Separate classification of related-party creditors – Commentary on Malaysian Federal Court Judgment
By Jung Sangbum (INSOL Asia Hub)
Introduction
In MDSA Resources Sdn Bhd v Adrian Sia Koon Leng [2023] 5 MLRA 358, the Malaysian Federal Court had the opportunity to rule on issues related to related-party creditors’ votes in a scheme of arrangement. By a 2-1 split decision, the Federal Court held, inter alia, that (a) a wholly-owned subsidiary or a related party of scheme company should not be placed in a single class with other third-party creditors; and (b) the votes of the related-party creditors must be discounted or given less weight.
While this decision makes significant developments to the law surrounding schemes of arrangement in Malaysia, it is argued that there is room for further clarifications on the expounded principles. This article explores the judgment and comments on the same.
Background facts
The scheme company, MDSA Resources Sdn Bhd (“MDSA”), had applied for a scheme of arrangement under section 266(1) of the Companies Act 2016 (“CA 2016”) to restructure its debt of RM374 million. Under the scheme, there was only a single class of unsecured creditors, comprising of both third-party creditors and related-party creditors – the ultimate holding company, MDSA’s Holding company, subsidiaries of MDSA, the directors of MDSA and related parties with common directors of MDSA.
The appeal to the Federal Court arose as the Court of Appeal affirmed the High Court’s decision not to grant the application. Both the High Court and Court of Appeal held that related-party creditors should not have been in the same class as the other third-party unsecured creditors.
The crux of the issue thus turned to the following two questions:
(a) Question 1: Whether the votes of related-party creditors are to be treated differently from the votes of other creditors in the same class in the scheme of arrangement.
(b) Question 2: If the answer to Question 1 is yes, whether the related-party creditors’ votes in the scheme should be discounted or disregarded.
The Federal Court answered both questions in the affirmative.
Question 1
In addressing the first question, His Lordship, Nordon bin Hassan FCJ, first acknowledged that the issue before the court was whether “there was a fair representation of the class of creditors”. He then explained that the class of creditors should uphold their common interests in order for the class to be fairly represented, and hence, the court should not disregard the interest of the group of creditors in the said class.
Subsequently, His Lordship considered various case laws before holding that a wholly-owned subsidiary or related party of a scheme company should not be placed in a single class of creditors. He explained that related parties have a special interest in promoting the scheme, and as a result, there is no community of interest between them and the other creditors. In addition, he also stated that the weight to be attached to the related parties’ votes is relevant in their classification. After all, where related parties’ creditors are placed in a single class with other creditors, the meeting stage and voting would only be an exercise in futility should the related parties’ votes be discounted or given less weight at the sanction stage.
Finally, having laid out the law, His Lordship held that MDSA’s related-party creditors should not have placed in the same class as the other unsecured creditors as they had a special interest in promoting the scheme.
Question 2
In addressing Question 2, His Lordship reiterated the fact that related parties have a special interest in supporting the proposed scheme through their relationship with the scheme company. He then proceeded to consider the various case laws, before holding that votes of the related parties must be discounted or given less weight. He also affirmed the High Court judge’s decision to disregard the votes of MDSA’s related parties.
Comment
While the Federal Court has made significant developments to the law, there is still room for further clarifications and developments.
First, it is posited that the courts ought to further clarify who constitutes a “related-party creditor”. As Her Ladyship, Zabariah binti Mohd Yusof FCJ, mentioned in the minority judgment, the CA 2016 does not contain a definition of related-party creditors in the scheme of arrangement. Hence, there is uncertainty as to whether certain creditors fall within the ambit of “related-party creditors”. Judicial guidance in this aspect is desirable. An example of such guidance can be observed in the Singapore Court of Appeal case of SK Engineering & Construction Co Ltd v Conchubar Aromatics Ltd and another appeal [2017] SGCA 51. There, the court stated that deciding whether a particular creditor is a related creditor of a scheme company ultimately involves a fact-sensitive and fact-intensive analysis. It then listed a number of relevant non-exhaustive factors, the existence of which could go towards establishing the existence of a relationship between a creditor and a scheme company.
Moving on, it appears from the Federal Court’s decision that the treatment of related-party creditors’ votes is still to be determined by the Courts vis-à-vis the application of discount and/or different weightage. There are two issues arising from this that require further clarification. First, it is questionable whether the discounting exercise is even necessary, given that the related parties’ votes will now be ring-fenced within their own class. It is arguable that the placing the related-party creditors in a separate class has the practical effect of discounting their votes to 0. One envisions that the discounting exercise would only be relevant where there exists competing interest between the related-party creditors, and further judicial clarification here would be helpful. Second, the Federal Courts has only provided limited guidance on how the discounting exercise will be carried out. The potential considerations that can be gleaned from the cited line of Singapore Court of Appeal authorities are as follows:
(a) the votes of wholly-owned subsidiaries will be wholly discounted;
(b) the vote of entities which have shareholding in and/or have shareholding held by the applicant company could be discounted by the monetary value of their shareholding in the applicant company; and
(c) the vote of entities which hold security over the shares of the applicant’s company could be discounted by the monetary value of their security in the applicant company.
Further judicial development here would be beneficial in injecting certainty to this area of the law.
Finally, as noted by Her Ladyship, Zabariah binti Mohd Yusof FCJ, in a scheme of arrangement, there is a need to balance the risk of empowering the majority to oppress the minority, against the risk of enabling a small minority to thwart the wishes of the majority. As mentioned before, the separate classification of related-party creditors has the practical effect of discounting their votes to 0. Coupled with the lack of cross-class cram down provisions in Malaysia, it is arguable that this may be striking the balance too strongly in favour of the minority. In this regard, a potential solution may be to provide the scheme company and/or the alleged related-party creditor an opportunity to adduce evidence at the application stage to establish that that their interests are not aligned. This would ensure that it is only the related-party creditors with a genuine “special interest” who are classified separately, providing a greater check on the power of the minority while maintaining fairness. In fact, this approach was suggested, in obiter, by the Singapore Court of Appeal in SK Engineering & Construction Co Ltd v Conchubar Aromatics Ltd and another appeal.
* This article was prepared with the sponsorship of INSOL International (Asia) Ltd.