The proceeds of an illegal contract (Part 3 of 3)

The proceeds of an illegal contract (Part 3 of 3)

In Part 1, I looked at when illegality would cause a contract to be struck-down.

Part 2 considered what would happen if illegality was involved, but it wasn’t the main crux of the contract.

It today’s segment(ed worm), a case study will look at what happens to the proceeds of an illegal contract.

Lau Kok Loon v Low Yee Meng

The facts of Lau Kok Loon v Low Yee Meng (WA-22NCC-530-10/2020) are interesting.

Lau Kok Loon (LKL) was the owner of shares in a company called Semenyih Jaya Sdn Bhd (which is a saga in and of itself). He owned 1 share, with the remaining 1 share held by his brother (Low Kok Tuan, LKT).

Semenyih Jaya owned a large plot of land. That was its only function.

Shares are transferred as a sham to defraud creditors

LKL and LKT were sued for defaulting on a loan facility. To put their shares in Semenyih Jaya out of the reach of their creditors, LKL transferred his shares to Low Yee Meng, his nephew (LYM). LKT transferred his shares to his son, Lau Tein Khang.

Both LKL and LKT were then adjudged bankrupt.

LKL managed to settle his debts. The bankruptcy order entered against him was subsequently annulled.

LYM was then asked to return the shares in Semenyih Jaya. He refused and LKL sued him for the same. In essence, LKL claimed that the shares in Semenyih Jaya were being held by LYM on trust for him (LKL).

LYM’s application to strike

LYM applied to strike the suit. The main plank of LYM’s argument was that LKL’s claim was premised upon a fraudulent enterprise (i.e., the shares were transferred to defraud LKL's creditors). Premised thereto, the agreement was unlawful for seeking to circumvent the Bankruptcy Act and the Penal Code.

Decision of the High Court

The High Court ultimately held that the suit would be struck-out. An analysis of the decision gleans valuable information.

LKL sought to rely on the doctrine of locus poenitentiae (withdrawal from an illegal enterprise absolving one of fault). Reference was made to the decision of Tribe v Tribe [1996] Ch 107. However, the High Court noted that unlike the facts of Tribe, the Court here was not concerned with an individual who had not gone through with his illegal contract. LKL had, in fact, carried-out the illegal contract and brought the same to fruition (by transferring his shares to LYM).

The High Court also noted that in negotiations between LKL and his creditors (whilst still a bankrupt), the bankruptcy sum of ~RM14million was reduced to RM6,000,000.00.

LKL had never disclosed his shareholding in Semenyih Jaya and that underscored the deception. The HC applied the ratio in Munday v Hibum [2014] EWHC 4496 which underscored that criminal liability committed by a bankrupt would not be affected by any subsequent annulment of the said order.

The unlawful proceeds

The HC also went on to consider the fact that LYM would be unjustly enriched, what with him being a party to the fraud. The learned Judicial Commissioner considered this but ultimately held that “To permit the claim will only encourage others to partake in similar arrangements and this will adversely affect the successful enforcement of judgments granted by the Courts. In the long term, the effectiveness and confidence in the bankruptcy law and the judicial process will be impacted. It will be inconsistent to the integrity of the bankruptcy regime if the Plaintiff’s claim is allowed.”

The learned Judicial Commissioner went on further to state:

[81] It is certainly true that the denial of the Plaintiff’s claim will indeed bestow upon the Defendant a windfall. However, however unattractive or unpalatable this may be, the opposite result of allowing the Plaintiff’s claim will bring greater harm. If the Plaintiff’s claim is allowed, it will mean that the Court will be seen as aiding the Plaintiff to achieve the very purpose for which the provisions stipulated in section 109 (1) of the Bankruptcy Act (now Insolvency Act) and in section 422 of the Penal Code aim to prohibit. This can only lead to the law being brought to disrepute and respect for the law diminished in our society. Whilst it is true that the punishment for the offence is a matter left for the criminal court, it will be inconsistent for this Court to permit the Plaintiff to recover the fruit of his illegal act in this action when the same action is deemed appropriate to be punished in the criminal court. In fact, the denial of the Plaintiff’s claim in this case is no difference from the Court’s approach when dealing with claims by lenders engaged in illegal moneylending transactions.

In what must be commended as a “wood for the trees” approach, the HC noted that to allow the Plaintiff’s claim to proceed, in the face of such stark admission, would be to undermine the rule of law as a whole.

As repugnant as allowing LYM to be unjustly enriched is, to allow LKL to proceed to trial and seek to recover would be far worse. LKL’s claim would encourage such transfers and underhanded approaches to flourish.

Conclusion

Premised upon the above, the HC struck-out the suit. The Judgment must be read in toto. In addition to the above, there is an assiduous appreciation of the law and facts that must be experienced first-hand.

Fraudsters and shysters beware; the Courts are more willing than ever to look behind agreements and to glean the true intention of the parties.

GAVIN JAYAPAL

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