Are Directors Liable For Company’s Debts? – Law on Separate Legal Entity
Introduction to Separate Legal Entity in Malaysia
One of the most fundamental principles of company law in Malaysia is the doctrine of separate legal entity. This concept, established under both common law and statutory provisions, forms the cornerstone of how companies operate in the country.
A separate legal entity means that a company is recognized by law as having its own legal identity, distinct from its shareholders, directors, or employees. This principle allows companies to own property, enter into contracts, sue or be sued, and continue to exist regardless of changes in ownership or management.
In this article, we will explore the origins of the separate legal entity doctrine, its application in Malaysian law, and the implications for business owners, investors, and creditors.
1. Legal Foundation of Separate Legal Entity in Malaysia
a. Companies Act 2016 (Act 777)
The Companies Act 2016 is the primary legislation governing companies in Malaysia. Section 20 of the Act states:
“A company shall on and from the date of its incorporation be a body corporate and shall—
(a) be capable of exercising all the functions of a body corporate;
(b) continue in existence until it is removed from the register; and
(c) be capable of suing and being sued in its own name.”
This legal provision confirms that once a company is incorporated, it becomes a distinct legal person, separate from its incorporators and members.
b. Common Law Principle – Salomon v A Salomon & Co Ltd (1897)
The leading case that established the principle of separate legal entity is Salomon v A Salomon & Co Ltd. In this UK case, which continues to be highly persuasive in Malaysian courts, the House of Lords held that:
“A company is at law a different person altogether from the subscribers to the memorandum; and though it may be that after incorporation the business is precisely the same as it was before… the company is not in law the agent of the subscribers or trustee for them.”
This case laid the groundwork for corporate personality, which has been adopted and followed by Malaysian courts.
2. Key Characteristics of a Separate Legal Entity
Understanding how a separate legal entity operates helps clarify the benefits and responsibilities of doing business through a company in Malaysia:
i. Distinct Legal Identity
A company can own assets, incur debts, and bear liabilities in its own name. This shields shareholders and directors from personal liability, except in limited circumstances.
ii. Perpetual Succession
The life of a company is not affected by the death, insolvency, or resignation of its members. It continues to exist until formally wound up.
iii. Ability to Sue and Be Sued
The company can initiate or defend legal proceedings in its own capacity. Shareholders cannot usually sue on behalf of the company unless in special circumstances (e.g. derivative actions).
iv. Separate Tax Liability
The company is a separate taxpayer from its shareholders. It must file its own corporate tax returns and pay tax on its profits.
3. Importance of the Doctrine in Malaysian Business
a. Limited Liability Protection
The most practical implication of separate legal personality is limited liability. Shareholders are generally not personally liable for the company’s debts. Their risk is limited to the amount unpaid on their shares.
This encourages entrepreneurship by allowing individuals to take business risks without risking personal assets, thereby promoting investment and economic growth.
b. Facilitates Capital Raising
Because the company is separate from its shareholders, it can issue shares and raise capital without affecting the legal structure. Investors are more willing to invest in entities where their liability is limited.
c. Business Credibility and Continuity
A registered company with a separate legal identity appears more credible to banks, suppliers, and customers. The principle also ensures business continuity, as the company survives beyond changes in ownership or management.
4. Exceptions to the Rule: Lifting the Corporate Veil
While the doctrine of separate legal entity is well-established, Malaysian courts may disregard it in exceptional cases where the company is used to commit fraud, evade legal obligations, or act as a sham.
a. Common Grounds for Piercing the Corporate Veil
- Fraud or Improper Conduct – If the company is used to defraud creditors or act illegally.
- Agency or Alter Ego – If the company is merely an agent or façade of its controllers.
- Undercapitalization – If the company has insufficient capital to meet its obligations.
- Group Enterprises – In some cases, courts treat a group of companies as a single entity if their operations are intermingled.
b. Notable Case Law
Gurmit Kaur a/p Jaswant Singh v Ho Kit Yen & Ors [2017] MLJU 849
In this case, the High Court stated that the corporate veil may be lifted if it is just and equitable to do so, especially when the company is used to shield wrongdoers.
Tan Lai v Mohamed Bin Mahmud [1984] 1 MLJ 219
The court lifted the veil where a company was used as an instrument of deception to avoid liability for a contract.
5. Challenges and Criticisms
While the doctrine is beneficial, it is not without criticism:
- Abuse of Corporate Form: Some unscrupulous individuals use companies to avoid liabilities, leaving creditors without recourse.
- Difficulty in Piercing the Veil: Courts are generally reluctant to disregard corporate personality, even when morally warranted.
- Overprotection of Directors: Some believe the principle may unfairly shield company directors from accountability.
6. Practical Tips for Business Owners in Malaysia
If you’re running or planning to start a company in Malaysia, here are a few things to keep in mind:
- Incorporate Properly – Register with the Companies Commission of Malaysia (SSM) and ensure compliance with the Companies Act 2016.
- Maintain Proper Records – Keep minutes, resolutions, and financial statements to uphold the integrity of the company’s separate legal identity.
- Avoid Commingling Funds – Do not mix personal and company assets. This helps preserve the distinction between the two entities.
- Comply with Legal Obligations – Directors and shareholders must not use the company for fraudulent or illegal purposes.
- Seek Legal Advice – Especially when entering into significant contracts or facing legal disputes involving the company.
Conclusion
The principle of separate legal entity is a cornerstone of our Malaysian company law. It provides numerous benefits including limited liability, business continuity, and corporate autonomy. However, it must be respected and used ethically.
Understanding how this principle works, its limits, and how Malaysian courts apply it will help business owners, directors, and investors navigate the legal landscape more effectively.
Whether you’re setting up a new enterprise or managing an existing one, knowing your rights and responsibilities under the Companies Act 2016 and the common law can make all the difference.
Frequently Asked Questions (FAQ)
1. What is a separate legal entity in Malaysia?
A separate legal entity is a company that is legally independent from its shareholders and directors. It can own assets, incur liabilities, and sue or be sued in its own name.
2. Why is the concept of separate legal entity important?
It protects shareholders from personal liability, ensures business continuity, and enables companies to operate independently.
3. Can the corporate veil be lifted in Malaysia?
Yes, courts can pierce the corporate veil in cases of fraud, misrepresentation, or abuse of the company structure.
4. Is a partnership a separate legal entity in Malaysia?
No, partnerships (except for limited liability partnerships) do not have separate legal status. Partners are personally liable for the business’s debts.
5. How can I ensure my company maintains its separate legal identity?
Maintain separate accounts, follow statutory requirements, and avoid using the company to commit fraud or evade responsibilities.
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Disclaimer: The above proposition is subject to actual facts and circumstances and shall never be referred as the actual law without seeking legal advice. Consult us for more information!