Protecting an Unguarded Pocket

[Originally published in Skrine’s Legal Insights Issue 2/2013]

The Singapore Court of Appeal in The Royal Bank of Scotland NV (formerly known as ABN Amro Bank NV) and Others v TT International Ltd and another appeal [2012] SGCA 53 revisited its earlier decision in The Royal Bank of Scotland NV (formerly known as ABN Amro Bank NV) and Others v TT International Ltd and another appeal [2012] SGCA 9 (“TT International No. 1”) (my earlier commentary on TT International No. 1 is found here) and laid down important guidelines on the disclosure of fees to be paid to a scheme manager in a scheme of arrangement.

BACKGROUND FACTS

Arising from the decision of TT International No. 1, the Court had ordered for meetings of the creditors to be called. At these meetings, the creditors approved a scheme of arrangement (“Scheme”) which was thereafter sanctioned by the Court. Under the terms of the Scheme, a Monitoring Committee made up of representatives from some of the major creditors was set up to oversee the implementation of the Scheme by the appointed Scheme Manager (“Scheme Manager”).

Close to a year after the sanction, during the implementation of the Scheme, the Monitoring Committee discovered that the company had prior to the sanction of the Scheme, entered into a success fee arrangement with the Scheme Manager’s firm. The Scheme Manager would be paid for the time costs incurred as well as a Value-Added Fee (“VAF”) which was a success-based fee. Under the VAF component, the greater the amount of the creditors’ debt that is written off or extinguished, the greater the quantum of the remuneration received by the Scheme Manager’s firm. By that stage, it was estimated that the quantum of the VAF was between S$15 million to $30 million.

The Monitoring Committee informed the Court of Appeal of the existence of this success fee arrangement and requested that the Court direct that the VAF be assessed in court. The key issue before the Court of Appeal was whether the VAF should have been disclosed to the creditors and/or the Court prior to the sanction of the Scheme.

COMPANY’S DUTY TO DISCLOSE MATERIAL INFORMATION

The Court of Appeal emphasised that transparency in the affairs of a distressed company through making available all material information that could impinge on the financial interests on creditors was essential. This duty of disclosure on the company has been emphatically declared to be an independent principle of law entirely distinct from the disclosure requirements mandated by statute.

The Court of Appeal took into consideration the prevailing practice of success-based fee remuneration of scheme managers both in Singapore and abroad. It was found that it was not uncommon for some scheme managers or financial advisers to include a success-based element in their fees for the debt restructuring work which they carried out. There was also no established practice in Singapore of such success-based fees of scheme managers being voluntarily disclosed to the creditors or the courts. Nonetheless, the Court of Appeal held that a commercial practice, no matter how widespread, does not have the force of law if it is contrary to legal principle.

In considering the legal issues, the Court of Appeal held that the company’s obligation to disclose all material information should cover liabilities such as the VAF which it had incurred immediately prior to the sanction of the Scheme. The VAF was a contingent liability incurred by the company which would have crystallised the moment the Scheme was successfully implemented. Ordinarily, such contingent liabilities would have been disclosed but the Scheme Manager’s firm was found to have been conveniently classified as an excluded creditor and therefore did not have to submit a proof of debt.

The Court did not view favourably the current practice of companies making use of the device of “excluded creditors” in order to not reveal to other creditors the actual or contingent liabilities, which may be very substantial. That practice would permit directors of an insolvent company to commit the company to a substantial contingent financial commitment that will come from an unguarded pocket. It held that the law does not allow such a practice as it can be used to conceal all kinds of financial arrangements which may prejudice the interests of the scheme creditors.

Therefore, it was held that the company was under a legal obligation to disclose all material information to the scheme creditors to enable them to make informed decisions on whether or not to support the Scheme. The company breached this obligation by failing to disclose the VAF to the scheme creditors. Furthermore, this information should have also been disclosed to the Court at the sanction stage.

SCHEME MANAGER’S DUTY OF DISCLOSURE

In referring to TT International No. 1, the Court of Appeal emphasised that it has been held that the Scheme Manager has to act in good faith towards the scheme creditors and must not mislead the scheme creditors or suppress material information.

In this case, the Scheme Manager had placed itself in a position of conflict, where the quantum of the VAF which would accrue to the Scheme Manager’s firm was dependant on the value of the debts which would be adjudicated upon by the proposed Scheme Manager himself. The Court of Appeal held that this conflict could only be resolved by the informed consent of the scheme creditors. There was no such informed consent because of the Scheme Manager’s (and also the company’s) failure to inform the scheme creditors of the VAF.

The Court of Appeal considered that the parties with a genuine interest to ensure that the proposed Scheme Manager is being reasonably remunerated would be the scheme creditors who would determine whether the scheme is commercially viable (and preferable to liquidation). It was therefore only fair, reasonable and right that both the company and the Scheme Manager disclose to the scheme creditors and the Court the terms of the proposed Scheme Manager’s appointment prior to the sanction of the Scheme.

REMUNERATION FOR INSOLVENCY PRACTITIONERS

In considering the above points, the Court of Appeal also considered that the issue of potentially exorbitant fees for insolvency practitioners was a matter of public interest. Central to this problem is the fact that their fees come from an unguarded pocket that in reality belongs to the creditors and not the financially distressed company.

The Court of Appeal found that the wildly divergent interests of the stakeholders often allow insolvency practitioners almost carte blanche to determine (without rigorous oversight) their levels of remuneration even for the most mundane tasks.

The Court of Appeal held as a matter of general principle, the determinative consideration as to the fair and reasonable remuneration for financial advisors/scheme managers should be the value contributed to the process in terms of tangible results for the creditors and the company, as opposed to the mere quantum of debt involved or the time spent.

CONSEQUENCES OF THE BREACH OF DUTY

As the company and the Scheme Manager were in breach of their common law duty of disclosure, the Court of Appeal found that ordinarily, the Scheme should be set aside and put to a fresh vote because it might not have been approved by the scheme creditors if they had known about the VAF. However, as the Scheme had been implemented for more than two years, the Court found that it was not practical to set it aside without causing more harm to the company and the scheme creditors.

Therefore, the Court of Appeal ordered the relevant parties to the dispute to try to reach an agreement on the proper amount of professional fees to be paid out. It also ordered that, if parties are unable to reach an agreement, then the fees would be assessed by a High Court Judge.

If the matter were to proceed to assessment, then the Court of Appeal laid down the following guiding principles. The Court would first consider the value (in this case the benefits, from a holistic and not mathematical standpoint, accruing to the company and the creditors) contributed by the Scheme Manager’s firm. Other factors would include the nature of the work involved, the time spent, the assistance provided, the scope of work and reasonable disbursements incurred.

CONCLUSION

Financial advisers or scheme managers in Malaysia may also include success-based components in their fee arrangements and there is no mandatory requirement to disclose such fee arrangements in the scheme papers.

Although decided in a Singapore context, the principles outlined in this decision should be equally applied here. The onus is on both the company and the scheme manager to disclose the fee arrangements of the company’s financial advisers or the proposed scheme manager to the scheme creditors and to the Court in a scheme of arrangement. This ensures that the informed consent of the scheme creditors is obtained and underlines the uncompromising need for transparency in relation to material information.

The aforesaid common law duty of disclosure imposed on the company and the proposed scheme manager would strike a sound balance between valuing the work done by financial advisors/scheme managers and safeguarding the interests of the creditors.

The decision is also significant in giving some guidance on the principle that should guide the determination of remuneration for such financial advisors/scheme managers in a scheme of arrangement. Rather than a mathematical scale based on the quantum of debt or time spent, the primary factor should be the value contributed to the process in terms of results for the creditors and the company.

Breaches of a shareholders agreement cannot form oppression

The Federal Court in Jet-Tech Materials Sdn Bhd & Anor v Yushiro Chemical Industry Co Ltd & Ors and another appeal [2013] 2 MLJ 297 (original Grounds of Judgment here) set out an important (and another possibly controversial) clarification on the law concerning oppression proceedings under section 181 of the Companies Act 1965 (“the Act”).

Raus Sharif PCA (delivering the judgment of the Court) first held that the just and equitable principle under 218(1)(i) of the Act, being principles emanating from the House of Lords decision of Ebrahimi, would equally apply in a situation involving section 181 of the Act. This is very useful and it helps streamline our Malaysia approach to the English approach already set out in the House of Lords decision of O’Neill v Phillips in that the concept of unfairness under section 210 of the English Companies Act (the equivalent of section 181 of the Act) is parallel to the concept of “just and equitable” expounded in Ebrahimi.

But the Federal Court seems to have made a sweeping finding at [37] that matters concerning a shareholders agreement and the breach of such an agreement are not matters relating to the affairs of the company. Therefore, such breaches cannot form the basis for a section 181 action. It was held that these are only private matters enforceable by the parties to the shareholders agreement. I do not think other jurisdictions and other cases in Malaysia have actually made such a far-reaching finding.

Oppression under section 181 of the Act revolves around whether there is commercial unfairness. Such unfairness is judged by the agreement, both formal and informal, reached among the parties. That is why the Articles of Association and, I would have thought, any shareholders agreement would be the primary assessment of whether any of the acts are unfair and are in breach of those formal agreements.

So say for instance, a typical situation where a shareholders agreement provides that there are reserved matters that will require the vote of the minority shareholder / nominated director of the minority shareholder. The shareholders agreement could contain a clause that the Articles of Association would be amended to reflect the terms of the agreement but it is quite common to see that the Articles of Association not amended. If the majority shareholder pushes through certain resolutions (for instance to transfer out assets) which is oppressive against the minority, a direct application of the Jet-Tech decision would mean that the minority shareholder would have not be able to rely on section 181 of the Act. The minority’s remedy may only be to sue for damages for a breach of the shareholders agreement.

I don’t think any Malaysian case or authorities from other jurisdictions have made such a sweeping finding before, in that breaches of a shareholder agreement cannot form the basis of oppression.

On a related note, this statement by the Federal Court, applied directly, may be used in support of the conflict between an arbitration clause in a shareholders agreement and statutory relief under section 218/181 of the Act (see for instance, the English Court of Appeal decision in Fulham Football Club (1987) Ltd The Football Conference Ltd [2011] EWCA Civ 855). It is now quite common to find an arbitration clause in a shareholders agreement. Therefore, if a breach of the shareholders agreement is only a private matter, then there may not be section 181 relief and parties may only be able to rely on the arbitration clause and have the dispute (for instance, the above example of the resolutions passed in breach of the agreement) referred to arbitration.

Directors Ability to Move the Company to Wind Itself Up

Section 217 of the Companies Act 1965 (“the Act”) lists out the persons who have standing to petition the Court for the winding up of a company, and section 217(1)(a) of the Act allows for the company itself to also petition for winding up.

The question then arises that when a company petitions to wind itself up, does this require merely a directors’ resolution or a shareholders’ resolution? It may not be clear whether the Board of Directors’ general power of management to conduct the business of the company extends to destroying the business of the company through winding up.

In the High Court decision of Miharja Development Sdn Bhd & Ors v Tan Sri Datuk Loy Hean Heong & Ors and another application [1995] 1 MLJ 101, Justice VC George (as he then was) considered the competing arguments and held that the Board would have such a power to move the company to wind itself up and bring itself within section 217(1)(a) of the Act.

In summary, the High Court agreed with the submissions that unlike section 254(1)(b) of the Act which expressly states the requirement of a special resolution for the purposes of voluntary winding up, section 217 of the Act for compulsory winding up makes no reference to either an ordinary or special resolution. Further, the High Court agreed that there may be circumstances that the directors will need to decide to wind up an insolvent company, as the directors may be exposed to criminal liability under section 303(3) of the Act. This section deals with insolvent trading and the liability on the part of the directors. The company may not be able to expeditiously hold a shareholders meeting or there may even be a form of deadlock at the shareholder level. Thus, there may be situations where the directors may need to urgently move the company to petition for winding up.

On a practical note, while the company may cross the threshold of section 217 of the Act, the Petitioning company will still have to ensure that it brings itself within one of the grounds for winding up listed in section 218 of the Act. For instance, in the case of an insolvent company, under section 218(1)(e) of the Act (where the company is unable to pay its debts) and read with section 218(2)(c) of the Act (taking into account the contingent and prospective liabilities of the company).

I set out below the relevant passages from Justice VC George from the High Court decision (starting from page 106). It makes for interesting reading in comparing the approaches from different jurisdictions:

I will first deal with the locus standi of a company to petition to wind up itself at the instance of the board of directors without the sanction of the shareholders.

In the State of Victoria, Australia, the courts have construed the article in the articles of association of a company in pari materia with art 116 in the articles of association of each of the petitioner companies that provides that:

The business of the company shall be managed by directors who may exercise all such powers of the company as are not by the Act or by these presents required to be exercised by the company in general meeting, subject nevertheless to any regulations of these presents, to the provisions of the Act, and to such regulations, being not inconsistent with the aforesaid regulations or provisions as may be prescribed by special resolution of the company, but no regulation so made by the company shall invalidate any prior act of the directors which would have been valid if such regulation had not been made. The general powers given by this Article shall not be limited or restricted by any special authority or power given to the directors by any other Article provided that any sale of the company’s main undertaking shall be subject to ratification by the members in general meeting.

as being limited for the purpose of conducting the business of the company and not for the purpose of destroying the company. They take the view that the board of directors have no power to present a petition to wind up the company without the support of the shareholders – Re StandardBank of Australia Ltd (1898) 24 VLR 304; 4 ALR 287 and Re Birmacley Products Pty Ltd [1942] ALR 276. The Irish courts hold the same view – Re GalwaySalthill Tramways Co [1918] 1 IR 62.

Although the old English case, Smith v Duke of Manchester (1883) 24 Ch D 611, also seemed to take a similar view, it would seem that up to the end of the 1979, it was the generally accepted English practice to recognize that the board of directors were entitled to present a petition to wind up the company without first obtaining the sanction of the shareholders to do so – see Buckley on the Companies Act (13th Ed, 1959) at p 462 and 1 Palmer’s Company Law (22nd Ed, 1976) at p 691.

This was the position until the end of 1979, when Brightman J delivered the judgment in Re Emmadart Ltd [1979] 1 Ch 540 at p 547; [1979] 1 All ER 599 at p 605; [1979] 2 WLR 868 at p 874 where he said:

The practice which seems to have grown up, under which a board of director of an insolvent company presents a petition in the name of the company where this seems to the board to be a sensible course, but without reference to the shareholder, is in my opinion wrong and ought no longer to be pursued … What is stated in Buckley to be the law according to Irish authority is in my view equally the law in this country.

In 1986, the legislature intervened and the English Insolvency Act 1986 specifically provided for the directors to present the petition without reference to the shareholders. In New Zealand also, there are statutory provisions to the like effect.

This issue of the locus standi in the context of the board of directors has apparently never come up before the Malaysian or Singapore courts and it has now fallen on me to lay down what the Malaysian practice should be.

I agree with Encik Sri Ram, leading for the petitioners, that Emmadart does not lay down any universal principle of law but only reversed a practice. In this context, I found myself persuaded by the reference and relevance of s 303(3) of the Companies Act 1965 and to the distinction between ss 217(1)(a) and 254(1)(b) of that Act which for convenience are reproduced here:

217(1) A company (whether or not it is being wound up voluntarily) may be wound up under an order of the Court on the petition of –

(a) the company; …

254(1) A company may be wound up voluntarily –

(b) if the company so resolves by special resolution.

303(3) If in the course of the winding up of a company or in any proceedings against a company it appears that an officer of the company who was knowingly a party to the contracting of a debt had, at the time the debt was contracted, no reasonable or probable ground of expectation, after taking into consideration the other liabilities, if any, of the company at the time, of the company being able to pay the debt, the officer shall be guilty of an offence against this Act.

My attention was particularly drawn to Palmer’s Company Law (24th Ed, 1982) at p 1374:

Petitions by the company are not very common; for if a company desires to wind up, it has only to pass a special, or an extraordinary, resolution for voluntary winding up (Insolvency Act s 84). However, if the directors find the company to be insolvent owing to matters which ought to be investigated by the court, it may well be that their proper course is to apply at once on behalf of the company to the court by petition for a compulsory order.

If the shareholders pass a special resolution, the comparatively simple and cheaper procedure for voluntary winding up of the company provided by s 254 can be invoked. If there is such a special resolution, there would appear to be no point in invoking the s 217 procedure for winding up by the court.

There is, I think, significance in the fact that the legislature has specifically provided in s 254 for a special resolution of the shareholders, and omitted to provide, as a condition precedent even, for an ordinary resolution with reference to s 217(1)(a). If it had been the intention of the legislature that one of the conditions precedent to the company taking out a s 217 petition is that the sanction of the shareholders be obtained, it would have provided for that and could have done so conveniently in s 217(2) where a number of qualifications to the provisions in s 217(1) are made. The omission must have been a deliberate and considered omission.

I also agree that in the face of s 303(3), a fetter on the directors is far from desirable. In the New South Wales case of Re Inkerman Grazing Pty Ltd (1972) 1 ACLR 102 at p 106, Street J said:

Not only is there the authority of a course of practice recognized and given effect by judges in this State and, practical justifications and, indeed, necessities, for recognizing this power in directors. As is pointed out in Palmer’s textbook, there can well be occasions where the proper course is for directors of a company to apply at once for a winding up by the court. It is often only by a procedure of this nature that a company with widespread financial interests affecting a great many actual and prospective creditors, let alone shareholders, can move to protect its creditors and shareholders in the event of a sudden financial crisis developing which leaves it in a position of insolvency.

Unlike Brightman J in Emmadart, who had to descend into the arena himself as it were because only one party to the matter before him was represented by counsel, I have here had the benefit of the learned and well researched submissions of the opposing teams of lawyers each led by an eminent leader of the commercial Bar in the persons of Encik G Sri Ram and Encik KS Narayanan who have, between them, covered every possible aspect of the issue. Inter alia, I take the point that was made that Brightman J does not appear to have been referred to the New South Wales practice and the merits of the practice as set out in the various judgments of the courts there. He was also not referred to the Privy Council’s opinion expressed in 1932 in the Australian case, Campbell v Rofe (1932) 48 CLR 258, PC. It had been contended in that case that either art 10 of the company in question or art 117 (in pari materia with art 116 in the Articles of the two companies here) had provided the directors with the power to take the action that they had taken in respect of which their Lordships of the Privy Council, having expressed the view that art 10 provided the power exercised by the directors, went on to say at p 265:

In this view, art 117, which only purports to confer additional powers, does not include the powers conferred by art 10; but, if their Lordships had taken a different view as to art 10, they would have been prepared to hold that art 117 clearly delegated to the directors power to do everything that the company could do except where the authority of a general meeting of the company is expressly prescribed, …

I would echo Inkerman and say that it is not desirable that there be a fetter on the directors. While the directors may not cause the company to voluntarily be wound up without a special resolution to do so by the members because there is express provision to that effect in s 254, they should not be prevented, if they feel that that is the sensible course to take, to move the court for a winding-up order without first obtaining the sanction of the shareholders to do so. I would apply the wide (rather than narrow) construction to art 116 recommended by the Privy Council in Campbell v Rofe. I would respectfully share the opinion of the English legislature manifested in the restoration of the English pre-1979 practice and of the New Zealand legislature in sanctioning a similar practice – I would and do lay down that the effect of and the practice in respect of s 217(1)(a) is and should be that the directors of a company may petition the court to wind up the company without having to first obtain the sanction of the shareholders. I have particularly in mind that there could be situations where expediency calls for urgent steps to be taken or where as is the case here, it is not possible to obtain the views of the real shareholders at an EGM because the shares are held as security by a financial institution in whose name they are registered and because of that it appears that it is not possible to obtain the sanction of the shareholders because of the doubt of the status of the alleged real shareholders vis-ê-vis the shares. It is not difficult to think of other situations obtaining where the directors think it desirable that the company be wound up but the shareholders cannot or cannot expeditiously be summoned for an EGM.

Shareholder WMDs: Winding up, Minority Oppression and Derivative Action

I have been trying out prezi ever since I saw a presenter use it last week at a conference. Took me quite a while but managed to do up my slides on the talk for today.

The talk is entitled ‘Shareholder WMDs: Winding up, Minority Oppression and Derivative Action.’

It is taking place at the Bar Council Auditorium today at 2.30pm. The flyer is here.

P.S. Getting prezi to embed to WordPress was a bit of a pain. Luckily came across this step-by-step guide.

Laying Down the Ground Rules: Schemes of Arrangement

Originally published in Skrine’s LEGAL INSIGHTS Issue 02/2012

The Singapore Court of Appeal decision of The Royal Bank of Scotland NV (formerly known as ABN Amro Bank NV) and other v TT International Ltd and another appeal [2012] SGCA 9 sets out guiding principles on how a scheme of arrangement should be implemented. The decision touched on issues concerning the role and duties of a scheme manager, the proof of debt process in a scheme of arrangement and the classification of creditors.

SUMMARY

The Court of Appeal elaborated on the stages leading to the sanctioning of a scheme of arrangement and approved of the English approach that issues of creditors’ classification should be considered by a court when it first hears the application for a creditors’ meeting.

The Court then laid down the following principles:

  1. A proposed scheme manager must act transparently and objectively and should not be in a position of conflict of interest (i.e. if he aligns his interests without good reason with those of the applicant company). In this case, the proposed scheme manager was conflicted because he was also the nominee for the individual voluntary arrangements filed by the chairman and an executive director (who was also the chairman’s wife) of the applicant company.
  2. A scheme creditor is entitled to examine proofs of debt submitted by the other creditors in a proposed scheme of arrangement only if he produces prima facie evidence of impropriety in the admission or rejection of such proofs of debt.
  3. A scheme creditor should be notified of the proposed scheme manager’s decision to admit or reject its own and other creditors’ proofs of debt before the votes are cast at the creditors’ meeting. In this case, the proposed scheme manager should have completed adjudicating all the proofs of debt submitted (and notified all scheme creditors of the admitted proofs) prior to the Scheme Meeting.
  4. A scheme creditor may appeal the proposed scheme manager’s decisions to admit or reject its own and other creditors’ proofs of debt for the purposes of voting. In this case, some of those decisions to admit or reject certain proofs of debt were held to be incorrect.
  5. Scheme creditors should be classified differently for voting purposes when their rights are so dissimilar to each other’s that they cannot sensibly consult together with a view to their common interest. In other words, if a creditor’s position will improve or decline to such a different extent vis-à-vis other creditors simply because of the terms of the scheme assessed against the most likely scenario in the absence of scheme approval (e.g. liquidation), then it should be classified differently.
  6. Related party creditors should have their votes discounted in light of their special interests to support a proposed scheme, by virtue of their relationship to the company. Wholly-owned subsidiaries should have their votes discounted to zero and are effectively classified separately from the general class of unsecured creditors.

BACKGROUND FACTS

The appeal arose from a High Court decision approving the scheme of arrangement of the applicant company, TT International Ltd (“Scheme”), despite the vigorous objections made by a number of creditors. The applicant company had obtained court approval to convene a meeting of a single class of creditors (“Scheme Meeting”). The proposed Scheme Manager chaired the Scheme Meeting and it was noted that the Scheme Manager was also concurrently the nominee for the individual voluntary arrangements (under the Bankruptcy Act) filed by the chairman and an executive director (who was also the chairman’s wife) of the applicant.

After the scheme creditors had voted at the Scheme Meeting, they were abruptly informed that the proposed Scheme Manager had not completed his adjudication of the proofs of debt. The proposed Scheme Manager later reported that the Scheme had been passed by a majority of creditors representing 75.06% in value, exceeding the statutory threshold of 75% by a razor thin margin. This prompted the opposing scheme creditors (the Appellants in this case) to seek copies of the proofs of debt lodged by certain creditors and other information regarding the other creditors’ claims.

Dissatisfied with the applicant’s adjudication of several proofs of debt as well as its response to their requests for information, the opposing scheme creditors objected to the Scheme. The High Court Judge, however, disagreed with those arguments and approved the Scheme. The opposing scheme creditors appealed to the Court of Appeal.

SCHEME OF ARRANGEMENT PROCEDURE

The Court of Appeal noted that there was a paucity of judicial guidance on the more precise mechanics of implementing the scheme of arrangement process and there was no statutory guidance on the many procedural issues relating to passing a scheme of arrangement. Hence, the Court summarised and laid down several guidelines.

The scheme of arrangement process takes place over three stages.

The First Stage

The first stage is the application to the court for an order that a meeting or meetings be summoned. The Court agreed with the approach in England (see the Practice Statement (Companies: Scheme of Arrangement) [2002] 1 WLR 1345) which would essentially require a preliminary determination of the correct classification of creditors.

The applicant would have to notify persons affected by the scheme of its purpose and the meetings which the applicant considers will be required. The applicant’s solicitors will have to unreservedly disclose all material information to the court to assist it in arriving at a properly considered determination on how the scheme creditors’ meeting is to be conducted. Any issues in relation to a possible need for separate meetings for different classes of creditors ought to be unambiguously brought to the attention of the court hearing the application.

After the issuance of the notices summoning the meeting(s), the prospective scheme creditors will submit their proofs of debt and supporting documents. The chairman then has to perform the quasi-judicial task of adjudicating upon disputes as to the voting rights of anyone claiming to be a creditor. His role is akin to that of a judicial manager in deciding whether to admit or reject proofs of debt lodged with him.

The Second Stage

The second stage is where the scheme proposals are put to the meeting or meetings held in accordance with the earlier order and are approved (or not) by the requisite majority in number and 75% in value of those present and voting in person or by proxy.

It has become usual practice for the chairman to post a list of the creditors and the corresponding amounts of their admitted claims (for the purposes of voting) at the meeting venue prior to the meeting. After the creditors cast their votes, the chairman will immediately tabulate the results and announce them by the end of the meeting. If the statutory majority is achieved at the meeting(s), the proposed scheme then proceeds to the third stage.

The Third Stage

The third stage involves an application to the court to obtain the court’s sanction of the scheme. The court must be satisfied of three matters, namely (1) the statutory provisions have been complied with; (2) those who attended the meeting were fairly representative of the class of creditors and that the statutory majority did not coerce the minority; and (3) the scheme is one in which a man of business or an intelligent and honest man, being a member of the class concerned, would reasonably approve.

PROPOSED SCHEME MANAGER’S DUTIES AND CONFLICT OF INTEREST

The Court of Appeal then proceeded to deal with the issues before the court. The Court of Appeal explained that a proposed scheme manager has a good faith obligation to the applicant company and the body of creditors as a whole as well. Similar to a liquidator, the proposed scheme manager, in adjudicating proofs of debt, owes duties to be objective, independent, fair and impartial.

On the issue of conflict of interest, a proposed scheme manager must strike the right balance and manage the competing interests of successfully securing the approval of his proposed scheme and uncompromisingly respecting the procedural rights of all involved in the scheme process. He will go too far when he begins to align his interests with those of the company beyond what has been set out.

The Court found it inappropriate in this case that the proposed Scheme Manager was also the nominee for the individual voluntary arrangements (under Singapore’s Bankruptcy Act) filed by the chairman and an executive director (who was also the chairman’s wife) of the applicant. The Court ordered the proposed Scheme Manager to elect either to continue as such only or as nominee for the two individuals, as a result of which he eventually chose to act for the applicant alone.

ENTITLEMENT TO INSPECT PROOFS OF DEBT

The Court of Appeal highlighted that unlike insolvency and bankruptcy regimes which allow creditors to inspect the proofs of debt of other creditors, the interest of a creditor in a proposed scheme of arrangement is different. In the latter, the creditor has an autonomous voting right which may be critical to the jurisdiction of the court to sanction the scheme. Hence, claims to be given access to proofs of debt of other creditors can only be justified if the information is relevant to his voting rights.

In principle, therefore, a creditor has no legal right to have access to the proofs of debt of other creditors, except where his voting rights have been or are likely to be affected. In other words, he is entitled to such access only if he produces prima facie evidence of impropriety in the admission or rejection of such proofs of debt.

NOTIFICATION OF CHAIRMAN’S DECISION TO ADMIT OR REJECT PROOF OF DEBT

The Court of Appeal approved of the practice of the chairman posting a list of the scheme creditors and the corresponding amounts of their admitted claims at the meeting venue before a creditors’ meeting. This allows the creditors to commence voting knowing how much their votes will count with or against those of their fellow creditors. In addition, the information allows some measure of informed consultation between the creditors regarding the exercise of their votes.

Therefore, the Court held that in the present case, the proposed Scheme Manager should have completed adjudicating all proofs of debt and then provided all the scheme creditors present with the full list of scheme creditors entitled to vote and the corresponding quanta of their claims that were admitted for the purpose of voting. A proposed scheme manager who cannot comply with such steps prior to the scheme creditors’ meeting should seek leave from the court to defer the meeting until the adjudication is completed.

APPEAL AGAINST DECISION TO ADMIT OR REJECT PROOF OF DEBT

The Court of Appeal recognised that there is no subsidiary legislation governing the admission and rejection of proofs of debt in relation to creditors’ meetings in a proposed scheme of arrangement. Having drawn comparisons with procedures in judicial management and liquidation, the Court of Appeal held that a creditor who has submitted a proof to the chairman of a scheme of arrangement creditors’ meeting can appeal the chairman’s decision in respect of the admission or rejection of both the creditor’s own proof of debt as well as those submitted by other creditors.

Such appeals should only be taken after the votes have been counted and it can be seen whether the vote in question would affect the result, preferably concurrently during the sanction stage. At such an appeal, the court will not ordinarily interfere with the chairman’s decisions based on his professional judgment unless it was affected by bad faith, a mistake as to the facts, an erroneous approach to the law or an error of principle. The court’s role is not to engage in its own valuation of a claim.

CLASSIFICATION OF CREDITORS

The principle on classification of creditors has been well established in that scheme creditors should be classified differently for voting purposes when their rights are so dissimilar to each other’s that they cannot sensibly consult together with a view to their common interest.

The Court of Appeal provided some clarification on this dissimilarity principle in that if a creditor’s (or a group of creditors’) position will improve or decline to such a different extent vis-à-vis other creditors simply because of the terms of the scheme (and not because of its own unique circumstances) assessed against the most likely scenario in the absence of scheme approval (for instance, the frequent scenario of insolvent liquidation), then the creditor (or group of creditors) should be placed in a different voting class from the other creditors.

WHEN SHOULD SCHEME CREDITORS VOTES BE DISCOUNTED

In the situation of related creditors, while they need not constitute a separate class of creditors for voting purposes simply because they were related parties, the Court of Appeal agreed that the cases have consistently held that it is the norm to discount such votes in light of the related creditors’ special interests to support a proposed scheme by virtue of their relationship to the company. However, no guidance was provided on how much such a discount of voting weightage should be applied.

For wholly-owned subsidiaries (which are unsecured creditors), it was held that while they may be classed along with the other unsecured creditors, their votes should be discounted to zero. This effectively classed them separately from other unsecured creditors. The Court of Appeal viewed wholly-owned subsidiaries as extensions of the applicant company itself and their votes would undoubtedly be entirely controlled by the applicant company.

The Court of Appeal emphasised however that its decision on this point is limited to the treatment of wholly-owned subsidiaries. It recognised that the treatment of partially owned subsidiaries also raises difficult issues but this question would be addressed in a more appropriate case.

COMMENTARY

This decision provides a great deal of guidance in the area of the laws and procedure for schemes of arrangement. While decided in a Singapore context, these principles which are aimed at maintaining the integrity of the scheme of arrangement process, particularly the process in which proofs of debt are properly admitted or rejected for the purpose of voting, should be equally applied here. Any scheme must be grounded on the principles of transparency and objectivity, implemented by an independent and impartial proposed scheme manager.

Resolution of the Dire Conflict on the Part of Liquidators

Originally published in Skrine’s Legal Insights.

The Federal Court in Ooi Woon Chee & Anor v Dato’ See Teow Chuan & Ors [2012] 2 MLJ 713 has reversed the decision made by the Court of Appeal in Dato’ See Teow Chuan & Ors v Ooi Woon Chee & Ors (including Can-One International Sdn Bhd as 15th respondent) and other appeals [2010] 6 MLJ 459 (click here for my case commentary on the Court of Appeal decision). The Federal Court has clarified several important points of law touching on when a liquidator can be held to be in conflict of interest where the liquidator’s accounting firm has provided auditing or other services.

BRIEF FACTS

In 1996, Kian Joo Holdings Sdn Bhd (“Company”) had been wound up by the Court by consent of the shareholders. The liquidators of the Company (“Liquidators”) were partners of KPMG Peat Marwick (“KPMG”) and KPMG Corporate Services Sdn Bhd (“KCSSB”) was an entity used by the Liquidators to carry out some of their duties.

The facts leading to the appeal in the Federal Court centred on two main applications filed in the High Court. The first application was filed by the majority contributories (“Majority Contributories”) of the Company seeking leave to proceed with legal proceedings (“Leave Application”) against the Liquidators, KCSSB, KPMG and Can-One International Sdn Bhd (“Can-One”) for alleged misconduct in a tender of the assets of the Company, namely its 34.46% shareholding in Kian Joo Can Factory Berhad (“KJCFB”), and eventual award to Can-One.

The second application was filed by the Liquidators for directions from the High Court as to whether to complete the sale to Can-One (“Directions Application”).

At the High Court, the Leave Application was dismissed and pursuant to the Directions Application, the Court directed the completion of the sale to Can-One. The decision of the High Court was reversed by the Court of Appeal. The Liquidators were granted leave to appeal to the Federal Court in respect of both the Leave Application and the Directions Application.

FINDINGS OF THE FEDERAL COURT

The Federal Court first dealt with the issues arising from the Leave Application. The Federal Court noted that the Court of Appeal, when reversing the decision of the High Court, had granted leave to the Majority Contributories to proceed with the suit against the Liquidators where the suit was commenced in the names of the Majority Contributories and not in the name of the Company. The Federal Court held that the High Court was correct in holding that no leave ought to be granted as no cause of action vested in the Majority Contributories. The complaint was that the sale of the Company’s shares in KJCFB was improperly conducted and any loss would be suffered by the Company. The proper plaintiff would therefore be the Company and not the Majority Contributories.

Further, the Federal Court agreed that no pecuniary loss was suffered by the Company by accepting Can-One’s offer as it was the highest.

The Federal Court then further assessed whether the Majority Contributories had made out a prima facie case against the Liquidators in order to allow the Leave Application. The Majority Contributories had raised three main areas in the claim against the Liquidators and the Federal Court looked at each in turn.

Can-One’s Offer

The first was the Majority Contributories’ claim that Can-One had no valid offer for the Liquidators to accept. The Federal Court analysed the facts surrounding Can-One’s offer and held that the Liquidators had correctly exercised their discretion in accepting Can-One’s offer.

Conflict of Interest

The Federal Court next considered the issue as to whether the Liquidators, KCSSB and KPMG had placed themselves in a position of conflict when the Liquidators accepted the tender from Can-One where Can-One and its holding company were audit clients of KPMG. The Federal Court was guided by the legal principle that there cannot be an actual or apparent conflict on the part of the Liquidators.

In order to constitute actual conflict, the Federal Court held that there must be another partner from KPMG advising Can-One on the very sale itself in the opposite interest. The Federal Court found that there was no one from KPMG or connected with the Liquidators advising Can-One and that KPMG only acted in the audit of Can-One. There was no connection between the sale and the audit and hence, no actual conflict.

On the issue of apparent conflict, the Federal Court assessed the connection between the Liquidators who are partners in KPMG operating out of Kuala Lumpur/Selangor and KPMG’s Penang branch who were auditors of Can-One. The Federal Court was of the view that commercial reality was such that large accounting practices will give rise to associations with persons whom insolvency practitioners will sell assets to. To disqualify a liquidator merely because of an audit relationship would mean that almost every large accounting firm would be disqualified from holding a tender exercise.

The Federal Court held that commercial reality dictated that the existence of such a relationship by itself should not disqualify liquidators or their audit clients. Firstly, there is no express prohibition under the Companies (Winding Up) Rules 1972 for such a disqualification. Secondly, the Federal Court held that the High Court had correctly applied the Canadian case of Cobrico Development Inc v Tucker Industries Inc 2000 ABQB 766 (“Cobrico”) in finding there was no conflict. In Cobrico, the appointment of an auction house was criticized because the receiver’s firm was the auditor of the auction house in the same way as the Liquidators’ firm was the auditor of Can-One. It was held in Cobrico that that fact alone did not constitute a conflict of interest.

Alleged Bribe and Solicitation

The Federal Court agreed with the High Court that the allegation of solicitation for a bribe was devoid of merit. The Federal Court examined the chronology of events, in particular how the complaint of improper conduct and fraud were only made by a member of the Majority Contributories after the announcement that Can-One was awarded the sale. The Federal Court also held that the allegation, even if it were true, had no effect on the validity of the agreement with Can-One and whether or not it should be completed. In any event, the Federal Court found that no bribe was ever paid.

There were also other important issues touched on by the Federal Court in relation to other findings made by the Court of Appeal.

Standards Applicable to Liquidators and Judges

The Federal Court examined the Court of Appeal’s finding that the Liquidators, as officers of the Court, were expected to abide by the same standards as judges and hence could not hold meetings in connection with a bid outside their offices.

The Federal Court disagreed and held that the standards applicable to a Judge have no application to Liquidators on the sale of assets. The Liquidators do not act in a judicial capacity in selling assets and were instead making business decisions to obtain the best possible price. A liquidator is obliged to enter into the market and to use all powers to get that price. The Federal Court held that it would be unrealistic and against commercial reality to expect a liquidator to sit in his office in the expectation that competitive bids would come streaming in.

Duty Owed by KPMG and KCSSB to the Contributories

The Federal Court held that the Court of Appeal had erred in finding that KPMG and KCSSB owed a fiduciary duty to the contributories of the Company. KPMG and KCSSB were not vehicles used by the Liquidators and thus could not be liable for the alleged acts of the Liquidators. The appointment of the Liquidators was personal and KPMG as a firm of accountants and KCSSB as a company were never appointed as liquidators of the Company. It was held that the Liquidators were perfectly entitled to appoint KCSSB as an agent to assist in the liquidation.

Decision in the Directions Application Not Appealable

At the Court of Appeal, the Liquidators had raised a preliminary objection as to whether the directions given by the High Court were appealable. The question was whether such a direction would fall within the meaning of “judgment or order of any High Court” under section 67(1) of the Courts of Judicature Act 1964. While the Court of Appeal held that such directions were appealable, the Federal Court disagreed. It held that the directions given by the High Court were in the nature of advice and were accordingly not a “judgment or order” and thereby non-appealable.

COMMENTARY

This Federal Court decision clarifying the issue of conflict of interest on the part of liquidators is welcomed. This decision would similarly apply to the situation where receivers and/or managers (“R&M”) are appointed over a company. The mere fact that the accounting firm of a liquidator/R&M has provided any auditing or other services to a company is not sufficient to give rise to a conflict of interest on the part of the liquidator/R&M when dealing with that company. The Federal Court gave great weight to commercial realities and the far-reaching effects of making any finding of conflict of interest.

This decision however may not be the end of this dispute. The Majority Contributories have filed an application to review this decision of the Federal Court on the grounds that the Federal Court grounds of judgment had substantially reproduced the written submissions filed by solicitors for the Liquidators and Can-One in the Federal Court. It has been reported that the Majority Contributories allege that there was insufficient consideration by the Federal Court of the Majority Contributories’ case.

It has been further reported that the Liquidators have filed an application to obtain leave to cite the 14 of the respondents and their counsel for contempt of court on the basis that the grounds for their review application showed disrespect to the Court and that the counsel for the 14 respondents may file counter-contempt proceedings against the Liquidators.

“Making a composition or arrangement with creditors” and its effect on contracts

The Federal Court in the as-yet unreported grounds of judgment in the Desa Samudra v Bandar Teknik and others (Federal Court Civil Appeal No. 02-9-2011) involved the consideration of the effect of the grant of a restraining Order and whether it would trigger a termination clause under a PAM contract.

It is very common for contracts (and in this case, it was a PAM Contract) to include a termination clause which allows for termination of the contract upon a contracting party facing winding up or when there is a “making a composition or arrangement with his creditors”.

The Federal Court ruled that a grant of a restraining order under s.176(10) of a Companies Act does not fall within the meaning of “making a composition or arrangement with his creditors” (for the purposes of a PAM Contract but this could be generally applied as well to other contracts if an identical phrase is used). The fact that a first step had been taken in relation to a scheme of arrangement through the grant of a restraining order did not mean such a scheme of arrangement was in the “making.”

It seems that only when the scheme of arrangement is eventually approved by the Court, would there be a trigger of the phrase “making a composition or arrangement with his creditors”.

An applicant company would have gone to Court two times (the first to seek leave to convene the creditor meetings and the second is to file a Petition for Court approval) and so those circumstances alone do not appear to be sufficient to trigger the phrase. I had further elaborated on the law concerning schemes of arrangement in my earlier article.

Singapore Court of Appeal addresses several important issues relating to schemes of arrangement

I had been looking forward to reading the Singapore Court of Appeal grounds for its landmark decision relating to the TT International case decision. The grounds were obtained from Singapore Law Watch.As both Singapore and Malaysia do not have guidelines or Practice Directions (unlike in the UK) to guide the schemes of arrangement process, the development of procedures through common law is extremely important. The TT International decision analysed the sometimes different approaches in Australia and the UK and the decision touched on classification of creditors, in particular the vexed question of how to deal with the votes of related creditors or wholly owned subsidiaries, the fiduciary duties owed by scheme managers and how to deal with the proof of debt process in a scheme.

The issues before the Singapore Court of Appeal were:

  1. when a proposed scheme manager might be placed in a position of a conflict of interest;
  2. whether scheme creditors are entitled to examine the proofs of debt submitted by other scheme creditors in respect of a proposed scheme;
  3. when a scheme creditor should be notified of the chairman’s decisions to admit or reject its own and other creditors’ proofs of debt;
  4. whether a scheme creditor may appeal the chairman’s decisions to admit or reject its own and other creditors’ proofs of debt;
  5. whether the chairman’s decisions to admit or reject certain proofs of debt for the purpose of voting, in this case, were correct;
  6. when scheme creditors should be classified differently for voting purposes in a s 210 scheme of arrangement; and
  7. when scheme creditors should have their votes discounted.
The Court of Appeal’s answers were:

  1. a proposed scheme manager is in a position of conflict of interest when he without good reason aligns his interests with those of the company, such as in this case, where the proposed Scheme Manager was the nominee for the individual voluntary arrangements (“the IVAs”) filed by Mr Sng and Ms Tong (see [74][78] of the decision);
  2. yes, scheme creditors are entitled to examine the proofs of debt submitted by other scheme creditors in respect of a proposed scheme (see [79][93]);
  3. a scheme creditor should be notified of the chairman’s decisions to admit or reject its own and other creditors’ proofs of debt before the votes are cast at the creditors’ meeting (see [94][99] );
  4. yes, a scheme creditor may appeal the chairman’s decisions to admit or reject its own and other creditors’ proofs of debt (see [100][110]);
  5. the proposed Scheme Manager’s decisions to partially reject Ho Lee’s proof of debt (to the extent that he did) and wholly admit St George Bank’s, Ascendas’ and First Capital’s proofs of debt for the purpose of voting were incorrect (see [111][129]);
  6. scheme creditors should be classified differently for voting purposes when their rights are so dissimilar to each other’s that they cannot sensibly consult together with a view to their common interest (see [130][151]);
  7. related party creditors should have their votes discounted in light of their special interests to support a proposed scheme, by virtue of their relationship to the company; wholly owned subsidiaries should have their votes discounted to zero and are effectively classified separately from the general class of unsecured creditors (see [152][171]).

It is a real pity that the law relating to schemes of arrangement is so underdeveloped in Malaysia. I still see too much of abuse of the restraining order in the Courts, a lack of sufficient understanding of the impact of schemes of arrangement, insufficient judicial safeguards of ensuring transparency and full disclosure in such schemes and with Courts not receiving enough guidance through reported decisions.