VEIL OF INCORPORATION
One of the consequences of incorporation is the separation of an
individual from the legal liabilities of a company. The veil of incorporation
ensures that a company is a separate legal entity from its directors, employees
and shareholders, thus protecting their personal assets from lawsuits. Such
protection also helps a company attract investment.
The law recognises that a company is a separate legal entity distinct
from its directors and shareholders. Therefore, the courts usually do not look
behind the veil of incorporation to inquire why the company was formed or who
really controls it.
However, there are a number of circumstances where the courts are
prepared to depart from this principle. This is referred to as ‘lifting the
veil of incorporation’. Such lifting of the veil of incorporation may occur
either by virtue of statutory provision.
The occurs will lift the veil of incorporation if the veil has been
misused to protect the owners or management of a company such that creditors
and third parties are disadvantaged. In such instances, the veil of incorporation
must be lifted to identify the person(s) responsible and make them liable.
Lifting the Veil of Incorporation Under Statute
Section 36, CA 1965: If the
number of members of a company fall below two and the company carries on
business for more than six months, that member is personally liable for the
company’s debts incurred after the six months.
Section 67(1) and 67(3), CA 1965: A
company is prohibited from giving financial assistance to anyone to buy shares
in the company itself. If it does so, the officers are liable.
Section 121(2)(c), CA 1965: An officer
of a company who signs or authorises to be signed on the company’s behalf any
bill of exchange, cheque or promissory note where the company’s name is not
properly or legibly written thereon, will be personally liable for the amount
if unpaid by the company.If there is improper use of a company’s name, the
officer who signs so, is personally liable unless the company is willing to be
bound: s 121(2), CA 1965. This would include cases where the officer did not
use words such as ‘Sdn Bhd’ or ‘Bhd’.
Section 169, CA 1965: Directors of
a holding company must prepare consolidated accounts for the group of
companies.
Section 304(1), CA 1965: Any person
who is involved in a company’s fraudulent trading is liable for the company’s
debts. Since the provision uses the term ‘any person’, it can include members,
officers as well a company since a company is a person in the eyes of the law.
Generally, it is not easy to prove fraud.
Section 304(2) and 303(3), CA 1950:
An officer who knowingly contracts a debt with no reasonable of expectation of
the company being able to pay the debt is guilty of an offence, and a
conviction may be the basis for a court to declare that the officer concerned
shall be personally liable to pay that debt. As the element of fraud is not
required, this is much easier to prove.
Section 365(2)(b), CA 1965: A director
or manager is liable if dividends are paid although there were no available
profits. Thus, dividends can only be declared if there are profits.
Section 140(1), Income Tax Act 1967:
The Director General of Inland Revenue can revoke and do whatever he thinks fit
to counteract transactions which have the effect of avoiding for evading tax: SBP
SDN BHD v DIRECTOR GENERAL OF INLAND REVENUE (1988) MSTC 243.
Lifting the Veil of Incorporation under Case Law
1. Avoidance Of Legal Duty And Fraud
The court has lifted the corporate veil if a company is used to avoid
legal duty.
GILFORD MOTOR CO LTD v HORNE (1933) Ch 935
Facts:
The defendant was an employee in the plaintiff company. Under his
employment contract, he was prohibited from soliciting the plaintiff Company’s
customers if he left his employment. Subsequently, he left the plaintiff
Company and formed a company. His wife and another person were the directors
and shareholders. He solicited the plaintiff company’s customers. The plaintiff
brought an action against the defendant. The defendant argued that the new
company, which solicited customers from the plaintiff company are separate.
Hence, he is not liable for the actions of the company. The company could
solicit the customers because the company is not a party to the contract of
employment and therefore not bound by the contract. The restriction is only on
him.
Held:
The court lifted the corporate veil and found that the defendant
controlled and managed the company. Hence, the formation of the company was a
sham. The defendant was trying to avoid his legal obligations. An order of
injunction was made against the defendant and the new company.
The veil can also been lifted if a company is used to avoid contractual
duty.
JONES v LIPMAN [1962] 1 WLR 832
Facts:
Lipman agreed to sell his land to Jones but later changed his mind and
endeavoured to put the land out of the reach of an order of specific
performance by conveying it to a company which he had formed for this express
purpose. He effectively owned and controlled this said company. In fact, Lipman
was also willing to pay damages to Jones but was not prepared to transfer the
land to Jones.
Held:
The court lifted the corporate veil and found that the company was a
mere sham. Lipman’s main purpose in creating the company and selling the land
to the company was to avoid his contractual duty to Jones. The court therefore treated
the company and Lipman as one and made an order of specific performance against
Lipman
2. Agency
A subsidiary company can be considered as an agent of its holding
company if the following requirements are satisfied as stated in SMITH STONE
& KNIGHT LTD v BIRMINGHAM CORPORATION [1939] All ER 116. This
is the most familiar ground argued in the courts:
the profits of the subsidiary must be treated as the
profits of the holding company
the persons conducting the business must be appointed
by the holding company
the holding company must be the head and brain of the
trading venture
the holding company must govern the venture and decide
what should be done and what capital should be embarked on it
the profits of the business must be made by the
holding company’s skill and direction, and
the holding company must be in effectual and constant
control.
In this case, the court lifted the corporate veil to enable a subsidiary
company operating business on land owned by the holding company to claim
compensation on the ground of agency.
In Firestone Tyre and Rubber Co Ltd v Lewellin (1957), agency was
the trigger for lifting the veil where a British company manufacturing types
for an American holding company was held to be its agent.
3. Group of Companies
It is quite common for businesses today to be carried out as groups of
companies. This is done mainly to share risks and take advantage of economies
of scale.
As a general rule, every company within a group of companies is separate
.
THE PEOPLE’S INSURANCE CO (M) SDN BHD v THE PEOPLE’S INSURANCE CO
LTD [1986] 1 MLJ 68
Facts:
The plaintiff, which was a company incorporated in Malaysia, was a
subsidiary of the defendant company incorporated in Singapore. Four senior
officers of the holding company were the directors of the subsidiary company.
The auditors of the subsidiary company stated that the company might not be
able to meet claims amounting to $2,001,725. At the Board of Directors’
meeting, the four directors said that the holding company would guarantee any
shortcomings faced by the subsidiary company. Subsequently the subsidiary
company claimed the amount from the holding company on the basis of the
guarantee given. However, the holding company denied liability on the grounds
that every company is a separate entity of its own.
Held:
The court found that the holding company is a separate entity from its
subsidiary company. The four officers who sat in the board meeting, sat as
directors and agents of the subsidiary company and not to the holding company.
A company cannot be made liable or responsible for the debts or actions of
another company within the group. Thus, the debts of the company belong to
itself.
However, sometimes the courts are prepared to treat groups of companies
as a single entity because there is essential unity of group enterprise –
HOTEL JAYA
PURI BHD v NATIONAL UNION OF HOTEL, BAR & RESTAURANT WORKERS
[1980] 1 MLJ 109.
The plaintiff
in this case was the holding company and a restaurant within its premises was a
subsidiary company. The workers in the restaurant were retrenched and the issue
before the court was whether the holding company was liable to pay. The court
held that the holding company had to pay the compensation. This was because the
hotel and the restaurant were inter-dependent – there was functional integrity
and unity of establishment between the hotel and the restaurant; and a number
of senior officers were common to both the hotel and the restaurant. Therefore
the hotel is the employer of the employees.
4. Where Justice Requires the Veil to be Lifted
In recent times, the Malaysian courts have shown a greater willingness
to lift the veil of incorporation where justice requires it.
ASPATRA SDN BHD & 21 ORS v BANK BUMIPUTRA MALAYSIA &
ANOR [1988] 1 MLJ 97, the court stated: ‘The generality of the judicial
power already vested in the superior Courts by the supreme law of the land is
unlimited, and for the purpose of achieving justice, the power of the Courts to
do what is just under any law requires no special legislation.’
5. When the Law Shows an Intention that the Veil be
Disregarded
In some cases, the courts have found that a particular legal rule should
be interpreted as requiring them to lift the veil of incorporation. For
instance, in times of war in order to determine whether a company is controlled
by enemy aliens. In Daimler Co Ltd v Continental Tyre and Rubber Co (Great
Britain) Ltd (1916) the court lifted the veil of incorporation to
look at the nationality of the persons in effective control of the company.
VEIL OF INCORPORATION
Reviewed by Kamaruddin Mahmood
on
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company incorporation in Singapore is one of the best decisions of life. Thanks for this info.
BalasPadam