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published on 10 March 2022 | reading time approx. 3 minutes
The term Corporate Governance refers to the mechanisms and processes which determine how a company is controlled and managed. In general, there are multiple sources of corporate governance rules, depending on the particular legal entity. Since most subsidiaries of European holding companies are operating in Malaysia in the legal form of a Private Limited Company or Sendirian Berhad (hereinafter referred to as "company"), this article focusses on the applicable sources of corporate governance of such legal entities.
The main body of corporate governance rules for a company in Malaysia is the Companies Act 2016 (CA 2016). In most jurisdictions, next to the statutory rules, a company would also pass its constitution, also referred to as memorandum and articles of association (MAA). Under the old Companies Act 1965, a company had to pass an MAA in the course of its incorporation to bind the members and the company. The new CA 2016 does not require a company to pass a constitution or MAA. Section 32 of the CA 2016 states that a company may adopt a constitution and that if it does, such constitution shall have no effect to the extent it contravenes or is inconsistent with the CA 2016.
Thus, members (or new investors) of a new company in Malaysia might rightfully ask why they should adopt a constitution if the main rules are provided in the CA 2016. Why spending extra effort and to a minor extent extra money on a legal document which, based on the applicable law, is not required?
The benefits from having a constitution are becoming more obvious if we look at the aspects such legal document can govern in accordance with Section 35 of the CA 2016: The objects of the company; the capacity, rights, powers or privileges of the company as well as restrictions of the same; matters which the CA 2016 suggests to be governed in a constitution and other matters which the company may want to include in such document.
From a member's and shareholder's perspective, a clear definition of the objects of the company might create some form of protection against a potential misuse of the company as legal entity. In the past, transactions outside of the defined scope might be void due to the ultra vires doctrine.
The 2016 reform of the Companies Act has abolished this doctrine even though Section 35 of the CA 2016 allows companies to define their objects. Third parties might argue that a transaction is valid considering that subject to Section 21 of the CA 2016, companies have full capacity and that Section 39 of the CA 2016 clearly states that no person shall be deemed to have knowledge about limitations addressed in a constitution. These concepts will also prevent companies from relying on reserved matters highlighted in their constitution which would for example prevent directors from entering into certain transactions given their nature or their value etc. A third party's claim against the company will, under normal circumstances, not be limited by the constitution and any provision about the objects of the company or reserved matters. Thus, unlike in the past, the protecting effects of a company's constitution are not affecting the external relationships (i.e. between the company and a third party), but there is a protecting effect with regard to the company's internal affairs. Stipulating limitations in the constitution (such as objects or reserved matters) might allow the company to hold the acting director liable who violated the limitations addressed in the constitution. In addition to such internal restrictions, it would be advisable that the company also implements such limitations in the director agreements, internal policies, and outlines such reserved matters in a shareholders and directors resolution.
The added value of a constitution becomes more obvious in light of the specific provisions within the CA 2016 which allow for certain aspects to be governed in a constitution:
A constitution of a company can create a framework within which a company can issue different share classes, stipulate the rights applicable to preference shares and waive the otherwise mandatory pre-emptive rights of existing shareholders to new shares. Such flexibility can be highly beneficial in joint venture situations, in situations where new investors join as members as well as in M&A situations. In joint venture and equity investment scenarios, preference shares or particular rules on voting rights and dividend allocations can help to establish stable conditions between the members and the shareholders. Another potential issue can be the statutory pre-emptive right, where new shares must be offered to existing shareholders before they can be issued to new shareholders. In M&A scenarios, this could potentially create an obstacle if one of the existing shareholders objects to a new shareholder. Hence, a constitution should always be implemented in joint venture scenarios and should be tailored to handle the case of new joining external equity investors or M&A transactions.
The CA 2016 provides that a constitution can, among others, address the appointment, removal of directors and proceedings of the board of directors. Specific rules on the appointment and removal of directors to and from the board of directors can provide more flexibility to a company. For a German holding company which might be unfamiliar with the CA 2016, having a constitution which clearly governs the appointment and removal would give guidance and an improved understanding and decision-making in such matter. The benefits of a constitution are even more obvious when it comes to the proceedings of the board of directors. Such proceedings are outlined in the Third Schedule of the CA 2016. Among others, the Third Schedule stipulates that a resolution in writing requires the signature of all directors and not just the majority. Thus, in situations where one director is unable or unwilling to sign a written resolution, this can create a temporary deadlock for the company. A constitution can outline the proceedings and can (to the extent possible under the CA 2016) be aligned with proceedings on the companies group level.
Subject to a constitution, the CA 2016 allows that meetings of members can take place at more than one venue by using modern communication technology. Thus, in particular in situations where corporate representatives of members might not be able to travel or to join a physical meeting in Malaysia, the constitution could provide the details for meetings at different venues. In particular for foreign investors and in times where the pandemic restricts international travel, it is crucial that such meeting options are properly stipulated and governed by a constitution to avoid potential disputes on the particular proceedings.
In conclusion, having a constitution should be part of any sounds corporate governance of a subsidiary in Malaysia. In our corporate practice we came across numerous situations where having a constitution would be beneficial for the company, its directors and members to resolve particular issues. The CA 2016, with its complexity and abstractness, does not provide the guidance and the framework most European clients require for their corporate governance in Malaysia.
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