English High Court – Litigation can be struck out if it is a collateral attack on concluded arbitration proceedings

The English High Court in Michael Wilson & Partners Ltd v Sinclair and others [2012] EWHC 2560 (Comm) confirmed that factual disputes decided in concluded arbitral proceedings should not be re-litigated. The subsequent litigation proceedings can be struck out as an abuse of court process as re-litigating it acts as a collateral attack on the concluded arbitral proceedings.

In this case, essentially the claim by A against B was struck out as an abuse of process even though B was not a party to the arbitration between A and C. B had merely appeared as a witness in the arbitration between A and C.

Justice Teare held the following:

59. In the present case there is no doubt that the factual allegations being made as to the conduct of Mr. Emmott in this action mirror exactly the failed allegations in the arbitration. The difference between the arbitration and the litigation is that the claim in the arbitration was against Mr. Emmott alleging that he had acted in breach of fiduciary duty whereas the claim in the litigation is against Mr. Sinclair alleging that he dishonestly assisted in that breach of duty. However, the underlying factual allegations concerning Mr. Emmott are the same. There is therefore a collateral challenge to the findings of the arbitration tribunal. But that can be said to be justified because Mr. Sinclair was not a party to the arbitration and had refused to be party to it. The Max action is therefore the only means by which MWP can bring its claim against Mr. Sinclair. It cannot, it is said, be an abuse of the process for MWP to seek to use its process in those circumstances.

60. If those had been the only material circumstances I would not have been persuaded that the proceedings in this court were being abused. However, there are, it seems to me, special circumstances in this case which must, in my judgment, be taken into account. First, Mr. Sinclair was a witness in the arbitration and was cross-examined. Second, Mr. Sinclair, no doubt because of his interest in the outcome of the arbitration, funded Mr. Emmott’s defence in the arbitration. Third, the arbitration tribunal concluded that the Max shares were held to the order of Mr. Sinclair. Fourth, the arbitration tribunal intended and expected that the effect of its award would be that EPIL would transfer the Max shares to Mr. Sinclair. To that end it authorised disclosure of the relevant section of its award to Mr. Sinclair, the EPIL Trustees and the Bahamian Court. That explains how Mr. Sinclair, a non-party to the arbitration, has a copy of the award and reasons which would ordinarily be private and confidential to the parties.

I believe this is the first occasion on which an English court has applied the abuse of process doctrine to a collateral challenge to an arbitration award.

Media Summary of Federal Court Judgments

It is a good step that the Federal Court now releases a media summary along with its Grounds of Judgment. I recall reading the Chief Justice stating that the Judiciary would now take that step so it is good that we now follow suit with other countries like Singapore and the UK.

Federal Court appeals should after all only deal with novel questions of law and questions of public importance so the media summary would help to educate the public at large on the significance of the decision.

However, the first Federal Court decision that comes with its Media Summary deals with a rather procedural and technical area of the law. The question being whether a failed attempt at setting aside the service of court papers out of jurisdiction (under Order 11 of the Rules of the High Court 1980) would then still allow for a successful striking out of the action (under Order 18 Rule 19 of the Rules of the High Court 1980). Not exactly the decision to digest and not with the widest application.

But this step of releasing a media summary is something to be applauded.

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.

Singapore High Court – Cannot Set Aside Interim Orders of Arbitral Tribunal

The Singapore High Court in PT Pukuafu Indah and others v Newmont Indonesia Ltd and another [2012] SGHC 187 has confirmed that under the Singapore International Arbitration Act, the Court has no power to set aside interim orders of the arbitral tribunal as such orders do not fall under the definition of “award”.

The policy argument as to why the Singapore Act was drafted in that manner, to deliberately omit the power to set aside interim orders, was set out as follows:

26     The temporary character of interim orders, as distinct from the finality of awards, also necessitates a separate approach towards these orders. It is possible that interim orders may be modified or terminated during the course of the arbitral proceedings. While the courts are willing to enforce these orders to ensure that the arbitration progresses smoothly, allowing parties to challenge an interim order would have the undesirable effect of staying the arbitration while judicial determination of the issue is pending. The better remedy, and one which could be determined with proper consideration of the substantive context of the dispute and which focuses on the actual merits of the grounds for ordering such relief, would be to have recourse to the arbitral tribunal and not the courts.

The provisions in Malaysia’s Arbitration Act 2005 would appear to also lead to a similar result in that a Court has no power to set aside an interim order (or interim measure) given by the tribunal. Section 2 of Malaysia’s Act also sets out that an “award” does not include interlocutory orders. Therefore, section 37 of Malaysia’s Act which provides for the setting aside of an “award” should not apply to interlocutory orders made by the tribunal.

Similar to the Singapore position, section 19 of Malaysia’s Act also provides that interim measures granted by the tribunal can be enforced by way of enforcement under section 38 (and be subject to opposition under section 39). There is an explicit omission to refer to section 37 for setting aside.

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.

Hong Kong Court of Appeal – Indemnity Costs against Unsuccessful Party Setting Aside or Resisting Enforcement of Award

The Hong Kong Court of Appeal in decision of Pacific China Holdings Ltd (in Liquidation) v Grand Pacific Holdings Ltd CACV 136/2011 has affirmed the principle that an unsuccessful party in applying to set aside an arbitral award, or in resisting the enforcement of the award, in the absence of special circumstances, will then be liable to pay costs on an indemnity basis.

The Court of Appeal affirmed this principle set out by Reyes J in the Hong Kong Court of First Instance case of A v R [2009] HKCFI 342. It is worth setting out the relevant passages by Reyes J which has the underlying principle that Courts should more readily respect arbitration proceedings and dissuade frivolous attempts to delay the enforcement of arbitral awards:

67. Parties should comply with arbitration awards. A person who obtains an award in his favour pursuant to an arbitration agreement should be entitled to expect that the Court will enforce the award as a matter of course.

68. Applications by a party to appeal against or set aside an award or for an Order refusing enforcement should be exceptional events. Where a party unsuccessfully makes such application, he should in principle expect to have to pay costs on a higher basis. This is because a party seeking to enforce an award should not have had to contend with such type of challenge.

69. Further, given the recent introduction of Civil Justice Reform (CJR), the Court ought not normally to be troubled by such type of application. A party unmeritoriously seeking to challenge an award would not be complying with its obligation to the Court under Order 1A Rule 3 to further the underlying objectives of CJR, in particular the duty to assist the Court in the just, cost-effective and efficient resolution of a dispute.

70. If the losing party is only made to pay costs on a conventional party-and-party basis, the winning party would in effect be subsidising the losing party’s abortive attempt to frustrate enforcement of a valid award. The winning party would only be able to recover about two-thirds of its costs of the challenge and would be out of pocket as to one-third. This is despite the winning party already having successfully gone through an arbitration and obtained an award in its favour. The losing party, in contrast, would not be bearing the full consequences of its abortive application.

71. Such a state of affairs would only encourage the bringing of unmeritorious challenges to an award. It would turn what should be an exceptional and high-risk strategy into something which was potentially “worth a go”. That cannot be conducive to CJR and its underlying objectives.

72. Accordingly, in the absence of special circumstances, when an award is unsuccessfully challenged, the Court will henceforth normally consider awarding costs against a losing party on an indemnity basis. The Respondent will here pay the Applicant’s costs on an indemnity basis.

This approach set out in A v R was however not followed in Australia, as seen in the Court of Appeal of the Supreme Court of Victoria in IMC Aviation Solutions Pty Ltd v Altain Khuder LLC [2011] VSCA 248.

It will be interesting to see which approach Malaysia takes when these competing arguments are raised before the Courts. I am not aware of any decision directly dealing with the issue of indemnity costs. The reported decisions appear to only award costs on the ordinary party-to-party basis, since parties may not have brought these issues to the attention to the Court.

I can see the strong public policy argument in support of the Hong Kong approach that the Courts should be pro-arbitration and do all that is necessary to minimise delay and umeritorous challenges to arbitral awards.

Polar Opposites: Setting Aside a Foreign Arbitral Award

Originally published in Skrine’s Legal Insights Issue 3/2012

The High Court has confirmed in its oral grounds of judgment in Twin Advance (M) Sdn Bhd v Polar Electro Europe BV (Penang High Court Originating Summons No. 24-2292-12/2011) that where the seat of arbitration is outside of Malaysia, the Malaysian Courts have no jurisdiction under section 37 of the Arbitration Act 2005 (“the Act”) or under its inherent jurisdiction to set aside such an arbitral award.

BRIEF FACTS

The foreign defendant commenced arbitration proceedings against the Malaysian plaintiff where the seat of arbitration was in Singapore. The defendant obtained an arbitral award for damages and thereafter commenced proceedings to enforce the award in Malaysia under section 38 of the Act.

The plaintiff then filed an Originating Summons in the Malaysian courts to set aside the arbitral award, relying on section 37 of the Act. The defendant obtained leave to enter conditional appearance and applied to strike out the proceedings under the Originating Summons on the grounds that the Malaysian courts had no jurisdiction to hear such an application and that any application to set aside the arbitral award should have instead been made in the Singapore courts where the seat of arbitration was.

MODEL LAW AND NON-INTERFERENCE

On 7 August 2012, the Court read out its oral grounds of judgment allowing the defendant’s striking out application. The Court first highlighted the historical context of the Act and the adoption of the United Nations Commission on International Law (UNCITRAL) Model Law on International Commercial Arbitration 1985 (“Model Law”). The Court also agreed with the approach that it was Parliament’s intention to limit the Court’s intervention in international arbitrations and that the Court may only exercise such powers if the Act expressly provides the Court with such powers.

The Court also referred to the Officiating Address by the Chief Justice of Malaysia at the Launch of the KLRCA Fast Track Rules made on 27 February 2012. The Chief Justice had stressed that with the amendments to the Act that came into force in July 2011, the Courts are more receptive to respecting the parties’ choice to go for arbitration. The Chief Justice had also highlighted that section 8 of the Act (being identical to Article 5 of the Model Law) states in clear terms that no court shall intervene in matters governed by the Act, except where expressly provided in the Act.

THE PLAINTIFF’S ARGUMENTS

The plaintiff advanced two main arguments in support of its contention that the Court had jurisdiction under the Act to hear the setting aside. Firstly, that the plain wording of section 37 of the Act (which is based on Article 34 of the Model Law) provides that “an award may be set aside by the High Court” and makes no reference to whether the award had its seat of arbitration in or outside of Malaysia.

Secondly, the plaintiff submitted that as the grounds for setting aside listed in section 37 of the Act are also repeated in the grounds for resisting enforcement under section 39 of the Act, it would be inconsistent to hear the grounds listed in section 39 without also being able to apply the grounds in section 37 of the Act.

FINDING OF NO JURISDICTION

The Court disagreed with the plaintiff’s submissions. The Court held that section 3 of the Act, being based on Article 1(2) of the Model Law, makes it clear that the provisions of the Act would not apply to any arbitration with the seat of arbitration outside of Malaysia. Nonetheless, it further held that section 3 is a general provision which must be read subject to any specific provisions under the Act, for instance enforcement under sections 38 and 39 of the Act (which are based on Articles 35 and 36 of the Model Law). Section 38 has a specific reference to “an award from a foreign State” while section 39 contained the wording “irrespective of the State in which it was made”.

Under the recent amendments to the Act, both section 10 which relates to a stay of Court proceedings (based on Article 8 of the Model Law) and section 11 which allows for interim measures (based on Article 9 of the Model Law) also expressly state that they apply to international arbitrations with the seat of arbitration outside of Malaysia.

The Court further went on to hold that there was a glaring distinction in the references to “an award from a foreign State” and “irrespective of the State in which it was made” in sections 38 and 39 respectively which were omitted from the wording of section 37 of the Act.

The Court also noted that sections 37(2)(a) and (b) of the Act listed out additional grounds allowing for the setting aside of an award which were absent in the grounds listed in section 39 of the Act.

On the basis of statutory interpretation, the Court held that the different wording in sections 38 and 39 compared with section 37 of the Act was not unintentional. It was intended for section 37 to be read in harmony with section 3 which would then only apply where the seat of arbitration is in Malaysia. Sections 38 and 39 are to be construed as an exception to the general position of section 3 of the Act.

Such an interpretation was in line with the Model Law framework and also consistent with the Federal Court authorities of The Government of India v Cairn Energy India Pty Ltd & Anor [2011] 6 MLJ 441 and Lombard Commodities Ltd v Alami Vegetable Oil Products Sdn Bhd [2010] 2 MLJ 23 which held that a setting aside of an award must be applied to the court at the seat of arbitration. While the Court recognised that these authorities were decided under the previous Arbitration Act 1952, the same principles would still apply in interpreting sections 37, 38 and 39 of the present Act.

Having held that section 37 of the Act was not applicable for the award where the seat of arbitration is outside of Malaysia, the Court then considered whether it could invoke its inherent jurisdiction in an application for setting aside. The Court answered in the negative and adopted the Court of Appeal decision of Sarawak Shell Bhd v PPES Oil & Gas Sdn Bhd & Ors [1998] 2 MLJ 20 in finding that the Court has no inherent jurisdiction to interfere with arbitrations.

It was held that it was the consensus of the parties to arbitrate any dispute and for the seat of arbitration to be in Singapore. The plaintiff’s remedy was clearly unaffected as it could have gone to the Singapore Courts to make the necessary application for setting aside. Therefore, the application pursuant to section 37 of the Act could not be maintained for want of jurisdiction and the Court struck out the proceedings. The plaintiff has since filed an appeal against this decision.

COMMENTARY

It is clear from this decision that an application to set aside an arbitral award under section 37 cannot be equated with the opposition to an application to enforce an arbitral award under section 39 of the Act. The former applies only to arbitral awards where the seat of arbitration is in Malaysia whereas the wording of section 39 makes it clear that that provision applies to an arbitral award irrespective of the State in which it was made.

This decision is significant in confirming that Malaysian Courts have no jurisdiction, whether under the Act or under its inherent jurisdiction, to set aside any foreign arbitral awards i.e. an award where the seat of arbitration is outside of Malaysia. This interpretation of the Act harmonises Malaysia’s arbitration laws with that of the approach under the Model Law. The proper venue for setting aside of such a foreign arbitral award must be the national courts of the seat of arbitration.

Validation Order in a Just and Equitable Winding Up

This post will feature the different considerations for a validation Order (to allow for dispositions of property after the presentation of a winding up Order) in a just and equitable winding up Petition compared to that of a Petition based on the company’s inability to pay its debts.

Introduction to Section 223: Void Dispositions

In a compulsory winding up in Malaysia, winding up is deemed to commence upon the presentation of a Petition rather than at the date of the actual winding up Order. Therefore, there is the real risk that any disposition of property after the presentation of a Petition will be deemed void (under section 223 of the Companies Act).

The purpose of section 223 is to protect the interests of the creditors, especially since such winding up proceedings by the Court is predicated on the fact that the company is insolvent.

In the English High Court decision of Re A.I. Levy (Holdings) Ltd [1964] 1 Ch 19, Buckley J stated the following of the identical provision under the English Companies Act (at page 27):

“It appears to me that the object of the section is to protect the interests of the creditors from the possibly unfortunate results which would ensue from the presentation of a petition, and to protect their interests as much during the period while the petition was pending as after an order has been made on it.”

Difference in Winding Up Petition based on Alleged Insolvency and that of a Shareholders Dispute

However, the law draws a distinction between a creditor’s petition based on alleged insolvency and a contributory’s petition for winding up not based on insolvency. The Court ought not interfere with mere disagreements of business management or judgments.

As observed in Low Siew Cheang ‘Corporate Powers – Accountability’ (2nd Edition, 2002) (at page 1275):

“In a contributory’s petition for winding up and the ground is not insolvency, the general principles of law applicable to director’s powers in the management of the business and affairs of the company assume greater significance in cases where the company is an active company. This is but an application of common sense – the court does not interfere with mere disagreements in matters of business management or judgments.”

The English High Court decision of Re Burton & Deakin Ltd [1977] 1 WLR 390 (“Burton & Deakin”) involved a shareholders dispute (albeit concerning an oppression petition). The company in that case sought for a validation order under the equivalent provision of the English Companies Act and the petitioners therein opposed the application. Slade J allowed the validation and held the following (at page 397):

“At least so long as a winding up petition has not been presented, the court will not generally, save in the case of proven bad faith or other exceptional circumstances, interfere with the exercise of the discretion conferred on the directors by a company’s articles of association at the instance of a shareholder.

…

I can see no good reason why the rights of interference by a shareholder vis-à-vis the company or its directors should, in this kind of situation, for practical purposes be drastically improved during the interim period, merely because he happens to have presented a winding up petition which is not demurrable and which has not yet been heard.

…

If on an application under section 227 relating to a solvent company, (a) evidence is placed before the court showing that the directors consider that a particular disposition, falling within their powers under the company’s constitution, is necessary or expedient in the interests of the company, and (b) the reasons given for this opinion are reasons which the court considers that an intelligent and honest man could reasonably hold, it will in the exercise of its discretion normally sanction the disposition, notwithstanding the opposition of a contributory, unless the contributory adduces compelling evidence proving that the disposition is in fact likely to injure the company.”

The case of Burton & Deakin was referred to approvingly and applied in the High Court decision of Lim Pin Chuan v Delimec Hygience Sdn Bhd & 4 Ors [2000] 1 AMR 454. This case similarly involved a winding up petition based on the just and equitable ground. Mohd Ghazali b Mohd Yusoff J (as he then was) allowed an application for validation and applied Burton & Deakin.

In the High Court decision of BSN Commercial Bank (M) Bhd v River View Properties Sdn Bhd and another action [1996] 1 MLJ 872, Abdul Malik Ishak J (as he then was) allowed the validation of payments to run its daily affairs. His Lordship held (at page 882):

“It is my judgment that the court will always have regard as to whether the disposition was made bona fide in the course of the company’s current trade, and if not validated, the trade of the company would be paralysed without any advantage … Likewise here, as Mr Wong Kim Fatt rightly pointed out that River View needed the money to pay dividends and to run its daily affairs, without which River View would be paralysed, and on these grounds, the validation of the dispositions should be ordered in favour of River View and I so ordered accordingly.”

Conclusion

The reality is that upon the presentation of any winding up Petition, whether based on insolvency or the just and equitable ground, many banks will immediately freeze the bank accounts of the company. So even where a perfectly solvent company is subjected to a shareholder dispute between competing groups of shareholders, this company may find that its business operations come to a grinding halt when its bank accounts frozen. It is common to even have the Petitioning shareholder(s) to immediately inform the banks of the presentation of the Petition in the hope of exerting pressure on the responding group of shareholders when the company finds it difficult to operate.

It is therefore imperative that the Court quickly hears applications for validation Orders and where the Court gives different considerations where the Petition is based on a shareholder dispute.

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.