Restraining Order under a Scheme of Arrangement Must Satisfy Pre-Conditions from the Start

An applicant must meet the statutory pre-conditions for the grant of a moratorium (otherwise known as a restraining order) under Malaysia’s scheme of arrangement even at the initial application stage. This was decided in a recent High Court decision dated 22 April 2019. The Court set aside the initial grant of the restraining order as the applicant companies had not satisfied the pre-conditions at the time of the application. I have since written the case commentary on this decision.

To my knowledge, this is also the first decision on this issue under the new section 368(2) of the Companies Act 2016 (CA 2016). There have been conflicting High Court decisions on this issue when interpreting the predecessor section 176(10A) of the Companies Act 1965 (CA 1965). The full grounds of judgment have not been issued yet.

The Restraining Order

Malaysia’s scheme of arrangement framework allows for a restraining order to be granted. The restraining order would restrain any further legal proceedings to be initiated against the applicant company applying for a scheme of arrangement.

A restraining order can be a crucial tool to allow the distressed applicant company to have a moratorium from creditors’ actions and to allow for a successful restructuring of the company’s debts through a scheme of arrangement. On the other hand, a restraining order could frustrate creditors’ actions over an extended duration but without a genuine scheme being proposed.

The Issue: Requirements to be Met for Initial Application or Extension Application

Section 368 of the CA 2016 sets out the restraining order provisions. The relevant sections are quoted below and with the emphasis in the underlined words.

The issue is whether the pre-conditions under section 368(2) i.e. section 368(2)(a) to (d), must be satisfied in either scenario 1 or scenario 2 below:

  • Scenario 1: The initial grant of a restraining order for a period of not more than 3 months must satisfy the pre-conditions; or
  • Scenario 2: Only the extension of the restraining order period must satisfy the pre-conditions.

Section 368 of the CA 2016 states:

Power of Court to Restrain Proceedings

(1) If no order has been made or resolution passed for the winding up of a company and a compromise or arrangement has been proposed between the company and its creditors or any class of those creditors, the Court may, in addition to any of its powers, on the application in a summary way of the company or any member or creditor of the company, restrain further proceedings in any action or proceeding against the company except by leave of the Court and subject to any terms as the Court may impose.

(2) The Court may grant a restraining order under subsection (1) to a company for a period of not more than three months and the Court may on the application of the company, extend this period for not more than nine months if-

(a) the Court 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 Court is satisfied that the restraining order is necessary to enable the company and its creditors to formalise the scheme of compromise or arrangement for the approval of the creditors or members under section 366;

(c) a statement of particulars 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) the Court approves the person nominated by a majority of the creditors in the application by the company under subsection (1) to act as a director or if that person is not already a director, appoints that person to act as a director notwithstanding the provisions of this Act or the constitution of the company.

 

A similar issue also arose under the predecessor provision of section 176(10A) of the CA 1965. The issue was whether an initial grant of a restraining order of not more than 90 days must meet the pre-conditions or only a longer or extended period of a restraining order must meet the pre-conditions.

Section 176 of the CA 1965 stated:

Power of Court to restrain proceedings

(10) Where no order has been made or resolution passed for the winding up of a company and any such compromise or arrangement has been proposed between the company and its creditors or any class of those creditors, the Court may, in addition to any of its powers, on the application in a summary way of the company or of any member or creditor of the company restrain further proceedings in any action or proceeding against the company except by leave of the Court and subject to such terms as the Court imposes.

(10A) The Court may grant a restraining order under subsection (10) to a company 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 formalise 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.

 

Under both section 368(2) of the CA 2016 and section 176(10A) of the CA 1965, the most difficult pre-condition to meet was the requirement under (d). Subsection (d) required a director to be nominated by a majority of the creditors and for the Court to approve this nomination.

This would essentially require an applicant to reveal to the creditors beforehand that it was intending to apply for a restraining order. The applicant would have to marshall support from the creditors for them to back a proposed director. Where a company was in financial distress and required urgent protection from creditor actions, it would be difficult for the company to meet this pre-condition. The creditors would be alerted to the intended action and may accelerate their legal actions.

The Previous Decisions under Section 176(10A)

In the High Court decisions of Re Bina Goodyear Berhad (Kuala Lumpur High Court Originating Summons No. 24NCC-126-04/2013, grounds of judgment dated 22 July 2013), Re PECD Bhd & Anor (No 2) [2008] 10 CLJ 486 and Re Sanda Industries Bhd & Ors [1999] 1 CLJ 459, the Court essentially held that the pre-conditions in section 176(10A) of the CA 1965 had to be complied with at the very initial application for a restraining order.

In the High Court decision of Chee Teck Fah v Rei Management Sdn Bhd [2016] MLJU 746, the Court held that section 176(10A) of the CA 1965 does not apply in the case where the restraining order is for a period of not more than 90 days. The Court referred to an earlier decision in Jin Lin Wood Industries Sdn Bhd & Anor v Mulpha International Berhad. The decision in Jin Lin Wood had been appealed up to the Federal Court and with the leave question relating to section 176(10A) of the CA 1965. But there were never grounds of decision of the Federal Court or the Court of Appeal to determine the issue.

The Recent Decision

In a decision on 22 April 2019, the High Court in Kuala Lumpur allowed the creditors’ applications to set aside the grant of the restraining order. The Applicant companies had not met with pre-conditions of (c) and (d) under section 368(2) of the CA 2016 at the time of obtaining the restraining order.

The High Court set out brief grounds of judgment and with the full grounds to follow.

The Court held that upon its proper construction, the conditions of section 368(2) had to be complied with at the time the application was made for a restraining order under section 368(1) of the CA 2016. This was consonant with the plain language and intent of the provisions.

The Court recognised that there are practical difficulties in meeting these conditions. These difficulties would be more acute if there is urgency due to the financial condition of the company applying for a scheme of arrangement. However, such practical difficulties have to be weighed against the somewhat drastic effect of a restraining order. Creditors would be stopped in their tracks in pursuing their legal remedies.

Applicants must conscientiously prepare a restraining order application with care. The application should not be made at the eleventh hour.

Comments

I can mention that I was involved at the hearing so I know the arguments that were raised. I set out some thoughts on the arguments and the possible issues arising. This is pending the issuance of the full grounds of judgment from the High Court.

(1) Plain Reading of Section 368(2)(d) of the CA 2016

On the plain reading of section 368(2) of the CA 2016, I believe the critical factor for the Court was the wording of the condition (d) where the Court approves the creditor-nominated director “in the application by the company under subsection (1)”. The plain reading of condition (d) would require that any application for a restraining order under section 368(1) must meet this condition. Hence, a Scenario 1 would apply where the initial application for the restraining order would already require, at the very least, condition (d) to be met.

The parties did not strongly argue whether condition (d) could then be read alone and whether conditions (a) to (c) should then be read separately. This is more so with the word “and” between conditions (c) and (d) which suggested a cumulative reading of conditions (a) to (d) of section 368(2).

(2) Legislative History Behind Introduction of section 176(10A)

The Court may have also taken into account the intent of the introduction of the conditions of (a) to (d). Looking at the legislative history, Malaysia is unique in imposing these conditions (a) to (d) in the grant of a restraining order in a scheme of arrangement. For example, Singapore also had near-identical language in its original section 210(10) of the Singapore Companies Act for a restraining order in a scheme of arrangement.

Malaysia introduced section 176(10A) of the CA 1965 through the Companies (Amendment) No. 2 Bill 1998. In particular, clause 14 of that Bill inserted the subsection (10A) to (10E) into section 176 of the CA 1965. The Explanatory Statement of the Bill explained the reason for the introduction of the new subsections:

“Clause 14 seeks the amend section 176 of Act 125 to ensure that creditors are aware of an application made under subsection (1o) and to ascertain that restraining orders under that subsection are only granted under specific conditions to avoid any abuse.”

The argument is that the original introduction of the conditions (a) to (d) to section 176(10) was to make sure that “creditors are aware of an application” beforehand and that “specific conditions” needed to be met “to avoid any abuse.” This meant that those conditions had to be met at the time of the initial application for the restraining order.

The argument was that this legislative purpose was maintained even for section 368(2) of the CA 2016. The Corporate Law Reform Committee process that led to the CA 2016 had recommended the imposition of a clear cut 3 and 9-month timeframe for the restraining order. This ensured that the maximum length of the restraining order would be one year. There was no intended change to the conditions (a) to (d).

(3) Comparison with Automatic Moratorium under other Corporate Rescue Mechanisms

Separately, the CA 2016 has introduced two corporate rescue mechanisms for a financially distressed company: corporate voluntary arrangement (CVA) and judicial management (JM).

The CVA provisions are in sections 395 to 402 of the CA 2016, along with the Seventh and Eighth Schedule of the CA 2016. The JM provisions are in sections 403 to 430 of the CA 2016, along with the Ninth Schedule of the CA 2016. In both the CVA and JM provisions, there is clear language to allow for an automatic moratorium to restrain legal proceedings.

In CVA, section 398 of the CA 2016 provides that a “moratorium in voluntary arrangement commences automatically from the time of filing of the following documents by the company to the Court”.

In JM, section 410 of the CA 2016 provides that from the time of the making of an application for a judicial management order, a moratorium applies and where “no other proceedings and no execution or other legal process shall be commenced or continued … against the company …”

One argument is that if it were intended that section 368 allowed for the initial grant of a restraining order with no specific conditions, then section 368 of the CA 2016 would have simply adopted similar language as in section 398 and section 410 of the CA 2016.

The Future

My view is that the proper step is to assess whether there is a need to amend the language of section 368(2) of the CA 2016. A wholistic assessment to balance the interests of a distressed company and that of the rights of the creditors.

As an example, Singapore introduced an option for an automatic moratorium under its scheme of arrangement provisions. Section 211B of the Singapore Companies Act allows for a 30-day automatic moratorium period.

However, there is a balancing of the rights of the applicant company and the creditors. The applicant company must provide, among others, evidence of support from the company’s creditors for the intended or proposed compromise or arrangement, a brief description of the intended compromise or arrangement, a list of every secured creditor and a list of all unsecured creditors not related to the company. The Court may also require:

  • a valuation report on each of the company’s significant assets.
  • information relating to the acquisition or disposal of property or grant of security
  • periodic financial reports of the company and its subsidiaries.
  • forecasts of profitability and cash flow from the operations of the company and its subsidiaries.

 

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