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Lifting of Corporate Veil

Theory of independent legal entity


Upon the issue of certificate of incorporation by
the Registrar, a company becomes a body
corporate, or in other words, a corporation.
In the eyes of law, a company is an
independent legal person separate and distinct
from its individual members or directors.
Re Sheffield & South Sheffield Yorkshire
Permanent Building Society, in Liquidation
A company is a legal persona just as much as
an individual. A company once created by the
aw can only be destroyed by the process of the
law.

Salomon v. A Salomon & Co. Ltd.


Aron Salomon had for many years carried
on a prosperous business as a leather
merchant
and
wholesale
boot
manufacturer trading on his sole account.
In 1892, he decided to convert the
business into a limited company.
For this purpose, Aron Salomon and
Company was formed with liability
limited by shares.
The memorandum of the company was
subscribed by Aron Salomon, his wife and
five of hid children.

It was all along the intention of these persons


to retain the business in their own hands.
The company purchased the business for
L39,000 and the price was satisfied by:(a)a sum amounting to L20,000 was paid to
Aron Salomon who then immediately
returned it to the company in exchange for
fully paid shares;
(b) a sum amounting to L10,000 was paid in
debentures for the like amount; and
(c)The balance sum, with the exception of about
L1,000 which Aron Salomon seemed to have
received and retained, went in discharge of
the debts and liabilities of the business at the
time of purchase.

In the result, apart from the fully paid


shares, Aron Salomon received for his
business about L1,000 in cash and
L10,000 in debentures.
A year after its incorporation, the
company became insolvent and went
into liquidation.
In an action brought by a debenture
holder on behalf of himself and all the
other debenture holders, the company
set out by way of counterclaim, inter
alia, that the company was a mere
nominee and agent of Arom Salomon ..

.. And that the company or the


liquidator was entitled to be
indemnified by Aron Salomon against
all the debts owing by the company
to creditors other than Aron Salomon
himself.
The main issue before the court was
whether the debenture originally
issued to Aron Salomon was valid
and therefore ranked in priority to
unsecured creditors.

The learned trial judge in that case held


that the company was only an alias or
agent for Aron Salomon, and therefore
Aron Salomon was personally bound to pay
the unsecured creditors of the company.
The decision of the learned judge was
affirmed by the Court of Appeal but on
somewhat
different
grounds
which
considered the relation between them to be
that of trustee and cestui que trust.
This difference of view did not affect the
conclusion that the right of the indemnity
claimed had been established against Aron
Salomon.

The House of Lord, however, unanimously


reversed the decision of the Court of Appeal
and held that Aron Salomon was not
personally liable.
In an oft-cited judgment, Lord Macnagthen
held:- 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 trustee for them. [continue]

Nor are the subscribers as members liable, in


any shape or form, except to the extent and
in the manner provide by the Act.
Lord Macnaghten had earlier said:- There is nothing in the Act requiring that the
subscriners to the memorandum should be
independent or unconnected, or that they or
any of them should take a substantial
interest in the undertaking, or that they
should have a mind and will of their own, as
one of the learned Lord Justices seems to
think, or that there should be anything like a
balance of power in the constitution of the
company.

Though Lord Macnaghten in the


Salomon case had attached the
independent legal entity concept to
the
subscribers
to
the
memorandum, subsequent cases
have extended this fundamental
concept also to persons who have
subsequently become members of a
company.
Company law will be critically altered
if the separate legal entity concept
confines its application to subscribers
to the memorandum only.

The Salomon principle is well accepted as


part of Malaysian company law.
Goh Hooi Yin v. Lim Teong Ghee & Ors
- It was said by Arulanandom J. that it was
incumbent on Malaysian courts to abide by
the doctrine as laid down by the English
court unless there were compelling reasons
not to do so.
Abdul Aziz bin Atan & Ors v. Ladang
Rengo Malay Estate Sdn. Bhd
- It was held that even if all the shares in a
company were transferred fro, the existing
member to another person, the transfer
would not change the company to another
entity.

Yap Sing Hock & Anor v. Public


Prosecutor
- It was held by the Supreme Court
that the independent legal entity
concept applied to criminal offences.
In the coming conclusion, The
Supreme Court adopted the decision
of the English Court of Appeal case in
Attorney-Generals Reference where
it
was
decided
that
a
sole
shareholder of a company was
capable of committing a theft of the
property of the company under the

Consequences of independent
legal entity

A company once it is incorporated under


the
Act
and
the
certificate
of
incorporation issued by the Registrar:(a)Is a body corporate;
(b)Is capable of exercising all the functions
of an incorporated company;
(c)Is capable of suing and being sued;
(d)Has perpetual succession;
(e)Shall have a common seal; and
(f) Has power to hold land.

A company is a legal fiction, an


abstraction, with legal but no physical
existence.
A company has neither body, parts or
passions. Apart from its corporation, it can
have
neither
thoughts,
wishes,
or
intentions, for it has no other mind than
the minds of the corporators.
Consequently, the will and directing mind
of a company must be sought in the
person of an individual who for some
purposes may be sought in the person of
an individual who for some purposes may
be called an agent, usually the director.

However, a director of a company


will not by virtue of his position as
director merely, be held liable for the
debts of the company.
A director of a company who
executes a contract in his capacity as
director for and on behalf of the
company cannot be held personally
liable for the breaches or acts of the
company under the contract unless
there are express provisions in
contract to the contrary.

Further, once a company has


executed in favour of a purchaser a
proper instrument of transfer of the
companys land, a director either as
an officer or in his personal capacity
as a shareholder of the company has
no fiduciary duty to challenge the
conduct of the company by entering
a private caveat under section
323(1)(a) or (b) of the National Land
Code 1965 for the purpose of
protecting his own interest or the
interest of other shareholders.

Lifting of the Corporate Veil


The Act
One of the main purposes of forming
a limited company is to enable the
business to be undertaken with
limited financial liability to its
members in the event of the
business proving to be a failure.
Lord Macnaghten in Salomon case
recognised that among the principal
reasons which induced persons to
form limited companies was the
desire to avoid the risk of bankruptcy

It has also been described in the


following way:- The limited liability corporation is the
greatest single discovery of modern
times. Even steam and electricity are
less important than the limited
liability company.
Despite the supposed benefits which
could be derived from the doctrine of
independent legal personality, it is
well recognized that the doctrine is
open to abuse and can in certain
situations lead to harsh injustice.

On various accounts, the legislature and


the
courts
have
disregarded
the
independent legal entity rule and drawn
aside the corporate veil.
They can pull aside the persona and look to
see who is behind by using a process
commonly referred to as lifting the veil of
incorporation.
By this process, those who are responsible
may be held personally liable for the acts
or purported acts of the company.
It is submitted that this process should not
be applied so much so that it divorces the
law from reality.

Circumstances where the


corporate veil may be lifted by the
Act
(1)Reduction
of
number
of
members
below
statutory
minimum
()A sole remaining member of a
company may be liable for the
payment of the debts of the
company under section 36 if at any
time the number of members of a
company is reduced to below two
and it carries on business for more

The sole remaining member of the


company during the time that it so carries
on business after the six months and who
is cognisant of the fact that it is carrying
on business with fewer than two members
is liable for the payment of all the debts of
the company contracted during the time
that it is carries on business after those six
months and he may be sued therefor.
Wong Kim Fatt v. Leong & Co Sdn Bhd
& Anor
- Chang Min Tat J. held that the reduction in
section 36 would include resignation or
loss of right to remain as a member.

(2)
Offence
relating
to
financial
assistance to purchase share, etc.
the privilege of limited liability accorded to a
member may be lost if he is convicted of an
offence under section 67.
In such a case, the court may, if satisfied
that the company or another person has
suffered loss or damage as a result of the
contravention that constituted the offence,
order the convicted person to pay
compensation to the company or the person
of such amount as the court specifies.
The order so made may be enforced as if it
were a judgment of the court.

Briefly, section 67 involves the


prohibition on a company providing
financial assistance for the purpose
of or in connection with a purchase
or subscription of its own shares or in
any way purchasing, dealing in or
lending money on its own shares.
However, following the amendment
to the Act, a new section 67A was
inserted, whereby public companies
are allowed to buy back their own
shares
in
certain
prescribed
circumstances.

3) Signing of bill of exchange, etc

If any officer of a company or any person on


its behalf signs, issues or authorises to be
signed on behalf of the company any bill of
exchange, promissory note or other
negotiable instrument or any endorsement
thereon or order wherein the name and
former name (if applicable) of the company
is not so mentioned, he shall be liable to the
holder of the instrument or order for the
amount due thereon.
The liability of the officer will not arise if the
amount is paid by the company.

4) Issuing of shares by directors

Section 132D prohibits the directors from


exercising any power of the company to
issue shares unless the power is exercised
with the prior approval of the company in
general meeting.
No provision in the memorandum or the
articles of a company can override this
statutory prohibition.
Where such a prohibition applies, any
shares
issued by the company in
contravention of the statutory provision
shall be void and consideration given for
the shares shall be recoverable accordingly.

More importantly, a director of the


company who knowingly contravenes
permits or authorizes the contravention of
the prohibition is liable to compensate the
company and the persons to whom the
shares were issued for any loss, damages
or costs which the company or that person
may have sustained or incurred thereby.
Notwithstanding the provision of the
Limitation
Act
1953,
the
recovery
proceedings must be commenced within
three years from the date of the issue of
the shares.

5) Consolidated accounts
Where companies are in the relationship of holding and
subsidiary, the Act generally puts aside the
independent legal entity concept by requiring a
consolidated profit and loss account of the holding
company and of its subsidiary companies. [s.169]
6) Wrongful trading
Pursuant to section 303(3), an officer of a company
may be guilty of an offence under the Act, if in the
course of the winding-up of the company or in any
proceedings against a company, it appears that the
officer who was knowingly a party to the contracting of
a debt had no reasonable or prabable ground of
expectation, after taking into consideration the other
liabilities, if any, of the company at the time, of the
company being able to pay the debt.
The knowledge of the officer must be tested at the time
when the debt was contracted.

Where an officer of a company has


been convicted of an offence under
section 303(3), the court may, if it
thinks proper so to do, on an
application made declare that the
officer be personally responsible
without any limitation of liability for
the repayment of the whole or any
part of that debt.
The application to the court may be
made by the liquidator or any
creditor contributory of the company.
An application under this section will

7) Fraudulent trading
The privilege of independent legal entity is
lost if it appear 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.
In such a situation, the High Court may if it
thinks proper to do so on an application made,
declare that any person who was knowingly a
party to the carrying on of the 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 High Court directs.

The application under this section may be


made by the liquidator or any creditor or
contributor of the company.
The expression intent to defraud and
fraudulent purpose were considered by K.L.
Rekhraj J.C in H Rosen Engineering BV v.
Siow Yoon Keong and the learned Judicial
Commissioner applied the reasonable
expectations of an honest businessman
test.
It was held in Eng Iron Works Ltd v. Ting Ling
Kiew & Anor that section 304(1) could apply
even prior to the winding up of a company.

Fraud for the purposes of this


section
is
actual
dishonesty
involving,
according
to
current
notions of fair trading among
commercial men, real moral blame.
It appears that the scope of personal
liability in section 304(1) is wider
than that in section 303(3) as the
former
subsection
extends
the
liability to any person whereas the
latter confines liability to an officer
of the company.

8) Payment of dividends out of capital

As part of the concept of capital


maintenance, it will be improper for a
company to pay dividends to its members
out of the share capital of the company.
Where any dividend of a company is paid
except out of profits or pursuant to
section 60, every director or manager of
the company who wilfully pays or permits
to be paid the dividend shall, in addiction
to the criminal penalty, be liable to the
creditors of the company.

The liability will be for the amount of


the debts due by the company to the
creditors to the extent by which the
dividends so paid have exceeded the
profits.
Such amount may be recovered by
the creditors or the liquidator suing
on behalf of the creditors.

Lifting of corporate veil Group Enterprise

theory of independent legal


entity in group enterprise
The deliberate formation of a
corporate
group
into
distinct
companies may be due to reasons of
commerce or legal sanctity.
The modern corporate structure in a
holding-subsidiary relationship can
be quite complex, and may comprise
of a network of holding, cross
holdings and circular-holding.

The
difficulty
in
providing
a
satisfactory description of this kind of
holding-subsidiary
corporate
structure can be gleaned from the
English
case
of
DHN
Food
Distributors v. London Borough of
Tower Hamles where Lord Denning
commenced his judgment by stating
that:- this case might be called the three
in one, three companies in one.
Alternatively, the one in three, one
group of three companies.

It is a cardinal principle of company


law that each company in a group is
a separate legal entity possessed of
separate legal rights and liabilities
independent of the others.
The fact that an individual holds
practically all the shares in a
company may give him the control of
the company, but the business
carried on by that company does not
thereby become his business, nor
does it make the company his agents
for the carrying on the business.

That proposition is just as true if the


shareholder is itself a body corporate.
The aggregate of all the fractions of
shares collected in one or more hands
does not constitute the shareholders
the owners of the companys property.
The starting point is that there is no
general principle that all companies in
a group are to be regarded as one.
The independent legal existence of
the constituent companies of the
group has to be respected.

Ebbw Vale Urban District Council


v. South Wales Traffic Area
Licensing Authority
The judge stated that:- Under the ordinary rules of law, a
parent company and subsidiary
company even a 100 per cent
subsidiary company, are distinct
legal entities, and in the absence of
an agency contract between the two
companies one cannot be said to be
the agent of the other.

Re Southard & Co Ltd


English company law possess some curious
features, which may generate curious
results. A parent company may spawn a
number of subsidiary companies, all
controlled directly or indirectly by the
shareholders of the parent company. If one
of the subsidiary companies, to change the
metaphor, turns out to be runt of the litter
and declines into insolvency to the dismay
of its creditors, the parent company and the
other subsidiary companies may prosper to
the shareholders without any liability for the
debts of the insolvent subsidiary

Applying the independent legal entity


theory to the concept of the group,
prima facie the acts a subsidiary are
not the acts of its holding company
and a holding company can neither
be responsible for the acts of the
subsidiary nor can it enforce the
rights which belong to the subsidiary,
and vice versa.
A holding company may not sue to
enforce the rights belonging to its
subsidiaries
and
the
holding
company is not liable for the debts of

In the absence of fraud or other exceptional


circumstances, where there are two
companies,
notwithstanding
that
the
controller is the same person, or where they
share a common managing director or
common directors, both the companies are
regarded in law as two independent legal
entities.
In the eyes of the law, the holding company
is nothing more than a majority member of
the subsidiary, so that the theory which
distinguishes the legal personality of a
company from its members also separates
the holding company from its subsidiary.