Schemes of Arrangement – Restructuring the debts of a financially distressed company
By Lee Shih
Part A. Introduction to Schemes of Arrangement
Part B. Restraining Order
In the interim period between the proposal of a scheme (the details of which may not be completely finalised) and its approval by the Court, a company would be vulnerable to its creditors who may move to wind up the company or institute execution proceedings on the assets of the company.
Under section 176(10) of the Act, the company or any member or creditor of the company may apply to the Court to restrain further proceedings in any action or proceeding against the company, except by leave of the Court. Such an order to restrain ‘any action or proceeding’ would extend to restraining legal suits, execution proceedings or winding up petitions filed against the company.
(i) Restraining Order for a Period of Not More than 90 days
Section 176(10A) of the Act sets out that the Court may grant a restraining order for a period of not more than ninety days or such longer period as the Court may for good reason allow if and only if-
“(a) it is satisfied that there is a proposal for a scheme of compromise or arrangement between the company and its creditors or any class of creditors representing at least one- half in value of all the creditors;
(b) the restraining order is necessary to enable the company and its creditors to formalize the scheme of compromise or arrangement for the approval of the creditors or members pursuant to subsection (1);
(c) a statement in the prescribed form as to the affairs of the company made up to a date not more than three days before the application is lodged together with the application; and
(d) it approves the person nominated by a majority of the creditors in the application by the company under subsection (10) to act as a director or if that person is not already a director, notwithstanding the provisions of this Act or the memorandum and articles of the company, appoints the person to act as a director.”
A question arises whether the requirements under sections 176(10A)(a) - (d) of the Act must be complied with even where the initial application for a restraining order is for a period of 90 days or less.
The unreported High Court decision of Jin Lin Wood Industries & 3 Ors v Mulpha International Bhd [2004] 1 LNS 432 (“Jin Lin”) involved an application to set aside the initial restraining order which was granted for a period of 90 days. Despite non-compliance with section 176(10A)(c) and (d) of the Act at the time of the grant of the initial 90-day restraining order, the Court dismissed the setting aside application.
The Court appeared to agree with the argument that section 176(10A) of the Act does not apply when a restraining order of not more than 90 days is sought and referred to the decision in Pelangi Airways Sdn Bhd v Mayban Trustees Bhd [2001] 6 CLJ 129 (“Pelangi Airways”).
In the earlier decision of Pelangi Airways, the High Court had allowed an application to set aside the initial restraining order which was granted for a period of 1 year. It is submitted that Jin Lin had misapplied Pelangi Airways since the latter never held that the requirements of sections 176(10A)(a) – (d) of the Act need not be complied with where the period was for not more than 90 days. Pelangi Airways merely held that the requirements under sections 176(10A)(a) – (d) of the Act must be complied with for extending the 90-day restraining period to the 1-year period.
This issue has also recently been considered in the unreported High Court decision of PECD Bhd & Anor (Applicants) (No. 2) [2008] 1 LNS 324 (“PECD Bhd”). The Court held that sections 176(10A)(a) – (d) of the Act “apply to any application for a restraining order pursuant to subsections (10) and (10A) of section 176 of the Companies Act regardless of the length of the period of the restraining order applied for." The Court found on a grammatical reading of the section, if the requirements of paragraphs (a) to (d) were meant to not apply to any restraining order for a period not exceeding 90 days, then subsection (10A) would have been drafted differently. Further, the Court also distinguished Pelangi Airways based on the facts of that case.
(ii) Extension of the Restraining Order
If the applicant seeks a restraining order past the period of 90 days, or for an extension of the initial restraining order past 90 days, the applicant must demonstrate a ‘good reason’. The High Court in Metroplex Bhd & Ors v Morgan Stanley Emering Markets & Ors; RHB Sakura Merchant Bankers & Ors (Interveners) [2005] 6 MLJ 487 (“Metroplex”) held the words ‘good reason’ in section 176(10A) of the Act to mean that:
(i) a bona fide scheme of arrangement is presented, with sufficient details provided to the creditors to enable them to make informed decisions as to its feasibility and merits (Re Kuala Lumpur Industries [1990] 2 MLJ 253);
(ii) the scheme of arrangement presented must not be such that it is bound to fail (Twenty First Century Oils Sdn Bhd v Bank of Commerce (M) Bhd [1993] 2 MLJ 353); and
(iii) the interest of creditors, that is, the beneficiaries under the proposed arrangement is safeguarded (Sri Hartamas Development Sdn Bhd v MBf Finance Bhd [1990] 2 MLJ 180).
Metroplex also made it clear that for extensions of a restraining order, all the provisions of section 176(10A) of the Act must be met afresh.
(iii) Approval of At Least 50% in Value of Creditors for the Restraining Order?
Metroplex had interpreted section 176(10A)(a) of the Act to mean that the section requires the approval of at least 50% in value of creditors in order for the Court to grant a restraining order. However, the High Court in Re Kai Peng Bhd [2007] 8 CLJ 703 (“Re Kai Peng Bhd”) construed the section differently and held that all the applicant needs to show is that the proposed scheme involves more than 50% of its creditors. The Court held that the approval of the creditors is only relevant at the stage of the creditors meeting ordered under section 176(3) of the Act, but not at the stage of the restraining order. It is submitted, that on a plain reading of the wording of section 176(10A)(a) of the Act, the interpretation of Re Kai Peng Bhd is to be preferred.
(iv) Restrain De-listing Procedures
It is not conclusive whether a restraining order obtained by a public listed company would extend to restraining de-listing procedures against the company.
The High Court in CHG Industries Bhd & Ors v Bursa Malaysia Securities Bhd [2007] 6 CLJ 710 involved the applicant company successfully arguing that a restraining order under section 176(10) of the Act would restrain Bursa Malaysia Securities Berhad (“Bursa Securities”) from proceeding with procedures to de-list the applicant.
However, in the unreported decision involving Avangarde Resources Berhad, Bursa Malaysia had on 11 April 2007 obtained a declaration from the High Court that a section 176 Restraining Order does not extend to include the decision of Bursa Securities to de-list the company in accordance with the listing requirements (see Listing Circular No. L/Q: 4285 of 2007).
(v) Protection of Creditors’ Interests
The restraining order has the wide-ranging effect of staying most, if not all, of the creditors’ actions against the company. In order to temper the risk of the creditors’ interests being prejudiced, certain safeguards have been put in place.
Section 176(10A)(d) requires the Court’s approval of the appointment of a director nominated by a majority of the creditors. This director would have access to the records of the company and is entitled to ask for any information and explanation he may require for the purposes of his duty (section 176(10B) of the Act). The Act is silent however on the extent and scope of the creditor-nominated director; must the director act in the interests of the company or can he act in the interests of the creditors?
Further, section 176(10C) of the Act also prevents any disposition of the company’s property and any acquisition of property by the company, other than those made in the ordinary course of business, unless the Court otherwise orders. A breach of this subsection will result in every officer in the company who is in default to be guilty of an offence which carries a penalty of imprisonment for 5 years or RM1 million fine or both (section 176(10D) of the Act).
(vi) Corporate Law Reform Committee
The Corporate Law Reform Committee (“CLRC”) had conducted an overall review of the Act and had recently published its ‘Review of the Companies Act 1965 – Final Report’. It is useful to highlight the CLRC recommendations on the changes to the scheme of arrangement framework under section 176 of the Act.
In relation to restraining orders, the CLRC recommended that any extension of the 90-day moratorium should only be for a maximum of one year. The CLRC noted section 176 of the Act has been used as a delaying mechanism by companies to frustrate the enforcement of any judgment debts by creditors.
Further, the CLRC recommended that a restraining order should not be effective against the companies and securities market regulators so as to prevent them from commencing any enforcement actions to ensure compliance of corporate and/or securities law or guidelines.
Generally as well, the CLRC recommended the requirement of an appointment of a qualified insolvency practitioner to assess the viability of a scheme of arrangement between a company and its creditors.
Where there is a proposed scheme of arrangement, the company will have to apply to the Court under section 176(1) of the Act to order a meeting of the creditors or class of creditors or of the members of the company or class of members. Separate meetings of each class of creditor or member would have to be called and classes are viewed as separate if their interests are so different that they will not be able to consult together with a view to their common interest, as set out in the authority of Sovereign Life Assurance Co v Dodd [1892] 2 QB 573 (“Sovereign Life Assurance”).
At each of the court convened meetings, the scheme is considered to have been agreed to only if a majority in number (i.e. more than 50% in number) representing 75% in value of the class present and voting in person or proxy at the meeting or adjourned meeting agreed to it (see section 176(3) of the Act).
(i) Insolvent Company Embarking on a Scheme of Arrangement
A great utility of the scheme of arrangement provisions is that it would allow a technically insolvent company to restructure its debts and to return that company to a position where it could trade. It was held in the High Court decision of Intrakota Komposit Sdn Bhd & Anor v Sogelease Advance (M) Sdn Bhd [2004] 8 CLJ 276 that even if the applicant companies were in fact insolvent, that would not preclude the applicants from embarking on a scheme of arrangement.
However, in the earlier High Court decision of Sri Hartamas Development Sdn Bhd v MBf Finance Bhd [1990] 2 MLJ 31, the Court adopted the public policy argument that a scheme undertaken by an insolvent company would be against commercial morality as the court could not condone or encourage individuals to carry on business activities in a company which was handicapped by a heavy burden of indebtedness. The High Court decision has recently been quoted with approval in the unreported Court of Appeal decision of PECD Bhd & Anor v Amtrustee Bhd (Civil Appeal No. W-02(IM)-386-2009) where the Court of Appeal held that it was against public policy to approve a scheme by an insolvent company.
(ii) Classification of Related Creditors
One practical problem that arises in schemes of arrangement is in the classification of creditors which are related companies to the applicant company in the proposed scheme.
For instance, if the proposed scheme were to set out one class of unsecured creditors where more than half the number consists of subsidiaries of the applicant company, then this may draw the ire of the other unsupportive creditors since they may be outvoted.
On this issue, there is some divergence in approach of the Malaysian court decisions and that of other jurisdictions.
In the High Court decision of Re Sateras Resources (Malaysia) Bhd [2005] 6 CLJ 194, it was held that it was unfair to group the applicant’s subsidiaries in the same class of creditors with the applicant’s unsecured creditors as there was a divergence of interest. The Court held that it was undeniable that the applicant having full control of the subsidiaries would cause the subsidiaries to vote in support of the scheme. The test there focused more on community of interests.
In contrast, in the Singapore Court of Appeal decision of Wah Yuen Electrical Engineering Pte Ltd v Singapore Cables Manufacturers Pte Ltd [2003] 3 SLR 629 (“Wah Yuen”), the test was focused more on community of legal rights. The Singapore Court of Appeal agreed with the submission that related party creditors did not constitute a separate class of creditors for voting purposes simply because they were related parties. The test applied by the Singapore Court of Appeal was based on similarity or dissimilarity of legal rights against the company, not in similarity or dissimilarity of interests not derived from such legal rights. The fact that individuals may hold divergent views based on their private interests not derived from their legal rights was not a ground for separating the related party creditors into a separate class.
(iii) Explanatory Statement
Section 177 of the Act requires that an Explanatory Statement be sent out to each creditor or member explaining “the effect of the compromise or arrangement and in particular stating any material interests of the directors, whether as directors or as members or as creditors of the company or otherwise, and the effect thereon of the compromise or arrangement so far as it is different from the effect on the like interests of other persons.”
This explanatory statement must ensure that the creditors are provided with sufficient or material information to make a meaningful decision, and a failure on the part of the applicant to make such disclosure may be fatal to the scheme.
In the English decision of Re Dorman, Long & Co Ltd [1934] Ch 635 it was held that it was essential to see that the explanatory circulars sent out by the board of the company were perfectly fair and to give all information reasonably necessary to enable the recipients to determine how to vote.
(iv) Without Prejudice Proposal?
An explanatory statement in setting out the effects of the proposed scheme will also list out the debts of the various scheme creditors. One issue raised before the Court of Appeal in PB Securities Sdn Bhd v Autoways Holding Bhd [2000] 4 MLJ 417 was whether there could be a ‘without prejudice’ proposal in a scheme of arrangement.
The case involved the applicant company issuing to a scheme creditor, various proposals for the restructuring scheme. After the applicant company had obtained leave to convene the meeting of creditors and had issued out the explanatory statement to all the creditors, the scheme creditor filed a proxy form stating that they would be voting against the scheme. The applicant then decided to oppose that creditor’s claim and had excluded their proxy representative from the court convened meeting.
The Court of Appeal overturned the High Court findings and held that the question of a bona fide dispute of the debt did not arise in light of the repeat acknowledgements in the various proposals. Further, the Court of Appeal held that there was no such thing as a without prejudice proposal under section 176 of the Act and there is no such thing as a restricted proposal. The appearance of the phrase ‘without prejudice’ had no effect on the proposal.
Part D. Court Approval
In the event the terms of the scheme are approved by the scheme creditors at the court convened meeting stage, a separate application has to then be made to the Court for approval of the agreed scheme.
When considering such an application, the court will generally be guided by the following principles:
(i) that the statutory provisions have been complied with;
(ii) that various classes were property identified and effectively represented by those who attended the meeting;
(iii) that statutory majority acted bona fide and did not coerce the minority in order to promote interests adverse to those of the class they purport to represent; and
(iv) that the arrangement is such as an intelligent and honest man, a member of the class concerned and acting in respect of his interest, might reasonable approve.
These general principles were examined in the High Court case of Re Sateras Resources (Malaysia) Bhd [2005] 6 CLJ 194.
Generally, the court should be slow in interfering with the decision of the majority of the creditors in the creditors meeting. Businessmen are better judges of what is to their commercial advantage than the court could be. However, the court may interfere if there has been some material oversight or miscarriage.