Case Update: Federal Court Decides that Restraining Order Can be Applied Without Notice

The Federal Court in the Mansion Properties decision (see the grounds of judgment dated 24 November 2020) held that the application for a restraining order in a scheme of arrangement can be made ex parte (without notice).

This makes it advantageous for a distressed company to seek urgent moratorium protection through a restraining order. The distressed company can then pursue the debt restructuring in a scheme of arrangement and to have stability.

The Federal Court reversed the Court of Appeal decision. I had covered the Court of Appeal decision in an earlier post.

Background Facts

Mansion Properties is the developer of a housing project in Penang known as D’Mansion. The respondents in the Federal Court were purchasers of the condominium units.

Mansion Properties did not deliver vacant possession within the stipulated time. Due to this delay, in 2017, some purchasers filed claims against Mansion Properties for liquidated ascertained damages.

In October 2017, Mansion Properties filed an ex parte court application (the 1st Proceedings). In the 1st Application, Mansion Properties applied for the holding of the creditors’ meeting as part of a proposed scheme of arrangement and a restraining order to restrain all proceedings against Mansion Properties.

A scheme of arrangement allows for a debt restructuring when essentially more than 75% in value of creditors, or classes of creditors, agree to the proposal. Pending the finalisation of the scheme of arrangement, a restraining order restrains the continuation and filing of legal proceedings against the debtor company. This is to provide the company with breathing room to focus on the scheme of arrangement.

In November 2017, Mansion Properties obtained the ex parte Order to hold the creditors’ meeting and for the restraining order. Mansion Properties served the ex parte Order on the purchasers and other creditors.

On 14 December 2017, Mansion Properties held the creditors’ meeting. The proposed scheme was approved by the creditors.

However, in the meantime, the respondents filed applications in the 1st Proceedings. The respondents essentially sought to intervene in the 1st Proceedings, to set aside the ex parte Order and to reject the proposed scheme. The applications were still pending.

On 2 February 2018, Mansion Properties filed a second set of ex parte court proceedings (the 2nd Proceedings). Having obtained the creditors’ approval at the meeting, Mansion Properties now sought for court sanction of the scheme. The Court hearing the 2nd Proceedings granted this order on 7 February 2018.

The respondents then filed applications in the 2nd proceedings. This was to intervene and to set aside the ex parte Order obtained in the 2nd Proceedings. The 1st and 2nd Proceedings were eventually consolidated.

On 17 August 2018, High Court allowed the respondents’ application to intervene. However, the High Court dismissed all the other reliefs sought. The High Court held that the proposed scheme was bona fide and that Mansion Properties had complied with all the relevant legal provisions. The respondents appealed to the Court of Appeal.

The Court of Appeal reversed the High Court decision. The Court of Appeal held there had been procedural non-compliance and abuse of process. For the 1st Proceedings, especially seeking for a restraining order, the court papers should have been first served on the respondents. An application for a restraining order must be served on the creditors whose actions or proceedings are sought to be restrained.

The Court of Appeal also decided that 2nd Proceedings was secretly filed and with the order obtained in a different court. This was mala fide. Since the first Judge in the 1st Proceedings had granted the relevant orders for the holding of the creditors’ meeting, the applications should have been heard before the first Judge.

Leave to appeal to the Federal Court was granted.

Question of Law

At the Federal Court, there was a single question of law:

Whether an Order made pursuant to an application under section 366 and section 368 of the Companies Act 2016 subsequently served on the creditors is an abuse of the Court process which renders the entire Court scheme or entire Court-sanctioned scheme liable to be set aside.

 

The Federal Court answered this question in the negative.

Decision

Mohd Zawawi Salleh FCJ delivered the judgment of the Federal Court.

(i) Background to the Scheme of Arrangement Framework

The Federal Court first set out a useful summary of the three stages of the scheme of arrangement framework. The scheme of arrangement provides companies saddled with debts a brief respite from their daily struggles of managing their affairs and the demands of the creditors.

At the first stage of seeking permission to hold the creditors’ meetings, the Federal Court observed that the Court’s role is essentially procedural. Generally, the application is made ex parte. The bona fides of the application is assumed.

Further, Malaysia’s scheme of arrangement allows for the grant of a restraining order. This is to restrain any legal proceedings to be initiated against the applicant company. The phrase “in a summary way” appears in both section 366(1) (the provision for permission to hold the creditors’ meeting) and in section 368(1) (the provision for the restraining order) of the Companies Act 2016 (CA 2016). This phrase means that the Court is entitled to deal with every issue summarily and without the necessity of a trial. But it is silent on whether the application is to be made ex parte or inter partes.

The Federal Court recognised that it is common practice for an applicant to seek a restraining order on an ex parte basis. The Court cited several cases. The restraining order is also often concurrently obtained with an order to convene the creditors’ meeting.

The purchaser-respondents challenged this practice. Their argument was that the restraining order should be made inter partes and not ex parte.

(ii) Whether Ex Parte Or Not

The Federal Court recognised that ex parte applications can be necessary and appropriate in certain circumstances. The Federal Court referred to its own apex decision in Tan Kim Hock Product Centre Sdn Bhd v Tan Kim Hock Tong Seng Food Industry Sdn Bhd [2018] 2 MLJ 1. It was a case on whether a trade description order could be made ex parte.

The general principles were that the Court should look to the legislative purpose of the statutory provision. An ex parte application is appropriate where there is a need to obtain an order swiftly to achieve that legislative purpose.

First, the Federal Court determined what is the purpose of a restraining order. It is to ensure that a company’s restructuring efforts are not rendered nugatory pending the approval of a scheme of arrangement. It is to preserve the status and to prevent efforts to approve a scheme of arrangement from being thwarted by the dissipation of the company’s assets.

Therefore, with the need for immediate action and speedy procedures, an ex parte application would be suitable and appropriate to achieve this legislative purpose.

Second, after the grant of the ex parte restraining order, the affected creditors have the right to intervene in the proceedings and to set aside the order. Therefore, there is no prejudice or breach of natural justice by reason of an ex parte restraining order or the omission to serve the application on the respondents before the hearing.

Third, there are also specific statutory safeguards in the grant of a restraining order. They are contained in section 368(2) to (7) of the CA 2016. For example, the pre-conditions to be met under section 368(2) and the person appointed as the director has the right of access to all the company’s records under section 368(3).

Fourth, it is clear that the legislature had addressed its mind to the specific questions of what measures are necessary to ensure that creditors are aware of restraining order applications. Parliament did not see it fit to include any requirement for an inter partes application or the need to serve the application prior to the hearing. This is in contrast with other requirements under the CA 2016.

Comments

First, on the finding that a restraining order can be obtained ex parte.

This Federal Court decision is welcomed. There had been a long debate on whether a restraining order could be applied ex parte or must be made on an inter partes basis.

After the Court of Appeal decision in Mansion Properties, it seemed that the prudent position was for the company to serve the restraining order application on its creditors. Or at the very least, to be first served on the creditors that had initiated legal proceedings already.

Giving prior notice inevitably resulted in many of these creditors appearing and opposing the making of the initial restraining order. The company would be delayed in obtaining the crucial breathing space.

This Federal Court decision now makes clear that it is consistent with the legislative intent to allow for an ex parte urgent restraining order.

Second, there is one ancillary effect of this decision. This case appears to endorse the point that an applicant must meet the four pre-conditions in section 368(2) of the CA 2016 from the very start. There cannot be an initial three-month restraining order without having first met the four pre-conditions. This Federal Court seems to tacitly acknowledge the need for these requirements at [50] of the grounds of judgment. See my earlier commentary on this.

Therefore, the company will still face the hurdle of obtaining some support from its creditors. In particular, the company would need more than 50% in value of the proposed scheme creditors to support the nomination of a director (see section 368(2)(d)).

Third, the Federal Court explained the legislative purpose of the restraining order at [47] of the grounds of judgment. To preserve the status quo and to prevent the dissipation of the company’s assets. Under section 368(1) of the CA 2016, a restraining order will restrain “further proceedings in any action or proceeding against the company“.

Legal proceedings would definitely fall within this phrase e.g. court and arbitration proceedings. But what about other proceedings such as a set-off, an appointment of a receiver, or a call on a performance bond? These would be contractual rights. But the exercise of these contractual rights or exercise of security would be detrimental to the status quo and deplete the company’s assets trying to undertake a scheme of arrangement.

It will be interesting to see a definitive decision in Malaysia on the interpretation of the terms “proceedings” and “proceeding” against the company in light of the legislative purpose of the restraining order.

 

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