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Cherry-Picking Your Creditors

Lee Shih explains a significant Federal Court decision on schemes of arrangement

The Federal Court in Francis a/l Augustine Pereira v Dataran Mantin Sdn Bhd & 6 others (Federal Court Civil Appeal No. 02(f)-91-11/2012(B)) (“Dataran Mantin Case”) has set out the definitive test on what constitutes a class of creditors within the meaning of section 176 of the Companies Act 1965 (“Act”).

The decision also clarifies that section 176 of the Act allows a company to confer preference on one group of creditors while excluding another group altogether, thereby giving a company some flexibility to cherry-pick the creditors that it wishes to enter into a compromise or arrangement with.

 

BRIEF FACTS

Dataran Mantin Sdn Bhd (“Dataran Mantin”) was a property development company involved in a joint venture luxury condominium project (“Project”) with its wholly-owned subsidiary, Mico Vionic Sdn Bhd (“Mico Vionic”). Mico Vionic was the registered proprietor of the land on which the Project was being built (“Project Land”). OCBC Bank had extended credit facilities to Dataran Mantin which were secured by a charge over the Project Land and a fixed and floating charge over the assets of Dataran Mantin.

Construction of the Project commenced in December 2004 but was abandoned in April 2007 when it was approximately 35% completed.

An unsecured creditor, Perkhidmatan Keselamatan Laksamana (M) Sdn Bhd, filed a winding up Petition against Dataran Mantin in 2009 and Provisional Liquidators were appointed. While these winding up proceedings were still on foot, several purchasers of the condominium units in the Project formulated a scheme of arrangement for Dataran Mantin pursuant to section 176 of the Act.

The scheme provided for a white knight company to acquire the Project and the Project Land from OCBC Bank. The white knight would complete the development of the Project and use a portion of the profits to satisfy the debts of the Project creditors, which was defined as the secured creditor of the Project, namely OCBC Bank, the unsecured creditors of the Project and the purchasers of the condominium units of the Project. The scheme excluded all the other secured and unsecured creditors of Dataran Mantin. The scheme was supported by the Provisional Liquidators of Dataran Mantin.

In June 2011, these purchasers obtained a Court Order under section 176 of the Act sanctioning this scheme (“Sanction Order”). Subsequently, several unsecured creditors who were excluded from the scheme filed an application to set aside the Sanction Order.

In November 2011, the High Court allowed the setting aside application and on the same day, ordered the winding up of Dataran Mantin. The appeal by the Provisional Liquidators and the purchasers who initiated the scheme was allowed by the Court of Appeal and the Sanction Order was reinstated.

Leave was granted to the unsecured creditors of Dataran Mantin who were excluded from the scheme to appeal to the Federal Court on two questions of law.

 

TEST FOR CLASS OF CREDITORS 

The first question of law before the Federal Court was as follows:

“Who in law would constitute a class of creditors within the meaning of section 176 of the Act?” 

The Federal Court expressly adopted the established principle in Sovereign Life Assurance Co v Dodd [1892] 2 QB 573 and answered that a class of creditors would be “all creditors of a company whose rights are not so dissimilar as to make it impossible for them to consult together with a view to their common interest”.

The Federal Court also cited with approval other English authorities of Re Alabama, New Orleans, Texas and Pacific Junction Railway Co [1891] 1 Ch 213 and Re Hawk Insurance Co Ltd [2001] 2 BCLC 480. It is useful to have the definitive test on the classification of creditors now set out here in Malaysia.   

 

PARI PASSU PRINCIPLE DOES NOT HAVE TO APPLY

The second question of law posed before the Federal Court (as amended by the Federal Court) was whether section 176 of the Act could confer preference on one group of creditors while excluding another group altogether where the company is in the process of being wound up.

The Federal Court considered the three arguments by the appellants that the scheme, in effect, was an undue preference (in breach of section 293 of the Act), that it gave preference to unsecured creditors over priority creditors (in breach of section 292 of the Act) and that it breached the pari passu rule.

The Federal Court found no undue preference as the Project Land was not the property of Dataran Mantin (the company which faced the pending winding up proceedings at that time) but was owned by Mico Vionic. The only asset of Dataran Mantin was the shares it held in Mico Vionic. 

The Federal Court also further found no breach of section 292 of the Act and that a scheme of arrangement can depart from the pari passu principle. The Federal Court applied the principles laid down by the Singapore Court of Appeal in Hitachi Plant Engineering & Construction Co Ltd and another v Eltraco International Pte Ltd and another appeal [2003] 4 SLR 384 where it was held that a departure from the pari passu principle should be allowed in other corporate rescue mechanisms, such as a scheme of arrangement, which falls outside the insolvency regime.

The Federal Court then answered the second leave question in the affirmative, thereby allowing a company to confer preference on one group of creditors to the exclusion of another from a scheme under section 176 of the Act even when a company is in the process of being wound up. 

 

CHERRY-PICKING

One interesting aspect of this appeal was the complaint that the scheme only took care of the creditors of Dataran Mantin in relation to the Project (i.e. certain unsecured creditors of Dataran Mantin) but not the other non-Project creditors of Dataran Mantin (i.e. the remaining unsecured creditors of Dataran Mantin).

In essence, the issue was whether a company in a scheme under section 176 should be allowed to ‘cherry-pick’ the specific creditors to be placed into a class (i.e. only the unsecured creditors of Dataran Mantin for the Project) or whether a class must include all the creditors who share the specified characteristics (e.g. all the unsecured creditors of Dataran Mantin).

The Federal Court held that section 176 of the Act allows for such cherry-picking of creditors. This aspect of the decision mirrors the issue which was before the English Court of Appeal in Sea Assets Limited v Perusahaan Perseoran (Persero) PT Perusahaan Penerbangan Garuda Indonesia [2001] EWCA Civ 1696 (“Garuda Indonesia”).

In Garuda Indonesia, the Indonesian national airline company, which was registered in England as an overseas company, applied for a scheme of arrangement. Certain unsecured creditors would have their debts restructured under the terms of the scheme while two other categories of unsecured creditors would be kept outside the scope of the scheme. These excluded creditors were, for instance, essential trade creditors from whom the airline would have to continue to obtain goods and services to continue its operations. These excluded creditors could therefore claim their debts in full against the airline.

It was argued that a class of creditors cannot be constituted by a process of arbitrary selection by the company, that there must be something that can be called a class which is identified by the sharing of objectively recognisable common characteristics and that the class must include all the creditors who share those characteristics.

The English High Court and Court of Appeal found that both the language of the English provision and the statutory purpose did not support such an interpretation. The proposer of a scheme is free to select the creditors to whom a scheme of arrangement should be put, provided that the rights of the creditors and the effect of the scheme on those rights are not so dissimilar as to make it impossible for those creditors to consult together with a view to acting in their common interest.

Although the Federal Court did not refer to Garuda Indonesia in the Dataran Mantin Case, it did refer to Re Hawk Insurance Co Ltd (supra) where a similar test was applied. According to the Federal Court, the Project creditors of Dataran Mantin could be recognised as a distinct class of creditors as their rights were not so dissimilar as to render it impossible for them to consult together with a view to advancing their common interest. The Court also opined that it would have been impossible for the Project creditors of Dataran Mantin to consult with the other unsecured creditors of Dataran Mantin as their interests were not common. 

Further, the Federal Court had also considered the fact that the excluded creditors of Dataran Mantin could not be said to be really prejudiced by the scheme. The Project Land was owned by Mico Vionic and was charged to OCBC Bank. The amount owing to OCBC Bank far exceeded the value of the Project Land. If the scheme were to be set aside, the Project Land would be auctioned off and there would not be any surplus sale proceeds to be paid to Mico Vionic and the creditors of Dataran Mantin.

Although not expressly referred to by the Federal Court, this reasoning is consistent with the principles set out in the English Court of Appeal case of  In re Tea Corporation Ltd [1904] 1 Ch 12 (“Tea Corporation”). Tea Corporation is authority for the proposition that it is not necessary for a company to consult any class of creditors or contributories who are not affected by a scheme, either because their rights are untouched or because they have no economic interest in the company.

So for instance, a class of creditors or shareholders may have no economic interest in a company because the assets of the company were insufficient to generate a return to them in liquidation and therefore need not be included in the scheme (see further examples in the English cases of In re myTravel Group Plc [2004] EWHC 2741; [2004] EWCA Civ 1734 and In re Bluebrook and others [2009] EWHC 2114).

 

CONCLUSION

The Federal Court’s decision in the Dataran Mantin Case will allow a company to have greater flexibility in determining the particular group of creditors with whom it wishes to deal with through the statutory procedure under section 176 of the Act so long as these creditors have similar rights that will enable them to consult together with a view to advancing their common interest and that the creditors who have been excluded from the scheme do not share such similar rights even though they may share other common characteristics with the scheme creditors, such as being unsecured creditors of the company.

Further justification for this cherry-picking of creditors can also be found where certain creditors may have no economic interest in the company, particularly in the case of an insolvent company. Hence, these creditors can be excluded from a proposed scheme.

 

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