Winding Up Companies - Who Bears The Responsibility For Fraudulent Trading?
The act of fraudulent trading in respect of companies which are in the course of winding up is governed by Section 540 of the Companies Act 2016 (CA 2016). Section 540(1) provides the court with the discretion of declaring any person who was knowingly a party to the carrying on of the business for fraudulent purposes be personally responsible. However, it must be established that, in respect of companies which were in the course of winding up or in the course of any proceedings against them, the business of the company was carried on with an intention to defraud or for any fraudulent purpose.
The Court of Appeal recently held in Zamzam Arabic Food Holding Sdn Bhd & Rami Ahmad Mohammad Alsa’bi v Johanjana Corp Sdn Bhd  5 MLJ that the liability imposed on the ‘person’ within Section 540(1) refers to a real person and not a company.
The respondent company (Johanjana Corp Sdn Bhd) originally initiated a claim against 11 appellants at the High Court, which included several companies in the ZamZam Group of companies (1st to 4th appellants) and the directors, officers and shareholders of the companies (5th to 11th appellants).
Prior to the claim being initiated by the respondent, the first appellant (A1) entered into tenancy agreements with the respondent to rent 7 premises for the purpose of operating its restaurant. Due to A1’s default on payment of rent under the tenancy agreements, judgment was obtained against A1 for the outstanding payment. Prior to being wound up for A1’s failure to settle its judgment debt, pursuant to a winding up petition, A1 transferred its assets and business operations to the other entities of ZamZam Group.
The respondent then initiated a claim against the 11 appellants at the High Court pursuant to Section 540 alleging that they had fraudulently conspired to allow A1 to escape the payment of its judgment debt. The respondent further sought an order to hold the 2nd to 11th appellants personally responsible without the limitation of liability to jointly and severally to settle A1’s debts.
Thereafter, the 1st and 2nd appellants applied to strike out the respondent’s writ of summons and statement of claim on the grounds that (i) the 1st appellant was a company and did not fall within the definition of ‘person’ under Section 540(1), (ii) the 1st appellant never had contractual dealings with the respondent and (iii) the 2nd appellant was wrongly made a party to the action as he personally had no connections nor dealings with A1.
High Court Decision
The High Court dismissed the striking out applications on the grounds that (i) the respondent’s statement of claim against the appellants had pleaded sufficient particulars of fraud or fraudulent trading against them, (ii) based on the definition of ‘person’ in Section 3 of the Interpretation Acts 1948 and 1967 (IA), ‘person’ would include a corporation and (iii) a joint reading of Sections 540(1), 540(3) and 540(4) of the CA 2016 enabled a company or individual involved in the activity or receipt of proceeds of fraudulent trading to be named as a defendant.
Court Of Appeal Decision
The Court of Appeal unanimously allowed the appeal, setting aside the decision of the High Court and striking out the respondent’s writ and statement of claim against the appellants on the following grounds:
(i)Section 3 of the IA could not be read with Section 540(1) as it would not give effect to the true meaning and underlying purpose of the latter provision, which was to impose a personal responsibility and liability on a person carrying out the business of the company. The word ‘person’ in Section 540(1) refers to ‘a real person’ and the wording of the provision is plain and unambiguous.
(ii)Section 540(1) further requires an intention to defraud. Only a real person could have an intention to defraud a creditor. A company does not have a mind to cheat (Kawin Industrial Sdn Bhd (in liquidation) v Tay Tiong Soong  1 MLJ 723). The High Court erred in accepting the respondent’s argument that a ‘person’ mentioned in Section 540(1) included a company. Therefore, the respondent did not have a cause of action against the 1st appellant, which was a company.
(iii)The 2nd appellant was not a director of the main defendant company. The 2nd appellant had no involvement at all in D1’s business. Section 540(1) was not applicable to an individual who was not a director in a company which carried on business with intention to defraud a creditor. The High Court erred in deciding that Section 540(3) enabled a person who was not a director, in the company involved in the fraudulent trading, to be named as a party in a claim brought under Section 540. This is due to the fact that Section 540(3) only applies after the court establishes that the elements in subsection 540(1) has been satisfied, which does not apply to the case in matter. As such, the respondent had no cause of action against the 2nd appellant and he should not have been named as a party in the action.
(iv)In view of the court’s findings that the respondent had no cause of action against both the appellants, the court held that the respondent’s claims were unsustainable. The Court of Appeal further held that the High Court erred in finding that there was a sufficient claim for fraudulent trading pleaded against the appellants. The Court of Appeal further found that none of the appellant’s involvement in A1’s business had been carried out with the intention to defraud the respondent.
In summary, the Court of Appeal struck out the respondent’s claims against the appellants and set aside the decision of the High Court. In its judgment, the Court of Appeal did not apply the definition of ‘person’ under the IA to the reading of Section 540 as it was inconsistent with its intended meaning. The underlying intention of which, was to impose a personal responsibility and liability on the persons carrying out the business of the company and not the company itself for carrying on the business of the company with intent to defraud a creditor. It is only fair that where a person is capable of having the intention to defraud a company, he too should be held personally liable for his actions, rather than being allowed to hide behind a corporate veil.
In the present case, it was affirmed that a company, in its capacity, cannot be held liable for fraudulent trading pursuant to Section 540. However, it should also be noted that proper care should have been taken in naming the parties to an action in order for the courts to give effect to the underlying intention of Section 540.
26 May 2023