayment. The impact of the doctrine of separate legal entity together
with the doctrine of privity, that is, only the parties to the contract can sue and be sued,
ensures this.
 The decision in Salomon also affirmed the rule that since the company and the members are
of separate legal entity, a member of the company can also lend money to the company. If
the loan is secured, the member-creditor has priority over the proceeds from the secured
assets. He ranks prior to the other unsecured creditors in respect of the secured assets.
 Therefore, the fact that all the shares are 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.
9

In Lee v Lee’s Air Farming Ltd (1961) Privy Council
enforces principle of separate legalentity
 Of the 3000 issued shares, 2999 of the shares were allotted to Mr Lee, and the other one share
was held by his solicitor as his nominee. Mr Lee was not only the beneficial owner of all the shares
in the company, he was also its managing director and employed by the company as a pilot. The
company effected a workmen’s compensation insurance naming Mr Lee as the employee.
 3000 issued shares, 2999 of the shares were allotted to Mr Lee, and the other one share was held
by his solicitor as his nominee. Mr Lee was not only the beneficial owner of all the shares in the
company, he was also its managing director and employed by the company as a pilot. The company
effected a workmen’s compensation insurance naming Mr Lee as the employee.
 Mr Lee was killed whilst at work, and his widow claimed for payment under the policy. The
issue was whether Mr Lee could be a worker since he was in full control of the company both as the
beneficial owner of all its shares and as the managing director.
 The Privy Council held that the company was a separate legal entity from Mr Lee and thus,
could enter into a contract of employment with him. As the managing director of the company, Mr
Lee was the company’s agent when negotiating the contract and when giving orders to Mr Lee, the
pilot. Thus, the court held that Mr Lee was an employee and his widow was entitled to claim
compensation.
10

Macaura v Northern Assurance Co Ltd (1925)
 Mr Macaura owned all the shares in Irish Canadian Sawmills Ltd. The shares were
registered in his and his nominees’ names. Mr Macauara sold all the timber in his estate
to the company. Soon thereafter, the timber was destroyed in a fire. As Mr Macaura had
insured the timber against fire, he claimed indemnity from the insurance company.
 The House of Lords held that Mr Macaura had no more interest in the logs after he
sold them to the company. The company and Mr Macaura were separate legal entities. As
Mr Macuara had no more insurable interest in the timber, the insurance policy was void.
Mr Macaura could not claim for indemnity from the insurance company.
 According to the House of Lords even if a person is the beneficial owner of all the
shares in the company, he does not have any legal or equitable interest in the company’s
property. The company’s property belongs to the company.
11

Foss v Harbottle (1843)
 There were 10 members in the company. Two of them instituted legal action against the other
eight for causing the company to purchase properties at inflated prices from another company
controlled by the eight members. Obviously, a wrong was committed against the buyer company.
But given the fact that the wrongdoers were in control of the buyer company, no action was
instituted against them. Thus, the two minority shareholders of the buyer company instituted legal
action against the wrongdoers.
 The court held that the members and the company were different entities. As the wrong was
committed against the company, only the company could institute the legal action. The members
had no cause of action against the wrongdoers as the wrong was not committed against them. Thus,
the company was the proper plaintiff. The established what is known as the Foss v Harbottle rule
12

Important principles established in the cases of Lee v Lee’s
Air Farming and Macaura v Northern Assurance Co Ltd
Establish the principle that it is immaterial that there is
only one beneficial owner of all the shares in the
company and that this sole member has full control of the
company.
The cases gave recognition to the fact that what was
material was that on paper, there were two members.
Compliance in form sufficed.
13

Minimum number of members in a company
Companies Act 1965
 The importance of having at least two members in a company
(unless the company was a wholly owned subsi.diary) was
established in s. 36
 It provided that a company, other than a wholly owned
subsidiary, must have at least two members. In the event the
number of members fell below two, the sole member should
transfer at least one share to another person within a period of
six months. Failing which, the company should not carry on
business. If not, both company and sole member would be guilty
of an offence. The sole member would also be liable for the
company’s debts incurred after that period.
 section 218(1)(d) of the CA 1965 also provided that it was a
ground to wind up the company if its membership was reduced
to one
 Ss. 36 and 218(1)(d) no more the law
Companies Act 2016
 allows the formation of a one
member company in Malaysia (section
9).
 In addition, where the company is
a private company, section 196
provides that it may have only one
director.
14

SEPARATE FROM OFFICERS
 The principle of separate legal entity also applies to the officers of the company, that
is, the directors, managers and secretary. An officer of the company is also not liable for
the company's debts.
 In the case of Re Application of Yee Yut Ee (1978), Mr Yee was a director of a
company. The company retrenched its staff and the Industrial Court awarded the
retrenched staff retrenchment benefits. As the company failed to comply, the Industrial
Court made an order that Mr Yee was liable to pay the benefits. Mr Yee appealed.
 The High Court held that Mr Yee was not liable. It further said that a director of a
company is not liable for the debts of the company unless fraud is proven, or the director
has committed breach of warranty of authority or under exceptional circumstances.
15

Exceptions to the principle that company is separate
from officers established under ss.20 and 192(1) of
CA 2016
 Circumstances when this principle of separate legal entity may lead to adverse
positions.
 Fraudsters may incorporate a company to commit fraud and hide behind the veil of
incorporation.
 Similarly, officers who carry out wrongful deeds in the name of the company are
protected by the veil of incorporation and thus, are not liable.
 Statutory exceptions have been enacted to lift the veil of incorporation under specified
situations and render the members or officers who committed the wrong liable.
 The doctrine of privity and the concept of separate legal entity will not protect the
wrongdoers under certain situations.
16

The CA 2016 has not adopted all the statutory
exceptions found in the CA 1965.
 Liability of sole member under section 36 of the 1965 Act, as a result of the
recognition of a one-member company under the new CA 2016;
 Liability of an officer who signed financial instruments wherein the name and
former name (if any) of the company were not mentioned (section 121(2) of
the CA 1965);
 Liability of every director and manager who paid dividend exceeding the
company’s profit. Under section 365 of the CA 1965, they would be liable to
the company’s creditors or liquidator suing on behalf of the creditors. Under
the CA 2016, the director and manager are liable to the company if the
dividend is paid contrary to the prescribed rule.
17

Provisions in the CA 2016 which confer rights on the
creditors of the company or outsiders against the
company’s officers.
 Section 65(1) provides that the person who signs the pre-incorporation contract will
be personally liable for the contract or transaction accordingly.
 But it does not explain the position of the person who signed the contract where the
company has ratified the contract.
 It is yet to be seen whether the general law of agency would then apply.
 If the provision in section 65(1) of the CA 2016 is applied strictly, then the person
who signed the pre-incorporation contract is bound notwithstanding the ratification by
the company after its incorporation.
 The current section 65 of the 2016 Act does not expressly allow the person who
signed the contract to exclude his liability, or allow him enjoyment of the contract in the
event the company does not ratify the contract after its incorporation.
18

Provisions in the CA 2016 which confer rights on the creditors
of the company or outsiders against the company’s officers.
Publication of company’s name - Section 30(2) of the CA 2016 requires a company to
incorporate its name and number in its business documents. This is to prevent a company from
committing fraud.
 Officers should ensure compliance of this requirement, for section 30(5) provides that it is an offence
not to do so.
 But unlike section 121(2) of the CA 1965, the new provision stops short of making the officer who
authorises or issues a bill of exchange, promissory note or other negotiable instrument without the name of
the company liable for the amount due thereon unless it is paid by the company.
 Thus, the payee of such instrument will have recourse against the officer only at common law or if the
transaction falls within another provision such as section 539 or 540
 If these two conditions are not fulfilled within four months from the issue of the prospectus, the
company is required to refund all moneys received to the applicants of the shares (section 186(4)(a)). The
refund should be made within five months after the issue of the prospectus (section 184(4)(b)).
 Subsection (4)(b) provides that in the event the company fails to refund the moneys, the directors will be jointly
and severally liable to refund the moneys with interest at the rate of 10% unless they can prove that the default was
not due to their misconduct or negligence
19

Distribution of profits
 Under the CA 2016, the rules on dividend have been tightened. However, the liability of the director or
manager who wilfully pays or permits payment of any cash dividend in contravention of the dividend rules will
be liable not to the company’s creditors (as in CA 1965) but to the company instead (section 133(2)).
Financial assistance to purchase shares
 Section 123 of the CA 2016 prohibits a company from giving any financial assistance for the purchase of
shares in the company or the company’s holding company.
 However, the legislature recognises that the breaches would have been authorised by the company’s
officers and section 123(3) stipulates that the officers in default shall then be guilty of an offence under the Act.
 Section 123(4) further provides that the officer who is convicted may be held liable by the court to
compensate the company or any person who has suffered loss or damage as a result of the breach.
20

Consolidated accounts
 Even though a company upon incorporation is a separate legal entity, section 247 of the CA 2016 provides that
the financial year of subsidiaries should coincide with that of its holding company.
 This is to facilitate the preparation of consolidated accounts, that is, the company’s accounts and those of its
subsidiaries are to be consolidated (section 250).
 Section 244 further provides that the consolidated accounts are to be prepared in accordance with the approved
accounting standards, and audited.
Wrongful trading
 Wrongful trading occurs when an officer of the company knowingly contracts a debt for the company at a time
he has no reasonable or probable ground of expectation that the company would be able to pay the debt.
 An officer of the company had committed wrongful trading, the officer would be guilty of an offence and
personally responsible for the repayment of the whole or any part of that debt. It is to be noted that the wrongful
trading was discovered when the company was being wound up or in proceedings taken against the company -
sections 539(3) and 540(2) of the CA 2016.
21

Fraudulent trading - happens when an officer of the company carries on any business of the company
with intent to defraud the company’s creditors.
 Section 540(1) of the CA 2016 imputes liability to any person who was knowingly a party to the
carrying on of any business of the company with intent to defraud the creditors of the company or any
person or for any fraudulent purpose. He may be made personally liable for all or any debts or other
liabilities of the company.
 Based on the Court of Appeal decision in Chin Chee Keong v Toling Corporation (M) Sdn
Bhd (2016). The court held that the requirements of section 304(1) CA1965 were as follows:
 The business of the company has been carried out with intent to defraud creditors or for any
fraudulent purpose. The dishonesty was in the form of incurring debts;
 The defendants were knowingly a party to the carrying on of the business in that manner; and
 The fraudulent trading was discovered when the company was being wound up or in proceedings
taken against the company.
22

Contributions to the Social Security Organisation
 If the defaulting employer is a company, section 108A of the Employees Social Security Act 1969
provides that the company, directors of the company at the time action is taken and the directors at the
time of non-payment are jointly and severally liable with the company for the unpaid amount.
Offences under the Employment Act 1955
 Amendment in 2011 - section 101B which provides that where an employer has committed an offence,
the directors and managers at the time the offence was committed may be charged jointly with the
company.
 With this new amendment, officers may be deterred from conniving to short change employees, for
they may be charged and fined upon conviction.
23

The cases where the courts have lifted the veil of
incorporation can be categorised as follows:
Fraud or improper purpose
 Courts will not assist fraud. Thus, if a company is used as a mask to commit a fraud, the court
may pierce its veil of incorporation.
 In Lim Kar Bee v Duofortis Properties (M) Sdn Bhd (1992), the Malaysian Supreme Court
held, “It is well settled that the courts have a discretion to lift the veil of incorporation for the
purpose of discovering any illegal or improper purpose.”
 In Re Bugle Press Ltd (1960), there were three shareholders, J, S and T in Bugle Press Ltd. J
and S wanted to purchase T’s shares. As T refused, J and S incorporated another company, J&S
Holdings Ltd. J&S Holdings Ltd then offered to buy all the shares in Bugle Press Ltd from J, S
and T. J and S accepted. J&S Holdings Ltd then exercised its legal rights to compulsorily take
over the company and compel T to sell his shares to the company. The court lifted the veil of
incorporation of J&S Holdings Ltd. It held that J&S Holdings Ltd was a sham. It was incorporated
to enable the majority shareholders of J&S Holdings Ltd, namely J and S, to expropriate from the
minority shareholder, that is, T.
24

The cases where the courts have lifted the veil of incorporation
can be categorised as follows:
Avoidance of contractual obligations - where a company is incorporated so that a person can
avoid his contractual obligations.
 In Jones v Lipman (1962), L entered into a contract to sell his house to J. Then L changed his mind
and to avoid specific performance, incorporated a company, A Ltd, and transferred the house to A Ltd. J
applied to the court for specific performance against L and A Ltd. A Ltd put up the defence that it was not
a party to the contract between L and J and therefore should not be sued. The court held that A Ltd was a
creature of L, “a device and a sham, a mask which he holds before his face in an attempt to avoid
recognition by the eye of equity”, and therefore ordered both L and A Ltd to perform the contract with J.
 In another case, Gilford Motor Co v Horne (1933), H was employed by G. Under the contract, H
agreed not to solicit G’s customers upon leaving their employment. After three years with G, H resigned
and incorporated a company, JM Horne & Co Ltd, whose shareholders were his wife and an associate. H
gave G’s contacts to JM Horne & Co Ltd. G obtained an injunction against both H and JM Horne & Co
Ltd to restrain them from continuing to solicit business from G’s customers. The court held that JM
Horne & Co Ltd was a mere sham or cloak to enable H to breach his contract with G. The court granted
the injunction.
25

The cases where the courts have lifted the veil of incorporation
can be categorised as follows:
Group of companies
 A company upon incorporation is a separate legal entity. The court in The People’s Insurance Co (M) v The
People’s Insurance Co Ltd (1986) held that this principle applies as well to related companies, including wholly
owned subsidiaries. However, despite this, there were instances where the court has held that the related
companies do not have separate legal entities; they are indeed one legal entity.
 The case of DHN Food Distributors Ltd v London Borough of Towers Hamlets (1976). In this case, DHN
carried on the business of operating a grocery on the property owned by one of its wholly owned subsidiaries.
The property was compulsorily acquired by the authority which refused to pay compensation to DHN as it did
not have any interest in the land. The English Court of Appeal held that the group operated as a single economic
unit and thus DHN could recover the compensation due to them under the law.
 The decision in DHN was followed by the Malaysian court in the case of Hotel Jaya Puri Bhd v Hotel, Bar &
Restaurant Workers (1980). In this case, the hotel company had a wholly owned subsidiary to carry out its
restaurant business in the hotel. Unfortunately, the restaurant suffered losses and was closed and the employees
retrenched. The Industrial Court ordered the hotel company to pay termination benefits to the employees. The
hotel company appealed, arguing that it was not a party to the contract of employment. Unfortunately for the
hotel company but fortunately for the employees, the court held that the hotel company and the restaurant
company were one group enterprise. The employees were in fact working for one entity. And thus, the hotel
company was liable to the restaurant’s employees.
26

The cases where the courts have lifted the veil of incorporation can be
categorised as follows:
Public Policy
 The court may also lift the corporate veil if public policy demands it.
 In the case of Daimler Co v Continental Tyre & Rubber Co (1916), the court
looked at the identities of the shareholders and held that the company, even
though incorporated in England, was an enemy company because its shares were
held by Germans. This happened during the First World War when the English
government issued a decree that no business could be conducted with the enemy,
namely, the Germans.
27

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