Directors risk being personally liable to contractor if their company orders additional work when there is no reasonable prospect of paying for it.
This is the implication following the recent decision of the Court of Appeal in Yap Wee Chun v Jalex Sdn Bhd (unreported). There were two grounds of judgment by the Court – a main judgment and a supporting judgment – which may be downloaded from here and here.
One of the parties in the case was City Properties Sdn Bhd (“City”), the owner of Avenue K, a retail complex in downtown Kuala Lumpur.
City had a wholly owned subsidiary, KL Landmark Development Sdn Bhd (the “employer”), who appointed Jalex Sdn Bhd (the “contractor”) to carry out refurbishment and renovation works to the complex.
The employer relied on its parent company (City) to obtain financing for the works. In this regard, the financing arranged for by City was a term loan from a bank, and this was the sole source of funds to pay for contractor’s works.
The projected total cost of the works had exceeded the term loan funds by August 2013. Despite this, the employer proceeded to instruct (through its consultants) for additional works to be carried out by the contractor.
There were outstanding payments for work done due from the employer to the contractor. The contractor pursued its claim for payment against the employer, obtaining two adjudication decisions followed by an order to wind-up the employer.
Thereafter, the contractor sued City and the directors of the employer (collectively the “defendants”) for fraudulent trading i.e. carrying on the business of the employer with intent to defraud creditors or for any fraudulent purpose. Section 540 of the Companies Act 2016 enables such a claim to be made.
The High Court found the defendants liable for fraudulent trading, and the Court of Appeal concurred. As a result, the defendants were made personally liable to pay the outstanding debt owing by the employer to the contractor.
One main reason for the Court of Appeal’s decision is that the defendants caused the employer to instruct the contractor to carry out additional works even though they knew that the term loan funds had been exhausted and there was no alternative source of funding; in short, they continued to cause the employer to incur debts without regard to the employer’s ability to pay (paras 111, 118 of the CA main judgment).
It is significant that the fact of payments made to the contractor even after the term loan was exhausted in August 2013 did not negate the existence of fraudulent trading. The relevant question is what the defendants knew or ought to have been known at the time the post-August 2013 debts were incurred, and not whether payments continued post-August 2013 (para 119 of the CA main judgment).
There was still a substantial sum outstanding (about RM 8 million) by the employer to the contractor, despite those payments (paras 10, 11 of the CA main judgment). The fact that the defendants were liable for fraudulent trading in those circumstances indicate that there must be a reasonable expectation of payment of the debt in full in order to avoid such liability.
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