While a company is a legal entity, it is in actuality merely an empty shell. As such, a company’s directors are essential to its operations and decision-making. That being said, the directors are also responsible to ensure that the business is financially stable and that the company is able to meet its obligations. Legal action against the directors may be necessary when a corporation accrues debts and doesn’t pay them back. Using Malaysian legal precedents as a guide, this article examines whether or not a civil lawsuit can be brought against a company’s directors for the company’s debts.
General Rule
In general, directors of a company are not personally liable for the debts of the company. This is because, under the law, a company is considered to be a separate legal entity from its directors and is therefore separate and distinct from its shareholders and directors. However, there are a number of exceptions to this rule.
Directors' Fiduciary Duty
Under Malaysian law, directors owe a fiduciary duty to the company. This has been codified in Section 213 of the Companies Act 2016, which reads as follows:
(1) A director of a company shall at all times exercise his powers in accordance with this act, for a proper purpose and in good faith in the best interest of the company.
(2) A director of a company shall exercise reasonable care, skill and diligence with:
(a) the knowledge, skill and experience which may reasonably be expected of a director having the same responsibilities; and
(b) any additional knowledge, skill and experience which the director in fact has.
(3) A director who contravenes this section commits an offence and shall, on conviction, be liable to imprisonment for a term not exceeding five years or to a fine not exceeding three million ringgit or to both.
One of the responsibilities associated with this duty is to ensure that the company does not take on debts that exceed its capacity to repay. This is of utmost importance since accumulating debts beyond the company’s ability to pay can jeopardize its financial stability and long-term success. Therefore, it is crucial to exercise prudent financial management and maintain a sound fiscal strategy when taking on any debt obligations.
Separate Legal Personality
That being said, the doctrine of separate legal personality applies in Malaysia. This is a legal concept, enshrined in Section 20 of the Companies Act 2016, that a company is a separate legal entity from its shareholders. Section 20 of the Companies Act 2016 reads as follows:
A company incorporated under this act is a body corporate and shall:
(a) have legal personality separate from that of its members; and
(b) continue in existence until it is removed from the register.
This would mean that the company is liable for its own debts and obligations, and its shareholders and directors are not personally liable for these debts or obligations. However, this does not mean that directors and shareholders can escape liability per se.
Fraudulent Trading
One of the grounds in which the corporate veil may be lifted and directors be held responsible for the debts or obligations of the company is where there is fraudulent trading. This is enshrined in Section 540 of the Companies Act 2016. Section 540(1) of the Companies Act 2016 reads as follows:
Responsibility for fraudulent trading
(1) If in the course of the winding up of a company or in any proceedings against a company it appears that any business of the company has been carried on with intent to defraud the creditors of the company or creditors of any other person or for any fraudulent purpose, the Court on the application of the liquidator or any creditor or contributory of the company, may, if the Court thinks proper so to do, declare that any person who was knowingly a party to the carrying on of the business in that manner shall be personally responsible, without any limitation of liability, for all or any of the debts or other liabilities of the company as the Court directs.
The case of Lai Fee & Anor v Wong Yu Vee & Ors [2023] 3 MLRA 495 involved a sale and purchase transaction of the business of the plaintiffs. Although the designated purchaser in the sale and purchase agreement was a company, the business was instead registered in the name of the shareholders cum directors of the company (the defendants).
When the company defaulted on payment, the plaintiffs commenced a suit against the company, and later commenced a suit against the defendants for the debt on the grounds of fraudulent trading.
The Federal Court held that, on the facts, the defendants had intended to defraud the plaintiffs. The scheme was orchestrated to insulate the defendants from any obligations and liability under the sale and purchase agreement knowing that the company that entered into the sale and purchase agreement was in fact dormant and had no way of paying the purchase price. The Federal Court, therefore, allowed the appeal, which effectively held the defendants personally liable for the debt.
Conclusion
In line with the statutory duty to act in good faith and in the best interest of the company with reasonable care, skill and diligence, directors must be aware of the financial health and affairs of the company before entering into contracts, lest they be found personally liable for the debt on grounds of fraudulent trading.
In the words of the Federal Court:
[68] For the foregoing reasons, we are of the view that in a situation where a vendor has agreed to the immediate transfer of an asset to a company relying on the representation of the company that the balance purchase price would be paid in the future, and the company subsequently fails to pay the balance purchase price when it falls due, then the directors of the company are ipso facto liable to the vendor under s 540 of the CA 2016. Accordingly, Question 1 is answered in the affirmative.
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