Planning to use the ‘It is not me but the company’ ruse? Think again.Not published yet ago
This article was written by Dinesh Sadhwani, a practicing advocate and solicitor of the High Court of Malaya.
The common understanding which most people, whether lawyers or laypersons, have is that a company has two key features:
- it has separate legal personality (i.e. it is separate from its shareholders) and capable of exercising all the functions of a body corporate and have the full capacity to undertake any business or activity including to sue and be sue, to acquire, own, hold, develop or dispose of any property and to do any act which it may do or to enter into transactions. This is reflected under sections 20 and 21 of the Companies Act 2016 (“Companies Act”).
- the shareholders (as well as directors and other representatives / agents, including employees) of the company are generally not liable for the company’s liabilities and obligations. Specifically in the case of shareholders – their liability or risk is only up to the amount they have invested or agreed to invest in the company. If the company were to go bust (i.e. its liabilities exceed its assets), the shareholders have no legal obligation to rescue the company. This is known as the ‘limited liability principle’.
However, the above merely represents the general rule. There are instances where the persons behind the company can be personally liable for acts purportedly carried out by or in the name of the company. This is sometimes called “piercing the corporate veil” i.e. to go behind the so-called “corporate veil” or “legal personality” and hold the ultimate “controlling mind” of the company personally liable.
At the risk of stating the obvious, the separate legal personality and limited liability concepts are well intended. The intention is to facilitate business or entrepreneurial activity and encourage bona fide risk taking respectively. However, they can also be abused and this is where the law steps in with exceptions, as further discussed below.
Let’s consider the case of a company that has gone bust (i.e. its liabilities exceed its assets) and the creditors will have to take a significant haircut / discount on the outstanding amounts owed to them. Investigations reveal that the directors have mismanaged the company and even siphoned out monies for their own benefit. However, if we strictly adhere to the limited liability concept, the creditors only recourse is against the company.
By virtue of section 540 of the Companies Act, the creditors may have some respite. Section 540 provides that if, in the course of the winding up of the company or in any proceedings against the company, it appears that the business of the company has been carried on with the intent to defraud the creditors of the company or for any fraudulent purpose, the court may declare that any person who was knowingly a party to the carrying of business in that manner shall be personally responsible, without any limitation of liability, for all or any of the debts or other liabilities of the company as the court directs.
What this means in simple English is that where a party has used the company for fraudulent purposes (e.g. caused the company to incur debts with no intention of making the company repay those debts), that person can be held personally responsible for the company’s debts.
Sham or fraud
Another exception to the separate personality / limited liability concept is where there is an element of sham or fraud involved. Unlike the section 540 example above, this exception does not have statutory footing and is a creature of the courts. What this means is that this exception is not specified in the Companies Act or any other act passed by parliament. Rather the courts have recognized the need for guarding against the use (or abuse) of a company to evade liabilities or obligations. The famous British cases of Gilford Motor Co Ltd v Horne and Jones v Lipman are best illustrations of this exception.
In the Gilford Motor case, the defendant was the former managing director of the plaintiff. The defendant’s employment contract with the plaintiff prevented him from competing with the plaintiff after he left their employment. To get round this restriction, he set up a company (owned by his wife and an employee) and started to trade through that company, in competition with his former employer. Needless to say, the plaintiff sued the defendant and sought an injunction. The courts ultimately ruled in favour of the plaintiff and held that:
“Of course, in law the company is a separate entity from the defendant but I cannot help feeling quite convinced that at any rate one of the reasons for the creation of the company was the fear of the defendant that he might commit breaches of covenant … and that he might possibly avoid that liability if he did it through the company. I am quite satisfied that this company was formed as a device, a stratagem, in order to mask the effective carrying on of the business of the defendant. The purpose of it was to try to enable him under what is a cloak or a sham, to engage in business which, on consideration of the agreement which had been sent to him before the company was incorporated, was a business in respect of which he had a fear that plaintiffs might intervene and object.”
In Jones v Lipman, the defendant agreed to sell land to the plaintiff, but changed his mind before completion of the sale and purchase agreement. The defendant transferred the land to a company where the sole directors and shareholders were him and his nominee. The plaintiff sued the defendant and his company and applied for specific performance of the agreement i.e. an order that the land be transferred to the plaintiff. The court granted the order of specific performance. The court said:
“The company is the creature of the defendant, a device and a sham, a mask which he holds before his face in an attempt to avoid recognition by the eye of equity. [Gilford v Horne] illustrates that an equitable remedy is rightly to be granted directly against the creature in such circumstances.”
So, for someone who intends to do something dubious and use the “it-is-not-me-but-the-company” argument, be wary!
Other than the Companies Act, there are various other laws that specifically provide that the directors of the company can be personally liable for certain debts of the company.
Two prominent and good examples of this are the Employees Provident Fund Act 1991 and the Income Tax Act 1967.
Section 46 of the EPF Act makes the directors of the company jointly and severally liable for the company’s unpaid EPF contributions. Similarly, section 75A of the ITA provides that where any tax is due and payable under the ITA by a company, any person who is a director of that company during the period in which that tax is liable to be paid, shall be jointly and severally liable for such tax that is due and payable.
The rationale behind imposing such liability is patently clear – the separate legal personality / limited liability concept should not be used as a shield to evade liability towards employees and the tax authority.
One interesting issue is whether a director can be held personally liable for tortious acts committed in the course of acting as director.
An example of this can be seen in the case of Williams & another v Natural Life Health Foods Ltd & another. The plaintiffs obtained franchise rights from the defendant, by relying on certain representations made in the defendant’s brochure. When the franchise turned out to be unsuccessful, the plaintiffs sued the director of the franchisor for the negligent misstatements. The court held that the director was not liable as there was no special relationship between the plaintiffs and the directors nor did the director assume any responsibility towards the plaintiffs.
However, this is not to say that a director can never be held personally liable for tortious acts. The principle is that a director should not attract liability in tort for simply carrying out his role in governing the company.
It would be different if the director went beyond a bona fide discharge of his duties – for example, where there is an element of fraud involved, the director should not be allowed to raise limited liability and separate legal personality as a defense.