LAW 604: LAW OF ASSOCIATION

JANUARY 2018, PART B, QUESTION 1

1) FARAH NABIHAH BINTI BADRUL ZAMAN (2017677894)

2) NURUL BALQIS DANIA BT AHMAD (2017683634) GROUP H
3) SITI NUR AFIQAH BINTI ISMAIL (2017683562)
JANUARY
2018,
PART B,
QUESTION 1
1 ST ISSUE

Whether the courts are able to lift the corporate veil between Syarikat
ABC Bhd and Syarikat XYZ Bhd?
EFFECTS OF INCORPORATION
Sec 20(a) of Company Act 2016:

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.

A fundamental concept of corporate personality is that the corporation is in law

a separate legal entity distinct from its members and controllers.
 SALOMON V A SALOMON & CO LTD [1897] AC 22
 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.
 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.
 SALOMON V A SALOMON & CO LTD [1897] AC 22
 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.

 The creditors claimed that:

1) Salomon was still the owner of the business and liable for its debts.
2) 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.
 HELD
 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.
 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.
 LEE V LEE’S AIR FARMING LTD
 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.
HELD

 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.
 LIFTING THE CORPORATE VEIL
 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.
 JUDICIAL EXCEPTION
Group Of Companies Exception:

DHN FOOD DISTRIBUTORS LTD V LONDON BOROUGH TOWERS HAMLETS (1976)

 DHN was the holding company in a group of three companies. There were two subsidiaries,
wholly owned by DHN. One subsidiary owned land used by DHN (Bronze), the other owned
vehicles used by DHN.
 In 1970 Tower Hamlets London Borough Council compulsorily acquired the premises to build
houses. As a result, DHN had to close down. Compensation was already paid to Bronze, one
and a half times the land value. DHN could only get compensation too if it had more than a
license interest. The Lands Tribunal held no further compensation was payable.
HELD
The Court of Appeal held that DHN and Bronze were part of single economic
entity. Therefore as if DHN had owned the land itself, it was entitled to
compensation for the loss of business.
 APPLICATION
By applying the law to the current case, due to the fact that Syarikat ABC Bhd
and Syarikat XYZ Bhd are related corporations under the Companies Act 2016,
where Syarikat XYZ Bhd are made under the directions of Syarikat ABC Bhd and
Syarikat XYZ Bhd was set up with the primary purpose of importing foreign
workers for the labour force of Syarikat ABC Bhd as they also has no employees
and the profits of Syarikat XYZ Bhd was used by Syarikat ABC Bhd in order to
settle their company’s debts. Thus, they are in holding-subsidiary relationship
whereas Syarikat ABC is the holding company while Syarikat XYZ is the subsidiary
company.
 APPLICATION
As according to the general rule by virtue of sec 20(a) of Company Act 2016 and in the

case of Salomon v A Salomon & Co Ltd, because of Syarikat ABC Bhd did not follow

the method of payment required in the ensuing resolution when they made payment

by cash of RM500,000 to Vertrue for the purchase of 50 tractors, even after the

company secretary had stated in the ensuing resolution that all contractual payments

must be made via internet banking. Hence, Syarikat XYZ Bhd objections may be valid

but only the company of Syarikat ABC Bhd may be liable, not the secretary company

of Syarikat ABC Bhd. This is due to there are separate legal entity.
APPLICATION
However, the court may ignore the separate legal personality of Syarikat ABC Bhd
and look at the controllers of the company which is the company secretary, by
lifting the corporate veil. Here, judicial exception under group of companies may be
applied by courts. By virtue of the judgment in DHN Food Distributors Ltd v London
Borough Towers Hamlets case, the secretary company of Syarikat ABC Bhd and the
company itself were part of single economic entity. Therefore, the company
secretary may be liable due to his/her fault of not following the agreed method of
payment as stated in the ensuing resolution by Syarikat ABC Bhd
CONCLUSION
In conclusion, the court may lift the corporate veil between Syarikat ABC
Bhd and the company secretary successfully and sue the company
secretary of Syarikat ABC Bhd.
2 ND ISSUE

Whether the objections made by the members of Syarikat XYZ Bhd

may be justified by using indoor management rule and its exceptions?
 INDOOR MANAGEMENT RULE
The indoor management rule also known as the Turquand’s rule was developed
as a means of mitigating the harshness and burden of the doctrine of
constructive notice in relation to outsiders dealing with companies.

The effect of the doctrine of constructive notice is harsh on the outsider who does
business with a company. An outsider who dealt with a company is deemed to
have a constructive notice of the contents of the documents of the company. An
outsider cannot claim relief on the ground that he was unaware of the powers of
the company in case of ultra vires of the company.
PRINCIPLE
A person contracting with a company and dealing in good faith may presume
that acts performed within the company’s constitution and powers were duly
performed and the person is not bound to inquire whether acts of internal
management have been regularly complied with.
ROYAL BRITISH BANK V TURQUAND (1856) 119 ER
474
The articles of association of a company authorised the directors to borrow
such sums as may be authorised by a resolution at the general meeting. The
company borrowed money from Mr. Turquand and issued a bond to him.
When the company was sued on the bond, it alleged that under its articles of
association, directors only had power to borrow what had been authorised by
a resolution, and that a resolution had been passed, but did not specify
how much the directors could borrow, thus claiming the bond as invalid.
HELD
Mr. Turquand was entitled to assume that that the acts of the company which
is a matter of internal management has been duly and properly performed and
that the company had complied with the procedure required for
borrowing money. He need not inquire whether necessary resolution had
been passed. Hence, the company was liable on the bond as the excess of
authority was a matter only between the directors and the members
COMPANIES ACT
Under the Companies Act 1965, outsiders dealing with the company are deemed to have
notice of the contents in its public documents, including the MOA & AOA, lodged with Registry
of Company.

However, section 39 Companies Act 2016 seeks to remove this doctrine totally.

Section 39 of Companies Act 2016: Non application of doctrine of constructive notice

 “No person shall be deemed to have notice or knowledge of the contents of the constitution
or any other document relating to the company, due to the fact –
• The constitution or document has been registered by the Registrar ; or
• That is available for inspection at the registered office of the company”
 EXCEPTIONS
There are four circumstances in which the rule is inapplicable.

1) Where the outsider knows or ought to have known of the irregularity at the
time of the transaction.

HOWARD V PATENT IVORY MANUFACTURING

The article provided that the value of £1000 was a limit that could not be
exceeded. However, the directors lent money to the company on the security
of debentures in excess of £1000. The directors then sought to enforce the
debentures.
HELD
The debentures were only valid to the extent of not more than £1000. The
directors must be taken to know that the internal requirements of the
company had not been observed, and thus, could not rely upon the indoor
management rule.
EXCEPTIONS
2) Where the outsider is relying on an irregularity concerning a forged
document.

RUBEN V GREAT FINGALL CONSOLIDATED

The company’s secretary forged the director’s signature on a share

certificate and affixed the seal without authority. It was held that the company
was not bound by the share certificate as it had not held out that the
secretary had the authority to do more than merely deliver valid
certificates.
EXCEPTIONS
3) When the outsider know or ought to have known of the limitation.

IRVINE V UNION BANK OF AUSTRALIA

Despite a limitation in the article, the directors exceeded the limit

imposed on the amount that could be borrowed and obtained a loan
from a bank. The bank sought to enforce the security given to it. It was
held that where a mere reading of the articles would have revealed the
limitation, the bank could not apply the rule in its favour.
EXCEPTIONS
4) When the outsider dealing with the company is put on inquiry and
fails to inquire. In other words, where there are unusual circumstances
which ought to have aroused the suspicions of the outsider.

PEKAN NENAS INDUSTRIES SDN BHD V CHAN CHING CHUEN

It was held that the purpose and extent of inquiry will depend on whether
the circumstances raised doubt regarding possible abuse of power or
existence of power.
 APPLICATION
By applying to our case, the payment of RM 500,000 was made by cash instead of internet
banking as stated in the ensuing resolution. According to the rule, Vertrue in dealing with
Syarikat ABC Bhd are not bound to ensure that all the internal regulations of the
company have in fact been complied with which is the way of contractual payments that
should be followed. It is not necessary for Vertrue to investigate whether or not any
irregularities had taken place. By applying the case of Royal British Bank v Turquand,
Vertrue are entitled to assume that all acts of internal management have been properly
carried out and the issue with regards to the way of payment made via internet banking is
a matter only between the members and the company.
 APPLICATION
Besides, under companies act 1965, Virtue is deemed to have notice of the
contents of Syarikat ABC’s public documents, therefore Virtue should have known
the way of payments that are required to be complied. However, by virtue of
section 39 of Companies Act 2016, this doctrine of constructive notice may not be
applied. Virtue shall not be deemed to have notice or knowledge of the contents of
the constitution or any other document relating to Syarikat ABC. Therefore, it may
be said the contract is valid as Virtue have no knowledge about the way of
payments that are required to be complied.
 APPLICATION
Apart from that, it may be said that all of the four exceptions to indoor management rule
may not be applied. This is because for the first exception, Vertrue did not know or ought to
have known of the irregularity of payments as it is a matter involving only the company and
its members. For second exception, the irregularity in this case was a non-compliance of
requirement of payments made and there was no issue of forged document involved here.
For third exception, verture did not know or ought to have known of the limitation as the
matter of payment were made only between the members and the company. For the fourth
exception, there was no unusual circumstances as to make Vertrue to make an inquiry
regarding the way of payments that should be complied. Therefore, it may be said that the
payment made by Syarikat ABC Bhd by way of cash is valid under indoor management rule.
CONCLUSION
In conclusion, the objections made by the members of Syarikat XYZ Bhd may be
set aside by applying the indoor management rule and therefore the contract
made between Syarikat ABC and Virtue is valid.
3 RD ISSUE

Whether the answer would be different if the contract of Syarikat ABC

Bhd with Vertrue is entered into before Syarikat ABC Bhd is
incorporated?
LAW
Pre-incorporation contracts are contracts made before a company is
incorporated.

Prior to its incorporation, the company has no legal capacity to enter into
any transactions or contracts as it is not yet been registered.

The promoters also cannot be held liable as agents acting for the company
as the principal is not in existence at that time.
COMMON LAW POSITION
Any contracts entered by a company before its incorporation are void due to
the facts that the company has no contractual capacity.

Thus, the company is not bound to any pre-incorporation contract.

According to the principal of the law of agency, an agent also cannot be

created by a principal that is not yet in existence and thus would not have such
authority to act for it.
 KELNER V BAXTER (1866) LR 2 CP 174
The promoters, acting on behalf of the Gravesend Royal Alexandra Hotel Co. Ltd,
which was in the process of being formed, entered into a contract for the
purchase of wine from the plaintiff.

The wine was delivered to the company after it has been formed, however,
before the payment was made, the company went into liquidation.

The court held the company was not bound to the contract before its
incorporation. Thus, the promoters were held personally liable for the non-
payment of the contracts.
NEWBORNE V SENSOLID (GREAT BRITAIN) LTD
(1954) QB 45
Leopold Newborne (London) Ltd. purported to sell goods to the Sensolid Ltd.
The contract has been signed by Mr. Leopold Newborne on behalf of the
company.

However, at that time, Leopold Newborne company has not yet been
incorporated. Thus, Sensolid Ltd. refused to accept the deliveries of the goods.

The court held that Mr. Leopold Newborne has made a contract for a company
which do not exist when he signed the contract as it has not yet been
incorporated. Thus, he could not enforce the contract.
 PHONOGRAM V LANE (1982) QB 938
Before incorporating a company called Fragile Management Ltd., Lane contracted with
the plaintiff (recording company) for a loan of 12,000 to finance a pop artists group called
Cheap, Mean & Nasty.

The plaintiff wrote to Lane in which reference was made to him undertaking to pay. He
nevertheless was required to sign and return a copy for and on behalf of Fragile
Management Ltd. However, the company was never formed and the amount was due. The
recording company brought an action against Lane, who represented the unformed
company.

The court held that Lane is personally liable to repay the money advanced.
 MALAYSIAN POSITION
The defect of common law position :

Third parties may not be aware whether a company has been incorporated or
not.

The difficulties above has been overcome with section 35(1) of CA 1965 which
stated that pre-incorporation contracts may be ratified by the company after its
formation and the company shall become bound by and entitled to the benefit as
if it had been in existence at the date of the contract.
 MALAYSIAN POSITION
Ratification can be done expressly or impliedly.
a) This can be seen in the case of AHMAD BIN SALLEH & ORS V RAWANG HILLS RESORT
SDN. BHD., when there is an express ratification, so long it is clear, the process of
ratification is deemed to be completed.
b) Based on the case of THAI HWA REALTY SDN. BHD. V KETUA PENGARAH HASIL
DALAM NEGERI, ratification can be implied by some act showing an intention to adopt
the pre-incorporation contract, either by silence or mere acquiescene or through usage
of the goods supplied under the contract.

Section 35(1) allows the third party to take action against the company for the failure to
perform the contract after ratification.
 MALAYSIAN POSITION
According to section 35(2), prior to ratification by company/person who act on behalf
of company shall in the absence of express agreement to the contrary be personally
bound by the contract or other transaction and entitled to the benefit thereof.

This means that if the company does not ratify, the 3rd parties may enforce the contract
and take action against the person who entered into contract on behalf of the company.

It is also need to be highlighted that the personal liability only occurs when ‘there is no
express agreement to the contrary’ or in the case of Phonogram Ltd. v Lane, such
words also means ‘unless otherwise agreed’ and clear words to exclude liability.
MALAYSIAN POSITION
Section 35(2) should also be read with section 65 which stated that any
pre-incorporation contract has effect as such contract/transaction made
with the person purporting to act for the company/agent is personally
liable on the contract. The contract may be ratified after its incorporation,
and then only the company shall be bound as the company exist and a
party on the date of the contract.
 APPLICATION
In this current situation, if the contract of Syarikat ABC Bhd with Vertrue is entered
into before Syarikat ABC Bhd is incorporated, the contract is known as pre-
incorporation contract.

If the common law was applied here, the pre-incorporation contract between
Syarikat ABC Bhd with Vertrue would be void as Syarikat ABC Bhd has no
contractual capacity to enter into any kind of contracts/transaction before
incorporation. This causes the company would not be bound to the said contract.
 APPLICATION
By applying the case Newborne v Sensolid (Great Britain) Ltd (1954) QB 45, the
contract could not be enforced as Syarikat ABC Bhd which has not yet been
incorporated will be considered as non-exist.

This causes difficulties on behalf of Vertrue who deals with Syarikat ABC Bhd, to
be aware whether Syarikat ABC Bhd is incorporated or not. Thus, by applying
section 35(1) of CA 1965, the pre-incorporation contract may be enforced with the
ratification made by Syarikat ABC Bhd. The ratification would cause Syarikat ABC
Bhd to be bound to the contract on purchasing the 50 tractors and entitled to the
benefit as it had in existence at the date of the contract.
APPLICATION
By applying the case of Ahmad bin Salleh & Ors v Rawang Hills Resort Sdn.
Bhd., Syarikat ABC Bhd should ratify it clearly in order to make express
ratification. However, according to the case of Thai Hwa Realty Sdn. Bhd. v
Ketua Pengarah Hasil dalam Negeri, the ratification from Syarikat ABC Bhd can
be said as has been given impliedly when Syarikat ABC Bhd has used the 50
tractors supplied by Vertrue.
 APPLICATION
If Syarikat ABC Bhd does not ratify the contract, Vertrue may take action against the
person who acts on behalf of Syarikat ABC Bhd in dealing with the pre-incorporation
contract by virtue of section 35(2). However, the personal liability only occurs if there
is no express agreement to the contrary in the contract between Vertrue and Syarikat
ABC Bhd.

By applying section 65, even the contract between Vertrue and Syarikat ABC Bhd is
made before Syarikat ABC Bhd incorporated, the contract still has effect on the person
who acts on behalf of Syarikat ABC Bhd. Syarikat ABC Bhd would be bound and
considered exist as a party once the contract has been ratified after its incorporation.
CONCLUSION
In conclusion, if the contract of Syarikat ABC Bhd with Vertrue is entered
before Syarikat ABC Bhd is incorporated, the contract requires ratification as
stated in section 35 of CA 1965 to enforce the contract as pre-incorporation
contract was void under the common law.