Directors Shuffle Funds Between Companies: The Legal Risks Under The Companies Act 2016

29 September 2018

Thanks to the concept of separate legal entity where each and every company is to be regarded as having separate existence and possessed of separate rights and liabilities, it is a common practice for directors to register multiple companies, regardless of whether they are related to one another or within the holding group, simply to enjoy the legal shelter offered by the law, which include, inter alia, limiting liabilities, isolate risks, and to be shielded from the debts of other related companies.

However, problems arise when the directors treat their companies as one single entity, by starting to shuffle funds and monies around the companies. It usually occurs when the directors have to meet financial exigencies. It is important to highlight that it is non-essential of how the directors view and treat the companies as a single entity or to have looked to the benefit of the group of companies as a whole, because under the eyes of the law, each and every company shall be treated as a separate and independent entity, in which the directors of each company shall discharge their duties in good faith in the best interest of each company independently.

In the event where the directors shuffle the funds between companies, simply to meet financial exigencies as they arise, the directors may expose themselves to the legal risks of breaching their duties and responsibilities. ‘A director of a company shall at all times exercise his powers in accordance with this Act, for a proper purpose and in good faith in the best interest of the company’, refers in Section 213(1) of the Companies Act 2016.

Should the directors transfer monies from, hypothetically speaking, Company A to Company B which was in financial difficulty, the directors have the duty of ensuring that such particular transaction is exercised in proper care and in the best interest of Company A. ‘In such a case the payment of money by company A to company B to enable company B to carry on its business may have derivating benefits for company A as a shareholder in company B if that company is enabled to trade profitably or realize its assets to advantage. Even so, the transaction is one which must be viewed from the standpoint of company A and judged according to the criterion of the interests of that company’, states the Court.

The action of shuffling money from Company A to Company B is not illegal per se, however, it is a test of ‘whether an honest and intelligent man in the position of a director of the company concerned could, in the whole of the existing circumstances, have reasonably believed that the transaction was for the benefit of the company’. Unless the transaction is specifically made in the interest of Company A, otherwise, that transaction would be ultra vires and void, notwithstanding that transaction might actually be beneficial to Company B, which the directors may have viewed as a single entity as Company A. ‘Each company in the group is a separate legal entity and the directors of a particular company are not entitled to sacrifice the interest of that company’, explains the Court.

Therefore, the directors must be mindful in managing and shuffling monies between the companies as one commercial entity. From the commercial viewpoint, it may seem natural to have look to the benefit of the group of companies as a whole, however, under the companies’ law of Malaysia, it is crucial for the directors to give separate consideration to the benefit of each company within the group.

1. Tengku Dato’ Ibrahim Petra Tengku Indra Petra V. Petra Perdana Bhd & Another Appeal [2018] 2 CLJ 641 | 2. New Kok Ann Realty Sdn Bhd V. Development & Commercial Bank Ltd New Hebrides (In Liquidation) [1986] 1 LNS 30