1MDB is Insolvent: Directors’ Liabilities for the Debts

In a Media Release on 23 May 2018, Malaysia’s Ministry of Finance announced that it had met with 1MDB’s Board of Directors. The directors confirmed that 1MDB was insolvent and was unable to pay its debts. 1MDB’s debts may be in the region of RM42 billion. This figure is based on the declassified Auditor General Report  issued in 2015.

 

With this tremendous amount of debt, I touch on one aspect of directors’ liabilities. The directors and other officers of 1MDB, when allowing 1MDB to take on so much debt, can be held personally liable for these debts.

Fraudulent Trading: Civil Claim

The previous section 304 of the Companies Act 1965 and the present 540 of the Companies Act 2016 deals with fraudulent trading. This provision applies when the business of the company has been carried on with intent to defraud the creditors or for any fraudulent purpose. In this situation, the Court can make an order against any person who was knowingly a party to such a business. That person can then be made personally liable for all or any of the debts of the company.

It is not necessary to outright show fraud. The intent to defraud can be shown when the directors knew that there was no reasonable prospect of those debts ever being paid.

While this section refers to ‘fraud’ and ‘fraudulent purpose’, the burden of proof is on a balance of probabilities. This is a civil claim that can be brought by the liquidator or shareholder of a company (if the company is wound up) or by any creditor. It does not matter whether the company has been wound up yet or not.

In determining fraudulent trading, we have to look back at the periods when 1MDB incurred its debts. The question is did the directors, or any other person, allow 1MDB to take on those debts where there was no real prospect of those debts being paid? We also know that from the Auditor General Report, 1MDB took on a significant amount of its debts in 2009 to 2015. Subsequently, in 2017, 1MDB also took on the US$1.2 billion debt to pay IPIC as part of settling the arbitration proceedings. 1MDB has  been unable to pay IPIC and the Ministry of Finance has had to step in to pay.

Insolvency Trading: Criminal Claim

A related provision to fraudulent trading is that of insolvent trading (section 303(3) of the Companies Act 1965 and section 539(3) of the Companies Act 2016). It contains similar wording targeting an officer of the company who knowingly was a party to the taking on of a debt. If there was no reasonable ground for the company to pay back the debt, then that officer can be liable of an offence.

This offence would involve criminal prosecution and would have to be established beyond a reasonable doubt.

If there is a conviction, the penalty under the Companies Act 2016 is a maximum jail term of 5 years or a maximum fine of RM500,000 or both.

However, this conviction can also lead to the company officer bearing personal liability for that debt of the company. A liquidator, creditor or shareholder can apply to the Court to declare that the person is personally responsible for this debt.

Possible Targets of a Fraudulent Trading or Insolvent Trading Claim

One would look at the relevant time the debts were created and who were the 1MDB directors at that time. Fraudulent trading does however cast its net wider than just the directors. Any person can be made liable as long as he was knowingly a party to the carrying on of that business.

Crucial in this determination is that several individuals may have never sat on the Board of 1MDB. But these individuals may have been giving instructions and been the beneficiaries of monies taken out of 1MDB. In an earlier post, I had also written about the law on shadow directors and how it would apply in the situation of a similar-sounding company called 1ABC.

Fraudulent trading and insolvent trading are necessary protection mechanisms for creditors. These provisions ensure that creditors are not prejudiced when individuals controlling the company have allowed the company to take on a lot of.  Such individuals, including the directors of the company, would then bear the grave risk of being made personally liable if those debts cannot be paid.

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