Saving Companies Which Face Financial Difficulties

Section 176 of the Companies Act 1965 has been very useful in saving companies which face financial difficulties from liquidation. However, it has also been exploited and abused by companies which are in distress to restrain further legal proceedings by creditors. Discuss.

Introduction

As an introduction, scheme of arrangement normally will be use in order to safe a company from bankruptcy by giving an opportunity to pay the debt to the creditor. The relevant section that should be referring to is s 176 of the Companies Act 1965 [1] . The main purpose of having this provision is to restructuring the financial affairs of a company which heavily burdened with debt. However, some of the companies who face the financial problem may misuse the provision for their own benefit. When this happen, it will create many problem and the objective of having s 176 already be misinterpreted. Most of the companies will use this provision as their reason to avoid the liability to pay back the debt to the creditor. As an example, the Financial Crisis of 1997 resulted in many companies that were in financial problems entering into schemes with creditors to put into effect a compromise or a moratorium [2] .

The advantage of this principle is to enable a company which in financial difficulties to carry on and ultimately pay out all creditors in full. In order to apply this principal, there are certain phrases that need to be defined to ensure the right way in interpreting the principal. Firstly, as one of the types of scheme of arrangement, ‘compromise’ and ‘arrangement’ [3] is one in which creditors agree to accept payment of less than the amounts they are owed in full satisfaction of their debts [4] . In other words, when the compromised done by the creditors and the company mean the company is released from any obligations or liability and is permitted to continue its business. However, the objective to let the company continue in their business is to ensure that they will pay back the debt of the creditor once their business already stable. Other than that, another type of scheme of arrangement that might be use by the company is ‘moratorium’ scheme of arrangement which can be used to distinguishing feature of such a scheme is the deferment of payment of certain debts for a specified period of time [5] . The creditors and debenture holders give an extension of time of payment is one of the examples of type of compromise and arrangement with creditors’ under the scheme of arrangement principal.

Secondly, ‘reconstruction’ can be define as rearranging of a company`s structure and it may involve transfer of assets of one company to a new company or an alteration to the capital structure of the company. Thirdly, the word of ‘amalgamation’ can be apply when there are two or more companies merge together or it also can be when a company may absorb another company under common control. From the difference word in above, we can now know the nature of the principle and may understand the way how the principle may be applied.

The significant to refer to s 176 is to sets out the procedure that must be complied with to put into effect a compromise or an arrangement between a company and its creditors or a class of its creditors and or its members or a class of its members [6] . In other words, this particular section provides a mechanism to facilitate a formal compromise which binds dissenting participants so long as agreement by the statutory majority has been achieved and this may help to overcome the impossibility of obtaining unanimous consent of all the creditors to implement a debt restructuring scheme [7] . Basically, by looking at the principle of scheme of arrangement, we will discuss the relevancy of s 176 and circumstances where the particular section may be apply. Other than that, we also can refer to the certain situations that provide the misused of the section made by the company in order to avoid the liability.

The law of scheme of arrangement; Section 176

When a company is wind up or going to be wind up, section 176 of Companies Act 1965 will be there to help the company from being chase by debts. It is like company to buy time to avoid coming up liquidation proceedings. In order to be protect under section 176, several procedures need to be comply.

Initially, when a company wants to used section 176, an application to the court must be made. It is laid down under section 176(1) which enquires the company itself, or the creditor, or the member to make an application to the court. Section 176 when to be applied must in way of inters partes. For instance, in the case of Re Foursea Construction (M) Sdn Bhd [8] , the court laid down the application of arrangement for ex parte is not allowed. It must be in form of inter partes to avoid injustice especially towards the creditors. The application of ex parte as in the case of PECD Bhd & Anor v Merino-Odd Sdn Bhd & ors [9] applicants filed an ex parte application, which in this case an ex parte application is only for exceptional cases of valid urgency, so the applicants have the duty to disclosure where there must be frank and fair disclosure of all relevant materials including any points that may unfavourable to the applicants themselves. The court will strictly comply of this requirement. However, in obtaining the ex parte order, they did not in their supporting affidavits sufficiently identify and draw attention to this key point of the scheme. As a result, the court held since the rule of fair and frank disclosure should be practiced by the applicants in this case regarding their application of the ex parte application, the failure to disclose the subject matter and decision of the previous court which was not favour to them, is actually against the principle of disclosure and in this case, it had been proven that the applicants had acted mala fide and the judge set aside his ex parte application and his restraining order under s. 176 of CA 1965. Though general rule ex parte is not allowed but it’s upon the discretionary of the judge if he may thinks it fits which usually the court will include several essential requirement as stated in this PECD Bhd & Anor v Merino-Odd Sdn Bhd & ors “duty to disclosure where there must be frank and fair disclosure of all relevant materials including any points that may unfavourable to the applicants themselves.”

The court then will order a meeting to be set out between the company and its members including creditors. Before that the court will usually look into three criteria as laid down in the case of Re Prince Mithcell Pte Ltd [10] which are Public Policy, Commercial Morality and The interest of creditors.

The duty of the director of the company is essential in the making of this arrangement, even before the application i.e. the proposed scheme. Section 176(8) provides the duties of director to instruct the accountants or advocate or both to make a report and to be send to the director. Section 176(8)(b) stated the said report shall be view by the shareholder or creditor at least seven days before of any meeting that had been ordered by the court. This report must also with explanatory statement as stated under section 177 which set out all the information of the scheme and any material facts about the directors and holders of the proposed arrangement. For instance in the case of Re Dorman Long & Co Ltd [11] ; this explanatory statement must contain all the relevant information and fair which then will guide the members of the meeting ordered by the court including creditors to vote. After this report had been viewed to the shareholders and creditors they can apply the application of proposed scheme to the court.

In the situation when the company need sometimes because of technical problems or others, section 176(2) can be apply. This section gives opportunity to the company to adjourn the meeting that ordered by the court provided that it is being approved by the members and creditors. Despite the application of adjournment, upon voting and the majority accept this arrangement applied under section 176(3) provided with consent and approval by the court shall be binding to all of them i.e. the shareholders, creditors and other members. According to the case of Nite Beauty Industries Sdn Bhd v Bayer (M) Sdn Bhd [12] , once the court gives approval, later cannot review or reopen the approved scheme of arrangement. Section 176(3) must be read together with section 176(5) where in this section, in completing the binding effect of section 176(3) a copy of the order must be lodge to the registrar [13] and upon that the order will take effect from the date of lodgment.

When the voting is settled, the court accepted and approved the arrangement; now under section 176(6) should and must be done which is to include the order made under section 176(3) in the memorandum of the company.

It is an offence for the company who does not comply with the requirement under this section in order to proposed scheme of arrangement especially section 176 (6) or section 176 (8). As result of it, penalty of two thousand ringgit will be impose on them.

After all the procedures under section 176 (1) until section176 (9) being fulfill, section 176(10) will come into effect. Overall, section 176(10) talks about restraining order. The court on the application of the members, creditors or the company may order a restraining order which is a restrain from any legal proceeding not more than ninety days [14] . However, a company may seek for adjournment of the restraining order more than ninety days provided with good reasons. Section 176(10A) does come with several reasons that have been accepted by the court [15] . For instance, in the case of Metroplex Bhd & Ors v. Morgan Stanley Emerging Markets Inc & Ors; RHB Sakura Merchant Bankers Bhd & Ors (Interveners) [16] , the court had construe the good reasons as in section 176(10A) means; a bona fide scheme of arrangement is presented, with sufficient details provided to the creditors to enable them to make informed decisions as to its feasibility and merits; next, the scheme of arrangement presented must be not such that it is bound to fail and lastly the interest of the creditors, that is, the beneficiaries under the proposed arrangement is safeguard.

This restraining order may not come into effect until it being lodge to the CCM. Section 176(10E) does provide with the requirements a company should take within seven days which are to lodge a copy of approve restraining order and an advertisement or notice to public. Not compliance with this section, the company will be liable for penalty of one hundred thousand ringgit.

Effect of restraining order

The general effect of this section 176 is that the company is free for a while from any proceeding due to the debts. But it is only for 90 days or may be further as it is upon discretions of the court. For instance in former case in 1886; Re Eldorado Union Store Co,

“A restraining order to prevent the execution by judgment creditors of process against the company can only be applied for after the presentation of the petition, and such petition can only be presented after four days’ notice” [17]

In our position in Malaysia, the restraining will come into effect after section 176 complies with. As an effect of that the court may under section 176(10) to grant restraining order to the said company. Additionally, the property of the company also will be safeguard during this restraining order as in section 176(10C). No compliance with this section, the person who is in default will be guilty under section 176(10D).

Another instance regarding the effect of restraining order can be seen in the case of Re Artistic Color Printing Co [18] ;

“A creditor within the jurisdiction will be restrained from proceeding with an action beyond the territorial” [19]

Consequences of restraining order

Sections 17(10A) and (10B):

When the court granting a restraining order to a company under section 176 (10) of Companies Act 1965, the court also can grant it for a period of 90 days if the court have good reason and only if it is satisfying the paragraph (a) to (d) under section 176 (10A) of Companies Act 1965. In the case of Re PECD Bhd [20] , the court dismissed the application and consistently decided that complying section 176 (10A) paragraphs (a) to (d) are mandatory. And when the application is being dismissed, it is due to non-compliance of section 176 (10A) paragraphs (a) to (d). Yet, the applicant argued. And later, decided that by complying section 176 (10A) paragraphs (a) to (d) is prerequisite for the court to grant restraining order and moreover, if an applicant want to seek extension of restraining order, the applicant must show there is ‘good reason’ for the court to grant it. [21]

As for the word ‘good reason’, in the case of Metroplex Bhd & Ors v. Morgan Stanley Emerging Markets Inc & Ors; RHB Sakura Merchant Bankers Bhd & Ors (Interveners) [22] , the learned Justice Vincent Ng stated that the words ‘good reason’ is when it should be predicated upon the applicants’ bona fide conduct to achieve a feasible detailed scheme of arrangement for presentation to the general body of creditors. If it was not feasible, the scheme to be presented was bound to fail and also it must comprise with:- [23]

(a) A bona fide scheme of arrangement is presented, with sufficient details provided to the creditors to enable them to make informed decisions as to its feasibility and merits; [24]

(b) The scheme of arrangement presented must not be such that it is bound to fail; and [25]

(c) The interest of the creditors, that is, the beneficiaries under the proposed arrangement is safeguarded. [26]

The facts of the High Court case of In Re Maxisegar Sdn Bhd [27] is that the applicant have financial difficulties which have been ran into when he was a housing developer. As a result of financial difficulties, they had a previous suit which a protection from the court sought under section 176 of Companies Act 1965 and they already have various extensions of that order. The applicant now, applying for further extension of time. Here, the learned Justice Hamid Sultan Abu Backer have referring many cases including of Re PECD Bhd (No 2) [28] , Metroplex Bhd & Ors v. Morgan Stanley Emerging Markets Inc & Ors; RHB Sakura Merchant Bankers Bhd & Ors (Interveners) [29] , and PECD Bhd & Anor v. Merino-ODD Sdn Bhd & Ors [30] .

Based from the cases that have been referred to by Justice Hamid Sultan Abu Backer, he stated that:-

‘The reading of the above cases will show that the criteria for granting the orders are not based on uniform principles or parameters. However the overriding consideration appears to be the justice of the case and is not based solely on the strict guide lines stated in the said section. In addition I will say the court should only condone an application under s. 176 when the company has suffered a trading loss or it’s like. Courts must be reluctant to entertain an application where the losses have arisen because of the wrongful misappropriation of money by the directors for the benefit of the directors or shareholders or it’s like of the company and the directors are attempting to mitigate the losses by using the 176 mechanism to further benefit from the creditors; as it will be against public policy to do so. To ascertain this, the supporting affidavit or additional affidavit must explain the reasons for the loss. There is a duty to disclose to the court why the losses occurred to ensure that court does not give a lending hand to directors who have misappropriated funds of the creditors or where the company has not suffered a genuine trading loss or its like’ [31]

So here, the learned Justice Hamid Sultan Abu Backer was saying that, in order to prevent further abuse of section 176 of Companies Act 1965 by the applicant, it is a need to disclose to the court why the losses occurred. Otherwise, the directors who are attempting to mitigate the losses by using section 176 of Companies Act 1965 will be in benefit. And so, after a while, the learned judge then decided to grant the applicant 90 days extension due to the ‘good reason’ he provides.

As for section 176(10B) of Companies Act 1965, it is stated that when the director which have been appointed or approved by the Court under subsection (10A) can have access to accounting and other records including registers of the company and when needed, he is entitled to enquire from any officer of company of any information and explanations for the purpose of his duty. Most of the cases, it do not discuss further regarding this matter as it quite clear on the literal interpretation itself. Therefore, the court only looks upon it without any difficulties.

Sections 176(10C) – 176(10F)

When a company had already granted the order [32] from the court, as stated under S. 176 (10C) of the Companies Act, the company shall not make any disposition over the properties which had been registered under the company’s name. This shall be including the company’s properties in action and any acquisition of the property by the company and other than those made in the ordinary course of the business. Therefore if any disposition or acquisition made by the company without the permission from the court, it shall be void [33] . And if later, the company still dispose or acquire any property which found to be not include within the ordinary course of business without the permission from the court, every officer of the company who is in default shall be guilty of an offence punishable with imprisonment not exceeding five years or a fine of RM1 million or both [34] .

Referring to the case of Intrakota Komposit Sdn Bhd & Anor v Sogelease Advance (M) Sdn Bhd [35] , the second applicant had obtained a restraining order [36] on 21 June 2003. After that, the applicant had apply the later application on 1 April 2004 together with the application under S. 176(10C) of the Companies Act for leave to dispose of the company’s assets to Syarikat Prasarana Negara Berhad (SPNB) on 1 April 2004. Then, the court had granted the leave under S. 176(10C) of the Companies Act as to give permission to the applicant to dispose its assets to the SPNB and this is indirectly making the applicants secure from the S. 176 (10D) of the Companies Act.

While in the case of Pelangi Airways Sdn Bhd v Mayban Trustee Bhd [37] , the defendant which is Mayban Trustee Bhd applied before the court to set aside the restraining order obtained by the plaintiff on 3rd July 2000 as the plaintiff has contradict with several requirements. And one of the requirements found to be under S. 176 (10C) of the Companies Act whereby the Pelangi Airways Sdn Bhd after granted order by the court [38] , it had actually disposed its certain properties without permission of the court. And the Justice Abdul Hamid Embong, in giving his jugdement for this case [39] , stating that Pelangi Airways Sdn Bhd failed to prove that its actions regarding the disposition of the properties was made with the leave of the court. Therefore, the court had set aside the restraining order obtained on 3rd July 2000 by the Pelangi Airways Sdn Bhd.

This case [40] shows that the court will obviously look into serious manner for any non-compliance with the requirements as include the S. 176 (10C) of the Companies Act. The failure to comply with the S. 176 (10C) of the Companies Act will not resulted the company to be liable under S.176 (10D) of the Companies Act but the restraining order [41] obtained by them could possibly been set aside by the court.

If a company had obtained favor from court for restraining order under S. 176 (10) of the Companies Act 1965, that particular company shall lodge an office copy of the order to the Registrar [42] or known as the Companies Commission of Malaysia (Suruhanjaya Syarikat Malaysia) [43] . Also, that company shall publish a notice of the order in a daily newspaper circulating generally throughout Malaysia [44] such as New Straits Times [45] , Berita Harian [46] , Harian Metro [47] , Nanyang Siang Pau [48] , Tamil Nesan [49] , or any other newspaper found to be suitable to be. Hence, the notice shall be publishing in the newspaper which distributed entire Malaysia in order to let all the members and creditors of the company acknowledged about the restrain order [50] . Therefore, in the future they are not entitled to further any proceedings against the company [51] because they were aware of the order [52] given by the court. It must be noted that the copy of order [53] and the notice [54] shall be made within seven days [55] from the date of the order has been construct by court. Also, under the S. 176 (10E) of the Companies Act 1965, stress out that any failure of the company in order to comply with all the requirement as listed [56] , could resulted the company and every officer that responsible on failure to comply with the requirements shall be guilty of an offence against the Companies Act and the penalty would not be exceeding RM100, 000.

Then, under S. 176 (10F) of the Companies Act stated that, the order made by court [57] shall not effecting any proceedings in any action or proceeding against any person other than the company which particularly had applied for the order. This would meant by that the restrain for any other proceeding could be apply to the company only not exceeding to the any person who relates with the company in any ways. Therefore, in order to interpret the term of ‘any person’ for the purpose under S. 176 (10F) of the Companies Act, the S. 176 (10G) of the Companies Act, has shown as ‘any person’ includes a guarantor of the company. So, if the guarantor of a company facing any proceeding against her or him, that guarantor is not entitled to use the order [58] to escape his or her liability from the particular proceeding [59] .

Conclusion

A major objective that an arrangement is set up between the companies with creditors is to delay the time from any legal proceeding but not only that. Other objective is to revive the company [60] and for the company to check any potential fraud or irregularities or unstable administrative of that company; that lead a companies to wind up situation. Thus, the arrangement made between them must be fair and equitable. When talk about this, a company may have different class of shareholders and creditors. Due to that separate meetings [61] must be conduct in order to meet the objective of fair and equitable.

As a conclusion, section 176 is very helpful to the companies which in the financial difficulties. It helps the companies to continue their business in order to gain the profit and pay back the debt of the creditor. In other words, it is only the question of time or period when the company can pay the debt. However, it will never excuse the companies from it liability to pay the debt to the creditor. The companies may use this provision as to avoid the obligation to pay debt but take note it is only for a time specified ; it is for those companies who really desperate to safe their company from bankruptcy.