Tuesday, July 13, 2010

Separate Legal Entity (Law 346)

LEGAL PERSONALITY

NATURE AND FORMATION OF COMPANIES

The law relating to companies in Malaysian is contained in the Companies Act, 1965. This Act is based on the English Companies Act 1948 and the Australian Uniform companies Act 1961. It is due in these historical ties, that the English and Australian Law has some significance on Malaysian Company Law. This is why you will see English and Australian judicial precedents being referred to, and applied in interpreting certain provisions of the Malaysian Companies Act.

It must be stressed here that since this Act is a piece of legislation that has its provisions constantly amended to keep up with the times, there may be slight changes to company law from time to time. It would be very helpful for you to ensure that the Act you refer to is the latest amended version.

NATURE OF COMPANIES

A company is a corporate body of a corporation. A corporation is an artificial legal person. The law sees it as separate and independent of the persons who are members of that corporate body. The legal recognition given to the company is provided by S.16(5) of the Companies Act, 1965. it says:
“On and from the date of corporation specified in the of incorporation…the subscribers to the memorandum together with such other person as from time to time become members of the company shall be a body corporate by the name set out in the memorandum…”

in other words, after fulfilling all the requirement of the Act incorporate the company, and the Companies Commission of Malaysia (CCM) issues a certificate of incorporation, a new legal entity comes into existence. The company, an artificial person, is ‘born’ out of the process of law. This new entity is separate from its members. Like a natural person it has its own name and can own property.

This means that the company can use own name to enter into transactions and need not go through its members, and that the company’s assets do not belong to the members. The reason for creating the legal fiction of the separate legal personality has been said to be a matter of convenience. The separate legal personality concept is useful in large companies where there are many shareholders, and these shareholders are frequently changing. If the company does not have a separate legal personality, it would mean that a change among the shareholders would require a transfer of the company’s assets.

Liabilities and contract form the former group of shareholders to the present group. It would entail a lot of difficulties to deal with multiple transfers. On top of that it would be difficult to keep up with the frequent transaction of shares on the market.

PRE-INCORPERATION DOCUMENTS

After the name of the company has been approved, the persons responsible must submit to the CCM the pre-incorporation documents together with the required fees, and a copy of the approval letter for the use of the name. The pre-incorporation documents are:

(i.) The memorandum and articles of association
(ii.) A statutory declaration by persons before appointment as director, or by a promoter
(iii.) A declaration by the person who has agreed to be the company secretary

The application for the registration of the company must be made within the three months of the application for the reservation of the name of the company.

CERTIFICATE of INCORPORATION

Once the CCM is satisfied that all the incorporation documents are in order, the CCM will issue the Certificate of Incorporation to the company. This certificate is the ‘birth certificate’ of a company. Once a company has been registered, it is recognized as a separate legal entity.



TYPES OF COMPANIES

Companies in Malaysia are classified according to (i) liability, (ii) private or public status.
Companies classified according to liability.
Types of companies.
company limited by shares
company limited by guarantee
company limited by share and guarantee
unlimited company

COMPANIES LIMITED BY SHARES

S.4 defines ‘company limited by shares’ as a company formed on the principle of having the liability of its members limited by the memorandum to the amount (if any) unpaid on the shares respectively held by them. This is the most common form of company. The liability of a member of this company will depend on whether his shares are fully paid or not. If he holds fully paid shares, he has no further liability to the company. If the company becomes insolvent he cannot be made to contribute to the assets of the company. Only if his shares are partly paid, he will be liable to contribute to the company’s assets, up to the amount still unpaid on his shares.



COMPANY LIMITED BY GUARANTEE

A company limited by guarantee id defined by section 4 as ‘a company in the principle of having the liability of its members limited by the memorandum to such amount as the members may respectively undertake to contribute to the assets of the company in the event of its being wound up’.

This type of company does not have a share capital and so does not require the members is specified in the memorandum of association. If the company is wound up, then a person who has been its member may be required to contribute up to his amount of guarantee towards payment of debts incurred by the company while he was a member. This liability extends to those who has left the company but was a member within a year before the company wound up.

Although this type of company does not have a share capital, it is a separate legal entity. It is not normally used for trading, but is often formed to run clubs and other organizations that is maintained by subscription, social activities and donations.

CLASSIFICATION AS PRIVATE OR PUBLIC COMPANIES
Classification according to status
Private Company
According to S.15(1)
Ø restrict right to transfer shares
Ø limit number of members to no more than 50
Ø prohibit invitation or offer of shares or debentures to public
Ø prohibit invitation or offer public to deposit money with company

According to S.15(1), a company is classified as a private company if its memorandum or articles:
Ø restrict the right to transfer shares. There is no prescribed form of restriction. The articles can have restrictions such as giving of pre-emption to other members before shares can be transferred to other persons, or there is to be no transfer of shares unless the directors approve. These restrictions will discourage membership as then the share would be difficult to sell.

Ø Limit the number of members to not more than 50. If shares are jointly held they are considered as held by one person. Employees of the company or its subsidiaries who are not members are not counted.


Ø Prohibit any invitation or offer to the public to subscribe for shares in or debentures of the company.

Ø Prohibit any invitation to the public to deposit money with the company.

A private company may have a share capital with limited or unlimited liability. As private companies do not seek funds from public, they enjoy certain privileges that are not given to public companies. A private company may be distinguished from a public company in having the word ‘Sendirian’ or the abbreviation ‘Sdn.’ as part of its name. If the company is a limited liability company then this word should come before the word ‘Bhd.’ e.g. the name of Syarikat Dua Lima, a private limited company, will appear as Syarikat Dua Lima Sdn. Bhd.

THE RELATIONSHIP OF LEGAL PERSONALITY TO LIMITED LIABILITY

It has been said that the most popular reason why a company is formed is to take advantages of the limited liability principle. However, it must be remembered that although a company is a separate legal personality, it can have unlimited liability. In order words, the shareholders may still be liable for the company’s debts.

A corporate body with limited liability means the shareholders of a company limited by shares are not liable for more than what they have to contribute for the shares they get. If the company is limited by guarantee, they are not liable for more than amount they have agreed to contribute to the assets on winding up.

The limited liability of a company has been said cost involved in the separation of ownership of the shares and control of the company. However, this may be true only for public companies. This has been said as a company has limited liability, it reduces the need to monitor management and other shareholders. Limited liability together with free transfer of shares, will also facilitate the market for control.

This is considered as an incentive for the management to perform efficiently. Apart from that, and other than making the shares marketable, limited liability would increase the volume of transactions that would improve the information fed to the market place. Limited liability also allows shareholders to diversity their shareholdings. Lastly, limited liability will result in a positive attitude to risk taking and so would facilitate investment decisions.


SEPARATE LEGAL ENTITY AND THE CONSEQUENCES THAT FLOW FROM IT.

The legal recognition given to the company is provided by s.16(5) of the Companies Act, 1965. It says:
“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 shall be a body corporate by the name set out in the memorandum.

Apart from recognizing the company as a legal entity, s.16(5) states the effect of incorporation are:
“…shall be a body corporate…capable forthwith of exercising all the functions of an incorporated body and of suing and being sued and having perpetual succession and a common seal with power to hold land but with such liability on the part of the members to contribute to the assets of the company in the event of its being wound up…”

Thus you can see the effect of incorporation as follows:

a body corporate comes into existence capable of exercising all the functions of an incorporated company;
it has the ability to sue and be sued;
it enjoys perpetual succession;
it has the power to hold property; and
the liability of the members depend on the type of company

A Body Corporate

A body corporate is a legal person that is created and given recognition by the law. This legal person is actually a legal fiction. It is an artificial legal person unlike human individuals who are known as natural persons. According to s.4(1) a ‘corporation’ is any body corporate wherever formed and includes any foreign company.

A company is a type of corporation that is recognized by the law as having powers and liabilities like an individual. The courts first recognized the company as an individual having a separate legal personality in the case of:




Salomon v A. Salomon & Co. Ltd. (1897) AC 22

Salomon was a boot and shoe manufacturer. He ran his business as a sole trader. In 1892 Salomon formed a limited liability company. He gave his wife and children one share each in the company. He then sold his shoe and boot business to the company for f39, 000. In consideration for the business, the company paid him partly in cash, partly in 20, 000 f1 shares, and partly in f10, 000 debentures issued by the company. By being a debenture holder, Salomon becomes a secured creditor of the company.

Salomon continued to run the business as one-man company. The business did not do well and after some time became insolvent. What was left of the assets of the company were not enough to pay off the creditors. It was mostly used to pay off the debenture held by Salomon. The other creditors tried to claim that Salomon had no right to the remaining assets as the sale of this business to the company was a sham, and that his wife and children were merely his nominees, and that Salomon and the company were in fact one and the same.

The House of Lords held that the incorporation process made Salomon and his company two separate persons. Even if the business were the same as before, and it was still managed by Salomon himself, the company was not an agent or trustee for the members. Although Salomon beneficially owned all the issued shares of the company, the court also recognized him as a separate person who can be a secured creditor with enforceable rights against the company.

The principle establishing the separate legal personality of the company from the members was applied in the case of:

Lee v Lee’s Air Farming (1961) AC 12

Lee formed Lee’s Air Farming Ltd. and held all the shares, except for one. The company was formed to undertake the business of aerial crop spaying. Lee was employed as the company’s pilot. He was killed in an accident while carrying out his work. His wife claimed workmen’s compensation under the New Zealand law, and she could only succeed if she could show that Lee was in effect an employee.

The Privy Council held although Lee was the controller of the company, personally he was separate from the company. He could enter into a contract with the company, and could be an employee.

Can Sue and be Sued

As the company is a separate legal entity, it can sue and be sued in its own name. It can sue in respect of rights that it has, and if it has liabilities, others may sue against it. The members of the company generally cannot take any legal action on behalf of the company. Only the company itself can enforce its rights. This is called the ‘proper plaintiff’ rule and it was established in the case of:

Foss v Harbottle (1843) 2 Hare 461

Two shareholders of a company brought action against directors of the company for misapplication and improper use of the company’s property.

The court held that as the injury complained of was injury to the company and not to the members. As such the members could not take action. Only the company had the right to sue.



Perpetual Succession

After a company is incorporated, it continues to exist until it is dissolved according to the law or it is struck off the register. Even if the membership changes, or all the original members die, the company does not come to an end. This continuous life of the company is said to be perpetual succession.

In the case of Re Noel Tedman Holdings Pty Ltd. (1967) QdR 561;

The company had a husband and a wife as its only shareholders. They were also the company’s directors. They died in an accident, leaving behind an infant child. After their death the company still existed. The problem that arose was, as the shareholders and directors had died, the shares could not be transferred as according to the will of the deceased to the infant child.

The court thus allowed the personal representative of the deceased to appoint directors of the company, so that these directors could allow the transfer of the shares to the child.


Power to Own Properly

S. 19 mentions that a company has the ‘power to hold land’. This can be taken to mean that a company can own other types of property too. The property of a company is its own, and not that of its members. Even if a member holds almost all the shares of a company, he does not have any proprietary interest in the company’s property. Once a person has sold or given his property to the company he no longer has any right over it. The property belongs to the company, and the member no longer has any right or interest.


Macaura v Northern Assurance Co. Ltd. (1925)AC619;

Macaura owned an estate and he sold all the timber one the estate to company called Irish Canadian Sawmills Ltd. All the shares in the company were owned by him or his nominee. Macaura had insured the timber that he sold to the company in his own name. After the insurance was taken, a fire broke out destroying the timber. When Macaura claimedn the insurance company refused to pay.

The House of Lords agreed that Macaura had no right to claim, because when he sold the timber to the company, he had given up his interest in it. The timber was the property of the company and Macaura no longer had insurable interest in it.

Liability of the Members

Once a company is incorporated it is liable for its own debts and obligations. The members are not responsible for it. This is one of the advantages of a company that has limited liability. In a company limited by shares, the members will make a contribution to the capital and he will be given shares. If the company should suffer losses, the shareholder is not liable to contribute any more to the company if he has fully paid for his shares. His actually loss would be the amount he has paid for the shares. Creditors of the company cannot be take any action against the members, because the members are separate from the company.


In the case of In the Application for Re Yee Yut Ee (978)2 MLJ 142

Yee was the secretary of a company that was a wholly-owned subsidiary of an American corporation. The company had retrenched their staff and dispute arose as to the retrenchment benefits. The matter was brought to the Industrial Arbitration Court where an award was made in the company’s absence. As the company did not comply with the award, the Arbitration Court ordered that Yee be personally liable as he had been appointed director by then.
The High court held that a director is nor liable for the company’s debts.



LIFTING THE VEIL OF INCORPORATION

The veil of incorporation is a fiction created by law separating the company as a legal personality from the people behind it. Once a company is incorporated, this veil comes down separating the company from the members. Normally the courts would not look beyond the ‘corporate veil’ to see who is behind the company and why the company was established. As you have seen from the effect of incorporation, the shareholders of a company cannot be personally sued for the company’s debts and obligations.

Sometimes the strict application of the separate legal entity principle, does have its disadvantages. We have seen in Macaura’s case where the application of the separate legal personality principle caused hardship to the one who owned almost all the shares of the company, who cannot claim for insurance taken under his own name. There are also cases where third parties suffer. Where a company is limited liability company, the creditors will suffer if the company incurs debts which it is unable to pay, as the shareholders are not liable beyond the amount they have contributed in full for their shares.

Due to some of the undesirable consequences of incorporation, company law recognizes a number of exceptions to the principle of veil of incorporation. Under these exceptional circumstances, the law looks at the situation and will ignore the separation between the company and its members or officers. This is called ‘Lifting the veil’. When the court lifts the corporate veil, the members or officers will be made liable for the company’s obligations. The corporate veil is lifted under situations provided by statue, and also according to the judicial decision under the common law.








[1] Section 36 CA 1965
[2] Section 44(2) CA 1965
[3] Section 48(4) CA 1965
[4] Section 121(2) CA 1965

5 comments:

  1. excuse me, can i ask. i don't understand in section 19 as you mention in company property. are section 19 in companies act or else? please eply me ASAP. thank you.

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  2. so means once co. is incorporated a co.is perpectually separated from its members and directors???

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  3. quiet appreciated with this kind of summary on facts & cases. really helping me to get easier understanding on this topic. thank u (^_^)

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  4. this is good summary,,thank you very much.....

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