Scheme of Arrangement: 4 Legal Issues Determined by the Federal Court in Malaysia
The scheme of arrangement is a vital tool for corporate restructuring and insolvency that enables financially troubled companies to restructure their operations, safeguard their assets, and fulfil their obligations. However, different jurisdictions appear to have different decisions regarding some legal issues arising out of a scheme of arrangement. Some of these issues have been put to rest through the decision of the Federal Court in MDSA Resources Sdn Bhd v Adrian Sia Koon Leng (Civil Appeal No.:02(i)-65-07/2022(M). Our firm, Bryan & Co., is honoured and proud to have assisted the Respondent from the proceedings in the High Court up until the final disposal of the matter before the Federal Court.
This is a run-of-the-mill case. The case involves a property developer, known as MDSA Resources Sdn Bhd (“MDSA“), that has entered into tenancy agreements with the purchasers of a development project known as ‘Hatten Place’. One of such purchaser was the Respondent, Adrian Sia (“Adrian“).
MDSA then defaulted on payments towards the purchasers but had applied for leave to convene a creditors’ meeting for a proposed scheme of arrangement. The leave was granted and a restraining order was also granted to maintain the status quo pending the scheme of arrangement.
Among the features of the proposed scheme include:
1. “earmarked properties” be sold in 3 to 5 years, the proceeds of which will be used to pay the creditors under the scheme;
2. a recovery rate of 70% under the scheme compared to a 40% recovery rate under winding-up;
3. the scheme creditors were grouped under a single class of unsecured creditors comprising of purchasers and trade creditors (“Third Party Creditors“), which included related companies of MDSA (“Hatten Group Creditors“); and
4. the value of Hatten Group Creditors’ debt constituted 73.8% of the total debts under the scheme.
THE HIGH COURT'S DECISION
However, the High Court dismissed MDSA’s application to sanction the scheme. The findings of the High Court in support of its decision include the following:
1. The proposed scheme was unreasonable and to the detriment of the Third Party Creditors;
2. The Hatten Group Creditors should not have been categorised together with the Third Party Creditors during the voting at the creditors’ meeting; and
3. There was much uncertainty in the proposed scheme, including where it involves the volatility of the property market.
THE COURT OF APPEALS DECISION
The Court of Appeal affirmed the decision of the High Court and decided, amongst other things, that the composition of class of creditors in a single class was unfair, uneven and lop-sided.
LEGAL ISSUES AS DECIDED BY THE MAJORITY DECISION OF THE FEDERAL COURT
A. Classification of Creditors in a Scheme of Arrangement
The majority in the Federal Court held that, while the creditors may have the same rights, the interest of the group of creditors in the same class should not be disregarded. Hence, a class of creditors must be fairly represented. This is because a related party may have a special interest to achieve in the proposed scheme and may disregard the interest of other creditors.
While the majority accepted that the general principle is that the classification of creditors should be based on the similarity or dissimilarity of legal rights against the company and not on the similarity or dissimilarity of interests not derived from such legal rights, the majority opined that a wholly-owned subsidiary or related party of the company that proposed the scheme should not be placed in the same class with other creditors due to their special interest in promoting the scheme.
Here, the majority found that the Hatten Group Creditors should not have been placed in a single classification of creditors as the Third Party Creditors.
B. Weight to be Attached to the Votes of the Related Parties in the Scheme
As the related parties to the company proposing the scheme of arrangement have a special interest in supporting the proposed scheme through their relationship with the said company, the votes of these related parties at the creditors’ meeting should be discounted to zero or to be given less weight if classified in the same class of creditors as other non-related parties.
C. Duty to Disclose Material Facts
In order for creditors to make an informed and meaningful decision that can protect of safeguard their interests, it is the company’s duty ensure that all material information necessary for such a decision, either to approve or reject the proposed scheme, be disclosed. This disclosure and transparency is also required to demonstrate the good faith of the company in initiating the proposed scheme of arrangement.
Even if the Court has the power to order further meetings or to furnish relevant particulars through amendments to the explanatory statement, what is important, as clarified by the majority in the Federal Court, is the information presented in initiating the proposed scheme and not the explanation given after the event. This would go to the reasonableness of the scheme and whether an intelligent and honest man, being a member of the class concerned and acting in respect of his interest, might reasonably decide.
In this case, the majority of the Federal Court agreed with the High Court that there were material facts that were not disclosed or revealed in the explanatory statement and that such non-disclosure runs counter to the reasonableness and fairness of the proposed scheme of arrangement.
D. Reasonableness and Fairness of the Scheme of Arrangement
One important criteria in the decision of whether or not a scheme of arrangement should be sanctioned or not is that the proposed scheme must be reasonable and fair to all creditors. The test is whether the proposed scheme is one that an intelligent and reasonable man would approve.
The majority in the Federal Court found, amongst other things, that:
1. the proposed scheme would extinguish any avenue of Third Party Creditors to claim their debts;
2. there were material uncertainties in the proposed scheme; and
3. the volatility of the property market supports the finding of uncertainty of the scheme.
The majority in the Federal Court then agreed with the decision of the High Court, which was affirmed by the Court of Appeal, that the proposed scheme is unreasonable, inequitable and unfair in that an intelligent and honest man would not have reasonably approved of this proposed scheme.
While the majority of the Federal Court did not answer all of the question posed before it, the majority decision now cements the legal position relating to:
1. the classification of parties related to the company proposing the scheme of arrangement in the classification of creditors;
2. the weight of votes if such related parties were classified in the same class of creditors as non-related parties;
3. the duty to disclose material facts, particularly on when such disclosure should be made; and
4. in any event, the scheme of arrangement must be one that is reasonable and fair to all creditors under the proposed scheme.