Restraining Orders Pursuant to Section 368 of the Companies Act 2016: Breathing Room for Financially Distressed Companies

Pursuant to Section 368 of the Companies Act 2016 (“CA 2016”), a Restraining Order (“RO”) temporarily restrains all current legal proceedings (including winding up petitions) initiated against a financially distressed company except by leave of court.

An RO may be granted to a company undergoing a restructuring exercise through a scheme of arrangement pursuant to s 366 of the CA 2016 in order to preserve the status quo and to prevent efforts to develop and approve a scheme of arrangement from being thwarted by the dissipation of the company’s assets.[1] The temporary moratorium and protection is meant to provide the financially distressed company with much-needed breathing room while it restructures its’ business and/or debt.

In this article, we will briefly delve into the characteristic of an RO as well as the requirements for obtaining an RO.

Brief Characteristics of an RO

Proceedings only Restrained After an RO is Granted

Once an RO is granted, creditors and/or third parties are restrained from commencing or continuing any legal proceedings against a company proposing a scheme of arrangement unless leave from court is obtained. Where a creditor fails to obtain leave from court to proceed against the company, such suit is liable to be struck out by the court.[2]

Unlike other corporate rescue mechanisms (such as Judicial Management and Corporate Voluntary Arrangements) where an automatic moratorium triggers upon the filing of an application, the RO will only be effective after an order is granted by Court. In other words, the company remain unprotected from all legal actions while the application for an RO is pending before the Court. As such, a company intending to apply for an RO must act fast.

Duration of a RO

If the company fulfills the requirements, the Court may grant an RO to the company for a period of not more than 3 months. The RO will automatically expire at the end of this period, unless it is extended by a Court order. A company may apply to extend the RO and the Court may allow extensions of not more than 9 months.

The Control of the Company When the RO is in Effect

An additional aspect of the RO is that the existing directors remain in control of the company’s operations and management throughout the process. This is in contrast with the judicial management process which places the company entirely under the management of a judicial manager. This aspect is particularly significant and attractive for companies that heavily rely on the expertise of qualified individuals in the company’s existing management.

However, there may be some cases where the creditors of the company may nominate additional director(s) to the board. [3]

Can the RO Restrain Proceedings Against the Company’s Guarantors?

It is rather common for a company to have the directors and/or third party to guarantee its financial facilities and/or for other contractual purposes. Those guarantors will nevertheless be placed in a situation where creditors will turn their bow towards the guarantor while the company is out of reach and protected by an RO.

The High Court in Sentoria Bina Sdn Bhd v Impak Kejora Sdn Bhd [2021] 12 MLJ 690 held that the protection of an RO may be extended to a guarantor if:

1. The company expressly seeks for the restraining order to be extended to such guarantor; and
2. Justification can be provided to support the same, such as where the guarantor is an integral component of the scheme to the extent that the proposed scheme would not be workable without such guarantor.

For example, such an extension may be granted in scenarios where the guarantor is one of the fund providers and/or financiers of a proposed scheme of arrangements.

Statutory Requirements for a RO 

Given the potency and effectiveness of an RO, the requirements to obtain such an order are strict in order to ensure that the RO provisions are not abused by errant insolvent companies in an attempt to avoid and/or delay paying their debts. Briefly, the four requirements for obtaining an RO are[4]:

1^st requirement: The court must be satisfied that the proposed scheme of arrangement (“proposed scheme”) involves at least half the creditors of the company in value.

2^nd requirement: The court must be satisfied that a restraining order is necessary to enable the company and its creditors to formalise the proposed scheme.

3^rd requirement: A statement of particulars as to the affairs of the company made up to a date not more than 3 days before the application must be lodged together with the RO application.

4^th requirement: The majority of the scheme creditors must nominate such a person to act as a director pursuant to s368(2) of the CA 2016 and the court must approve the appointment of such person.

The above 4 statutory requirements are mandatory and must be fulfilled before an RO can be granted by Court.[5] Any non-compliance can lead to the result of the dismissal of an RO application and/or an RO being set aside for irregularity.[6]

Conclusion

In conclusion, an RO granted under the CA 2016 provides temporary reprieve from legal proceedings and actions for financially distressed companies while it restructures its business and debts. Notwithstanding the strict requirements, an RO is undoubtedly a vital tool to safeguard the assets of a company and to allow time for a proposed arrangement to be finalised.

Nonetheless, there is genuine risk that the rights of creditors may be hindered over an extended period. In such situations, it is prudent for creditors to be aware of their rights in a scheme of arrangement to safeguard their own interest (See our article wherein the rights of creditors in a scheme of arrangement are discussed).