What happens when one contracts with a dormant company, and that dormant company thereafter defaults in its obligation?

Such was the situation that the appellants in Lai Fee & Anor v Wong Yu Vee & Ors [2023] 3 MLJ 503, FC found themselves to be in.

The appellants were partners in a business (FAVE) with timber logging rights. They agreed to sell the partnership to the respondents for a sum of RM7 million.

For the purpose of the transaction, the respondents incorporated a dormant company (“Centennial”) to acquire the partnership. Thereafter, the respondents paid RM4.5 million to the appellants via another company belonging to them (“Westhill”). However, the final RM2.5 million was not paid.

The appellants sued Centennial for the unpaid balance sum vide Suit 128. Centennial raised the defence of misrepresentation, claiming that the timber rights were in fact limited. The learned judge in Suit 128 dismissed the defence and ordered Centennial to pay RM2.5 million to the appellants. Centennial did not pay.

Thereafter, the appellants sued the respondents, being directors of Centennial, pursuant to s 540 of the Companies Act 2016, claiming that the directors ought to be personally liable for fraudulent trading. The appellants contend that the use by the respondents of Centennial as a dormant company to be the contracting party was calculated to defraud the appellants of recourse in the event of non-payment.

Both the High Court and the Court of Appeal decided against the appellants, hence the appeal to the Federal Court.

At the Federal Court, the learned Vernon Ong FCJ delivering the decision of the Court, observed that the use of a dormant company with neither asset or income as the contracting vehicle was unusual. By using Centennial as the contracting party, Westhill as the paying party, for purposes of buying over FAVE which was transferred to the respondents personally, it appears that the entire transaction was arranged in a manner that is purposefully layered to insulate the respondents from personal liability.

Consequently, the Federal Court found that the respondents were dishonest according to the standards of reasonable and honest people, hence they were liable for fraudulent trading and ought to be personally liable for the balance RM2.5 million debt of Centennial.

Although the result was positive at the end of the day for the appellants, it took the full spectrum of litigation (starting with a suit against Centennial, and followed by a suit against the respondents personally which had to go all the way to the Federal Court) in order for the appellants to obtain their justice. That would have been a lengthy and costly process, and most litigants would have given up or compromised along the way.

A better approach, when contracting with a dormant company, would be to procure the personal guarantees of the directors from the outset. A counterparty who chooses to use a dormant company as the vehicle for contract, yet refuses to provide any guarantee for the obligations of the dormant company, ought to be viewed with suspicion.

The learned Vernon Ong FCJ opined that “the law did not expect people to arrange their affairs on the basis that others might commit fraud”. That is a sound legal proposition, but not necessarily realistic in dealing with human affairs. That is because the law aspires towards the ideal, but realistically, “all man have sinned and fallen short”.

Written by: Chan Kheng Hoe ([email protected]).

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