section 216A case - Poondy Radhakrishnan v Sivapiragasam s/o Veerasingam

A new case on statutory derivative actions cocerning a company named Megatech System & Management Pte Ltd (the Company).

The plaintiffs were members of the Company.

Their allegations made against S, a director of the Company were that he had done the following illegal acts -
(a) diverted for his personal use the recruitment fees and renewal fees received from Indian workers and a recruitment agent for employment with Megatech System;
(b) improperly deducted the foreign worker levy component from the wages paid to the Malaysian workers of Megatech System and diverted that deduction for his personal use;
(c) made purported loans to Megatech System for purpose of creating an indebtedness owing by the company to himself; and
d) sold off Megatech System’s profitable security guard business contrary to the interests of the company.

The court noted that the allegations were not as this stage proven. However, the plaintiff-members had produced supporting affidavits. Unlike some earlier cases where the applications under section 216A were dismissed, here, there was reasonable evidence by persons with direct knowledge of the wrongdoing to support the allegations. Some of the allegations, if true, would expose the Company to liability to employees. Accordingly, the allegations had some semblance of merit. It should be noted that this approach is consistent with the requirement in section 216A that the action only needs to be prima facie in the interests of the company. There is thus a very low threshold in obtaining court approval.

The Malayan Diariy/Vitagen case

A recent lawsuit concerning the shareholders of several companies including Malayan Diary Industries Pte Ltd which sells well known brand Vitagen resulted in the founder losing his claim (case name - Thio Keng Poon v Thio Syn Pyn).

The founder, Thio Keng Poon, sued his wife and 6 sons and daughters over his dismissal as director of several family owned companies. Among his claims was oppression under section 216 of the Companies Act. This section is often known as the oppression or unfair prejudice section. What is oppression? It covers a wide range of situations such as

a) acts of the company being unfairly discriminatory;
b) affairs of the company are being conducted in an oppressive manner; and
c) acts of the company are prejudicial against the member.

(Note that there are several other situations not mentioned in this posting).

The main theme behind all these situations is unfairness.

The alleged unfairness here was the breach of an understanding between the founder and his family that he would not be removed as director of the companies. Unfortunately, in court, his evidence was so weak that he was not able to prove his claims and the defendants won the case without even having to testify in court. A comment on this alleged understanding - for there to be an understanding, the express or implied agreement between the parties does not have to reach the legal status of a contract (which has rules regarding its formation, eg offer, acceptance, consideration, intention to create legal relations). There is therefore a far lower threshold which the founder failed to meet.

The facts on the case also showed that the founder was dismissed as director because of alleged breaches of director's duties in that he double claimed his travel expenses - eg for one trip, he would claim his travel expenses from more than 1 company in the family group. This fact would normally lead to removal of any director in any company, but this point was not fully canvassed in the court's decision.

One important point - for founders and controlling shareholders of companies, do not give your shares to your children before your death, for they may well remove you as director. However, giving shares to them is often necessary to show your love and to motivate them to work for the company. But there are ways to give them shares while protecting your own position.

Directors' right to inspect the accounts - more

Under section 199 of the Companies Act, a director is entitled to inspect the accounts and financial records of a company of which he is a director. This is a very valuable right in uncovering wrongdoing. What about members' rights to the accounts of the company?

As a member, a person is entitled to information which is mainly the annual financial statements relating to a company. However, this information is aggregated information. For example, you may find that total sales is $10 million in the past year and costs of goods sold ids $6 million, but there will be no information about individual transactions.

Information about individual transactions is extremely important in detecting fraud. There have been cases of directors buying supplies at above market price to benefit their associates and relatives, or selling goods at below market price. All these actions are breaches of fiduciary duties and offences at the minimum under section 157 of the Companies Act. It is less likely that such transactions will escape the attention of an alert director.

A director can inspect all financial documents such as contracts, delivery notes and purchase orders, etc. Detailed inspection may of course take a long time and may require outside expertise. Before making a substantial investment in a non-listed company, it may be wise to consider asking for a board seat.

If a director is refused his right of inspection by other directors, it is possible to obtain a court order for the accounting documents to be inspected by the director or his accountant. It should be noted that where there are good grounds to suspect dishonesty on the part of other directors, it may be possible for a director to apply ex parte to the High Court for a court order authorising inspection. Only the applying party's lawyers will appear in court to obtain the court order. This means that the other parties are not warned about the situation until the court order is served on them. This helps to prevent the hiding or destruction of incriminating documents.

Corporate rescue - General Motors and Chrysler

One of the methods used in corporate rescue situations like judicial management and schemes of arrangement is the equity for debt swap. You pay your debts will shares instead of cash.

You can bet that creditors will be extremely unhappy with this. However, if saving the company gives them a better return that immediate winding up, they should consider it. Some factors that might be important are how are the shares valued, and how much would the creditors end up with at the end of the rescue package. Also important, how much control will the existing shareholders have after the whole process.

The US car giants General Motors and Chrysler are now undergoing bankruptcy with steps taken to try to save at least part of their business operations. Although US laws are rather different from Singapore laws, we can still see the equity for debt swap. Union workers, and company bondholders have all been offered shares in the new entity in return for giving up their debt claims against the company.

Directors' right to inspect accounts - new case

A new case on the right of a company director to inspect company accounts under section 199 of the Companies Act is

Singapore Flyer Pte Ltd v Purcell Peter Francis [2009] SGHC 120.

The decision of an Assistant Registrar of the High Court is to be found at
http://www.singaporelawwatch.sg/remweb/legal/ln2/rss/judgment
62085.html?utm_source=web%20subscription&utm_medium=web&title=Singapore%20Flyer%20Pte%20Ltd%20v%20Purcell%20Peter%20Francis%20[2009]%20SGHC%20120.
(or at the Supreme Court website - www.supcourt.gov.sg)

Note that the report is normally available for about 3 months and it only relates to a striking out application.

The case is part of a continuing battle between various shareholder factions within the company which operates Singapore tourist attraction the Singapore Flyer.

Offshore companies

One thing that Singapore companies do not have are bearer shares as this type of shares are prohibited under the Companies Act. These bearer shares have no shareholders' names. They are transferred like cash, by passing the appropriate documents to the intended recipient.

Many offshore companies allow for bearer shares. Offshore companies are formed in countries where regulation is much laxer and often income tax is low or non-existent.

With bearer shares, the opportunity for protection of privacy is increased. Tax avoidance and planning is also more effective.

Corporate rescue - raising new capital

How do you rescue a company in financial trouble?

One method is of course to raise new capital. This of course will not be easy. One change in the law that makes the process slightly easier is the removal of the concept of par value. Formerly, all shares had to have a par value which was the minimum price at which a company could issue its shares. In normal times, this was not too much of a restriction.

However, in bad times, it was unlikely that a new investor would be willing to pay par value for the shares. For example, if the existing shareholders paid $1 for each $1 share of the company's, with the company in desperate straits, a new investor would demand that new shares be issued to him at a much lower price, especially since it would not be clear how long the company would survive. The par value rules would prevent this new issue without court approval.

Now, without the rules relating to par value, companies will have more flexibility in raising capital.

section 216 - a trap for the unwary

Section 216 of the Companies Act is known as the oppression or unfair prejudice section.

Where someone has harmed the company but is in control of the company (for example, a director), the rule in Foss v Harbottle prevents shareholders starting a lawsuit against the wrongdoer.

However, section 216 allows the shareholder to apply to court and the court may allow an action (or lawsuit) to be started against the wrongdoer in the name of the company. However, this course of action is not recommended.

The foreign equivalents of this section have been described by judges as "a shambles" and "a legal minefield". These are warnings that even experienced lawyers may have a hard time navigating the complicated case law relating to this section. Perhaps using section 216A may be a better choice.

Directors duties, enforcement and s 216A

What happens when directors of the company who have breached their duties are also the ones in control of the company, e.g. through their majority shareholding?

Section 216A of the Companies Act provides a "simple" method to enforce the duties owed to the company. A minority shareholder of a private company can serve a 14 day notice on the board requiring them to take legal action in respect of a wrong done to the company. If the board fails to take the action, the shareholder can then apply to court for permission to start the lawsuit. The section requires the court to be very lenient in granting permission since the main requirement is that the lawsuit should prima facie (or at first sight) be in the interests of the company. The court should not examine the lawsuit in great detail to check whether it has a good chance of succeeding.

If the court grants permission, then the 2nd stage begins - the director(s) is sued for breaches of duty, which have to be proved on a balance of probabilities.

This second stage is called a statutory derivative action since the lawsuit is in the name of the company, and any damages awarded are derived from the harm to the company, and not harm to the shareholder.

Malaysian Dairy Industries case

The recent major company law case over the past few days has been the Thio Keng Poon case where the founder of Malaysian Dairy Industries (MDI), a major milk distributor, sued his wife and children for removing him from his post of managing director.

Although this wife and children own the majority of the shares in the company and other family companies, he is claiming that he controls the shares until he dies, and that his family is therefore not allowed to use his shares to remove him. This raises issues of trust law - whether there is a trust over the shares with Thio Keng Poon having the life beneficial interests, and his family being merely trustees of this life interests (and therefore having restrictions on what they can do with the shares).

The family is claiming that he breached his directors' duties by double claiming for his travel expenses. If these allegations are true, they would at the very least be offences under the Companies Act or the Penal Code. As such, convictions for double claiming could be regarded as offences that might disqualify him from the position as director.

The case has just closed with the defence arguing no case to answer. This means that the defence takes a big risk - they will call no witnesses but will argue that the plaintiff cannot win based on the evidence produced so far. The benefit is the trial is shortened and the defendants do not have to submit to cross-examination by the plaintiffs' lawyers.

Directors duties - more on Regal Hastings

This post will cover the breaches of directors' duties in Regal Hastings.

The company had set up a subsidiary to undertake a project. However, the directors of the holding company later found that the subsidiary did not have enough capital to undertake the project. The holding company also did not have enough additional funds to inject into the subsidiary. The holding company directors then decided to invest personally in the subsidiary. Later, these investments paid off as these directors made a good profit.

A court later found that the directors had breached their duty to the holding company. They could have injected their investment into the holding company which could then increase the capital of the subsidiary. Their method had bypassed the holding company to which they owed fiduciary duties, and thus deprived the holding company of the potential profits.

Directors' duties - the Regal (Hastings) case

The Raffles Town Club is in the news again today with reports of the trial of its lawsuit just being concluded. The Club which is actually a company, is suing its past directors for breach of directors' duties. This echoes the famous (to company law students and corporate lawyers) case of Regal (Hastings) v Gulliver.

This case involved some directors who had taken an opportunity belonging to their company, being sued by the company after ownership of the company had been sold to new owners. The new board then used the company to successfully sue the former directors. The end result was that the new owners received a windfall since some of the price of buying control of the company was offset by damages recovered for breaches of directors duties.

The moral of the story is that if you are a director, before you sell control of your company to new owners, make sure that all previous actual and potential breaches of directors duties are regularised. Some of the steps might include making full and frank disclosure to the general meeting and then passing resolutions to approve past acts and to waive any breaches. Indemnities against future lawsuits might be also obtained from new owners although these indemnities may not always be effective. Legal advice should be sought to avoid problems.

It is unclear what steps the former directors of Raffles Town Club had taken to avoid a Regal Hasting situation. We eagerly await the court's written judgment for more details.

Company lawsuits and lawyers

Order 5, rule 6 of the Rules of Court (which are rules regulating procedures in the civil court, require that a body corporate (this includes a company) be represented in court only by a lawyer and no one else.

This means that even if the managing director is an experienced lawyer but is not practising at that time, he cannot represent the company. The logic of this rule escapes me. Surely it should be up to the directors and members whether they insist of professional legal representation or are willing to accept an alternative which may be second best.

This appears to be a important but overlooked advantage of using partnerships for business - as a partner, you can represent the firm in court if you are daring enough, but with a company, you must use a practising lawyer.

Partnerships - Audit firms

The Limited Liability Partnership or LLP is meant to combine the best of both worlds - the protection of company with the legal convenience of a partnership.

The newspapers recently reported that audit firms have taken this route.

KPMG is the latest of the major audit firms to have converted from a partnership to an LLP. Ernst and Young, and Deloitte and Touche were reported to have converted earlier this year.

(original post - October 2008)

Company law - entrenchment of articles 2

Why would a company wish to entrench some of its articles? The following provides an example of why a company founder may wish to do so.

A businessman, R Wong, sets up a company and wishes for it to remain family owned. The company's articles restrict members to only his children, their descendants, and the spouses of both these groups. Normally, the restrictive article can be amended by special resolution. Wong is worried that his children might get greedy and allow non-family members to buy shares. So he tells his lawyers to make the restrictive article amendable only if all members agree.

His lawyers warn Wong that his children or descendants might not be good at business. To deal with this event, the restrictive article allows amendment with special resolution if the company loses money for 3 consecutive years. This allows the members to bring in outsiders to inject capital and management expertise into the company.

Directors' duties - de facto directors

The National Kidney Foundation (NFK) case was one case which cast the spotlight on de facto directors - please see the posting on 3rd March, 2009.

Another case which will again turn the spotlight on such directors is the Raffles Town Club case against its former directors. Included among the defendants is former top remiser Peter Lim. He is being sued as a de facto director and the allegations are that he and the others breached their directors' duties to the company.

Who can be held to be a de facto director? Some possible persons - major shareholders, and major creditors. It should be noted that being a major shareholder or major creditor does not make one automatically a de facto or shadow director. It is inteference with the management of the company that may. So watch out if you are not a director but you often give instructions to the directors or even attend board meetings. However, professional advisers like auditors or lawyers will normally not be classified as de facto directors.

Alternatives to using companies

For those seeking to do business but need the protection of limited liability, there are 2 important alternatives to using companies. They are limited liability partnerships (LLPs) and limited partnerships (LPs).

Both offer the informality of partnerships with none of its disadvantages of unlimited personal liability and complex regulation.

The difference between an LLP and an LP is the with the former, all partners have limited liability whereas with an LP, at least 1 partner, known as the general partner, must have unlimited liability. Only this partner is allowed to take part in the management of the partnership business with the limited partners being silent partners.

NKF 2 - Type of company

The NKF saga was also interesting in that the type of company involved was not a normal company limited by shares, a class to which perhaps 99% of Singapore companies belong. Rather, it was a company limited by guarantee. In this type of company, members have their liability limited to the amount stated in the company's Memorandum of Association.

This type of company is often used for non-profit groups such as churches, charities like the NKF, cultural and sometime political associations. It is thought that instead of registering as a society which these groups can also do, forming a company limited by guarantee is easier procedurally and less subject to bureaucratic red tape when the constitution of the organisation is altered.

NKF 1 - Why was Durai sued?

TT Durai, well-known National Kidney Foundation (NKF) head was sued for breaches of director's duties. The interesting thing about the whole matter was that he was not even a director.

However, under the Companies Act, section 4, the definition of a director reads as a " 'director' includes any person occupying the position of director of a corporation by whatever name called and includes a person in accordance with whose directions or instructions the directors of a corporation are accustomed to act and an alternate or substitute director."

This type of person is normally referred to as a shadow director or a de factor director - one who on the facts, has the powers of a director. A person found to be a de facto director is also subject to provisions relating to directors duties under the Companies Act.

Liquidation and winding up

For more information about liquidations and windings up of companies,
please see blog http://windingupsg.blogspot.com/

Directors' duties - Chuan Soon Huat

The recent case involving the directors of listed furniture maker Chuan Soon Huat (CSH) highlighted the issue of reasonable diligence in the discharge of the duties of the directors as required by section 157 of the Companies Act.

The executive chairman of the company was seriously ill and was unable to discharge his duties for a period of over 2 years. The board of directors failed to disclose that there had been a change in effective control of CSH between 1 Jan 2004 and 31 October 2006.

This piece of information is often of great importance to investors and to the market generally. The directors of the company failed to inform the Singapore Exchange (SGX) of this material fact. As a result, they were charged under section 157. They were fined the maximum amounts and were disqualified by the District Court for varying lengths of time.

On appeal to the High Court, Justice of Appeal VK Rajah reduced the disqualification periods for all of the accused except for the the managing director whose disqualification of 5 years was left unchanged. It is unclear if written reasons relatig to the appeal will be released publicly. The decisions of the Subordinate Courts are still available at the website www.subcourts.gov.sg. as at late February 2009.

The directors involved were -Mr Lee Thian Soon who was managing director, then-executive directors Lee Siew Hoe and her husband Lim Kiang Soon, and independent director lawyer Peter Moe

This case therefore illustrates the principle that even non-executive directors are expected to carry out their duties under the Companies Act and any breach will be severely dealt with.

Aim and Introduction

This blog aims to cover important past and present issues and cases in company law. The target audience is the professional like company secretaries and accountants who may have a need for company knowledge in their jobs and the businessman who very often uses companies as his preferred business vehicle.

The experienced corporate lawyer will not find much of interest here since the discussion is pitched at the level of an intelligent accountant with a basic knowlede of company law but who wishes to know more and to be updated on recent developments.

DISCLAIMER - Please note that the blog only provides general information. Continuing to read this blog means that you agree that you will not hold the authors or contributors in any way responsible for the content and you warrant that you will seek legal advice where necessary.