Warning Signs Creditors Should Look For
A creditor who suspects fraud should look beyond the unpaid invoice or breached contract. The following warning signs may support a fraudulent trading claim:
- • The company had no real assets, funds, employees, office, operations or business substance;
- • The company was newly incorporated or dormant when it entered into the transaction;
- • The company incurred substantial liabilities despite having no realistic ability to pay;
- • The individuals behind the company made promises of payment while knowing the company could not perform;
- • Payments, assets or benefits were diverted to related parties;
- • Another related company received the benefit of the transaction while the debtor company carried the liability;
- • The company’s business records are incomplete, inconsistent or suspicious;
- • There were unusual transfers before or after the debt arose;
- • Directors or shareholders resigned, disappeared or moved assets after the creditor demanded payment;
- • The corporate structure appears designed to distance the wrongdoers from liability.
However, no single factor is necessarily conclusive; the Court will assess the evidence in its totality and consider the overall circumstances.
Case Illustration: Tetuan Sulaiman & Taye v Wong Poh Kun
The Court of Appeal’s decision in Tetuan Sulaiman & Taye v Wong Poh Kun & Anor and another appeal [2023] 3 MLRA 298 illustrates how section 304(1) of the Companies Act 1965 (of which the present section 540(1) of the CA 2016 is a verbatim adoption) may operate.
The plaintiff was engaged by Bistari Land Sdn Bhd to provide legal services in litigation concerning the company’s land. On 2.7.2014, the plaintiff issued a bill for RM5,907,500.00. As no payment was received from Bistari Land, the Plaintiff initiated a civil suit against Bistari Land.
The plaintiff subsequently learned that Bistari Land had sold its only asset, comprising lands in Johor, and applied for an injunction to preserve RM6 million from the sale proceeds. In response, one of Bistari Land’s directors affirmed an affidavit stating that the company would not dissipate the proceeds to avoid paying the plaintiff, would satisfy all its debts and was solvent.
However, Bistari Land was wound up on 29.1.2016. It was later established that the company had received RM71,310,616.46 before it was wound up, which was more than sufficient to satisfy its creditors. Despite this, the directors allowed the company to fall into liquidation and could not explain where the proceeds had gone. Both directors were mandatory signatories to the company’s bank accounts.
The Court drew an adverse inference from the directors’ failure to account for the monies, which had been dissipated while they remained in control of the company. It concluded that there was more than ample evidence that the directors had carried on the company’s business to defraud its creditors and held them personally liable for the plaintiff’s legal fees.
For creditors, the case shows that the Court may infer an intention to defraud where a company had sufficient funds to pay its creditors, but its assets were dissipated without explanation. A director cannot avoid liability merely by claiming ignorance where the evidence shows that he knowingly participated in the dissipation or deliberately turned a blind eye to it.
The Court ultimately ordered the directors to pay the legal fees of RM5,907,500.00, together with interest, directly to the plaintiff on a joint and several basis.
Evidence Creditors Should Preserve
A fraudulent trading claim will depend heavily on evidence. Creditors should act early to preserve documents and reconstruct the transaction.
Useful evidence may include:
- • Company searches and corporate profiles;
- • Directorship and shareholding records;
- • Financial statements and management accounts;
- • Bank records and payment trails;
- • Invoices, purchase orders, contracts and delivery documents;
- • Emails, WhatsApp messages and letters;
- • Payment promises and representations made before and after the transaction;
- • Records showing transfers of money, assets or business opportunities to related parties;
- • Evidence of common directors, shareholders, addresses, employees or bank accounts between related companies;
- • Evidence showing that the company had no real ability to perform when the liability was incurred.
The timing of events is often important. Creditors should look carefully at what happened before the debt arose, what was represented at the time of contracting, and what happened after payment was demanded.
Why Creditors Should Consider Section 540 Early
Creditors often spend time and money suing only the debtor company, only to discover that the company is an empty shell. By then, assets may have been dissipated and the individuals behind the fraud may have had more time to distance themselves from the transaction.
Where fraud is suspected, creditors should consider section 540 at an early stage.
This does not mean that every unpaid debt should be treated as fraudulent trading. But where the facts suggest that the company was used dishonestly, creditors should consider whether to pursue the individuals who were knowingly involved.
Possible steps may include:
- • Conducting company and litigation searches;
- • Identifying the real controllers of the debtor company;
- • Tracing where the benefit of the transaction went;
- • Preserving correspondence and payment representations;
- • Considering whether the claim should be framed to include fraudulent trading;
- • Considering whether winding up or existing proceedings against the company provide the appropriate procedural route; and
- • Seeking urgent relief where assets may be dissipated.
The sooner these issues are considered, the better the creditor’s prospects of preserving evidence and identifying the proper defendants.
Civil and Criminal Consequences
The most direct consequence of fraudulent trading is personal liability. The Court may declare that the wrongdoer is personally responsible for all or part of the company’s debts or liabilities.
This is a serious remedy. It removes the protection that the wrongdoer may have expected from using a company.
There may also be criminal consequences. Section 540(5) of the CA 2016 provides that where the company’s business is carried on with intent to defraud creditors or for any fraudulent purpose, every person who was knowingly a party to that conduct commits an offence and may, upon conviction, be liable to imprisonment for a term not exceeding ten years, a fine not exceeding RM1 million, or both.
Conclusion: Creditors Should Not Stop at the Company
A company is a separate legal person. Its debts are generally its own. But that principle does not give wrongdoers a licence to commit fraud through a corporate vehicle.
For creditors who have been misled, unpaid or left dealing with an empty company, section 540(1) of the CA 2016 may provide an important route to recovery.
The key question is whether the case is merely one of non-payment, or whether the company was knowingly used for a fraudulent purpose. Where the evidence points to the latter, creditors should not assume that their only remedy is against the company. They may be able to pursue the directors, shareholders, controllers or other persons who knowingly participated in the fraudulent carrying on of the company’s business.
Limited liability protects honest enterprise. It does not protect those who use companies as instruments of fraud.
If your company or you are or suspect that it is a victim of fraud, you can reach out to Kumar Kanagasabai at kumar@hhq.com.my and Erica Wong at erica.wong@hhq.com.my from our Fraud, Asset Recovery & Investigations Practice Group.
About the authors
Siva Kumar Kanagasabai
Senior Partner
Head of Dispute Resolution Practice Group
Halim Hong & Quek
kumar@hhq.com.my
○
Erica Wong Jia Chie
Associate
Dispute Resolution
Halim Hong & Quek
erica.wong@hhq.com.my
