Volume 5 Issue 21 (December 2020) PP. 130-137DOI 10.35631/IJLGC.5210010INTERNATIONAL JOURNAL OF LAW,GOVERNMENT AND COMMUNICATION(IJLGC)www.ijlgc.comDIRECTORS’ DUTY AND LIABILITY IN INSOLVENTTRADINGShereen Khan1*, Nasreen Khan2, Olivia Tan Swee Leng3123*Faculty of Management, Multimedia University, MalaysiaEmail: [email protected] of Management, Multimedia University, MalaysiaEmail: [email protected] of Management, Multimedia University, MalaysiaEmail: [email protected] AuthorArticle Info:Abstract:Article history:Received date: 25.10.2020Revised date: 17.10.2020Accepted date: 22.11.2020Published date: 06.12.2020The effect of the novel coronavirus (Covid-19) pandemic has resulted incurrent and future liquidity, balance sheet, and cash flow problems. There is ananticipated decline in the profitability of the businesses during this uncertainperiod and attention has been turned to the directors’ ‘duties and liabilities’ tocreditors when the company is on the verge of insolvency. Directors have tostrike a balance among the shareholders, creditors, and workers in the corporaterestructuring process. In engaging with these stakeholders during thetransformation process, the directors play a key role. It is about quick choicesand decisions to be taken to save a business on the verge of insolvency, and itis therefore vital that directors act at the first sign of financial distress. There isa general duty for directors not to trade when insolvent or close to the point ofinsolvency. Directors also have a contractual obligation to avoid insolventtrading. This article discusses the duties of directors under the Companies Act2016 (CA 2016) to avoid insolvent trading. It further discusses by analysingbased on the comparative study with other selected jurisdictions. This articleproposes that while it is important to protect creditors’ interest by making thedirectors personally liable for insolvent trading, for the best interest of allstakeholders, there should be a balance between the security of creditors andthe rescue of the company.To cite this document:Khan, S., Khan, N,, & Tan, O. S.L.(2020). Directors’ Duty and Liabilityin Insolvent Trading. InternationalJournal of Law, Government andCommunication, 5 (21), 130-137.DOI: 10.35631/IJLGC.5210010.This work is licensed under CC BY 4.0Keywords:Directors’ Duties; Insolvent Trading; RestructuringCopyright GLOBAL ACADEMIC EXCELLENCE (M) SDN BHD - All rights reserved130

Volume 5 Issue 21 (December 2020) PP. 130-137DOI 10.35631/IJLGC.5210010IntroductionThe effect of the novel coronavirus (Covid-19) pandemic has resulted in current and futureliquidity, balance sheet and cash flow problems. There is an anticipated decline in theprofitability of the businesses during this uncertain period and attention has been turned to thedirectors’ ‘duties and liabilities’ to creditors when the company is on the verge of insolvency.Directors have to strike a balance among the shareholders, creditors and workers in corporaterestructuring process. In engaging with these stake holders during the transformation process,the directors play a key role. It is about quick choices and decisions to be taken to save abusiness on the verge of insolvency, and it is therefore vital that directors act at the first signof financial distress. There is a general duty for directors not to trade when insolvent or closeto the point of insolvency. Directors also have a contractual obligation to avoid insolventtrading. This article discusses on the duties of directors under the Companies Act 2016 (CA2016) to avoid from insolvent trading.Overview of Breach of Directors’ Duties in Insolvent TradingThe general duties of directors owed to the company and subsequently to creditors are ratherbroad. The responsibility of directors to creditors beyond those owed to the corporations tendsto be in conflict with the fundamental principles of corporate law focused on the definitions ofdistinct corporate identity and limited liability. These laws are meant to favour shareholdersand eventually provide the economy with advantage. It is a settled rule that, at the time ofimminent insolvency, directors have an obligation to take into account of the needs of creditors.While there is a general duty of directors not to trade when insolvent or close to the point ofinsolvency, the implementation statutory requirement to be proactive on the part of directorwill result in extending the corporate rescue procedures to be introduced as a part of the dutiesof the directors.The House of Lords in Salomon v A. Salomon & Co. Ltd1 defined the basic company functionof separate legal personality. The case was later referred to as the “Salomon concept” thatrecognises members’ limited liability. The Court may order the lifting of the corporate veil incertain circumstances, especially in cases of fraudulent unfair trade and under certain statutoryprovisions. When one carries on business with the intention of defrauding creditors or fordishonest purposes, fraudulent trading occurs. Wrongful trading applies to a case in which acompany has entered an effective insolvency stage and proceeds to operate despite the fact thatthe company’s directors are aware of or should have known prior to the company’s dissolutionthat there was no reasonable prospect of the company preventing the dissolution due to itsinsolvency. Different jurisdictions have codified these fraudulent and wrongful transactionsinto their respective legislation and directors are held to be liable accordingly.In the United Kingdom, the United States and Malaysia, insolvent trading is referred to as‘wrongful trading’ and ‘fraudulent trading’ whereas in Australia as ‘insolvent trading’. Thelegislation prohibits the directors from continuing to trade and imposes an obligation ondirectors to prevent from insolvent trading. The duties of directors are generally towards thecompany. The interest of creditors are protected by directors’ indirect fiduciary obligations tocreditors in situations where corporations are nearly insolvent. The interests at stake in such1[1897] AC 22Copyright GLOBAL ACADEMIC EXCELLENCE (M) SDN BHD - All rights reserved131

Volume 5 Issue 21 (December 2020) PP. 130-137DOI 10.35631/IJLGC.5210010situations are those of creditors whose interest is at stake by the trading of the company. Thereare the legislations to protect the creditors by prohibiting the company from insolvent trading.Breach of Director’s Duty in MalaysiaThere are few effective provisions which impose duties on creditors directly or indirectly oncompany directors in Malaysia. In recent years, several jurisdictions have added a growingnumber of legislative protections designed to protect creditors and enforce liability on directors.The Companies Act 2016 improved the common law position by incorporating the insolventtrade rules to protect the creditors.The Companies Act 2016 (CA 2016), which includes different rules regulating the term forcivil lawsuits and criminal acts, describes fraudulent trading. Wrongful trading is described ins.539 (3) of the CA 2016 where the action can only be brought against the company officials(most commonly the company directors), fraudulent trading actions can be brought against anyperson who was knowingly a party to the conduct of the business. Thus, the directors can incurpersonal liability under the CA 2016 for allowing the company to trade while insolvent. In thisregard, section 539(3) of the CA 2016 provides that:‘If in the course of winding up of a company or in any proceedings against a company,an officer of the company who knowingly was a party to the contracting of a debt had,at the time the debt was contracted, no reasonable or probable ground of expectation,after taking into consideration the other liabilities, if any, of the company at the time,of the company being able to pay the debt, commits an offence and shall, on conviction,be liable to imprisonment for a term not exceeding five years or to a fine not exceedingfive hundred thousand ringgit or to both.”In s. 540 (1) of CA 2016, ‘fraudulent trading’ is defined as follow:“If in the course of the winding up of a company or in any proceedings against acompany it appears that any business of the company has been carried on with intent todefraud the creditors of the company or creditors of any other person or for anyfraudulent purpose, the Court on the application of the liquidator or any creditor orcontributory of the company, may, if the Court thinks proper so to do, declare that anyperson who was knowingly a party to the carrying on of the business in that mannershall be personally responsible, without any limitation of liability, for all or any of thedebts or other liabilities of the company as the Court directs.”In Kawin Industrial Sdn. Bhd. (in liquidation) v. Tay Tiong Soong2, the question before thecourt relates to the interpretation of s. 304(1) of CA 1965 which is pari materia with s. 540(1)of CA 2016.3 The issue was whether the facts of the case are within the scope of that provision.The Court held that the language of this provision is very clear. In order to constitute fraud, itis not necessary for the creditors to have actually been defrauded as long as there is an intentionto defraud. An attempt to defraud in this regard is an attempt to deprive creditors or othercreditors of economic benefit or to impose such economic losses on them.23[2009]1MLJ 723 at pg.724Coleman v The Queen (1987) 5 ACLC 766Copyright GLOBAL ACADEMIC EXCELLENCE (M) SDN BHD - All rights reserved132

Volume 5 Issue 21 (December 2020) PP. 130-137DOI 10.35631/IJLGC.5210010The phrase 'with intent to defraud creditors or for any fraudulent purpose' within the contextof s. 540 (1) of CA 2016 had been interpreted in a number of cases to include (i) “a situationwhere a company continues to carry on business and to incur debts at a time when there is tothe knowledge of the directors no reasonable prospect of the creditors ever receiving paymentof those debts”4; (ii) that “fraud in the context of fraudulent trading connotes 'actual dishonestyinvolving, according to current notions of fair trading among commercial men, real moralblame'”5; (iii) “where a person who takes part in the management of a company's affairs obtainscredit or further credit for the company when he knows that there is no reason for thinking thatfunds will become available to pay the debts when it becomes due or shortly thereafter” 6; (iv)“where a company accepted the purchase price in advance knowing that it could not supply thegoods and would not repay the advance paid”7 and (v) “a person was knowingly party to thebusiness of a company having been carried out with intent to defraud creditors if at the timewhen debts were incurred by the company he had no good reason for thinking that funds wouldbe available to pay those debts when they became due or shortly thereafter and there wasdishonesty involving real moral blame according to current notions of fair trading”.In the case of JCT Ltd. v. Muniandy Nadasan & Ors.8, it was concluded that “a single act todefraud the creditors of the company in the course of business was sufficient to triggerfraudulent trading. Through its managing director, the appellant company dealt in transactionsthat fraudulently gave creditors the impression that the company was a continuing concernwhen it was actually insolvent”.The phrase 'if it appears' in s. 540 (1) needs only a lower degree of proof. The directors owe aresponsibility to the company and the creditors to ensure that the company’s affairs are properlyhandled and that its assets are not dissipated or abused to the disadvantage of the creditors orto the detriment of the creditors9. The main objective of s.540 is to place a statutory duty onthe directors of the insolvent company to pay their creditors if they have engaged in fraudulenttrading. Civil litigation for unlawful trading is not limited to the businesses which are in theprocess of winding-up proceedings, such an action may also be available in the process of anyother legal proceedings against the company.10 When s. 540 (1) and (5) state that withfraudulent intent, a person who was “knowingly a party to carrying on business”, spells out anaspect of deceit to be displayed in order to trigger dishonest trading. It is not enough simply todo business with the knowledge that the company would not be able to pay later to cause“fraudulent trading”. The Court in Siow Yoon Keong v. H Rosen Enginnering BV11, held that itmust be shown that there is an element of dishonesty on the part of the alleged defendant whenthe business at issue was conducted.4Re William C Leitch Bros Ltd [1932]2 Ch 71Re Patrick & Lyon Ltd [1933]Ch 786 at pg.7906R v Grantham [1984]3 All ER 166, CA7Re Gerald Cooper Chemicals Ltd [1978]2 All ER 498[2016] 6 MLJ 6359Winkworth v Edward Baron Development Co Ltd & Ors. [1987]1 All ER 114, HL10Haidar J in Tang Eng Iron Works Co Ltd v Ting Ling Kiew & Anor, Originating Summons No Kg 144 Of 1989High Court (Kuching) 1990-2 MLJ 440.11[2003] 4 MLJ 569.5Copyright GLOBAL ACADEMIC EXCELLENCE (M) SDN BHD - All rights reserved133

Volume 5 Issue 21 (December 2020) PP. 130-137DOI 10.35631/IJLGC.5210010If a person is merely accused of incurring a debt without reasonable prospect of repayment,s.540 (2) allows the liquidator, creditor or contributor as follow:“Where a person has been convicted of an offence under subsection 539(3) in relationto the contracting of such a debt as is referred to in that section, the Court on theapplication of the liquidator or any creditor or contributory of the company may, if theCourt thinks proper so to do, declare that the person shall be personally responsiblewithout any limitation of liability for the payment of the whole or any part of thatdebt.”12Thus, an action must be first brought before s.540 (1) CA 2016 by the prosecutor, and must becompleted and effective against the delinquent directors. This is likely to create unnecessarychallenges for creditors or liquidators if they wish to obtain remedy for damages resulting froma continuation of trade in a civil case. Where, at the request of the liquidator or any creditor orcontributor of the corporation, a person has been convicted of an offence under s. 539 (3) inaccordance with the contradiction of the debt referred to in that section, the Court may, if itfinds it necessary to do so, declare that the person is personally liable without restriction ofliability for the payment of the whole or any part of the debt.Generally, no particular distinction is made as to what constitutes 'intent to defraud' in civil andcriminal cases. The standard of review in civil claim may be slightly lighter than that under thecriminal action.13 The purpose to defraud, however, can be identified when the party in questioncloses its eyes to the obvious out of a deliberate fear that to enquire further will confirm analready existing presumption of wrongdoing. In the criminal context however, an objectiveapproach may be adopted which might help the prosecutor in establishing his case whichsupposedly require a burden beyond reasonable doubt. If a director has violated the ‘statutoryduty of care’ is determined by taking into account of the actual amount of care and diligenceexercised and comparing it with the level of care and diligence that would have been exercisedby a reasonable person with the same responsibilities. If the director has any additionalknowledge, skill and experience, the court would also consider whether he had exercised thedegree of care and diligence that he should have exercised in view of the additional knowledge,skill and experience that he has.14Based on the data received from the Company Commission of Malaysia (CCM), most of thecases prosecutes by CCM with regards to breached of directors’ duties are mainly relating tosome other duties such as failure to hold an Annual General Meeting (AGM), failure to lodgethe annual return to the Registrar of Companies, failure to table the company’s profit and lossaccount in AGM, making false statements, offering illegal investment and submittingmisleading information to CCM. Only 10% of the cases prosecuted by CCM are on breach ofdirectors’ duties as to fiduciary duty and there is no reported case for breach of directors’ dutyas to ‘fraudulent trading’. Thus, existing provisions are not relatively ineffective to deter the12Section 540 (2) CA R v Clowes (No 2) [1994] 2 All ER 316 at pp 332-334, where in a proper case a defendant holding a subjectivebelief that he was acting lawfully would not be thought dishonest, as he believes he is acting honestly by ordinarystandards.14Section 213 (2) CA 201613Copyright GLOBAL ACADEMIC EXCELLENCE (M) SDN BHD - All rights reserved134

Volume 5 Issue 21 (December 2020) PP. 130-137DOI 10.35631/IJLGC.5210010directors from breach of their duties as to insolvent trading since it is a requirement to provethe element of fraud to take the action under the section 540 (CA 2016) and Malaysia needsseparate provisions relating to breach of directors’ duty in the case of insolvent trading.Comparative Analysis of Directors’ Duties in Other JurisdictionsIn the United Kingdom, a director may be held to be liable under section 214 of the InsolvencyAct 1986 if the director allows the trading of the company to continue and he will be incurfurther liability if he has the knowledge or should have the knowledge that the company mayresult in insolvency unless it can be proved that every step was taken by the director to lessenthe loss of the creditors concerned.Likewise, Singapore Companies Act has ss.339 (3) and 340 (1) dealing with the contractingdebts where there is no possible way of payment of the debts which have similar provisions inCA 2016 of Malaysia. The disqualification of incompetent directors of insolvent company isaddressed in section 149(2) (b) of the Singapore Act.The Australia Companies Act 2001, section 588 G, deals with the inability of the directors toprevent insolvent trading and subject to four specific defences. Contravention of this sectionmay give rise to civil proceeding and criminal proceeding in some circumstances. Section 588V– X extends the responsibility to the parent company for failure to prevent a subsidiary frominsolvent trading. Section 214 of the Insolvency Act 1986 of the United Kingdom sets out thesame obligation on directors not to engage in wrongful trading. In fact, the most significantpart of duty of care is the insolvent trading. This is subject to both civil and criminal sanctionsin Australia and personal liability in most of the jurisdictions discussed above. Interpretationof the provisions relating to insolvent trading and specific available defences are still in doubt.The United States does not have any specific provision relating to insolvent trading.There were just a few cases of duty of care and insolvent trading, but there have been morecases of insolvent trading in other jurisdictions, such as Australia and New Zealand, and theconsequences for directors are serious.15 When the company trades while insolvent, directorsmay become directly responsible for the corporation’s debts. And if one director is liable forinsolvent trading, unless one of them is able to rely on the defences offered under the statue, itis probable that all will be held to be liable. In most cases, as members of a board of directors,all the directors would have the same knowledge. However, there are the legislation whichallows to have an insurance against such risk if there is a possibility that a director may be heldto be liable for insolvent trading. Introducing the insurance to the directors in a way wouldreduce their burden in case they are being sued and held to be liable personally for the breachof duties of directors in insolvent trading.Despite the fact that Australian law has codified the insolvent trading and the provision hasbeen established in Australian law, there are questions as to the necessity of having it in theirsystem. It was argued that these provisions protect the creditors’ interest overly and as a result15Farrar, Directors’ Duties of Care, at pg. 756.Copyright GLOBAL ACADEMIC EXCELLENCE (M) SDN BHD - All rights reserved135

Volume 5 Issue 21 (December 2020) PP. 130-137DOI 10.35631/IJLGC.5210010creditors have been overly compensated.16 However, provisions relating to ‘insolvent trading’are vital to protect the interest of creditors to ensure that the economy of the country is intact.Hence it is pertinent that a provision similar to that of insolvent trading in Australian Lawshould be codified in Malaysia.It can be seen that Australia’s approach is too strict whereas the approach in the UnitedKingdom is not clear. The approach in the United States seems to work well so far in theirsystem of pro-debtor approach. To ensure that directors take the responsibility at the time ofrestructuring process and at the same time, not to impose too much regulation and resulting inentering into formal restructuring process too soon, there must be a balance among all thesefactors. A framework which strikes the best balance of all these factors and at the same timeallowing the directors to have some breathing space by providing useful defences for caseswhere the directors has acted ‘honestly and in good faith’ and ‘to the best interest of thecompany’ i.e. similar to Business Judgement Rule under the Companies Act 2016. Byintroducing this framework, errant directors can be curbed effectively without compromisingthe interest of creditors involved. Like some commentators have suggested it would beinteresting to refer back to the Cork Report on the basic principle of wrongful and fraudulenttrading.ConclusionIn this current situation where Malaysia is under the conditional movement control orderbecause of the global pandemic, directors of the companies have to be extra vigilant of theirduties and potential liability and not to enter into any trading if the company is near toinsolvency. There are a number of businesses suffer losses and could not continue to operateand thus have to resort to closing it completely. Thus, it is vital that the directors would actprudently and take all the necessary measure to avoid themselves from being personally liable.The Companies Act 2016 impose both civil and criminal liability on the officers of thecompany for engaging in insolvent and fraudulent trading. It is therefore suggested thatmanagement of the company will take some precautionary measures such as having a specificbusiness plan in the era of global pandemic, review all the transactions before entering andseek professional advice if needed be and conduct all their activities with skill, care anddiligence as stated under the section 132 (1) of the Companies Act 2016 of Malaysia.ReferencesAndrew Keay et. al., (2020). ‘Business Judgement and Director Accountability: A Study ofCase-Law over Time’: Journal of Corporate Law Studies Vol. 20, Issue 2.Andrew Keay. (2020). Directors’ Duties, fourth edition, Jordon Publishing.Bruce, M., (2018). Rights and Duties of Directors. Bloomsbury Professional, London.Chief Justice Wayne Martin, ‘Official Opening Address’ (Speech delivered at the InsolvencythPractitioners’ of Australia 16 National Conference, Perth, 28 May 2009) 13.Chin, J. L. (2011). Women and Leadership: Transforming Visions and Current Contexts.Forum on Public Policy: A Journal of the Oxford Round Table, (2), 1–12.David Morrison, ‘The Economic Necessity for the Australian Insolvent Trading Prohibition’ (2003) 12International Insolvency Review 171, 17716Copyright GLOBAL ACADEMIC EXCELLENCE (M) SDN BHD - All rights reserved136

Volume 5 Issue 21 (December 2020) PP. 130-137DOI 10.35631/IJLGC.5210010Cory D Kandestin. (2007). ‘The Duty to Creditors in Near-Insolvent Firms: Eliminating the“Near-Insolvency” Distinction’: Vanderbilt Law Review (60) 1235, 1262David Morrison. (2003). ‘The Economic Necessity for the Australian Insolvent TradingProhibition’: International Insolvency Review 12Gerard McCormack. (2008). ‘Corporate Rescue in Singapore and the Appropriateness ofChapter 11 of the US Bankruptcy Code as a Model’: Singapore Academy of LawJournal (20) 396, 425.thIan Fletcher. (2017). The Law of Insolvency (5 edt.), Sweet and Maxwell, London.Lo, S. H. (2020). Proposals for Insolvent Trading Laws in Hong Kong: A ComparativeAnalysis. J. Int'l & Comp. L., 7, 229.Mark Byrne. (1994). ‘An Economic Analysis of Directors’ Duties in Favour of Creditors’:Australian Journal of Corporate Law (4) 275, 277.Michael Whincop, (1996). ‘Taking the Corporate Contract More Seriously: The EconomicCases Against, and a Transaction Cost Rationale For, the Insolvent Trading Provisions’:Griffith Law Review (5) 1, 1.Niall Coburn. (2003). Coburn’s Insolvent Trading: Global Investment and Fraud andndCorporate Investigations (2 ed,) xi-xii.ndPhilip Wood. (2007). Principles of International Insolvency (2 edt.), Sweet & Maxwell,London.Ramsay, I. (2017). Personal insolvency in the 21st century: A comparative analysis of the USand Europe. Bloomsbury Publishing.Rosemary Langford. (2015). ‘The Duty of Directors to Act Bona Fide in the Interests of theCompany: A Positive Fiduciary Duty? Australia and the UK Compared’: Journal ofCorporate Law Studies Vol. 11- Issue 1.Rosemary Langford. (1998). ‘The New Statutory Business Judgment Rule: Should it Apply tothe Duty to Prevent Insolvent Trading’: Companies and Securities Law Journal (16)533.The White Paper on Modernising Company Law by House of Commons, Trade and IndustryCommittee, Sixth Report of Session 2002-03 published on 13 May 2003.Williams, R. (2015). What can we expect to gain from reforming the insolvent trading remedy?.The Modern Law Review, 78(1), 55-84.Copyright GLOBAL ACADEMIC EXCELLENCE (M) SDN BHD - All rights reserved137

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