More Hats Than Heads?


A commentary by Wong Chee Lin on the Pesaka Astana Case



On 8 November 2011, the Court of Appeal handed down its judgment in 4 appeals that arose from a High Court action relating to an issue of corporate bonds in Malaysia. This commentary highlights certain aspects of the judgment by the Court of Appeal.




Pesaka Astana Sdn Bhd ("Pesaka") was awarded 3 contracts by the Government of Malaysia ("contracts"). It decided to issue Al-Bai Bithaman Ajil bonds ("bonds") to part-finance the execution of these contracts.


To facilitate the issue of the bonds, Pesaka appointed KAF Discounts Berhad ("KAF") as the lead arranger, facility agent and issue agent and Mayban Trustee Berhad ("MTB") as the trustee for the bonds.


Pesaka issued an information memorandum ("IM") in relation to the proposed bond issue. The IM stated that various bank accounts ("designated accounts") would be established under the control of MTB as the sole signatory. The revenue from the contracts ("assigned revenue") would be deposited into one of the designated accounts controlled by MTB ("revenue account") and be applied to redeem the bonds. This arrangement, often described as "ring fencing", would in effect put the assigned revenue beyond the control of Pesaka to protect the interest of the bondholders.


The bonds were to be issued to a primary subscriber, namely K&N Kenanga Bhd ("Kenanga"), who would then sell the same to other investors.


Various transaction documents were entered into in relation to the bonds, including a Subscription and Facility Agreement between Pesaka, KAF and Kenanga ("Agreement"), a Trust Deed whereby Pesaka appointed MTB as trustee for the bondholders ("Trust Deed") and an Assignment and Charge whereby Pesaka assigned to MTB, as trustee for the bondholders, the assigned revenue that would be deposited into the revenue account maintained by Pesaka with CIMB Cosway Branch ("CIMB")("Assignment").


As the revenue under two of the contracts had been assigned to CIMB, the relevant parties, including CIMB executed a Release and Assignment Agreement ("Release") which amongst other matters, disclosed that the assigned revenue would be assigned by Pesaka to MTB as trustee for the bondholders.


A notice of assignment was issued by Pesaka to CIMB pursuant to the Assignment. Amongst others, the notice informed CIMB that all rights in respect of the revenue account and all moneys therein had been assigned to MTB and irrevocably instructed CIMB to act upon the instructions of MTB in relation to any withdrawals and all other matters relating to the revenue account.


Although Pesaka had passed a resolution to appoint MTB's nominees as signatories for the revenue account, it did not appear that the resolution had been delivered to CIMB.


The bonds were issued on 1 April 2004 and the proceeds of approximately RM149.3 million (less agreed deductions and payments to various parties) were disbursed by KAF to Pesaka on the same day.


Sometime between July 2004 and September 2005, the assigned revenue was deposited into the revenue account and withdrawn by Pesaka. This was due to the fact that KAF and MTB had not taken steps to ensure that the signatories for the revenue account had been changed to MTB's nominees. Although CIMB was aware of the Assignment, it did not stop Pesaka's signatories from withdrawing the assigned revenue from the revenue account.


The bondholders declared an event of default on the bonds on 30 September 2005. Subsequently they filed a claim in the High Court against various parties including Pesaka, KAF and MTB. Arising from this proceeding, KAF filed a claim for an indemnity against Pesaka. Similarly MTB filed an indemnity claim against Pesaka and other parties. MTB also filed a claim against CIMB seeking damages on grounds that CIMB had breached its duties as a constructive trustee of the assigned revenue.




Upon completion of the trial, the High Court awarded judgment to the bondholders in the sum of RM149.3 million against KAF and MTB in the proportion of 60%:40% respectively. The Court dismissed KAF's claim against Pesaka as well as MTB's claim against Pesaka and other parties. It also dismissed MTB's claim against CIMB.


Appeals were filed by various parties to the Court of Appeal.




Liability of KAF and MTB


The Court of Appeal highlighted the following provisions of the Agreement –


(i) one of the conditions precedent that had to be fulfilled for the issue of the bonds was that KAF, the lead arranger, had received confirmation from Pesaka that it had opened the designated accounts and the mandates were in form and content satisfactory to KAF and Kenanga (clause 3.1 read with paragraph 11 ("CP11") of Schedule A);

(ii) the conditions in Schedule A could only be waived by Kenanga (clause 3.2); and

(iii) the issue of the bonds was subject to the condition that no event of default had occurred or is continuing (clause 4.3).


According to Dato' Jeffrey Tan JCA, the above-referred provisions required KAF to be satisfied that there was no default in CP11. His Lordship further ruled that in order to be so satisfied, KAF as lead arranger, facility agent and issue agent could not rely on Pesaka's confirmation but had to independently verify that all were in place before the bonds were issued.


In His Lordship's opinion, KAF had to be absolutely sure that the "ring fencing" arrangements, namely the establishment of the designated accounts with MTB in sole control, were in place before the issuance of the bonds. As it transpired, these arrangements were not in place when the bonds were issued, nor were they in place when the bond proceeds were disbursed or more critically, when the assigned revenue was deposited into the revenue account.


In the absence of the "ring fencing", the assigned revenue which belonged to the bondholders was not controlled by MTB but rather by Pesaka and this enabled the latter to withdraw all the assigned revenue from the revenue account.


The Court of Appeal held that despite the strenuous arguments by KAF and MTB, there was no getting away from the fact that there were no designated accounts or any "ring fencing" in place when the bonds were issued.


The learned Court of Appeal Judge held that KAF had failed to ascertain that CP11 had been complied with and that such non-compliance constituted an event of default under clause 4.3 of the Agreement. His Lordship concluded that by permitting the bonds to be issued in the face of an event of default, KAF had breached the IM and the Agreement as the promised security was not in place. In the opinion of the learned Judge, that was the next proximate cause for the loss (apart from the unauthorized withdrawals of the assigned revenue by Pesaka).


According to His Lordship, the absence of "ring fencing" was not the proximate cause of the loss. Had KAF not permitted the bonds to be issued, no loss would have arisen even in the absence of those arrangements.


Although MTB had agreed under the Trust Deed to take sole control of the designated accounts, it had failed to do so not only before the issuance of the bonds, but it also failed to act with urgency even after the bonds were issued. This enabled Pesaka to withdraw the assigned revenue from the revenue account. The Court of Appeal concurred with the findings of the High Court that MTB had failed to exhibit the level of professionalism, competence and skill expected of professional trustees.


In the opinion of Dato' Jeffrey Tan JCA, both KAF and MTB had failed to appreciate that it was absolutely necessary for MTB to control the designated accounts before the issuance of the bonds. He then concluded that this was a serious lapse for which MTB must be held to account.


The Court of Appeal also ruled that MTB had failed to discharge its statutory duties to "exercise reasonable diligence" under section 82(1)(c) of the Securities Commission Act ("SCA") by failing to ascertain whether Pesaka had committed any breach of the provisions of the Trust Deed.


The Court of Appeal held that both KAF and MTB had failed to carry out their statutory and contractual duties. The Court then unanimously held that both were equally liable for the loss and to that extent, allowed KAF's appeal against MTB.



Liability to bondholders

One of the grounds of appeal put forward by KAF was that it was not liable to the bondholders as there was no contract between KAF and the bondholders and that KAF was in any event exempted from liability by the disclaimer of liability on the front page of the IM.


In the opinion of the Court of Appeal, KAF could not include the disclaimer of liability in the IM as it could not contract out of its statutory duties or liabilities. The Court relied on section 65 of the SCA which renders void any agreement to the extent that it purports to exclude liability under certain provisions of the SCA, including section 57 (right to recover loss or damage for false or misleading statement in prospectus) and section 153 (civil liability of person in contravention of the SCA).


After considering the provisions of the bond documentation, the Court was of the opinion that the IM was issued not only to the primary subscriber but to all potential bondholders. Thus, KAF could not elude its statutory and contractual obligations and duties under the IM and other security documents to all bondholders, both primary and secondary.


For the aforesaid reasons, the Court of Appeal unanimously dismissed this ground of appeal by KAF.



Pre-judgment interest

The bondholders appealed against the refusal by the High Court to grant pre-judgment interest. The Court of Appeal allowed the bondholders' appeal as the provisions of the Agreement and the Trust Deed imposed an obligation on Pesaka to pay compensation on overdue amounts at such rate as may be prescribed by the Syariah Advisory Council ("SAC") of the Securities Commission or any other relevant authority.


In coming to its decision to award pre-judgment interest at 3% on the amount claimed by the bondholders, the Court relied on a resolution passed by the SAC on 26 May 2005 which recognized that the court may impose late payment penalty charges on judgment sums as decided by the court's compensation mechanisms. The SAC had also resolved that the court may impose penalty charges for actual loss (ta'widh) and to adopt the "annual average overnight weighted rate" of the Islamic money market as a reference point.



Indemnity claim against Pesaka

Both KAF and MTB appealed against the decision of the learned High Court Judge to disallow their claim for a full indemnity from Pesaka for losses suffered by them.


KAF relied on clause 13.1 of the Agreement whereas MTB relied on breach of contract, negligence, fraud or misrepresentation by Pesaka.


The learned trial judge had rejected KAF's indemnity claim as KAF's loss had all resulted from its own gross negligence in failing to ensure that MTB became the sole signatory of the designated accounts.


In the case of MTB, the High Court held that clause 14.1 of the Trust Deed disallowed the indemnity claim where there was gross negligence on the part of MTB.


The Court of Appeal overturned the decision of the High Court on grounds that the exemption clause contained in clause 13.1 of the Agreement and clause 14.1 of the Trust Deed must be strictly construed and their application must be restricted to those particular circumstances of gross negligence, willful misconduct or fraud or willful default by KAF or MTB.


Dato' Jeffrey Tan JCA held that on its true construction, the exemption clauses could not reasonably have been intended to apply even when Pesaka had by its unauthorized conduct intervened to alter the circumstances in which those clauses would ordinarily apply. He added that any other construction would mean that Pesaka could break every covenant with impunity and that such an absurd result could never be right.


Although KAF and MTB were negligent, it was ultimately Pesaka which caused KAF and MTB to suffer for their negligence by its unauthorized withdrawal of the assigned revenues from the assigned account. Accordingly, the Court of Appeal unanimously allowed the appeals of KAF and MTB against Pesaka.


However, the Court of Appeal did not deem it fit to order a full indemnity as that would mean that KAF and MTB were blameless. As both KAF and MTB had been found wanting in their respective roles as lead arranger/facility agent and trustee, the Court of Appeal judges unanimously ruled that they should jointly bear 1/3 of the total loss of approximately RM149.3 million and ordered Pesaka to pay KAF and MTB 2/3 of the aforesaid sum.



MTB's claim against CIMB

MTB also appealed against the decision of the High Court to dismiss its claim for damages against CIMB on grounds that the latter was a constructive trustee of the assigned revenue.


Although the High Court had made a finding that CIMB had received the notice of the Assignment, CIMB contended that the Assignment required its consent which had not been obtained and that the signatories of the revenue account had not been changed from the nominees of Pesaka to those of MTB. CIMB further contended that without a change in the mandate being made, it was obliged to execute the instructions of Pesaka or its nominees.


According to the Court of Appeal, the issue was whether CIMB had a duty to hold onto the assigned revenue regardless of the fact that the mandate had not been changed.


The Court of Appeal found that CIMB had actual knowledge that the assigned revenue did not belong to Pesaka and that by permitting Pesaka to transfer such moneys to others, it had knowingly facilitated and so participated in a breach of trust.


In the opinion of the Court of Appeal, the notice of assignment cast a duty on CIMB not to participate in a breach of trust.


The Court of Appeal rejected CIMB's contention that it had not consented to Assignment. The Court held that by entering into the Release, CIMB had agreed to Pesaka's assignment of the assigned revenue to MTB as trustee.


The Court was of the view that CIMB was a constructive trustee of the assigned revenue as it had knowledge that such revenue in the revenue account belonged to the bondholders. The Court ruled further that CIMB could not permit Pesaka to transfer the assigned revenue out of the revenue account. In permitting so, CIMB had permitted a breach of trust and breached its duty as constructive trustee.


The Court of Appeal allowed MTB's appeal against CIMB. However, as the Court was of the view that greater fault lay with MTB, it unanimously ordered CIMB to indemnify MTB to the extent of 1/3 of the liability that MTB had to bear.




The decision of the Court of Appeal in the Pesaka Astana Case has been long awaited by stakeholders in the Malaysian capital market.


The decision is noteworthy as it sets out the legal principles and provides guidance on the Court's expectations on the standard of conduct of the key participants in a private debt securities issue, namely, an issuer, a lead arranger and facility agent, a trustee and a bank at which an assigned account is established.


The Court of Appeal's decision is also noteworthy as it provides a cogent interpretation of indemnity and exemption clauses commonly found in bond issue documents.


It is appropriate to conclude this article by reproducing the last paragraph of the judgment of Dato' Jeffrey Tan JCA –


"As our final remark, we wish to add en passé that bonds is complex financial business which needs more heads than there are hats. We like to ask, had there been more heads than there were hats, could the instant bond fiasco have been averted?"



Writer's email: This e-mail address is being protected from spambots. You need JavaScript enabled to view it




IFLR 1000 2019 Rankings


IFLR 1000 2019 has ranked Skrine as a Tier 1 firm in four practice areas. In addition, eight of our lawyers were listed among the leading lawyers.


Asialaw Profiles 2019 Rankings


Asialaw Profiles 2019 has ranked Skrine as an ‘Outstanding’ firm in seven industry and practice areas. In addition, 10 of our lawyers were listed among the leading lawyers.


Benchmark Litigation Asia-Pacific 2018


We are pleased to announce that our firm is recognised as a Top Tier Firm in the inaugural Benchmark Litigation Asia-Pacific 2018. Some of our partners were also listed in the rankings.



English | Bahasa Malaysia