Judicial Management in Malaysia

The recent case of Leadmont Development Sdn Bhd v Infra Segi Sdn Bhd represents a landmark ruling in Malaysia being the first case to discuss and spell out the background and framework surrounding the law of judicial management in accordance with the provisions governing Malaysia’s judicial management scheme as contained in Division 8 Subdivision 2 of the Companies Act 2016.

Introduction

In this case, Leadmont and their subsidiary, Sierra Delima, had successfully applied ex parte (i.e. with respect to or in the interests of one side only or of an interested outside party) for judicial management in order to facilitate the rehabilitation of the companies. The successful rehabilitation of these companies was contingent of the completion of the Selayang Star City Project, in which Leadmont is the developer. Consequent to the granting of the judicial management order, a secured creditor of the companies, Infra Segi, intervened to set aside the orders. Consequently, the court set aside the judicial management order for reasons that will be analysed below.

The Analysis

In the case of Leadmont, the court first considered the background surrounding the implementation of judicial management provisions in Malaysia (the legislative purpose of judicial management). Consequently, the court addressed the statutory test that the court would apply when deciding on whether to make an order for judicial management (the test for judicial management).

1. The Creation of Judicial Management

On 17th March 2003, the Corporate Law Reform Committee (“CLRC”) was established. In addressing the purpose of the CLRC’s establishment, Wong Chee Lin JC found that the CLRC was to undertake a fundamental review of the legislative policies on corporate law and to propose amendments. These amendments were to ensure corporate and business activities are able to function in a “cost effective, consistent, transparent and competitive business environment in line with international standards of good corporate governance”.

Consequently, the CLRC published 12 Consultative Documents for public consultation, of which was the introduction of a statutory scheme known as judicial management in order to facilitate the rehabilitation of a company in financial distress.

The court in Leadmont referred to the Hansard debate of the Companies Bill where it was clear that the main purpose of the introduction of judicial management was to rehabilitate financially distraught companies and to reduce the number of cases in which companies are wound up.

In line with the legislative purpose of rehabilitating the company, Section 410 of the Companies Act imposes an automatic moratorium on the company upon the filing of a judicial management application. This provision halts any winding up, enforcement of security, or other proceedings against the company thereby ensuring that the company will be able to shift its focus to the sole purpose of rehabilitating the company.

2. The Test

The requirements for a judicial management application are laid out in Section 404 of the Companies Act 2016 while the law governing the court’s power to an order for judicial management is laid out in Section 405 of the said Act. Section 404 states that an application for a company to be placed under judicial management may be made by either the company or the company’s creditor when either of these parties considers that:

1. the company is or will be unable to pay its debts; and
2. here is a reasonable probability of rehabilitating the company or of preserving all or part of its business as a going concern or that otherwise the interests of creditors would be better served than by resorting to a winding up.

The substantive test for judicial management is laid out in Section 405(1) of the Companies Act 2016. Section 405(1) inter alia provides that where a company or its directors, or a creditor, makes an application under Section 404, the court may make a judicial management order in relation to the company if:

1. the Court is satisfied that the company is or will be unable to pay its debts; and
2. the Court considers that the making of the order would be likely to achieve one of more of the following purpose:
   1. the survival of the company, or the whole or part of its undertaking as a going concern;
   2. the approval under section 366 of a compromise or arrangement between the company and any such persons as are mentioned in that section;
   3. more advantageous realization of the company's assets would be effected than on a winding up.

The aforementioned test is two-pronged. Firstly, the courts would have to be satisfied that the company is or will be unable to pay its debts. The court in Leadmont in interpreting the word “satisfied” referred to the English decision of Re Harris Simons Construction Ltd which interpreted Section 8 of the Insolvency Act 1986, a provision similar to Section 405(1) of the Companies Act 2016. The court in Re Harris held that the term “satisfied” indicates a higher threshold of persuasion. With regard to the company being unable to pay its debts, the relevant definition is found in Section 466 of the Companies Act 2016.

Secondly, the applicant would have to prove to the Court that it meets one or more of the criteria stipulated in Section 405(1)(b) of the Companies Act 2016. Consequently, as per Wong Chee Lin JC, the court merely needs to “consider” that there is a “real prospect” that one of those outcomes is achievable. Section 405(1)(b)(i) refers to the “the survival of the company … as a going concern.” The court in Leadmont referred to the International Standard on Auditing (ISA) 570 as well as ‘Words & Phrases (Vol.2) (2nd ed.)’ in defining the phrase “going concern”. The court found that the phrase “going concern” is interchangeable with the phrase “will continue its operations for the foreseeable future”. Therefore, the court will consider whether the making of the order would allow the company to continue its operations for the foreseeable future.

However, should an applicant not fall within Section 405 of the Companies Act 2016, the court would still have the overriding power to make a judicial management order if it considers the public interest so requires. Such powers are set out in Section 405(5)(a) of the Companies Act 2016. As to what constitutes “public interest” is not defined in the Companies Act 2016, the court in Leadmont decided that “public interest” is to be determined on a case by case basis.

In short, the application of a judicial management order would first have to be brought by either a company or its creditors in accordance with Section 404 of the Companies Act 2016. Subsequently, the court would have to be satisfied that the applicants have satisfied the statutory test laid out in Section 405 of the Companies Act 2016, before making a judicial management order.

3. The Decision in Leadmont

The court in Leadmont set aside the judicial management order. The Respondent, Infra Segi, sought to set aside the judicial management order on the grounds that there had been a material non-disclosure of facts on part of the Applicant, and that the Applicant had acted mala fide.

However, evident from the judgement in Leadmont, the Court found that the Applicant satisfied the test in Section 405(1) of the Companies Act 2016 and that the Applicant had disclosed sufficient facts. However, the Court proceeded to set aside the judicial management order on the basis that the court will not act in vain.

The Companies Act 2016 set out only four situations in which the judicial management order can be discharged, namely:

1. if, in the creditor's meeting, the Judicial Manager's proposal (with or without modification) has not been approved by 75% of the total value of creditors whose claims have been accepted by the Judicial Manager and the Judicial Manager reports the result of the meeting to Court (Section 421(5)); or
2. if the purpose of judicial management has been achieved (Section 424(1) and 424(2)(a)); or
3. if the purpose of judicial management is incapable of achievement (Section 424(1) and 424(2)(a)); or
4. if the company's affairs, business and property are being or have been managed by the judicial manager in a manner which is or was unfairly prejudicial to the interests of its creditors or members, or if a particular act or omission by the judicial manager is or would be so prejudicial to them (Section 425(1)(a) and 425(3)(d)).

What is important to take away from this decision is how this case took into consideration that the proposed scheme by the appointed judicial manager was not going to be approved by the requisite 75% majority of the creditors. In totaling the value of the Respondent and the six nominated sub-contractors who opposed the proposed scheme, it was found that it amounted to 46.9% of the total value of the creditors in Sierra Delima. In Leadmont, the Respondent’s debt was approximately 26% of Leadmont’s total indebtedness. Clearly, in no circumstance would the scheme be approved as it would require the approval of more than 75% of the total value of creditors in accordance with Section 421(2) of the Companies Act 2016.

The court proceeded to inquire if the Respondents would be willing to give the Applicant and Sierra Delima a chance to put forth the scheme via the Judicial Manager for approval by the creditors to which the Respondents refused. Relying on the case of The Royal Bank of Scotland NV v TT International Ltd, the court held that the likely prospects of the approval of the scheme have to be considered. As the scheme would have no chance of being approved, Wong Chee Lin JC decided that the court would not act in vain and set aside the judicial management order.

However, the Court did not consider the element of public interest in this instance which is an overriding consideration the Court can give weight to in granting a judicial management order nor the consideration of whether the making of the order would allow the company to continue its operations for the foreseeable future which may ultimately satisfy the debts of the creditors.