Fraudulent Trading

The doctrine of separate legal entity is the cornerstone of modern company law which provides that a company is a distinct legal entity from its directors and shareholders. Thus, liabilities incurred by the company are not attributable to its directors and shareholders. However, a few exceptions may enable the Court to lift the corporate veils and find the directors or shareholders accountable for liabilities incurred by the company.

Section 540 of the Companies Act 2016 (Responsibility for fraudulent trading) is one of the examples where corporate veils can be lifted. Section 540 provides that in the course of winding up of a company or in any proceedings against a company, if it appears that the business of the company has been carried on with intent to defraud creditors or for fraudulent purpose, the Court may order that the person knowingly a party to such carrying on of business be personally liable for debts or liabilities of the said company.

Simply put, there are two essential elements to be satisfied before anyone can be found personally liable for the company’s debts or liabilities under Section 540. First, the company must have conducted its business with intent to defraud. Secondly, the said person has knowledge of such mode of business. The following decided cases will illustrate the application of Section 540.

Tradewinds Properties Sdn Bhd [2019] 1 MLJ 421

In this case, TPSB sued company X and its director to recover an outstanding debt. A consent judgment was then entered between all parties where X and its director shall pay a total of RM1.5 million to TPSB and that the liability of the said director shall be absolved after the first payment of RM500,000.00. After paying a total sum of RM654,000.00, company X and its director defaulted in paying the balance. TPSB later discovered that company X passed resolutions allowing company Y to accept and receive consultancy fees payable to company X. The director of company X was also a director in company Y. Thus, TPSB commenced an action under Section 540 against the said director, company X and company Y.

The Court of Appeal agreed that the said director had committed fraudulent trading. Around one to three months after the consent judgment was entered on 9 February 2011, the said director passed resolutions transferring Company X’s future earnings (around RM2.3 million as admitted by the said director) to company Y. The director further admitted that company Y was incorporated to receive assignments of company X’s fees. As a result, company X is now a dormant company since all its business and income are transferred to company Y.  The Court of Appeal held that this is a clear evidence of intent to defraud TPSB on the part of company X to evade outstanding payment under the Consent Judgment. Consequently, the director and company Y were held to be liable to pay the balance judgement sum owing by company X to TPSB.

Chin Chee Keong [2016] 3 MLJ 479

Between 9 October 2003 to 24 February 2004, the Plaintiff company supplied resin amounting to RM588,093.00 to another company called Pacific Plastic Industries Sdn Bhd (“PPSB”). PPSB later failed to pay the said amount and the Plaintiff obtained Judgment in Default against the same. The Judgment Sum remains unpaid until today and the Plaintiff commenced action against directors of PPSB for fraudulent trading.

The High Court found the directors liable for fraudulent trading and the Court of Appeal upheld such decision. The Court of Appeal discovered that it was apparent from PPSB’s audited reports for year 2002, 2003, 2004 that PPSB was in financial difficulty and had no reasonable prospect to pay its debt. Despite aware of such information, the directors of PPSB directed PPSB to place unusually large orders from the Plaintiff Company. Without evidence to the contrary, the Court of Appeal found that such placement of orders was carried out with intent to defraud and the directors of PPSB, who were the knowing parties of such orders, must be held personally liable to PPSB’s debt pursuant to the fraudulent trading provisions.

Huatah Sdn Bhd [2020] 8 MLJ 98

In this case, the Plaintiff company entered into a licence agreement and supply agreement with another company called Billionz Showcase Sdn Bhd (“BSSB”) to carry out business under the Tai Lei Loi Kei trademark. The Plaintiff then made various payment and royalties to BBSB but later discovered that BBSB was never a registered franchisor in Malaysia pursuant to Franchise Act 1998. The Plaintiff then obtained a Court’s order declaring the agreements void and ordering restitution of all monies paid. Nevertheless, BBSB never paid the Judgment Sum was subsequently wound up.

The Plaintiff then discovered that the statements of accounts provided by BBSB to the liquidators were inaccurate at all. The directors of BBSB admitted that they have destroyed all documents and records of the company. The High Court held that it was very bizarre for them to do so thus raising a red flag of deep suspicion. Adverse inference must be drawn against them and the High Court declared that the directors must be held personally liable to BBSB’s debt pursuant to Section 540.

Conclusion

From decided cases, it is apparent that fraudulent trading is fact-sensitive and Section 540 must be applied to facts of each case.  In addition, fraudulent trading also attracts criminal liability where the knowing party may be liable to imprisonment not exceeding 10 years or a fine not exceeding RM 1 million or to both. Afterall, business shall be practiced with integrity and honesty and no one is entitled to hide behind the corporate veils to gain unjust or wrongful benefits.