A. Introduction

When a company falls into financial distress, one option may be to propose a compromise or restructure its debts via a scheme of arrangement with its creditors. The Companies Act 2016 provides for a statutory scheme of arrangement and the first hurdle for a company ('the scheme company') is to obtain the Court's leave to convene a meeting between the company and its creditors to consider a proposed scheme.1 After considering the proposed scheme, if the compromise or arrangement is agreed by a majority of 75% of the total value of the creditors or class of creditors present and voting either in person or by proxy at the meeting and sanctioned by Court, the scheme will be binding on all creditors or class of creditors under the scheme,2 including minority creditors which object.

The prevalence of intercompany financing between companies in a group corporate structure could, however, present some tricky issues to a scheme company trying to obtain the Court's sanction on a scheme of arrangement. Should related company creditors which may have special interests to promote a scheme (for example, by virtue of their relationship with the scheme company) be put in the same class as other unrelated creditors with no such special interests? If placed in the same class as other unrelated creditors, would there be a fair representation of this class of creditors? Should the votes of such related company creditors be disregarded or discounted for purposes of determining whether the statutory majority of 75% in value or class has been reached? And more importantly, how does the weight attributed to the votes of such creditors affect the Court's decision on whether or not to sanction a proposed scheme?

In this article, we discuss the Court's considerations when deciding on these issues, with a brief analysis on -

a. the recent High Court case of Top Builders Capital Bhd & Ors v Seng Long Construction & Engineering Sdn. Bhd. & Ors [2022] 8 MLJ 604 ("Top Builders"), and

b. the approach adopted in other Commonwealth jurisdictions when dealing with related party creditors, related company creditors and creditors with special interests.

B. Top Builders Capital Bhd & Ors v Seng Long Construction & Engineering Sdn. Bhd. & Ors [2022] 8 MLJ 604 ("Top Builders")

Classification of Creditors

The classification and discount of votes of related company creditors were discussed extensively in the recent High Court case of Top Builders.

In this case, the opposing creditors (which were non-related, unsecured creditors of the scheme company) argued that the statutory majority of 75% for the scheme had not been met, as the related company creditors of the Top Builders group of companies should form a separate class of creditors and/or their votes at the scheme meeting should be excluded or discounted.

Ong Chee Kwan JC held that intercompany creditors and/or related company creditors should be classified into the same class as non-related unsecured creditors, reasoning that the classification of creditors should be determined by the following two-stage test:

a. whether there is any difference between the creditors inter se in their strict legal rights; and

b. if there is, to postulate by reference to the alternative if the scheme were to fail, whether objectively there would be more to unite than divide the creditors in the proposed class, ignoring for that purpose any personal or extraneous interests or subjective motivations operating in the case of any particular creditors.

Therefore, as the strict legal rights of the related company creditors of the Top Builders group of companies were the same as those of other unsecured creditors, they should not be segregated into separate classes of creditors, even though their personal or subjective interests in the scheme may differ - for instance, the related company creditors had a subjective interest in ensuring the continuity of the business of the scheme companies, whereas non-related creditors were only concerned with recovering the debts owed to them by the scheme companies.

What determines the classification is that both groups of creditors must have the same legal rights to claim payment of debts owed under the scheme. The fact that the related company creditors had chosen to waive their entitlement to the adjudicated debts under the scheme for the benefit of the scheme company also did not mean that their legal rights under the scheme were dissimilar to the legal rights of other unsecured creditors.

Court's Discretion in respect of Discount or Exclusion of Votes from Related Company Creditors

With regard to the weight attributed to the votes of related company creditors, the Court held that whether such votes should be excluded or discounted is a matter of discretion for the Court based on the facts of the case. In exercising its discretion, the Court may consider a wide range of factors, including whether the creditors would likely derive better benefits from the scheme as compared to the alternative liquidation scenario, any self-interest or ulterior motive on the part of the related party creditors, and whether the percentage of independent creditors who had voted in the scheme reflects a desire on the part of an overwhelming majority in value of the scheme creditors wanting the scheme.

In the case of Top Builders, it was concluded that the opposing creditors had failed to demonstrate to the Court that the scheme creditors would be better off without the scheme, or that there is a "good possibility" that the scheme companies "were in a position to significantly improve" on the scheme. Mere "special interests" to see the continuity of the scheme company as a going concern is not a reason to disregard the votes from the related company creditors. There was also no evidence to suggest that the debts from such creditors are not genuine, or that the "special interests" of such creditors are adverse to the interests of the other scheme creditors. The Court also took into account the fact that a high majority in value and in number of the independent creditors had voted in favour of the scheme. Accordingly, Ong Chee Kwan JC refused to disregard or discount the votes of the related company creditors and proceeded to sanction the proposed scheme.

C. Approach in other Commonwealth Jurisdictions

Classification of related party creditors and creditors with "special interests"

The test for classification of creditors in Top Builders was based on the principle enunciated in the seminal case of Sovereign Life Assurance Co v Dodd [1892] 2 QB 573 ("Sovereign Life"), wherein Bowen LJ held that a class of creditors "must be confined to those persons whose rights are not so dissimilar as to make it impossible for them to consult together with a view to their common interest". This is the same test which was applied for the classification of related company creditors in Top Builders.

In the United Kingdom, Australia and Hong Kong, the test for classification of creditors is also based on the similarity or dissimilarity of legal rights of the creditors against the company, even though the "special interests" of the creditors may affect the Court's decision on whether to sanction the scheme.

An example of this is the English High Court case of Re Lehman Brothers International (Europe) (in administration) [2018] EWHC 1980 (Ch) ("Lehman Brothers"), wherein Hildyard J held that the majority creditors which has special interests to support the scheme could be placed in the same class as the other creditors which do not share such special interests, as these creditors shared similar legal rights. Hildyard J went on to sanction the scheme as it could not be proven to be flawed or unfair.

In the Hong Kong Court of Final Appeal case of Re UDL Holdings Ltd & Ors [2002] 1 HKC 172, Lord Miller held that although the internal creditors in the proposed schemes of arrangement undoubtedly had a special interest in promoting the schemes, this did not disqualify them from being treated as ordinary creditors. The test for classification of creditors is based on similarity or dissimilarity of legal rights against the company, not on similarity or dissimilarity of interests not derived from such legal rights. The fact that individuals may hold divergent views based on their private interests not derived from their legal rights against the company is not a ground for calling separate meetings.

This same test for classification of creditors was adopted in the Australian cases of Re Landmark Corporation Ltd [1968] 1 NSWR 759 ("Re Landmark Corporation") and Re Jax Marine Pty Ltd [1967] 1 NSWR 145, where related company creditors and shareholder creditor with special or additional interests were classified in the same class as other ordinary creditors with no such interests as the creditors shared similar legal rights.

Therefore, as far as classification of creditors is concerned, these Commonwealth jurisdictions have classified creditors based on the creditors' strict legal rights rather than their subjective interests or benefits derived from the proposed schemes.

Such classification is however far from saying that equal weight will be given to votes cast by related company creditors or creditors with "special interests" for a proposed scheme as compared to unrelated creditors with no such "special interests" shown.

Discount or Exclusion of Votes from Creditors with Special Interests and Related Party Creditors

In the English High Court case of Lehman Brothers (supra), Hildyard J held that if it is shown that the creditors had some "special interests different from and adverse to" the other creditors of the same class, the Court has a discretion to disregard or discount the votes of such creditors, and thereafter consider what effect that should have in terms of whether or not the Court should sanction the scheme.

Hildyard J however refused to disregard the votes of the majority creditors and proceeded to sanction the scheme mainly on the basis that the creditors' voting was motivated by the objective of ensuring speedy distribution of the surplus to creditors, and a majority of independent creditors had voted in favour of the scheme.

In Singapore and Australia, the votes of related party creditors have been discounted in cases such as the Singapore Court of Appeal case of The Royal Bank of Scotland NV (formerly known as ABN Amro Bank NV) and others v TT International Ltd and another appeal [2012] 2 SLR 213 ("TT International") and the Australian case of Re Landmark Corporation (supra).

In TT International, the Singapore Court of Appeal held that the votes of related creditors who are wholly-owned subsidiaries of the scheme company should have been discounted to zero and classified separately from the general class of unsecured creditors as they were entirely controlled by their parent company, which was the scheme company. Further, related party creditors (here, creditors with shares in the company) should generally have their votes discounted by the value of their interest in the scheme company.

In the Australian case of Re Landmark Corporation, Streets J observed that the votes of the related company creditors "must be regarded as cast with due deference to the wishes of the [scheme company]", as they had voted in favour of the scheme when their affairs were fully controlled by their parent company. Such votes could not be regarded as indicative of the wishes of the class of creditors in respect of what is best in the interests of that class of creditors. He then effectively weighted the votes of the related company creditors of the scheme company to zero and refused to approve the scheme.

D. Conclusion

In light of the above, the general principle would be that:

a. Courts will classify creditors purely by reference to similarity or dissimilarity of legal rights against the scheme company, and not based on interests not derived from such legal rights - the same test applies to classification of creditors with special interests, related party creditors and related company creditors.

b. Whether the votes of such creditors should be discounted or disregarded is a matter of discretion for the Court when considering whether or not to sanction the scheme based on the facts of the case.

In other words, while the special interests of such creditors would not affect their classification as creditors, the weight the Court decides to attribute to the votes of such creditors. This may affect the Court's ultimate decision on whether to sanction the scheme.

It must be borne in mind that the Court's role is not to rubberstamp a scheme which has prima facie been approved by the statutory majority - the Court is not bound to exercise its discretion to sanction a scheme without being satisfied that the scheme is a fair scheme which an intelligent and honest man, a member of the class concerned and acting in his own interest, may reasonably approve.

What can be drawn from the cases above is that if there are elements of unfairness, coercion of the minority or voting which is not representative of the class of creditors in the proposed scheme of arrangement, these factors may influence the Court to exercise its discretion to exclude or accord less weight to the votes of such creditors, and eventually refusing to sanction the scheme.

Footnotes

1. Section 366(1), Companies Act 2016.

2. Section 366(3), Companies Act 2016.

Originally published October 2022.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.