Legal issues in business: Legal Perils of Neglecting Proper Documentation in Business

Key takeaway: Ensure proper documentation for all business transactions to avoid potential accusation of wrongdoings, impropriety, or fraud

Introduction

Running a business inherently involves risks. One of the significant risks arises from neglecting proper documentation.

The following real events are instructive.

A few years ago, there was a tale of 2 factions of shareholders of a company embroiled in lengthy legal tussles in the Kuala Lumpur High court, Commercial Division.

Initially, there were 4 shareholders in this company which carried on property investment and development business. Three of them were the only directors. Practically they were the company at that time. They were unanimous in all of their business decisions.

Potential Business Opportunity

One day, they chanced upon an investment opportunity. They saw great potential in a piece of land somewhere strategically located in the district of Ampang. They swiftly negotiated with the land owner to acquire this promising real estate.

Negotiations progressed smoothly and the price for the purchase was agreed at RM7.3 million. The customary 3+1 month period was given for them to complete the purchase. Lawyers representing both sides were appointed to do the necessary. The conventional 10% deposit was paid when the formal agreement was signed.

However, for reasons best known to the land owner, they insisted that the formal sale and purchase agreement to only reflect RM5.3million as the purchase price and the remaining RM2mil payment to be addressed via a letter of undertaking or a separate agreement.

To facilitate the transaction, the company passed a resolution confirming the sale and purchase of that land at RM5.3 million, in alignment with the formal sale and purchase agreement. However, the RM2mil payment was not mentioned there. This seemingly innocuous omission soon proved to be a pitfall, sparking a contentious lawsuit.

Due to the lack of funds to complete the transaction, they scrambled to obtain financing. But, alas, despite the best efforts, they just could not secure any loan. As time was ticking away, they were under the immense pressure to secure financial assistance to avoid losing the right to purchase the land and from having the deposit forfeited.

Along Came another Shareholder

Given the constraints, they decided to approach a businessman for financial assistance. And the businessman similarly saw the potential in that piece of land and agreed to assist with the condition that he would become the majority shareholder of the company. They had no choice but to agree. Overnight, from being the absolute owner of the company, they became the minority shareholder of the company.

Things went well at first. The new business partnership between the 2 factions seemed promising. However, time would soon prove them wrong. Relations between the majority and the minority turned sour over time. Mistrusts instead of property development became the order of the day. Lawsuits were filed against each other. The majority tried to oust the minority whilst the minority tried to outwit the majority.

Entering the Legal Battle

One lawsuit was initiated by the majority using the company’s name against the minority in Kuala Lumpur High Court. The company, practically the majority, alleged that the minority had defrauded the company when they caused the company to make the RM2 million payment (as mentioned earlier) without valid justification.

After a full trial, the Kuala Lumpur High Court ruled that the minority had defrauded the company of the RM2million. The High Court, amongst others, reasoned that the company resolution and the formal sale and purchase agreement did not mention about the RM2million payment. The High Court also reasoned to the effect that the inadequate or unsatisfactory documentation surrounding the RM2 million payment was indicative that the payment was made fraudulently as it was not authorised by any resolution and there was no legal obligation for the minority to do so at that time.

Ironically, the minority was the absolute owner of the company, being the only shareholders and directors at that material time. Were they practically defrauding themselves at that time? Were they, being the absolute owner at that time, not capable to run their business in the way they deemed fit, albeit informally?

Dissatisfied with the decision, the minority appealed to the Court of Appeal. The Court of Appeal reversed the High Court’s decision. The appellate court took the view that the allegation of fraud was not made out taking into account the surrounding circumstances. In effect, the court was of the view that the RM2million payment was indeed made to secure the purchase of the land, albeit not disclosed in the sale and purchase agreement and the resolution.

The Lessons

Even though the Court of Appeal may have overturned the High Court’s decision, the whole suit could perhaps have been avoided if the documentation was properly done to reflect the necessary particulars of the RM2 million payment and the purpose behind it. The lack of those gave rise to the pitfalls of unnecessary accusations of impropriety, wrongdoings or fraud being made against them especially when relations between business partners turned sour.

The above clearly underscores the importance of proper documentation in every business transactions. As tedious as it may be, if one is not mindful enough in the documentation of any business transaction, one could easily end up in an unnecessary lawsuit as can be seen above.

Business relations are not always constant as it may turn sour during bad times but proper documentation will remain constant throughout irrespective of what may happen to the business.

If you have any questions or require any additional information, please contact our lawyer that you usually deal with.

This article is written by 

Colin Liew
Principal Associate, Low & Partners