By Joel Chng, Daniel Liu, Tan Kai Yun, Clayton Chong, Adnaan Noor, Eden Li and Muhammed Ismail Noordin (WongPartnership LLP)
Introduction
Insolvency set-off is an important quasi-security device that enables mutual debts owed between a party and a company to be set off against each other in the company’s judicial management or liquidation. Without it, a party dealing with a company which enters judicial management or liquidation would have to pay its debt to the company in full, while only being entitled to receive a pari passu repayment on the debt owed by the company to it.
The General Division of the High Court (“High Court”) examined the parameters of insolvency set-off in Park Hotel CQ Pte Ltd (in liquidation) and others v Law Ching Hung and another suit [2024] SGHC 105 (“Park Hotel”), finding that:
(a) A creditor of a company in insolvent liquidation can only invoke a statutory insolvency set-off against the company (as opposed to other types of set-off, such as legal and equitable set-off). Hence, a defendant being sued by such a company can only advance a counterclaim without requiring the Court’s permission if such counterclaim is subject to insolvency set-off.
(b) A defendant which is sued by a company’s liquidators for alleged wrongdoing cannot rely on insolvency set-off to diminish the claims against him, as a claim based on his wrongdoing does not constitute “mutual dealings” with the company (a requirement for insolvency set-off to apply).
Case Background
Section 133(1) of the IRDA (“Section 133(1)”) provides that “no action or proceedings may be proceeded with or commenced against [a company in respect of which a winding up order has been made or a provisional liquidator appointed] except … by the leave of the Court”.
Two companies in insolvent liquidation commenced proceedings against certain creditors. The creditors sought leave under Section 133(1) to amend their defence and introduce counterclaims against the companies.
Two interrelated questions arose from the creditors’ applications:
(a) When, if ever, can a creditor advance a counterclaim in proceedings initiated by a company in insolvent liquidation without having to obtain leave of court under Section 133(1)?
(b) Can a creditor rely on other forms of set-off known to the general law, such as legal and equitable set-off, against a company in insolvent liquidation?
The High Court’s Decision
The High court answered the above two questions as follows:
(a) A creditor can only advance a counterclaim that amounts to a permissible set-off against a company in insolvent liquidation without having to obtain leave under Section 133(1).
(b) A creditor can only invoke an insolvency set-off against a company in insolvent liquidation.
Only counterclaims amounting to permissible set-offs (i.e., insolvency set-offs) can be advanced without leave of court under Section 133(1)
The High Court held that only counterclaims amounting to permissible set-offs against the company’s claims can be advanced without obtaining leave under Section 133(1). It is only where the defendant is relying on a counter-claim to extinguish the insolvent company’s claim against him, through the operation of insolvency set off, that leave of court under Section 133(1) would not be required.
The High Court rejected the defendants’ contention that Hyflux Ltd v SM Investments Pte Ltd [2020] 4 SLR 1265 was authority for the broader proposition that any counterclaim is outside the scope of the moratorium in Section 133(1) and therefore may be brought without leave of court.
As a matter of general principle, neither legal set-off nor equitable set-off can be asserted
The High Court held that insolvency set-off displaces all other forms of set-off, including legal set-off and equitable set-off, against a company in insolvent liquidation, reasoning that:
(a) Pari passu distribution is the default rule in insolvent liquidation. Anything that provides for some other form of distribution is an exception to that rule.
(b) True exceptions to the pari passu principle seem to be exclusively – or almost exclusively – prescribed by statute, as the pari passu principle is entrenched and put into place by statute (see section 172 of the IRDA). As such, apart from provisions of the IRDA varying pari passu distribution, no other exception can be admitted under common law.
(c) Insolvency set-off is an example of a statutory (true) exception to the pari passu principle (as recognised in Kyen Resources Pte Ltd (in compulsory liquidation) and others v Feima International (Hong Kong) Ltd (in liquidation) and another matter [2024] SGCA 7). It allows an unsecured creditor to use his own indebtedness to the company as de facto security by setting it off against the company’s claim(s) against him, if the requirements of insolvency set-off are met.
The High Court then highlighted that:
(a) Neither legal nor equitable set-off have a statutory foundation, being doctrines developed in judge-made law. This weighs against legal or equitable set-off being able to operate in the insolvency context as an exception to the pari passu principle.
(b) Allowing legal or equitable set-off to apply when insolvency set-off may not be available produces anomalous outcomes that undermine the pari passu principle and its underlying policy, for example, by allowing creditors to obtain satisfaction of non-provable claims through legal or equitable set-offs.
Legal set-offs cannot be asserted against a company in insolvent liquidation
(a) In a legal set-off, the creditor would be circumventing the proof of debt mechanism put in place as the proper mode of enforcement of debts against an insolvent company. There is no principled reason why a creditor’s position should be vastly improved by the wholly fortuitous circumstance that he happens to be a defendant in a litigation brought by the insolvent company against him.
(b) In addition, legal set-off is procedural in nature, being an expedited method of enforcing a claim against the claimant that is made available to the defendant in the interests of procedural efficiency. Allowing it to be used as a mode of enforcement against an insolvent company would permit a defendant to undermine the proof of debt regime and gain priority at the expense of other creditors through a procedural device. This would not be right.
Equitable set-offs cannot operate against a company in insolvent liquidation
(a) Although it is arguable that equitable set-off is inherent within the company’s right of action such that it must remain available even after the company passes into insolvent liquidation based on impeachment of title, most claims that could amount to equitable (and legal) set-offs would already be subject to the mandatory operation of insolvency set-off. Creditors would not be visited with unfairness from their inability to rely on equitable set-off post-liquidation.
(b) There is no basis for an unsecured creditor to be accorded priority treatment over other unsecured creditors. An equitable set-off is a counterclaim (a personal right of action) and cannot be treated in the same way as a proprietary interest in the company’s assets. As it is similar to contractual rights of set-off, which insolvency law has long restrained, there is little difficulty in the same approach being taken for equitable set-offs.
(c) The effect of an equitable set-off is the same as paying a preference – the unjust enrichment of the set-off beneficiary at the expense of other unsecured creditors. As such, it would be exceedingly rare that an equitable set-off could apply against an insolvent company.
Application to the facts of the case
Here, the High Court dismissed the creditors’ application on the basis that the plaintiffs’ claims were based on the defendants’ wrongdoing. As one of the conditions of insolvency set-off is that “the company’s claim must not have been based on the creditor’s wrongdoing”, the defendants were not entitled to rely on insolvency set-off to advance their counterclaims without obtaining leave of court under Section 133(1).
Conclusion
This decision provides useful guidance on the scope and operation of insolvency set-off. There are other unresolved complications relating to insolvency set-off, particularly in relation to how it operates for a company in judicial management. It was only recently through the commencement of the IRDA in 2020 that the applicability of insolvency set-off was extended to companies in judicial management. For more on this topic, read our article published in the Singapore Academy of Law Journal Special Issue on Insolvency.
* The full version of this article was originally published by WongPartnership LLP. This summary was prepared with the assistance of Kwong Kai Sheng (WongPartnership LLP).
