Separate Legal Personality, Limited Liability and the Corporate Veil

The doctrine of separate legal personality divorces the rights, liabilities and asset-ownership of a company from that of its shareholders. To understand how it works, we need to take a brief historical excursion back to historic England and examine how and why the doctrine came to be.

Historical Perspective: Partnership Law and Limited Liability

The concept of legal personality originates from the the English 18th century legal vehicle of a 'private co-partnery'. At the time, there was no limit to the extent of liability a member could incur for the debts of the partnership.

With the rise of railway companies during the industrial revolution coupled with the development of a share exchange in the United Kingdom, a demand was created for a type of legal entity that could accommodate large sums of capital injection without holding each and every member or shareholder unlimitedly liable for the debts of the company.

Enter the joint stock company - a 'public co-partnery' as it was called then called, which allowed for incorporation with the option of limited liability for its members by way of simple registration as early as 1856, requiring only 7 members to sign the memorandum of association. With the advent of limited liability, the debts of the company were seen as separate from that of its members.

The dichotomy between a company and its members permeated further separating rights, liabilities, and ownership of assets. The company thus began to look like an entirely separate entity from that of its members, giving rise to what we now call the doctrine of separate legal personality.

Separate Legal Personality in Malaysia

Coming back to Malaysia, the doctrine of separate legal personality has been codified under Section 20 of our Companies Act 2016. The upshot of this is that a company is able to do the following:

(i) To Contract and Transact

Upon incorporation, a company is able to enter into agreements in its own name. It will be able to deal, acquire, transact, sell, buy and register any property in its own name. The property will belong to the company alone. Its director, shareholders and/or creditors will not hold any legal and/or equitable interest over the assets of the company by virtue of their positions within or in relation to the company.

In fact, under English law, a share is not viewed as a proprietary interest nor percentile of ownership over the assets of the company, but rather as a mere right to receive dividends.

(ii) To Sue and be Sued

Separate legal personality also entails recognizing that the company is as a wholly separate person having its own rights and obligations. This means that the company is able to enforce its own rights and may have its own obligations enforced against it..

In fact, if a company wishes to enforce its rights by bringing an action or if someone seeks to enforce obligations against a company, the company must sue as a plaintiff or be sued as a defendant in its own name, not its members nor directors. This is commonly referred to as the 'proper plaintiff rule'.

(iii) To Incorporate and Congregate

Another consequence of separate legal personality is that a company may become a member of another company through registration or incorporation. Just as individuals may gather as members to incorporate a company ("Company Z"), another company ("Company X") may also incorporate or join the membership of Company Z.

This gives rise to corporate group structures or using the example above, Company Z as the parent/holding company of Company X, and Company X as the subsidiary company of Company Z. Malaysian law makes it clear, however, that companies within corporate group structures are all distinct and separate from each other i.e. Company X is a separate legal entity from that of Company Z, notwithstanding the fact that Company X is a member of Company Z

(iv) To Survive and Thrive

The continued existence of a company does not depend on any variation to its membership, otherwise known as 'perpetual succession'. A company, does, however, require at least one person to remain a member of the company. Apart from that, the existence of a company may only be terminated through deregistration which may take without or after winding-up.

(iv) To Limit Liability

The Companies Act 2016 provides for various schemes of liability for the members of a company. Members may opt for one of three options being:

• unlimited liability;

• limited liability by way of shares; or

• limited liability by way of guarantees.

Under a limited liability scheme, liability of members members for any debts of the company will only be limited to either amount that they have paid for their shares (shareholders) or to the amount they have guaranteed to pay in the event the company becomes insolvent (guarantors).

Piercing/Lifting the Corporate Veil of Incorporation: Beyond Limited Liability

The term assigned to the legal divide between a company and its members is the 'corporate veil of incorporation', which as the term denotes, comes into effect upon the incorporation date of the company under Section 18 of the Companies Act 2016.

As illustrated above, this veil shields members or directors from becoming liable for the wrongdoings committed by the company (proper plaintiff rule) and limits the liability of members in any event to the amount they have paid their shares for or guaranteed.

The exception to this, however, is when the corporate veil is being used by a company's members and/or directors as a 'sham' or a façade, a Court will either 'pierce' or 'lift' the veil to hold a company's members and/or directors responsible for the actions of the company.

Given that our local jurisprudence in this area of law is rather nascent, recourse will be made to English law concerning subverting the veil. Malaysian Courts regularly cite and rely upon English cases when dealing with corporate veil lifting or piercing cases.

(i) Piercing the Corporate Veil

Piercing disregards the veil in its entirety and hold the person(s) behind the corporate veil. Courts will only pierce the veil if it is being used to evade an existing liability. Consider the example below:

Fraud, tax evasion, and money laundering are few among many common features of veil-piercing cases.

(ii) Lifting the Corporate Veil

Lifting, on the other hand, does not disregards the veil. It merely looks beyond the veil to discover and ascertain the true identities of those behind the actions of the company or companies in question. Courts will only lift the veil if it is being used to conceal the identity of the real perpetrators. Consider the example below:

In lifting the veil, the Courts look at various factors in determining whether a company or a group of companies are being used to conceal the identities of wrongdoers. This is especially difficult to do where parent and subsidiary companies are interpolated to create complex layers of concealment. In such cases the following factors are relevant:

• whether one company is merely being used as an agent for another company;

• whether the profits of one company are directly transposed to the profits of another company;

• whether one company exerts control over another company by determining its boardroom composition, direction, and capital;

• whether one company truly exists as a separate legal entity in its own right and exercises independent judgment; and

• whether several companies band together to act as a single economic unit.

Concluding Remarks

What once began as an vehicle for economic modernization in the United Kingdom has now made its way into the statutes of Malaysia. Like all advancements, potential for abuse remains always an inevitable feature. Though hallmarks of Malaysian company law, the concepts of limited liability, the corporate veil and separate legal personality can and have all been used to perpetrate criminal and fraudulent endeavors. The twin doctrines of veil piercing and lifting therefore serve to mitigate such abuse and police white collar crime. To end with a quote from Denning LJ in Lazarus Estates Ltd v Beasley [1956] 1 QB 702, 712:

"No court in this land will allow a person to keep an advantage which he has obtained by fraud. No judgment of a court, no order of a Minister, can be allowed to stand if it has been obtained by fraud. Fraud unravels everything …"