Company Law and the Corporate Veil

Introduction

As the day company is formed, it can be said that the company is “incorporated”. As the company uniqueness is that it provides for effective separation of resources and managements of its resources and it is further compounded on the fact that the owner of the capital can limit his or her liability to the third parties. Therefore the company is recognized as a separate entity and it is treated in its own capacity. In nowadays business companies, it can be seen that companies have both advantages and disadvantages in measuring the limited liability of the shareholders on the basis that the company is liable for its debts and obligations. Therefore, double-edged sword is created which means it has both good and bad elements.

In this assignment, details about the doctrine of separate legal entity will be analyzed. Also statements of features of company as separate legal entity and circumstances the veil of incorporation will be lifted will be analyzed with reference to some cases.

Doctrine of separate legal entity

In company law of Malaysia, a company is treated as a separate legal entity from its members constituted in it which is its shareholders and directors. This is the doctrine of separate legal principle.

The company is a different separate body from its member. Thus, the members of the company are not liable for the company debts. For instance, when a company turn into a contract, the company itself will personally liable for the contract rather than the shareholders and the directors. Therefore, a company is a corporate body. A corporation is an artificial legal person that exists independently of the individuals who at any given time are the members of the corporate body. This principle was established by the House of Lords in Salomon v Salomon & Co Ltd.

The rule of Agency

An agency is a relationship where one person consents or is deemed to have consented that the other person should act on its behalf so as to affect its relations with third parties.

Features of Separate Legal Entity

At the time the company is incorporated, it is a separate legal person, it brings forth some effect which can be the features of it. Under section 16(5) of the Companies Act 1965 states that, once a company had been incorporated, the company had all the ability as an incorporated company. For instances, it is means that the company can enjoys its right and function as a legal person. Company that incorporated is a legal personality that is created and recognized by the law as stated by Salleh Abbas F.J in Tan Lai v Mohamed bin Mahmud.

When a company register under Companies Act, it becomes vested with corporate personality which is an independent legal person and separate from its members. For instance, the company is a legal person. In Salomon v. Salomon & Co. Ltd. (1987), unsecured creditors claimed that the company never had an existence of independent although it was incorporated. They claimed that it was Salomon himself trading under another name, but the House of Lords held Salomon & Co. Ltd. must be regarded as an independent person from Salomon. This is because of the fact that the company was not role as an agent for the member. Thus, Salomon and the others are mere subscribers of the company although he owned all the issued shares. Hence, Salomon could enforce its rights against the company as a secured creditor.

Furthermore, the company also has the ability to sue and be sued in its own name. Therefore, a company can make legal action to enforce its right. It was established in the case Foss v Harbottle where action brought by the members of the company made an injury complain towards the company and it was fail. Therefore the member could not take action on behalf of the company.

Besides, a company has perpetual succession which means members may join and leave, but the company will continue go on. When a company become incorporation, it will continue operate until it is dissolved according to the Companies Act 1965. Under the case of Re Noel Tedman Holdings Pty Ltd, the court allowed the representative personal of the deceased to appoint the directors of the company so that the directors could allow the transfer of the shares to child. This proves that although the shareholders had leave but the company is still exiting and continue go on.

Other than that, a company also has ability to own property on its own name. According to section 16(5) a company has power given to own personal land and other types of property. While company is separate legal person from its member, the member has no legal right and interest with the property and it is belongs to company. In case Macaura v Northern Assurance Co. Ltd, Macaura owned a tree plantation which was covered by an insurance policy. Later he sold the plantation to a company which he was the only shareholder. After the sale, Macaura continued to insure the plantation in his own name. A fire broke out and the plantation was destroyed. Macaura then attempted to claim on the insurance policy but the insurance company refused to pay. The issue was whether Macaura had an insurable interest at the time of the loss. It was help that the insurance company was right in not paying. The plantation company was a legal entity in its own right, separate from its shareholders.

Other than that, in a corporate body, the shareholders of the company can enjoy limited liability. While a company is a separate legal entity, the shareholders are not liable for the debts and the liability is limited by shares. Therefore, creditors have no rights to take any legal action against the shareholders. In case Ye Yut Een 1978, the director of the company is not liable for the company’s debt. It is the company who had not complied with the procedures related to the retrenchment benefits.

Lifting The Veil of Incorporation

Although the company has privilege as separate legal entity, it must not be used for any unlawful or illegal business purposes, in case a fraudulent or dishonest use is made of the legal entity, the concerned individuals will not be allowed to take the shelter of the corporate personality. The court will disregard the corporate veil to see the real persons behind it. Generally, the law will not go behind this veil of incorporation to look at the membership of the company. But the courts will ‘lift the corporate veil’ in some exceptional cases.

Salomon v Salomon & Co Ltd case have decided that the members of the company are not liable for any contract that contracted by the company. This will cause they may have a chance hiding behind the veil to defraud the creditors and other parties that contracted with the company.

The court will pierce the corporate veil by applying the principle known as ‘piercing the corporate veil’. When there is no entity separate from members, the court will pierce the corporate veil and take action. After that the court will make the company and its members liable for any breach of contract.

The veil of incorporation can be lifted in according to situation provided under statutory provision and by judicial interpretation under the common law. For instance, section 36, Companies Act 1965 states that if the number of members of a company is reduced to below two and its carries on business more than six months, the person who is a member of the company during the time that is so carries on business after those six months, and is aware of it, the person is personally liable for all the debts that the company contracted after those six month and he may be sued therefor.

According to the section 304(2), Companies Act 1965, together with the section 303(3), provide that an officers who knowingly contract a debts on behalf of the company. It means borrow money and knowing that that the company is most likely unable to pay the debt is guilty of an offence and on conviction be made personally liable to pay that debt.

Under section 304(1), Companies Act 1965 provides that when a company’s intention is to purposely defraud its creditors, the veil of incorporation is lifted. In the course of the winding up of a company or in any proceedings against a company it appears to the court when hearing the application of the liquidator or any creditor or contributory of the company that any business of the company has been carried on with intent to defraud creditors of the company or creditors of any other person or for any fraudulent purpose, the court may hold any persons who were knowingly parties to the fraud personally responsible for all or any of the debts or other liabilities of the company as the court directs.

Under section 365(2), Companies Act 1965 provides that any payment of dividend not from profit is prohibited. Any payment made of dividends to shareholders is personally liable by the director towards the creditors of the company when there are no profits available.

There are also situations where the court thinks it is appropriate and it will lift the veil of incorporation at common law. The situation whereby the veil of incorporation is lifted where the company is acting as agent or partner of the controlling or parent company. Group of the companies the problems can be complex. Subsidiary own and fund money of a business has been held to do so as agent for the holding and parent company. So, holding and parent company actually operating business. This is applied in case Smith, Stone and Knight Ltd v Birmingham Corporation (1939).

Besides, the veil of incorporation will be lifted when there is a group of companies, including holding and subsidiary company, the court can lift the veil and treat a company and its subsidiary as one economic unit. In case DHN food Distributors Ltd v Tower Hamlets London Borough Concil, subsidiary company owns a piece of land while the DHN which is parent company operated the business on the land. The local authority purchases the said land. The DHN claimed compensation for disruption. The local authority refused to pay the compensation on the grounds that the land did not belong to DHN. The court lifted the veil of establish that DHN is connected with the subsidiary company as treated as one economic unit, they did suffer a loss as a result of acquisition from the local authority and allowed to claim the compensation.

At last, lifting the corporate veil can also assist in the prevention of fraud. In case Aspatra Sdn Bhd & Ors v Bumiputra Bank Malaysia Berhad (BBMB), Lorrain Osman, one of the director of Aspatra Sdn Bhd, was once a director of Bumiputra Bank Malaysia Berhad, must account for the secret profit he made in breach the fiduciary duty. To avoid detection Lorrain Osman had channeled the monies which is the secret profit he make into several companies that he controlled, one is the Aspatra Sdn Bhd. BBMB feared that the money Lorrain Osman took would leave Malaysia and applied for an injunction. The veil lifted to reveal that the assets of Aspatra Sdn Bhd belong to the Lorrain Osman and the injunction was accepted.

Conclusion

In conclusion, it clearly stated that the doctrine of separate legal entity have created double-edged swords to the shareholders of the company. Although it brings many features to the shareholders but it also have drawback towards the company itself and creditors in some situation. Hence, there will be some defects of incorporation. However, lifting the veil of incorporation by the court will reduce the defects of incorporation.

SALOMON v SALOMON & CO LTD [1897] A.C. 22, House of Lords

SALOMON v SALOMON & CO LTD [1897] A.C. 22, House of Lords

Foss v Harbottle(1843) 67 ER 189

Re Noel Tedman Holdings Pty Ltd. (1967) QdR 561

Macaura v Northern Assurance Co Ltd[1925] AC 619

Yee Yut Ee(978)2 MLJ 142

[1939] 4 All ER 116

DHN Food Distributors Ltd v Tower Hamlets London Borough Council[1976] 1 WLR 852

Aspatra Sdn Bhd v Bank Bumiputra Malaysia Bhd (1988) 1 MLJ 97