Company Law Case Update: Must Meet Pre-Conditions for Restraining Order in a Scheme of Arrangement

The High Court has again confirmed that for the initial grant of a restraining order in a scheme of arrangement, the applicant must meet all the pre-conditions in section 368(2) of the Companies Act 2016 (CA 2016).

This was confirmed in the recent decision in Lagenda Erajuta Sdn Bhd (Grounds of Judgment dated 20 February 2020).

Summary of the Decision and Significance

The distressed applicant company was the developer of a mixed development project. This project had been abandoned. The applicant proposed a scheme of arrangement with the purchasers, and obtained a restraining order. Some of the purchasers intervened and successfully set aside the restraining order and the order to hold the scheme meeting.

The High Court upheld the purchasers’ argument that all four requirements under section 368(2)(a) to (d) of the CA 2016 must be met even for the initial restraining order application.

In particular, the applicant had failed to satisfy section 368(2)(a): that the scheme of arrangement was proposed to creditors representing at least half of the value of all the creditors. Second, the applicant had failed to satisfy section 368(2)(d): there was no director nominated by a majority of the creditors and to be approved by the Court.

This decision is similar to the earlier High Court decision in the Barakah Offshore case in confirming all these four requirements must be met.

The High Court also upheld the purchasers’ arguments that the scheme was not bona fide and that there was failure to make full and frank disclosure when the initial Order was obtained ex parte.

This decision confirms that a distressed company faces a difficult hurdle when seeking for a restraining order in a scheme of arrangement.

Brief Facts

Lagenda Erajuta was the developer of the mixed development project, 1 Gateway, in Klang, Selangor. This project had been abandoned.

Lagenda Erajuta had then applied for leave to call the scheme creditors meeting as part of a proposed scheme of arrangement. The company had also obtained an ex parte restraining order. The proposed scheme would involve a White Knight trying to revive the abandoned project.

The scheme creditors’ meeting was held and with 92% in value of the scheme creditors approving the proposed scheme.

Lagenda Erajuta then applied to the Court for sanction of the proposed scheme. Some of the purchasers then applied to intervene in the court proceedings. They applied to set aside the original Order for the restraining order and for leave to call the scheme creditors meeting. These purchasers also wanted to oppose the sanction application.

Decision

Lagenda Erajuta objected to the intervention application but the Court allowed the intervention.

The Court then proceeded to make these particular points in deciding in favour of the purchasers’ arguments:

  1. Lagenda Erajuta had imposed a requirement to submit a proof of debt ahead of the voting at the scheme creditors meeting. The Court found that this was self-imposed by Lagenda Erajuta. There was no Court Order or written rule imposing such a condition before the purchasers were recognised creditors for voting. There was no such term or condition mentioned in the Order granting leave to convene the scheme creditors meeting. There was also no such term in the proposed rules of meeting that a proof of debt must first be filed. Sdection 366(3) of the CA 2016 permits creditors to vote at the meeting without any requirement to first file any proof of debt.
  2. The proposed scheme was prima facie not bona fide and is bound to fail. Due to the various details in the scheme, including the White Knight’s lack of assets and cash to rehabilitate the project, the Court agreed on the purchasers’ objection on this issue.
  3. The Court agreed that there had been a failure to make full and frank disclosure on three issues. There was non-disclosure of the latest statements of assets and liabilities.
  4. The Court agreed that the four requirements under section 368(2)(a) to (d) of the CA 2016 had to be met even for the initial restraining order application. Here, Lagenda Erajuta had failed to comply with the requirements of section 368(2)(a) and (d) of the CA 2016.

Therefore, the purchasers’ setting aside application succeeded. The Court then also made no order in terms of the sanction of the scheme. The scheme was now effectively dismissed.

Comments

This decision continues with the trend of first instance decisions that confirm that a restraining order applicant must satisfy all four requirements of section 368(2) of the CA 2016 from the start. Creditors would then not be taken by surprise by the moratorium effect of the restraining order. However, this places a distressed company with a difficult hurdle in obtaining urgent moratorium protection.

This decision is also important in emphasising the importance of making full and frank disclosure. The practice is to apply ex parte for the restraining order and leave to convene the scheme creditors meeting. However, on this point, we will have to take note of the Court of Appeal decision in Mansion Properties (see my write-up here). If there are already pending legal proceedings, the application must first be served on those creditors.

Finally, the Court will continue to be vigilant in ensuring the bona fides of any scheme. The scheme creditors had overwhelmingly approved the proposed scheme. But at the sanction stage, and in hearing the arguments by the aggrieved scheme creditors, the Court agreed that the scheme lacked bona fide. The earlier Order for leave for the scheme creditors meeting was set aside and the sanction Order not allowed.

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