1 The Legal Nature of Companies

THE LEGAL NATURE OF THE COMPANIES

A. INTRODUCTION A corporation or body corporate is a legal person created and recognised by the law. Corporation is defined under sec 4 of the companies act as anybody corporate formed or incorporated or existing within Malaysia or outside Malaysia including any foreign company but not including: Anybody that is incorporated within Malaysia and is by notice of the Minister published in the Gazette declared to be a public authority or an instrumentality of agency of the government or of any state or to be a body corporate which is not incorporated for commercial purposes. Any corporation sole Any societies registered under any written law relating to cooperative societies Trade unions registered under any written law as a trade union.

THE CHARACTERISTIC OF A COMPANY Effects of Registration Upon incorporation, which is evidenced by the fact that there exist a certificate of incorporation, the company virtue of s 16 (5): Is capable forthwith of performing all the functions of an incorporated company. Is capable of suing and being sued on its own name Has perpetual succession and shall have a common seal Has power to acquire, hold and dispose of property

a) Body Corporate

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Section 16(5) provides that on and from the date of incorporation specified in the certificate of incorporation, the subscribers to the memorandum, together with such other persons as from time to time become members of the company. b) Suing and Being Sued Section 16(5), among other things, provides that the company once it is incorporated can sue and be sued in its own name. This effect is the direct consequences of the fact that upon incorporation the company is a legal entity separate from its members. Having a legal person in its own right, it follows that the company can enforce rights owed to it by suing other in its own name. c) Perpetual Succession The death or incapacity of its members cannot affect the company, as the company is an artificial person having a separate existence from its member. d) Common Seal A company is required to have a common seal: s 16(5). Section 121 (2) (a) furthers provides that if an officer of a company or any person on its behalf uses or authorizes the use of any seal purporting to be a seal of the company whereon the companys name does not appear, he or she shall be guilty of an offence under the act. At common law, the only way in which a company could evince its corporate will was by a document bearing an impression of the common seal of the company. There are therefore no special formalities that need to be observed for a company to be bound by a contract. The act may require the company seal to be affixed on company documents. e) Power to Own Property The members do not have a proprietary interest in shares that they own. By virtue of s 19(2) a company formed for the purposes of recreation, commerce, art, science or other like objects not involving the acquisition of gain is prohibited from holding land unless the appropriate Minister grants a licence.

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f) Liability of members Section 16(5), that members of a company have such liability to contribute towards the asset of the company in a winding up as is provide by the act. Section 214 sets out the extent of contribution that must be made by a member in the event his or her company is wound up.

TYPE OF COMPANY Incorporation under the companies act is not only way in which a company may be formed. 3 type of company are recognized by section 716. 1. Registered companies First company formed under the act in the manner describe above. This is a typical and indefinitely the most important kind of company at the present day and that with which this book is primarily concerned.

2. Statutory companies Bodies with special type of object formed under general public acts. Although some of these bodies, particularly building society formed under the industrial and provident society acts, closely resemble companys fall outside the scope. As a result of post war nationalization measure, most of the statutory company taken over by public boards and cooperation. Some statutory companies remain and others may be formed.

3. Chartered companies This related to the companies which granted a charter by the crown under the royal prerogative or special statutory power. But as it was regarded as dubious policy for the crown to refer a full charter or incorporation on an ordinary trading concern, it was empowerment b the trading companies act 1834 and the chartered companies act 1873. Today, this method of incorporation is used only by organizations formed for charitable.

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THE FUNCTIONS OF COMPANIES Inadequacy of legal definitions The companies and normal trading companies are adopting the same legal frame work which under company act 1965. If sole traders want to convert their business to the company, they need to bring more than one partner which free benefit and interest in the part of operation. If the business want apply to the large public companies, the company will running by other members. The Modern Corporation and private Property which drew attention to the revolutionary change thus brought about in our traditional conceptions of the nature of property. Today, large public companies in which many individual directly or indirectly contributed as a shareholder. The modern shareholder in a public company ceased to be a quasi-partner and has become instead simply a supplier of capital. The three functions of the modern company 1. Companies formed for purposes other than the profit of their member. 2. Companies formed to enable a single trader or a small body of partners to carry on a business. 3. Companies formed in order to enable the investing public to share in the profits of an enterprise without taking any part in its management. Guarantee companies The Company Act has 2 forms of company limited by guarantee. There is without a share capital and with a share capital. The members are under no liability so long as the company remains a going concern; they are liable, to the extent of their guarantees. Companies limited by shares The members; liability to contribute towards the companys debts is limited to the nominal value of the shares for which they have subscribed, and once the shares have been paid up they are under no future liability.

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Public and private companies Private company defined as one which limited the membership to 50, restricted the right to transfer share and prohibited any invitation to the public of its shares. Companies not coming within this definition were normally described as public companies

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A. SEPARATE LEGAL PERSONALITY The law treats a company as being a separate person from its members and those who manage its operations. This is the doctrine of separate legal personality. This means that the company can incur and receive obligations and hold property in its own name, for example: a company can lend or borrow money, enter into contracts with is participants and with outsiders such as supplier and customer, be the registered proprietor of land and own chattels (personal property), be a lessee or a lessor, operate a bank account and take out insurance and act as trustee of a trust in its own right. The rights it holds and the obligations it incurs are the companys own, not those of its managers the people who have invested in it, or its employees. The legal rules that separate the company from its participants are referred to by lawyers as the corporate veil. What are the consequences of treating the company as a separate legal entity? The effect of incorporation is set out in sec 16 (5) of the Companies Act. On and from the date of incorporation specified in the certificate of incorporation, the subscribers to the companys memorandum, together with any other people who from time become members of the company, are body corporate. Liability on the part of the members to contribute to the assets of the company in the event of its being wound up is as provided by the Companies Act. The consequences of treating the company as a separate person from its participants include the following: A companys obligations and liabilities are its own, and not those of its participants Where a company incurs a contractual obligation or a liability in tort, that obligation or liability is the companys and not an obligation or liability of its members or officers. Because companies are separate entities, creditors of a company are generally unable to look to the participants in the company to pay the companys debts.

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Debts of a partnership are the debts of the partner themselves. In contrast, debts of a company are not the debts of its shareholders. The reason is that in the former case, partnership does not have a legal existence which is searate from its partners. In the latter case, an incorporated companys legal entity stands between its creditor and its shareholders. In Fairview Schools Bhd v Indrani Rajaratnam & Ors Mahadev Shanker J said that Limited companies are formed so that its shareholders are not expose to unlimited liability for the companys debt. In exchange for this immunity, share capital is pumped into the company which thus becomes available to the companys creditors. A company can sue and be sued in its own name Since a company is a separate legal entity, it follows that it may enforce rights by suing. It can also incur liabilities and be sued by other parties. The liabilities are not liabilities of the members. In a company limited by shares, members liabilities are limited to the amount, if any, unpaid on the nominal value of the share. This means that it is not necessary for the members of the company or its officers to be named as parties to legal proceedings where the proceedings only involve the company. A companys perpetual succession This means that the company is a continuing entity in law with its own identity regardless of changes in its membership. The company continues in existence until it is deregistered under the statutory procedure set out in the Companies Act. A company may also be dissolved under sec 208 of the Companies Act which empowers the Registrar of Companies (ROC) to cancel the registration of and to dissolve a company where it has reasonable cause to believe that the company is not carrying on business or is not in operation. A companys property is not the property of its participants As a result of the separate entity rule, a company may own property distinct from the property of its members. They therefore have no ownership rights in respect of it. For example, in Macaura v Northern Assurance Co Ltd, Mr Macaura transferred his interest in a timber plantation to a company
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controlled by him. He had insured the timber in his own name but failed to transfer the insured policy to the company. When the timber was destroyed by fire, the insured company refused to pay out under his policy because he did not have an insurable interest in the timber, as he was not its owner. The company was the owner of the timber. Members only own shares in the company. A change in the ownership will not effect the ownership of the property. A company can contract with its controlling participants Because they are separate legal entities, a company and its participants can enter into contracts with each other. For example, we have seen from Salomons case that a company can lend money to or borrow money from its controlling shareholder. In Lee v Lees Air Farming Ltd, the controlling shareholder and managing director of a company that operated a business which involved aerial topdressing of farm land was killed in a flying accident. His widow successfully argued that she was entitled to a pay-out under workers compensation insurance for her husbands death because her husband was a worker , that is, that he had entered into a contract of service with the company. Unless the company and its controller were separate legal entities, the finding that a contract existed between them would not be open to the court, because a contract requires at least two separate parties.

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B. THE EXCEPTIONS PIERCING THE CORPORATE VEIL Despite the general rule established by Solomons case that a company and its participant must be treated as a separate legal entities, courts are sometimes asked to lift the corporate veil and ignore the separate personality of the company. The courts have been prepared to pierce the corporate veil and treat the company and one or more of its participants effectively as the same person. Incorporation does not fully cast a veil over the personality of a limited company through which the courts cannot see

1. The corporate veil and tort claimants A person who is injured by another may be entitle to recover damages or compensation for their injury, if the facts establish a valid legal claim under tort law. The shareholders or managers of a company will not be required to make up the difference between the companys assets and the amount of the debt, unless the court is prepared to depart from the general rule and pierce the corporate veil in one of the ways described below. The effect of the separate legal personality of companies on tort claimants is illustrated by the case of Briggs v Janmes Hardie & Co Pty Ltd. In the James Hardie case Mr Briggs was employed by a subsidiary of James Hardie & Co Pty Ltd that operated an asbestos mine. Mr Briggs contracted asbestosis and wanted to sue both the subsidiary and the parent company. To sue the parent company successfully, Mr Briggs would be required to pieree the coporate veil separating James Hardie from is subsidiary. The matter went before the NSW Court of Appeal on a preliminary point. To win on this preliminary point. Mr Briggs needed to persuade the court that is was at least possible that a court considering the merts of the claim would find that there was sufficient evidence to pierce the corporate veil and hold the parent company liable for the acts and omissions of the subsidiary.

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2. In what circumstances have courts pierced the corporate veil? In exceptional circumstances, courts may pierce the corporate veil and disregard the separate legal personality of the company. This may occur: At common law, where the corporate form is being used to avoid an existing legal duty; where the company is acting as the agent or partner of its controller; or where a particular law shows an intention that the corporate veil should be disregarded in applying it; or Under statute namely under sec 36, sec 67 (3), sec 121, sec 169, sec 303 (3), sec 304 and 304(2) of the Companies Act.

3. When have courts pierced the corporate veil at common law? Where corporate form is used to ovoid an existing legal duty If a company is formed for the sole purpose of or for the dominant purpose of doing something that one of the participants is prevented from doing in its personal capacity through an existing legal obligation, the courts may pierce the corporate veil to treat the obligation that binds the participant as one that also binds the company. Cases cited support of the proposition that the courts will pierce the corporate veil to treat obligations imposed on participants in a company as binding on the company in circumstances where the company has been used to avoid that duty include Jones v Lipman. However neither case is particularly strong authority and alternative grounds for the finding of the court in each case be put forward. In Jones v Lipman, Mr Lipman entered into a contract to sell land to the plaintiffs. Before the sale was completed, Mr Lipman transferred the land to a company controlled by him. The intention was to put the land beyond the reach of the purchasers- while they would be entitled to sue Mr Lipman for damages for frailer to transfer the land to them, they would not be able to compel him to do so because the land had been transferred to a third party- the company. In this case, the court pierced the corporate veil and treated the contractual obligation on
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Mr Lipman to transfer the land as also binding on the company. This was because the court took the view that the company had been used by Mr Lipman as a device to avoid his existing contractual obligation. Where the company is acting as the agent or partner of the controller Because they are separate legal persons, it is possible for a company to be the agent or partner of its controller. However, this depends on establishing particular facts. We saw in Salamons case that the Fact that a person controls is a company is not sufficient to make the company an agent of the person. In some very limited circumstances, English courts have been prepared to treat the company as the agent or partner of its controllers, where the company was clearly under-resourced to carry on the activities for which it was formed and did not operate independently in any way from its controllers. For example, in Smith, Stone & Knight Ltd v Birmingham Corporation, a company (the parent company) that controlled another company (its subsidiary) argued successfully that the subsidiary should be treated as carrying on its business as agent for the parent company, entitling the parent company to receive compensation for disruption to its business when the premises on which the business was conducted were compulsorily acquired by the local council. Where the law shows an intention that the corporate veil be disregarded In some cases, courts have found that a particular legal rule should be interpreted as requiring them to ignore the corporate veil. For example, during the First World War, legislation was passed in Britain preventing people from trading with the enemy. To give effect to that legislation, an English court was prepared to look through a company incorporated in Great Britain to discover the nationality of its controllers.

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4. How do the statutory provisions operate to loft the corporate veil? In some situations, the corporate veil is lifted and officers are made criminally liable for the companys breaches of the Companies Act. for example, the prohibition against a company providing financial assistance for the purchase of its own shares contained in sec 67(5) of the Companies Act provides that, if a company contravenes this provision then not withstanding sec 369 the company is not guilty of the ofence. Instead, each officer who is in default is guilty of an offence. An offence will result criminal liability and the penalty is imprisonment for five years or fine of RM100,000 or both. Sec 169 of the Companies Act requires the directors of a holding company to prepare consolidated accounts incorporating the financial position of the holding company and its subsidiaries. In this respect, the companies Act does not regard each company in the group as a separate legal identity but recognizes the reality that a group of related companies function as a single commercial entity. Sec 121 of the companies Act provides that an officer of the company who signs or is authorized to sign on the companys behalf any bill of exchange, cheque or promissory notes where the companys name is not properly or legibly written is guilty an offence and is liable to the holder of the instrument or order for the amount the (unless it is paid by the company) Insolvent trading and fraudulent trading Sec 304 of the Companies Act provides that and officer can be personally liable to creditors for debts incurred by the company. This can occur if the company is being wound up but it continues to trade and incur debts with intent to defraud creditors or for any fraudulent purpose. In this situation, the court may, on the application of the liquidator or any contributor of the company, declare that any person who was knowingly a party to carrying on the business is personally liable for all or any debt incurred. Carrying on business with fewer than the statutory minimum number of member Under sec 36 of the Companies Act, if the number of members falls below two(except in the case of a wholly owned subsidiary) and the company
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carries on business for more than six months, any member who is aware of this is personally liable for debts contracted after the period and is also guilty of an offence.

Piercing the corporate veil under other statues There are also other statues. For example the Income Tax Act 1967, that make allowance for piercing corporate veil and the companys members or officers to be made liable for its action. This allows the Director General of Inland Revenue to ignore transactions which have the effect of avoiding or evading tax.

Situations where the veil was not lifted 1. When there is no dispute as to the identity of the controller of the company 2. Where there is delay in bringing proceedings by those who seek to lift the corporate veil 3. When a company has been duly incorporated and the alleged wrongdoer is not even a shareholder or director of that duly incorporated company 4. Where the subsidiary whose veil that is sought to be lifted is not wholly owned by the holding company 5. Where the company is a victim of fraud or wrongful deprivation by the person who solely controls it

Situations where the veil has been lifted 1. Where an element of fraud exist or where there is abuse of the separate entity principle 2. When it is necessary to give effects to the true intentions of the parties an agreement 3. Where the group entity is essentially a single unit 4. Where the veil is merely a mask to defeat justice.

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C. CORPORATE CAPACITY 1. What do we mean by corporate capacity? Sec 16(5) of the Companies Act provides that a company is an artificial legal person, as opposed to an individual who is known as a natural person. However, it has the legal ability to do most things that a natural person can do, and some additional things. Accordingly, sec 16(5) also confers upon the company the capacity to sue and sued. Perpetual succession and the ability to acquire, hold and dispose of property. Further, while a companys constitution may include internal limitations on its permitted activities, these do not affect the validity of its acts as against outsiders. 2. The capacity of a company The extent of the companys corporate power- its legal capacity- to do a particular act or thing. There is also an extensive body of company law that is concerned with the authority of individuals (such as its officers and agents ) to exercise that that corporate power. 3. How wide are the powers of companies When a new company is created by registration, the Companies Act confers on that company powers to do acts that have a legal effect. A company has the capacity to do many acts which a natural person can do although this does not extend to things that, by reason of their artificial nature, companies are unable to do such as appearing in person without a legal representatives before a court. On the other hand, statutory companies are limited to doing acts related to the purpose for which they were established. For example, the Securities Commission (SC) is a body corporate incorporated under the Securities Commission Act 1993, its powers are limited to whatever is necessary for or in connection with, or reasonably incidental to, the performance of its functions. By virtue of sec 16 of the Companies Act, every company must have a memorandum containing the particulars required under sec 18 of the Companies Act in numbered paragraphs.

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They are: The name of the company The objects clause If the company is limited by share, a share capital clause A liability clause An association clause A subscriber clause

Sec 19 states that the powers of a company are as stated in sec 19(1) and the Third Sch the Companies Act, unless expressly excluded or modified by its memorandum or articles of association. Where the company acts beyond its powers or capacity, such acts are not rendered invalid. This lack of power or capacity can be relied on in any proceedings by a member against the company or its officers or in a winding up of the company by the Minister. 4. What is the effect of any internal limitation on powers? Sec 20 of the Companies Act states that the fact that the company did not have the capacity to enter into a particular transaction is irrelevant as against third parties. However the lack of capacity on the part of the company may be relied on by the persons concerned and in the circumstances prescribed in sec 20 (2) (a), (b) and (c) namely In proceedings against its company by members, holder of a debenture secured by floating charge (or his trustee) to restrain the doing of any act or any acts or the conveyance or transfer of any property to or by the company In proceedings by the company or member against the present or former officers of the company A petition by the Minister to wind up the company

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D. LIMITED LIABILITY 1. What is limited liability Limited liability means that a member of a company limited by shares is usually not required to contribute amounts from their personal wealth, beyond the subscription price of their shares, to meet the debts of the company. The liability of members to contribute In company limited by shares, the initial members of the company subscribe for shares that represent a claim against the company to which certain rights (such as control rights and distribution rights) attach. Subscription for shares involves the person who wishes to become a member of the company paying an amount of money (referred to as the issue price or subscription amount) to the company in return for the share. The issue price is determined by the directors at the time they decide to issue the new share. A shares issued on this basis is called a party paid share. What is the underlying principle? The underlying principle of limited liability is that a member who holds a share in the company is not required to contribute to the company to meet the debts of the company, beyond the amount initially subscribed, or agreed to be subscribed, for the share. Where a member holds a fully paid share, that member is not required merely because of that membership to contribute any further amount to the company to cover the companys debts in the event that the companys own assets are insufficient to do so. Where member holds a party paid share, that member is required to pay the balance of the issue price to the company when the company makes a call on the member to do so. 2. What is the rationale for limited liability? Important remember that limited liability is a privilege conferred by law on remembers of a company limited by shares. Limited liability is said to:

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Encourage risk taking and entrepreneurial behaviour, by enabling investors to quarantine their wealth from particular risky undertakings Decrease the need for shareholders to monitor the managers of companies in which they invest because the financial consequences of company failure are limited. Shareholders may have neither the incentive (particularly if they have only a small shareholding) nor the expertise to monitor the actions of manager.

Provide incentives for managers to act efficiently and in the interests of shareholders by promoting the free transfer of shares. This argument has two parts to it. First , the free transfer of shares is promoted by limited liability because under this principle the wealth of other shareholders is irrelevant.

Assist the efficient operation of the securities markets because, as was observed in the preceding point, the prices at which shares trade do not depend upon an evaluation of the wealth of individual shared holders.

If a principle of unlimited liability applied and a shareholder could lose his or her entire wealth by reason of the failure of one company, shareholders would have an incentive to minimize the number of shares held in different companies and insist on a higher return from their investment because of the higher risk they face.

However, if a principle of unlimited liability applies, managers may reject some investments with positive present values on the basis that the risk to shareholders is thereby reduced

3. Contractual agreements that circumvent limited liability A member of limited company may agree separately with a creditor to assume responsibility for a companys debt in certain circumstances. This would be a matter of contract between the particular member and the creditor. What is the effect of such an agreement?

The effect of such an agreement, in practice, is to negate the benefits of limited liability for the members of the company in respect of the debt the subject but of the agreement.
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These arrangements only operate under contract. Unless a particular creditor has specially contracted with a member of a company to obtain a guarantee, the member will be able to rely on the principle of limited liability. In what circumstances can a parent company lose the benefit of limited liability? However, holding companies can be liable for the liabilities of its subsidiary if it falls under the exception of the corporate rule namely the corporate group exception. In Malaysia this was decided in the case of Hotel Jaya Puri Bhd v National Union Bar and Restaurant Workers (1980) 1 MLJ 109. There is no specific statutory provision in the Companies Act provides that the characteristic and structure of holding and subsidiary which indicates that they are different entities without discussing its liability and sec 17 of the Act stresses on the membership of holding company. However there is sec 168 and sec 169 of the Companies Act which provide for group accounts for holding and subsidiaries which, in effect, will give rise to liabilities for holding companies for the account of their subsidiaries.

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REFERENCES

Aiman Nariman Mohd. Sulaiman, Aishah Bahar. 2005. Commercial Applications Company Law In Malaysia. CCH Asia Pte Limited Rachagan, Shanty. 2002. Principles of Company Law in Malaysia. Malayan Law Journal: Kuala Lumpur L. C. B. Gower. 1981. Principles of Modern Company Law. Stevens & Sons : Londonx

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