Tutorial Questions ABBL3144 Corporate Law & Governance

TUNKU ABDUL RAHMAN COLLEGE

DIPLOMA IN BUSINESS STUDIES

CORPORATE LAW & GOVERNANCE

Tutorial 2

1. What important rule of company law was established in the case of Salomon v Salomon & Co. Ltd?

The principle that the company is a separate legal entity was firmly established in the case of Salomon v Salomon
(1897).

Facts:
• Mr. Aron Salomon was a shoemaker in England and had for many years carried on a prosperous business
as a leather merchant. His sons wanted to become his business partners, so he converted his business into
a limited company (Salomon & Co Ltd).
• Salomon & Co Ltd purchased Mr. Salomon’s business for above market value.
• His wife and his five children became members. The two eldest sons became directors of the company, and
Mr. Salomon was the Managing Director.
• Mr. Salomon was allocated 20,001 of the company’s 20,007 shares.
• The company gave Mr. Salomon £10,000 in debentures and received an advance of £5,000 from Edmund
Broderip, on security of the debentures.
• Salomon’s business eventually failed, and it defaulted on its interest payments on the debentures (half held
by Broderip). Broderip sued to enforce his security.
• The company went into liquidation. Broderip was repaid his £5,000. This left £1,055 company assets
remaining. Salomon claimed this amount under his retained debentures. This would leave nothing for
unsecured creditors.
• The company’s liquidator argued that Salomon should be responsible for the company’s debts. Salomon
sued for the £1,055.

Decision:
• As the company was duly incorporated, it is an independent person with its rights and liabilities appropriate
to itself, and that “the motives of those who took part in the promotion of the company are absolutely
irrelevant in discussing what those rights and liabilities are.”
• Mr. Salomon is not personally liable for the company’s debts, and he is entitled to enforce his rights against
the company. (He is also a secured creditor of the company)

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2. Discuss with reference to relevant cases the situations in which the veil of incorporation may be lifted by the
courts.

*Lifting/ piercing veil of incorporation means the court now ignores the principle of separate legal entity. Lifting
veil of incorporation makes the members of the company personally liable for the debts of the company. This
happens when there’s evidence that the members of the company are hiding behind their company to commit
fraud or avoid their legal obligations, for purpose of justice etc.

Jones v Lipman (Company set up to avoid contractual obligation)

• In the case of Jones v Lipman, Lipman had entered into a contract to sell certain land to Jones.
• He later changed his mind and in order to “keep” the land for himself, he transferred the land to a
company that he controlled.
• The court found that the company was a sham had been used by Lipman solely for the purpose of evading
the transaction or legal obligation or agreement with Jones.
• The corporate veil was lifted, and the court ordered specific performance against Lipman and his
company to transfer the land to Jones.

Gilford Motor Company v Horne (company set up for purpose of dishonestly evading or avoiding legal
obligations or to perpetuate fraud)

• Horne set up a new company and began to attract or solicit his former company’s clients and this was
against his valid restraint of trade agreement.
• The new company was a mere sham allowing him to go against the contractual obligation he had with
his former company.
• The veil of incorporation was lifted, and the court imposed an injunction order against Horne and his
company.

Smith, Stone & Knight Ltd v Birmingham Corporation (company acting as agent or partner of the
controlling company)

• Smith, Stone & Knight (SSK) were the owners of a premise, but the business was being operated by a
subsidiary company.
• The local council, Birmingham Corporation (BC) issued a compulsory purchase order on this land.
• The local council law states that only the owner of the premises was entitled to compensation if the
business was operated by the owner himself.
• Since the subsidiary company did not own the land, BC claimed they were entitled to no compensation.
• SSK successfully argued that the veil should be lifted so as to treat the subsidiary company as carrying
on its business as agent for the parent (holding) company, thus entitling the parent company to receive
the compensation for disruption of its business when the premise was compulsorily acquired by the local
council.
• The court held BC must pay compensation to the parent (holding) company.

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Hotel Jaya Puri Sdn Bhd V National Union Bar & Restaurant Workers (related corporations)

• The plaintiff in this case was the holding company and a restaurant (Jaya Puri Chinese Garden Restaurant
Sdn Bhd) within its premises was the wholly owned subsidiary company of the hotel.
• The restaurant faced some financial loses and 56 workers in the restaurant were retrenched and the issue
before the court was whether the holding company (Hotel Jaya Puri) was liable to pay compensation to
the restaurant workers.
• The court held that the holding company had to pay the compensation. This was because the hotel and
the restaurant were inter-dependent –where a number of senior officers such as the managing director
and secretary were common to both the hotel and the restaurant.
• Therefore, the hotel is the employer of the restaurant employees.
• The corporate veil was lifted because of justice requirement.

Note: In the case of related corporations i.e. corporations that have a holding and a subsidiary relationship between
themselves, the corporate veil may be lifted to allow one corporation to be liable for the acts committed by another
corporation.

Re FG (Films) Ltd:

• Facts: An American film company called FGI had the rights to produce a movie.
• They wanted to receive a subsidy offered in England for local filmmakers, so its president
incorporated a British company.
• FG’s participation in the undertaking of the film was so small and the sole purpose of making the
company was to obtain the subsidy.
• Thus, the corporate veil was lifted because court looked into actual shareholders and not just the
company as registered in England.

3. Romeo and Juliet wish to start a business manufacturing dolls. They have an initial capital of RM 10,000 but
they estimate that the business would require RM 50,000. Friends and relatives are willing to invest in this
business, but Romeo and Juliet wish to be in control in terms of decision making and voting power. They
have plans to export the dolls to Singapore possibly within two years of operation. They seek your advice on
the following matters:

a) What form of business structure would be appropriate for this type of business? Give reasons for your
answers.

There are 3 types of business which are sole proprietor, partnership, and company. The risk is extremely high to
start a business manufacturing dolls as there are many competitors.

Partnership also can be considered because there is a combination of skills and expertise of partners and there is
ability to raise more capital. Profits and losses must be shared. However, Partnership is not suitable because the
members of partnership have unlimited liability. Their wealth such as the assets and properties may be affected
to pay off partnership debts due to unlimited liability.

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It is advisable not to form public company, as it is risky to do so. No one would buy the shares of the company
because it is a new business, and the brand name is not well known by the public. Therefore, it is hard to raise
money.

On the other hand, the members of the private company have limited liability. Friends and relatives can invest in
their business. Besides that, the private company has perpetual succession and can sue or be sued by others.
Furthermore, it can own property or enter into contract in its own name. Therefore, private company is suitable.

Romeo and Juliet may also become the majority shareholder so that they can control management decision.

b) Is it true to say that Romeo and Juliet will never be personally liable for the debts of the business in the event
that they form a limited company?

Yes, they will never be personally liable because it is limited liability unless they enter into any transactions
which falls under one of the exceptions under lifting the veil of incorporation. Generally, the liability of members
of a limited company is limited to the amount of unpaid shares held.

c) When they expand their business in two years’ time and more capital is required how should they proceed?

They could convert private company to public company when they expand their business. They can raise their
capital by issuing shares. More people will buy the shares because the company is established.

4. Explain the statutory exceptions in lifting the corporate veil of incorporation.

Section 540(1) CA 2016 – According to this section, if in the course of the winding up of a company or in any
proceedings against a company, the Court finds that the business of a company has been carried on with intention
to defraud creditors or for any fraudulent purpose it may declare that any persons who were knowingly parties to
carrying on the business in this fashion shall be personally liable for the debts of the company as the court may
decide.

Section 539(3) CA 2016 – If in the course of winding up of a company or in any proceedings against a company,
an officer of the company enters into the contract to borrow money knowing that the company is unable to pay
the debt, that officer shall be personally liable.

5. Can a company adopt a constitution?

• Company may adopt a constitution.

• Section 32(1) CA 2016 provides that a company may adopt a constitution for the company and the
adoption shall be by way of special resolution.

• Section 32(3) CA 2016 provides subject to the provisions of this Act, the constitution adopted under
subsection (1) shall be binding on the company, its directors, and its members.

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6. Which types of company must adopt a constitution?

• A company limited by guarantee must have a constitution. – Section 31(1) CA 2016.

• Companies limited by shares have the option of adopting a constitution or not. If a company issues

preference shares/ different classes of shares, it must adopt a constitution.

7. What are the contents of a constitution?

Section 35(1) CA 2016 states the constitution of a company may contain provisions relating to—

o the objects of the company;

o the capacity, rights, powers or privileges of the company if the provision restricts such capacity, rights,
powers or privileges;
o matters contemplated by this Act to be included in the constitution; and
o any other matters as the company wishes to include in its constitution.

8. What is a notice of registration under the Companies Act?

The notice of registration is conclusive evidence that the requirements of this Act in respect of registration and
matters precedent and incidental to such registration have been complied with and that the company is duly
registered under this Act – S.19 CA 2016

9. What are objects of a company limited by guarantee?

S.45 (1) CA 2016 states, a company limited by guarantee shall be formed with the following objects:
• providing recreation or amusement;
• promoting commerce and industry;
• promoting art;
• promoting science;
• promoting religion;
• promoting charity;
• promoting pension or superannuation schemes; or
• promoting any other object useful for the community or country

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*Examples of problem questions

Consider the following separate and independent situations and advise the parties whether the veil of
incorporation may be lifted.

a. Alex and Max are friends. Max agrees to sell his apartment to Alex at a very fair price because
Alex urgently needs a place to stay in the city. When Max shares this news with his wife Betty,
she convinces him to change his mind as Betty just read in the newspaper that the value of real
estate in Klang Valley is expected to increase significantly in the next six months. The following
week, when Alex approaches Max regarding his apartment, Max informs him that he had sold
the apartment to a company called DBC Sdn. Bhd. As a matter of fact, DBC Sdn. Bhd.’s sole
director is Max’s wife while both his wife and he are the sole shareholders of the company. Advice
Alex on his legal status.

• Issue is whether the veil of incorporation may be lifted so as to allow Alex to enforce the
contract of sale of the apartment?
• S.20 CA 2016 provides that a company incorporated under CA 2016 is a body corporate and
shall have legal personality separate from that of its members and continues in existence until
it is removed from the register.
• This principle of veil of incorporation was originally found in the Salomon v Salomon & Co
Ltd (1897) where although the company was controlled by Salomon, who was the controlling
director and majority shareholder, the court held that the company was a separate legal entity
and was solely responsible for its own debts.
• It is capable of exercising all the functions of a body corporate and have the full capacity to
carry on or undertake any business or activity as provided in S.21(1) CA 2016.
• Although the company is a separate legal entity from its members, in certain situations under
common law and statute, this principle may be disregarded. This is referred to as “lifting the
veil of incorporation”.
• When the court lifts the veil of incorporation this means the court no longer regards the
company and its members as separate. By doing so the law can make a company officer or
member responsible for the company’s liability.
• As a general rule, once DBC Sdn. Bhd. was incorporated, it is a separate legal entity from Max
and Betty.
• However, since it is clear that they only have incorporated DBC Sdn. Bhd. for the purpose of
avoiding selling the apartment to Alex, this falls under a judicial exception where veil of
incorporation may be lifted where the corporate form was set up to avoid a contractual duty,
i.e., to avoid performance of the contract.
• In the case of Jones v Lipman (1962), Lipman the owner of the land contracted to sell it to
Jones, but then changed his mind. In order to ‘keep’ the land, he set up a company and sold the
land to the new company in the hope that, although he personally would have to pay damages
to Jones, the land would still be owned by ‘his’ company which was a separate person. The veil
was lifted, and specific performance was awarded against both him and the company to transfer
the land to Jones.
• Therefore, in conclusion, in this case the veil of incorporation also may be lifted as it is clear
the only reason DBC Sdn. Bhd. was set up was to avoid selling the apartment to Alex.
• The court may order specific performance against Max, Betty and DBC Sdn. Bhd. to sell the
apartment to Alex.

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b. Bella worked as a hairstylist at Fancy Style Sdn. Bhd. a popular hair salon. The owner of Fancy
Style Sdn. Bhd. asked Bella to sign a contract which included a term that prohibited her from
being employed or involved in the hair styling business within 10kms of a Fancy Style hair salon.
Bella resigned from Fancy Style hair salon after 1 year and incorporated a company with her
sister, called Beauty Style Sdn. Bhd. for her own hair styling business. Bella’s new salon was
situated 5 doors away from Fancy Style Sdn. Bhd. Most of Bella’s former clients from Fancy Style
Sdn. Bhd. have since stopped going there and started using’s Bella’s services instead. Advice
Fancy Style Sdn. Bhd. on their legal status regarding this matter.

• Issue is whether the veil of incorporation may be lifted to enforce a valid restraint of trade
agreement against Beauty Style Sdn. Bhd.?
• S.20 CA 2016 provides that a company incorporated under CA 2016 shall have legal personality
separate from that of its members.
• This principle of veil of incorporation was originally found in the Salomon v Salomon & Co Ltd
(1897) where although the company was controlled by Salomon, who was the controlling director
and majority shareholder, the court held that the company was a separate legal entity and was solely
responsible for its own debts.
• Once a company is incorporated, it is capable of exercising all the functions of a body corporate
and it has the full capacity to carry on or undertake any business or activity as provided in S.21(1)
CA 2016.
• Although the company is a separate legal entity from its members, in certain situations under
common law and statute, this principle may be disregarded. This is referred to as “lifting the veil
of incorporation”.
• When the court lifts the veil of incorporation this means the court no longer regards the company
and its members as separate. By doing so the law can make a company officer or member
responsible for the company‘s liability.
• As a general rule, once Beauty Style Sdn. Bhd. was incorporated, it is a separate legal entity from
Bella.
• However, since Bella’s company was set up for the main purpose of dishonestly evading existing
legal obligations (to avoid contracts) or to perpetuate fraud, this falls under a judicial exception
where veil of incorporation may be lifted.
• In the case of Gilford Motor Co. Ltd. V Horne (1933), Horne an ex-company director was
personally bound by a valid restraint of trade agreement from approaching his former company’s
customers. He set up a new company and attempted to do so. The court lifted the veil to expose his
act of evading an existing legal obligation and imposed an injunction against his new company as
well as against him.
• Therefore, in this case, the veil of incorporation may be lifted, and Bella’s company may be bound
by the restraint of trade agreement and Bella should not approach Fancy Style’s customers or
continue to operate her shop within the 10km distance from Fancy Style’s salon.

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