6 - Luke Mizzi, Emma-Marie Sammut

Luke Mizzi Emma-Marie Sammut Can Directors and Shareholders be held liable for acts committed by the Company?

Luke Mizzi (LL.D) (LL.M) (Lond) is an Associate at GTG Advocates and forms part of the Corporate and Financial Services team. After graduating with a Doctor of Laws from the University of Malta in 2016, Luke was admitted to the Maltese Bar in 2017. In 2019, Luke completed a Master of Laws in International Finance and Banking Law from the University College London (UCL).

Emma-Marie Sammut is a fourth year student at the University of Malta, reading for a Bachelors in Law. She presently works for GTG Advocates as a legal trainee. Emma was previously Għaqda Studenti tal-Liġi’s Publications Officer for the term 2018/19, and went on to become Vice President the following year, for the term 2019/20.

id-dritt

1. Introduction

G

ood corporate governance is a fundamental pillar of company law.

There are several mechanisms in place to ensure that those entrusted with the administration of the company and the members of such company act with the utmost due diligence and respect to the statutory obligations in place. Directors and members alike must act in good faith and exercise those actions that are considered to be in the best interest of the company.

This article will give a brief explanation on the notion of the corporate veil and how it is employed in instances where the law, or the courts, require that the separate identity of the company and its members is to be ignored, effectively putting aside the principles established in Salomon vs Salomon.1 This will be the foundation for the discussion relating to the duties of the directors in relation to the management of the company, as well as in protecting the interests of the company. Moreover, a director’s position renders him liable to be subject to creditors and shareholders alike and, therefore, is held at a higher esteem in terms of responsibility than any other member of the company. Indeed, a director’s liability comprises effective and thorough due diligence, attention and care in respect to any activities pertaining to the assets and dealings of the company.

Moreover, if the circumstances so warrant, the lifting of the corporate veil may also apply in instances where shareholders act in bad faith. However, such instances are foreign to the current statutory mechanisms in place.

Instances where shareholders may be held liable for their actions may only find their basis elicited through case law. The courts would adjudicate as the circumstances of the case so dictate.

2. The Corporate Veil: Explained The landmark English judgment of Salomon vs Salomon2 established the principle of separate judicial personality and today, represents a fundamental pillar of company law principles. Notwithstanding, this doctrine has created several problems and has often been the subject of abuse by parties who 1 2

Salomon vs A Salomon & Co Ltd [1896] UKHL 1, [1897] AC 22.

Ibid.

116

Corporate Law

use the corporate form to protect them from any wrongdoings.

The law, by way of exception, occasionally ignores the separate identity of the company and its members. This is known as the lifting of the corporate veil. Professor Muscat broadly classifies two exceptions when the corporate veil is lifted and refers to them as statutory exceptions and judicial exceptions.3 Statutory inroads are easily established. It is through legislation, which in some way directly or indirectly affects companies, that a clear picture of instances in which the corporate veil may be lifted is provided.

However, the circumstances in which a Maltese court is prepared to lift the corporate veil and depart from general principles are more difficult to identify and categorise.4

2.1. Statutory Inroads The Companies Act5 may be regarded as the main body of legislation which specifically caters for those instances in which the ‘veil’ may be lifted.

Such laws, however, do not aim to neutralise the separate personality of the company, but instead seek to penalise any wrongdoings on behalf of the company’s ‘constituents’. The provisions, in fact, mainly relate to the management of the company and not to its shareholders. Statutory inroads, therefore, may be viewed as providing an exception to the rule that a mandatary should not be held responsible for the acts of the principal.

2.1.1. Number of shareholders falls below two A company is not validly established unless the Memorandum of Association is entered into and subscribed to by at least two persons.

Nonetheless, an exception exists in the case of single member companies, where a single member would satisfy the specific requirements. If the number of members falls below two for a period longer than six months, 3 Andrew Muscat, ‘Principles of Maltese Company Law’, Malta University Press (ed. 2 Vol II) (2019) 333,334.

4 Ibid.

5 The Companies Act (Chapter 386 of the Laws of Malta).

117

id-dritt

the company may be subject to being dissolved or wound up by the court.6 If within those six months, the remaining member continues to carry out business activities, that member may be held unlimitedly and jointly and severally liable with the company for those obligations contracted within that six-month period, until the date the company is dissolved or until the situation is rectified. Liability arises only if it can be proven that the remaining member was aware that he was the sole member of the company. In such an instance, the ‘veil’ is to be lifted and the sole member is to be held liable.7 Despite this, however, the separate legal personality of the company would successfully remain intact.

It is not the company being put into liquidation which gives rise to an exception to separate legal personality, but if the number of members is reduced to below two for six months and the sole remaining member continues to trade, knowing that the company lacks the statutory requirement for members. This requirement of knowledge was added by virtue of Act IV of 2003. Prior to this, a member was to be held liable even without knowledge of the company’s membership deficit. Moreover, it is to be noted that the liability of the sole member does not substitute that of the company. Rather, the sole member becomes jointly and severally liable together with the company as a legal entity in its own right.

2.1.2. Fraudulent trading If any business of the company has been carried out with the intention of defrauding creditors, or for any fraudulent purpose, the court may hold any person who was knowingly party to that fraud responsible, without any limitation for the liability of debts of the company.8 A wrongdoer may be held liable not only for contractual obligations undertaken by the company, but also for any form of obligation, including liability in tort and statutory claims against the company, whether it was liquidated or not. Such liability is not restricted to debts and liabilities of the company incurred before or after the fraud. However, liability is not 6 7 8

Ibid, Article 214(2)(b)(i).

Ibid, Article 214(4).

Ibid, Article 315.

118

Corporate Law

automatic but upon application. Despite this, liability may be invoked against any person, including directors, managers and shareholders.

This provision was considered to be quite difficult to use in practice because it can only be invoked in the process of a winding up, and the onus of proving fraud is quite high. Essentially, this remedy does not really involve an exception to the principle of the separate legal personality of the company.

The company continues to be regarded as a separate juridical person and to be liable for its obligations independently of the liability attached to the wrongdoer. Nevertheless, the wrongdoer is considered to be personally responsible for his actions.

Prior to the introduction of the Companies Act, there nevertheless existed a remedy. This is the criminal sanction; a person knowingly participating in a fraud, whether as a principal or as an accomplice, would be committing a criminal offence under the Criminal Code. At first glance, therefore, the provision in the Companies Act may not have been required, but in reality, the civil sanction is far wider.

2.1.3. Wrongful trading9 An action for wrongful trading may only take place when the company enters into insolvent liquidation. The action is exclusively brought forward by the liquidator against the directors, and thus, the action is narrower in scope than the action for fraudulent trading. The creditors may, nevertheless, instigate the liquidator to bring forward this action.

The court may declare the director liable to contribute towards the company’s assets, as long as it is proven that the directors knew, or ought to have known, that there was no reasonable prospect for an insolvent liquidation to be avoided. Evidently, this approach sheds light on the nature of directors’ fiduciary duties not only towards shareholders but also towards creditors as stakeholders, in view of the limited liability of the company. Directors will only be liable unless they show that they took every reasonable step to protect the interests of the creditors. If they do not show that they took such steps, then it is in this instance that the court would issue an order condemning the directors to make a contribution to the assets of the company.

9

Ibid, Article 316.

119

id-dritt

Liability for wrongful trading may be incurred even if the company ceases trading as soon as it is realised that insolvent liquidation is inevitable. Examples of conduct capable of attracting liability include: failure to preserve the assets of the company; concluding transactions at an undervalue; payment of excessive remuneration, and so forth.

The law also provides for both a subjective and an objective test when deciding the director’s liability: his personal skill and knowledge and the knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions.10 Any director, moreover, acting in good faith is afforded some protection. The court will not grant an application for wrongful trading against such a director, or directors, if it is satisfied that the person concerned took every step he ought to have taken with a view to minimise potential losses to the creditors.

As can be seen, Article 316 of the Act is a powerful tool in the creditor’s arsenal. One need not prove fraud or dishonesty, as the onus of proof falls upon the director to prove that he has taken every step to minimise any potential losses. The Price Club11 case is a brilliant example of the provision in action, wherein the Court held the directors responsible for trading when the company in question was practically insolvent, seriously prejudicing the interest of creditors.

2.1.4. Group of companies The Companies Act is not the only body of legislation providing for statutory inroads. The Income Tax Act12 also aids in this endeavour. Both Acts allow the separate judicial personality of companies to be set aside for the purpose of viewing a group of companies as one single entity, for financial or fiscal reasons.

Where a company holds a subsidiary relationship, that is, it is the parent company and holds a relationship with other subset companies, that company is regarded as a single entity and must also submit group accounts.

10 Ibid, Article 316(4)(a)-(b).

11 Dr. Andrew Borg Cardona v. Victor Zammit, Christopher Gauci u Wallace Fino, Civil Court, First Hall (2007).

12 The Income Tax Act, Chapter 123 of the Laws of Malta.

120

Corporate Law

Apart from the obligation of each company to prepare audited financial statements personally, the parent company must also prepare its accounts.

These consolidated accounts will provide a true and fair view of the assets, liabilities and financial position of the group of undertakings as a whole.

Similarly, Article 16 of the Income Tax Act makes an exception to separate personality because in certain limited circumstances, the Act allows the surrender of group relief. The losses made by individual companies within a group, which normally will not go beyond that company, can under limited conditions be utilised by other companies within the group.

2.1.5. Miscellaneous Statutory Inroads Other statutory inroads, as per the Companies Act, include instances such as: (i) premature trading – where transactions are entered into before the company has come into existence, all persons carrying out business in the name of the company, shall be jointly and severally liable for the dealings; (ii) misstatements in prospectus13 - the Act also imposes joint and several liabilities on those persons who are responsible for, or who have authorised, the issue of a prospectus for any damage sustained by a person subscribing to those shares on the basis of the prospectus, when it contains untrue statements; (iii) unlawful distributions14; (iv) liability of past directors and shareholders in relation to the redemption or purchase by the company of its shares15; and (v) restriction on the reuse of company names.16 13 14 15 16

Companies Act, Article 94.

Ibid, Article 204.

Ibid, Article 217.

Ibid, Article 317.

121

id-dritt

2.2. Judicial Inroads The court has, upon occasion, been asked to disregard the separate personality of a particular company in circumstances where the law itself does not provide for such a course of action. There are several court judgments, both in Malta and the UK, that can illustrate the judicial inroads.

In the UK, efforts to lift the corporate veil have been constrained by the Salomon17 case, which had destroyed the possibility of regarding the oneman company as a mere alias of, or agent for, the principal shareholder.

Nevertheless, the Maltese courts have been receptive to the argument that disregarding a company’s separate judicial personality is necessary to achieve principles of justice. Basing itself on largely UK doctrine, the Maltese Courts have developed a well-structured doctrine for the allowance of judicial inroads.

2.2.1. Fraud The concept of fraud, in this context, is wider than that given to it in a Criminal law context. It encompasses fraud and improper conduct, which goes beyond a deliberate attempt to deceive. The court has often been faced with situations in which it decided to lift the corporate veil to issue judgements in line with good faith principles. Most of these cases have involved an attempt at evading contractual obligations by hiding behind a corporate personality.

The court confirmed its willingness to lift the corporate veil in situations of bad faith in the landmark judgement of Herrera vs Tabone18. The Court stated that the principle of separate legal personality is not a universally applicable principle, and that the Court has the ability to look beyond what is at the surface in order to achieve justice. Essentially, the courts have held that the principle of good faith overrides that of separate legal personality.

17 18

Salomon vs A Salomon & Co Ltd [1896] UKHL 1, [1897] AC 22.

Dr Jose Herrera et vs Tancred Tabone et noe, Court of Appeal (1992).

122

Corporate Law

Moreover, in Supermarkets Limited vs Le Cram Developments Co. Ltd19, the defendants attempted to argue that a judgement issued against them in their personal capacity was to have no effect on the company they formed part of. The Court remarked that when determining whether a company was in good faith, one must look at the conduct of the representatives of that company.

Therefore, where bad faith exists and the circumstances so warrant, the court may lift the corporate veil, ascribing responsibility to persons beyond the company itself. Bad faith, however, can never be presumed and must be proven by the party alleging it.

2.2.2. The Single Economic Unit The ‘single economic entity’ principle has often been viewed as an exception to the Salomon principle. The UK Courts, in the 1970s and 1980s, put forward a justification for the disregarding of the separate judicial personality of related companies based on the ‘the requirements of justice’, and went on to regard related companies as single economic entities. This notion is inherently vague and provides neither the courts nor professional advisers with any clear guidance. It was first accepted by Lord Denning in the case of DHN Food Distributors Limited vs Tower Hamlet London Borough Council20, where a holding company conducted business on land owned by one of its wholly-owned subsidiaries. When the Council compulsorily acquired the land, the holding company entered a claim for compensation in respect of the disturbance caused to it. The claim was upheld, with Lord Denning holding that the Court could look to the economic entity of the whole group and treat the business as being carried on by that group: [t]his group is virtually the same as a partnership in which all the three companies are partners. They should not be treated separately so as to be defeated on a technical point. They should not be deprived of the compensation which should justly be payable for disturbance. The three companies should, for present purposes, be treated as one.21 19 Supermarkets Limited vs Le Cram Developments Co. Ltd Court of Appeal (2002).

20 DHN Food Distributors Limited vs Tower Hamlet London Borough Council [1976] 3 ALL ER 462.

21 Ibid

123

id-dritt

However, in the Adams vs Cape Industries Plc22 case decided in 1990, the UK Courts went on to reject the notion. Here, the defendant was part of a group of companies and attempted to take advantage of its corporate structure to avoid the risk that any member of the group would be subject to United States law and, thus, liable for any injury caused by asbestos. The Court of Appeal rejected the argument that the plaintiff company should be regarded as comprising part of a single economic entity. In this case, the Court opined that ‘it would be technical for [it] to distinguish between the parent and subsidiary company... economically [the plaintiff] said, they were one. But [the Court is] concerned not with economics, but with law. The distinction between the two is, in law, fundamental and cannot here be bridged.’23 Economic integration of companies, according to some commentators, should result in ‘enterprise liability’, meaning that the separate personality of each making up the company is to be ignored and the enterprise should be held responsible as a whole. However, this was not the position adopted by the Maltese Courts in Pisani vs Borg Bartolo.24 The Court held that although the term ‘group of companies’ denotes the existence of a number of affiliated companies, this does not mean that this ‘group’ is to have a separate existence.

A group of companies cannot be seen as a separate juridical person as it is merely a descriptive term.

3. Definition of a Director A director is generally someone who manages the company. Shareholders, on the other hand, are individuals that have an equity stake in the company.

From a Maltese perspective, the Companies Act does not define who a director is, however, a description of what a director is may be found under Article 2: “director” includes any person occupying the position of director of a company by whatever name he may be called carrying out substantially the same functions in relation to the direction of the company as those carried out by a director.

22 Adams vs Cape Industries Plc [1990] Ch 433.

23 Ibid.

24 Pisani vs Borg Bartolo, Civil Court, First Hall (1989).

124

Corporate Law

Thus, a person is held to be a director where he has been formally appointed to the board as a first director or as a subsequent director, in accordance with Articles 69(1)(g) and 139 of the Companies Act, whether appointed as an executive or a non-executive director (a ‘de jure’ director), and also where, although not formally appointed as aforesaid, he carries out substantially the same functions in relation to the direction of the company as those carried out by a director (a ‘de facto’ director). The definition would also appear to encapsulate any person appointed as an alternate director, where the Articles of Association of the company expressly allow for such an appointment.25 Under Maltese law, it is a long-standing principle that directors have a fiduciary relationship towards a company and are required to act in good faith as a bonus paterfamilias.26 A director’s duties are generally embodied in sources such as the memorandum or articles of association of a company, the Companies Act, as well as several bodies legislation imposing specific duties on directors. The instances wherein personal liability may attach to a director derive from the duties attributed to directors by law, which are primarily two: 1. The general duties of a director arising from a director’s juridical position under general principles of Maltese law; and 2. The administrative duties of a director arising under specific provisions of Maltese laws.

3.1. Duties of Directors In the performance of their directorship, directors are under a duty to exercise care, diligence and skill. This duty is laid down in the context of the broader requirement that directors of a company are to promote the well-being of the company and are responsible for its general governance, for its proper administration and management, as well as for the general supervision of its affairs.

25 Daniela Gauci, ‘Duties and Liabilities of Directors of Companies In Distress’, University of Malta (2015) 36.

26 Andrew Muscat, ‘Principles of Maltese Company Law’, Malta University Press (ed. 2 Vol II) (2019).

125

id-dritt

3.1.1. General Duties Article 136A of the Companies Act encapsulates the general duties which directors owe to the company. For ease of reference, such article is replicated below: 136A. (1) A director of a company shall be bound to act honestly and in good faith in the best interests of the company.

(2) The directors of a company shall promote the well-being of the company and shall be responsible for: (a) the general governance of the company and its proper administration and management; and (b) the general supervision of its affairs.

(3) In particular, but without prejudice to any other duty assigned to the directors of a company, or to any one of them, by the memorandum or articles of association or by this Act or any other law, the directors of a company shall: (a) be obliged to exercise the degree of care, diligence and skill which would be exercised by a reasonably diligent person having both (i) the knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as are carried out by or entrusted to that director in relation to the company; and (ii) the knowledge, skill and experience that the director has; (b) not make secret or personal profits from their position without the consent of the company, nor make personal gain from confidential company information; (c) ensure that their personal interests do not conflict with the 126

Corporate Law

interests of the company; (d) not use any property, information or opportunity of the company for their own or anyone else’s benefit, nor obtain benefit in any other way in connection with the exercise of their powers, except with the consent of the company in general meeting or except as permitted by the company’s memorandum or articles of association; (e) exercise the powers they have for the purposes for which the powers were conferred and shall not misuse such powers.27 Four main principles may be extracted from Article 136A. These principles, according to Professor Andrew Muscat, comprise the ‘duty of loyalty’28 of directors.

Firstly, directors must act in the best interests of the company, and secondly, directors must act honestly and in good faith. English authors Gower and Davies believe that the grounds for ‘good faith’ should be tested on common sense principles, and the respective court must ask itself whether it is proved that the directors have done what they honestly believed to be right.29 In essence, this aims to preclude the courts from doubting the board of directors’ decisions as to where the best commercial interests of the company lie. Such a notion was discussed in the English case of Charterbridge vs Lloyds Bank30, where the Courts held that the test is ‘whether an intelligent and honest man in the position of a director of the company could, in the whole of existing circumstances, have reasonably believed that the transactions were for the benefit of the company’.

Directors are required to act bona fide in what they consider, and not what a court may consider, is in the interests of the company due to their faith and reasonable skill31. This principle was reiterated in Re Smith vs Fawcett.32 Nevertheless, directors may breach such a duty, even if there is no conscious dishonesty on their end, if they fail to consider whether a proposed action is 27 Companies Act, Article 136A. 28 Andrew Muscat, ‘Principles of Maltese Company Law’, Malta University Press (ed. 2 Vol II) 568, 570.

29 Gower and Davies: Sweet; 9th Revised Edition (2012).

30 Charterbridge vs Lloyds Bank [1970] 1 Ch 62.

31 Andrew Muscat, ‘Principles of Maltese Company Law’, Malta University Press (ed. 2 Vol II) (2019) 587.

32 Re Smith vs Fawcett Ltd [1942] Ch 304 [1942] 1 All ER 542.

127

id-dritt

indeed in the best interests of the company, as noted in Re W & M Roith Ltd.33 Farrar and Hannigan opine that what should be taken into consideration is the directors’ subjective opinion as to the interests of the members as a general body, balancing the short-term interests of the present members against those long-term interests of future members.34 Thirdly, the directors must use their powers for the purpose for which these powers have been conferred and not for an improper purpose. The main sources of the powers of directors are the Companies Act and the company’s memorandum and articles of association. Indeed, Article 137(3) of the Companies Act states that the business of a company ‘shall be managed by the directors who may exercise all such powers of the company… as are not by this Act or by the memorandum or articles of the company, required to be exercised by the company in general meeting’.35 The memorandum and the articles, in practice, generally set very few parameters within which the powers of directors are to be exercised and, in turn, the powers of directors are thus usually limited only by the provisions of the Companies Act.36 Directors must act intra vires and cannot do anything which is illegal, ie: ultra vires to the company’s objects. They must not, without the authorisation garnered through a general meeting, do any act or enter into any transaction which is beyond the powers conferred on directors by the articles. Directors are under the obligation to follow what is embodied within the Companies Act, as well as the memorandum and articles. If the directors engage in any such activity, they may be liable in damages on a joint and several basis for a breach of duty37, aside from the consequences specified in the Act. Fourthly, a director must not have a conflict of duty or of interest. A director who may be interested in a contract or proposed contract that the company may enter into, is under the obligation to declare the nature of his interest to the other directors.38 If he fails to do so, such a director would be liable to a penalty as specified by the Act. The director must flag out a conflict of interest immediately, even if such an interest or conflict may be premature, as 33 Re W & M Roith Ltd [1967] 1 W.L.R. 432.

34 Farrar’s Company Law: Fourth (4th) Edition, Butterworths Law; 4th Revised Edition (1 July 1998).

35 Companies Act, Article 137 (3) 36 Andrew Muscat, ‘Principles of Maltese Company Law’, Malta University Press (ed. 2 Vol II) (2019) 592.

37 Companies Act, Article 147.

38 Companies Act, Article 145.

128

Corporate Law

otherwise he would be in breach of his duties. Moreover, a director may not, without the shareholders’ consent, carry on business on his own account or on account of others, if such a business is in competition with the company.39 Although the general duties of directors are broad in their scope of application, the consensus is the same: the duties of directors in their dayto-day management of the company or any other actions relating to the company hinge on the notion of ‘good faith’. Indeed, this may be seen in cases such as Grech vs Chetcuti40, wherein a resolution taken by a board of directors was deemed to be null and void, as the directors were acting out of personal interest.

3.1.1.1. Duty of Care, Diligence and Skill The Companies Act requires directors to exercise the degree of care, diligence and skill which would be exercised by a reasonably diligent person, reaching both an objective and subjective standard respectively.

These standards are: a) the knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as are carried out by, or entrusted to, that director in relation to the company (the objective standard); and b) the knowledge, skill and experience that the director has (the subjective standard).41 Therefore, a director is required to meet the higher of the two standards and thus, a director must meet the objective standard. The subjective standard operates in a way which increases the level of care, diligence and skill expected from a particular director depending on that director’s specific personal knowledge, skill and experience.

39 Ibid, Article 143.

40 Mary Grech et. vs Joseph Chetcuti pro et noe. in rappresentanza tas-socjeta’ J.B.Limited, First Hall Civil Court (5 October 2004).

41 Companies Act, Article 136A (3)(a)(i)-(ii).

129

id-dritt

3.1.2. Specific Duties Additionally, various pieces of legislation also impose specific duties on directors. From a high-level perspective, these may be classified into six categories: 1. The duties relating to the keeping of statutory registers, including the list of members and directors, and minute books, these being the meeting minutes; 2. The duties relating to the filing of returns and documents. On an annual basis, a company must file an annual return with the Company Registry and a tax return, and on a quarterly basis, a VAT return; 3. The duties relating to board and general meetings. The directors of the company meet and make decisions by means of board meetings; 4. The duties relating to record keeping and financial statements, that is, the keeping of trade books; 5. The duties relating to the liquidation of the company. If the company has its asset base depleted to a particular degree, it is the duty of the directors to inform the shareholders to liquidate the company; 6. The miscellaneous duties.

In particular, if the company is listed on the Malta Stock Exchange, the special duties became more onerous. A director, thus, must comply with its rules and the principles of good corporate governance, including the Insider Dealing and Marketing Abuse Offences Act.

3.3. Liability of Directors In English law, the directors are considered to be the trustees or agents 130

Corporate Law

of the company. At common law, directors are fiduciaries and as such, are subject to a number of fiduciary duties.42 Essentially, as held in Great Eastern Railway Co vs Turner43 and Kuwait Asia Bank EC vs National Mutual Life Nominees Limited44 respectively, they are considered to be trustees of the company’s property and monies, and agents in the transactions they enter into on behalf of the company.

Meanwhile, under Maltese law, directors have generally been regarded as mandataries and agents. Professor Cremona observes that in their internal dealings with the company, directors should be classified as mandataries of the company and that in their dealings with third parties they should be considered as agents thereof.45 In Musu’ vs Vella46, the Maltese Commercial Court, as early as 1890, recognised that ‘amministratori ed i membri di un comitato di direzione’ of a società anonima were to be regarded as mandatories, and that if they acted outside the parameters of their mandate, they were to be held personally liable in damages. Moreover, in Dr Ian Refalo noe et vs Albert David Boweck et47, the Civil Court stated that ‘...id-diretturi għandhom jitqiesu bħala aġenti jew mandatarji tal-kumpanija li tgawdi personalità ġuridika u indipendenti mill-membri li jikkomponuha.’ In this case, however, it should be noted that the Court held the terms ‘agent’ and ‘mandatory’ to be one and the same.

However, later judgments affirmed that agency is a species of mandate, as per Article 49 of the Commercial Code.48 Nonetheless, the existence of an agency, like that of a mandate, gives rise to legal consequences both between the agent and his principal, as well as between the principal and the third party. It is suggested that the juridical nature of agency and that of mandate are so closely linked that it is unnecessary to distinguish between the character of a director as a mandatary in his internal dealings with the company and that of an agent in his dealings with third parties.49 42 Farrar and Hannigan (supra n.3) 378.

43 Great Eastern Railway Co vs Turner [1872] 8 Ch. App. 149.

44 Kuwait Asia Bank EC vs National Mutual Life Nominees Limited [1990] BCLC 868.

45 Professor F Cremona, ‘Notes on Commercial Partnerships’, 113.

46 Francesco Saveria Musu’ vs Vincenzo di Saverio Vella et, Vol. XII. 527 (1890).

47 Dr Ian Refalo noe et vs Albert David Boweck et First Hall, Civil Court (18 March 1983).

48 The Commercial Code (Chapter 13 of the Laws of Malta).

49 Andrew Muscat, ‘Principles of Maltese Company Law’, Malta University Press (ed. 2 Vol II) (2019) 566.

131

id-dritt

Moreover, through Act XIII of 2004, Articles 1124A and 1124B were included within the provisions of the Civil Code to introduce the prospect of fiduciary obligations. In turn, such provisions have rendered directors to be regarded as fiduciaries of a company. Fiduciary obligations arise in virtue of law, contract or quasi-contract, unilateral declarations including wills, and trusts, assumption of office or behaviour whenever a person, dubbed ‘the fiduciary’: (a) owes a duty to protect the interests of another person. In turn, it shall be presumed that such an obligation where a fiduciary acts in or occupies a position of trust is in favour of another person; or (b) has registered in his name, holds, exercises control or powers of disposition over property for the benefit of other persons, including when he is vested with ownership of such property for such purpose; or (c) receives information from another person subject to a duty of confidentiality and such person is aware or ought, in the circumstances, reasonably to have been aware, that the use of such information is intended to be restricted.50 A principle duty of the director is to protect the interests of the company.

A director often holds or exercises control or powers of disposition over property of the company and, in such a case, he would qualify as a fiduciary also under the second limb of the definition, and is in receipt of information from the company subject to a duty of confidentiality, which would qualify him as a fiduciary also under the third limb of the definition.

Moreover, a director may incur personal liability if, though not initially bound by a contract entered into on behalf of a company, he/she goes on to assume liability for the company’s contractual obligations. Such an instance may be seen in Anchor Bay Leisures Limited vs Edgar Urpani et51, where the defendant, Urpani, entered into contract on behalf of the defendant company with the plaintiff. At a later stage, when the defendant company failed to pay its dues to the plaintiff, Urpani issued a cheque under his own name which was ‘referred to drawer’. By issuing the cheque, Urpani assumed the liability for the obligations of the defendant company. Therefore, Urpani 50 51 2011).

The Civil Code (Chapter 16 of the Laws of Malta), Article 1124A. Anchor Bay Leisures Limited vs Edgar Urpani et, First Hall, Civil Court (29 September

132

Corporate Law

and the defendant company, were held in solidum and, were both to pay the relative amount to the plaintiff.

3.3.1. The Creditors & Insolvency Maltese company law recognises that directors owe a duty to take into account the interests of the creditors of the company, in an instance where the company under their management and control is in financial distress.

This may be seen from Article 316 of the Companies Act, whereby in cases of wrongful trading, the directors are under the obligation to ensure that every step is taken to minimise the potential loss to the company’s creditors, especially where the company has no reasonable prospect of avoiding dissolution due to its financial state or is subject to an impending reality of being unable to pay its debts.52 It is unlikely that general principles of law could be relied upon, in the absence of fraud or breach of the criminal law, to impose duties on directors towards creditors. Given that directors act on behalf of the company, their actions vis-à-vis third parties are generally regarded to be one of the same with the action of the company itself. Professor Muscat opines that it would be an odd occurrence of the courts were to equate the interests of the creditors with the interests of the company.53 Nonetheless, Maltese judgments have recently started to occasionally refer to a duty of directors to take into account the interests of the creditors when the financial position of the company is in a parlous state. For example, in the case of Dr Andrew Borg Cardona vs Price Club Holdings Limited et54, the Civil Court remarked that the financial situation of a company may require the interests of creditors to be taken into consideration. Even if, legally speaking, a director is only an agent of a company and his duties are towards the company he represents, the obligation of the director to consider creditors’ interests is of utmost importance.

The Civil Court made an impressive revelation in Maltacom plc vs Mark 52 53 54

Companies Act, Article 316.

Andrew Muscat, ‘Principles of Maltese Company Law’, Malta University Press 580.

Writ number 25/2003, First Hall, Civil Court (12 October 2007).

133

id-dritt

Gaffarena et55, where the Court held the company directors personally liable for their failure by their insolvent company to pay its bills to the plaintiff company. Moreover, in All Invest Company Limited vs X et56, the Court recognised a duty owed to the creditors of the company by the directors, when the company was approaching insolvency. Quoting the English Case of Gwyer & Associates Ltd vs London Wharf (Limehouse) Ltd57, the Court held that directors have a fiduciary responsibility vis-à-vis creditors when the company is close to bankruptcy.

After taking all of the above into consideration, could directors, furthermore, be held personally liable to creditors on the basis of the rules on tort? Can directors who have failed, in the management of the company, to exercise prudence, due diligence and attention of a bonus paterfamilias or who have breached a duty imposed by law, be held liable under the principles of the Civil law of tort for damages which creditors have suffered as a result of failing to recover what is due to them from the company because of insolvency?

As aforementioned, as directors act on behalf of the company, it is unlikely the court would hold directors personally liable towards creditors in these circumstances. However, this position would be different if the directors’ conduct were to amount to fraud or involve a breach of Criminal law. In such instances, the courts would be entitled to impose a direct liability on directors vis-à-vis affected creditors of the company.

The question of the liability in tort is also related to the broader question of the potential liability of a company in tort. The prevailing view is that a company may be held liable in tort, as discussed in Albert Mizzi noe. vs Rev Prof George Schembri.58 However, if a company is to be held liable in tort, it alone should be held liable. On the other hand, if a court were to regard a company as being incapable of committing a tort, then liability should be imposed on the directors themselves.59 Despite all of the above, it is to be noted that the Companies Act’s 55 Maltacom plc vs Mark Gaffarena et, Court of Appeal, Inferior Jurisdiction (28 November 2008).

56 All Invest Company Limited vs X et , First Hall, Civil Court (17 March 2014).

57 Gwyer & Associates Ltd vs London Wharf (Limehouse) Ltd [2003] 2 BCLC 153.

58 Albert Mizzi noe. vs Rev Prof George Schembri, Vol. LXXVI. ii. 210.

59 Andrew Muscat, ‘Principles of Maltese Company Law’, Malta University Press 583.

134

Corporate Law

provisions on fraudulent preferences60, fraudulent trading61, wrongful trading62 and the remedy against delinquent directors63 should afford to creditors of the company ample protection against misconduct or serious mismanagement by the directors, without the need for the courts to develop duties and remedies based on general principles.

3.3.1.1. Tort & Fiduciary Obligations Cautious directors may refrain from taking business risks for fear of contracting personal liability under the wrongful trading provisions. Keay64, vis-à-vis the importance of directors being able to take business risks as well as the protection of creditors, opines that it is important to strike an appropriate balance between the two extremes of taking into account creditors’ interests only after a company is insolvent, and that of considering the creditor’s interests at the first sign of financial distress. In this regard, the former part of Keay’s consideration would give creditor’s very little possibility of protection. The latter part, meanwhile, may possibly interfere with the directors’ decision-making, as they may become overly cautious in their business strategies.65 The Act provides several mechanisms through which the company, as well as the body of creditors, may sue the directors for a breach of duty.

However, the Act offers no remedy to the individual creditor who suffers a loss as a result of a director’s conduct in the management of the company’s affairs. In this regard, would a creditor be successful in bringing an action based in tort against the directors of his debtor company’s for their failure to use prudence, diligence and the attention of a bonus paterfamilias in the management of the company’s affairs, inevitably holding them personally liable for payment of a debt of the company or damages?

Maltese judgements seem to be divided on this matter. In cases such 60 Companies Act, Article 122.

61 Ibid, Article 315.

62 Ibid, Article 316.

63 Ibid, Article 312.

64 Andrew Keay, ‘The director’s duty to take into account the interests of company creditors: When is it triggered?’ (2001) 25 MULR 315, 319.

65 Companies Act, Article 315.

135

id-dritt

as Briffa vs Abela66, the Court upheld a demand for a director to be held personally liable in solidum with the company under his management for a debt owed by it on the basis that he had committed fraud. Indeed, ‘ma [kienx] hemmx dubju li f’ċerti determinati sitwazzjonijiet d-direttur ikun personalment responsabbli għall-ħsara bl-aġir delittwuż minnu stess kommess’. The Court, citing Palmer67, supported the concept of personal liability on behalf of directors who were party to fraud or the commission of any other tort towards the injured party. Previous judgments such as Bugeja vs Vella Gatt68 reveal that the Maltese Courts are partial to holding a director personally liable for debts of the company under his management by reason of fraud committed by him. Moreover, the case of Galea vs Hili69 established that liability in tort also arises where the director, although not personally committing the tort or ‘l-aġir dilettwuż’ - allows another to commit it.

However, cases such as Theuma vs Cachia70 and Hi-Timber Company Limited vs Baldacchino71 reject the notions established in the abovementioned cases. In both instances, the demand for a declaration of the joint and several liability of the defendant directors, with the defendant company for the debts of the latter, were based on claims of personal liability due to the fact that the directors had continued to trade, knowing that the company was in a bad financial situation. The Court, instead of framing the action in tort, framed the action under Article 316 of the Companies Act,72 and went on to reject the claim on the basis that an action for wrongful trading could only be made after the company has gone into insolvent liquidation.

66 Anthony Briffa pro et noe vs Vincent Oliver Abla pro et noe, First Hall, Civil Court (28 March 2003).

67 Palmer’s Company Law, 21st Edn (1968) 572.

68 John Bugeja vs Giuseppe Maria Vella Gatt pro et noe, Court of Appeal (Commercial) (31 January 1977).

69 Victor Galea vs Marin J. Hili noe, Commercial Court (1 October 1996).

70 Brian Theuma vs Chris Cachia pro et noe, First Hall, Civil Court (14 October 2004).

71 Hi-Timber Company Limited vs Joseph Baldacchino et, First Hall, Civil Court (15 December 2005).

72 (1) The provisions of this article shall apply where a company has been dissolved and is insolvent and it appears that a person who was a director of the company knew, or ought to have known prior to the dissolution of the company that there was no reasonable prospect that the company would avoid being dissolved due to its insolvency. (2) The court, on the application of the liquidator of a company to which this article applies, may declare the person who was a director referred to in sub-article (1) liable to make a payment towards the company’s assets as the court thinks fit. (3) The court shall not grant an application under this article if it is satisfied that the person who was a director knew that there was no reasonable prospect that the company would avoid being dissolved due to its insolvency and accordingly took every step he ought to have taken with a view to minimising the potential loss to the company’s creditors.

136

Corporate Law

Furthermore, it is also dubious as to whether the creditors of the company would be successful in a claim against the directors for a breach of fiduciary obligations towards them. Directors do not owe any fiduciary duties to creditors. Although the Court, in All Invest Company vs X73, in quoting the Gwyer74 case, opined that ‘id-diretturi għandhom dmirijiet fiduċjarji fil-konfront tal-kredituri meta l-kumpanija tkun waslet fl-għatba tal-insolvenza’, the reference to fiduciary obligations should be interpreted as a reference to the general duty of directors to act in the best interests of the company - a duty which, in itself, is of a fiduciary nature and which comprises the duty to take into account the interests of the company’s creditors when that company is in financial turmoil.

4. Definition of a Shareholder Companies are formed as a result of subscribers who decide to form the company. The persons who are contributing are known as the subscribers to the memorandum, and generally speaking, they are then the shareholders.

The term ‘shareholders’ covers all the persons who, at a moment in time, have at least one share in the company. A Maltese company has a separate legal personality and existence from that of its members and officers.

A company can therefore sue, or be sued, in its own name and may hold separate rights and obligations. The liability of a shareholder, as a general principle, is limited to any amount which is unpaid over the shares to which the shareholder is subscribed.

Both shareholders and creditors supply capital to a corporation. Creditors have fixed claims towards a company and are, consequently, entitled to receive the repayment of their principle, with interest, at a specified time.

On the other hand, shareholders have the right to participate in firm profits through dividends as they may be declared by the directors and, to share in residual assets, that is, those assets which remain after creditor payment, upon dissolution. The probability of conflict between shareholders and creditors augments in cases of unsuccessful firms.75 73 All Invest Company Limited vs X et , First Hall, Civil Court (17 March 2014).

74 Gwyer & Associates Ltd vs London Wharf (Limehouse) Ltd [2003] 2 BCLC 153.

75 J. William Callison, ‘Why a Fiduciary Duty Shift to Creditors of Insolvent Business Entities is Incorrect as a Matter of Theory and Practice’, Journal of Business & Technology Law, Vol. 1, University of Carey (2007) 431, 432.

137

id-dritt

4.1. Shareholder liability Shareholders may be held personally liable for certain acts or omissions.

This instance is oftentimes referred to as the ‘piercing’ or ‘lifting of the corporate veil’. Circling back to what was mentioned in Section 1 of this article, the corporate veil is essentially a mechanism, which protects the company and gives it its personality. The company is regarded, at law, as a separate person from its shareholders. As a general rule, the veil of the corporation or the principle of separate juridical personality is generally opaque and impassable.

The instances wherein shareholders have been found personally liable through judicial practice is not a concept which arises from Maltese statutory law. It is through jurisprudence that the personal liability of shareholders for fraud and improper conduct is recognised. The notion of ‘improper conduct’ goes beyond an attempt to create a level of deceit and includes notions such as concealment and evasion.

In Herrera vs Tabone76, for instance, the Courts lifted the corporate veil for a situation in which the shareholders hid behind the separate legal personality of the company to avoid fulfilling contractual obligations. Moreover, in Supermarkets Limited vs Le Cram Developments Co. Ltd77, it was established that where shareholders act in bad faith and if the circumstances so warrant, the courts have the power to lift the corporate veil and attribute personal liability to shareholders.

5. Conclusion The Companies Act, alongside complementing legislation, is a powerful mechanism in combating situations of fraud, abuse of power and defaulting of contractual obligations with regards to third parties. Meanwhile, it is not solely the Act which may deem that directors acted ultra vires or in male fede.

Tort law principles may also apply to specific situations. The rights of third parties, through the relevant laws and case law, is therefore ensured through 76 77

Dr Jose Herrera et vs Tancred Tabone et noe, Court of Appeal (1992).

Supermarkets Limited vs Le Cram Developments Co. Ltd Court of Appeal (2002).

138

Corporate Law

such legislative devices. Established notions of jurisprudence, moreover, not only strengthen the framework for assuring that good corporate governance is maintained but go on to safeguard the notion of equality before the law.

Shareholders and directors alike may share liability, and therefore, the possibility of hiding behind the protections afforded by the law are minimal.

Indeed, while the law gives certain rights and remedies to shareholders and directors in relation to their positions, the Act ascertains that such rights and remedies are not made use of in an abusive manner, especially if such actions are subject to jeopardising the rights of third parties with invested interests in such company.

139