COMPANY LAW

LIFTING OF THE CORPORATE VEIL

LECTURE 11

Charles Nicholson

LIFTING OF THE CORPORATE VEIL

The principle of separate corporate personality as confirmed in Saloman v. A Saloman & Co. Ltd. [1897] forms the Ltd. cornercorner-stone of co. law. Incorporation of a co. casts a veil over the true controllers of the co, a veil through which the law will not usually penetrate. There are however instances when the law will disregard or look behind the corporate personality and have regard to the reality of the situation. Lifting or piercing the corporate veil mean in effect ignoring the fact that the business is carried on by a co. and looking behind the co. to see who is actually operating it. 2

This would involve treating the rights or liabilities or activities of the co. as the rights or liabilities or activities of its shareholders, for example treating the business of a co. as that of its principal shareholder. Lifting the corporate veil is sometimes expressly authorised by statute (statutory exceptions) and exceptions) sometimes it is adopted by the courts (judicial exceptions). exceptions). Each case has to be approached based on its own peculiar facts rather than purely on legal rules. We need to look at the cases as examples of situations as to when the courts have lifted the corporate veil.
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Exceptions to the Separate Entity Doctrine i.e. when will the corporate veil be lifted? A. Statutory Exceptions

1. When the membership of a co. falls below two s. 36 Companies Act 1965 If at any time only one member of a co. remains, that member has six months in which to find another member. If after the six-month grace period the co. is sixstill carrying on business with only one member, that member is personally liable for all of the debts of the co. contracted after the grace period. The co. and the member shall be guilty of an offence. Except in the case of a wholly owned co.
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2. Where a person signs, issues or authorizes the signing or

issue of certain instruments on which the company's name does not appear properly - s.121(2)(c).

The name of the co. must appear in letters on all bills of exchange, promissory notes, cheques, negotiable instruments, indorsements and orders. If the name of the co. is not properly mentioned on any of these documents, the person who signed or issued the document (or who authorized the signing or issue) is liable to the holder of the document for the amount due, unless the co. pays upon the instrument.

Hendon v. Adelman (1973) the directors of L & R Agencies Ltd were personally liable under the equivalent of s.121(2) because they purported to sign a cheque on behalf of the co. by writing LR Agencies Ltd. This was not the correct name of the co. Jenice Ltd v. Dan (1994) the companys name Primekeen Limited was misspelt Primkeen Limited. It was held that the directors were not personally liable when the cheque was dishonoured. The mere omission of a single letter in the middle of a name was not the same as the omission of a word.

3. Where debts are contracted on behalf of a co. and at the time that the debts were contracted the officer responsible had no reasonable or probable expectation that the co. would be able to pay the debts, that officer may be guilty of an offence and on conviction, he may be liable to pay of the whole or any part of the debt so contracted s. 303(3) 4. Fraudulent trading -Where any business of the co. has been carried out with intent to defraud creditors of the co., the court may make the person who was knowingly a party to the transaction personally responsible for the debts or other liabilities of the co.- s. 304(1) . He shall co.also be guilty of an offence under s. 304(5) of the Act. Siow Yoon Keong v. H. Rosen Engineering [2003] 4 MLJ 569; [2003] 5 AMR 735. Kawin Industrial Sdn Bhd (in liquidation) v. Tay Tiong Soong [2009] 1 MLJ 723.
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Siow Yoon Keong v. H Rosen Engineering BV Rosen had completed works under a contract between Rosen and Petronas Gas Sdn Bhd dated 24/3/1990. Petronas made payments to Ventura Industries Sdn Bhd totalling RM 1067,100. Under an agreement between Ventura and Rosen, Ventura would retain 20% thereof and remit the balance of 80% to Rosen. Ventura paid a sum of RM 423,000 to Rosen but failed to pay the balance of RM 423,000. The appellant, Siow, as managing director and alter ego of Ventura, had used Venturas funds to invest in shares on the stock exchange under his own name, instead of discharging the debt to Rosen. Having acquired the shares, partly using Venturas funds and partly his own funds, Siow realising that he was about to incur losses on his investments, arranged for a co. resolution to be passed by the board of directors to 8

ratify the investment and the use of the cos funds, including that which was due to Rosen. This had the effect of transferring the losses on his investments to the co. The cos funds were used to pay Siows losses and the co. was left with no funds to pay Rosen, to whom RM 423,000 was due. The court applying s. 304(1) held that it was very clear that the intention of Siow was to defraud Rosen, the creditor and it was also equally clear that it was done for a fraudulent purpose. Siow was held to be personally liable for the debt and the court ordered Siow to pay to Rosen the balance sum of RM 423,000 together with interest for which judgement had been obtained by Rosen against Ventura.

Kawin Industrial Sdn Bhd (in liquidation) v. Tay Tiong Soong [2009] 1 MLJ 723. On 12/8/2000, P (Kawin Industrial) purchased eight units of knitting machinery, accessories and spare parts (the machinery) from Kawin Knitting Pte. Ltd (Kawin). During the time of the purchase of the machinery, P had already ceased operations and become an insolvent co. On 19/4/2001, P sold the machinery to Skytex Industries (M) Sdn Bhd at the price of RM 115,500. This sum was paid to the defendant, D, who was the managing director of the co. P failed to pay the purchase price of the machinery and judgement was entered for S$210,334.23 against P on 9/4/2002.

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On 7/8/2003 an order for winding up was made against P and a provisional liquidator (L) was appointed. L found that P was insolvent based on the audited accounts of P for the financial year ending 31/3/2001. P filed an application in court for a declaration that that the payment of RM 115,500 made by Skytex to P which ought to have been paid into Ps account, constituted an act of fraudulent preference in favour of P and was therefore illegal pursuant to s. 304(1) of the CA 1965. The principal issue to be considered by the court was whether in the circumstances, the business of P had been carried out with intent to defraud creditors of the co. co. within the meaning of s. 304(1).

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The court held that, on the facts, there was an intention to defraud Kawin, the creditor, or it was done for a creditor, fraudulent purpose. It was clear that P purchased the machinery when it had already ceased operations and D knew that P being insolvent had no funds to pay the outstanding purchase price to Kawin. Thus, by later selling the machinery and paying the purchase price of RM 115,500 to himself it was obvious that D had the intention to fraudulently defraud Kawin, a creditor. Furthermore, D, as managing director had acted in a manner which had prejudiced the creditors of P when the co. was already insolvent. On the facts, a case had been made out under s. 304(1) of the CA . See also: LMW Electronics Pte Ltd v. Ang Chuang Juay & Ors. [2010] 1 MLJ 185
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5. Where dividends are paid when there are no available profits out of which to pay them . No dividends may be paid to the shareholders of a co. unless there are profits available. If a director or manager of a co. willfully pays or permits the payment of a dividend when there are no available profits, he is liable to the creditors of the co. for the amount of the debts due to them to the extent by which the dividends exceeded the available profits and shall be guilty of an offence.offence.s. 365(1) & (2b); Art: 100, Table A. A. 6. If a co. breaches the prohibition against providing any financial assistance for the purchase of its own shares, s. 67(3) makes its officers guilty of an offence.
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B. JUDICIAL EXCEPTIONS 1. FRAUDULENT CONDUCT Where there is fraudulent behaviour or fraudulent intention on the part of the corporators in forming the co. courts will be ready to pierce or lift the corporate veil. Fraud here is used in a very wide sense to cover inequitable and improper conduct, including cases where conduct, the corporator seeks to evade a contractual liability by the use of the corporate form. In Guilford Motor Co. Ltd. v. Horne [1933] Ch. 935 CA. E B Horne, the first defendant, was formerly employed by the plaintiff co. as the managing director. His contract of employment included a covenant not to solicit the customers of the plaintiff after he left their employment. When H left their employment he set up a co. called JM Horne & Co. Ltd., the second defendant, to carry on his business. 14

The shareholders and directors of the co. were himself, his wife and an employee. JM Horne & Co. Ltd. then began to solicit the customers of the plaintiff by sending out circulars to persons who were at the crucial time customers of the plaintiff co. The plaintiff brought an action to try to restrain H from carrying on in this way. The Court of Appeal held that H had breached his covenant with the plaintiff and granted an injunction against both H and his co. H was in breach of the valid co. covenant in restraint of trade contained in his contract of employment. The court held that the co. was a mere cloak or sham for the purpose of enabling H to commit a breach of his covenant.
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Lord Hanworth MR made the following observations:observations:I am quite satisfied that this co. was formed as a devise, a stratagem, in order to mask the effective carrying on of a business of Mr. E B Horne. The purpose of it was to try to enable him, under what is a cloak or sham, to engage in business which, on consideration of the agreement which had been sent to him just about seven days before the co. was incorporated, was a business in respect of which he had a fear that the plaintiffs might intervene and object.

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This decision was followed in Jones v. Lipman [1962] 1 All ER 442. 442. L, the defendant (vendor), contracted with J, the plaintiff (purchaser), to sell J a piece of land for 5,250. Before conveyance of the land to J, L changed his mind. Instead he sold and transferred the land to a co. called Alamed Ltd. which he had formed (he and a clerk for his solicitors were shareholders and directors) for 3,000, of which 1,564 were borrowed by the co. from a bank and the rest remained owing to L. Alamed Ltd. was expressly formed for the purpose of putting the land beyond the reach of an order for specific performance.
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J then brought this action to compel L to transfer the land to him. Russel J. ignored the corporate veil and ordered specific performance against both the defendant and his co. So L could not evade his contractual liability by co. using the corporate form. In his judgement, the Judge said: The defendant co. is the creature of the defendant, a devise and a sham, a mask which he holds before his face in an attempt to avoid recognition by the eye of equity... an equitable remedy is rightly to be granted directly against the creature in such circumstances.
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See also: also: Sunrise Sdn Bhd v. First Profile (M) Sdn Bhd [1996] 3 MLJ 533 per Chong Siew Fai CJ (Sabah & Sarawak) FC: We are in complete agreement with the basic principle of the fundamental attribute of corporate personality, i.e. that the corporation is a legal entity distinct from its members, be they individuals or corporate bodies -- a principle firmly established since Aron Salomon v. A Salomon & Co Ltd [1897] AC 22. Thus, in cases where there are signs of separate personalities of companies being used to enable persons to evade their contractual obligations or duties, the court would disregard the notional separateness of the companies. Referred to in: Golden Vale Gold Range & Country Club Sdn Bhd v. Hong Huat Enterprise Sdn Bhd [2008] 4 MLJ 839 CA. 19

In Aspatra Sdn. Bhd. and 21 Ors. v. Bank Bumiputra Malaysia Bhd. & Anor. [1988] 1 MLJ 97, the Supreme Anor. Court held that the court could generally lift the corporate veil in order to do justice particularly where an element of fraud is involved. Here, there was an element of fraud in the receipt of secret profits by Lorraine Osman as alleged and that was sufficient for the court to lift the corporate veil for the purpose of determining whether the assets of the co. are really owned by them. The first plaintiff, Bank Bumiputra Malaysia Bhd (P1) and the second plaintiff, Bumiputra Malaysia Finance (P2), a wholly owned subsidiary of P1, sued Lorrain Osman, a director of P1 and the Chairman of P2 for an account of secret profits that he allegedly made while he was director of the P1 and Chairman of P2.
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The plaintiffs alleged that L received the sum of M$ 27,652,853-06 through his solicitors in Kuala Lumpur 27,652,853wrongfully and without the knowledge and approval of the plaintiffs and in breach of his fiduciary duty as a director of the P1 and Chairman of P2. On the same day that the plaintiffs had filed the writ against L, they made an ex parte application for a Mareva injunction to restrain L from removing from the jurisdiction of the Court, selling, transferring or otherwise dealing with his assets held in the companies controlled by him, including monies that L held in his accounts with various banks, limited to the above sum. The appellant companies, inter alia, challenged the Mareva injunction on the ground that the court should not have treated the assets of the companies as Ls assets the companies and L are separate entities the Salomon principle.
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The learned trial judge found that L was the alter ego of the companies. Only 32 out of 21,796,395 shares in the appellant companies did not belong to L. He exercised effective or sole control of the companies by holding more than 99% of the total paid up capital of the 22 appellant companies. Further, he was also a director in 15 of them. These were the main factual bases on which the learned judge lifted the corporate veil.

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The case of Lim Kar Bee v. Duofortis Properties (M) Sdn. Bhd. [1992] 1 AMR 4 concerned a scheme that was Bhd. devised by the co. the primary purpose of which was to avoid paying the estate duty. The Supreme Court held that the scheme was illegal. His Lordship, Peh Swee Chin SCJ, in delivering the judgement of the court made the following observation on lifting the corporate veil for the purpose of discovering any illegal or improper purpose:purpose:When the issue of illegality was raised, we have lifted the corporate veil of each co. wherever we found it necessary, for it is well settled that the courts have a discretion to lift it for the purpose of discovering any illegal or improper purpose
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The court will not allow a section to be invoked for an improper purpose or for a purpose not contemplated or intended by the section. In Re Bugle Press Ltd. [1961] Ch 270 the Court of Appeal held that section 209, CA 1948, U.K. (s. 180 CA 1965, Malaysia) may not be used by the majority shareholders to expropriate the shares of a minority shareholder. S. 428 CA 1985, U.K. permits a co. which has acquired 90% or more of another companys shares as a result of a takeover bid to compulsorily buy out the remainder of the shares. Bugle Press share capital consisted of 10,000 1.00 shares. Jackson and Shaw each owned 4500 of these shares (the majority shareholders) and Trelby owned the remaining 1000 shares.
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Jackson and Shaw tried to buy out Trelby but he refused to sell his shares. They then formed a 100 co., Jackson & Shaw (Holdings) Ltd. in which they were the only shareholders. J & S (Holdings) Ltd. then made an offer addressed to the shareholders in Bugle Press Ltd., to purchase their shareholdings at 10 per share. Jackson and Shaw obviously accepted and their shares were transferred to the co. but Trelby again refused on the ground that the price was too low. Since J & S (Holdings) Ltd. now owned 90% of Bugles shares, it sought to exercise the statutory right under s. 428 by giving Trelby notice of its intention to purchase his shares compulsorily.

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The Court of Appeal held that J & S (Holdings) Ltd. could not do this. The scheme was not binding on Trelby. For all practical purposes, J & S (Holdings) Ltd. was entirely equivalent to the nine-tenths of the nineshareholders of Bugle Press who have accepted the offer of J & S (Holdings) Ltd. The Court will not allow the section to be invoked for a purpose not contemplated by the section (an improper purpose), which is, for the purpose of enabling majority shareholders to expropriate or evict the minority shareholders.
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2.

AGENCY

In exceptional cases, an agency between a co. and its shareholders or controllers may be found to exist as a matter of fact. In the case of Re FG (Films) Ltd. [1953] 1 WLR 483 a finding of agency allowed the court to lift the corporate veil. Here, an American corporation called Film Group Incorporated set up a co. in the U.K. called FG Films Ltd. The co. had a nominal share capital of 100 consisting of 100 1-00 shares. 90 of these shares were held by the 1President of the American corporation who was a director of the co., and the remaining 10 shares was held by a British director. The third director had no shareholding. The co. only carried on business at its registered office and did not employ any staff.
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It then made a film called Monsoon. The story rights of this film were held by the American corporation. The film was made in India and it costs over 80,000. The co. sought to have the film registered as a British film under the Cinematograph Films Act 1938-48, which 1938provided certain restrictions on films unless they were made by a British person or co. The Board of Trade refused the application on the ground that the film had in reality been made by the American corporation. The applicant co., FG Films, sought a declaration from the court that it was the maker of the film within the meaning of the Act.
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The Court held that this film had not been made by a British co. It was not a British film. All the finance for the film had come from the American corporation and it held that the participation of the British co. in the making of the film had been so small as to be practically negligible and in so far as it acted at all in the matter, it acted merely as the nominee or agent of the American corporation, Film Group Incorporated.

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In Smith, Stone and Knight Ltd. v Birmingham Corporation [1939] 4 All ER 116 Atkinson J, allowed a holding co. to claim compensation for compulsory acquisition as if it were an owner-occupier, on the ownerground that its subsidiary which occupied the land in question was merely its agent for the purpose of carrying on its business. A parent co., Smith Stone & Knight held 497 out of 502 shares in a subsidiary co. called Birmingham Waste Co. Ltd. The remaining 5 shares were held by the directors of the parent co., who were the directors of the subsidiary, in trust for it (a so called wholly owned subsidiary). The parent co. was in total and constant control of the subsidiary. The defendant corporation, Birmingham Corporation, compulsorily acquired the land that was owned by the subsidiary on which the business was carried.
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The parent co. then claimed compensation in respect of the removal and disturbance to the business. The defendants claimed that the parent co. was not the proper claimant for this disturbance. They said that the proper claimant was the subsidiary. The judge agreed that the mere fact that a man owns all the shares in a co. does not make the business carried on by the co. his business. Nor does it make the co. his agent for the carrying on of that business. However, in this case, the judge had no difficulty in deciding that the business of the subsidiary co. was the business of the parent co. and the subsidiary was merely its agent, employee or tool.
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Atkinson J said this: There was nothing to prevent the parent co. at any moment from saying we would carry on this business in our own name. They had but to paint out the subsidiarys name on the premises, change their business papers and forms and the thing would have been done. I am satisfied that the business belonged to the parent co. They were in any view the real occupiers of the premises.

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3. GROUP ENTITY Courts have ignored the separate legal entities of various companies within a group and instead looked at the economic entity of the whole group. DHN Food Distributors v London Borough of Tower Hamlets [1976] 3 All ER 462 CA The facts in this case were similar to those in Smith, Stone & Knight and it is another case which involves compulsory purchase. In compulsory purchase cases under the Compulsory Purchase Act the claimants themselves are asking for the veil to be lifted.
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Here DHN was the parent co. It ran a wholesale cashcashandand-carry grocery business from premises owned by one of its wholly owned subsidiaries called Bronze Investments Ltd. The premises were compulsorily acquired by the Borough Council of Tower Hamlets in 1970. Under the Act, compensation was payable under 2 heads:heads:- 1) compensation for the value of the land, and 2) compensation for the disturbance to any business on the land. But someone claiming compensation under either of these 2 heads must have an interest in the land greater than that of a bare licensee i.e. a yearly tenant. There was no problem with the first head. Bronze owned the land and it was entitled to compensation for the value of the land.
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However, the business was run by DHN. Bronze itself took no part in the running of the business. DHN was only a licensee i.e. they had an interest in the land which was less than that of a yearly tenant and so the Borough Council claimed that DHN was not entitled to compensation under the second head. However, it was held by the Court of Appeal that you could regard the group of companies here as a single economic entity. The directors of DHN were the same as entity. those of Bronze and the shareholders of Bronze were the same as in DHN. The decision to pierce the corporate veil was expressly based upon a group entity view treating the group of companies as one economic entity or unit rather than by using agency principles
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Shortly after this case, the House of Lords declined to pierce the veil in the case of: Woolfson v. Strathclyde Regional Council Authority [1978] 38 P & LR 521, a case which had originated in Scotland. This case again concerned compulsory purchase. Here, the shop premises were occupied by C Ltd. for its business. There were 1000 issued shares in C Ltd. and 999 were owned by Woolfson and the remaining one by his wife. The wife, he said, did not hold this share as his nominee. She was an independent shareholder. While Woolfson was the only director, he obviously controlled the business. He also owned the premises. The shop premises were compulsorily acquired. 36

The issue was: whether compensation should be paid to Woolfson for disturbance of the business. Unfortunately, C Ltd. had not been joined as a party to the claim. Woolfson was asking for piercing of the corporate veil of C Ltd. on the ground that he and C Ltd. should be treated as the same entity. He claimed that if the reality entity. of the situation was looked at it would be seen that he was the occupier carrying on the business as well as the owner of the premises. The House of Lords rejected his claim.

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Lord Keith said that, it is appropriate to pierce the corporate veil only where special circumstances existed indicating that it is a mere facade concealing the true facts. facts. They held that this was not the case here. It had not been shown that there was a mere facade. It was C Ltd. which carried on the business on the premises and not Woolfson and and that Woolfson was not beneficially entitled to the whole of the shareholding in the co. because his wife was an independent shareholder and not a nominee for her husband.

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In the Malaysian case of Tiu Shi Kian & Anor. v. Red Rose Restaurant Sdn. Bhd. [1984] the court treated the Bhd. subsidiary and the parent co. as functionally one entity. entity. Here, the plaintiffs/applicants (P) operated a nightclub and restaurant called the Golden Million Cabaret and Night Club in the premises of Red Rose Restaurant S/B., a subsidiary of Hotel Berjaya S/B. The restaurant was situated in Hotel Shangrila which was also owned by Hotel Berjaya S/B. A dispute arose between the P and Red Rose regarding the renewal of the Ps licence to operate the club. P obtained an interim injunction on 14 March 1983 to restrain the defendants from disturbing Ps quiet use and enjoyment of the premises until the action was tried.
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On the nights of 14 and 15 March, P were able to carry on their business at the premises but on the following night, 16 March, P found the restaurant premises were locked in breach of the injunction. P then instituted committal proceedings for civil contempt of court against the directors of Red Rose in breaching the order of 14 March 1983. The respondents contended that the closure of the premises was effected by a separate entity, Hotel Berjaya S/B, the owner of Hotel Shangrila. The defendant co. and the respondents should not, therefore, be responsible for such acts.

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The court held that there was functional integrity between the hotel and restaurant. Hotel Berjaya and Red Rose were one single entity. The respondents were entity. found guilty of contempt and fined accordingly.

The decision of the High Court was affirmed by the Federal Court and Privy Council. See: Datuk Hong Kim Sui v Tiu Shi Kian [1985] 1 MLJ 145 (Federal Court) and [1987] 1 MLJ 345 (Privy Council).

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The same approach was taken by the court in Hotel Jaya Puri Bhd. v National Union of Hotel, Bar and Restaurant Workers. [1980] 1 MLJ 109. Workers. The court held that the Hotel (Hotel Jaya Puri Bhd) and the Restaurant (Jaya Puri Chinese Garden Restaurant SB), a wholly owned subsidiary of the Hotel, where both had the same managing director, were functionally one and treated them as one single entity ignoring the separate legal personalities of the companies. See also: also: Win Line (UK) Ltd. V. Masterpart (Singapore) Pte. Ltd. Ltd. [2000] 2 SLR 98 where the court refused to treat two companies which have no common shareholders or directors as being a single economic unit and thus a 42 single legal unit.

4. PUBLIC POLICY The case of Daimler Co. Ltd. v Continental Tyre and Rubber Co. (Great Britain) Ltd. [1916] 2 AC 307 Ltd. shows that courts will pierce the veil when there are overwhelming public policy grounds for doing so. Here, the Continental Tyre Co. was incorporated in England. All of its shareholders, except one, were resident in Germany and all its directors resided in Germany. The Secretary who held the remaining share resided in England and was a British subject. The issue in this case was whether this co. had standing to sue and recover a debt in an English court during the First World War when England was at war with Germany.
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The defendants (Daimler) alleged that the co. was an alien enemy and that the payment of the debt would constitute trading with the enemy alien. The action was eventually dismissed on a procedural point but the majority of the House of Lords were of the opinion that a co. could have an enemy character despite the fact that the co. had been incorporated in England and they were ready to say here that the co. was an alien co. co. This was likely to occur when a companys agents or persons in control of the co. were residents in an enemy country or were acting under the control of such persons.

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See Article: The Application of the Rule in Salomon v. Salomon in Malaysian Company Law Berna Collier Clayton, Professor of Commercial Law, Faculty of Law Queensland University of Technology [1998] 2 MLJ lxv; [1998] 2 MLJA 65

Charles Nicholson

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