Project Owners’ Practice of Using Separate Companies to Avoid Paying Contractors Censured by the Court
By Datin Chu Ai Li, Partner of Azman Davidson & Co.
Contractors who submit tenders for projects to project owners are sometimes asked to enter into construction contracts with companies who are not the project owners upon the award of the tender. The companies that the successful tenderers are asked to sign the construction contracts with may be subsidiaries or related companies of the project owners. However, it is not unusual for contractors to be asked to sign their construction contracts with companies who have more tenuous ties to the project owners, such as through common directors or directors who have family relationships. A main contractor who contracts with a company who is not the project owner ends up in the contractual hierarchy as “sub-contractor” to the company it has contracted with. When payment disputes arise, the project owner often denies it has any legal liability to pay the “sub-contractor”, relying on the absence of any contract between the project owner and the “sub-contractor”. The “sub-contractor” would then be compelled to pursue its claims for payment from the company it has contracted with whose financial standing may be weak.
This practice of project owners using separate companies to avoid paying contractors has received scrutiny by our High Court. In the case of LTK Façade Specialist Sdn Bhd v Sri Mutiara Development Sdn Bhd and other cases [2021] MLJU 1185, LTK Façade Specialist Sdn Bhd (“LTK”) entered into construction contracts with Axisjaya Sdn Bhd (“Axisjaya”), the main contractor for two projects in Cyberjaya. LTK commenced adjudication proceedings against Axisjaya under the Construction Industry Payment and Adjudication Act 2012 (“CIPAA”) and obtained adjudication decisions in its favour. Axisjaya failed to pay LTK the adjudicated amounts in the adjudication decisions.
LTK issued notices under Section 30(1)[1] of CIPAA to the employers of the projects, namely Seri Mutiara Development Sdn Bhd (“Seri Mutiara”) and Brecon Synergy Sdn Bhd. (“Brecon”). Section 30 of CIPAA imposes a statutory obligation on a “principal”[2] to pay directly to a party who has obtained an adjudication decision in its favour in the event the party against whom the adjudication decision was made fails to pay the adjudicated amount once the requirements in that section have been met. Seri Mutiara and Brecon did not make the direct payments demanded by LTK. LTK then commenced court proceedings against Seri Mutiara and Brecon to seek orders from the Court pursuant to Section 30 of CIPAA for Seri Mutiara and Brecon to pay the adjudicated amounts to LTK. The Court granted the orders sought by LTK against Seri Mutiara and Brecon.
In its grounds of judgment, the High Court noted that LTK had asked the Court to lift the corporate veil of Axisjaya, Seri Mutiara and Brecon as well as two other companies (referred to by the Court as “SMD” and “DBH”) to enable the Court to ascertain the true factual position. The Court was of the view that it could exercise its discretion to lift the corporate veil if there was proof of commission of actual fraud or constructive fraud. The Court noted that the Supreme Court had in a previous case explained “constructive fraud” as “unmeritorious or unconscionable conduct which is known as constructive or equitable fraud”.
The Court found that Axisjaya, Seri Mutiara, Brecon, SMD and DBH had committed equitable fraud against LTK in order not to pay LTK for the construction works done by LTK. The Court based its finding on, among others, the directorships and shareholding of the companies as well as the relationships between the companies, which includes following:
(1) Axisjaya, Seri Mutiara and Brecon have one common majority shareholder, i.e. DBH.
(2) DBH has only two directors, namely Datuk Hoe and Datin Yap.
(3) Datuk Hoe and Datin Yap own the majority of shares in DBH.
(4) Datuk Hoe is Axisjaya’s Managing Director.
(5) Datuk Hoe is a director of Seri Mutiara and Brecon.
(6) The companies have common registered and business addresses and common company secretaries.
The Court was of the view that if the companies were honest, there was no reason for Seri Mutiara and Brecon not to pay directly to LTK whatever was due or payable to Axisjaya because such direct payment made could be recovered or set off by Seri Mutiara and Brecon against Axisjaya under Section 30(4)[3] of CIPAA.
The Court held that “it is clear that Axisjaya, Seri Mutiara, Brecon, SMD and DBH constitute a single group entity controlled by Datuk Hoe which has abused corporate personality so as to commit Equitable Fraud against the Plaintiff by not paying for the Plaintiff’s Works”.
The High Court’s readiness to apply the legal principle relating to equitable fraud to the facts of LTK Façade Specialist Sdn Bhd signals the Court’s strong censure against the practice adopted by some project owners to use separate companies to avoid payment obligations to contractors. The Court’s judgment offers welcome relief to contractors who find themselves trapped in contractual hierarchies that have been deliberately constructed to shield project owners from claims by contractors.
[1] Section 30(1) of CIPAA states “(1) If a party against whom an adjudication decision was made fails to make payment of the adjudicated amount, the party who obtained the adjudication decision in his favour may make a written request for payment of the adjudicated amount direct from the principal of the party against whom the adjudication decision is made.
[2] Section 4 of CIPAA defines “principal” as “a party who has contracted with and is liable to make payment to another party where that party has in turn contracted with and is liable to make payment to a further person in the chain of construction contracts”.
[3] Section 30(4) of CIPAA states “(4) The principal may recover the amount paid under subsection (3) as a debt or set off the same from any money due or payable by the principal to the party against whom the adjudication decision was made.”