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Cases & Deals
Cases
Fraudulent Trading and the Duty of Good Faith in Contracting
July 2023
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An action for fraudulent trading under s 540 of the Companies Act 2016 (‘Act’) (formerly s 304 of the repealed Companies Act 1965) is a statutory exception to the common law doctrine of corporate personality which has been codified in s 20 of the Act. Where a vendor agrees to immediately transfer its assets to a company relying on the representation of the company that the balance purchase price will be paid in the future and the company subsequently fails to pay the balance purchase price when it is due, the directors of the company are, by that very fact, personally responsible to the vendor under s 540 of the Act: Lai Fee & Anor v Wong Yu Vee & Ors [2023] 3 MLJ 503. The Federal Court held that the directors had acted dishonestly by orchestrating a scheme to insulate themselves against any personal liability in which the vendor was induced to immediately transfer its assets to them on the representation that the balance purchase price would be paid by a dormant company who contracted with the vendor and had no funds to pay the purchase price.
The Federal Court reversed the decision of the Court of Appeal which held that the appellants could only blame themselves for not checking up on the buyer company’s financial standing and had entered into the contract with a conscious mind relating to the buyer’s position. While the English common law does not recognise a general principle of good faith in contracting except in certain categories of contracts, the Federal Court held that the principle that the law does not expect people to arrange their affairs on the basis that others may commit fraud represents the law in Malaysia. The Federal Court reasoned that the principle is in line with the element of free consent that makes a valid contract as required in the Contracts Act 1950 and is an integral part of the negotiation preceding the contract. Thus, there is a duty to act honestly and in good faith in the creation of a contract.