The Veil of Incorporation

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Veil of Incorporation The veil of incorporation means there is a separate personality between the members and the company. Thus, protecting them from being personal liable for the company’s debt and other obligations. (Reference) The members of the company are the shareholders, employee and director. Veil of incorporation will protect the members of the company by establishing a limited liability. This will protect their personal assets and wealth, and expanding the company’s venture. Undeniably, this will create a win-win situation for both the company’s members and the company. If any legal actions are taken against the company, such as being sued, the company’s member will only lose the initial amount invested. For example, if a person has incorporated a company, and the company has incurred a debt of RM 1,000,000 and unable to pay it. And when the debtors decided to take legal action and sue the company, then the veil of incorporation will be applied and protecting his personal assets from being seized. Thus, he would not need to pay the RM 1,000,000 debt because the company and he are a separate entity. History of Veil of Incorporation The veil of incorporation concept was adopted back in 1897. In the case law, Salomon v. Salomon 1897, (EXPLAIN) Lifting the Veil of Incorporation Most of the time, the courts do not go against the veil of corporation. They will just treat the members and the company as a separate legal entity. But in some circumstances or situations, the court would have to take the action by lifting the veil of incorporation if it has been misused or the justice are being threatened. For example, a member of the company uses the company’s name to commit fraud or to cover their wrongdoings, then that is considered as misuse of the veil of incorporation. In the end, the veil of incorporation will be lifted, and the court will take necessary action against the member of the company. According to the Companies Act 1965, there are few conditions where the veil of incorporations will be lifted to reveal the wrongdoers or for justice purpose. There 9 sections in the act that state when will the veil of incorporation will be lifted. First of all, Section 36 of the Companies Act 1965 states that it is prohibited to carry a business with less than the statutory minimum of two members for more than six months. The member of the company that is handling the business with fewer than two members after that particular period of six months shall be liable for the payment of any debt incurred. If this situation is not handled and it exceeds the six months period less than two members, then the court will ignore the veil of incorporation. The company and the responsible member shall be guilty against this act. The default penalty would be a fine of RM 2,000. Furthermore, Section 46 of the Companies Act 1965 states civil liability of members of the company for the misstatements in the company’s prospectus. Company stakeholders will depend a lot on the prospectus of the company to make financial decision such as buying or selling of the company shares. If the company prospectus contain material misstatements, then it will result in providing false and inaccurate information to the stakeholders. Thus, greatly affecting the stakeholders’ decision making. The court will then take legal action against the person responsible by lifting the veil of incorporation. Section 46(1) mentions that the director of the company, person who is named in the prospectus as director or as having agreed to become a director, promoter of the company, and person who authorized and caused the issues in the prospectus shall be liable to pay compensation to stakeholders that purchase any shares and debentures on the faith of the company prospectus and suffered loss and damages due to the misstatement. Section 46(2) states Section 46(3) states that there are four ways that the member of the company shall not be liable on the debts that incurred. First of all, if he is able to prove that he as the director withdraw his consent before the issue of the prospectus. The second way is that the prospectus was issued without his permission, and he managed to give public notice after realizing it. The third way is that the he realized the misstatements in the prospectus after issuance of it, and withdrew his approval of the prospectus by giving out a public notice. Lastly, it is when at the time of the misstatements were made, he believed the statements were true. xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx Moreover, Section 119 of the Companies Act 1965 states a company must register their office once it commends its business. Once it starts its business, the communication or notice should be able to access to the public for not less than 3 hours on every business hours during ordinary business hours, except for weekly and public holidays. If this not done accordingly, then the company and the member responsible will be fined a penalty of RM 1,000. Then, Section 121(1) of the Companies Act 1965 states that the name of the company should be shown in the correct forms. This means the name should be in legible Romanized letter and the company number shall be presented in its seal, and all business letter, invoices, cheques and other source documents which are issued and approved by or on behalf of the company. Company number is the number given out by CCM once the company is incorporated. Section 121(2) also mentions there are three ways where any company member shall be charged guilty of an offence against this act. First of all it is when he uses or approves the use of any seal purporting to be a seal of the company, where its name does not so appear. The second way is when he approves the issue of any business letters, statement of accounts, invoice, official notice or publication of the company, where the name is not mentioned. The third way is when he approves the issue of any financial documents and instruments such as bill of exchange, promissory notes, and cheque and receipts, wherein the company name is not mentioned as well. The person responsible shall be liable for the payment to the holders of instrument for any losses and damages it caused, unless it is paid by the company. If the name of the company is not displayed on all offices in the correct form, then the company and its member would be subject to a penalty of RM 1,000. Section 303 of the Companies Act 1965 also mentions the liability where the proper account not kept. Section 303(1) says that upon investigation where the company is wound up, if no proper accounts are kept accordingly to the act, the company member responsible shall be charged guilty as an offence against the act. Unless, he can justify that he acted honestly and prove that it was excusable. The penalty of the offence shall be imprisonment of three years or a fine of RM 10,000. Section 303(3) states that if the company member contracted a debt and did not have the expectation to repay the liabilities incurred at the time the debt contracted, then he shall be charged guilty. The court will ignore the veil of incorporation and penalize the wrongdoers. The penalty shall be imprisonment for one year or a fine of RM 5,000. Section 304(2) states that the persons which has been convicted to the offence under Section 303(3), shall be personal liable for the payment of the debt incurred without any limitation of liability. Section 304(1) mentions that if the business is carried out with the intention to cheat and defraud its creditors, then the court will ignore the veil incorporation and will penalize the wrongdoers. The person responsible shall be liable for the payment for the debt incurred without any limitation of liability. If a company is unable to pay its debt yet the director on behalf of the company still incur more debts, then the veil of the incorporation will be lifted and the director will be liable for the debts. Furthermore, Section 304(2) of the Companies Act 1965 states that the veil of incorporation will be lifted when the member of the company is involved in fraudulent trading. Which means the establishment of the company is used for fraudulent purposes. When there is intention to cheat the creditors or the director of the company convicted an offence mostly like under subsection 303(3), then the company will be sued and the veil of the incorporation will lifted. Section 365(2) of the Companies Act 1965 states that any dividend payments made that are not from the profit is prohibited. The director of the company is not allowed to pay dividends out from the source which is not made from the profit earned in the day to day operation. Then, the company also should not incur any dividend payable. If the company does not incur any profit for that particular year of assessment, then only the company is allowed to make dividend payable. Section 169(1) requires every director of the company to present its profit and loss account at its Annual General Meeting (AGM) at some date not later than eighteen months after the incorporation of the company, and once at least in every year at intervals of not more than fifteen months. The profit and loss account shall be made up a date not more than six months before the date of the meeting. Section 169(5) of the Companies Act 1965 states that the director of the company must prepare a consolidated account for the state of affairs of the holding company and all its subsidiaries. And it must be signed by not less than two of the directors. The director must prepare a consolidated account such as a complete and reliable financial statements. The reason behind this is to let the shareholders gain confidence for investing in the company. xxxxxxxxxxxxxxxxx Section 67(1) of the Companies Act 1965 mentions that a company shall not provide financial assistance to the member of the company in connection with the purchase or subscription made for the company shares. There are three exceptions under Section 67(2). First of all, it is when the lending of money is made during the ordinary business activity. The second way is when the purchase and subscription of shares is for the benefit of employees or a subsidiary company. The third way is when the financial assistance is given out to members other than the directors, bona fide for the employment. Section 76(3) states if there is a breach of the section, the company is not charged guilty, but the members involved shall be guily. There are six ways where the court would be able to ignore the veil of incorporation. They are fraud, agency, sham/façade, unfairness and group of companies. (source) Fraud Gilford Motor Co v Horne 1933 This is a case law regarding the lifting of veil of incorporation. This case law was originated from United Kingdom, where the court will ignore the veil incorporation and treat the company and its members as one when it is used for fraudulent pupose. In this case, Mr. EH Horne, the former managing director of the company, signed his employment contract that he would never acquire the company’s customer if he were to leave the company one day. He was fired later on, and incorporated his own business and compete with Gilford Motor Co. Then, he obtained legal advice that this would result in a breach of the contract, and he might get sued by Gilford Motor Co. He then started a new company of his, with the name JM Horne & Co Ltd. The newly formed company was incorporated by his wife and a friend of his, Mr. Howard. Both of them were the directors and sole shareholders. It is clear that only Mr. EH Horne has binding contract with his former employer, Gilford Motor Co, not his newly formed company, JM Horne & Co Ltd. Thus, JM Horne & Co Ltd was able to compete with Gilford Motor Co. But, the court decided that Mr. EH Horne used the new company as an instrument of fraud to evade his legal obligations with his previous company. Jones v Lipman 1962 This is case law was originated from United Kingdom as well. This case demonstrates on the lifting of veil of incorporation when the company is misused in a wrongful way to disguise the true facts. Back in 1962, Mr. Lipman has made an agreement to sell his house at 3 Fairlawn Avenue to Mr. Jones for£5,250. He then changed his mind at the last moment and no longer wanted to sell that particular house. In order to avoid from being sued for breaching of contract, he then formed a new company and sold the land to the company, which he and another were the shareholders and directors. After that, he claimed that he was no longer the owner of the land and could not fulfil the obligation according to the contract. Mr. Jones sued Mr. Lipman for a breach of contract. In this case, Mr. Lipman used his new company to escape from legal obligations. Therefore, the court when the interest of justice will lift the veil of incorporation and make Lipman to be liable for the defraud act done by him (Clement Chigbo, 2007). Agency Smith, Stone & Knight Ltd v Birmingham Corp. 1939 Smith, Stone & Knight (SSK) is the owner is a company that owned some land, and one of their subsidiary company was responsible on operating one piece of their land. After a while, Birmingham Corp decided to purchase this piece of land. And any company who owned the land would be paid for it, and would reasonably compensate any owner for the business they ran on the land. After that, Birmingham Corp claimed for the compensation on the ownership of the land. Then, Considering the subsidiary company was not the owner of that particular land Ampol Petroleum Pty Ltd v Findlay Sham/Facade Re FG(Films) Ltd. Unfairness Aspatra Sdn Bhd & Ors v Bank Bumiputra Malaysia Bhd. The case law states that in order to do justice when the case was involved by an elemant of fraud, the court can generally lift the veil of incorporation. Hotel Jaya Puri Bhd. V National Union of Hotel, Bar & Restaurant Workers & Anor (1980) The court is willing to life the veil of incorporation if justice of the case so demands. The veil can be lifted by statute (section) and case law (court). The court will ignore the separate legal personality and lift the veil to determine who would be liable for an offence. Group of Companies DHN Food Distributors Ltd v Tower Hamlets London Borough Council
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