Court of Appeal Decision on the Tests for the Appointment of Judicial Managers and Abuse of the Judicial Management Process

Introduction

This week, the Court of Appeal delivered its decision in PNL Capital Sdn Bhd & Others v Loh Teck Wah & Others and Other Appeals. The case involved a company called Fintree Capital Sdn Bhd (“Fintree”) which was placed under judicial management (the “JMO”) (and interim judicial management (the “IJM Order”)) by the High Court in June 2021 on the application of Loh Teck Wah (“Loh”). Several interveners, including the PNL Group of Companies applied to set aside the JMO and IJM Order. When the interveners’ applications were dismissed by the High Court, they appealed to the Court of Appeal.

At the Court of Appeal, the interveners argued that the JMO and IJM Order ought to be set aside as the High Court had failed to consider the history, role, nature and function of Fintree in the scheme of Loh to deceive the PNL Group of Companies and is tainted with mala fide. The interveners also argued that the JMO should not be allowed as the requirements under Section 405 of the Companies Act 2016 (“CA 2016”) had not been met by Loh. It was also argued that the IJM Order which was obtained on an ex-parte basis should not have been allowed.

Decision of the Court of Appeal

The Court of Appeal allowed the interveners’ appeals and set aside the JMO and IJM Order. In delivering the judgment of the Court, Lee Swee Seng JCA made several significant findings concerning the law on judicial management.

(1) Abuse of the Judicial Management Mechanism

The Court of Appeal dedicated a significant portion of its judgment to this issue and held at paragraphs 54 and 55 of its judgment that:

1. the “prophylactic properties” of the judicial management mechanism which was designed to rehabilitate and revive a company in financial distress should not be abused by anyone to advance their own personal interests in the target company;
2. The judicial management mechanism should not be used by unsecured creditors to substitute and enforce their views on the management of the affairs of the company; and
3. The Court should not grant an IJM Order where it would have the effect of allowing a party in a shareholders’ dispute to gain an unfair advantage over the other party under the guise of an application made in the best interests of the company.

Critically, Lee Swee Seng JCA held that the High Court ought to have taken into account the fact that there was a significant shareholders’ dispute between Loh and the PNL Group of Companies. The Court of Appeal found that the JMO and IJM Orders were used by Loh to wrest control of Fintree from its sole shareholder and director, Liew, and to prevent a consent judgment which had been entered between Liew, Fintree, and the PNL Group of Companies from being sealed due to the automatic moratorium which was put in place upon the filing of the JMO and the appointment of the IJM.

The Court of Appeal found therefore that the High Court did not put enough emphasis on the nature of the disputes unfolding between the parties and should not have “shut its eyes to the reality of such a dispute cascading over and contaminating an otherwise pure commercial consideration in the appointment of an IJM and subsequently the JMO”. Instead, the High Court ought to have found that the JMO and the IJM Order were not being made bona fide and was instead being used as a weapon by Loh to gain an upper hand in the ongoing shareholders’ disputes against the PNL Group of Companies.

(2) Inability to Pay Its Debts – Application of the Test under Section 405 CA 2016.

The Court of Appeal held that the requirement for a finding that the target company of a JMO is or would not be unable to pay its debts is fundamental to the appointment of a judicial manager. It is a prerequisite to any JMO application and if the court is not satisfied (i.e., there is insufficient material to show that the target company is or would be commercially insolvent), then the inquiry by the court at the hearing of an application for a JMO would end there. Lee Swee Seng JCA held at paragraph 97 of the judgment that:

“The requirement of a finding to the satisfaction of the Court that the Company is or would not be able to pay its debt is a sine qua non for the appointing of a JM over a company. Once that is not satisfied, the inquiry of the Court would end there. That requirement must first be satisfied and if not, no JMO should be made and the application for Judicial Management dismissed.”

In the present case, the Court of Appeal found that the IJM reports which were prepared and relied on in the application before the High Court took into account significant contingent liabilities of Fintree without correspondingly considering the company’s contingent assets. Had the contingent assets of the company been considered, the only conclusion that could be drawn is that the company had sufficient sums to pay its creditors. As such, it was concluded that it was not possible to find that the company was unable to pay its debts and the application for the JMO ought to have been dismissed.

(3) Likely to Achieve One or More of the Purposes under Section 405(1)(b) CA 2016

The Court of Appeal agreed with the decisions of Leadmont Development Sdn Bhd v Infra Segi Sdn Bhd & Anor Case [2019] 8 MLJ 473 and Re Harris Simons Construction Ltd [1989] BCLC 202 that the threshold of persuasion required under Section 405(1)(a) (i.e., on the inability of the target company to pay its debts) is higher than that required for Section 405(1)(b) (i.e., the likelihood of the JMO fulfilling one of the purposes under Section 405(1)(b)).

For further context, Hofffman J (as his Lordship then was) observed in Re Harris Simons the use of the words ‘satisfied’ and ‘consider’ and held:

“Second, the section requires the court to be ‘satisfied’ of the company’s actual or likely insolvency but only to ‘consider’ that the order would be likely to achieve one of the stated purposes. There must have been a reason for this change of language, and I think it was to indicate that a lower threshold of persuasion was needed in the latter case than the former.”

(4) Applications for an IJM Order Can Be Made Ex-Parte

The Court of Appeal also observed that there is no prohibition in applying for an IJM Order on an ex-parte basis. In support of this, Lee Swee Seng JCA observed that the Companies (Corporate Rescue Mechanism) Rules 2018 and the High Court has on several occasions recognised the possibility of an IJM Order being made ex-parte. It was also pointed out to the Court of Appeal that the subject company in the Federal Court decision of Mansion Properties Sdn Bhd v Sham Chin Yen & Ors [2021] 1 MLJ 527 was also placed under an IJM Order granted ex-parte.

While that may be the case, Lee Swee Seng JCA’s judgment also provides several guidelines when it comes to an ex-parte application for an IJM Order:

1. There must be sufficient reasons to justify the appointment of an IJM on an ex-parte basis.
2. There also ought to be full disclosure of all material facts relevant to the application as the Court is being asked to make an order without the benefit of the hearing the company over whom the IJM is to be appointed. If an ex-parte application is granted, it is liable to be set aside if it is later revealed that there had been material non-disclosure of facts.

In the present case, the Court of Appeal found that Loh had failed to disclose several material facts such as his interests as the beneficial shareholder of Fintree and thus, the ex-parte IJM Order ought to be set aside.

(5) Impartiality of a Judicial Manager

Finally, the Court of Appeal also observed that a judicial manager should not only act impartially but must be seen to be impartial and independent. At paragraph 95 of the judgment, Lee Swee Seng JCA remarked that:

“Whilst we are not unaware that some applicants may nominate a “friendly” JM, what is important is that the JM must be like Caesar’s Wife, to be above reproach. He must not just act impartially but must be seen to be impartial.”

This is ultimately in line with the fact that a judicial manager is deemed an agent of the company (Section 416 CA 2016) and is tasked with fulfilling the purpose of their appointment (i.e., to achieve one or more of the purposes under Section 405(1)(b)). In performing their duties, the judicial manager should not act unfairly and Section 425 CA 2016 provides some measure of protection to members and creditors who have been unfairly prejudiced by the actions of a judicial manager.

Commentary

This is an interesting decision by the Court of Appeal as it recognises that courts ought to be wary that the judicial management mechanism may be abused by parties due to the automatic moratorium provided under the mechanism. This decision now means that Courts have to consider the surrounding circumstances of a judicial management application, particularly when there are significant allegations or disputes being raised among the shareholders and/or directors of the target company. However, as this decision is being appealed, it remains to be seen if this will remain as the position of law moving forward.

Besides the above, the Court of Appeal’s decision is also welcome as it clarifies the validity of ex-parte IJM applications, as well as the different thresholds of persuasion required under Sections 405(1)(a) and (b).