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Incorporation and Its Effects

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1 Incorporation and Its Effects
LAW 485 COMPANY LAW TOPIC 3: Incorporation and Its Effects BY: Muhammad Umar bin Abdul Razak & Mazlina Mahali Faculty of Law UiTM Shah Alam


A Certificate of Incorporation shall be issued where the pre- registration procedures have been complied with – Section 16 (4) The certificate of incorporation serves as conclusive evidence that a company has been duly registered from the date mentioned in the certificate – Section 361 The certificate shall state: a. type of company registered; b. date of registration; c. name of company; d. company number

4 Once the company is duly registered, the law shall regard the company to be of a body corporate – Section 16 (5) The registered company is now a corporate personality. A fundamental concept of corporate personality is that the corporation is in law a separate legal entity distinct from its members and controllers. The case that established the concept of separate legal entity is Salomon v A Salomon & Co Ltd

5 EFFECTS OF INCORPORATION The effects of incorporation are stated on S
EFFECTS OF INCORPORATION The effects of incorporation are stated on S. 16 (5). The company: i) is capable forthwith of performing all the functions of an incorporated company; ii) is capable of suing and being sued iii) has perpetual succession and shall have a common seal; and iv) has power to acquire, hold and dispose of property.

6 SEPARATE LEGAL ENTITY A corporation is a legal person created and recognized by law. It is an artificial legal person. Upon incorporation, a company has a legal personality of its own apart from the persons who form it. The law will treat the company and the members as separate legal persons.

Salomon carried a successful business as a sole trader in boots and shoes. In 1892 he formed a company, and transferred his business to that company. The company had seven shareholders that included Salomon, his wife and his five children. He took the price partly in 20,000 £1 shares, partly in cash and partly in debenture secured by floating charge.

8 So Salomon became a secured creditor of his own one-man company and had claim to the assets of the company in priority over the unsecured creditors in the event of liquidation. After sometime, the company went into liquidation and the assets of the company were insufficient to meet the claims of secured creditors and the unsecured creditors.

9 The liquidator found that the secured creditor is Salomon himself, and the majority shareholder, decided to pay the unsecured creditors first. Salomon challenged this and went to court.

10 The creditors claimed that:
Salomon was still the owner of the business and liable for its debts. The company was irregularly formed because 6 out of the 7 shareholders were mere nominees of Salomon and that Salomon and the company were one and the same.

11 The House of Lords held that Salomon & his company were two separate persons with the result that:
The business was owned by the company and therefore, its debts were the liabilities of the company and not of Salomon personally.

12 Although Salomon owned 99% of the issued shares of the company, he could also be a secured creditor with enforced rights against the company in that capacity because once a company is incorporated, it is separate from the person who formed it.

13 Effects of Salomon’s case
The company will be liable for its own debts and liabilities A company can sign a contract with its own shareholders or officers.

14 Application from Salomon’s case:
Lee v Lee’s Air Farming Ltd :where company and members/shareholders are 2 separate entities. Foss v Harbottle : Ability to sue and being sued under its own name. Macaura v Northern Assurance Co Ltd : Ability to own peroperty Re Noel Tedman: Perpetual succession

Lee forms a company, Lee’s Air Farming Ltd. in which he owned all the shares but one. He was the company’s sole director and was also employed by the company as its chief and only pilot. Lee was killed while flying for his company. His wife made a claim for workmen’s compensation under the New Zealand workmen’s compensation legislation. Payment of such compensation depended on the fact whether Lee was a worker or not.

16 The New Zealand court refused to hold that Lee was a worker because a man could not in effect employ himself. However, the Privy Council held Mrs. Lee was entitled for compensation because even though Lee maybe controller of the Company, it is separate legal entity.

A company may sue and be sued in its own name. In fact, it must sue on its own behalf according to what rights it has and duties owed to it. Case: Foss v Harbottle

18 CASE: FOSS V HARBOTTLE Two shareholders in a company brought an action against the company’s directors. They alleged that the property of the company had been misused. Held: The injury complained was an injury to the company. In law, the company and its members were not same. Therefore, the members cannot maintain such suit. It was for the company to sue and not the members. In other words, the company is the proper plaintiff to initiate actions in respect of wrongs done to it. Thus, the proper organ to commence the action on behalf of the company is the board of directors. A single director or officer of the company cannot sue on the company’s behalf unless specifically authorized to do so.

A company can own property in its name. Although the members have shares in the company, the property is held or owned by the company. Case: Macaura v Northern Assurance Co Ltd. Macaura owned an estate. He sold all the timber on the estate to a company. He and his nominees owned all the shares of the company.

20 Macaura insured the timber that he sold to the company in his own name
Macaura insured the timber that he sold to the company in his own name. The insurance policy was not transferred into the company’s name. The timber was destroyed in a fire. Macaura claimed the insurance but the insurance company refused to pay.

21 Held: When Macaura sold the timber to the company, he gave up his interest in it and the company had become the owner of it. He had no interest in the timber that he could insure. Therefore the insurance company was not obliged to pay.

22 PERPETUAL SUCCESION The company is immortal. It will continue to live until it is properly wound up or struck off the register. Even if all the member dies, the business still exists. Case: Re Noel Tedman Pty Ltd The company had 2 directors who were also the only shareholders, a husband and wife. Both died in a traffic accident . One infant child survived.

23 The article of association required the approval of directors before shares could be transferred under the will of deceased member. There were no directors. Normally, this problem would be rectified by the appointment of new directors. However, to appoint directors the member had to vote. There were no members.

24 In the end, the court allowed the personal representatives of the deceased to appoint the directors, so that these new directors could assent to the transfer of the shares to the beneficiary

Incorporation of a company casts a veil over the true controllers of the company, a veil through which the law will not usually penetrate. However, in certain situation, a court may ignore the separate legal personality of a company and look at the members or controllers of the company and make them liable for the debts of the company. This is known as the lifting up of the corporate veil or in other words disregarding the separate legal personality of the company.




29 INCOME TAX ACT 1967 The corporate veil is consistently lifted in the area of taxation. For example, the Director General of Inland Revenue Malaysia may choose to ignore transactions which alter the incidences of tax or evade or avoid any liability to tax. These transactions conceal the true nature of the company’s affairs and the DG may disregard them in his assessment of taxes payable. See Section 140 (1) of the Income Tax Act.

30 These transactions conceal the true nature of the company’s affairs and the DG may disregard them in his assessment of taxes payable. See Section 140 (1) of the Income Tax Act.

31 COMPANIES ACT 1965 Section 36 When the membership of a company falls below 2 (people), the remaining member must within 6 months find another person to become a member. If he still proceeds with the business after that period by himself, he will be personally liable for the debts of the company incurred after six months period, unless he can prove that he did not know that he was the only member of the company. However, this section is not applicable to wholly owned subsidiaries

32 2. Section 121(2)(c) When a person signs, issues or authorizes the signing or issue of certain instruments in which the company’s name does not appear properly. When signing or authorizing certain documents like promissory notes, bill of exchange, cheques etc in which the name of the company is not stated properly

33 If the company fails to honour such documents then the person who signed the instruments will be personally liable for the debts.

34 3. Section 303(3) read with Section 304(2)
When debts are contracted when there is no reasonable or probable expectation of these debts being paid. When debts are contracted, the officer must really find about the ability of the company to repay debts. If he knew or has reasons to believe that the company is not in a position to repay debts, but still entered into the contract, he will be personally liable for the debts, if the company goes into liquidation.

35 4. Section 304 (1) In the case of fraudulent trading, if the company is formed or the business of the company is carried for fraudulent purposes, the person who is knowingly a party to the carrying on the business in that manner will be personally liable for the debts of the company if the company goes into liquidation.

36 5. Section 365 (2)(B) Where dividends are paid even though there are no available profits out of which to pay them, then the directors who declared the dividend will be liable to the creditors of the company if the company is unable to pay the creditors in the event of liquidation, to the extent by which the dividend exceeded the available profits.


38 JUDICIAL EXCEPTIONS In Malaysia, the court will lift the corporate veil when the justice of the case so requires. Malaysian courts have in the past lifted the corporate veil in several circumstances such as fraud, agency and where corporations within the group are essentially one.

39 A. FRAUD Use of a company to evade legal obligation or to commit fraud. The separate personality doctrine can not be used for evading legal obligation. If a person tries it, the court can lift the veil i.e. disregard the separate legal personality doctrine.

40 Case: Gilford Motors Co Ltd v Horne
Case: Jones v Lipman Case: Tiu Shi Kian v Red Rose Restaurant Sdn Bhd

Horne was formerly a MD of the plaintiff’s company. He had agreed not to solicit the company’s customer after the termination of his employment. However, when he left the company, he set up JM Home Co & Ltd through which he solicited the plaintiff’s customers.

42 The court held that he had breached his agreement and was using his company to evade his legal obligation.

43 CASE: JONES V LIPMAN Lipman agreed to sell a house to Jones. For some reasons, he changed his mind. To avoid the transfer of the house to Jones, Lipman set up a company and transferred the house to it. He offered to pay damages for the breach of contract. Jones sought an order of specific performance. Lipman raised defence that the company was not the party against whom specific performance could be ordered. Held: The company was a creature of Lipman in order to avoid his obligation under the contract with Jones. Both Lipman and the company were ordered to specially perform the contract to sell the house.

44 Case: Tiu Shi Kian v Red Rose Restaurant Sdn Bhd
TSK ran a night club in the Red Rose Restaurant (RRR), which was wholly owned and controlled by Hotel Berjaya Sdn Bhd, where the club was situated. A dispute arose between the plaintiff and RRR regarding the renewal of plaintiff’s license to operate the nightclub. The plaintiff obtained injunction order restraining RRR from interfering with their business until the case is finally disposed off. One night, plaintiff found that the restaurant premises were locked in breach of the injunction order. The plaintiff sued for contempt of court’s order. It was pleaded that RRR did not lock up the restaurant but it was Hotel Berjaya. Held: It was a devise to avoid the court’s order. Hotel Berjaya and RRR were functionally one entity and there had been contempt of court.

45 B. AGENCY Company employed as an agent of its controllers.
A company, like any other legal person, may act as an agent for its member or controllers. If a person incorporates a company, specifically to take over a person’s obligations, it is likely that the company will be held to be that person’s agent.

46 Case: Aspatra Sdn Bhd v Bank Bumiputra Malaysia Berhad
BBMB and its subsidiary BMF, sued Lorrain for an account of secret profit that he allegedly made while he was a director of BBMB and chairman of BMF. When writ was filed, BBMB & BMF also got injunction order to restrain Lorrain from transferring his assets out jurisdiction. The order was extended to Aspatra Sdn Bhd. Aspatra challenged the injunction order on the ground that the court should not have treated their assets as Lorrain’s assets for the purpose of granting the injunction order. It was found that Lorrain exercised effective and sole control over the appellant company through his shareholdings and directorships. Held: Court could lift the veil to determine whether assets of the company were really owned by them or whether there was an abuse of the principle that a company is a separate legal entity.

47 C. SHAM/MERE FACADE Incorporation is often used as a device to circumvent the law or to hide the true state of affairs from the court. Some people might use the corporate form as a means to exploit loopholes in the law. In such situation, the court will not be blinded to reality, notwithstanding the technical separateness of the company and its members.

Shaw and Jackson held 4,500 shares each and Trelby held the balance 1000 shares out of total of 10,000 shares. Shaw and Jackson wanted to buy over Trelby’s shares. To effect this, they incorporated a company called Jackson and Shaw (Holdings) Ltd., which made an offer to purchase all the Bugle shares. Shaw and Jackson accepted this offer. Trebly declined. Jackson and Shaw Holdings then purported to use Section 209 (equivalent Malaysia section 180) of the UK Companies Act 1948 to acquire Trelby’s shares. The Court of Appeal declined to allow Jackson and Shaw Holding to take advantage of this section to buy Trelby’s shares.

49 D. GROUP OF COMPANIES In certain situation, a group of companies may be treated as a single corporate entity, although the general rule is that each company within a group is distinct entity. This is due to commercial realities. Case: Hotel Jaya Puri Sdn Bhd v National Union Bar & Restaurant Workers

50 Case: Hotel Jaya Puri Sdn Bhd v National Union Bar & Restaurant Workers
Jaya Puri Chinese Garden Restaurant Sdn Bhd was closed down and workers were retrenched. This company was wholly owned subsidiary of Hotel Jaya Puri Bhd, whose premises the restaurant was situated. The Union claimed that the actual employer was the hotel and the hotel was still in business. Therefore the workers could not have been said to have being retrenched on the closure of a business. The Industrial Court allowed this and made order of compensation against the hotel. The hotel appealed to the High Court.

51 Held: Although technically the restaurant and the hotel were separate legal entities, in reality, the two companies were functionally one. Technically, a person working for the restaurant was an employee of the restaurant, the reality was that the workers were employees of the hotel. The court ignored the separate identities of the restaurant and the Hotel and treated them as one single entity.

52 The End. Any question?

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