Diluting the Soup: Exercise to Increase Share Capital in the Context of Oppression under S346 of the Companies Act 2016?

Introduction

In less-than-ideal circumstances, shareholders may wish to increase the share capital of a company with a view of diluting the shareholding of some shareholders.  Is this oppressive?

What is oppression?

Oppression happens when affairs of the company are being conducted in a manner prejudicial to public interest or in a manner oppressive to any member or members. The basis can be found in Section 346(1) of the Companies Act 2016:

“Remedy in Cases of an Oppression

346.(1) Any member or debenture holder of a company, may apply to the court for an order under this section on the ground –

(a) That the affairs of the company are being conducted or the powers of the directors are being exercised in a manner oppressive to one or more of the members or holders of debentures including himself or in disregard of his or their interests as members, shareholders, or holders of debentures of the company; or

(b) That some act of the company has been done or is threatened or that some resolution of the members, holders of debentures or any class of them has been passed or is proposed which unfairly discriminates against or is otherwise prejudicial to one or more of the members or holders of debentures (including himself).”

Possible remedies may be found in Section 346(2):

(2) If on such application the Court is of the opinion that either of those grounds is established the Court may, with the view to bringing to an end or remedying the matters complained of, make such order as it thinks fit and without prejudice to the generality of the foregoing the order may —

1. direct or prohibit any act or cancel or vary any transaction or resolution;
2. regulate the conduct of the affairs of the company in future;
3. provide for the purchase of the shares or debentures of the company by other members or holders of debentures of the company or by the company itself;
4. in the case of a purchase of shares by the company provide for a reduction accordingly of the company’s capital; or
5. provide that the company be wound up”.

In order to establish a case under Section 346 of the Companies Act 2016, a complainant must prove oppression, disregard or unfair discrimination or prejudice. There must exist commercial unfairness, or in the words of Lord Wilberforce in Re Kong Thai Sawmill (Miri) Sdn Bhd; Kong Thai Sawmill (Miri) Sdn Bhd & Ors V Ling Beng Sung [1978] 2 MLJ 227), there must be a visible departure from the standards of fair dealing and a violation of the conditions of fair play which a shareholder is entitled to expect before a case of oppression can be made (Elder v Elder & Watson Ltd 1952 SC 49). In any event, “the essence of the wrong done to the minority member under s 181(1)(b) is the 'unfairness' of the discrimination or prejudice suffered by the member”, the test for unfairness is objective (Jaya Medical Consultants v Island & Peninsular [1994] 1 MLJ 520 approving of Wayde & Anor v New South Wales Rugby League Ltd (1985) 10 ACLR 87).

Importantly, where attention is called to particular acts or omissions, it is sufficient that the effects of a single act or omission are such that they persist at the date of presentation of the petition/originating summons (per Gopal Sri Ram JCA in Owen Sim Liang Khui v Piasau Jaya [1996] 1 MLJ 113).

Increase of Share Capital

The recent case of ISM Sdn Bhd v Queensway Nominees (Asing) Sdn Bhd & Ors and Other Suits [2021] 7 MLJ 506 may be of assistance. 

Here, the Plaintiff (“ISM”) alleged minority oppression under section 181 of the Companies act 1965 (now section 346 of the Companies Act 2016). The Plaintiff held 30% of the shares in the JV companies.  It is important to note that this case dealt with an oppression claim in a quasi-partnership (Ebrahimi-type companies) context.

The core of the dispute surrounded the obligations of the respective parties to provide funding to 5 Joint Venture companies (the “JV Companies”). ISM’s position was that the funding for the JV Companies was to be divided into a cash portion and a loan portion, apportioned on a 30:70 basis. Of the cash portion, ISM would be liable to contribute 30% (in other words, 30% of 30%, or 9% of the total funds required in respect of each JV company). The Plaintiff’s position, among others, was that the majority shareholder, MPHB Capital Bhd (“MPHB”) would be liable to contribute 70% of the cash portion and would also be liable to fund the entire loan portion, at a rate of interest of 8% pa.

ISM subsequently alleged oppression under several headings, but among those is that MPHB caused a few rights issue exercises which had the effect of diluting ISM’s holding in 3 JV Companies from 30% to fractions of 1%.  All these were done without the assent of ISM.

The Court held that these rights issue exercises constitute oppression.  This is the context:

A rights issue is an invitation to existing shareholders to purchase additional new shares in the company.  MPHB had caused each of the 3 JV companies, i.e.: Queensway Nominees (Asing) Sdn Bhd, Queensway Nominees (Tempatan) Sdn Bhd and Mulpha Kluang Maritime Carriers Sdn Bhd to undertake a rights issue exercise. In the case of Mulpha Kluang, MPHB’s interests were held through Multi-Purpose Shipping Corp Bhd, a wholly owned subsidiary of MPHB.

The effects were as follows:

• ISM in Queensway Nominees (Asing)
  • Pre rights – 30%
  • Post rights – 0.01%
• ISM in Queensway Nominees (Tempatan)
  • Pre rights – 30%
  • Post rights – 0.02%
• ISM in Mulpha Kluang Maritime Carriers
  • Pre rights – 30%
  • Post rights – 0.05%

Pertinently, in each case, the rights issue did not raise any fresh capital for the relevant JV Companies but was affected by way of capitalisation of intercompany debt. Here is how it is done: In 2009, the parties explored a corporate exercise, which contemplated the injection of the lands held by some of the JV companies into Caribbean Gateway Sdn Bhd (“Caribbean Gateway”). Even though the corporate exercise did not materialise, Caribbean Gateway nonetheless proceeded to obtain, and to draw down upon, four loans from Malayan Banking Bhd.  Thereafter, several novations were effected causing the debts to become due by the relevant JV Companies to MPHB, which pave the way for the rights issuances by the JV Companies, where the debts owing to MPHB and Multi-Purpose Shipping Corp Bhd were capitalised, resulting in the dilution of interests of ISM in the JV companies.  

There is oppression because:

1. In light of the relationship of mutual trust and confidence between ISM and MPHB, it is not open for MPHB to carry out an exercise to increase the share capital in the JV Companies by rights issue without the assent and approval of ISM.
2. MPHB’s motive is nothing other than to dilute ISM’s shares.

The relevant excerpts from the judgment are as follows:

“[154] Firstly, because of the nature of the relationship of mutual trust and confidence between ISM and MPHB, it would not have been open to MPHB to carry out an exercise to increase the share capital of the JV companies by the rights issue without the assent and approval of ISM. Such an exercise could only be described as a betrayal of the mutual trust that had underpinned the relationship between them. In this case, it would not have mattered whether MPHB knew or could reasonably have supposed that ISM would not have been able to take up its rights entitlement. The relationship, by the defendant’s own evidence, had proceeded upon the basis of consensus for many years, and to depart from that principle at that stage of the project — once all the lands that were needed to be acquired had been procured — would have been an iniquity that this court would not permit”.

“[155] The fact that the rights issue to MPHB and Multi-Purpose Shipping Corp Bhd was carried out by converting the MPHB shareholders’ advances to equity (comprising both loan and the cash portions) meant that no additional funds were raised by the rights issue exercises. This lent support to the contention that the motive of the rights issue exercises was nothing other than to dilute the plaintiff’s interests. However, for the reasons explained in the preceding paragraph, even absent such an ulterior motive, the rights issue could not have been carried out without the assent of ISM, because unanimity and consensus formed the very basis of the relationship of trust and confidence between them.”

Another case where the increase of share capital intermingled with oppression can be seen is in Choy Yuk Kong & Ors v Landyork Farming Sdn Bhd & Ors [2020] 10 MLJ 806, where the Plaintiffs were the minority shareholders of the first defendant company and the 1^st Plaintiff was also a director of the 1^st Defendant company.  The Plaintiffs alleged, among others, that there is an abuse of power  and bad faith in diluting the shares of the 1^st and 2^nd Plaintiffs, by allotting 600,000 shares to the 2^nd Defendant.

The Court held that the allotment of 600,000 shares was not oppressive. Here is why:

Firstly, the 1^st Plaintiff himself had declined to subscribe to the shares of the 1^st Defendant company and had even agreed for the sum to be treated as a loan by him as director, to be repaid by installments, free of interest, unsecured, and with no fixed repayment term. Under such circumstances, it was inequitable and misplaced for the Plaintiffs to now claim minority oppression for a loan that was personal from the 1^st and 2^nd Plaintiffs to the 1^st Defendant company, and for which the 1^st and 2^nd Plaintiffs had agreed to be repaid via installments and interest-free. 

Secondly, the 1^st Plaintiff was informed that the percentage of his shareholding in the first defendant company would be diluted. He even acknowledged it but refused to subscribe for new shares. In light of the 1^st Plaintiff’s knowledge, it was inequitable and spurious for the Plaintiffs to now claim that the reduction of their shares was done in bad faith.

Moreover, the Court stated that caution must be heeded, to prevent the Plaintiffs from seeking an order not with the genuine object of obtaining the relief claimed, but with the predominant object of exerting pressure to achieve a collateral purpose. This was the case here. 

As such, the Court found that the Plaintiffs were not genuine regarding their complaints and dismissed their claim as being an abuse of process. 

Similarly, Cheah Ngun Ying v Low Cheong & Sons Sdn Bhd & Ors [2010] 9 MLJ 385 warrants our attention.

Here, the Plaintiff was the executrix of the estate of her late husband, Low Lai Kui ('Low'). Low, while he was alive, was a director and shareholder of the first defendant company. The first defendant was a family company established by Low's father, one Low Cheong, deceased. At all material times Low was the majority shareholder in the company. He held 52% of the shareholding in the company. However, on 15 October 1987 the second defendant and her father, Low Cheong, as directors of the company, allotted 157,579 shares of RM1 par. As a result of this issuance of the additional 157,579 shares and allotment, Low's shareholding in the company was reduced to about 42%. Thus, he no longer had majority control in the company. The Plaintiff alleged that the purpose of the issuance and allotment of the shares was to dilute Low's majority control over the company, and therefore sought a declaration that the allotment of the 157,579 shares was in breach of the directors' fiduciary duties and was unlawful; and that the said allotment should be declared null and void.

The Court held that the board of directors had acted in breach of their fiduciary duties when they made the issuance and allotment of the shares, in particular, the issuance and allotment of the shares of the late Low Lai Kui. 

There is oppression, here is why:

1. The allotment shares under article 5 of the articles of association of the company must be used for a proper and bona fide purpose.
2. In the present case that power was used for a collateral purpose. That power was not applied equally but selectively where shares were allotted and issued to all the other shareholders in proportion to their respective shareholding, but no shares were allotted or issued to Low or his estate.
3. In effect, this exercise of power is that Low Lai Kui’s family lost their majority and control of the company.

Conclusions:

There is oppression when the exercise of increase share capital show that:

1. The Plaintiff is reduced to an insignificant minority. 
2. The Plaintiff is not informed or did not assent to such an exercise.
3. The exercise is made for a collateral purpose.