Category Archives: company law

Strict Requirements for a Stay of a Winding Up Order

A recent High Court decision sets out the strict requirements to be met when applying for a stay of a winding up. In this case, despite there being no objections raised by the liquidator or the other parties, the Court would still scrutinise the evidence before deciding whether to grant the stay or not.

In the Grounds of Judgment dated 2 June 2015 for the case of Percetakan Warni Sdn Bhd, the Court dismissed an application by a shareholder under section 243 of the Companies Act 1965 for a permanent stay of a winding up. This is despite the Petitioner and the Liquidator (being the Official Receiver)) not objecting to the application and where the Respondent (through its shareholder) would be paying off the debts of the Respondent company.

Of interest was that there were uncommon features which the Court insisted should have been met for such a section 243 stay application. The Court took the step of carefully assessing whether all of these requirements were met:

  1. In addition to the established section 243 principles from the leading Federal Court case of Vijayalakshmi and other cases, the Court held that there must be evidence to demonstrate the company will be commercially solvent after the section 243 stay. It is not sufficient to show assets outweigh the liabilities. Commercial solvency can be shown through injection of funds from a “white knight”, evidence that the company will be gaining a lucrative contract, or an expert opinion from a restructuring expert or accountant on the likelihood of the company’s commercial solvency. There was no evidence of any of these.
  2. The company had earlier been granted an ad interim stay of the winding up, since the OR had no objections to that. However, there was no evidence that the Board had even carried on the business or operated the company throughout that ad interim stay.
  3. The Court also scrutinised the Statement of Affairs filed by the directors and compared it with the Liquidator’s report filed by the OR. There were inconsistencies in the directors’ Statement of Affairs and not sufficient disclosure. While no objections were raised by the other parties, the Court held that this showed that the applicant’s evidence was not credible.
  4. The application also did not exhibit the latest audited accounts of the company. The last audited accounts were in 2010 and no updated financial information was provided by the applicant.

As these requirements were not met, the stay application was dismissed. So be aware of the possibly stringent requirements when seeking for a section 243 stay of a winding up Order. These additional requirements would also provide good grounds to object to a section 243 stay application.

 

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Some Procedural Points for the Statutory Derivative Action

In the recent unreported High Court decision of Abdul Rahim bin Suleiman and another v Faridah binti Md Lazim & 7 Others dated 3 April 2015, Justice Wong Kian Kheong considered an application for leave under section 181A of the Companies Act 1965 to bring a statutory derivative action. I have written a commentary on the statutory derivative action provisions over here before.

The decision is useful in setting out some of the procedural guidelines that must be met in bringing such an action. Some of the significant points are:

  1. A complainant only apply under 181A to bring a new action, to act for the company when the company intervenes in an action, and to defend a pending action against the company.
  2. A complainant cannot seek to apply to act for the company where the suit is already concluded or where the suit is pending (as that suit would be under the control of the present management of the company).
  3. Notice under section 181B must be given to each of the directors. It is not sufficient just to address it to the Board of Directors.
  4.  This decision gave some guidance on what should be in the contents of the section 181B notice and the decision referred to several Canadian cases.
  5.  The application for leave is filed by way of Originating Summons (OS). In the OS, the applicant need only cite the Company itself as the sole Defendant. There is no need to cite the other alleged wrongdoers as parties to the OS. Nonetheless, citing the other alleged wrongdoers was not fatal in this case.

A Singularis Approach to Cross-Border Insolvencies

[Originally published in Skrine Legal Insights Issue 1/2015]

The Privy Council in Singularis Holdings Ltd v Pricewaterhouse Coopers [2014] UKPC 36 (“Singularis”) has clarified the extent to which courts can render common law assistance for cross-border insolvencies.

In summary, there is a limited common law power to assist a liquidator appointed by a foreign court by ordering the production of information. Such information must be necessary for the administration of the foreign winding up and this power is only exercisable if the foreign court could have made such an equivalent order.

BACKGROUND: MODIFIED UNIVERSALISM

In a cross-border insolvency, courts may be faced with difficult questions. Should a domestic court apply its domestic laws as if the case had no international aspects or should a domestic court defer to the foreign laws of the main jurisdiction of incorporation of the wound up company?

In other words, should a ‘territorialist’ approach be applied where the domestic court only applies its domestic laws? Alternatively, should a ‘universalist’ approach prevail in allowing a single set of the foreign laws of the main winding up jurisdiction to govern all of the global winding up proceedings?

A middle ground between these two concepts is that of ‘modified universalism.’ The courts of all countries should cooperate, as far as possible, with the laws of the main jurisdiction, except where the domestic jurisdiction has a compelling reason to apply its domestic laws.

It is against this backdrop of the increasing recognition of modified universalism that the facts of Singularis are set out below.

BRIEF FACTS OF SINGULARIS

Singularis Holdings Limited (“Singularis”) had been wound up in its place of incorporation, the Cayman Islands. The liquidators of Singularis (“Liquidators”) obtained court orders in the Cayman Islands against the company’s former auditors, PricewaterhouseCoopers (“PwC”) in Bermuda, to deliver up to the Liquidators certain documents. This was in order to facilitate the Liquidators’ investigations to trace certain assets. However, the law of the Cayman Islands only provided for documents “belonging to” a company to be delivered up to a liquidator. There was no dispute that this would not include material belonging to PwC itself, principally their audit working papers.

Subsequently, in Bermuda, while there was no ancillary liquidation of Singularis, the Liquidators obtained an order from the Bermudan court recognising their status as liquidators. Where a company is wound up in Bermuda, Bermudan law had a wider provision where documents “relating to” a company are to be delivered up to the liquidator of the wound up company. Relying on this Bermudan provision, the Liquidators applied for a Bermudan court order for PwC to deliver up its audit working papers.

At first instance, the Bermudan court allowed the Liquidators’ application and relied on the principle of modified universalism. The Bermudan court exercised a common law power to order PwC to produce the same documents which they could have been ordered to produce under the relevant Bermudan provision.

PwC appealed the decision and on appeal, the Bermudan Court of Appeal set aside the first instance decision. The Liquidators appealed to the Privy Council.

PRIVY COUNCIL DECISION

The Privy Council, by a three to two majority decision,  dismissed the appeal on grounds that the Liquidators would not have had the power to require PwC to produce the documentation under the laws of the Liquidators’ main winding up jurisdiction i.e. Cayman Islands law. While the Privy Council was deciding on Bermuda law, the common law of Bermuda is the same as that of England.

The Privy Council had to consider two issues:

(1)    Whether a common law power existed to assist foreign liquidators by ordering parties to provide information in circumstances where the equivalent statutory power did not apply to foreign liquidators; and

(2)    Whether, if such a power existed, it should be exercised where an equivalent order could not have been made by the court in the main winding up proceedings.

Firstly, the Privy Council upheld the general principle of modified universalism as set out in the Privy Council case of Cambridge Gas Transport Corp v Navigator Holdings plc Creditors’ Committee [2006] UKPC 26 (“Cambridge Gas”). At common law, the Court has power to recognise and grant assistance to foreign insolvency proceedings. However, the Privy Council overruled some of the other wider principles set out in Cambridge Gas and held that a domestic court does not have the common law power to assist the foreign court by doing whatever it could have done in a domestic insolvency.

In dealing with the issues in the appeal, the majority decision held that there is a common law power to assist a foreign insolvency court by ordering the production of information, whether oral or documentary, which is necessary for the administration of a foreign winding up.

However, this common law power is subject to the following five limitations:

(i)    It is only available to assist the officers of a foreign insolvency court. It would not be available, for example, to assist a voluntary winding up, which is essentially a private arrangement and is not conducted by or on behalf of an officer of the court.

(ii)    It is a power of assistance and exists to enable courts to surmount the problems posed for a world-wide winding up of the company’s affairs. It is therefore not available to enable foreign liquidators to do something which they could not do under the law by which they were appointed.

(iii)    It is available only when it is necessary for the performance of the office-holder’s functions.

(iv)    Such an order must be consistent with the substantive law and public policy of the assisting domestic court, in this case that of Bermuda. Following from this, it is not available to exercise such a common law power to obtain material for use in actual or anticipated litigation. Further, in some jurisdictions, it may be contrary to domestic public policy to make an order which there would be no power to make in a domestic insolvency.

(v)    The exercise of this power is conditional on the applicant being prepared to pay the third party’s reasonable costs of compliance.

Therefore, the Bermuda court had both the right and the duty to assist the Cayman court in so far as it properly could within the limits of its own inherent powers. This was to enable the officers of the Cayman court to do in Bermuda that which they could do in the Cayman Islands.

However, the Bermuda court could not exercise a common law power which was not exercisable by the Cayman court and could not apply the legislation applicable to its domestic winding up by analogy ‘as if’ the Cayman winding up was a domestic (i.e. Bermudan) winding up. It was not a proper use of the Bermuda court’s common law power of assistance for it to purport to use a power analogous to the Bermudan statutory provision to compel disclosure and production of information which belonged to PwC rather than the company.

LOCAL APPLICATION

In Malaysia, the Privy Council decision would not be binding but would be persuasive. Where a foreign company is wound up by the court of its main jurisdiction, and there is no ancillary winding up in Malaysia, the foreign liquidator would likely be able to obtain a Malaysian order recognising its status as a liquidator and possibly obtain an order for the production of information which is necessary for the administration of the foreign winding up.

Similarly, a local court-appointed liquidator of a Malaysian company with worldwide links may also apply for such orders for production of information in other common law jurisdictions.

It appears that this broad principle of allowing a production of information, both oral and documentary, would allow a foreign liquidator to also apply for orders allowing for private or public examination of persons in connection with the affairs of the company in winding up (assuming that there are such equivalent provisions in the foreign liquidator’s main jurisdiction).

Decades ago, the Singapore High Court in Re China Underwriters Life and General Insurance Co Ltd [1988] 1 MLJ 409 held that the court had no inherent jurisdiction or power to order the private or public examination of persons and dismissed the Hong Kong liquidator’s application. It was recognised in that case that such a power of examination was an extraordinary one which invoked images of the Inquisition and of the Court of Star Chamber. This decision was upheld by the Singapore Court of Appeal in Official Receiver of Hongkong v Kao Wei Tseng & Ors [1990] 2 MLJ 321. At that time, it was held that it was only a statutory power available in a domestic winding up.

As a result of Singularis, we may now have a broadening of the courts’ power in Malaysia to assist foreign court-appointed liquidators.

Time can be Extended for Affidavits in Winding Up

In winding up proceedings, the Companies (Winding-up) Rules 1972 provide for strict timelines for the filing of the affidavits. Rule 30 provides that the affidavit in opposition to the Petition shall be filed and served at least 7 days before the hearing of the Petition. In turn, the Petitioner’s affidavit in reply to the affidavit in opposition shall be filed and served within 3 days of the date of service of the affidavit in opposition. This makes the timeline very tight, especially for the Petitioner’s affidavit in reply.

Since the Court of Appeal decision in Crocuses & Daffodils (M) Sdn Bhd v Development & Commercial Bank Bhd [1997] 2 MLJ 756, there has been a line of authorities which has applied these timelines strictly. This is due to the use of the word “shall” in the Rule 30.

Court of Appeal decision in Kilo Asset

In the recent unreported grounds of judgment in Hiew Tai Hong v Kilo Asset Sdn Bhd, the Court of Appeal had to consider the issue as to whether there could be an extension of time to allow for the late filing of the various affidavits in a winding up Petition. In this case, the winding up petition involved a shareholder dispute where the petition relied largely on the just and equitable grounds. Extensive facts and the history between the shareholders were set out in the petition. This was not a case where the petition was based on an inability to pay debt and where a creditor was petitioning for winding up.

While the affidavits in opposition by the respondent were filed in time, the Petitioner filed his three affidavits in reply well past the 3-day timeline as set out in Rule 30. The Respondent then filed further affidavits in opposition.  Presumably because of an objection raised on the late filing of the affidavits in reply, the Petitioner filed an application for an extension of time. This application was based on Rule 193 which allows for enlargement or abridgment of time and Rule 194 which provides that no proceedings shall be invalidated by any formal defect or any irregularity unless the Court views that substantial injustice has been caused.

The High Court Judge dismissed the Petitioner’s extension of time application and therefore disregarded the Petitioner’s affidavits in reply. As the High Court Judge viewed that the Respondent’s affidavits in opposition was therefore left unanswered, the Petition was dismissed.

On appeal, the Court of Appeal allowed the extension of time and ordered that the Petition be remitted back to the High Court for a full hearing. Firstly, the Court of Appeal was guided by the wordings of Rules 193 and 194 which would allow for an extension of time. These Rules were not referred to in the judgment of Crocuses & Daffodils. This is consistent with the current approach of the Courts to have regard to the justice of the case and not only to the technical non-compliance.

Secondly, the Court of Appeal also made a distinction between the present just and equitable winding up Petition and a Petition based on an inability to pay a debt (the latter being the Petition in Crocuses & Daffodils). In a just and equitable winding up Petition, involving a dispute among the shareholders and allegations against the directors, it is common for the facts to be hotly disputed and  where there is the possibility of cross-examination of deponents as well. Therefore, it would not be possible for the Court to adopt such a rigid approach to non-compliance.

Commentary

This decision is welcomed in taking a step away from a mechanical rigid approach for such affidavit timelines. Instead, the Court weighs up the justice of the case in deciding whether to allow for an extension of time or not. This is even more important in such a just and equitable winding up scenario where the facts are commonly disputed and where it is very common to have an extensive exchange of affidavits.

In practice, for a just and equitable winding up petition, the solicitors commonly agree among themselves for an extension of time for the filing and exchange of affidavits. It can be very difficult for the Petitioner to comply with the 3-day rule to file in the affidavit in reply. Rule 30 is also silent in allowing for the further filing of affidavits since no timeline is provided. This decision however appears to only apply in the context of such a Petition based on the just and equitable ground. A party seeking such an extension of time must still file in an application under Rules 193 and 194.

However, this decision does not go so far as to outright overrule the Crocuse & Daffodils approach in maintaining strict timelines for the inability to pay debt scenario. It can also be quite common to have a lengthy exchange of affidavits if the debt is heavily in dispute. Nonetheless, to prevent the risk of such a technical objection, all parties had best still comply strictly with the timelines set out in Rule 30.

 

 

Speaking in Kuching on the Companies Bill

I have been invited by CLJLaw to speak on 16 January 2015 at the Pullman Hotel, Kuching.The registration form is over here.

Due to the good response in KL the last time for the Companies Bill seminar, this will now be held over in Kuching.

 

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A lot of us are expecting the new Companies Bill to be tabled during the Parliamentary sitting in March 2015. The Bill and the changes it brings have been long-awaited.

Insolvency and Arbitration: Will a winding up petition be stayed in favour of arbitration?

I am just setting out my thoughts and where I will be planning to write a more extensive article on this area. I have always been fascinated on the interaction of the statutory process of winding up and the contractual bargain of arbitration. Will one process always necessarily trump the other?

There are now several cases which try to deal with whether there can be a form of a stay of the Court winding up proceedings in favour of arbitration. The winding up itself can arise from either a creditor petitioning on the grounds of insolvency or a shareholder petitioning on the just and equitable grounds. In the former scenario, the petition may be grounded on a debt arising from a contract containing an arbitration clause. In the latter, the shareholder’s complaints may be arising from a shareholders’ agreement with the other shareholders. I now just record down some cases in the scenario of a petition being presented by a creditor on the grounds of insolvency.

There is a recent English Court of Appeal decision in Salford Estates (No. 2) Limited v Altomart Limited [2014] EWCA 1575 Civ  which held that the mandatory stay provisions in the English Arbitration Act would not apply to stay winding up proceedings. Instead, the Companies Court would exercise its usual discretion in whether to stay or dismiss a winding up petition, for example, if there was a bona fide dispute of the debt on substantial grounds.

This is a similar approach taken in Hong Kong, where its Arbitration Ordinance closely follows the Model Law (and therefore, may be more persuasive in Malaysia). The case of Jade Union Investment Limited [2004] HKCFI 21 also similarly held that the mere existence of an arbitration clause does not mean that the mandatory stay provisions under the Arbitration Ordinance would apply. The Court would still apply the test as to whether there was a bona fide dispute of debt when hearing the petition. Another case of Re Sinom (Hong Kong) Ltd [2009] HKCFI 2201 similarly followed Jade Union when deciding whether to grant an injunction to restrain the presentation of a petition.

It will be interesting to see how such a situation would play out in Malaysia. I am not aware of any such case involving a stay of a winding up petition or an injunction to restrain presentation based on the Arbitration Act 2005 (“AA”). I know of one or two cases under the old Arbitration Act 1952 where a stay of winding up proceedings was sometimes granted and sometimes not.

If there is an arbitration clause in a contract and a statutory demand is made for payment under the contract, would the other contracting party be able to apply under section 11 of the AA for an injunction to restrain the presentation of the petition? What would the test for such an injunction be? Would it still be the Tan Kok Tong Court of Appeal test of a bona fide dispute of debt on substantial grounds? Or would the mere existence of an arbitration clause be sufficient? Or would an application for an injunction have to be grounded outside of the AA and the Court would exercise its inherent jurisdiction to grant a Fortuna injunction to restrain the presentation?

If the Petition was filed, would a stay of those Court proceedings be allowed under section 10 of the AA? The test for a stay under section 10 of the AA will not require the Court to decide on whether there is a bona fide dispute (that original provision has been taken out) and it is almost mandatory for a stay unless the arbitration clause can be questioned (e.g. the clause is null and void or inoperative).

I will try to deal with these questions in my more extensive article and after I have done more research.

The Repetitive Restraining Orders

Background and History to the Restraining Order

Under the scheme of arrangement framework, the Court can grant a restraining order under section 176(10) of the Companies Act 1965 (“Act”) to restrain further proceedings in any action against the company undertaking a proposed scheme. This allows the financially distressed company to have a moratorium and have breathing space from creditor action, while the company attempts to restructure or compromise its debts. Ordinarily, it would be the company itself which would apply for a restraining order but section 176(10) of the Act allows any member or creditor of the company to also make such an application. I had earlier written a general overview on the law of schemes of arrangement.

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The restraining order would have to strike a balance between different interests. On the one hand, a moratorium may be beneficial to the overall pool of creditors in order to prevent the scramble by creditors to execute against the distressed company’s assets. The restraining order could therefore facilitate the orderly restructuring of the debts where there was a genuine and viable scheme proposal. On the other hand, a wide stay of legal proceedings could also be abused. A company could sit on a restraining order, without any viable scheme proposal, and frustrate the actions by the creditors.

The potential for the abuse of the restraining order may have led to the amendment to our Act in late 1998 to tighten up the use of restraining orders. Additional restrictions and creditor-protection provisions were built in through the introduction of sections 176(10A) – (10G) of the Act. Essentially, it limited the grant of each restraining order to prima facie not more than 90 days with certain mandatory requirements to be met. Further, once the restraining order was granted, there could not be the disposition of any property of the company outside the ordinary course of business.

A recent case highlighted a situation where there could be the repeated use of a restraining order. That might delay legal proceedings by creditors but it may also be a lifeline for an ailing company, if there was a viable scheme proposal.

The Repeated Use of a Restraining Order

In the unreported case of Dynawell Corporation (M) Sdn Bhd (in provisional liquidation) v Universal Trustee (M) Berhad (Seremban High Court Originating Summons NCVC-24M-63-06-2013) (see [2013] 1 LNS 1391), the High Court was made aware of multiple applications for a restraining order and made a finding that the application for a restraining order was mala fide. Dynawell can also be read together with the related High Court decision in RHB Bank Berhad v Gula Perak Berhad [2013] 1 LNS 1409. From a reading of both the cases, the brief facts appear to be as follows.

Gula Perak Berhad was listed on the stock exchange and in May 2010, it was classified as a PN17 company. It was eventually de-listed in May 2011. In turn, Dynawell is a wholly-owned subsidiary of Gula Perak Berhad and where its core asset is the Dynasty Hotel. Several secured lenders initiated legal proceedings against both Gula Perak and Dynawell, including foreclosure proceedings on the Dynasty Hotel. Winding up proceedings were also taken against Gula Perak and Dynawell and where both companies had Provisional Liquidators appointed over them.

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During the course of these legal proceedings, there appeared to be at least 6 different applications filed in different Courts seeking for a restraining order on the basis of a proposed scheme of arrangement. Applications were filed in Kuala Lumpur, Shah Alam, Seremban and Taiping. There were different applicants, some may have been creditors or members of Gula Perak/Dynawell or in the Dynawell case, it was Dynawell itself. It was noted in the Dynawell judgment that the proposed schemes of arrangement applications had similar grounds and traits and where the averments in the affidavit in support were largely the same. Justice Zabariah Yusof remarked that this indicated that it originated from the same source or author.

Procedurally, an application for such a restraining order would ordinarily be taken out ex parte. This is because  only the Applicant would need to apply and need not necessarily add in any other party, or to add in any of the other creditors with pending legal proceedings for instance. Once the initial restraining order is granted ex parte, and this should only be for a limited time not exceeding 90 days, it will then have a universal effect in restraining all legal proceedings by all the creditors listed in the proposed scheme. The onus then shifts to the opposing creditors to intervene and to attempt to set aside the restraining order or to oppose the extension of the restraining order.

Hence, the two judgments show that the opposing creditors had to go to each of the different Courts to apply to set aside the restraining orders obtained by different parties. The restraining orders and the related legal proceedings also delayed the foreclosure and the winding up proceedings.

The history of the litigation then led to the High Court in Taiping and in Seremban making orders that any further application for a restraining order be made inter partes and for such an application to be advertised in 3 newspapers.

Justice Zabariah Yusof made the following critical remarks:

“In view of the circumstances and the time line of the ex parte Originating Summons in Enclosure 2 filed, clearly shows the mala fide intent of Dynawell to conceal the application from UTB and at the same time concealing the material and relevant facts from the court.

…

Section 176(1) of the Companies Act does not state that an RO application may be made ex parte. It merely states that a party may apply. However, given the chequered history of Dynawell, the propose (sic) scheme of arrangements and the ROs applications which have been explained above, this is a case of abuse of process of the highest order. I would be failing in my duty if I do not invoke my inherent jurisdiction to curb further abuse by Dynawell.”

Costs of the setting aside of the restraining order were then made personally against the director of Dynawell.

Conclusion

A restraining order is usually a useful and often crucial mechanism to achieve a viable restructuring. However, this case shows how the repeated use of a restraining order could amount to an abuse of process. The present provisions in the Act, and the impending amendments to the Act, will not address this potential for abuse. An application for a restraining order can continue to be taken out ex parte, and where an applicant may still attempt to bypass the mandatory protection laid in the section 176(10A) requirements. Any creditor or member of the company could potentially also apply for a restraining order, thereby resulting in multiple and parallel restraining orders. The protection against any abuse of process therefore rests on the vigilance of the Courts when hearing such ex parte applications.

Auditors Beware: Auditors Owe a Duty of Care to Company’s Investors

[this article was originally published in Skrine’s Legal Insights Issue 3/2014]

The Court of Appeal in CIMB Investment Bank Bhd v Ernst & Young & Another Appeal [2014] 6 CLJ 438 (see the Grounds of Judgment from the Kehakiman website) held that in carrying out statutory audits under the Securities Industry Act 1983 (“SIA”), the auditors of a fund management company owed a duty of care to the company’s investors.

This appellate decision is significant as it confirms the tests to be applied to ascertain whether auditors owe a duty of care to the company’s investors. On the facts of this case, the auditors’ agreement to conduct an SIA audit for a fund manager created a special relationship between the auditors and the company’s investors which gave rise to a common law duty of care on the part of the auditors to undertake a proper audit in the course of carrying out their statutory duty.

BACKGROUND FACTS

SJ Asset Management Sdn Bhd

The appeal centred on SJ Asset Management Sdn Bhd (“SJAM”), a licensed fund management company under the SIA and the Capital Markets and Services Act 2007 (“CMSA”). The appellants in one appeal were clients, or in other words investors, of SJAM. In the second appeal, the appellant had caused its clients to invest in SJAM. SJAM held, administered and managed various investments of the appellants.

SJAM had engaged the respondent auditors to perform the necessary statutory audits under the Companies Act 1965 (“CA”) and under the SIA. Pursuant to their engagement, the auditors produced audit reports.

Following complaints against SJAM, the Securities Commission (“SC”) investigated SJAM, revoked its capital market services license and eventually wound up SJAM.

The appellants, in turn, appointed their own accountants to investigate the accounts of SJAM. Based on their accountants’ findings of fraud in the management of the funds of the clients, the appellants commenced the High Court action against the auditors based on negligence. The appellants’ contentions were that they had relied on the auditors’ audit reports to make, advise on or facilitate investments in SJAM.

Preliminary Issues for Determination by the High Court

In the High Court action (reported in CIMB Investment Bank Bhd v Ernst & Young and Another Case [2014] 3 CLJ 322), the Court heard an application for the determination of the issue on whether the auditors owed a duty of care to the appellants in the two situations that arose in this case.

The first situation was when the auditors were carrying out the statutory audits in accordance with the CA for SJAM and issuing the CA audit reports. The second situation, and what was more significant in this appeal, was when the auditors were carrying out the statutory audits in accordance with the SIA for SJAM and issuing the SIA audit reports.

The High Court decided in favour of the auditors and found that the auditors owed no duty of care to the appellants in both situations. For the CA audit reports, it was held that CA audit reports were not intended for the appellants, as investors of the company, but were meant for SJAM and its shareholders in the general meeting. As for the SIA audit reports, it was held that they were not meant for making investment decisions but to enable SJAM to furnish such information to the SC.

Therefore, the appellants’ claims were dismissed. The appellants appealed to the Court of Appeal.

FINDINGS ON THE DUTY OF CARE

Guiding Principles on Establishing a Duty of Care

The Court of Appeal was guided by the Federal Court decision in The Co-operative Central Bank Ltd v KGV & Associates Sdn Bhd [2008] 2 CLJ 545 in accepting the guidelines laid down by the House of Lords in Her Majesty’s Commissioners of Customs and Excise v Barclays Bank [2007] 1 AC 181.

The Federal Court in Co-operative Central Bank acknowledged that three general tests could be used to determine whether a duty of care existed in cases that involved economic loss.

The first is the ‘assumption of responsibility’ test as to whether the defendant assumed responsibility for what he said and did vis-à-vis the claimant, or is to be treated by the law as having done so. The second is the threefold test: whether loss to the claimant was a reasonably foreseeable consequence of what the defendant did or failed to do; whether the relationship between the parties was one of sufficient proximity; and whether in all the circumstances it was fair, just and reasonable to impose a duty of care on the defendant towards the claimant. The third is the incremental test.

Against this backdrop, the Court of Appeal found that the High Court had determined the existence of the duty of care solely on the basis of the threefold test. In applying this test, the High Court had ruled that the appellants had failed to satisfy the ‘sufficient proximity’ element. The Court of Appeal held that instead, the High Court should have applied the guidelines in Barclays Bank, in particular, the first test of assumption of responsibility.

Duty of Care on the Part of the Auditors

The application of the assumption of responsibility test would mean that:

(a) reliance on the auditors’ report is no longer an essential ingredient to establish a duty of care;
(b) no anterior relationship between the appellants and the auditors is necessary to satisfy the ingredients of foreseeability and proximity; and
(c) the ingredient relating to proximity is satisfied so long as the assumption of responsibility may be inferred by reason of the existence of a special relationship.

The Court of Appeal drew a distinction between the CA audit and the SIA audit and found that Parliament could not have intended for both audits to be for the same purpose. There would be a difference in the scope and approach of the SIA audit as compared to the CA audit.

The focus of the SIA audit included the safeguarding of the assets of the appellants held by SJAM. The report by the auditors would serve to alert the SC and/or the relevant government authority to take such further action as is required. If in the course of the audit, the auditors come across a transaction or an accounting entry that does not comply with the provisions of Division 3 of Part VII of the SIA, the auditors had a duty to look deeper. The auditors could not ignore the irregularity or breach. Therefore, the SIA audit framework is a critical means of both ensuring compliance and detecting non-compliance by SJAM in relation to the management of the appellants’ assets.

The Court of Appeal also disagreed that any breach of the SIA provisions could only be enforced by the SC. Further, this was an appropriate case where the legislative framework in the SIA could be a basis to found the claim for breach of the common law duty of care arising from the careless performance of a statutory duty.

In concluding that the auditors owed a duty of care, the Court of Appeal stressed that the appellants were in an unusual situation whereby their funds and investments were in the hands of a trustee fund manager (SJAM) but over which funds they had no control. The auditors’ agreement to conduct the SIA audit for SJAM with knowledge or imputed knowledge of the unusual situation in which the appellants were placed, gave rise to a duty on the part of the auditors to undertake a proper audit in the course of carrying out their statutory duty. This obligation created a relationship between the auditors and the appellants so as to give rise to a common law duty of care.

If the auditors had not breached their duty of care, the SIA audit reports would have been qualified and the irregularity in the accounts of SJAM would have been reported to the SC. Such a report to the SC, in turn, would have caused the SC to take the appropriate action thereby causing SJAM to cease trading and consequently, diminish the losses of the appellants. However, because the audit reports that were produced by the auditors were ‘clean’, the SC took action much later and the ensuing winding up of SJAM was correspondingly delayed, thereby causing substantially more losses to the appellants.

The Court of Appeal therefore ruled that the auditors owed a common law duty of care to the appellants. The Court of Appeal ordered that the matters be remitted to the High Court for the trial on the issue of the liability of the auditors, if any, to the appellants.

CONCLUSION

This decision is significant in confirming that auditors who carry out a statutory audit under the SIA for a fund management company owe a duty of care to the investors of that company. Although the SIA has been repealed and replaced by the CMSA, it is likely that a similar duty of care on the part of the auditors would arise under the CMSA.

It is also likely that the Court would still impose such a duty in favour of the investors of the company even if the auditors build disclaimers into such a statutory audit (whether under the SIA or CMSA) to exclude liability or obligations to third parties.

MIA International Conference 2014

I will be moderating a session at the Malaysian Institute of Accountants Conference 2014 this Wednesday 5 November 2014. It will be on the new Companies Bill and its impact on Malaysian businesses and economy. It should be a very interesting session and I have been liaising with the speakers on the panel. Will keep the format as a group discussion and try to draw out all the different issues.

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Shareholder Oppression Action Not Arbitrable

The Singapore High Court in the Silica Investors case (Silica Investors Ltd v Tomolugen Holdings Limited and others [2014] SGHC 101) refused a stay of an oppression action initiated by a shareholder pending a reference to arbitration. The Court found that based on the facts of the case, the minority oppression claim was non-arbitrable. There were relevant parties, including other shareholders, who were not parties to the arbitration. Further, the Plaintiff in the oppression action was seeking for remedies that the arbitral tribunal could not grant, including winding up.

Briefly, there was an arbitration clause in an agreement between only two of the shareholders. The Plaintiff filed an oppression action against both the party to the arbitration agreement as well as against non-parties (being the directors and some of the other shareholders of the Company). The Plaintiff sought a share buy-out order, an alternative prayer for winding up, and for several declaratory orders.

The Judge took great lengths in looking at the developments in Australia, Canada and the UK, and the academic commentary arising from those cases. In particular, the Judge distinguished the English Court of Appeal decision in Fulham Football Club (1987) Ltd v Richards and another [2012] Ch 333 (where an unfair prejudice action was stayed pending arbitration) as the unfair prejudice relief in that case was for a specific injunction Order. There was no possibility of a share buy-out or winding up in that case.

This is a fascinating area of the law where there is still no clear answer on the right balance to be struck. On the one hand, there is the policy of interpreting an arbitration clause as wide as possible in order for contracting parties to be bound by their bargain to go to the exclusive forum of arbitration. On the other hand, parties e.g. shareholders, may still want to rely on their statutory remedies and the Court will have to consider whether a dispute is arbitrable or not.