Fraudulent Trading & Risk of Personal Liability to Directors of an Insolvent Company
Most businesses are not allowed to operate during the Movement Control Order (“MCO”) period starting from 18.3.2020, which is now extended to 28.4.2020. Despite the various initiatives and financial assistance offered by the government and the statutory bodies, many companies have completely lost their income while continue incurring their usual monthly overhead expenses. They are struggling and looking for alternatives with the hope of keeping their business and sustaining their livelihood.
But, the future looks bleak. After the MCO is lifted, businesses may be slow and revenue may not be sufficient to cover costs and expenses. There may even be situations where some companies have substantial assets and investments that are not easily realizable, yet there are no assets available to meet their current liabilities. These companies will be regarded as commercially insolvent and may be wound up. If that is the case, can these companies continue to trade?
Directors’ Personal Liability
In Malaysia, a director is generally not liable for the debts or liabilities of the company due to the legal principle that a company is a legal person that is independent of and separate from its directors and shareholders.
However, there is one exception to the limited liability principle and that is found in section 540(1) of the Companies Act 2016 (“CA 2016”).
In essence, the statutory provision states that, in the course of the winding up of a company or any proceedings against a company, any person who has knowingly caused the company to carry on any fraudulent trading shall be personally liable, without any limitation of liability, for all or any of the debts or other liabilities of the company as the court directs. Fraudulent trading is also a criminal offence which is punishable with an imprisonment of not more than 10 years or a fine of not more than RM1 million or both.
What is Fraudulent Trading?
Fraudulent trading involves an “intention to defraud” which is widely defined to include:
a) dishonesty in incurring debts which cannot be repaid; or
b) knowledge that there is a “substantial and unreasonable risk” that the debts incurred will not be repaid.
An example of fraudulent trading would be a situation where a company continues to carry on its business and incur debts knowing that it will not be able to pay employees’ salary, EPF / SOCSO contributions and/or workers’ compensation.
In Dato’ Prem Krishnan Sahgal v Muniandy Nadasan & Ors  10 CLJ 385, the employees of a public listed company (“CNLT”) filed a suit against, amongst others, the directors of CNLT for fraudulent trading and conspiracy. The Federal Court held that the arrears of salary and workers’ compensation claimed by the employees were valid debts and hence, the employees were creditors of CNLT. The appellant (i.e. the Executive Managing Director of CNLT) was well aware of such claims but had nevertheless continued to carry on the business and incur debts despite knowing that there was no reasonable prospect of the employees ever receiving their payments. As such, the Federal Court held that fraudulent trading under section 304 of the Companies Act 1965 (now section 540 of CA 2016) was established and the appellant was personally liable to the employees’ claims.
Who can complain?
The persons who may apply for an court order to be made under section 540 of the CA 2016 are:
a) the liquidator (including interim liquidator) of a company;
b) any shareholder or contributory of the company; or
c) any creditor (including judgment creditors, contingent creditors or prospective creditors) of the company.
When a company is commercially insolvent, its directors (including chief executive officer, chief finance officer, chief operating officer or any other person primarily responsible for the management of the company) should be extremely mindful and alert to raise a red flag on any transaction that may be regarded as a fraudulent trading and act reasonably to minimise creditor losses. In case of doubt, it will be prudent to consult the expert and avoid personal liability for debts or liabilities incurred by the company.
Lau Kee Sern
Joshua Tan Jo-Ven
Messrs Kee Sern, Siu & Huey
2nd Floor, Block C, Rivercity Jalan Sultan Azlan Shah (Formerly Jalan Ipoh)
51200 Kuala Lumpur
Tel: +60(3) 9212 2688
Fax: +60(3) 4044 0448
All rights reserved. The contents of this publication, current at the date of publication set out above, are for reference purposes only. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action based on this publication.