Although the court did not make such a ruling, the act of the controller is caught by ..... Brennan CJ, McHugh and Kirby JJ, took the view that the phrase âintent to ...
CORPORATE INSOLVENCY AND THE PROTECTION OF CREDITORS⊕
by MOHAMMAD RIZAL SALIM*
The Position of Other Corporate Controllers Fiduciary duties to act in the best interests of the company are not limited to directors alone; they also extend to other corporate controllers, who, although not formally appointed as directors, exercise control over the company. In Yukong Line Ltd of Korea v Rendsburg Investments Corp of Liberia (No 2), the court ruled that a corporate controller, although not a shareholder or director, may nevertheless be liable for misfeasance pursuant to section 212 of the Insolvency Act 1986.1 In this case, assets were transferred out from one company to another. The court found that an individual was in control over both companies and that the transfer was motivated by the need to place the corporate assets of the transferor company out of the reach of its creditors. Although this individual was neither the registered shareholder nor director of the two companies, he exercised real control over both. He was the beneficial owner of the entire share capital of the transferor company and on his instructions had caused the resignation of two directors of the company. As a controller of the transferor company, this individual was placed in a position similar to that of a director. The learned judge then referred to West Mercia Safetywear Ltd v Dodd2 (which cited with approval the proposition made by Street J in Kinsela v Russell Kinsela Pty Ltd (in liq)3) and said:4 Where a director, or person having the management, of an insolvent company acts in breach of his duty to the company by causing assets of the company to be transferred in disregard of the interests of its creditor or creditors, under English law he is answerable through the scheme which Parliament has provided [section 212 Insolvency Act 1986]. Although this case is not a direct authority that corporate controllers owe a duty to creditors, it is implicit in the judgment that a duty may be imposed, partly because of the reference to West Mercia.5 Although the court did not make such a ruling, the act of the controller is caught by section 212 of the Insolvency Act 1986.
⊕
*
1 2 3 4 5
This is a continuation of part 1 which appeared in the previous edition of this journal. Lecturer, Faculty of Law, Universiti Teknologi MARA, Malaysia, PhD (Lancaster), LLM (Melbourne), LLB (Hons) (Malaya), Advocate & Solicitor, High Court of Malaya. The research for this paper was funded by the Institute of Research, Development and Commercialisation (IRDC), Universiti Teknologi MARA. [1998] 4 All ER 82. [1988] BCLC 250. (1986) 10 ACLC 395. [1998] 4 All ER 82 at 99. [1988] BCLC 250.
1 Electronic copy available at: http://ssrn.com/abstract=1462902
Perhaps another way to impose fiduciary duties on a corporate controllers is to label him/her as a “shadow director”, defined as “a person in accordance with whose directions or instructions the directors of a corporation are accustomed to act”.6 A shadow director would be clothed with fiduciary duties to the company, as with any other director formally appointed.
The Position of Employees Under the Companies Act 1965, the reference to “officers” includes directors, secretary and employees of a corporation.7 Sections 303(3) and 305 of the Companies Act 1965 provide for liabilities of “officers”, which, by virtue of section 4(1) of the Act, extends to employees as well. Section 304(1) extends liabilities to any person who carries on the business of the company, which thus includes officers or employees. Employees may, in certain circumstances, owe fiduciary duties to the company. In Canadian Aero Service Ltd v O’Malley,8 the Supreme Court of Canada found that the unofficial president and vice-president of a company, although not properly appointed as directors of the company, had acted as directors. In particular, the court found that the two were “top management” and not “mere employees” and therefore stood in a fiduciary relationship to the company. They had breached this duty when they had obtained a business advantage at the expense of the company.9 Although the case is not an authority for saying that employees in discharging their duties must consider the interests of creditors, certainly there can be a strong argument in support. Since a duty is owed to the company, it includes the interests of creditors of the company as a stakeholder of the company, especially so where the company is insolvent.
Directors’ and Officers’ Statutory Duties Fraudulent trading The Companies Act 1965 provides for both civil and criminal liabilities for fraudulent trading. Section 304(1) of the Companies Act provides that where the business of the company has been carried on with intent to defraud creditors, any person who was knowingly a party to the carrying on of the business in that manner shall be personally responsible for the debts or other liabilities of the company. Sub-section (5) to the section provides for criminal liability for the same offence. The Malaysian provision for fraudulent trading was borrowed from the Australian Companies Code 1961, which was, in turn, modeled after the section 332 of the UK Companies Act 1948. This provision was introduced as a result of the recommendation of 6 7 8 9
See the definition of “director” in s 4(1) of the Companies Act 1965. Ibid. (1974) 40 DLR (3d) 371. Ibid at 381-382.
2 Electronic copy available at: http://ssrn.com/abstract=1462902
the Greene Committee’s Report in 1926.10 This provision initially suffered from two serious weaknesses – firstly because of the limitation of the provision itself, and secondly because of restrictive judicial interpretation. The provision is limited in the sense that it applies only to companies that are being wound up.11 This has been rectified in the subsequent English and Australian legislations that were duly adopted in Malaysia. Therefore, the law as it stands now allows recovery by individual creditors. Criminal proceedings can be taken not only in the course of the winding up of a company but also “in any proceedings against a company”. Another weakness of the provision is that the fraudulent trading provision is both a civil and criminal wrong. The inherent problem with this is that judges tended to view the provision as a penal section, although it is settled law that in such cases the standard of proof is civil and not criminal.12 Additionally “intent to defraud” is not easy to prove.13 There must be a positive act on the part of the wrongdoer, as “mere silence and omission to give advice” does not make a person “a party to the carrying on of the company’s business”.14 It is also not clear whether damages shall be compensatory or punitive in nature.15 The ability of creditors to bring a direct action against the wrongdoer and the power of the court to order the wrongdoer liable for the debt is another perceived weakness of this provision.16 The creditor who takes action will be able to gain some preference over other creditors, which may otherwise be construed as fraudulent preference. The current fraudulent and wrongful trading provisions in the UK Insolvency Act 1986 removes this problem by allowing only liquidators to take action and, if the action is successful, the wrongdoers will be ordered to contribute to the assets of the company and distributed to the creditors according to the rule on priorities as provided by law.17 The courts have also struggled to find a consistent meaning to the phrase “intent to defraud” and the test to be applied. Some courts prefer to apply a liberal interpretation of the phrase, while others opted for a strict approach. The following quotations are illustrations from some cases: Re William C. Leitch Brothers Ltd: In my opinion I must hold with regard to the meaning of the phrase carrying on business “with intent to defraud creditors” that, if a company continues to carry 10 11 12 13
14 15
16 17
Report on Company Law Amendment, Cmnd. 2657 (1926). See for example Re William C Leitch Bros Ltd [1932] Ch 261. Hornal v Neuburger Products Ltd [1957] 1 QB 247; [1956] 3 All ER 970. See discussion by Harry Rajak, “Company Directors – The End of An Era?” (1989) 139 New Law Journal 1374. Re Maidstone Buildings Provisions Ltd [1971] 3 All ER 363 at p 369. But, applying the ordinary rules of construction, if there remains any doubt or ambiguity, the person against whom the penalty is sought to be enforced is entitled to the benefit of the doubt: Re Maidstone Buildings Provisions Ltd [1971] 3 All ER 363 at 369. But see Re Cyona Distributors Ltd [1967] 1 All ER 281 and Re Gerald Cooper Chemicals Ltd [1978] Ch 262. This applies to the wrongful trading provision under s 303(3) as well. Although individual aggrieved creditors may find themselves without any course of action where the liquidator refused to act.
3
on business and to incur debts at a time when there is to the knowledge of the directors no reasonable prospect of the creditors ever receiving payment of those debts, it is, in general, a proper inference that the company is carrying on business with intent to defraud.18 Re White & Osmond (Parkstone) Ltd: In my judgment, there is nothing wrong in the fact that directors incur credit at a time when, to their knowledge, the company is not able to meet all its liabilities as they fall due. What is manifestly wrong is if directors allow a company to incur credit at a time when the business is being carried on in such circumstances that it is clear that the company will never be able to satisfy its creditors. However, there is nothing to say that directors who genuinely believe that the clouds will roll away and the sunshine of prosperity will shine upon them again and disperse the fog of their depression are not entitled to incur credit to help them get over the bad time.19 Hardie v Hanson: To obtain goods on credit with the intention of not paying for them is dishonest; to obtain goods on credit when it is known that there is no chance of paying for them may amount to much the same thing; in either case the unpaid creditors could be said to have been intentionally defrauded. It is different however that if no such intention can be imputed to the buyer or if he does intend to pay for the goods but in the event fails to do so. In such a case the degree of fault depends upon the buyer’s estimate of the probability or improbability of payment at the time when the goods were purchased, but even if the chances of payment of all creditors in full were so remote that it belonged to the realms of hope rather than belief, it seems to me that the fault, grievous though it may be, falls short of fraud unless it is coupled with something else, such as misrepresentation of the position or an intention to use goods purchased on credit for the purpose of dishonest gain, which gives it a fraudulent character. 20 R v Grantham: “defraud” … requires a person as its object; that is, defrauding involves doing something to someone. Although in the nature of things it is almost invariably associated with the obtaining of an advantage for the person who commits the
18
19 20
[1932] 2 Ch 71, per Maugham J at 77; and referred to with approval by the Malaysian High Court in H Rosen Enginering BV v Siow Yoon Keong [1997] 1 CLJ 137 at p 144. However, in a later case, Re Patrick & Lyon Ltd [1933] Ch 786, Maugham J said (at 790) that the phrase intent to defraud must “connote actual dishonesty involving, according to current notions of fair trading among commercial men, real moral blame.” This case was followed in Malaysia in Tang Eng Iron Works Co Ltd v Ting Ling Kiew [1990] 2 MLJ 440 (HC); Ting Ling Kiew v Tang Eng Iron Works Co [1992] 2 MLJ 217 (SC). Per Buckley J, unreported 30 June 1960, quoted in R v Grantham [1984] 3 All ER 166. [1959-60] 105 CLR 451, per Menzies J at 466-467.
4
fraud, it is the effect on the person who is the object of the fraud that ultimately determines its meaning.21 As can be seen, the judges disagreed on whether fraud existed where the directors knew that the company cannot pay its debts.22 Such a situation could otherwise be described as “constructive fraud”. Should there be something more than knowledge that the company cannot pay its debts, such as dishonest intention?23 Even Maugham J. contradicted himself in two cases in subsequent years.24 Lord Lane C.J. in R v Grantham25 referred to the passages by Maugham J. in both Re William C Leitch Bros Ltd and Re Patrick & Lyon Ltd,26 and Lord Buckley J. in Re White & Osmond (Parkson) Ltd.27 Lord Lane disagreed with Lord Buckley J. and proposed that whether or not there was fraud depends on the effect on the person who was the object of the fraud. This is a very liberal test of fraud, more than that which was suggested by Maugham J. in Re William C Leitch Bros Ltd.28 Lord Lane C.J.’s decision came under criticism by Farrar,29 where he commented that the principle in R v Grantham30 was too strict and while it may be justifiable on the facts, it “imposes a potentially harsh standard which in future will apply across the board”.31 Farrar recommends the test in Hardie v Hanson.32 However, disagreements arose again in Canane v Cannane33 where the dissenting judge, Gummow J, relying on Hardie v Hanson,34 taking the minority view that “intent to defraud” can only be proven if there is a subjective intention. The learned judge quoted a passage in Kitto J.’s judgment in that case where it was said that an “actual purpose, consciously pursued, of swindling creditors out of their money had to be established” to prove “intent to defraud”. The majority, however, disagreed. Brennan CJ, McHugh and Kirby JJ, took the view that the phrase “intent to defraud” does not require any subjective test of dishonesty or intent to defraud - an inference would suffice to prove such intent, if, after considering all the circumstances, it could be shown that there is “a subtraction of assets which, but for the impugned disposition, would be available to meet the claims of present and future creditors”.35 From this discussion, it is clear that the laws have been inconsistently applied.
21
22 23 24 25 26 27 28 29
30 31
32 33 34 35
[1984] 3 All ER 166 per Lord Lane CJ at 170, quoting a passage from Welham v DPP [1960] 1 All ER 805, per Lord Radcliffe. For example Re William Leitch Brothers Ltd [1932] 2 Ch 71. For example Re Patrick & Lyon Ltd [1933] Ch 786; R v Grantham [1984] 3 All ER 166. Re William Leitch Brothers Ltd, [1932] 2 Ch 71and Re Patrick & Lyon Ltd, [1933] Ch 786. [1984] 3 All ER 166. [1932] 2 Ch 71. Unreported, 30 June 1960. [1932] 2 Ch 71. JH Farrar, “The meaning of intent to defraud in s 332 of the Companies Act 1948” [1984] JBL 357 at 360. [1984] 3 All ER 166. See also the criticism on the provision by P Alldridge, “The Mental Element of the Crime of Fraudulent Trading” [1984] JBL 505. [1959-60] 105 CLR 451. (1998) 192 CLR 557. [1959-60] 105 CLR 451. Ibid at 566-567.
5
As for the Malaysian position, only one case has stood out – H. Rosen Enginering B.V. v Siow Yoon Keong.36 Rekhraj JC in this case first applied the meaning “fraud” in Concise Oxford Dictionary as “the use of false representation to gain an unjust advantage; a dishonest artifice or trick; a person not fulfilling what is expected of him/her”. The learned judge further said that “fraud and fraudulent purpose connotes actual dishonesty involving, according to current notions an unfair trading among commercial men, real moral blame in relation to the expected standard of an ordinary and honest people”, an apparent reference to Maugham J.’s judgment in Re Patrick & Lyon Ltd.37 The judge then goes on to cite, and approve, the test of fraud proposed in Re William C. Leitch Bros. Ltd.38 where Maugham J. said that “if a company continues to carry on business and to incur debts at a time when there is, to the knowledge of the directors, no reasonable prospect of the creditors ever receiving payment of those debts, it is, in general, a proper inference to be drawn that the company was carrying on business with intent to defraud.” It must be said that it is not easy to reconcile these tests, and the judge did not attempt to do so. However, the judgment in this case provides for an interesting discussion. The facts are as follows: Ventura Industries Sdn Bhd (the company) was the plaintiff’s agent in Malaysia. The company entered into a contract with Petronas Gas Sdn Bhd (Petronas), and the company agreed to pay the plaintiff 80% of payments made by Petronas and keep the balance of 20% as its entitlement. The defendant, who held all but one share in the company and who was also the company’s managing director, used the company’s funds to speculate in the stock exchange under his own name, which resulted in a loss that was passed on to the company, causing in the company to become insolvent. He then realised that he was about to incur a loss on his investments; and to avert that loss falling on him personally, he attempted “to legitimise the use of the company’s funds” by having the company ratify all his past acts. The plaintiff also alleged that the defendant had also repaid to himself as an unsecured creditor his advances to the company which was a fraudulent preference. Rekhraj JC made several statements: 1. 2.
36 37 38 39 40
The defendant used the plaintiff’s money in share investments in his personal name.39 He took a risk which was clearly an unauthorised transaction and a risk of this nature should be to his own account. The defendant was also made accountable to the company for the losses caused to the company and to the creditors. He had no right to risk the funds in speculation to the prejudice of the plaintiff’s right; he is “guilty of commercially unacceptable conduct in the particular context involved”.40
[1997] 1 CLJ 137 at 144. [1933] Ch 786. [1932] 2 Ch 71. [1997] 1 CLJ 137 at 145. Ibid. The emphasis is original.
6
3.
4.
5.
The defendant was expected to live up to the standards to be observed by honest businessmen and not unconscionable conduct contrary to good conscience. The law of equity and good conscience is to be adopted in such commercial transactions to make good the resulting loss to an innocent person whose trust in the defendant has been betrayed by his misconduct.41 The defendant holding 199,999 shares out of 200,000 shares was the company; and the company was the defendant; and their state of mind was imputed to each other.42 This was not a case where the company’s money was lost in the ordinary course of the business or as a result of poor administration. The defendant has no right to employ the company’s money to purchase of shares in his own name thereby creating a loss, resulted in the company being unable to pay the plaintiffs and thus become insolvent.43
Several things ought to be noted. First, the learned judge said that the defendant misused the plaintiff’s money and not the company’s. The reason for this is not clear, but this may be due to the fact that Petronas awarded the contract directly to the plaintiff, and the company was merely a “conduit” by which payment of the contract amount was channeled through. Therefore, the money was never the company’s but the plaintiff’s, and the company held the money on trust for the plaintiff. The court held that the defendant, when taking the risk to engage in an unauthorised transaction, was guilty of commercially unacceptable and unconscionable conduct, and therefore, adopting the law of equity and good conscience, held that the defendant be liable to make good the loss suffered by the plaintiff. The basis for imposing such obligations under equity to the defendant was because the defendant owned all but one share in the company. Therefore, the defendant and the company’s state of mind are “imputed to each other”.44 Hence, logically, the company and the defendants’ breach of duties are imputed to each other. This is significant because the duty is not owed by the defendant but by the company, and, as their state of mind was imputed to each other, the company had, through the conduct of the defendant, breached that duty. Therefore, section 304 applies as “the business of the company has been carried on with intent to defraud creditors”. The approach taken by the learned judge is curious for several reasons,45 but nevertheless underlines some of the problems relating to the section. 41 42 43
44 45
Ibid at 145-146. The emphasis is original. Ibid at 146. Ibid. The judge went to on cite the case of Aberdeen Ry Co v Blaikie Bros [1854] 1 Macq 461 at p 471 relating to the principle of directors’ duties not to have conflicting interests. Ibid at 146. Some of the questions which arise from the judgment in this case: (1) the statement that the money belongs to the plaintiff (not the company) (2) the imputation of the mind of the defendant to the company’s and (3) would the misappropriation the money done in the course of “carrying on the business of the company”? This misappropriation has nothing to do with the carrying on business of the company; it is simply misappropriation for the defendant’s personal benefit. Oliver J said in In re Murray-Watson Ltd, unreported but quoted in In re Gerald Cooper Chemicals Ltd [1978] Ch 262: [Section 304(1)] is aimed at the carrying on of the business … and not at the execution of individual transactions in the course of carrying on that business. I do not think that the words “carried on” can be treated as synonymous with “carrying out”, nor can I read the
7
Wrongful trading The offence for wrongful trading is provided by sections 303(3) and 304(2) of the Companies Act 1965. Section 303(3) provides that if 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 of the company being able to pay the debt, the officer shall be guilty of an offence. Section 304(2) further provides that the court may declare that the officer shall be personally responsible without any limitation of liability for the payment of the whole or any part of the debt. Wrongful trading was first enacted in the United Kingdom to complement the fraudulent trading provision. While there is no requirement to prove “intent to defraud”, the provision requires the knowledge of an officer of a company that there was no reasonable or probable ground of expectation of the company being able to pay the debt, at the time the debt was contracted. Thus, it is easier to impose liabilities on officers of the company. Nevertheless, this remedy is also fraught with difficulties. As with fraudulent trading, wrongful trading is both a crime46 as well as a civil wrong.47 As difficult as it is to prove fraudulent trading, it is perhaps even more difficult to obtain a remedy for wrongful trading as the wrongdoer must first be convicted under section 303(3). Also, as with fraudulent trading, wrongful trading originates from Australia. Initially, wrongful trading was a criminal offence, but was later extended to a civil wrong.48 Apart from the requirement that a conviction must precede a civil wrong, the other deficiencies of this section, as pointed out by the Australian Law Reform Commission: (1) (2) (3) (4) (5)
46 47 48
49 50
The procedure was lengthy. It gives the benefit of the civil liability to the creditor taking action and thus is only of advantage to a creditor with the resources to take such an action. It fails to provide a liquidator with standing to bring an action for the benefit of all creditors.49 It contains a number of technical deficiencies. It requires a multiplicity of actions if all creditors who have been affected by the behavior of the directors are to be compensated, with the possible result that the first creditors to take action may exhaust the assets of the errant directors.50 words “any business” as synonymous with “any transaction or dealing”. The director of a company dealing in second-hand motor cars who wilfully misrepresents the age and capabilities of the vehicle is, no doubt, a fraudulent rascal, but I do not think that he can be said to be carrying on the company’s business for a fraudulent purpose, although no doubt he carried out a particular business transaction in a fraudulent manner. The Malaysian Companies Act 1965, s 303(3). Companies Act 1965, s 304(2). For a history of the provision, see The Australian Law Reform Commission, General Insolvency Inquiry (1988) at p 123. Although this is not an issue in the Malaysian context as s 304(2) allows liquidator to take action. Note 48 at 124 –125.
8
The lack of reported decisions in Malaysia on this provision may reflect the truth of some of the above observations.51 It should be observed that fraudulent and wrongful trading provisions had been reviewed and substantially amended in Australia and, to a certain extent, the United Kingdom.52 Misfeasance Section 305(1) of the Companies Act 1965 provides: If in the course of winding up it appears that any person who has taken part in the formation or promotion of the company or any past or present liquidator or officer has misapplied or retained or become liable or accountable for any money or property of the company or been guilty of any misfeasance or breach of trust or duty in relation to the company, the Court may on the application of the liquidator or of any creditor or contributory examine into the conduct of that person and compel him to repay or restore the money or property or any part thereof with interest at such rate as the Court thinks just, or to contribute such sum to the assets of the company by way of compensation in respect of the misapplication retainer misfeasance or breach of trust or duty as the Court thinks just. This section is useful for enforcing directors’ duties to the company.53 However, liability under the section arises only where winding up proceedings against the company have begun. In addition, the section does not create any new rights subsequent to the commencement of the winding up proceedings. The decision in Re Coventry and Dixon’s Case54 emphasises the fact that it must be based on an act which could have been the subject of litigation by the company if it was not in the process of winding up. Liability under section 295 Section 295 of the Companies Act 1965 allows for a liquidator to examine any cash transaction for the purchase or sale of any property, business or undertaking with a person who has been a director of a company or a person connected with the director, within a period of two years before the commencement of winding up of the company.55 51
52
53
54
55
There is no reported decision on this section, but see PT Anekapangan Dwitama v Far East Food Industries Sdn Bhd [1995] 1 MLJ 21 and Miharja Development Sdn Bhd v Tan Sri Datuk Loy Hean Heong [1995] 1 MLJ 101. See ss 588G and 592 of the Australian Corporations Law and ss 213 and 214 of the U.K. Insolvency Act 1986. BR Cheffins, Company Law: Theory, Structure and Operation (Clarendon Press Oxford 1997) at 539; CA Riley, “Directors’ Duties and the Interests of Creditors” (1989) 10 Company Lawyer 87 at 90-91. (1880) 14 Ch D 660 at 670 per James LJ. See also Sally Wheeler, “Swelling the Assets for Distribution in Corporate Insolvency” (1993) JBL 256. Section 295(1) reads: Where any property business or undertaking has been acquired by a company for a cash consideration within a period of two years before the commencement of the winding up of a company-
9
Further, where the value of the property, business or undertaking exceeded the cash consideration, the liquidator may recover from such a person.56 There is no reported case on this provision,57 perhaps due to the limitations of the section. The first limitation is that a winding up proceeding against the company must precede an action under this section. Secondly, the section provides for the unnecessary requirement for “cash consideration”.58 Thirdly, the section “creates considerable evidentiary problems” on the issue of valuation of the property, business or undertaking.59 These are loopholes, which allow directors to escape liability, and this thus presents a valid cause for a review.
Disqualification of Directors It is to the creditors’ interest to ensure that directors of companies should be persons who are qualified and fit to become directors. The Companies Act provides for the disqualification of certain people from becoming directors in sections 130 and 130A. Disqualification on conviction of certain offences Section 130(1) provides for disqualification of a person from becoming a director or promoter or taking part in the management of a corporation for a period of 5 years where he has been convicted: (a) (b) (c)
of any offence in connection with the promotion or formation or management of a corporation; of any offence involving fraud or dishonesty punishable on conviction with imprisonment for three months or more; or of any offence under sections 132, 132A or 303.
The section provides for automatic disqualification, unless the court grants leave. A notice to the Registrar must be given before an application may be made60 and the Registrar may oppose the granting of the application.61 It should be noted that the
(a) (b)
56 57
58
59 60 61
from a person who was at the time of the acquisition a director of a company; or from a company of which, at the time of the acquisition, a person was a director who was also a director of the first-mentioned company, (c) the liquidator may recover from the person or company from which the property business or undertaking was acquired any amount by which the cash consideration for the acquisition exceeded the value of the property business or undertaking at the time of its acquisition. Section 295(2). Although the issue on notice to be sent out to creditors were discussed by the High Court of Singapore in Re Anrite Aviation Co Pte Ltd [1990] 3 MLJ 396. Defined in sub-s (5) as “consideration for the acquisition or sale payable otherwise than by the issue of shares in the company”. See Low Chee Keong, “Recovery from directors of insolvent companies: A case for reform” [1996] 1 MLJ xlix at lii. Ibid. Section 130(2). Section 130(3).
10
person must be convicted of any of the offence stated in paragraphs (a) to (c) before he can be disqualified. There are several aspects of this section that warrants some discussion. First, the section is too wide and may lead to unfair and even draconian results. The phrase “offence in connection with the promotion formation or management of a corporation” under paragraph (a) is not even defined. Hence, a director may be disqualified from being a director for a period of five years even if the conviction is for a relatively trivial offence. There are also precedents that give “management” a broad meaning.62 Second, the conviction may be for offences outside of the Companies Act.63 Third, the period of disqualification is inflexible as it does not allow the court to exercise its discretion depending upon the gravity or seriousness of the offence which results in the conviction. Fourth, the section does not specifically mention the offence of fraudulent trading under s 304(1) which is criminally punishable under section 304(5), or the offence of misfeasance under s 305, although it is likely that an offence under these sections are offences “in connection with the … management of a corporation” pursuant to paragraph (a). Disqualification of directors in insolvent companies Section 130A provides for disqualification of directors of insolvent companies where it appears to the court that a person was a director of two companies which have gone into liquidation within five years of each other, and that his conduct as director of any of those two companies makes him unfit to be concerned with the management of a company. However unlike section 130 which provides for automatic disqualification, disqualification under this section can only be made upon an application being made by the Registrar or Official Receiver.64
Scheme of Arrangement A company unable to meet its obligations to creditors may make a compromise or arrangement to pay its creditors through a scheme of arrangement. This is a statutory devise which allows companies to satisfy its obligations to creditors otherwise than by way of payment in accordance with the original contract. The scheme, if approved by the majority of the creditors, will bind all other creditors, regardless of whether they consented to the arrangement. The scheme of arrangement in Malaysia is provided for and governed by section 176 of the Companies Act 1965.65 Section 176(1) empowers the High Court to order a meeting of the creditors of the company for the purpose of an arrangement under section 176.66 The scheme will bind all creditors if “a majority in 62 63
64 65 66
See discussion in R v Campbell (1983) 92 Cr App R 95; Drew v Lord Advocate (1996) SLT 1062. See for example PP v Allan Ng Poh Meng [1990] 1 MLJ v where the disqualification was a result of a conviction for insider trading under the Securities Industry Act 1983. Section 130A(2). The scheme may be referred in this paper merely as “scheme” or “arrangement”. Section 176(1).
11
number representing three-fourths in value of the creditors agrees to the compromise, and the scheme is further approved “by order of the Court”.67 The Court is empowered to either order or refuse a creditors meeting.68 Before making an order under section 176(1), the court must ensure that the scheme is “viable, feasible, workable or intelligible”.69 In Sri Hartamas Development Sdn Bhd v MBf Finance Bhd70 it was argued on behalf of the company that the court is ill equipped to examine the practical implications of the scheme, and so long as the scheme on the face of it is bona fide and does not offend any principles of law, public policy or commercial morality, the Court should exercise its powers under section 176(1) to allow the meetings to be convened. Siti Norma Yaakob J rejected this argument. The learned judge explained the duties and nature of the discretion given to the court pursuant to subsection (1) and (4) of section 176 as follows:71 I consider that by virtue of the discretion given to me under section 176(4), to either order or refuse a creditor’s meeting, orders can and may be made at the summary stage. That being so, I see nothing objectionable to the [creditor] raising objections to the scheme at the summary stage rather than allow matters to proceed. Moreover different considerations apply at every stage of the proceedings. At the summary stage when the creditors’ meetings are applied for, the [Company] need only establish that the court has the necessary jurisdiction to entertain such an application and having so ascertained, the court must then decide whether the scheme is cast in terms such that it achieves the ¾ majority of all the creditors attending and voting at the creditors’ meetings under section 176(3) and the court will be likely to approve it at the subsequent unopposed application for its sanction. However, at the creditors’ meetings, despite the respondent’s objections, it may be outvoted by the majority of the other creditors and once the scheme is before the court again for its approval and sanction, the court is most reluctant to hold a scheme as being unreasonable as it is greatly influenced by the size of the majority vote and it has been held in the case of Re English, Scottish and Australian Chartered Bank72 that the court should only overrule the decision of the majority if there has been some material oversight or miscarriage on their part. Thus the applicant is left with little or no effective recourse once the order under section 176(1) is made. It is at the summary stage of the proceedings that the court must be vigilant to ensure that all the requirements of section 176(1) are met and for this very reason, I consider that it is not right and proper to shut out the [creditor] from expressing its misgivings to the scheme that is now under review.
67 68 69 70 71 72
Section 176(3). Section 176(4). Twenty First Century Oils Sdn Bhd v Bank of Commerce (M) Bhd (No 2) [1993] 2 MLJ 353. [1990] 2 MLJ 31 Ibid at 35-36. [1893] 3 Ch 385.
12
Applications must also be made summarily by hearing the application inter partes and that opportunity must be given to known creditors to make their representations instead of putting them into unnecessary expense in setting aside a section 176(1) order.73 For a scheme of arrangement to materialise, there is a need for the company to be given time to work out an arrangement acceptable to the majority if not all creditors, and to prevent creditors from rushing to court in an attempt to obtain a preference over other creditors for the repayment of the company’s debts. Thus, section 176(10) gives the High Court a power to restrain further proceedings pending the completion of a scheme.74 The period where the restraining order is in force is commonly called the moratorium period. This section is open to abuse by companies seeking a breathing space from its creditors as companies may apply for a restraining order without sincerely seeking to make a proposal for arrangement. Further, there is no maximum period for the moratorium period that may be imposed on the company’s creditors. It may thus be possible that a court may order an unreasonably lengthy moratorium period. Such a period may be extended. There are no guidelines to guide the court on the factors that they should consider in approving the extension of the moratorium period, as well as the length of the extension. In addition, it is not unusual for directors and other corporate controllers to quickly rearrange the company’s assets or place those assets beyond the reach of the creditors, once a restraining order is obtained. These problems are compounded by the inadequacies of the laws relating to fraudulent and wrongful trading, discussed above. In addition, there is no legal requirement for the company to have a firm or proper scheme in place before applying for the restraining order under section 176(10). All that is required is a mere proposal of a scheme.75 In Re Kuala Lumpur Industries Bhd,76 MBf Finance Bhd, a creditor of Kuala Lumpur Industries Bhd Group of Companies (“the Company”) objected to and applied to set aside a restraining order obtained by the Company pursuant to section 176(10) of the Companies Act 1965. They argued that there had not been any proposal of any scheme made to any of the creditors. There was also no application made pursuant to section 176(1). VC George J rejected this argument, saying:77 In my view such a proposal of compromise or arrangement could come into existence and be recognized as such without it having been put to the company or to the creditors…. The proposal for such compromise or arrangement itself is not necessarily between anybody. It could be unilateral…. For there to be a proposal within the meaning of section 176, it is not necessary that there should be a scheme in a complete form capable of being presented to the creditors for being voted on.
73 74 75 76 77
Re Foursea Construction (M) Sdn Bhd [1998] 4 MLJ 99 at p 103; [1998] 3 CLJ 135 at p 140. Section 176(10). Re Kuala Lumpur Industries Bhd [1990] 2 MLJ 180. Ibid. Ibid at 181-182.
13
The learned judge further said that an application for a restraining order need not be tagged on to a section 176(1) application. The two may be brought independent of the other.78 The judge further said:79 In my view, what must be available to the court when considering a section 176(10) application must be a proposal of a scheme of compromise or arrangement not necessarily ready for presenting to the creditors to be voted upon but with sufficient particulars to enable the court to assess that it is feasible and merits due consideration by the creditors when it is eventually placed before them in detailed form. Further, the court has to be satisfied that there is or that there would be a bona fide section 176(1) application. To counter some of these weaknesses, the legislature has introduced sub-section 10A to section 176. The sub-section now limits the initial period for the restraining order to not more than 90 days. The Court may, however, grant a restraining order for a period exceeding this period if: (1) (2) (3) (4)
There is a proposal for a scheme between the company and creditors representing at least one-half in value of all the creditors;80 The restraining order is necessary to enable the company and its creditors to formalise the scheme;81 A statement of affairs of the company is lodged together with the application;82 and The court approves a nominee director for the majority of the creditors.83 The nominee director shall have a right of access to the accounting and other records of the company and is entitled to require information or explanation from any officer of the company.84
In addition, any disposal and acquisition of property by the Company except in the ordinary course of business shall be void, unless with the consent of the Court.85 The defaulting officer shall be liable for sanction by the Court.86 This is a specific provision applying only to section 176 which should overcome the inadequacies of the more general fraudulent and wrongful trading provisions.
78
79 80 81 82 83 84 85 86
Ibid at 182. However, it is interesting to note that although an application under s 176(1) must be made inter partes, see Re Foursee Construction (M) Sdn Bhd [1998] 4 MLJ 99. An application for a restraining order under s 176(10) may be made ex parte, as tacitly approved in Re Kuala Lumpur Industries Bhd [1990] 2 MLJ 180; Twenty First Contury Oils Sdn Bhd v Bank of Commerce (M) Bhd (No 2) [1993] 2 MLJ 353; Sri Hartamas Development Sdn Bhd v MBf Finance Bhd [1990] 2 MLJ 31. Re Kuala Lumpur Industries Bhd [1990] 2 MLJ 180. Section 176(10A)(a). Section 176(10A)(b). Section 176(10A)(c). Section 176(10A)(d). Section 176(10B). Section 176(10C). Section 176(10D).
14
The new sub-section also requires every company in relation to a restraining order, to lodge a copy of the order with the Registrar87 and publish a notice of the order in a daily newspaper.88 Sub-section 10A appears to be concerned about restraining orders for a period of not more than 90 days, and provides for safeguards to prevent abuses in using the restraining period to buy breathing space without a bona fide intention to enter into a scheme of arrangement. The wording in paragraph (a) to sub-section 10A – that there be a proposal to creditors representing at least one-half in value of all the creditors – seems to approve the decision in Re Kuala Lumpur Industries Bhd89 that an application for a restraining order need not be tagged to s 176(1). However, the wording of the section is not very clear – how is the Court to ascertain that there is a proposal between the company and “creditors or any class of creditors representing at least one-half in value of all the creditors”? What amounts to a proposal? Should there be communication of the proposal? Should there be an indication that the proposal is or would be accepted by the prerequisite number of creditors? Bear in mind the judgment by VC George J. in Re Kuala Lumpur Industries Bhd,90 where the learned judge said that a proposal could come into existence and be recognized as such without it having been put to the company or to the creditors and that it could be unilateral. It is thus not clear how this provision will work. Another difficulty posed by the new sub-section 10A is on the appointment of nominee directors. As a general rule, a director must act bona fide in the interests of the company.91 This is a director’s main and overriding duty. However, if a director is nominated to protect the interests of a particular person or persons, conflict of interest situations may arise. The question is, to what extent would a nominee director be legally able to represent the interests of his nominator, in view of his fiduciary duties to act in the best interests of the company? On this issue, there are two schools of thought. Lord Denning represents the traditional view in two cases, Scottish Co-operative Wholesale Society v Meyer92 and Boulting v Association of Cinematograph Television and Allied Technicians.93 In Scottish Cooperative Wholesale Society,94 three out of five directors were nominated by the society in its subsidiary. The society subsequently lost control over the subsidiary and adopted a policy to transfer the business of the subsidiary to itself, thus starving the subsidiary of any business. On the issue of the fiduciary duties of the nominee directors, Lord Denning said:95 87 88 89 90 91 92 93 94 95
Section 176(10E)(a). Section 176(10E)(b). [1990] 2 MLJ 180. Ibid. Re Smith & Fawcett Ltd [1924] Ch 304; Chua Boon Chin v JM McCormack [1979] 2 MLJ 156. [1959] AC 324. [1963] 2 QB 606. [1959] AC 324. Ibid at 366-367.
15
So long as the interests of all concerned were in harmony, there was no difficulty. The nominee directors could do their duties by both the companies without embarrassment. But, so soon as the interests of the two companies were in conflict, the nominee directors were in conflict, the nominee directors were placed in an impossible position ... It is plain that, in the circumstances, these three gentlemen could not do their duty to both companies, and they did not do so. They put their duty to the co-operative society above their duty to the [subsidiary] in this sense, at least, they did nothing to defend the interests of the [subsidiary] against the conduct of the co-operative society. They probably thought that “as nominees” of the co-operative society their first duty was to the co-operative society. In this they were wrong. Lord Denning suggested that the least the three nominee directors could have done in this circumstance was to protest against the conduct of the society. This they failed to do, resulting in a breach of their fiduciary duties to the subsidiary.96 Whether the court is willing to relieve them from their duties if they were to protest, is a question which remains unanswered. Lord Denning’s strict view on directors’ duties found support in Australia where Street J said in Bennetts v Board of Fire Commisioners of NSW:97 Once a group has elected a member he assumes office as a member of the board and becomes subject to the overriding and predominant duty to serve the interests of the board in preference, on every occasion upon which any conflict might arise, to serving the interests of the group which appointed him. With this basic proposition there can be no room for compromise. The second and more liberal view acknowledges that a director’s prime duty is to the company in which he serves as a director, while commercial realities require some flexibility when dealing with nominee directors.98 In Levin v Clarke99 the court discussed the duties of nominee directors appointed by a debenture holder: However, I consider that it is permissible for them so to act [in the interests of the debenture holder]. It is of course correct to state as a general principle that directors must act in the interests of the company ... However that leaves open the question in each case - what is the interest of the company? It is not uncommon for a director to be appointed to a board of directors in order to represent an interest outside the company-a mortgagee or other trader or a particular shareholder. It may be in the interests of the company that there be upon its board of directors one who will represent these other interests and who will be acting solely in the interests of such a third party and who may in that way properly be 96 97 98 99
Ibid at p 367. (1967) 87 WN (Pt 1) (NSW) 307 at p 311. See discussion by P Redmond, “Nominee Directors” (1987) UNSWLJ 194. [1962] NSWR 686.
16
regarded as acting in the interests of the company as a whole. To argue that a director appointed for the purpose of representing the interests of a third party, cannot lawfully act solely in the interests of that third party, is in my view to apply the broad principle, governing the fiduciary duties to directors, to a particular situation, where the breadth of the fiduciary duty has been narrowed, by agreement amongst the body of the shareholders. In another case - Re Broadcasting Station 2GB Pty Ltd,100 the parent company’s nominee director was alleged to have acted in the parent company’s interest to the detriment of the subsidiary. Jacobs J. held that the nominee directors may follow the wishes of the parent company so long as there is a “bona fide belief that the interests of the [parent] company were identical with the interests of the [subsidiary] as a whole.”101 Jacobs J further said that to require the nominee directors to disregard the wishes of the parent company “is to ignore the realities of company organisation” and would “make the position of a nominee or representative director an impossibility.”102 The judge concluded by saying: The view which I take of the conduct of the directors does not in my approach to this matter amount to oppression of any shareholder nor to improper conduct so long as they bona fide believed that the [parent] companies would act in the interests of the company as a whole. Mahon J said in Berlei-Hestia:103 As a matter of legal theory, as opposed to judicial precedent, it seems not unreasonable for all the corporators to be able to agree upon an adjusted form of fiduciary liability, limited to circumstances where the rights of third parties vis-avis the company will not be prejudiced. The stage has already been reached, according to some commentators, where nominee directors will be absolved from suggested breach of duty to the company merely because they act in furtherance of the interests of their appointors, provided that their conduct accords with a bona fide belief that the interests of the corporate entity are likewise being advanced. Another difficulty regarding the position of nominee directors is in relation to the nominee’s potential liability in relation to fraudulent or wrongful trading. It has been generally accepted that nominee directors stand on the same footing as any other director. Thus nominee directors may be made liable for fraudulent or wrongful trading. One way to overcome this situation is for the nominator to agree to indemnify the nominee for any liability that the nominee incurs whilst acting as a director.104 While this is effective for compensating the nominee for civil liabilities and fines imposed upon the nominee for 100 101 102 103 104
[1964-65] NSWR 1648. Ibid at 1663. Ibid. Berlei-Hestia (NZ) Ltd v Fernthough [1980] 2 NZLR 150. It is to be noted, however, that the Companies Act 1965 disallows the indemnity of directors by the company: s 140.
17
contraventions of the legislation, it does not help the nominee’s position in the event a custodial sentence is imposed. The nominee may also be disqualified from acting as a director for a period of 5 years pursuant to section 130A of the Companies Act 1965. In addition, the nominee will be disqualified from acting as a director for a period of 5 years pursuant to section 130 of the Companies Act 1965 for convictions of offences that are mentioned in the section. These will be great disincentives for individuals to act as directors in an insolvent company.
Special Administration Pursuant to Pengurusan Danaharta Nasional Berhad Act 1998 (“Danaharta Act”) The Danaharta Act was enacted in 1998 during the height of a regional economic turmoil, with three specific objectives:105 (1) (2) (3)
To assist financial institutions by removing impaired assets; To assist the business sector by dealing expeditiously with financially distressed enterprises; and To promote the revitalisation of the nation’s economy by injecting liquidity into the financial system.
These objectives will be met by the establishment of an entity known as Pengurusan Danaharta Nasional Berhad, a public company limited by shares incorporated under the Companies Act 1965. The objective of Danaharta is to carry on business as an asset management company and acquire, manage, finance and dispose of assets and liabilities.106 Powers of Danaharta and the Special Administrator One of Danaharta’s most important powers is in relation to the appointment of the Special Administrator. Danaharta may, with the approval of an Oversight Committee,107 appoint a Special Administrator of a debtor company108 if Danaharta is satisfied that: 109 (1) (2)
(3) 105 106
107
108 109
The appointment would serve public interest; or The company (a) is unable or likely to become unable to pay its debts; or (b) is unable or likely to become unable to satisfy its obligations to its creditors; The survival of the company and the whole or any part of its assets as a going concern may be achieved; Preamble to the Danaharta Act. Danaharta Act, s 3. On specific powers in relation to acquisition and disposal of assets, see Part V of the Act. The Ministry of Finance, the Central Bank and the Securities Commission will each be represented in this Oversight Committee: Danaharta Act, s 22(2). Ibid, s 24(2). Section 25.
18
(4) (5)
A more advantageous realization of the company’s assets may be achieved than on a winding up; or The appointment may achieve a more advantageous realization or a more expeditious settlement of a duty or liability owed by any person to Danaharta.
The Special Administrator, once appointed, shall have very wide powers in relation to the debtor company. The Special Administrator shall assume all the functions of the board of directors of the debtor company.110 None of the officers of the debtor company, including the board of directors, may perform their functions and exercise their duties without the written consent of the Special Administrator.111 In addition, the Special Administrator shall have certain statutory powers as listed in the Second Schedule of the Act.112 Effect of the appointment of Special Administrator and the interests of creditors In effect, once Danaharta has appointed the Special Administrator, the overall management of the debtor company will be in the hands of the Special Administrator. All transactions or dealings by the debtor company or on behalf of the debtor company will be void unless they are entered into or specifically authorised by the Special Administrator.113 In addition, any contravention of this provision is an offence.114 Upon the appointment of the Special Administrator, a moratorium will automatically take effect for a period of 12 months from the date of his/her appointment.115 The moratorium may be extended for a further period of 12 months or such other period or periods as Danaharta may recommend.116 During this moratorium period, the court shall dismiss any petition for the winding up of the debtor company117 and no resolution may be passed or order made for the winding up of the debtor company.118 No receiver, receiver and manager or provisional liquidator may be appointed, or if appointed, his appointment shall immediately cease.119 During this moratorium period, no steps may be taken, except with Danaharta’s consent, to create, perfect or enforce any security over any asset of the debtor company;120 or to enforce a judgment over any asset of the debtor company;121 or to re-possess any asset in the possession, custody or control of the debtor company;122 or to set off any debt owing to the debtor company in respect of any claim against the debtor company.123 In addition, no proceedings and no execution or other legal process may be commenced or continued with, and no distress may be levied against the debtor company 110 111 112 113 114 115 116 117 118 119 120 121 122 123
Section 33(2). Section 33(1). Section 30. Section 34(1). Sections 33(4) and 34(2). Section 41(1) and (2). Section 41(3). Section 41(1)(a). Section 41(1)(b). Section 41(1)(c). Section 41(1)(d)(i). Section 41(1)(d)(ii). Section 41(1)(d)(iii). Section 41(1)(d)(iv).
19
or its assets without Danaharta’s consent.124 Any application made under section 176 of the Companies Act 1965 shall be adjourned sine die and any restraining order under subsection 176(10) of the Companies Act 1965 shall be immediately discharged and set aside.125 Finally, no proceedings and no execution or other legal process may be commenced, or continued with, against any person providing a guarantee or acting as a guarantor for the liability of the debtor company in respect of that liability except with Danaharta’s consent.126 Needless to say, the Danaharta Act empowers the Special Administrator and Danaharta with very extensive powers. It is perhaps unprecedented that a creditor (after all this is what Danaharta basically is), which otherwise will only possess rights provided by contract, is to be given such wide powers, to the extent of subjugating the interests of the shareholders and other creditors of the debtor company. As for the Special Administrator, it may reasonably be expected that the Special Administrator will be imposed with duties to be fair to shareholders and creditors or even fiduciary duties to the debtor company as the Special Administrator is usurping the powers of the board of directors of the debtor company. In addition, it is implicit in section 25 of the Danaharta Act that the Special Administrator’s appointment may either be for the benefit of the debtor company (and therefore its shareholders, ultimately), if it is to survive as a going concern; or its creditors, if it is to be wound up; apart from the consideration for public interest. However, only a general duty can be found in the Danaharta Act, which provides that the Special Administrator shall take control or custody of all the assets of the debtor company and shall manage the assets and affairs of the debtor company.127 This seems more like a power rather than a duty, despite the marginal note to the section reading “General duties of the Special Administrator”. Other than this, the Danaharta Act is silent as to whether the Special Administrator owes any duty at all, whether to the public; or to the debtor company; or to its shareholders; or to Danaharta as its appointor; or to the other creditors of the debtor company generally. This silence is highly regrettable as it causes uncertainties in the law. What should the Special Administrator’s main objective be when taking over the management of the debtor company? Should the Special Administrator try to restructure the company, dispose non-core assets and settle with creditors with the main objective of returning the debtor company to its shareholders? Or should the Special Administrator strip the assets and try to recover as much as possible from whatever is left from the debtor company with the objective of paying off the creditors? Or should the Special Administrator mainly be concerned about the debts owed to Danaharta? The Danaharta Act offers no guidance. It could very well be the case that the last option, ie to consider mainly the interests of Danaharta, to be the Special Administrator’s main objective. After all, it is Danaharta who appoints the Special Administrator and Danaharta too may recommend
124 125 126 127
Section 41(1)(e). Section 41(1)(f). Section 41(1)(g). Section 31.
20
his/her removal.128 Apart from that, the Special Administrator is practically free to exercise his discretion in any way he/she wishes. The Special Administrator will only be liable to any party if it can be proved that he/she has caused loss or damages which is due to his/her wilful misconduct or gross negligence.129 It is perhaps useful to contrast the situation created by the Danaharta Act to an administrator in the United Kingdom and a judicial manager in Singapore.130 The administrators in the United Kingdom and the judicial managers in Singapore are imposed with statutory duties to act fairly to both creditors and members of the company.131 Dissatisfied creditors may commence proceedings in court, which is then empowered to make such orders as it thinks fit for giving relief in respect of the matters complained of.132 Unfortunately, the Special Administrator or even Danaharta are free from such statutory duty. It is also unlikely that the courts may impose fiduciary duties133 as the Danaharta Act now provides that a breach of the Act or any other law by Danaharta, the Special Administrator, Independent Advisor or the Oversight Committee does not invalidate any act done by them in good faith.134 In addition, the Danaharta Act now provides that an order of a court cannot be granted:135 (1) (2)
(3)
128 129 130
131
132 133
134 135
which stays, restrains or affects the powers of Danaharta, Oversight Committee, Special Administrator or Independent Advisor under the Act; which stays, restrains or affects any action taken, or proposed to be taken, by Danaharta, Oversight Committee, Special Administrator or Independent Advisor under the Act; which compels Danaharta, Oversight Committee, Special Administrator or Independent Advisor to do or perform any act. Section 28(2). Section 28(4). Both appointed by the court on the application of creditors of an insolvent company to manage the company and its assets. UK Insolvency Act 1986, s 27; Companies Act of Singapore, s 227R. Section 27(1) of the UK Insolvency Act reads: At any time when an administration order is in force, a creditor or member of the company may apply to the court for an order under this section on the ground(a) that the company’s affairs, business and property are being or have been managed by the administrator in a manner which is unfairly prejudicialto the interests of its creditors or members generally, or of some part of its creditors or members (including at least himself) or, (b) that any actual or proposed act or omission of the administrator is or would be so prejudicial. UK Insolvency Act 1986, s 27(2). See, however, discussion by Mohammad Rizal Salim, “Pengurusan Danaharta Nasional Berhad – A Case for Imposing Fiduciary Duties on the Special Administrator” (1999) 26(2) JMCL 205. Note that the discussion was based on the before the amendment to the Danaharta Act in 2000, with certain amendments to take effect retrospectively from the date the Principal Act came into force in 1998. Danaharta Act, s 71. Section 72.
21
Any order made by a court in contravention of this provision shall be void and unenforceable.136 Such powers on the part of Danaharta and the Special Administrator, coupled with the virtual immunity from court intervention, preclude creditors or shareholders of a company from taking an action under section 181 of the Companies Act 1965 for oppression or unfair conduct, or even breach of fiduciary duties by them.
Corporate Debt Restructuring Committee (“CDRC”) The CDRC was set up to “facilitate the restructuring of large corporate debts”, to provide a “platform for both borrowers and creditors to workout feasible debt restructuring schemes without having to resort to legal proceedings”.137 The CDRC is mainly concerned with large corporate debts of at least RM50 million owed to financial institutions.138 The key principles governing the corporate workout process sponsored by CDRC are:139 (1) (2) (3) (4) (5) (6) (7)
(8)
Preservation of viable business; Voluntary process that can be initiated either by the creditors or debtors; A Creditors Committee representing at least 75% of total debt of all creditors to be established for each debtor company; The Creditors Committee process is based on full information disclosure and sharing of information with all creditors; Creditors will observe a “standstill” period of 60 days so that the debtor company’s financial viability and needs can be determined; The Creditors Committee could appoint independent consultants to help in the development and/or review or workout options; Existing priority of creditor claims will be preserved except in the case of new financing which could receive senior status over existing debt if consented to by existing creditors; Stakeholders’ approval is required for workout proposals.
The process The arrangement is informal and without any legal status and can be called off by any party at any time.140 The corporate borrower who is usually the party initiating a debt restructuring process, will communicate with the CDRC of its intention. Upon CDRC’s 136 137
138
139 140
Ibid. CDRC, “Introduction to CDRC”, available at Bank Negara’s homepage at viewed on 18 July 2000. CDRC, “Terms of Reference of CDRC”, available at http://www.bnm.gov.my/cdrc/terms.htm viewed on 18 July 2000. Ibid. Note 137.
22
approval,141 an initial meeting will be arranged between the borrower and a main lender, and, if successful, a first creditors’ meeting will be arranged. In this meeting, an agreement must be reached for a “standstill” agreement between the creditors and the borrower whereby the creditors will not commence any legal proceedings against the borrower in respect of the borrower’s debt for a certain period of time.142 During this meeting, a Creditors’ Committee will be formed to spearhead the restructuring process and a Lead Creditor will be nominated to co-ordinate and liaise with the parties involved. Next, consultants will be appointed to conduct a review of the borrower’s viability and make the necessary recommendations to the creditors. The consultants’ report must be supported by the creditors present and voting, representing 75% of the total debt. Once this is achieved, the corporate borrower will implement the restructuring proposals assisted by the consultants and the Steering Committee.143 The interests of creditors As a corporate reconstruction workout is an informal process, there is no moratorium imposed on creditors other than the financial institutions who are privy to the standstill agreement. In addition, even if the majority approve the consultant’s proposal, there is no legal impediment to any participating minority creditors from taking legal action to recover their debts, provided that the standstill period has expired. In other words, no creditors may be forced to accept a settlement arising from a corporate restructuring contrary to their wishes.
Conclusion The concept of limited liability transfers the risk of entrepreneurship from shareholders to creditors. Creditors may protect themselves by contract, but such protection is sometimes inadequate. As creditors form a part of the corporate constituent of a company, active consideration must be given to them to ensure that they are not prejudiced by the acts of directors, officers or corporate controllers. Reliance on judge-made laws and concepts such as piercing the corporate veil and imposing fiduciary duties upon directors, either towards the company or towards creditors as a corporate constituent, is insufficient to protect the interests of creditors for a number of reasons. Judge-made laws are fact-based, and therefore lack comprehensiveness. A good example is the issue of directors’ duties to creditors which raised unsolved questions on the enforcement rights of creditors, ratification and the test for insolvency. They are also prone to inconsistency, again 141 142 143
Based on criteria set out by CDRC: note 138. This is another name for a moratorium. The Steering Committee’s roles are, inter alia, to convene the meetings of debtors and creditors, to consider debt restructuring, to provide broad guidelines on steps to be taken in the debt restructuring process, to mediate disputes amongst creditors and between debtors and creditors: see CDRC, “Roles of Steering Committee”, available at viewed on 18 July 2000. A more detailed restructuring process is available at CDRC, “CDRC Process and Guidelines”, available at viewed on 18 July 2000.
23
exemplified by the issue of directors’ duties to creditors, and also the test of “intent to defraud” as discussed above. In the hands of judges who lack the necessary level of expertise and experience, established legal principles can be distorted, as can be seen in the judgment in H. Rosen Enginering B.V. v Siow Yoon Keong.144 All these make legal principles hard to discern and the outcome of legal proceedings hard to predict. Judge-made laws are therefore a poor substitute to legislation in the context of the protection of creditors in the event of corporate insolvency. Provisions in the Companies Act 1965 seek to achieve this, but unfortunately they are outdated and contain numerous loopholes and weaknesses to be of much value. In the United Kingdom and Australia, countries from which our laws were transplanted, the laws have been updated by filling up the loopholes and making corporate controllers more accountable to the creditors in insolvent companies, while retaining the basic principle of directors’ duties to the company. Unfortunately there has been no similar initiative in Malaysia. Finally, there is the issue of Danaharta and the extensive powers of the Special Administrator. Nowhere in the common law world has a single individual been vested with such extensive corporate powers as the Special Administrator. The Special Administrator’s powers are, in real terms, absolute, because of the absence of statutory or other duties and the lack of countervailing powers, compounded by the legal immunity enjoyed by him. Perhaps there can be argument that this is a contravention of the basic principles of good corporate governance as well as an abuse of human rights and the individual’s fundamental rights to property.
144
[1997] 1 CLJ 137.
24
