CHAPTER 2

PARTNERSHIP LAW

What is partnership?
Partnership is defined by section 3(1) of Partnership Act 1961 as “the relation
which subsists between persons carrying on a business in common with a
view of profit”.

Characteristics / Nature of Partnership:

1. Number of partners
The minimum number is 2 and the maximum number is 20 for non-professional
partnership and unlimited for professional partnership. Presently, this type of
business is known as the conventional partnership to distinguish with the limited
liability partnership governed by the Limited Liability Partnership Act 2012. In
Tan Teck Hee v Cheng Tien Peng (1915), the firm consisted of 25 members.
The Court held that the firm was void. Therefore, legal action cannot be taken.

2. There must be an agreement between the persons to have a business in

common.
The agreement can be made either orally or in writing. Partnership could only
be registered using a business name with Registrar of Business under
Registration of Business need to complete forms supplied by SSM and pay
certain fee.

3. ‘Business in common’ means the parties must intended to run the same nature
of business. In Chooi Siew Cheong vs Lucky Height Development Sdn Bhd
& Anor [1995] 1 MLJ 513, the Court held that no partnership from a joint
venture agreement between a landlord who agreed to contribute land and a
housing developer because there was different types business.

4. According to section 2, ‘business’ includes every trade, occupation or

profession and it must already been established.
In Gulazam V Noorzaman And Sobath [1957] 23 MLJ 45, both parties made
an agreement to form a partnership to purchase, breed and sell cattle. There
was a partnership because business exists.

In Keith Spicer Ltd v Mansell [1970] 1 All ER 462, the defendant, Mansell
and his friend Bishop decided to open up a restaurant. The restaurant has not
yet operated. Bishop order goods from the plaintiff for the restaurant but did not
pay for the goods. The plaintiff sued for the unpaid goods. It was held that there
was no partnership because the business has not yet started. The plaintiff’s
claim failed.
 5. The agreement between the persons to carry on the business for ‘profit’. If a
group of people raise funds to run a charitable organization, this is not a
partnership. It must not include club or charitable trusts that set up for welfare.

In Badeley v Consolidated Bank (1888) 38 Ch D 238, if one person carries

on the business and share the profit of the business with another, they are
partners.
Section 4 - The sharing of gross returns does not of itself create a partnership
same as Cox v Coulson [1916] 2 KB 177, they were not partners because
they were not sharing profits but sharing gross returns.

ESTABLISHING THE PARTNERSHIP

The definition of a partnership should be seen in two aspects. The definition of s.3(1)
is a general definition, and whether a partnership exists or not will depend on
whether s.3(1) has been fulfilled. This general definition is followed by s.4 which
specifically sets out rules to determine certain relationships that do not constitute a
partnership.
Section 4 of the PA 1961 lays down certain circumstances which are not ‘prima facie
‘partnerships .The rules for determining the existence of a partnership are set out
under s.4 which concerns three situations:
 S.4(a) Joint tenancy and tenancy in common
 S.4(b) Sharing of gross returns
 S.4( c ) Receipt of share of profits
Section 4 of the 1961 Act gives a detailed guidance on the establishment of
partnership. Certain circumstances are not ‘prima facie’ partnership. Here, the term
‘prima facie’ means evidence based on first impression or at the first view before
further investigation.

1. Section 4(a) – ‘joint tenancy’ and ‘tenancy in common’ refer to ownership of

property by two or more persons, common or joint ownership does not imply
the existence of partnership.

Case: Davis v Davis (1894)

A father left his 2 sons, his business and three freehold houses in equal shares as
tenant in common. They let one of them and employed the rent in enlarging the
workshop attached to the 2 houses. They continued to carry out the business. They
each drew out from it a weekly sum but no accounts were kept. The rent of the 3rd
house was divided between them. It was held that there was a partnership as to the
business but not as to the freehold houses.
 2. Section 4(b) – the sharing of gross return also does not imply the existence
of partnership

Case: Cox v Coulson

The defendant (Coulson) was the manager of the theatre and agreed with Mr Mill to
provide his theatre for one of Mill’s production. The defendant was to pay for lighting
and the posters and Mr Mill has to provide the company and the scenery. Under the
agreement the defendant was to receive 60% of the gross takings and the remaining
40% to Mr Mill. The plaintiff was shot by one of the actors during the performance. She
sought to make the defendant liable on the ground that he was a partner of Mr Mill. It
was held that the sharing of gross returns did not create a partnership.

3. S.4( c ) of the PA 1961: The general rule is that if a person receives a share
of the profits, he is prima facie deemed to be a partner of the firm. However,
the courts will look at the other circumstances surrounding the receipt of the profits
to decide whether or not there is a partnership. There are five circumstances
pointed out under s.4 ( c ) where the sharing of profits does not make the person
receiving a partner.Receipt of such a share of profits of a business, does not itself
make him a partner in the business.
 Section 4(c)(i) – payment of debts / payment by instalments

Case: Badeley v Consolidated Bank

Badely advanced money to CB. CB agreed to pay an interest of 10% on the sum
advanced from the net profit of his business. HELD: Badeley is not a partner of CB.

 Section 4(c)(ii) – Payment of servant or agent (remuneration)

The relationship of employer and employee is inconsistent with partnership and that
of an independent agent is clearly distinguishable on the basis that there is no
involvement in the business.

Case: Abdul Gaffoor V Mohamed Kassim (1969)

The sharing of profit as remuneration for an employee does not itself make an
employee as a partner.

 Section 4(c)(iii) – annuity to the widow or children of a deceased partner.

Usually, in partnership agreement, the partner will make the provision that the
partner’s widow or children are to receive a specified proportion of the profits of the
business after his death. Such receipt is clearly no evidence of partnership.
Case: I.R.C v Lebus’s Trustees (1946)
A deceased partner, in his will, bequeathed his share of the profits in a firm to his wife.
The widow’s share of the profits was not paid by the continuing partners and was in
that year surtaxed by the Inland Revenue. It was held that the widow was not a partner
in the business and none of the assets of the firm is belonged to her. Therefore, her
share of profits should not have been surtaxed.
  Section 4(c)(iv) –Loan given with a rate of interest varying with profits.

Case: Re Young , ex parte Jones(1896)

Mr Llyod Jone and Mr Young entered into an agreement provided that Llyod Jone
should lend £500 to Young. In consideration for the payment, Llyod Jone will receive
£3 per week out of profits. Llyod Jone was also to assist in the office. There was also
an option for Llyod Jone to become a partner but he never exercises this option.
HELD: Even though Llyod Jone received a share in the profit, he was not a partner.
He was a creditor.

 Section 4(c)(v) –consideration for goodwill

Case: Pratt v Strick (1932)

A professional man sold his practice and goodwill to another. In the agreement, he
would continue to generate goodwill for his purchaser for a period in return for a share
of the profits. HELD: There was no intention that a partnership was to be established.

FORMATION OF PARTNERSHIP

Number of partners

The minimum number is 2 and the maximum number is 20 for non-professional

partnership and unlimited for professional partnership. In Tan Teck Hee v Cheng Tien
Peng (1915), the firm consisted of 25 members. The Court held that the firm was void.
Therefore, legal action cannot be taken.
Capacity

Where one or more parties to a partnership contract lack of such capacity, the contract
may be invalid.
(a) Minor
The age of majority in Malaysia is 18 as provided in the Age of Majority Act 1971. Until
that age, he is referred as a minor. A minor is a person who has not reached the age
of majority. In Malaysia, the provision of section 11 of the Contracts Act 1950, states
that a minor has no capacity to enter into a contract and this includes a partnership
agreement.

Case: William Jacks & Co (Malaya) Ltd v Chan & Yong Trading Co
Plaintiff claimed RM12,000 for goods sold and delivered to the defendants who were
partners. Yong, a minor at the time the goods were purchased, took no steps to defend
the action, but Chan denied Plaintiff’s claim alleging that the goods bought were for
Yong’s personal use and therefore the partners were not liable.

HELD: The fact that Yong made use of the goods did not mean that the firm and
consequently the partners were not liable. Further, as Yong had not taken any steps
to repudiate the partnership after attaining the age of majority, he was also liable as a
partner of the firm.
Thus, whenever a minor has attained the age of majority, he must make a decision
either to continue or discontinue his existence in the partnership. If he chooses to
remain , he will be regarded as a major/adult partner and thus accountable for the
partnership’s accounts and liabilities.

Case: Goode v Harrison

A minor would be in a partnership for any duration of time until he wanted to disaffirm
it. However, minor cannot incur or be responsible for any contractual liability for the
firm’s debt.

(b) Unsound mind

Unsound mind is not itself a bar from entering into a partnership. There can still be
legally binding agreement to form a partnership between a person of unsound mind
and another person provided the person of unsound mind can establish that the other
person has prior knowledge of his insanity at the time of the agreement.

Illegality
A partnership agreement, like any other contract may be void ab initio because its
either commercial purpose is illegal or because it is proposed to carry on an otherwise
lawful business in an illegal manner. In addition, a partnership may be void for illegality
because the law prohibits partnerships between certain persons. If a partnership is
illegal, the parties will have no rights as against each other or against anyone else.

Partnership is illegal if it is formed for a purpose prohibited by statute or at common

law. In times of war it is illegal for a person resident in one country to form a
partnership with a person resident in an enemy country.

A partnership agreement also illegal if the intention of the parties is to conduct illegal
business. Eg: a partnership created for the export or import of drugs as it was
prohibited by law.

Types of partners

1. General partner – this is the normal type of partner who contributed his capital
for the business and manages the business.
2. Active partner – This partner did not contribute capital but managed the
business.
3. A dormant (sleeping) partner – This partner only contribute his capital into the
business but did not involve in the managing the business.
4. A quasi partner – This partner did not legally register his name as a partner but
his involvement in management of the business and his existence make third
party believe that he is legally the partner of the business. (Partner through
holding out or estoppels).
RELATIONSHIP BETWEEN PARTNERS AND OUTSIDERS
(1) Liability under contract

Section 7 Partnership Act 1961

Every partner is an agent of the firm and his other partner. His action binds the firm
(other partners) if it is done:
1. In the usual way of business or in the usual manner
2. Third party knows that the person contracting is a partner or an agent to the
partnership
3. Third party believes that the partner has authority. The authority could be actual
or apparent.

But, the firm would not be liable for personal debt of partner if it is not done in the usual
way of business or not for business purpose.

Case: Chan King Yue v Lee & Wong (1962)

The plaintiff’s husband borrowed from her $35,000 as a loan from her to the firm which
he was a partner. He gave her a receipt in the name of the partnership. The money
was paid into the partnership account and immediately thereafter utilized by the firm
to pay off some of its debts. The plaintiff initiated an action to recover the loan. The
other partners contended that the plaintiff’s husband was not authorized by the firm to
borrow the money.
HELD: The borrowing was an ‘act necessary for the carrying on of the business’ of the
partnership and as such bound the co-partners.

Case: Sithambaram Chetty v Hop Hing (1928)

Two partners who are living in Singapore opened a shop in Penang. The shop was
run by two managers. The partners never revealed themselves as having connection
with the business and as far as the public could see, the managers were running the
business as partners. One of the manager borrowed money from the plaintiff and then
disappeared. The plaintiff sued the partners in Singapore. The partners said that the
manager had no authority to borrow money.
HELD: All the partners are liable.

Section 8 Partnership Act 1961

Partners are bound by act of any person (not necessarily a partner) on behalf of firm
if it is done in the usual way of business and the person is authorized. The contract
made by employee or agent to the firm may bind the partners.
When a partner deals with third parties (an outsider), he is considered as an agent for
the firm and the other partners. Therefore, whatever contracts that he has entered into
with third parties will bind the firm and the other partners as well provided that he does
so within the authority given to him.

What is authority? Authority is a mandate given to an agent by the principals to perform

a particular act or services of an act for them. As an agent, a partner may have;

i. Actual authority
Simply means that an agent may bind his principal to any act which is expressly /
clearly authorized by his principal to do so.

ii. Apparent / ostensible authority

An authority which is not expressly given to the partner but 3rd party may assume that
a partner will have the usual authority of a partner in that particular kind of business.

Section 9 Partnership Act 1961

Where one partner pledges the credit of the firm for the purpose apparently not
connected with the firm’s ordinary courses of business, the firm is not bound unless
he is in fact specially authorized by the other partners but this section does not affect
any personal liability incurred by an individual partner.

Thus, to summarize that for a third party to hold the partnership firm and the rest of
the partners liable, the following condition must be satisfied;

1. the act must be done for the purpose of the business of the partnership
2. The act must be done in the firm’s ordinary course of business
3. The act must be done by the partner as a partner of the firm and not in his own
personal capacity.

Case: Mercantile Credit Co v Garrod (1962)

Mr Garrod and Mr Parkin formed a partnership carried on a garage business. Their
partnership agreement stated that their usual scope of business would exclude the
buying and selling of car. Parkin, without Garrod's knowledge, sold a car to which he
had no title, to Mercantile Credit Co Ltd for $700. The company brought an action
against Garrod to claim back $700.

It was held that Garrod was liable, because the sale of the car was the doing of "an
act for carrying on in the usual way business of a kind carried on by the firm" within
the scope of the Partnership Act.
Section 11 Partnership Act 1961
Each partner is jointly liable with other partners for debts and contractual obligations
while he is a partner.

Joint liabilities means the creditor has only one cause of action. If he sues one partner
or some only and obtain judgment against him or them, he can no longer sue the
other partners who are jointly liable. This is because he can only constitute a single
action and not several actions against member of the firm.

Case: Kendall v Hamilton (1879)

The creditor sued all the obvious members of a partnership and was awarded
judgment against them. He failed to recover the debt in full. He subsequently
discovered a wealthy dormant partner whom he sought to sue for the balance of the
debt.
HELD: Since the debt was a joint one only, the first action prevents the next action.
Therefore, the action taken failed.

After the death of a partner, his estate becomes severally liable for debts and
obligation incurred while he is a partner. However, the liability is subjected to prior
payment of his personal debts. If there is insufficient partnership property to settle
debt, 3rd party may bring separate action against the property of the deceased partner.

(2) Liability of firm for wrongs (liability under tort)

Section 12 Partnership Act 1961
This liability arises when there is an act or omission of a partner, which caused loss or
injury to third party. The wrongs must be committed in the ordinary course of business
and he acts with the authority of his co-partners.

Case: Hamlyn v Houston & Co. (1903)

A partner in Houston & Co bribed a clerk in a rival firm to disclose to him confidential
information relating to it. The rival firm suffered a loss in consequence and sued
Houston & Co for damages.
HELD: The action succeeded. Houston & Co were liable for the partner’s wrongful act
as he had been acting in the ordinary cause of business of the firm.

(3) Misapplication of money or property received from 3rd party for or in custody
of firm
Section 13 Partnership Act 1961
The firm is liable for the loss to third party if a partner, acting within the scope of his
authority, receives money or property and misapplied it.

Case: Rhoudes v Moules (1895)

The plaintiff sought to raise money by way of a mortgage on his property. He used a
solicitor in a firm who had told him that the lenders wanted additional security and so
he handed the solicitor some share warrants to bearer. The solicitor misappropriated
them and the plaintiff sued the firm.
HELD: The firm was liable.

Nature of liability under sections 12 and 13

Section 14 Partnership Act 1961

The liability under section 12 and 13 of the Act every partner is liable jointly with his
co-partners and also severally for everything for which the firm becomes liable whilst
he is a partner. The distinction in the Act is between joint liability for contracts and joint
and several liabilities for torts.

(4) Improper employment of trust property

Section 15 Partnership Act 1961

If a partner being a trustee improperly employs trust property, he will be liable
personally. Other partners liable if they have noticed of the breach of trust and allow it
to happen.

Case: Blyth v Fladgate (1891)

Trust money may be recovered from the firm if it is still in possession and under the
control of the firm.

(5) Criminal liability

Although partners are jointly liable in civil cases, they are not jointly liable in criminal
cases. So, any criminal offence committed by any partner, he is personally liable.

Case: Chung Shin Kian & Anor v Public Prosecutor (1980)

Both partners (the first and second accused) were accused of applying a false trade
description name “Texwood” to 10 pieces of jackets and 57 pairs of jeans. During the
raid, only the first accused was present in the shop. The second was not present. Both
were charged and sentenced for an offence. They appealed.
HELD: The first accused’s appeal was dismissed. The 2 nd accused conviction was
quashed because he was not present during the raid on the premise and there was
no evidence that he was involved.

(6) Persons liable by “holding out”.

Section 16 Partnership Act 1961

If a person is not a partner but represents himself or allows himself to be represented
as a partner, he may be liable like a partner for the debts of the firm. He is liable as if
he is a partner but only to the third party who has given credit upon believing in that
representation.
Case: Tower Cabinet Co Ltd v Ingram (1949)
Christmas and Ingram entered into a partnership and carried on the business of
household furniture under the name ‘Merry’s’. The partnership was dissolved in but
Christmas continued to carry on business under the same name. Tower Company
Limited which had not previously dealt with “Merry’s” received an order to supply
Merry’s with some furniture. The price for the furniture was never paid and the
company obtained judgment against Ingram on the fact that Ingram’s name appeared
on the headed notepaper which used in relation to the ordered goods.

The court held Ingram was not liable because he had not ‘knowingly’ suffered himself
to be represented as a partner.

(7) Liability of incoming and outgoing partners

Partners are liable without limit for all debts committed by the firm whilst they are
partners. However, partners may come and go. Thus it is necessary to know when a
retiring partner ceases to be liable for the debts of the firm and a new partner assumes
such liability.
Liability of incoming / new partner

Section 19(1) Partnership Act 1961

An incoming or new partner is not liable to creditors for anything done before he
becomes a partner unless there is a special agreement to accept liability.

Case: Rolfe and Bank of Australasia v Flower Salting & Co (1865)

The new partners were held liable to the debts of the old firm as they had impliedly
agreed to accept liability by not objecting to the accounts provided by the creditors. In
other word, a new partner will still be made liable to the debts of his old firm even
though he has joint a new firm

Section 19(2) Partnership Act 1961

Liability of outgoing / retiring partner - Where a partner retires from the firm, he remains
liable for partnership debts incurred while he is a partner unless there is an agreement
to release him.

Case: Court v Berlin (1897)

It was HELD that the retiring partners were liable for the debts incurred in the course
of continuing transaction that commence while they were partners. Since they did not
give the notice of retirement, they were also responsible for the debts incurred after
the retirement.

What about debts incurred by the firm after a partner’s retirement?

According to section 38(1), he is still liable the persons who deal with the firm and his
acts still bind the company unless the firm / he has given express notice to such
persons to inform that he is no longer a partner.
Case: Tan Sin Moh v Lebel Ltd (1988)
Third party must be specifically notified. There must be an express notice or actual
notice given to them or advertised in Federal Gazette. A mere notice to the Registrar
of Business was insufficient.

Case : Re Siew Inn Steamship Co. (1943)

The creditor, who was an old customer, sued the retired partner for the repayment of
his money lent to the firm after his retirement.

HELD: The retired partner was liable even though he had inserted the notice of
retirement in the newspaper. This is because of his failure to give an actual notice to
the creditor. The advertisement in the newspaper considered to be insufficient.

TUTORIAL QUESTION & SAMPLE ANSWER

QUESTION 1
Lina, Mila and Fieda are partners in a firm called “ The New You” which specializes in beauty
treatment.

Lina, without Mila’s and Fieda’s knowledge, borrowed RM50,000 from Sure Finance to pay
off some debts of the firm and to buy new treatment machine. Sure Finance demanded
repayment of the loan form Mila and Fieda when Lina defaulted a few monthly instalments.

Discuss whether Sure Finance is likely to succeed in its action.

SAMPLE ANSWER

a)Issue:

Whether Sure Finance can succeed in its action to sue “The New You “ ?

Principles of Law/General Rules:

(1) Liability under contract

Section 7 PA
Every partner is an agent of the firm and his other partner. His action binds the firm (other partners) if it is done:
(i) in the usual way of business or in the usual manner
(ii) third party knows that the person contracting is a partner or an agent to the partnership
(iii) third party believes that the partner has authority. The authority could be actual or apparent.

But, the firm would not be liable for personal debt of partner if it is not done in the usual way of business or not for
business purpose.
Case: Chan King Yue v Lee & Wong
The plaintiff’s husband borrowed from her $35,000 as a loan from her to the firm which he was a partner. He gave
her a receipt in the name of the partnership. The money was paid into the partnership account and immediately
thereafter utilized by the firm to pay off some of its debts.
The plaintiff initiated an action to recover the loan. The other partners contended that the plaintiff’s husband was
not authorized by the firm to borrow the money.
HELD: The borrowing was an ‘act necessary for the carrying on of the business’ of the partnership and as such
bound the co-partners.
Case: Goldberg v Jenkins & Law
The Court held that the borrowing of money by a partner was held not to amount to the ‘usual way’ due to the
exorbitant rate of interest of the loan.
Case: Sithambaram Chetty v Hong Hing & Ors
Two partners who are living in Singapore opened a shop in Penang. The shop was run by two managers. The
partners never revealed themselves as having connection with the business and as far as the public could see,
the managers were running the business as partners. One of the manager borrowed money from the plaintiff and
then disappeared. The plaintiff sued the partners in Singapore. The partners said that the manager had no authority
to borrow money.
HELD: All the partners are liable.

Section 11 PA
Each partner is jointly liable with other partners for debts and contractual obligations while he is a partner.

Third party may sue all the partners individually or the firm. It is because all the partners in the firm are jointly liable
for all contractual and other debts and liabilities including tax and judgment debts which are incurred while each is
a partner.

Kendall v Hamilton.
The creditor sued all the obvious members of a partnership and was awarded judgment against them. He failed to
recover the debt in full. He subsequently discovered a wealthy dormant partner whom he sought to sue for the
balance of the debt.
HELD: Since the debt was a joint one only, by suing the apparent partners the creditor elected to sue only them
and could not commence a fresh proceedings against the other partner.

After the death of a partner, his estate becomes severally liable for debts and obligation incurred while he is a
partner. However, the liability is subjected to prior payment of his personal debts. If there is insufficient partnership
property to settle debt, 3rd party may bring separate action against the property of the deceased partner.

Application:
According to section 7 of the PA 1961, a partner’s action will make the other partners and firm liable for the
partners action ,if the 3 conditions are fulfilled.
By applying CKY v. L & W to this present case, , the borrowing power is regarded as an act necessary for the
carrying on off the business of the partnership.
Thus, whatever that has been made Lina as long as it is necessary for the ‘New You” firm , her action will make
the other partners (Fieda and Mila) are accountable too. Furthermore, Fieda and Miela are jointly liable with other
partners for debts and contractual obligations while he is a partner .Sure Finance may sue all the partners
individually or the firm

Conclusion:
In conclusion, Sure Finance is likely to succeed in its action to sue the firm “New You” if all the conditions stipulated
under section 7 and 11 are been fulfilled.

QUESTION 2
Eza, Piekah and Amal are partners in a firm manufacturing “ikan masin”(salted fish).The
partnership was formed on 1st January 2016 under the name “Masin Enterprise”.

Discuss the legal position of the concerned parties in the following situation:-
i) On 1st May 2017, Eza retired from the firm. Piekah and Amal continued the business of the
firm without changing the name of the firm. The firm had borrowed a sum of money from Koko
Bank in March 2018. The firm had also borrowed RM10,000 from Semperit Bank in
September 2018.

Consider the liability of Eza towards Koko Bank and Semperit Bank.

SAMPLE ANSWER :

ISSUE:whether Koko Bank and Semperit Bank can sue Eza ?whether Eza is liable towards the said Banks?

PRINCIPLES OF LAW/ GENERAL RULES:

A new partner
Section 19(1) PA – Liability of new partner
Generally, a new partner is not liable to creditors for anything done before he becomes a partner unless there is a
special agreement to accept liability.

Section 19(2) PA – Liability of retiring partner

Where a partner retires from the firm, he remains liable for partnership debts incurred while he is a partner unless
there is an agreement to release him.

What about debts incurred by the firm after a partner’s retirement?

He is still liable the persons who deal with the firm and his acts still bind the company unless the firm / he has given
express notice to such persons to inform that he is no longer a partner.

Section 38(1) provides that where a person deals with a firm after a change in its constitution, he is entitled to treat
all apparent members of the old firm as still being a member of the firm until he has notice of the change.

Case: Tan Sin Moh v Lebel Ltd

Third party must be specifically notified. There must be an express notice or actual notice given to them or
advertised in Federal Gazette. A mere notice to the Registrar of business was insufficient.
Gazette : official journal with public notice.
Notice in newspaper may not be sufficient.

Case : Re Siew Inn Steamship Co.

Advertisement of retiring partner in a newspaper, believed to be read by potential customers, was held to be
insufficient. Thus the retired partner was still liable.

APPLICATION:
In this case, Eza who is a retired partner is under a duty to inform her old cutomers or clients that she has now
retired from Masin Enterprise. Otherwise, she is accountable to their old and new customers. By applying section
19(2) of the PA 1961 Eka, a partner who retires from the firm, will remain liable for partnership debts incurred
while he is a partner unless there is an agreement to release her.Besides that, under section 38(1) of the PA 1961,
Koko and Semperit Bank are entitled to treat all apparent members of the old firm including Eka as still being a
member of the firm until the has notice of the change.

CONCLUSION:
In a nutshell, Koko and Semperit Bank can succeed in their actions to sue Eka since Eka has not
informed her retirement to the old clients.
RELATIONSHIP BETWEEN PARTNERS INTER SE

Section 21 - Right and duties under the acts or agreement may be varied by consent
of all parties and not majority.

Section 26 - Interest and duties of partners are subjected to the agreement made
between all partners. If there is no agreement, all the provisions in section 26 are
applied.

Section 26 of Partnership Act:

(a) profits and losses are to be shared equally

(b) the firm must indemnify every partner in respect of payment made and personal
liabilities incurred by him:
(i) in the ordinary and proper conduct of the business of the firm ;or
(ii) in or about anything necessarily done for the preservation of the
business or property of the firm
(c) loan or advances by a partner to the firm are to bear interest at the rate of 8% per
annum

(d) no interest payable on the partners’ capital

(e) every partner is entitled to participate in management of the business
(f) no partner is entitled to a salary for participating in a partnership business

(g) introduction of a new partner must be by unanimous consent from all existing
partners

Byrne v Reid (1902)

A father proposed his son as partner as allowed under a partnership deed. The
other partners refuse to admit the son. Later they agreed to execute all deeds
necessary for his admission. However, they did not fulfill with their promise, and
still refused to admit him. The son sued them.
HELD: The partners were bound by the partnership deed. The son was a partner
in the eyes of the law upon his father's proposal and therefore could exercise his
rights as such.
(h) ordinary matters may be decided by majority of the partners, but no changes may
be made of the nature of business without the consent of all existing partners
(i) the partnership book must be kept at the principal place of business and accessible
to every partner. They must also be allowed to have a copy of the accounts.

Section 27 - Every partner cannot expel any partner unless that power was conferred
by prior express agreement between the partners.
Green v Howell (1910)
A clause in a partnership agreement provided that if a partner committed any flagrant
breach of his duties as a partner, the other partner could expel him. One partner was
guilty of flagrant breach and the other partner served a notice of expulsion without
giving an opportunity to explain.
HELD: The notice was valid in accordance with the provision in the agreement.

DUTIES OF PARTNERS
(i) They must act in utmost good faith or bona fide towards every other member. They
cannot gain benefit at the expense of the firm. This is because the relationship
between partners is based on mutual trust and confidence.

Case: Vasu Devan & Ors v V.A Nair (1985)

A partner alleged that his co-partner fraudulently sold the business without discussing
the sale agreement with him or obtaining his consent.
HELD: The mala fide partner can be held liable.

(ii) Section 30 – Duty to render proper account

The partners are bound to render true accounts and full information of all things
affecting the partnership to any partner or his legal representatives.

Case: Law v Law (1905)

A, a partner, sold his share in the partnership to another partner, B for $21,000. A later
discovered that the partnership assets consisted of mortgages and other securities.
This fact had not been disclosed to him by B. A asked an order to set aside the
contract.
HELD: The contract could be set aside.

(iii) Section 31 - Account to the firm for any secret profit / benefit
A partner cannot make secret profit. If there is any, he has to account it to the firm
regarding to any transaction concerning the partnership or from any use by him of the
partnership property, name or business connection.

Case: Bentley v Cravan (1853)

A partner must not make a profit from a sale of the firm’s property without full disclosure
to the other partners.

(iv) Section 32 – Duty not to compete with the firm

A partner cannot carry on any business of the same nature as and competing with that
of the firm. If this duty is breached, the remedy has to pay to the firm and all profits
made in the competing business.
Case: Ass v Benham (1891)
A partner cannot use information obtained by him in the course of partnership business
to compete with the partnership itself. In this case, the court HELD that the partner’s
involvement in the business of shipbuilding did not amount to competition with his
firm’s shipbroking business.

PARTNERSHIP PROPERTY

Section 22
“All property and rights and interests in property originally brought in the partnership
stock or acquired, whether by purchase or otherwise on account of the firm or for the
purposes and in the course of the partnership business…and must be held and applied
by the partners exclusively for the purposes of the partnership and in accordance with
the partnership agreement;

Provided that the legal estate or interest in any land which belong to the partnership
shall devolve according to the nature and tenure thereof and the general rules of law
applicable thereto but in trust, so far as necessary, for the persons beneficially
interested in the land under this section.”

The meaning rather wide as it includes not only property but also rights and interests
in property.

Three ways of determining partnership property:

1. All property originally brought into the partnership stock is considered as

partnership property unless there is an express or implied agreement between
the partners to consider it otherwise.
Case : Miles v Dark
Dark carried on a photography business on premises for which he was the
owner of the lease. Miles, a freelance photographer entered into a partnership
with Dark, bringing with him his business connection. They had quarrel and
decided to dissolve partnership. Held; partners had only agreed to share profits
and there was no other arrangement with regard to property. Only consumable
stock in trade was considered partnership property, the lease and equipment
as well as the goodwill was not.

2. Where the property is obtained through a purchase or through any other way
for the firm. Where the property is brought with the partnership money, the
property is deemed bought for the firm.
Case : Ex parte Hinds
A few partners traded as merchants in Liverpool and Barbados. The partner in
Liverpool had purchased shares in a railway with money that belonged to the
 firm without the knowledge of the others. His intention was to buy it on behalf
and for the firm. Held; the shares were partnership property.

3. The property is obtained through any lawful means where the property is
obtained for the purpose and in the course of the partnership business.
However not all property used in the course of partnership business is
partnership property.

TUTORIAL QUESTION & SAMPLE ANSWER

Ida, Ima and Hana are partners of a beauty saloon. Their saloon is located in section 9, Shah
Alam. Without the knowledge of the other two, Ida set up her own beauty saloon in Jalan
Telawi 3 Bangsar. Two months later, Ima and Hana came to know about Ida’s saloon and
demanded that Ida hand over all profits made by her saloon as she has breached her duty as
a partner under the Partnership Act 1961.

Identify the duty in question and the section which provides for it. Decide
whether Ida is, in fact, in breach of that duty.
(20 marks )

a)Issue:

whether Ima and Hana can sue Ida for the keeping of profits to herself ?

whether Ida has breached any duties as a partner i.e. for setting up her own beauty
salon without the knowledge of the other partners ?

General Rules:

(1) Section 31 - Account to the firm for any secret profit / benefit
A partner cannot make secret profit. If there is any, he has to account it to the firm
regarding to any transaction concerning the partnership or from any use by him of the
partnership property, name or business connection.

Case: Bentley v Cravan (1853)

A partner must not make a profit from a sale of the firm’s property without full disclosure
to the other partners.

(2)Section 32 – Duty not to compete with the firm

A partner cannot carry on any business of the same nature as and competing with that
of the firm. If this duty is breached, the remedy has to pay to the firm and all profits
made in the competing business.

Case: Ass v Benham

A partner cannot use information obtained by him in the course of partnership business
to compete with the partnership itself.

Application:
By virtue of section 31, Ida’s action has shown to us that she has breached the duties
as a partner. Thus, she is accountable to render the private profit to the partnership
consisting Ima and Hana.This is in line with the decision in Bentley v Cravan where
a partner must not make a profit without the full disclosure to the other partners.

In accordance to s.32, Ida’s action of setting up a beauty saloon on her own and
without the knowledge of the other partners clearly depicts that it is of the same nature
and competing with the firm’s business.
This is further supported by Aas v. Benham case whereby a partner cannot use
information obtained by him in the course of partnership business to compete with the
partnership itself.

By applying. s31 and s.32 and Benham’s case to Ida’s case, we can summarise that
as a partner, Ida has done something which is contrary to the duties as a partner.
Thus, she is accountable on what he has done to the partnership bisness.

Conclusion: In conclusion, Ima and Hana can sue Ida for breach of duties as a partner
and Ida has to account for the profit derived from the partnership.
DISSOLUTION / TERMINATION OF PARTNERSHIP

Part V of the Partnership Act deals with dissolution of partnership in the following ways:

1. By agreement
a. Terminated on the expiry of the period fixed by the partnership agreement.
b. The partner may mutually agree to dissolve the partnership at any time.

2. By operation of law – section 34(1) PA 1961

a. By expiration of fixed period or
b. By completion of single project
c. By notice - If there is no fixed time or provision regarding dissolution, a
partner may terminate the partnership at any time by giving a notice to other
partners. It can be orally or in writing depend on the agreement between
partners if the partnership was originally constituted by written document,
notice in writing is required.
In J.M.M Lewis v W.E Balasingham, a notice of dissolution would be
ineffective as there was in existence an agreement which had provided for
a means of terminating a partnership. If the partners have agreed as to the
method by which the partnership can be dissolved, no other way is to be
used.

3. Death or bankruptcy of any partner – section 35 (1) PA 1961

In Lee Choo Yam Holdings Sdn Bhd v Khoo Yoke Wah it was held that death
or bankruptcy of any partner may dissolve a partnership unless there is an
agreement to provide otherwise. Therefore partners may agree that any
bankruptcy or death or any partner may not dissolve the partnership.

4. By charging on shares – section 35(2) PA 1961

If any partner charges his shares of partnership property for his own personal
debt, the partnership would be dissolved

5. By supervening illegality – section 36 PA 1961

Any event which makes the business becomes unlawful. Eg: there is a change
in circumstances or status in law.
In R v Kupfer the Court held that the partnership was dissolved as soon as war
was declared as the partners of the firm were considered enemies of each other
as they came from two countries at war.
In Hudgell Yeates & Co v Watson, the partnership was automatically ended
one of three solicitors in a firm forgot to renew his practicing certificate without
which he was forbidden to practice under Solicitors Act 1974.

6. By court’s order. A partner may be dissolved by a court order on the application

by a partner – section 37 of the partnership Act 1961. This is discretion by High
Court for just and equitable. On application by a partner, the court may order
the dissolution in any of the following cases:
a. Insane of a partner
b. Permanent incapacity
c. Conduct calculated to prejudicially affect the carrying out the partnership
business by any partners other than the applicant.
Case: Carmichael V Evans, C and E were partners. C was convicted of
travelling on the railway without a ticket and with intent to defraud. The court
held that as the conviction was for dishonesty, it is detrimental to the
partnership business.
d. Willful or persistent breach of the partnership agreement by any partner.
e. When the business of the partnership can only be carried on at loss.
f. If in the opinion of court, it is just and equitable to dissolve the partnership.
For example, where there are only two partners and the partnership has
reached a deadlock although it may continue to make profits as in the case
of Re Yenidje Tobacco Co. Ltd.
 CHAPTER 3 (a)

COMPANY LAW

Definition
Section 2 of the Companies Act 2016 defines company a : ‘ A company is incorporated
pursuant to Companies Act’.

Formation or Incorporation of companies in Malaysia

Section 9 of the Companies Act 2016 (hereinafter CA 2016) : the company shall have

1. A name
2. One or more members, having limited liability or unlimited liability for the
obligation of the company
3. One or more shareholders for a company limited by shares.
4. One or more directors.

Application for incorporation

Section 14: anyone who desires to form a company must make an application to the
Registrar of Company. The application must the following particulars:

1. The name of the proposed company

2. The status of the company whether private or public company
3. The nature of the business
4. The name, identification, nationality and the ordinary place of residence of
every person who is to be a member of the company
5. The name, identification , nationality and the ordinary place of residence of
every person who is to be a director of the company
6. The name, identification, nationality and the ordinary place of residence of
every person who is to be a secretary of the company
7. In the case of company limited by shares, there must be the details of class and
the number of shares to be taken by a member
8. In the case of a company limited by guarantee, the amount up to which a
member undertakes to contribute to the assets of the company in the event of
its winding up
9. Other information as Registrar may require.

Registration for incorporation

Section 15 : if the registrar satisfied that the requirement are complied with and upon
payment of the prescribed fees, the Registrar shall:

1. Enter the particular s of the company in the register

2. Assign the registration number to the company as its registration number
 3. Issue the notice of registration in the form and manner as the Registrar may
determine.

Name of the company

Section 25 : a company name must end with the following:

1. For a Public Company, the word ‘Berhad’ (Bhd)

2. For a private Company, the word ‘Sendirian Berhad’ (Sdn Bhd)
3. For an unlimited company, the word ‘Sendirian’ (Sdn)

Section 26 : The name of the company must not be:

1. Undesirable or unacceptable
2. Identical to an existing company, corporation or business
3. Identical to a name that is being reserved under Companies Act 2016
4. A name of kind that the Minister has directed the Registrar not to accept for
registration

The use of certain words in company’s name must be approved. Some of the
legislations restricted words as follows:

1. Accountants Act 1967: taxation, accounting, public accountant, auditor, tax

consultant and tax advisor.
2. Medicine ( Advertisement and sale ) Act 1956 : clinic, treatment, hair clinic, hair
loss, etc
3. Financial Services Act 2013: bank, insurance, assurance.

There are also words with suggest association with activities regulated by the
government such as:

1. Collage, institute, university – approval from the Ministry of Higher Education

Malaysia
2. Wakaf, Baitulmal, Halal – approval from JAKIM

Names which may be accepted with the consent of the Ministerial:

1. Words connections with the crown such as ‘Royal’ or ‘Imperial’.

2. Words connections with any ASEAN or Commonwealth
3. Words connections with the state, federal government department, statutory
body, government agency or other local authority.
4. Words connections with any policies, party, society, trade union, or cooperative
society
5. Words that are misleading as to identity, nature, objects or purpose of the
company
6. Blasphemous or offensive words
7. Names including a proper name which is not the name of the director
Register of members

Section 50: every company must keep a register of its members and record in the
register:

1. The name, addresses, IC number, nationality and the ordinary place of

residence of every person who is to be a member of the company
2. For the company with share capital, a statement of a shares held by each
members
3. The date at which the name of each person was entered in the register as a
member.

Register of Director, Managers and Secretaries

Section 57: the company must register the following particulars:

1. In respect of a Director – his name, residential address, service address, date

of birth, business occupation identification and particular of any directorship of
public companies or companies which are subsidiaries of public company held
by the director.
2. The managers or secretaries – his full name, identification, residential address,
business address and other occupation.

Commencement of business

Section 18:

1. Private company can start to carry on business from the first day of its
existence, that is the date of registration, as stated on the notice of registration
2. Public company
(a) Public company not issues prospectus can start the business if the
statement complies with Act has been lodge with the Registrar AND every
director of the company has paid to the company on each share taken or
contracted to be taken.
(b) Public company issued prospectus can start the business if there is no more
possibility for the money invested by members.

TYPES / CLASSIFICATION OF COMPANIES.

1. Companies based on liability of members

- Company limited by share
- Company limited by guarantee
- Unlimited company

2. Companies based on status

- Public company
- Private company
 3. Company based on relationship with other companies
- Holding company
- Subsidiary company
- Related company
4. Company based on place of incorporation / business
- Local company
- Foreign company

A. CLASSIFICATION ACCORDING TO LIABILITY OF MEMBERS

1. Company Limited by Share

Section 10(2): a company is limited by shares if the liability of its members is limited
to the amount, if any, unpaid on shares held by the members.

It means, if the member has fully paid his shares, he will not be liable for the debt of
the company. If the company wound up and all the assets of the company are
insufficient to meet its liabilities, a member who was fully paid his shares will not liable
to contribute.

But, if the member has not fully paid on his shares, he will be liable for the debt of the
company and he may be called upon at any time by the company to pay the unpaid
shares.

For example, Ali has subscribed 5000 unit shares from ABC Sdn. Bhd with nominal
values of RM1 per unit share. He supposed to pay to the company RM5000. He
however, paid RM3000 only. This means, if the company is insolvent, Ali must settle
the balance of RM2000. His liability is limited up to the amount that has not been paid
yet.

2. Company Limited by Guarantee (CLBG)

A company limited by guarantee is a public company incorporated with the principle

liability of its members is limited by the constitution to such amount as the members
agrees to contribute to the assets of the company if the company is wound up. Such
company depends on fees collected from members to fund its operations.

There are two types CLBG under the Companies Act 2016:(a) CLBG without the word
"Berhad" or "Bhd"; and (b) CLBG with the word "Berhad" or "Bhd"

3. Unlimited Company

Section 10(4) there is no limit on the liability of its members.

The members are responsible for the whole liabilities of the company, but such liability
arises only when the company is wound up and is unable to meet its debt. In this
respect, it is quite similar to a partnership.
Members of unlimited company are liable for all the debts of the company. But the
benefit of an unlimited company over that of a partnership is an unlimited company
enjoys separate legal entity from its members and thus, has perpetual succession.

B. CLASSIFICATION BASED ON STATUS OF COMPANY

1. Private Companies

Private company is usually small in size and the shareholders are often also the
directors. Private company is defined in Section 4(1) as:

 A company incorporated as such by virtue of section 15 or its predecessors

which has retained its private status;
 Any company converted into a private company under section 26(1).

The conditions which are required of a private company under Companies Act 2016
as laid down under Section 15(1) are;

 It is a company limited by shares

 It restricts the right to transfer its share
 It has not more than 50 shareholders
 It cannot offer its shares or debentures to the public
 It cannot allot shares or debentures with a view of offering them to the public
 It cannot invite the public to deposit money with the company

Exempt private company

Section 2(1)
Private company in the shares of which no beneficial interest is held directly or
indirectly by any corporation and which has no more than 20 members none of whom
is a corporation.

The main advantages of exempt private company are as regard to:

 Ability to keep financial information private where it is exempted from filing its
audit and financial statements with ROC.
 Not prohibited from lending money or giving financial assistance to its directors.

All companies are required to lodge an annual return and to attach certified copies of
their financial statement to their annual returns. However, exempt private companies
need not lodge their financial statements together with the annual return. They are
only required to provide financial statements in the prescribed forms to their
shareholders.
2. Public Companies

Section 2(1)
Public company is a company other than private company

A public company may be a limited or an unlimited company. It may be limited by

shares or guarantees.

Unlike private company, a public company may have any of the following
characteristics;

 It is a company limited by shares or guarantee, or it can be an unlimited company;

 It need not restrict the right to transfer its share
 It can have more than 50 shareholders
 It can offer its shares or debentures to the public
 It can allot shares or debentures with a view of offering them to the public
 It can invite the public to deposit money with the company

DIFFERENCES BETWEEN PRIVATE AND PUBLIC COMPANIES

Private Companies Public Companies

Name End with the word End with the word ‘Berhad’ or
‘Sendirian Berhad’ or Sdn ‘Bhd’
Bhd’
Transfer of Restriction on transfer of No restriction on transfer of
shares shares shares
Number of Number of members must No limit in number of members
members not exceed 50
Subscribing Cannot invite public to No restriction as to inviting the
of share subscribe for shares or public to subscribe for shares or
debentures debentures so long as prospectus
requirements are observed
Deposit Cannot invite public to Can invite public to deposit money
money deposit money with the with the company eg. Bank
company
Allotment No need to register a Must register a prospectus before
of shares prospectus before allotting shares are offered to the public
shares
Members’ Meeting or circulation Meeting
resolution
Annual Not required Required
General
Meeting
C. CLASSIFICATION ACCORDING TO THE RELATIONSHIP WITH OTHER
COMPANIES

1. Holding and Subsidiary Companies

Companies Act, 2016 defines subsidiary and holding company in section 4. It state
that the relationship between holding (H) and subsidiary (S) company may occur in
any one of four situations:

Section 4(1)(a)(i)
H controls the composition of the board of directors of S. Means, H can appoint or
remove all or a majority of its directors of its S;

Section 4(1)(a)(ii)
H controls more than half (more than 50%) of the voting power in S;

Section 4(1)(a)(iii)
H holds more than half (more than 50%) of the issued share capital of S;

Section 4(b)
S is a subsidiary of any corporation which itself is a subsidiary of H.
2. Ultimate Holding Company

Under section 5, a company is an ultimate holding company of another company is :

 That other company is subsidiary of that holding company ; and
 The holding company is not itself a subsidiary of another.

3. Wholly Owned Subsidiary

A company is wholly owned subsidiary under section 6 if none of its members is a

person other than:
 Its holding company
 A nominee of its holding company
 A subsidiary of the holding company
 A nominee of such a wholly owned subsidiary

4. Related Companies

According to section 7, where a corporation is a holding company with subsidiaries,

all of the companies are deemed to be related to each other if:
 1. It is the holding company of another corporation;or
2. It is a subsidiary of another corporation; or
3. It is a subsidiary of the holding company of another corporation.

D. CLASSIFICATION BASED ON PLACE OF INCORPORATION

1. Foreign Company

According to section 2(1), foreign company means;

 A company, corporation, society association or other body incorporated
outside Malaysia; or

 An incorporated society, association or other body which under the law of its
place of origin may sue or be sued, or hold property in the name of secretary
or other officer of the body or association duly appointed for that purpose and
which does not have its head office or principal place of business in Malaysia.

A foreign company desiring to establish a place of business within Malaysia must

become registered by lodging certain document with CCM

2. Local company

Local company is a company incorporated in Malaysia.

EFFECTS OF INCORPORATION OF A COMPANY

THE DOCTRINE OF SEPARATE LEGAL ENTITY/PERSONALITY

A company is an artificial person. Once it is incorporated by complying with the

prescribed procedure, it comes into being and is a separate legal entity from its
members and officers.

The principle of separate legal entity is laid down under Section 20 of the Companies
Act 2016 which reads;

“A company incorporated under this Act is a body corporate and shall;

(a) have legal personality separate from its members; and
(b) continue in existence until it is removed from the Registrar

Section 192(1) provides that;

“A member shall not be liable for an obligation of a company by reason only of being
a member of the company’.

The above section explains the effect of incorporation namely:

a) the company is a body corporate having a power of an incorporated company
b) the company has a right to sue or being sued on its own name
c) it has a perpetual succession
d) it may have its own property
e) the liability of the members may be limited

a) The company is a body corporate having a power of an incorporated

company (has separate legal personality from the person who manages the
company).

The concept of legal entity was established in the leading case of Salomon v
Salomon & Co Ltd (1897). In this case Mr. Salomon was a businessman. He
incorporated his business into a company “Salomon & Co. Ltd” and became the
director of the company. He gave one share each to his wife and five children and
20,001 shares to himself. He sells his business to the company for £10,000 and issued
the debenture.

The company’s business failed and later got into liquidation. The value of its asset only
£6000 when the company’s debt £17,000. The company went into liquidation and the
liquidator claimed that Mr.Salomon cannot claim the debenture of £10,000 he should
be responsible for the company’s debt.
The House of Lords held that Mr. Salomon and the company were two separate
entities even Mr. Salomon owned majority of shares in the company. The members
were not liable to pay company’s debt.

In Abdul Aziz bin Atan & 87 Ors v Ladang Rengo Malay Estate Sdn. Bhd. (1985),
all the shareholders of the company sold and transferred their entire shares to a certain
buyer. The question arose in the dispute was whether the estate was sold and if so
whether a change of employer took place? The court held that an incorporated
company is a legal person separate and distinct from the shareholders of the
company. The company did not change its personality or identity even though all of
shares have been transferred to the new owner.

b) The company has a right to sue or being sued on its own name

In the case of Foss v Harbottle (1843), the directors of a company had misapplied
properties belonging to Victoria Park Company. The shareholders of the company
sued the director. It was held that the Company should take action against its directors.

c) The Company has a Perpetual Succession

Even though all the directors have resigned or dies, the company is still legally exists
until its name has been struck off from the register or if it is wound up.

In the case of Re Noel Tedman Holding Pty Ltd, the company had only two
shareholders, a husband and wife. They were also the directors of the company. Both
died in a traffic accident. The court held that even though all the shareholders and
directors were dead, the company still exist.

d) The Company has the ability to own property

All assets, rights and liabilities incidental to the company’s activities belong to the
company and not to the members or shareholders.

In the case of Macaura v Northern Assurance Co. Ltd (1925), Macaura sold all his
timber to a company in which held majority of shares. He took out fire insurance in his
own name. When the timber was destroyed by fire, Macaura claimed compensation
from the insurance company. His claim was rejected on the ground that the timbers
belong to the company and it should be insured under the company’s name.

e) The liability of the members may be limited for the debts of the company
because the company is liable for its own debts.
In the case of Re Application of Yee Yut Ee (1978), Yee was a secretary in a
company. Later, he was appointed as a director in the company. The company
retrenched its staff without paying them retrenchment benefits. The retrenched
workers brought the case to the Industrial Arbitration. The Arbitration ordered that Yee
should be responsible for the retrenchment benefits. Yee brought the case before the
High Court. It was held that Yee was not liable to pay.

LIFTING THE VEIL OF INCORPORATION (EXCEPTIONAL RULE)

In these exceptions, the company is treated as one or identified with its members or
those who manage it. It can be classified into two categories namely statutory and
judicial exceptions.

Statutory Exceptions

1. Pre-incorporation contract.

Pre-incorporation contract means a contract or transaction made on behalf of the

company at the time when the company has not been performed. According to section
65(1) CA 2016, the person who signs the pre-incorporation contract will be personally
liable for the contract or transaction accordingly.

2. Financial assistance to purchase share

Section 123 CA 2016 prohibits the company from giving a financial assistance for
purchase of shares of the company. An officer is liable if he authorises the finance for
the purchase of the company’s shares.

3. Allotment of shares

Section 186 CA 2016 prohibits the allotment of shares unless the minimum
subscription and the amount payable on application for the subscribed shares have
been received by the company.

Section 186(4)(a)
If these two conditions are not fulfilled within four months from the issue of the
prospectus, the company is required to refund all moneys received to the applicant of
the shares.

Section 186(4)(b)
In the event of the company fails to refund the moneys, the director will be jointly and
severally liable to refund the moneys with the rate of interest 10% unless they can
proof that the default was not due to their misconduct or negligence.
4. Wrongful Trading
According to Section 539(3) CA2016, wrongful trading occurs when an officer of the
company knowingly contracts a debt for the company at a time he has no reasonable
or probable ground of expectation that the company would be able to pay the debt.

Section 540(2) CA2016, the officer of the company would be guilty of an offence and
personally responsible for the repayment of the whole or any part of the debt.

5. Fraudulent Trading

It happens when an officer of the company carries on any business of the company
with intend to defraud the company’s creditors.

In section 540(1) CA2016, any person who was knowingly a party to the carrying on
of any business of a company with intend to defraud the creditors of the company or
any person or for any fraudulent purpose, he may be personally liable for all the debts
and liabilities of the company.

6. Misappropriation of money.

Section 541 CA 2016 provides that the promoter or officer of the company, who
misapplied or retained the company’s money or property, shall be liable to restore or
repay in the event the company is wound up. If an officer misapplied the assets, he is
liable for breach of trust.

Judicial Exceptions

1. Using a company to evade legal obligations

In the case of Gilford Motor Co v Horne [1933], Horne was the managing director in
the plaintiff’s company. He had entered into an agreement stating that he would never
solicit the plaintiff’s customers after his termination of employment in that company.
After he left the company, he set up his own company and solicited his ex-company’s
customers. The plaintiff’s company sought a legal proceeding against Horne and his
company for taking its customers. The court granted an injunction against Horne and
his company for breaching the agreement he made before.

2. Using the company to commit Fraud or improper purpose

In Re Bugle Pres Ltd (1960), there were three shareholders, J, S and T in Bugle
Press Ltd. J & S wanted to purchase T’s shares. As T refused, J & S incorporated
another company, J & S Holdings Ltd. J & S Holdings Ltd then offered to buy all the
shares in Bugle Pres Ltd. J & S accepted. They compelled T to sell his shares. It was
held that the court may lift the veil of incorporation and the action done by J & S
Holdings was a sham. It was incorporated to enable J & S to expropriate from the
minority shareholder, that is, T.
3. A company has been controlled and become and an agent to its controller

In the case Aspatra Sdn Bhd v Bank Bumiputra Malaysia Bhd. [1988], Lorrain
Osmane was a director in Bank Bumiputra Malaysia Bhd. (BBMB) and a chairman in
Bumiputra Malaysia Finance (BMF). BBMB and its subsidiary, BMF took a legal action
against Lorrain for secret profit he allegedly made when he was holding his post in the
companies. The companies also applied for Mareva injunction to restrain Lorrain from
transferring his assets out of jurisdiction. The injunction was also extended to Aspatra
(which Lorrain holds majority of shares and he is also the director of the company).
Aspatra challenged the Mareva injunction stating that the court should not treat the
company’s assets as Lorrain’s assets.

The court held that it will lift the corporate veil in order to do justice particularly when
it involves the element of fraud. The court in this case found that Lorrain had used his
shareholdings and directorships to control the company.

4. In a case of group of companies

The doctrine of separate legal entity is not only applied to the company and its
members, but also applied between the company and its subsidiary.

In the case of Industrial Equity Ltd v. Blackburn (1977) , the holding company had
declared the payment of dividend out of the profits of a subsidiary. The court held that
the holding company and its subsidiary should be treated as separate legal entities,
therefore, the payment of dividend cannot be done.

However, in certain situations, a group of companies may be treated as a single

corporate entity as in the case of Hotel Jaya Puri Bhd v National Union of Hotel,
Bar and Restaurant Workers [1980]. It was held that the Restaurant and the Hotel
as one single entity.

5. Where the court exercises an equitable discretion

Sometimes, the court will use its own discretion to ignore the doctrine of separate legal
entity of the company, if it thinks just and equitable to do so. Therefore, where the
court may look behind the operation of the company to determine who actually acts or
has a control over the act of the company.
 CHAPTER 4

THE COMPANY’S CONSTITUTION

UNDER THE PREVIOUS ACT (THE COMPANIES ACT 1965)

The Constitution of a company consists of the Memorandum of the Association (MoA)

and Article of Association (AoA).

Under CA1965, every company must have MoA and AoA. Both MoA and AoA bound
the company and members of the company as if they had signed the document. They
were deemed to have agreed to observe and be bound by the provisions in MoA and
AoA.

Where there were a conflict of inconsistency between the MoA and AoA, the
Memorandum prevailed.

Section 18(1) of the Companies Act 1965 provides that the Memorandum of
Association must contain the following:

 Structure of company i.e. Name, object, amount of company’s share capital (unless
it is unlimited company), name of director/s etc;
 Aims of the company;
 The manner in which the company’s share capital is divided into shares of fixed
amount;
 Whether liability of a members is limited of unlimited;
 The full names, addresses and occupations of the subscribers, etc

Section 33(1) of the Companies Act 1965 states that;

AoA explains the internal regulations of the company that thus the regulations by which
a company is governed. They included matters relating to transfer or shares,
proceedings at general meetings, power of directors, payment of dividends and so
forth.

UNDER THE NEW AMENDED ACT (THE COMPANIES ACT 2016)

Under this new Act, the term constitution is used to replace “MoA” and “AoA”
collectively.

Section 31(1) CA2016

“A company, other than company limited by guarantee, may or may not have a
constitution”.

As mentioned above, the MoA contains important information about the company. The
AoA contains the internal rules on the management of the company. Where then this
information found if the company does not have a constitution?
Section 31(2) CA2016
“If the company has a constitution, the company, each director and each member of
the company shall have rights, powers, duties and obligations as set out in the Act,
except to the extends that such rights, powers, duties and obligations are permitted to
be modified in accordance with this Act, and are so modified by the constitution of the
company”.

Section 31(3) CA2016

“If the company has no constitution, the company, each director and each member of
the company shall have the rights, powers, duties and obligations as set out in the
Act”.

(1) Company limited by guarantee

Section 38(1) CA2016

“A company limited by guarantee is required to have a constitution”.

Section 38(2) CA2016

“The constitution of the company limited by guarantee shall be lodged at the same
time the company is incorporated”.

Content
Apart from the requirement that the constitution is to be signed by the person intending
to incorporate the company limited by guarantee, section 38(3) prescribes the
constitution should contain the following information:

(a) that the company is company limited by guarantee;

(b) the objects of the company;
(c) the capacity, rights, powers and privileges of the company;
(d) the number of members with which the company proposed to be incorporated;
(e) matters contemplated by this Act to be included in the constitution; and
(f) any other matters as the company wishes to include in its constitution.

(2) Company limited by shares

Section 32 CA 2016
Although a company limited by shares is not mandated to have a constitution, section
32 allows a company limited by shares to adopt one by passing a special resolution;
and company is required to lodge with the ROC within 30 days from its adoption.

The constitution may contain provisions on the following:

(a) the objects of the company;

(b) the capacity, rights, powers and privileges of the company if this provision restricts
such capacity, rights, power or privilege
(c) matters contemplated by this Act to be included in the constitution; and
(d) Any other matters as the company wishes to be including in its constitution.
(3) Unlimited company

Section 31(1) CA2016

Unlimited company also can adopt a constitution. The provisions applicable to a
company limited by shares in relation to the form and content of its constitution should
also apply to an unlimited company.

THE EFFECT OF THE CONSTITUTION

The constitution of a company is binding on the company on and the members to the
same extent as if the constitution had been signed and sealed by each member and
contained covenants on each member to observe all provisions in the constitution.

Effectively, the constitution is a statutory contract between the company and members,
and between the members themselves.

In a nutshell, it is a contract between company and members effectively, ,i.e. the

constitution is a statutory contract between the company and members, and also
between the members themselves.

(1) Contract between company and members

The constitution is a contract between the company and its members. In case of:

Case: Hickman v Kent of Romney Marsh Sheep Breeder’s Association (1915)

The company’s article of association provided that if there was any dispute between
the company and any member, the dispute must be referred to an arbitrator. However,
Mr. Hickman instead of going to arbitration filed an action in court.
The court held that Mr. Hickman was bound by the article and must refer the dispute
to arbitration.

Case: Quins & Axtens Ltd v Salmon (1909)

The company’s article provided that certain contract must be approved by Mr. Salmon
and Mr. Axtens. In one instance, Salmon refuse to consent and the directors called for
an Extraordinary General Meeting to approve the transaction. The court granted an
injunction to restrain the company from acting on the member’s resolution.
Held: If the company had wanted to do away with Mr. Salmon approval, it should have
taken steps to alter the article.

(2) Contract between members inter se

The CA 2016 also stipulates that the constitution is a contract between the members
of the company, as if each of them has signed on it. They are bound by it.

Case: Rayfield v. Hands (1958)

The company’s AoA provided that any member who wish to transfer shares had to
inform the directors first. These directors had to take the share equally between them
at a fair value. Rayfield wanted to transfer his shares. But the directors, who were also
members, refused to take them.
Held: The directors had to purchase those shares as states in the AoA.

Case: Wong Kim Fatt v Co Sdn Bhd (1976)

In this case, one of the articles of the company provided that the majority shareholder
could require the minority shareholder to sell his shares to the former. Pursuant to this
article, the majority shareholder requisitioned the purchase but the minority
shareholder refuses to oblige.
The court held that the said article was a contractual obligation which must be fulfilled
by the minority shareholder.

(3) Position of outsider

The constitution is a contract between the company and members, and between the
members. The doctrine of private does not permit the constitution even when the
clause purportedly confers a right on him.

Case: Raffles Hotel Ltd. V. Malayan Banking Bhd. (No.2) (1966)

The company’s AoA provided that the lessor of the land may appoint the director of
the company. Malayan Banking was the lessor and it appointed itself as the company’s
director. The company claimed that appointment was invalid.
Held: Malayan Banking was not a member and therefore could not enforce the rights
provided in the AoA.

Case: Eley v Positive Assurance (1875),

The company’s articles provided that Eley would be the company’s solicitor. After
some time, the company stopped giving legal work to him, and instead gave the work
to other solicitors. Eley sued the company for breach of contract.
The court held that the articles did not create any contract between the company and
Eley as solicitor.
THE DOCTRINE OF ULTRA VIRES

Under the 1965 Act, section 18(1) (b) mandated that every company’s memorandum
of association must include a clause on its objects.

Arab-Malaysian Finance Bhd v Meridien International Credit Corp Ltd London

(1993) defines the object of a company as the company’s business activities.

The objects clause was mandated as it might be important for the third parties to know
the company’s object before they deal with the company or subscribe to its shares.

Ultra vires are acts which are not its objects clause in the constitution of the company.

For example, a Muslim will not want to invest a company that has businesses which
are not halal. Thus, before he invests the company, he will peruse the company’s
objects clause to ensure that is does not include any business which is not halal.

(1) Under Common Law

At common law, a transaction which is outside the company’s objects clause is ultra
vires the company and consequently, VOID.

Case: Ashbury Railway Carriage & Iron Co. v. Riche (1875)

The objects of the company as stated in the MOA were;
“…to make, sell…railway carriages and wagons...”
When the directors entered into a contract on behalf of the company to construct a
railway, the court held that such transaction was not included in the object clause and
thus was an ultra vires transaction.

Case: Re Introductions Ltd. (1970)

The company’s main object was to provide services for tourism. It also gave the power
to the directors to borrow money. But the directors could not borrow money to enable
the company engaging into pig-breeding business because such business was not
stated in the object clause.

Effects of Ultra Vires Doctrine Under Common Law

i. Contracts with third party become null and void. Therefore, if a company
enters into an ultra vires transaction, there is no need for it to fulfill its
contractual obligations.
ii. If the directors enter into an ultra vires transaction on behalf of the company
(under a breach of fiduciary duties).
(2) Under Companies Act 2016

2.1 Company Limited by Guarantee

A company limited by guarantee is required by section 38(3) to state its objects in its
constitution. Means, its activities are limited to the object clause of the company. It
also applies common law rules on ultra vires doctrine.

2.2 Other Companies

2.2.1 Not having a constitution

Section 21(1) CA2016

“A company shall have the capacity to carry on or undertake any business or activity”.

Section 21(2) CA2016

“A company shall have the full rights, powers and privileges for those purposes”.

Section 14(3) CA2016

“The application for the incorporation of a company to include, among others, the
nature of business of proposed company”.

Means, CA2016 gives full capacity to a company to carry on or undertake any business
or activity. However, in reality, the company cannot undertake all types of business.

For the other types of companies, they are required to put their nature if business in
their application for incorporation and their annual return. They may also have an
object clause in their constitution.

Thus, by implication, the company is not restricted by the nature of business as stated
in the application for incorporation or in its annual return. It has the capacity to do any
businesses other than that stated in its application and annual return, so long it is not
outside the objects set out in its constitution.

2.2.2 Having a constitution

The other companies can have its constitution by passing a special resolution; the
effect is like the company Limited by Guarantee. The sections below give the power
to do so.

Section 35(1) CA2016

“It may adopt a constitution and state therein its objects”.

Section 35(2) (a) CA2016

“If the constitution states the objects of the company, then the company shall be
restricted from carrying on any business or activity that is not within those objects”.
RIGHTS

Rights of the third party

Where the third party is not aware that is transaction with the company is outside the
company’s object clause, the contract is valid and must still be performed.

This is because section 21(1) of the CA2016 provides that a company has full capacity
to carry on or undertake any business or activity, and thus the third party can assume
that the transaction is not ultra vires.

The third party cannot be said to have known about the company’s objects clause as
stated in its constitution.

Thus, as far as third party who is dealing with the company is concerned, he would not
be deemed to have knowledge of the company’s objects; he can assume that the
company he is dealing with has full capacity to carry on or undertake the business or
activity.

It is submitted that the third party who was not aware of the company’s lack of capacity
when the contract was made, can enforce the contract; the company is bound and
cannot use the lack of capacity as a defense to avoid the contract.

Rights of the company

The next issue is whether the company can enforce the contract which is ultra vires
its objects clause.

Section 20(1) CA 2016 provided that a contract was not invalid by reason only of the
fact that the company was without capacity. As the contract was not invalid, it followed
that the company could enforce the ultra vires contract.

However, the right of the company to enforce an ultra vires contract under CA 2016 is
not stated.

Section 213 CA 2016

It is the duty of director, chief executive officer, chief financial officer, chief operating
office and any person primarily responsible for the management of the company to
exercise his powers for a proper purpose and in good faith in the best interest of the
company.

Thus, it should follow that the company could sue the director not acting for a proper
purpose when he authorized the ultra vires transaction.

Rights of the members and debenture holders

The CA 2016 does not give any specific right to members or debenture holder to
restrain the performance of ultra vires contract. However, the debenture holder or
shareholder who feel cheated or disagree with the ultra vires contract can seek the
protection under:

(a) Section 346(2) CA2016 – oppression

Member or debenture holder can apply from the court for an order that the affairs of
the company are being conducted or the powers of the directors are being conducted
in a manner oppressive to one or more members or debenture holder.

(b) Section 465 CA 2016 – petition for winding up

i. If the Director acted In the manner which appears to be unfair or unjust to
members
ii. The court is on the opinion that is just an equitable that the company be wound
up.

ALTERATION OF THE CONSTITUTION

There are two methods to alter the constitution:

(1) By the company

Section 36 CA2016
A company may alter its constitution by passing a special resolution. All clauses in the
constitution may be altered unless the constitution itself prohibits its alteration.

The company must notify the Registrar pertaining to be alteration or amendment and
lodge a copy of the constitution within 30 days from the date the special resolution was
passed.

(2) By the court

Section 37 CA2016
A director or a member may apply to the court for an order to alter the constitution.

Section 37(1) CA2016

The court may grant the order on such terms and condition as it thinks fit if it “is
satisfied that it is not practicable to alter or amend the constitution of the company
using the procedures set out in this Act or in the constitution itself”

So, constitution may be freely altered or added a special resolution needed. It means
that the consent of 75% of the members is required. Even though there are members
who object the propose alteration, it can still be carried out validly so long as the
requirement of the special resolution is complied with.

RESTRICTION ON ALTERATION

1. Section 194 CA2016 – Alteration of the constitution cannot bind the shareholder
to acquire additional shares

The conditions are:

 a) Requires the shareholder to acquire or hold additional shares in the company
more than the number held on the date the alteration made
b) Increase the liability of shareholder to the company
2. Section 36 of the CA 2016 – Any alteration or amendment to its constitution
cannot be made if it is prohibited by the constitution itself

Thus, if the constitution prohibits the alteration on certain provisions, these provisions
cannot be altered. Any alteration must also comply with the procedures set out in the
constitution.

For example, the constitution may require the higher majority to pass the resolution,
or require a particular condition to be fulfilled.

3. The constitution cannot be altered unless it is made to benefit the company as a

whole.

Case: Shuttleworth v. Cox Brothers & Co. (Maidenhead) (1927)

The alteration of the AoA to dismiss Mr. Shuttleworth was valid because it was to
benefit the company as a whole since he was defrauding it.

Case: Allen v Gold Reefs of West Africa Ltd (1900)

Allen held both fully paid-up shares and partially paid-up shares. Despite repeated
calls, he failed to pay to pay up. The company altered the articles to the effect that in
the event a member failed to pay the called on his partially paid-up shares, the
company would have a lien on the fully paid up shares as well.

HELD: that even though the alteration was prejudicial to one shareholder, it was done
bona fide for the benefit of the company of a whole. Therefore, the resolution was held
to be valid.

4. The constitution cannot be altered to avoid company from its contractual obligation
under a separate contract.

Case: Sourthern Foundries Ltd. V. Shirlaw (1940)

Mr. Shirlaw became a managing director under the provisions in the AoA. The
company later altered its AoA and consequently Mr. Shirlaw was dismissed as the
managing director.
Held: The alteration induced the company to breach its contract and thus was liable
for it.

5. Section 346 CA2016 – Alteration to the constitution cannot be contrary to court’s

order.

The company cannot make a further alteration to the constitution which is inconsistent
with the court’s order unless the company has obtained the prior approval from the
court.
The constitution must not deprive members of the rights given to them by the court.
For example, the court has, by order, made an alteration in the constitution in order to
help the minority shareholders to overcome an Act of unfair prejudice by the majority,
those provisions cannot be altered without the approval of the court.

6. The constitution cannot be altered so as to include an illegal clause

An alteration would not be invalid if it tried to overrule the general law. For instance, a
provision in the constitution which gave permission to a company to carry on an illegal
business such as those involving drug abuses would be void as contravening to the
general law.

ALTERATION OF OBJECTS CLAUSE

The new CA 2016 does not prescribe any special procedure on the alteration of the
company’s objects clause. If the nature of business is stated in the company’s
constitution, then the company may alter it just like any clause in the document, that
is, by passing a special resolution.

If the nature of the business is not stated in the constitution, then it appears that the
board of directors has the discretion to change the nature of business without any
reference to the members.
 CHAPTER 5

PROMOTERS AND PRE-INCORPORATION CONTRACTS

PROMOTERS

The persons who take they’re initiatives to set up the company and get it going are
the company’s promoters. Normally, promoters will become directors of the company.
Thus, promoters are normally those who are interested in the company.

Section 12(1) CA2016

“A person who desire to form a company”

Case: Twycross v Grant (1877)

Cockburn CJ held that, “A promoter is one who under takes to form a company with
reference to a given project and to set it going, and who takes the necessary steps to
accomplish that purpose”.

Case: Wheal Ellen Gold Mining Co NL v Read (1908)

Higgin J held that the term ‘promoter’, “denotes those persons who bring the company
into existence, i.e. by taking an active part in forming it, or in procuring person to joint
is as it is technically formed”.

Case: Tracy v Mandalay Pty. Ltd (1953)

It was held that a person who is joint adventurer and who will benefit from the
incorporation of company will also be considered to be promoter, Even though he does
not take an active part in the formation of company.

So, the persons who take their initiative to set up the company to get it going are
obviously the company’s promoters. Normally, promoters will become the directors of
the company. Thus, promoters are normally those who are interested in the company.

DUTIES OF POMOTERS

A promoter usually engages in the transaction for the company yet to be formed. Such
pre-incorporation contracts may also involve the sale of the promoter’s assets to the
non-existence company. A promoter is in a fiduciary relationship with the company
and therefore he owes certain obligations towards the company, namely to act bona
fide (good faith) for the interest of the company and not have conflicts of interest with
the company.

A promoter is the one who has an interest in the company. Therefore, as a promoter,
he is an agent of the company. A promoter’s fiduciary obligations towards the company
are:

i. Duty no to make a profit out the promotion without adequate disclosure

Case: Erlanger v New Sombrero Phosphate Co. (1878)
Erlanger and several associates formed a syndicate to purchase an island for 55,000
pounds. After that, a company was formed for the purpose of purchasing the island
from the syndicate. When the syndicate was incorporated, its members became the
directors for the company. The island was sold to the company for 110,000 pounds.
The island was worth considerably less than the purchase price the company had paid.
Eventually, the company sacked the directors and appointed the new ones. The new
directors sought to have the contract rescinded.
The court held that the contract could be rescinded on the ground that the promoters
failed to disclose their interest in the transaction to an independent Board of Director.
The purchase money was returned to the company and the island was transferred
back to the syndicate.

ii. Disclosure must be full and frank

The disclosure must be made to the independent board of directors not a certain group
of directors only. This obligation is imposed to ensure that there is no conflict between
the interest of the promoter and the interest of the company.

Case: Gluckstein v Barnes (1900)

The syndicate was formed to purchase a particular property for $140,000 with a
discount of $20,000. The company then was formed for the purpose of buying the land
sold by the syndicate to it for $180,000. The company later sought to recover the
amount of profit acquired by the promoters.

The House of Lords held that the promoters were under a duty to disclose all profits
made and that the disclosure to the board of directors comprised of other member of
the syndicate formed for the purpose of making profit was insufficient.

iii. Duty to disclose whatever commission or payment that he receives upon the
transfer of the property to the company.

Case: Whaley Bridge Calico Printing Co. v Green & Smith (1879)
Green purchased certain printing works for 15,000 pounds and purported to sell them
to Smith for 20,000 pounds. When a company was formed, Smith sold the work to the
company 20,000 pounds. In the arrangement, Green promised to pay smith 3,000 out
of the money he received. This commission was not disclosed to the company.
The court held that Smith would have to be liable for the secret profit made. However,
since Green had not yet paid the full amount to Smith, the company was allowed to
recover the unpaid balance of the secret commission from Green.
REMEDIES FOR BREACH OF PROMOTERS’ DUTIES

If a promoter breaches the fiduciary duties owed to the company, the company can:

i. Rescind the contract that has been entered into by the promoter on behalf of
the company.

This remedy is only available if the company is lack of knowledge or ignorant of the
true facts that the promoter had breached his fiduciary duty.

Case: Lagunas Nitrate Co. v Lagunas Syndicate (1899)

The court held that the disclosure made by the promoters in the MOA and AOA was
considered as sufficient. Therefore, the company cannot rescind the contract made by
the promoter in breach of their duty because they have made a disclosure and the
company has a knowledge regarding the transaction.

This remedy cannot be used if:

a) The company wishes to proceed with the contract. In this case, the company
is considered as accepting or affirming the contract done by the promoter;
b) The parties in the contract cannot be restored to its original position, unless
if there if fraud done by the promoter;
c) The third party has obtained or acquired his right and his particular right
cannot be defeated.
ii. Recover the promoter’s secret profit

Case: Gluckstein v Barnes (1900)

The court allowed the company to recover from the promoter the portion of the
undisclosed profit that received.

Case: Whaley Bridge Calico Printing Co. v Green & Smith (1879)
It was held that the company was allowed to enforce the claim for payment of a secret
commission against Green.

The company cannot recover the secret profit that has been made by the promoter if
he knows about the secret profit but affirms the contract.

iii. Claim damages for breach of fiduciary duty

Besides rescission or recovery of the secret profit, the company may also claim
damages from the promoter for breach of his duty. In some instance, damages may
be awarded if rescission is not possible.
PRE-INCORPORATION CONTRACTS

Pre-incorporation contracts are contracts made by the company or on behalf of the

company before the company is incorporated. In other words, at the time the contract
is made, the company is not yet in existence.

Section 65(1) CA2016

“A contract or transactions that purport to be made by or on behalf of a company at a
time of the company has not been formed”.

Pre-incorporation Contracts under Common Law

It is a settled principle that after its incorporation, a company has a power to enter into
any contract or transaction. A company cannot enter into any contract before it is
legally incorporated. This is because before incorporation, the company does not have
a separate legal entity. Therefore, it cannot obtain rights or incurring liabilities.

At common law, before it comes into existence, no contract can be made by the
company or its agent. This is based on the principle in the law of agency that an agent
cannot make a contract for the principal which does not exist.

Apart from that, a company also cannot be bound by contracts entered into prior to its
incorporation. After its incorporation, it also cannot enforce any contracts that have
been made before it comes into existence.

Case: Newborne v Sensolid (Great Britain) Ltd (1953)

Newborne contracted to sell 200 cases of tinned ham to Sensolid. The contract was
made on behalf of Leopold Newborne, a company that yet to be incorporated. When
the market tinned ham fell, Sensolid refused to take delivery. Sensolid raised their
defense that the company could not enforce the contract as it had not been existence
when it was made. The court of Appeal upheld this defense. The contract was void.

Case: Kelner v Baxter (1866)

The promoters were held personally liable for entering into a contract on behalf of a
company which was not yet in existence because they knew the fact that the company
was not yet in existence and so they must have intended to be personally liable.

Case: Black v Smallwoods (1966)

It was held that neither the company nor the promoters were liable for the transactions
entered into before the formation of the company.
Pre-incorporation Contracts under Malaysian Companies Act 2016

Section 65 CA2016

(1) A contract or transaction that purport to be made on behalf of the company at

the time when the company has not been formed has the effect as a
contract or transactions made with the person purporting to act for the
company or an agent for it, and he is personally liable on the contract or
transaction accordingly.
(2) A contract or transaction may be ratified by the company after its
incorporation and the company shall be bound by the contract or the
transaction as if the company had been existence at the date of the contract or
the transaction...”

Basically, a promoter cannot enter into any agreement on behalf of the company which
is not yet exist. However, the effect of section 65 gives a right to a third party to enforce
the contract either:

(i) Against the company after it is incorporated when it ratifies the contract; or
(ii) Against the persons who have entered into the contract on behalf of the non-
existent company if the company does not ratify the said contract.

Case: Ahmad bin Salleh & Ors v Rawang Hills Resort Sdn Bhd (1995)
A sale and purchase agreement was executed on 12 April 1991 by one Chan Wan
Leong “for and on behalf of the purchaser Rawang Hills Resort Sdn Bhd”. At that time,
Rawang Hills Resort Sdn Bhd was not yet incorporated. The company was
incorporated on 25 April 1991. He Company then ratified the contract by passing a
special resolution.
Held: The resolution was held to be an effective ratification on the pre incorporation
contract.

Case: Bay v Illawara Stationery Supplies Pty Ltd (1986)

An accountant, who was one of the four promoters of a company, entered a pro-
incorporation contract for office supplies on behalf of the proposed company. All of
the four promoters were also parties to the contract for office suppliers. However, the
company failed to ratify the contract.

Held: Only one accountant is liable, as he was the one who signed the contract.
 CHAPTER 6

MANAGEMENT OF COMPANIES ( DIRECTOR & AUDITOR)

DIRECTORS

Section 2(1) CA2016 states the word director includes:

1. Any person occupying the position of director of a corporation by whatever
named called; and
2. Includes a person in according with whose directors or instructions the majority
of directors of corporation are accustomed to act; and
3. An alternate or substitute director.

The term ‘director’ wherever appearing in the Act also includes the following:

1. de facto director, that is, a person who occupies the position of directors even
though he was not appointed or his appointment was defective;
2. A shadow director, that is, “in accordance with whose directions or instructions
the directors of a corporation are accustomed to act”; and
3. An alternate or substitute director, that is, a person nominated by another
director to attend meetings or perform duties on his behalf

APPOINTMENT OF DIRECTORS

Section 196(1) CA2016

A company shall have a minimum number of directors as a following:
1. Private company – one director
2. Public company – two directors

Section 196 (2) CA2016

“A director shall be a natural person who is at least 18 years of age”.

Thus, it is clear that only human being can be a director.

Section 196(4) CA2016

The minimum number of directors:
1. Shall ordinary resides in Malaysia by having a principal place of residence in
Malaysia; and
2. Shall not include an alternate or substitute director.

Section 201 CA2016

A person cannot be appointed as a director of the company unless he has consented
in writing to be a director and has made a declaration that he is not disqualified under
CA2016 from being appointed as a director or to hold office as a director.
Section 202 CA2016
The first director(s) may be appointed by being named as a director in an application
for incorporation of the company.

QUALIFICATION OF DIRECTORS

1. Natural person

Section 192(2)
A director of a company must be a natural person. It means that only human can be a
director. A corporation being an artificial person cannot be appointed as a director of
a company.

2. Age

Section 192(2)
A director must be off a minimum age of 18 years. There is no maximum age limit for
a person to be a director, for a public or private company.

3. Residency

Section 196(4)
The minimum number of director must satisfy two criteria that he;
(a) Is ordinarily resident in Malaysia; and
(b) Has a principle place of residence in Malaysia.

4. Solvent person

Section 198(1)
A person shall not hold office as a director of a company or whatever directly or
indirectly be concerned with or take part in the management of a company, if the
person is undischarged bankrupt.

DISQUALIFICATION OF DIRECTOR

(1) Section 199 CA2016 – Disqualification by courts order

Upon application by the Registrar or by the Official Receiver, the court may grant an
order to disqualify the person from acting or holding office as a director or promoter or
to be concerned with or take part in the management of the company whether directly
or indirectly if;

(a) Within last five years, the person has been a director of two or more company
which went into liquidation resulting from the company being insolvent due to
his conduct as a director which contributed wholly or partly to the liquidation;
(b) Due to his contravention of duties of a director;
(c) Due to his habitual contravention of CA2016.
(2) Section 264 CA2016 – Auditor of the company

A person cannot be appointed is a director if he or his spouse is an auditor of the

company. He has first to resign as a company’s auditor if he wishes to be appointed
as a company’s director.

(3) Section 218(1)(e) CA2016 – Unsound mind

The office of director must be vacated if the director becomes of unsound mind. A
person is of unsound mind or suffer mental disorder as prescribed in the Mental Health
Act 2001 is disqualified to be appointed as a director.

(4) Disqualification on amount of shares

The director must hold a minimum number of shares. But it is up to the constitution or
the company itself to set up the period for the director to comply with the share
qualification requirement.

VACATION, RESIGNATION OR DEATH OF A DIRECTOR

Section 208(1) CA2016, the office of a director of a company shall be vacated if the
person holding that office;

1. Resigns by giving a written notice to the company at its registered office;

2. Has retired in accordance with CA2016 or the constitution and not re-elected;
3. Is removed from office in accordance with CA2106 or the constitution;
4. Becomes disqualifies from being a director
5. Becomes unsound mind
6. Dies; or
7. Otherwise vacate his office in accordance with the constitution of the company.

REMOVAL OF DIRECTORS

(1) Private company

Section 206 CA2016 states that, a director may be removed before the expiry of the
period of office, by ordinary resolution. It should be passed at a physical meeting and
cannot be passed by way written resolution.

(2) Public Company

Section 206(2) CA2016 provides that the company may by ordinary resolution remove
a director from office before the expiry of his term appoint another in his stead.

This section gives an opportunity to the members of a public company to remove a

director if they are dissatisfied with his performance. The provision allows the
members of a public company to remove its director by passing an ordinary resolution.
DUTIES OF DIRECTORS

1. Duty to exercise power for proper purpose and good faith for the interest of
the company

Section 213(1) CA2016

“A director of a company shall at all times exercise his powers in accordance with this
Act for a proper purpose and in good faith in the best interest of the company”.

Proper purpose

A director may be acting honestly in what he considers to be in the interests of the

company. However, he is still considered to have breached his fiduciary duty if he uses
his power or misapplies the company’s assets for wrong purpose, not for the interest
of the company.

Case: Mills v Mills (1938)

Directors are considered to have breached their fiduciary duties if they use their power
for improper purpose even if they honestly believe that it would benefit the company.

Case: Howard Smith Ltd. V. Ampol Petroleum Ltd. (1974)

If the directors use their power to increase the number of majority shareholders at the
expend of the minority even if they honestly believe that it would benefit the company,
the court would hold them to have breached their fiduciary duty.

Case: Re Duomatic Ltd. (1969)

The court held that the directors were liable for misapplication of the company’s fund
even though they had acted honestly and were ignorant of the existing law.

Duty to act in good faith for the interest of the company

The court may not consider what the interests of the company are. It is the directors’
duty in what they consider is the interest of the company.

Case: Re Smith and Fawcett Ltd. (1942)

The directors must exercise their discretion in they consider - not what the court may
consider to be in the interest of the company.

Case: Re W & M Roith Ltd. (1967)

The director owned a substantial portion of shares in the company. He was terminally
ill and wanted to provide for his wife, thus he entered into a contract with the company
to pay a pension to his widow.
The court held that the contract was void as the board of directors did not act in the
best interest of the company but for the widow of the director. It was not made in good
faith.
Case: Greenhalgh v Ardene Cinemas Ltd. (1951)
The directors must act in the interests of the shareholders as a collective group.

Case: Parke Daily v Daily News Ltd. (1988)

A director of an insolvent company must have regard to the interests of its creditors.

2. Duty of Care, Skill And Diligence

Section 213(2) CA2016 provides that:

A director of a company shall exercise reasonable care, skill and diligence with –

a) The knowledge, skill and experience which may reasonably be expected of a

director having the same responsibilities; and
b) Any additional knowledge, skill and experience which the director in fact has.

Case: Re City Equitable Fire Insurance Co (1925)

The court held that a director:

a) Did not have to exhibit in the performance of his duties a greater degree of skill
than might reasonably be expected from a person of his knowledge and
experience;
b) Did not have to give continuous attention to the affairs of the company; and
c) Did not have to attend all meetings but he must attend in the circumstances he
was reasonably able to do so.

Case: Re National Bank of Wales (1899)

A director may delegate to the company’s officials to draw cheques. He will not be able
to be personally liable if the persons he trusted defrauded him.

Case: Re Brazilian Rubber Plantations & Estate Ltd. (1911)

The directors did not have knowledge of the rubber industry and made losses from
rubber speculation. The court held that they were excused from liability. A director was
not required to have any skill or qualification suitable for his office.

Case: Re Forest of Dean Coal Mining Co (1879)

Directors must use fair and reasonable diligence and to act honestly.

3. Duty to avoid conflict of interests

Section 218 CA2016

A director or officer of a company shall not, without the consent or ratification of a
general meeting:
a) Use the property of the company;
b) Use the information acquired by virtue of his position as a director or officer of
the company;
c) Use his position as such director or officer;
d) Use any opportunity of the company;
e) Engage in business which is competition with the company
To gain directly or indirectly, a benefit for himself or any other person, or cause
detriment to the company.

Case: Lai Ah Kau v Public Prosecutor

Held: The directors must separate the company’s interests from their own and acts as
trustees for all company funds which come into their hands.

Case: Mahesan v Malaysian Government Officers’ Co-operative Housing

Society (1978)
Mahesan was the director of the society. The object of the society was to provide
housing for government workers. In the process of purchasing a piece of land for the
society, Mahesan received a bride amounted RM120, 000.
Privy Council HELD that Mahesan had breached his duty to the society.

Case: Aberdeen Railway Co. v Blaikie (1854)

A railway company entered into a contract to supply a large quantity of iron seats with
a partnership. At the time the contract was entered into, one of the partners was a
director of the company. Upon discovering this, the company sought to avoid the
contract.
HELD: The Company could avoid the contract because it is a duty of a director to
avoid a conflict of interest.

CORPORATE OPPORTUNITY DOCTRINE

A director is not allowed to procure any property or business opportunity that properly
belongs to the company or has been negotiating for.

Case: Cook v Deeks (1916)

The company had four directors. Three of them (the defendants) decided to break
away from the other one (the plaintiff). Two of the defendants negotiated a contract on
behalf of the company. When the contract was awarded, the defendants formed a new
company of the company. The Plaintiff sued on behalf of the company, claiming that
defendants had breached their fiduciary duty.
Held: The court agreed with the plaintiff and ordered the defendants to return the profit
to the company.

Case: Canadian Aero Service Ltd. V O’Malley (1973)

The directors of a company resigned in order to take up the contract which they had
negotiated in the first place for the company.
Held: The resignation was irrelevant because it was prompted to take up the contract
that properly belonged to the company.

Case: IDC Ltd. V Cooley (1972)

Cooley was a managing director of a company, IDC. He negotiated a contract with the
Gas Board on behalf of the company. But the Gas Board wanted Cooley to be the
project manager himself. Cooley resigned and accepted the post.
Held: Cooley was accountable and was held liable for the profit to IDC even though
IDC could not get the contract anyhow. The fact that Cooley put himself in a conflicting
position with the company’s interest rendered him liable for breach of his duty as a
director.

Case: Peso Silver Mines Ltd. (NPL) v Cropper (1966)

The company has bona fide rejected an opportunity or a business advantage, a
director is allowed to take that opportunity himself without having to disclose it to the
company.

REMEDIES FOR BREACH OF DUTY

As a director owes his duty to his company, in the event of a breach, the company
may obtain remedies. There is more than one remedy available to the company, and
it may choose the remedy most suitable.

1. Sue for damages

The company may sue for damages where it suffers a loss in the case of negligence
or breach of fiduciary duty. The company can take a common law action for tort of
deceit and may recover damages where the director if fraudulent. Damages are meant
to put the company in a position it would have enjoyed had the director net breached
his duty.

2. Seek return of property

If there is misapplication of company’s property, the company may seek a declaration

that a director holds property on trust for the company. The company may seek the
return of specific property, and the director is liable to return them. Normally the order
for the return of specific assets will be made if the assets are still under the director’s
control.

3. Recover secret profit

The company may claim any secret profit made by the director. Any breach of the
directors’ duty to act honestly, the director is liable to the company for any profit he
has made or for any damage suffered by the company due to the breach.

4. Rescission of contract

A contract entered into by a director in breach of his duty can be rescinded at the
company’s option. Normally this would be done where the contract is to the company’s
detriment. The company would declare the power exercised by the director in breach
of his duty as null and void. This will mean that the transaction entered into by the
director will have no effect. Any money paid will be returned.
AUDITORS

Every company must have their accounts audited and thus must appointed at least
one auditor to audit its accounts. The function is to carry out and present a reliable
and independents report on the accounts and financial position of the company. An
auditors’ report contains a professional opinion, omission or fraud in the accounts. An
auditor’s job includes detecting any material error, omission or fraud in the accounts.

QUALIFICATION OF AUDITOR

Who may be an auditor?

Section 264(1) (c) (i) CA2016

A person may act as an auditor only if he is approved as a company auditor by the
Minister charged with the responsibilities for finance. He must also be a chartered
accountant as defined under the Accountants Act 1967.

Section 265(5) CA2016

He may not be appointed as the auditor of the company unless he has given his written
consent to the appointment.

DISQUALIFICATION OF AUDITOR

Section 264 CA2016

To ensure the independence of the company auditor, the company cannot appoint as
its auditor a person who is connected to the company in any of the manners given
below.

Thus, an approved company auditor shall not consent to be appointed as an auditor

of a company if:

i. He is indebted to the company or its related corporation for an amount

exceeding RM25, 000 (Section 264(1)(c)(ii));
ii. He is an officer of the company (Section 264(1)(c)(iii)(A));
iii. His spouse is an officer of the company (Section 264(1)(c)(iii)(A));
iv. He is a partner, employer or employee of an officer of the company (Section
264(1)(c)(iii)(B));
v. He is a partner or employee of an employee of an officer of the company
(Section 246(1)(c)(iii)(C));
vi. He is a shareholder of a corporation whose employee is an officer of the
company (Section 264(1)(c)(iii)(D));
vii. His spouse is a shareholder of a corporation whose employee is an officer of
the company (Section 264(1)(c)(iii)(D));
viii. He is responsible for the keeping of the register of members or the register of
debenture holders of the company (Section 264(1)(c)(iv));
 ix. He is the partner, employer or employee of a person responsible for the keeping
of the register of members or the register of debenture holders of the company
(Section 264(1)(c)(iv));
x. He is an undischarged bankrupt within or outside Malaysia except with leave of
the court (Section 264(1)(c)(v)); or
xi. He has been convicted of any offence involving fraud or dishonesty punishable
with imprisonment for three months or more (Section 264(1) (c) (vi)).

In the above chart, Mr. A, B, C, D, E, F, G, H, 1 and Mr. J cannot be the auditor

of the company X Bhd. because:

1. Mr. A is an officer of the company;

2. Mr. B is spouse, a partner, employer or employee of Mr. A who is an officer of the

company;

3. Mr. C is an employee of Mr. A who is an officer of the company;

4. Mr. D is a partner or employee of Mr. C who is an employee of Mr.

5. Mr. E is a shareholder or his wife is a shareholder of company Y Bhd. where Mr.

A is an employee, who is also an officer of company X Bhd.

Mr. F is an officer of the company;

Mr. G is a partner, employer or employee of Mr. F who is an officer of the

company;

8. Mr. H is indebted to the company,its holding or subsidiaries in an amount

exceeding RM25000/=;
9. Mr. I is an undischarged bankrupt;

10. Mr. J is a convicted person for fraud or dishonesty.

APPOINTMENT OF AUDITOR

Private company

Section 267(3) CA2016

The board directors shall appointed the first auditor at least 30 days after the
company’s audited financial statements are circulated to its members.

Public company

Section 271(2) CA2016

The Board shall appoint the first auditor at any time before the company’s first annual
general meeting (“AGM”) and he shall hold office until then conclusion of the first AGM.

Section 271(4) (a)

For subsequent auditors of a public company, the members may appoint an auditor at
the AGM, and the auditor shall hold office until the conclusion of the next AGM.

Thus, there is no provision for the automatic re-appointment of an auditor. The

appointment is on a yearly basis.

VACATION OF OFFICE

Removal and Resignation of Auditors

Section 276
An auditor may be removed from the office by an ordinary resolution of the members
at a general meeting of which special notice has been given (section 277).

Members who want to remove the auditor are required to serve a special notice or
notice of intention on the company at least 28 days before the scheduled members’.
The company shall send a copy of the notice to the auditor. At the members; meeting,
the editor shall be entitled to have his representation read out as well as speak to the
members. Then, the resolution to remove the auditor will be put to vote. After an
auditor is removed, the company must notify the ROC.

Section 281(1) CA2016

An auditor can resign from his office by giving notice to the company at its registered
office. The auditor’s resignation will be effective at the end of 21 days after the notice
is given or from the date stated in the notice.
RIGHTS OR POWERS OF AUDITORS

The CA 2016 gives wide rights or powers to an auditor of a company to enable him to
conduct his duties. The following are the statutory rights or powers of auditors:

l. An auditor has the rights of access at all reasonable times to the accounting such as
books and vouchers and other records, including registers of the company and its
subsidiaries.(s.266(4) & (5) )

2. An auditor is entitled to require from any officer of the company and any auditor
of a related company or of any subsidiaries, for information and explanation as he
desires for the purpose of carrying out his duties or for the purpose of reporting on the
consolidated financial statements.s.266(4) &(5)

3. An auditor is entitled to attend any general meeting of the company and also
has the right to speak on any part of the business of the meeting that concerns him in
his capacity as auditor.(section 266(7) )

4. An auditor has the rights to receive all notices of, and any other communication
relating to any general meeting which a member is entitled to receive.

Section 266(12) provides that an officer who refuses or fails without lawful excuse to
allow an auditor to access any accounting and other records of the corporation in his
custody or control or refuses or fails to give any information or explanation as and
when required or otherwise hinders, obstructs or delays an auditor in the performance
of his duties shall be guilty of an offence against this Act. On conviction, the officer
shall liable to imprisonment for a term not exceeding three years or to a fine not
exceeding RM500,000 or to both.

DUTIES OF AN AUDITOR

(1) Statutory duties

(i) Duty to report to members

Section 266(1) CA2016

The auditor is required to report to the members of the company’s annual accounts.
Where the company is a public company, the audited accounts must be laid before
the company in its AGM, and where the company is a private company; the accounts
will either be circulated to its members or laid before the company at its members’
meeting.

(ii) Duty to attend meeting

Section 285(1) CA2016

The auditor of a public company is required to attend every AGM. This is because the
company’s audited financial statements are tabled at the AGM. The auditor could then
respond to the members’ queries on the audit of the financial statements.
A private company is not required to hold an AGM. However, the company may, if it
so wishes holds a members meeting where its financial statements are laid. An auditor
who is given due notice is required to attend the meeting to respond to the members’
queries which are relevant to the audit to the financial statements.

(2) Common Law Duties

(i) Duty to carry out an audit

Before an auditor can form an opinion whether the company’s accounts provide a true
and fair view of its position, an audit must be carried out. In carrying out an audit,
particularly where the company’s account is complex, an auditor is required to devise
procedures in assist in the detection of errors or fraud.

Case: Pacific Acceptance Corp Ltd v Forsyth (1970)

Moffit J: “An auditor pays due regard to the possibility of fraud or error by framing and
carrying out his procedures…”

(ii) Duties to report to members

An auditor is appointed to safeguard the interest of members. He must provide a report

which is circulated among the members. If fraud is uncovered or suspected, an auditor
is under a duty to report promptly the matters to the directors or appropriate
management rather than wait until the AGM.

Case: WA Chip & Pulp Co. Ltd v Arthur Young & Co. (1987)
An auditor will breach his duty if, having detected a possible irregular not amounting
to a suspicion of fraud, fails to investigate further and report the matter.

(iii)Duty to be independent

The purpose is to ensure that the shareholder receive an unbiased opinion of the true
and fair view of the company’s position.

Case: Re Transplanters (Holding Co) Ltd (1958)

Wynn Parry J: “Once a man takes upon himself a position of auditor… he must stand
aloof and divorce from the aims, objects and activities of the company”.

This doesn’t mean that an auditor must server all other connections with the company.
Auditors are entitled to seek assistance from the company’s director, accountants and
other employees in carrying out their functions. However, auditors will be breach of
their duty if they rely on them for information on which they are required to form their
own independent judgement or opinion.

Case: Dominion Freeholders Ltd v Aird (1966)

An auditor prepared to an erroneous report. The company brought an action against
him for breach of his contractual duty of care and he sought to join the company’s
accountant as company defendant on the basis that the accountant had supplied him
with incorrect information and was in breach of duty owed to him.
HELD: The application by the auditor was rejected. Auditors must not rely or depend
on company’s officers for information or representation in respect of matters upon
which they do so rely; they cannot shed their responsibility by casting the liability on
the company’s officer.

(iv)Duty to use reasonable care and skill

An auditor must use reasonable care and skill in carrying out the audit and in forming
an opinion on the company’s account. Failure to do this renders an auditor liable to
the company in damages for breach of contract.

An auditor may also be liable in negligence. An auditor who uses less than the required
degree of care and skill is liable to the company for any loss suffered as a result.

Case: Re Kingston Mill & Co (No2) (1896)

The auditors failed to detect fraud done by the managing director. They relied on false
certificates supplied by him as to the value of stock. The audited accounts indicated
that profits had been made and consequently dividends were paid. Had the value of
stock been properly determined, there would have been no profit from which dividends
could be paid. An action was brought against the auditors seeking to recover the loss
caused by the wrongful payment of dividends.

HELD: The auditors were not in breach of duty because standard of care did not
require them to take stock. They were entitled to rely on the manager’s certificates as
they were no grounds for suspicion and the manager was widely regarded as a man
of good character and trustworthy.

These days, the standard of care and skill expected from auditor is more exacting. The
standard of reasonableness depends on the circumstances and is affected by
changed expectations. Higher standard of care is now applies.

Case: Re Thomas Gerrard & Sons Ltd. (1968)

The managing director had over the period of years been making obvious alterations
to invoices receives from suppliers. Whilst some of these invoices had come to
attention of the auditors, they nevertheless relied on the stocktaking procedures set
up by the managing director without investigating the matter any further. Soon, after
discovery of the true situation, the company went into liquidation. The liquidator
brought an action against the auditors.
Held: The auditors were liable to the company because one altered invoices had been
discovered, the auditors were put on inquiry and it was insufficient that they merely
sought assurances from the managing director and they should have informed the
board. The auditors had therefore failed to exercise reasonable care and skill.
Case: Pacific acceptance Corp. Ltd v Forsyth (1970)
The auditors left the audit with several clerks. Irregularities were detected on several
occasions by different audit clerks. These matters were not followed up.

Held: The auditors were held to be negligent in employing inexperienced staffs who
were not properly supervised.

LIABILITIES OF AUDITORS TO THIRD PARTY

Under common law, an auditor may be liable to third parties for loss incurred due to
reliance on misleading financial statement. Third parties include actual and potential
shareholders, vendors, bankers and other creditors, employees and customer. A
remedy is available to such persons, where auditors fail to exercise the appropriate
standard of care.

Case: Ultramares Corporation v Touche (1932)

Ordinary negligence is insufficient for liability to third parties because lack of privity
of contract between the third parties and auditors unless the third parties are primary
beneficiaries (a person about whom the auditors were informed prior to conducting
the audit). However, if there is proof of fraud or gross negligence on the part of the
auditor, he would always be liable to the aggrieved party irrespective of whether there
is privity of contract or not.

Case: Hedley Byrne v Heller (1964)

Lord Denning LJ: An auditor being a professional is a subject to extra-contractual
responsibilities to those parties who can demonstrate that they were owed a duty of
care by the auditor.
This case introduced a concept of proximity in that liability could arise where a
special relationship exist between the party making the negligent statement and the
party to whom he was made. Such a relationship would exist if the party giving the
advice had known or to have known that the inquirer was relying on them.

Case: Jeb fastener Ltd v Mark Bloom & Co (1983)

Jeb enquire the entire share capital of BG Fastener Ltd. audited by Mark Bloom. The
plaintiff claimed that they made the acquisition relying on the negligently prepared
financial statement. It was established that at the same time the accounts were
audited, the auditors did not known of the plaintiff or his purpose or that a takeover of
the company was contemplated.
Held: The auditor owed a duty of care to the plaintiff who relied on the report.

Case: Caparo Industries PLC v Dickman (1990)

Caparo, a shareholder of Fidelity PLC, who received an audited account purchased
more shares and later made a successful takeover bid. After the takeover, Caparo
brought an action against the auditors of the company on the grounds that the profits
were overstated. In fact, the company mad a loss.
Held: auditors owed no duty to potential investors who seek to base their investment
decision on the audited accounts whether they are existing shareholders or not.

Case: Al Saudi Banque v Clarke Pixley (1990)

Held: mere foreseeability in terms of reliance on the auditors’ report was inadequate
to establish a duty of care.
Therefore, to make an auditor liable to third party, he must prove;
1. Foreseeability
2. Proximity
3. Justice for each case

Case: Pacific Acceptance Corporation Ltd v Forsyth (1970)

An auditor may trust the company’s own internal provided:
1. He must ascertain the creditability of the company’s system
2. He must appraise the system to determine to what extend he may rely on the
system
3. He must test the system

Case: Scott Group Ltd v McFarlane (1978)

The reason why auditors should be made liable to person who rely on their reports:
1. Auditors are professional who provide expert advice
2. Auditors should reasonably expect their report would be used by other persons
apart from the company
3. It is reasonable for an outsider to rely on the reports as they might not have the
time or knowledge to examine the company’s accounts themselves
4. Auditors reports are publicly available

Case: Lloyd Cheyham & Co Ltd v Littlejohn & Co (1987)

Auditors can escape from liability of negligence by showing that they have acted in
accordance with a practice accepted as proper by a body of responsible and skilled
professional opinion.

CAUSATION AND DAMAGE

In order to render an auditor liable in damages, it is not sufficient to establish merely

that he was negligent in carrying out the audit. It must further be proved that the
damage caused was a result of negligence. The general legal principle of causation
is also relevant professional negligence cases involving auditors.

Case: Cambridge Credit Corp Ltd v Hutcheson (1985)

Court held that although the audit was carried out negligently, this was not the cause
of the loss to the company. The court found that the real cause of the loss was the
dramatic downturn