Scheme of Arrangement: Classifying Creditors

A scheme of arrangement (“SOA”) is one of the corporate rescue mechanisms provided for under the Companies Act, 2016 (“CA 2016”) wherein, essentially, the company enters into a binding agreement with its creditors to restructure its debt with them. 

The 3-step procedure to obtain an SOA is as follows:

1. Application to Court pursuant to Section 366 CA 2016 for leave to summon a meeting of the company with its creditors and/or members; 
2. Holding the meetings of different classes of creditors and/or members to approve the proposed scheme of arrangement (the “Proposed Scheme”); and
3. If a 75% majority of the total value of creditors (or class of creditors) or members (or class of members) approve the Proposed Scheme, a further application to Court for sanction of the Proposed Scheme. 

For a more detailed introduction to SOA, click here.

The Significance of ‘Classes of Creditors’

Under the current legislative framework, the way the creditors (or class of creditors) are determined have a big impact on the Proposed Scheme’s success. If there is only 1 class of creditors, the applicant would require a 75% majority of the total value of these creditors in order for the Proposed Scheme to succeed.

However, if there are 2 classes of creditors (for instance, secured creditors and unsecured creditors), then separate meetings will have to be held and both classes of creditors must approve the Proposed Scheme by a 75% majority of the total value for the Proposed Scheme to succeed. This increases the risks of an entire SOA failing due to errant voting of a company’s creditors. 

Who Decides the Classes of Creditors?

When applying for an SOA, the applicant has discretion on which creditors to include (or exclude) from the Proposed Scheme. There is no obligation to include all of a company’s creditors in a Proposed Scheme, as long as the applicant is able to justify why a particular group of creditors is excluded.  See the High Court case of Jin Lin Wood Industries Sdn Bhd & Ors v Mulpha International Bhd (No. 2), which was subsequently affirmed on appeal:

“…The mere exclusion of a certain creditor does not open the applicants to imputations of mala fides and abuse of process. Under s. 176(1),the applicants have the discretion not to compromise with all creditors and the rights of the remaining creditors are merely stayed…”

An SOA can even depart from the ‘pari passu’ or ‘undue preference’ principle which, generally, provides a descending priority of creditors in winding up and renders invalid any transaction meant to give undue preference to one or more creditor(s) to the exclusion of certain others. 

Classification of Scheme Creditors

Scheme creditors are grouped according to the nature of their legal rights. Although there is no hard and fast rule in classifying creditors, the English case of Sovereign Life Assurance Co v. Dodd (“Dodd”) does elucidate with the following test to determine which creditors fall into a separate class:

“a class must be confined to those persons whose rights are not so dissimilar as to make it impossible for them to consult together with a view to their common interest”.

The test in Dodd has been referred to in Malaysian jurisprudence, including in the Federal Court decision of Francis Augustine Pereira v Dataran Mantin Sdn Bhd & Ors and other appeals (“Dataran Mantin”), which provides that:

“A class of creditors is determined by their common interest, such interest separating them from other creditors with whom they are unable to consult together in respect of that common interests.”

An example of the ‘common interest’ test is that unsecured creditors should not be classified in the same manner as secured creditors (e.g. banks with financing facilities and a charge over the company’s land). This is because both parties have different interests as to whether the Proposed Scheme should be approved. 

Conclusion

Given that any class of creditors have the power to derail an entire SOA by their dissent to the Proposed Scheme, an applicant must give careful thought in how it classifies creditors in such a way that the Proposed Scheme can be approved without violating the entire purpose of classifying creditors.