Misappropriation of Company Funds - Director Held Liable for Turning a Blind Eye

“I don’t know where the money went!” – A nefarious line many wrongdoers resort to.

In the recent Court of Appeal case of Tetuan Sulaiman & Taye v Wong Poh Kun & Anor [2023] 1 LNS 184, the wrongdoers were the directors (”Directors”) and the mandatory signatories of bank accounts of a wound-up company (“Company”). They were also brothers.

As the Directors failed to explain how the Company’s funds disappeared, the Court of Appeal concluded that they dissipated the funds to defraud its creditors. The Creditor was a law firm that provided legal services to the Company but was not paid.

Although the alleged fraudulent act occurred before any proceeding was commenced against the Company, the Court of Appeal opined that Section 540 of the Companies Act 2016 (“CA 2016“) still applied.

The Court of Appeal also decided that the Directors were personally liable to the Creditor, and that payment should be made to the Creditor directly.

Background Facts

Sometime in 2010, the Company engaged the Creditor for legal services (“Creditor“). On or around 2.7.2014, the Creditor billed the Company a sum of RM5,907,500.00 to account for legal fees.

Having not received any payment, the Creditor commenced an action in August 2014 against the Company and obtained a Judgment in Default of Appearance on 12.9.2014.

Subsequently, the parties agreed for the bill to be taxed. However, before that could happen, the Company was wound up by the Government of Malaysia (”GOM”) based on a statutory demand of RM5,651,663.48 issued on 21.4.2015.

The Creditor then filed a claim against the Directors alleging that:-

the Company, although having disposed its lands for a sum of RM429,868,897.92 on 1.10.2023 and received a sum of approximately RM70 million, failed to satisfy its debts;
the sum received was more than sufficient to satisfy all the Company’s debts;
the Directors failed to utilise the proceeds to pay the Creditor and the GOM, and instead dissipated the proceeds to themselves; and
such fraudulent acts were evident when a sum of RM4,999,991.00 was transferred from the Company’s account on 19.6.2014 to one of the Directors. This was done one day after receiving the money.

The High Court allowed the Creditor’s claim. The Directors were to pay the legal fees owed to the Creditor and the sum owed to the GOM. The payment was to be made to the liquidator of the Company, as contribution to the assets of the Company.

Both parties appealed against the High Court’s decision.

The Law

Under the repealed Section 304(1) of the Companies Act 1965, and now Section 540(1) of the CA 2016, it is stated that:

“(1) If in the course of the winding up of a company or in any proceedings against a company it appears that any business of the company has been carried on with intent to defraud the creditors of the company or creditors of any other person or for any fraudulent purpose, the Court on the application of the liquidator or any creditor or contributory of the company, may, if the Court thinks proper so to do, declare that any person who was knowingly a party to the carrying on of the business in that manner shall be personally responsible, without any limitation of liability, for all or any of the debts or other liabilities of the company as the Court directs.”

Therefore, there needs to be two main elements (Huatah Sdn Bhd v Yap Chee Kian & Ors [2020] 2 CLJ 560):-

the business of the company has been carried out with the intent to defraud creditors or for any fraudulent purpose; and
the defendants were knowingly parties.

Intent is a question of fact. It is to be inferred from the surrounding circumstances and the subsequent conduct of the defendants (LMW Electronics Pte Ltd v Ang Chuang Juay & Ors [2010] 4 CLJ 849).

There is also no need for evidence of a scheme to defraud the company’s creditors. A single act is sufficient to invoke Section 540 of CA 2016 (JCT Ltd v Muniandy Nadasan & Ors and Another Appeal [2016] 3 CLJ 692).

Findings of the Court of Appeal

(I) Liability for Fraudulent Trading

The Directors contended that the transfer of funds out of the Company occurred before any debt was due. At that time, no proceeding was commenced against the Company.

Hence, it was argued that Section 540(1) of the CA 2016 could not apply, given that the transfer was not made “in the course of the winding up of a company or in any proceedings against a company”. In fact, the transfer was made two months before the commencement of the action.

The Court of Appeal disagreed with that argument. There is no requirement under Section 540(1) of CA 2016 that acts of fraudulent trading can only occur during those periods.

In finding intent to defraud, the Court of Appeal held that the Company fell into liquidation even after receiving a sum of RM71,310,616.46 for the sale of lands. The Directors, as mandatory signatories of the Company’s bank accounts, allowed that to happen. On top of that, there was no explanation forthcoming as to where the proceeds had gone to. By right, the funds would be more than sufficient to satisfy any creditor. Based on this, the Court was satisfied that the Directors were guilty of fraudulent trading.

One of the Directors claimed he was following his brother’s instructions. But he was a mandatory signatory, and thus the Court of Appeal held that he was knowingly a party to fraudulent trading. Turning a “blind eye” to the fraud perpetrated would sufficiently implicate him. Furthermore, given that the same Director refused or failed to explain the disappearance of the hefty funds, the presumption of adverse inference was invoked against him.

(II) Payment to Liquidator as Contribution or to Creditor Directly?

The Court of Appeal held that the High Court was wrong in ordering payment to be made to the liquidator of the Company as contribution to the Company’s assets.

The Directors’ contention that there would be an undue preference was not accepted. Their contention was anchored on Section 528 of the CA 2016, which states:

(1) Any transfer, mortgage, delivery of goods, payment, execution or other act relating to property made or done by or against a company which is unable to pay its debts, as the debts become due, from its own money in favour of any creditor or any person in trust for any creditor shall be deemed to have given such creditor a preference over other creditors in the event of the company being wound up on a winding up petition presented within six months from the date of making or doing the same and every such act shall be deemed fraudulent and void.

But the issue of undue preference, in the context of fraudulent trading, is not envisioned under Malaysian law. Under Section 540 of the CA 2016, apart from the liquidator, any creditor or contributory may initiate an action for fraudulent trading. The preference issue, therefore, does not arise.

This is at variance with the position in the UK. There, only a liquidator can commence an action for fraudulent trading under Section 213 of the UK Insolvency Act 1986. The Court of Appeal opined that this provision in the UK tackles the issue of undue preference. It reads:

(1) If in the course of the winding up of a company it appears that any business of the company has been carried on with intent to defraud creditors of the ocmpany or creditors of any other person, or for any fraudulent purpose, the following has effect.

(2) The court, on the application of the liquidator may declare that any persons who were knowingly parties to the carrying on of the business in the manner above-mentioned are to be liable to make such contributions (if any) to the company’s assets as the court thinks proper.

Hence, in the UK, payments from a fraudulent trading claim shall be made to the wound-up company, through the liquidator. The English cases relied on by the High Court were premised on the same jurisprudence.

But in Malaysia, given that there is no such restriction, the Creditor had the right to recover the debt from the Directors personally for fraudulent trading. Accordingly, any payment arising from a finding of liability shall be made to the Creditor.

Besides, the action was only for Creditor’s personal claims. The liquidator had not intervened, and the GOM was not a party. Hence, the judgment should be in favour of the Creditor but not the liquidator or the GOM.

Conclusion

The Court of Appeal’s decision serves as a reminder that directors who dissipate company funds to defraud creditors will be held personally liable for the debts owed. The case also clarifies that fraudulent trading can still occur even before any proceedings have commenced against the company. And if liability is established, payment is to be made to the Creditor directly.