Effect of Incorporation

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Effect of Incorporation by Mind Map: Effect of Incorporation

1. Lifting the corporate veil

1.1. Incorporation of a company casts a veil over the true controllers of the company, a veil through which the law will not usually penetrate.

1.2. However, in certain situation, a court may ignore the separate legal personality of a company and look at the members or controllers of the company and make them liable for the debts of the company.

1.3. This is known as the lifting up of the corporate veil or in other words disregarding the separate legal personality of the company.

1.4. Statutory exceptions under the CA

1.4.1. Income Tax Act 1967 The corporate veil is consistently lifted in the area of taxation. In Section 140 (1) of Income Tax Act, the Director General of Inland Revenue Malaysia may choose to ignore transactions which alter the incidences of tax or evade or avoid any liability to tax. These transactions conceal the true nature of the company’s affairs and the DG may disregard them in his assessment of taxes payable. These transactions conceal the true nature of the company’s affairs and the DG may disregard them in his assessment of taxes payable.

1.4.2. Companies Act 1965 Section 67(3) makes its officers in default and not the company, guilty of a criminal offence if a company breaches the prohibition against providing financial assistance for the purchase of its own shares. Section 304(2) which should be read in conjunction with Section 303(3) an officer who knowingly contracts a debt with no reasonable or probable ground of expectation of the company being able to pay 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. Section 169 the directors of a holding company is required to prepare consolidated accounts consolidating the financial position of the holding company and its subsidiaries. In this respect the Act does not treat each company in the group as a separate legal entity but recognizes the reality that a group of related companies functions as a single entity. Section 36 if the number of members of a company is reduced below two and it carries on business for more than 6 months while the number is so reduced, a person who is a member of the company during the time that it so carries on business after those six months and is aware of it, is personally liable for all the debts of the company contracted after those 6 months and may be sued therefor and shall also be guilty of an offence against the Act. Section 304(1) Persons who were knowingly party to fraudulent trading may be personally liable to make such contribution the assets of the company as the court may think proper. Section 121, 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.

1.5. Judicial exceptions

1.5.1. In Malaysia, the court will lift the corporate veil when the justice of the case so requires.

1.5.2. Malaysian courts have in the past lifted the corporate veil in several circumstances such as fraud, agency and where corporations within the group are essentially one.

1.5.3. Fraud Use of a company to evade legal obligation or to commit fraud. The separate personality doctrine can not be used for evading legal obligation. If a person tries it, the court can lift the veil i.e. disregard the separate legal personality doctrine. Case: Gilford Motors Co Ltd v Horne Horne was formerly a MD of the plaintiff’s company. He had agreed not to solicit the company’s customer after the termination of his employment. However, when he left the company, he set up JM Home Co & Ltd through which he solicited the plaintiff’s customers. The court held that he had breached his agreement and was using his company to evade his legal obligation. Case: Jones v Lipman Lipman agreed to sell a house to Jones. For some reasons, he changed his mind. To avoid the transfer of the house to Jones, Lipman set up a company and transferred the house to it. He offered to pay damages for the breach of contract. Jones sought an order of specific performance. Lipman raised defence that the company was not the party against whom specific performance could be ordered. Held: The company was a creature of Lipman in order to avoid his obligation under the contract with Jones. Both Lipman and the company were ordered to specially perform the contract to sell the house. Case: Tiu Shi Kian v Red Rose Restaurant Sdn Bhd Tiu Shi Kian ran a night club in the Red Rose Restaurant (RRR), which was wholly owned and controlled by Hotel Berjaya Sdn Bhd, where the club was situated. A dispute arose between the plaintiff and RRR regarding the renewal of plaintiff’s license to operate the nightclub. The plaintiff obtained injunction order restraining RRR from interfering with their business until the case is finally disposed off. One night, plaintiff found that the restaurant premises were locked in breach of the injunction order. The plaintiff sued for contempt of court’s order. It was pleaded that RRR did not lock up the restaurant but it was Hotel Berjaya. Held: It was a devise to avoid the court’s order. Hotel Berjaya and RRR were functionally one entity and there had been contempt of court.

1.5.4. Agency Company employed as an agent of its controllers. A company, like any other legal person, may act as an agent for its member or controllers. If a person incorporates a company, specifically to take over a person’s obligations, it is likely that the company will be held to be that person’s agent. Case Aspatra Sdn Bhd v Bank Bumiputra Malaysia Berhad BBMB and its subsidiary BMF, sued Lorrain for an account of secret profit that he allegedly made while he was a director of BBMB and chairman of BMF. When writ was filed, BBMB & BMF also got injunction order to restrain Lorrain from transferring his assets out jurisdiction. The order was extended to Aspatra Sdn Bhd. Aspatra challenged the injunction order on the ground that the court should not have treated their assets as Lorrain’s assets for the purpose of granting the injunction order. It was found that Lorrain exercised effective and sole control over the appellant company through his shareholdings and directorships. Held: Court could lift the veil to determine whether assets of the company were really owned by them or whether there was an abuse of the principle that a company is a separate legal entity.

1.5.5. Sham/ mere facade Incorporation is often used as a device to circumvent the law or to hide the true state of affairs from the court. Some people might use the corporate form as a means to exploit loopholes in the law. In such situation, the court will not be blinded to reality, notwithstanding the technical separateness of the company and its members. Shaw and Jackson held 4,500 shares each and Trelby held the balance 1000 shares out of total of 10,000 shares. Shaw and Jackson wanted to buy over Trelby’s shares. To effect this, they incorporated a company called Jackson and Shaw (Holdings) Ltd., which made an offer to purchase all the Bugle shares. Shaw and Jackson accepted this offer. Trebly declined. Jackson and Shaw Holdings then purported to use Section 209 (equivalent Malaysia section 180) of the UK Companies Act 1948 to acquire Trelby’s shares. The Court of Appeal declined to allow Jackson and Shaw Holding to take advantage of this section to buy Trelby’s shares.

1.5.6. Group of companies In certain situation, a group of companies may be treated as a single corporate entity, although the general rule is that each company within a group is distinct entity. This is due to commercial realities. Case: Hotel Jaya Puri Sdn Bhd v National Union Bar & Restaurant Workers Jaya Puri Chinese Garden Restaurant Sdn Bhd was closed down and workers were retrenched. This company was wholly owned subsidiary of Hotel Jaya Puri Bhd, whose premises the restaurant was situated. The Union claimed that the actual employer was the hotel and the hotel was still in business. Therefore the workers could not have been said to have being retrenched on the closure of a business. The Industrial Court allowed this and made order of compensation against the hotel. The hotel appealed to the High Court. Held: Although technically the restaurant and the hotel were separate legal entities, in reality, the two companies were functionally one. Technically, a person working for the restaurant was an employee of the restaurant, the reality was that the workers were employees of the hotel. The court ignored the separate identities of the restaurant and the Hotel and treated them as one single entity.

2. Introduction

2.1. The effects of incorporation are stated on S. 21 CA 2016,the company has full capacity to carry on the following: i) to sue or be sued. ii) to acquire, own, develop or dispose of any property. iii) to do any act which it may do or to enter into transactions.

3. Separate legal entity

3.1. # A corporation is a legal person created and recognized by law. It is an artificial legal person. Upon incorporation, a company has a legal personality of its own apart from the persons who form it. The law will treat the company and the members as separate legal persons. (Section 20) A company shall have a legal personality separate from its members; and continue in existence until it is removed from the register.

3.2. Case Salomon v Salomon & Co. Ltd

3.2.1. Facts: Salomon owned a business. He then formed a company in the name of Salomon & Co Ltd. Salomon sold his shoes business to the company and in consideration, the company issued debentures to him. The company then become insolvent and the liquidator claimed the debentures owned by Salomon.

3.2.2. Held: Once the company is legally incorporated, it must be treated like any independent person wit its right and abilities appropriate to itself, and that the motives of those rights and abilities are.

3.2.3. Effects of Salomon's case: The company will be liable for its own debts and liabilities A company can sign a contract with its own shareholders or officers.

3.2.4. Application from Salomon’s case: #Lee v Lee’s Air Farming Ltd :where company and members/shareholders are 2 separate entities. #Foss v Harbottle : Ability to sue and being sued under its own name. #Macaura v Northern Assurance Co Ltd : Ability to own peroperty #Re Noel Tedman: Perpetual succession CASE: LEE V LEE’S AIR FARMING LTD: Lee forms a company, Lee’s Air Farming Ltd. in which he owned all the shares but one. He was the company’s sole director and was also employed by the company as its chief and only pilot. Lee was killed while flying for his company. His wife made a claim for workmen’s compensation under the New Zealand workmen’s compensation legislation. Payment of such compensation depended on the fact whether Lee was a worker or not. The New Zealand court refused to hold that Lee was a worker because a man could not in effect employ himself. However, the Privy Council held Mrs. Lee was entitled for compensation because even though Lee maybe controller of the Company, it is separate legal entity.

3.3. Ability to sue and be sued

3.3.1. A company may sue and be sued in its own name. In fact, it must sue on its own behalf according to what rights it has and duties owed to it.

3.3.2. Case: Foss v Harbottle Two shareholders in a company brought an action against the company’s directors. They alleged that the property of the company had been misused. Held: The injury complained was an injury to the company. In law, the company and its members were not same. Therefore, the members cannot maintain such suit. It was for the company to sue and not the members. Specifically authorized to do so. In other words, the company is the proper plaintiff to initiate actions in respect of wrongs done to it. Thus, the proper organ to commence the action on behalf of the company is the board of directors. A single director or officer of the company cannot sue on the company’s behalf unless

3.4. Ability to own Property

3.4.1. A company can own property in its name. Although the members have shares in the company, the property is held or owned by the company.

3.4.2. Case: Macaura v Northern Assurance Co Ltd. Macaura owned an estate. He sold all the timber on the estate to a company. He and his nominees owned all the shares of the company.Macaura insured the timber that he sold to the company in his own name. The insurance policy was not transferred into the company’s name. The timber was destroyed in a fire. Macaura claimed the insurance but the insurance company refused to pay. Held: When Macaura sold the timber to the company, he gave up his interest in it and the company had become the owner of it. He had no interest in the timber that he could insure. Therefore the insurance company was not obliged to pay.

3.5. Perpetual Succesion

3.5.1. The company is immortal. It will continue to live until it is properly wound up or struck off the register. Section 20 CA 2016

3.5.2. Even if all the member dies, the business still exists.

3.5.3. Case: Re Noel Tedman Pty Ltd The company had 2 directors who were also the only shareholders, a husband and wife. Both died in a traffic accident . One infant child survived. The article of association required the approval of directors before shares could be transferred under the will of deceased member. There were no directors. Normally, this problem would be rectified by the appointment of new directors. However, to appoint directors the member had to vote. There were no members. In the end, the court allowed the personal representatives of the deceased to appoint the directors, so that these new directors could assent to the transfer of the shares to the beneficiary