12 January, 2018
Most companies are forged with the intention of seeking out prosperous financial returns as it is the dream of every entrepreneur to hit the jackpot. Though some have been successful, it is unfortunately common to hear of companies being wound-up upon facing unsustainable mounting debts. One of the popular questions we get from directors usually revolves around the issue of their personal liability when it comes to their company’s debts: Will I be accountable for the debts owing by the Company?
The Separate Entity Principle
A basic tenet of company law propounded in the English case of Salomon v Salomon is that companies are deemed to be a separate legal entity distinct from that of its members and officers. It can sue and be sued by its own name. It follows that the company’s liabilities are then entirely of its own and not those of its members. If the company breached a contract or incurs debt and liabilities, the company must be sued and not its members or directors. There is therefore a “corporate veil” that separates a company from its members and officer.
Case laws provide a reasonable explanation as to why such principle is enforced; If every director is found to be liable for debts accrued by their company, no one would ever want to be a director of an incorporated company.
As a fundamental rule of company law, directors cannot be held liable for the decisions they made on behalf of the company provided that they had acted honestly, reasonably and in the best interest of the company.
Exceptions to the principle
Despite the safeguard afforded by the principle above, directors may still be personally liable for the debts of its company in cases of fraud, breach of warrant of authority and other exceptional circumstances. In those instances, the Court is permitted to lift the corporate veil that separates the identities of directors and the company to affect appropriate justice.
However, applicants must show strong circumstantial evidence of the said wrongdoings as the separation entity principle is not meant to be tampered wantonly.
In RDS Bina Sdn Bhd v Ong Chin Hoe & Anor [2013] MLHRU 3, the Plaintiff filed a claim against the directors of a company in order to enforce payment due under a settlement agreement entered with the company that subsequently ceased operations and dissolved. The Plaintiff presented evidence of fraudulent acts by the directors to deregister their company to evade paying the monies owed to the Plaintiff. The Court allowed the Plaintiff to lift the corporate veil and found the directors to be personally liable for the debts owing to the Plaintiff.
In the recent case of Keller (M) Sdn Bhd v Ong Leong Chiou & Ors [2017] MLRHU 1, the Plaintiff roped in several parties including a director of a company for the amount due to them as the appointed sub-contractor for work done in the construction of a shopping mall project. Upon close examination of the relationship between the parties, it was discovered that the 1st Defendant (Director) had orchestrated a complex plan to hide under the corporate veil in order to escape liability. The 1st Defendant used a company (2nd Defendant) under his control and command to shield another company (3rd Defendant) from liability for fraud engineered by him. Shortly after the project was completed, the 1st Defendant and other directors from the 2nd Defendant resigned and transferred their shares to other parties. In furtherance to the fraud, the 1st Defendant had also actively concealed vital information from the Plaintiff. These actions allowed the Court to pierce the corporate veil and have the Defendants jointly liable to pay the Plaintiff.
In conclusion, the law generally provides a safe haven for directors through the separation of entity principle to prevent any liability of the company being attached to the director. However, directors should not abuse their position by taking advantage of it. Authorities are clear that directors cannot hide under the shell of incorporation to escape liability when fraud has been perpetrated.
For further information, please contact:
Donovan Cheah, Partner, Donovan & Ho
donovan@dnh.com.my
