Corporate Rescue Talk at MIA

I was invited by the Malaysian Institute of Accountants to deliver a talk on 4 March 2014 focusing on the insolvency-related provisions of the Companies Bill. It was an interesting session, with a lot of questions and a lively discussion among the participants. The areas I touched on were the changes to the receivership, winding up and schemes of arrangement provisions, and the introduction of judicial management and the corporate voluntary arrangement.

rescue

A copy of my slides can be downloaded here.

Winding Up Petitions and Cross-Claims

I came across the unreported case of Josu Engineering Construction Sdn Bhd v TSR Bina Sdn Bhd [2013] MLJU 279 where Mary Lim J made a very thorough analysis of the issue of cross-claims and winding up petitions.This is a rare case where a cross-claim was successful in grounding an injunction to restrain the presentation of a winding up petition, even though the section 218 notice was based on a judgment debt.

There is a seemingly inconsistent position as to whether a genuine cross-claim (which exceeds the initial debt) is sufficient to oppose a winding up petition or to even ground an injunction to restrain the presentation of a winding up petition but this case carefully dissects the different Malaysian appellate authorities as well as other authorities from other jurisdictions.

BRIEF FACTS

The facts in Jose Engineering are important in understanding why the High Court allowed the injunction to restrain the presentation of a winding up petition. The Plaintiff and Defendant were earlier involved in litigation against each other in two different cases, and for ease of reference, I will call them the First Suit and the Second Suit.

In the First Suit, the Defendant succeeded in its counterclaim against the Plaintiff and then issued a section 218 notice seeking for payment under the counterclaim. There was an application filed for a stay of execution but with no hearing date fixed yet.

In the Second Suit, the Plaintiff in turn had obtained a judgment with damages to be assessed by the Senior Assistant Registrar. This was a final judgment as it was upheld by the Court of Appeal and leave to the Federal Court was dismissed. The assessment of damages had yet to be fixed for hearing and with the Plaintiff claiming that it had filed its bundles of documents and had prepared its witness statements. The Plaintiff’s contention is that its claim under the Second Suit judgment would far exceed the quantum of the First Suit’s counterclaim which was claimed in the section 218 notice.

LEGAL PRINCIPLES

The High Court’s analysis of the different authorities ran the gamut from the Malaysian cases of Pontian United Theaters Sdn Bhd v Southern Finance Berhad [2006] 1 CLJ 1067 (C.A.), People Realty Sdn Bhd v Red Rock Construction Sdn Bhd [2008] 1 MLJ 453 (C.A.) and Zalam Corporation Sdn Bhd v Dolomite Readymixed Concrete Sdn Bhd [2011] 9 CLJ 705 (C.A.) (where all the cross-claim arguments were dismissed) to the Singapore Court of Appeal cases of Metalform Asia Pte Ltd v Holland Leedon Pte Ltd [2007] SGCA 6 and Pacific Recreation Pte Ltd v SY Technology Inc & Another Appeal [2008] SGCA 1.

In general, where a debt is undisputed, an injunction to restrain the presentation of a winding up petition is generally refused. And a judgment debt is a clear undisputed debt. However, the High Court found guidance in the Singapore Court of Appeal Metalform decision which allowed an injunction to restrain the presentation of the petition even based on an undisputed debt due to the cross claim. The Singapore Court of Appeal rejected the New Zealand test of having to show that the winding up petition is “bound to fail.” In cross-claim cases, the appropriate test in allowing such an injunction that “there is a likelihood that the petition may fail or that it is unlikely that a winding up order would be made.”

APPLICATION

The High Court noted that unlike the facts before the Court, the earlier Malaysian cases did not involve a cross-claim in the nature of an interlocutory judgment. While the Defendant had a final judgment through the counterclaim, the Plaintiff was also armed with an interlocutory judgment which was also a final judgment. It was only the quantum of damages which had to be assessed. The cross-claim was therefore found to not only be genuine but also bona fide.

The injunction was allowed in restraining the presentation of the petition but on terms that the Plaintiff pay the full judgment sum to its solicitors to be held as stakeholders pending the assessment of damages.

CONCLUSION

This case, and the various authorities referred to in the decision, demonstrate the high threshold to be met in allowing a cross-claim to effectively defeat the right of a judgment creditor to present a winding up petition. This is understandable since the judgment creditor already comes armed with an undisputed debt through the judgment and has a statutory right to present a winding up petition. Whether the petition will be allowed at the hearing is another issue altogether. In litigation, the allegation of a cross-claim is sometimes only raised once the section 218 notice is presented and a cross-claim, exceeding the judgment sum, is cobbled together in order to try to prevent the presentation of the winding up petition.

Chapter 11 of the US Bankruptcy Code

[Originally published in Skrine’s Legal Insights Issue 3/2013]

Lehman Brothers. WorldCom. General Motors. Enron. These companies are among the largest bankruptcies in US history and they held a total of US$900 billion in assets at the time of filing for protection under Chapter 11 of the US Bankruptcy Code.

While a company seeking relief under Chapter 11 is often seen as entering ‘bankruptcy’ or insolvency, it will be shown that the Chapter 11 process is more akin to a debt restructuring mechanism rather than liquidation. The aim of this process is to allow the company to have some breathing space to reorganise its affairs and to then exit its financial distress.

This article will touch on some of the interesting features of the Chapter 11 framework while also drawing parallels with the debt restructuring mechanism of a scheme of arrangement under section 176 of the Companies Act 1965 (“Act”).

PROCEDURE

A typical Chapter 11 process is initiated through the debtor company filing a petition with a bankruptcy court setting out a list of its creditors and a summary of its assets and liabilities. The debtor has a legal right to initiate the procedure subject to the court determining that the petition was filed in ‘good faith’ primarily for the purposes of reorganising its debts.

Technically, there is no requirement of ‘insolvency.’ For instance, in 1995, the Dow Corning Corporation filed for Chapter 11 protection from creditors when it faced massive personal injury suits involving silicone-gel breast implants. It emerged from Chapter 11 only after nine years.

DEBTOR IN POSSESSION

Unlike liquidation which involves a liquidator taking over the management of the company, in a Chapter 11 scenario, the control of the debtor remains with its management through the concept of ‘debtor in possession.’ A trustee is rarely appointed to oversee the debtor’s operations. The rationale behind this concept is the belief that the management represents the most economical and efficient means to reorganise since they would have the most knowledge of the company’s affairs.

As a safeguard, the debtor will be subjected to oversight by the bankruptcy court and the United States Trustee (a representative of the Department of Justice responsible for overseeing bankruptcy cases). Generally, a committee of creditors would also be appointed to act in a supervisory role.

MORATORIUM

Upon the filing of the Chapter 11 petition, an automatic moratorium would stay legal proceedings against the debtor and enforcement of judgments and security without leave of the bankruptcy court. The stay is effective during the entire time the petition is pending but creditors and other parties may apply to lift or modify the stay.

This is similar to the moratorium enjoyed under a restraining order granted pursuant to section 176(10) of the Act although there is no automatic grant of a restraining order. Instead, the requirements under section 176(10A) must be met for the grant of a time-limited restraining order as well as for any extension of this order.

PROPOSALS TO CREDITORS

Under Chapter 11, the debtor has the exclusive right to formulate the plan of reorganisation for 120 days from the date of filing and this exclusivity period can be extended up to a maximum of 18 months.

In contrast, in a scheme of arrangement, the company, any creditor, any member or the liquidator (where the company is being wound up) can apply to the High Court to initiate the scheme of arrangement process.

DISCLOSURE STATEMENT

Before the debtor solicits approval for the restructuring plan, it must provide creditors with a disclosure statement that has been approved by the bankruptcy court as containing adequate information to allow a reasonable hypothetical creditor to be able to consider the plan.

This is very similar to the scheme of arrangement requirement of the explanatory statement under section 177 of the Act. The explanatory statement must provide the creditors with sufficient or material information to make a meaningful decision. However, the explanatory statement is not subject to the added safeguard of requiring approval by the Court before its issuance to the creditors.

CLASSIFICATION OF CREDITORS AND VOTING

Chapter 11 requires creditors to be classified into classes on the basis that claims that are substantially similar should be classified together. This is similar to a scheme of arrangement scenario.

The creditors of each class would need to vote in favour of the plan by a majority in number and two-thirds in amount of those actually voting (while in a scheme of arrangement, the approval threshold is higher in that a majority in number and three-fourths in value is required). The minority is bound by the class vote.

UNDUE PREFERENCES

Similar to winding up, the US Bankruptcy Code gives a debtor certain powers to avoid or recover certain transfers of property. Generally, a debtor can avoid such transfers made within 90 days before the filing of the petition to a creditor on account of a pre-existing debt if such a transfer allows the creditor to receive more than it would have received compared to other creditors. These are called preferences.

A debtor can also avoid fraudulent transfers made within one year before the filing of the petition. In this context, a fraudulent transfer is one which is made with the intent to hinder, delay or defraud a creditor.

CHERRY-PICKING

Under the US Bankruptcy Code, the debtor generally has the power to pick which contracts or leases by which it wants to be bound following its reorganisation. Further, under certain circumstances, the company can adopt its favourable contracts and then assign them regardless of whether the contracts themselves prohibit such an assignment.

The Bankruptcy Code prescribes deadlines within which different types of contracts may be rejected. The debtor is not required to perform the obligations under the rejected contracts but will be liable for “rejection damages” that arise from its non-performance of the obligations under such contracts.

Chapter 11 therefore provides the debtor with wide-ranging powers with which it can reject, adopt or assign contracts. This power, especially when combined with the ability to sell assets and borrow money, enables the company to address its operational needs.

INCENTIVES FOR LENDER FINANCING

The Bankruptcy Code gives lenders incentives to provide financing to the debtor (called Debtor in Possession or DIP financing). DIP financing is unique from other financing methods in that it usually has priority over existing debt, equity and other claims. The lender may be given a lien over assets that are not pledged to other lenders. The bankruptcy court may also authorise liens superior to certain priority claims in the bankruptcy process or even grant new senior liens on collateral already pledged to another party.

‘QUICK-RINSE’ BANKRUPTCY

The term ‘quick-rinse’ bankruptcy generally describes a pre-packaged bankruptcy where the debtor has negotiated a plan and solicited votes even before the filing of the Chapter 11 petition. An example of this is Chrysler in 2008, where it entered and exited Chapter 11 in less than two months with the sale of most of its assets to a new entity. Similarly, General Motors in 2009 exited Chapter 11 in just over a month, having also sold most of its assets to a new General Motors entity and shedding almost US$90 billion in debt.

CONCLUSION

The Chapter 11 procedure allows a great deal of flexibility for the resuscitation of a financially distressed company with the breathing space of a moratorium. However, criticisms have been levelled against the fact that the persons who caused the company to petition for relief continue to be the same ones in control; akin to leaving the fox in charge of the hen house.

Federal Court Rules on Plagiarism Claim

Arising from an earlier Federal Court decision involving Kian Joo Holdings Sdn Bhd and its liquidators (see my earlier post on the decision), the dissatisfied contributories had filed an application to review this decision  on the grounds that the Federal Court grounds of judgment had substantially reproduced the written submissions filed by solicitors for the liquidators. The allegation was that there was insufficient consideration by the Federal Court of the Majority Contributories’ case.

I have now read off the Bernama website that this application has been dismissed on 22 May 2013. It is reported that in the Grounds of Judgment read out by Chief Justice Tun Arifin Zakaria, it was held that the adoption of counsel’s submissions as the court’s ground of judgment in itself was not a sufficient ground for the Federal Court to set aside its earlier judgment. Nonetheless, the Court did not encourage such practice as it had a tendency to invite negative perception, which would go against the presumption of judicial impartiality and accountability.

Chief Justice Tun Arifin Zakaria said scrutiny of the court’s grounds of judgment revealed that not all the submissions made by the liquidators’ counsel were adopted by the court.

He said out of the 189 paragraphs of the submissions, only 70 paragraphs were adopted by the court.

“And in so doing, the court inserted their own words in parts of the judgment.

“All these could not be done without the learned judges in fact applying their minds to the issues raised in the appeal,” said Arifin in a judgment delivered today.

In his 37-page judgment, Arifin said there had been due process as the case had gone through the full appeal process before the Court of Appeal and the Federal Court and that both the grounds of the High Court and Court of Appeal judgments were before the Federal Court.

Arifin said the 25 applicants were also given full liberty to make their oral submissions at the hearing before the Federal Court which was stretched over a period of two days, adding that written submissions were also filed.

“In fairness to the panel (three-member Federal Court panel), we have to assume that they must have considered the judgments of the courts below and the submissions of the parties, both oral and written, before arriving at their decision,’ he said.

The judiciary’s top judge (Arifin) said the adoption of counsel’s submissions as the court’s ground of judgment in itself was not a sufficient ground for the Federal Court to set aside its earlier judgment.

He cited a minority decision of a British Columbia Court of Appeal in the case of Cojocaru vs British Columbia Women Hospital and Health Centre which held that there was nothing inherently wrong with adopting the submissions of a party in whole or in part as reasons for judgment so long as those submissions truly and accurately reflect the judge’s own independent analysis and conclusion.

Arifin however said the court did not encourage such practice as it had a tendency to invite negative perception, which would go against the presumption of judicial impartiality and accountability.

What is still pending before the Federal Court are the application by the liquidators to cite these contributories and their lawyer, Datuk V K Lingam, for contempt of court for alleging plagiarism in the Federal Court judgment and the application to set aside this contempt application.