When Company Money Goes Missing

Discovering that a director, partner or senior employee has diverted company funds is a serious matter. Beyond the immediate financial loss, it represents a fundamental breach of the trust placed in that person. Malaysian law provides several civil remedies to recover misappropriated funds and hold wrongdoers accountable.

This article explains the legal options available to companies and their stakeholders when facing such situations.

Understanding Fiduciary Duties

Directors and partners occupy positions of trust. The law imposes fiduciary duties on them, requiring that they act honestly and in the best interests of the company or partnership.

Directors Under the Companies Act 2016

Section 213 of the Companies Act 2016 sets out the statutory duties of directors. A director must exercise his powers for a proper purpose and in good faith in the best interest of the company, and with reasonable care, skill and diligence. Section 218 prohibits a director from using company property, information or opportunities, or his position, to gain a benefit for himself or another person, or to cause detriment to the company, without the company's consent or ratification. Section 221 requires a director to disclose his interest in contracts and proposed contracts with the company. These statutory duties sit alongside the director's fiduciary duties under the general law.

When a director diverts company funds for personal use, this will usually be a breach of fiduciary duty and of these statutory duties. Money taken in this way is held by the director on constructive trust for the company, and the company may sue the director personally to recover the misappropriated sums. If the company is later wound up, the liquidator may also apply under section 541 of the Act for the court to order a delinquent officer to repay or restore money or property.

Partners Under the Partnership Act 1961

Partners owe similar duties to one another and to the partnership. The Partnership Act 1961 requires partners to render true accounts and full information regarding matters affecting the partnership. A partner who secretly profits at the expense of the partnership must account for those profits.

Employees in Positions of Trust

Senior employees who handle company finances may also owe fiduciary duties depending on their role and responsibilities. Where an employee has control over company assets and abuses that position, the company may have a claim for breach of fiduciary duty in addition to breach of contract.

Civil Causes of Action

Several legal claims may be available when pursuing misappropriated funds.

Breach of Fiduciary Duty

This is often the primary claim. The company must establish that the defendant owed fiduciary duties, that those duties were breached, and that the company suffered loss as a result. Remedies include an order that the wrongdoer restore the loss to the company and disgorgement of any profits made by the wrongdoer.

Breach of Contract

Directors and employees typically have service agreements or employment contracts. Misappropriation of funds will almost certainly breach express or implied terms of those agreements. This provides an additional basis for claiming damages.

Knowing Receipt

Where misappropriated funds have been transferred to third parties, the company may have a claim against those recipients. A claim for knowing receipt requires showing that the recipient received trust property, that the receipt was for their own benefit, and that the recipient had knowledge that the funds were transferred in breach of trust.

A person who did not receive the funds but dishonestly assisted in the breach of trust may also be liable for dishonest assistance. These claims are particularly important when the wrongdoing director or partner has moved funds to family members, related companies or associates.

Conspiracy

If two or more persons acted together to misappropriate funds, a claim in conspiracy may lie. This can be useful for bringing in additional defendants who assisted in the wrongdoing.

Tracing and Following Assets

Money that has been misappropriated often does not sit in a bank account waiting to be recovered. It may have been used to purchase property, invested in other ventures, or moved through multiple accounts.

The Tracing Process

Tracing is a legal process that allows the company to follow its funds through various transformations. If company money was used to purchase a property, the company may be able to assert a proprietary claim over that property or a proportionate share of it.

Equitable tracing permits the company to follow funds even when they have been mixed with other money, subject to certain rules. This can give the company a proportionate share of, or an equitable lien over, assets purchased with the mixed funds.

Proprietary Claims

A key advantage of establishing a proprietary claim through tracing is that it may give the company priority over other creditors if the wrongdoer becomes insolvent. Rather than being an unsecured creditor claiming for damages, the company may be able to recover specific assets.

Account of Profits

Where a fiduciary has profited from their breach of duty, the company may elect to claim an account of profits instead of recovery of its loss. This remedy requires the wrongdoer to hand over all profits made from their wrongdoing.

An account of profits can be more advantageous than damages where the wrongdoer made profits exceeding the company's actual loss. For example, if a director diverted a business opportunity and made substantial gains, the company may claim those gains even if the company itself would not have pursued the opportunity.

Court Orders to Preserve Assets

Timing matters. A wrongdoer who knows they are about to be sued may attempt to dissipate assets, move funds overseas, or transfer property to put it beyond reach.

Freezing Orders

A freezing order, sometimes called a Mareva injunction, is a court order that prevents the defendant from disposing of or dealing with their assets up to a stated value. The court may grant such an order before the main case is heard, or, where the matter cannot wait, even before proceedings are formally commenced.

To obtain a freezing order, the applicant must typically demonstrate a good arguable case on the merits, a real risk that the defendant will dissipate assets to frustrate any judgment, and that the balance of convenience favours granting the order. The applicant must also make full and frank disclosure of all material facts and will usually be required to give an undertaking in damages.

Search Orders

In some cases, there may be a risk that the defendant will destroy documents or evidence. A search order permits the applicant to enter premises and search for specified documents or items. These orders are granted sparingly and only where there is clear evidence of a risk of destruction.

Disclosure Orders

The court may order a defendant to disclose information about their assets. This assists in both preserving assets and understanding where misappropriated funds have gone.

Limitation Periods

In Peninsular Malaysia, claims must generally be brought within the time limits set by the Limitation Act 1953 (Sabah and Sarawak have their own limitation ordinances). Under section 6 of that Act, claims in contract and in tort must generally be brought within six years from when the cause of action accrued.

However, limitation in cases involving breach of fiduciary duty can be more complex. Under section 22, no limitation period applies to a claim in respect of a fraud or fraudulent breach of trust to which the trustee was a party, or to recover from the trustee trust property, or its proceeds, still held by the trustee or converted to the trustee's own use. Under section 29, where a claim is based on fraud or the fraud has been concealed, time does not begin to run until the claimant discovers the fraud or could with reasonable diligence have discovered it.

Acting promptly is advisable both for limitation purposes and to improve the chances of recovering assets before they are dissipated.

Practical Steps

If you suspect misappropriation of company funds, consider taking the following steps:

  • Secure and preserve all relevant documents, including financial records, bank statements, contracts and correspondence
  • Conduct an internal investigation to understand the scope of the wrongdoing
  • Consider whether forensic accountants should be engaged to trace funds
  • Assess whether interim court orders are needed to preserve assets
  • Determine the appropriate parties to bring the claim and the causes of action available

Derivative Actions

In some situations, the company itself may be unwilling or unable to pursue a claim, particularly if the wrongdoers remain in control. The Companies Act 2016 provides for derivative actions, allowing a complainant, such as a shareholder or a director, to bring proceedings on behalf of the company with leave of the court.

Section 347 provides for derivative proceedings and section 348 governs the application for leave, which generally requires thirty days' written notice to the directors first. In deciding whether to grant leave, the court will consider whether the complainant is acting in good faith and whether it appears prima facie to be in the best interest of the company that leave be granted.

Moving Forward

Recovering misappropriated funds requires careful analysis of the facts, identification of the appropriate legal claims, and often prompt action to preserve assets. A director who is sued may ask the court for relief under section 581 of the Act on the basis that he acted honestly and reasonably, although relief is discretionary and unlikely where funds were taken dishonestly. Each situation is different, and the available remedies will depend on the specific circumstances, the identity of the wrongdoers, and where the funds have gone.