Understanding Section 228 of the Companies Act 2016: Shareholders’ Approval for Substantial Property Transactions with Directors, Substantial Shareholders or Connected Persons

In general, the directors of a company have the power and authority to make decisions pertaining to the business of the company. However, it is essential to note that certain transactions require approval from the company’s shareholders, as stipulated by the Companies Act 2016 (“Act”). An instance of this is when the company engages in substantial property transactions with its directors, substantial shareholders, or persons connected with them. This requirement is defined in Section 228 of the Act.

Rationale for Section 228

Section 228 is designed to prevent potential abuses, such as self-dealing and asset-stripping, by directors and controlling shareholders. This often occurs through transactions involving acquisition of assets for the company or sale of the company’s assets at non-market rates or on less favourable terms than the company would have received from a bona fide third party. Such actions can be detrimental to the interests of shareholders, given that they are unfairly structured to shift wealth from the company to the interested individuals involved.

To address these risks, Section 228 introduces specific procedures that must be observed and complied with by a company when a transaction falls within its scope. Essentially, this section requires shareholders’ approval to be obtained for transactions involving related parties as defined by its provisions. Transactions entered into by a company in contravention of Section 228 shall be void.

Identifying Transactions Falling under Section 228

To fall under the umbrella of Section 228, there are 3 elements that must be present:

Element 1: Type of arrangements or transactions

The type of arrangements or transactions falling under Section 228 contains in two limbs – Section 228(1)(a) and (b). Such arrangements or transactions can take any of the following forms between the company and a related party:

• acquisition or disposal of shares; or
• acquisition or disposal of non-cash assets.

“Non-cash asset” means any property or interest in property other than cash.

Furthermore, it is clear from Section 228(1)(a) and (b) that the acquisition or disposal of shares or non-cash assets shall be made with the company (Kam Thai Eng Linda & Anor v Tan Sri Dato’ Kam Woon Wah & Ors [2020] 1 LNS 2124).

Element 2: Categories of Related Parties                                 

Section 228 applies where transactions made by the company are with any of the following related parties:

(a) a director (as defined in Section 210 of the Act) of the company or its holding company; or

(b) a substantial shareholder (as defined in Section 136 of the Act); or

(c) a person connected with the director or substantial shareholder.

A “person connected with a director” is defined in Section 197 and includes:

• family members of the directors;
• a body corporate associated with the director;
• a trustee of a trust under which the director or a family member of the director is a beneficiary; or
• a partner of that director or partner of persons connected with that director.

This same definition also applies to persons connected with a substantial shareholder.

Element 3: Requisite Value

Section 228 only applies where the transactions meet the requisite value threshold stated under this section.

For public listed companies and their subsidiaries, requisite value shall mean the value as defined in the listing requirements of the stock exchange where shareholders’ approval at a general meeting is required.

On the other hand, for private or unlisted public companies, it depends on the value of non-cash assets involved in the transaction. The table below summarises when the prior approval of shareholders is required to be obtained to comply with Section 228:

Threshold Value	Shareholders’ Prior Approval
Less than RM50,000	No
More than RM50,000 and less than 10% of the company’s net assets	No
More than RM50,000 and more than 10% of the company’s net assets	Yes
More than RM250,000	Yes

The value of the company’s net assets is determined based on the accounts prepared in accordance with Section 245 of the Act for the last financial year preceding the transaction. In cases where no accounts have been prepared prior to the transaction, the value is determined based on the company’s called-up share capital.

Exempted Transactions

There are exceptions to Section 228. Section 229 identifies various transactions that do not qualify as related party transactions. These exceptions include:

• a transaction involving group companies, i.e. between a company and any of its wholly-owned subsidiaries, between a company and its holding company which holds all the issued shares of the company, and between a company which is a wholly-owned subsidiary of a holding company and another wholly-owned subsidiary company of that same holding company;
• a transaction entered into by a company which is being wound up by a creditor’s voluntary winding up or by court (excluding members’ voluntary winding-up);
• a transaction that occurs in the ordinary course of business and on terms not favourable than those available to its employees or the public;
• a transaction not involving transfer of cash or property and which shall have no effect unless approved by the general meeting or the relevant authority;
• a transaction under a scheme of arrangement approved by the court under Section 366; or
• a transaction which is made by a company made in connection with a take-over offer in accordance with the relevant law applicable to a take-over.

For transactions falling within these exceptions, the approval of shareholders is not a prerequisite.

When all 3 elements mentioned above are satisfied, the approval of the company’s shareholders in a general meeting must be obtained before the said arrangement or transaction can be carried into effect and valid in law, unless the transaction comes under one of the exceptions provided under Section 229 (Omega Securities Sdn Bhd v. Yeo Lee Hoe [2003] 1 CLJ 276).

How is prior approval obtained?

If a transaction or arrangement falls within the ambit of Section 228, it must be approved through a resolution passed by the shareholders at a general meeting. The resolution required is an ordinary resolution, and Section 228(1)(A) or (B) specifies that the approval must occur at a general meeting. This means that a member’s resolution in writing is not an option for the purpose of compliance with Section 228.

As for the reading of Section 228(1)(A) and (B), the High Court in Kam Thai Eng Linda held that Section 228 only requires shareholders’ prior approval before an arrangement or transaction is ‘carried into effect’, rather than before the transaction is “entered into,” which can be made subject to the shareholders’ approval. The implication is that shareholders are required to provide their approval before the transaction is executed or implemented. However, it is possible for initial negotiations or discussions about the transaction to occur or for the parties to enter into the arrangement before seeking shareholders’ approval, as long as approval is obtained for the company to formally proceed with the transaction and become legally bound by the terms of the arrangement.

If the transaction or arrangement benefits a director or substantial shareholder of the company’s holding company, or a person connected with such a director or substantial shareholder, it also necessitates prior approval through a resolution of the holding company (Section 228(2)(b)).

In cases where the company involved in the acquisition or disposal is an unlisted subsidiary of a publicly listed company, approval for the same transaction or arrangement is required from the shareholders of the unlisted subsidiary at a general meeting. Additionally, the directors of the holding company must secure approval for the same transaction or arrangement through an ordinary resolution passed by the shareholders of the holding company at a general meeting (Section 228(3)).

Restriction on Voting by Disinterested Shareholders

Section 228(4) prohibits related parties from voting on the resolutions whether or not to approve the substantial property transactions. However, this provision only applies to public companies, their holding companies, or subsidiaries, and does not apply to private companies. In other words, interested shareholders in private companies are still allowed to vote on such resolutions in respect of transactions which are governed by Section 228.

Consequences of Non-Compliance

Any transaction or arrangement carried into effect by the company in contravention of Section 228 would be deemed void (Section 228(2)). It is not possible for the company to ratify the transaction. In the Kam Thai Eng Linda case, the High Court held that an arrangement or transaction is only deemed void if “carried out” without prior approval, but “entering into an arrangement or transaction” without prior approval does not make it void so long as it is made subject to the approval.

Section 228(6) provides that any member or director of the company can seek court intervention to restrain the company from entering or carrying into effect an arrangement or transaction that contravenes Section 228(1). Moreover, by virtue of Section 66 of the Contracts Act 1950, any party benefiting from a contract that has been declared void must restore the benefits received in relation to the void contract.

In addition, directors, substantial shareholders, or individuals connected to such directors or substantial shareholders can face criminal charges if they knowingly derive benefits from the company’s involvement in an arrangement or transaction that violates Section 228. Such individuals may be liable to a maximum imprisonment term of 5 years, a fine not exceeding RM3 million, or both (s.228(7)).

Section 228(5) mandates that the director, substantial shareholder, any person connected with the director or substantial shareholder, and any director who knowingly sanctioned the arrangement or transaction in contravention of Section 228 must account for any direct or indirect gains derived from the arrangement or transaction. They are also liable to indemnify the company for any losses or damages stemming from said arrangement or transaction.

Conclusion

Section 228 of the Act  places an obligation on directors to obtain shareholders’ approval for substantial property transactions that involve directors, substantial shareholders, or persons connected with them. This ensures that major decisions involving the company’s substantial assets and shares are considered more objectively by the directors and made in the best interest of the company. Consequently, it serves to strike a balance between the wide authority of company directors and the protection of shareholders from potential harm that can result from decisions made by directors or controlling shareholders that are motivated only by their own self-interest.

When performing due diligence on private companies, it is essential to be aware that transactions lacking the necessary shareholder approvals may be rendered void. This risk is particularly high when the company involves other minority shareholders who may not have been informed of these transactions.