Corporate Rescue Mechanisms: Considerations for Creditors [Part 2 of a 2 Part Series]

The first part of this series dealt with the Corporate Voluntary Arrangement(“CVA”), one of two corporate rescue mechanisms under the Companies Act 2016 (“Act”). The second rescue mechanism for which the relevant provisions are set out in Part III Division 8 Subdivision 2 of the Act (“Subdivision 2”) and the Companies (Corporate Rescue Mechanism) Rules 2018 (“Rules”), is judicial management. 

Judicial Management

Introduction

Subdivision 2 and the Rules establish a mechanism, judicial management (“JM”), by which a distressed or insolvent company is allowed a period of time to rehabilitate as a going concern, or to arrive at a compromise or arrangement with its stakeholders or to facilitate an orderly and more advantageous realisation of its assets. 

Protection from creditors during this period comes initially from a limited moratorium which comes into effect the moment an application to court for a judicial management order (“JMO”) is made (“Limited Moratorium”) and following that, assuming a JMO is granted, a more extensive moratorium (“Full Moratorium”) whilst the company is under the control of a court-appointed officer, the judicial manager (“Manager”)  

By contrast with the CVA, as a rescue mechanism, JM involves the courts to a much larger degree. In fact, the key elements of JM, including the making of a JMO, appointment of a Manager, extension of the Full Moratorium and the protection of creditors and members whilst a JMO is in force, are dependent on what orders a judge may be persuaded to make.  

The courts have a broad discretion regarding the grant of a JMO, the test for which under the Act is simply whether the court is satisfied that the company is or will be unable to pay its debts and considers that the making of a JMO would likely achieve one or more of the following (“JM Objectives”):

  1. the survival of the company (in whole or in part) as a going concern;
  1. the approval of a scheme of compromise or arrangement between the company and its creditors or any such persons as are mentioned in section 366 of the Act; and
  1. the company’s assets may be realised in a more advantageous manner than on a winding up.

Availability of JM

The Act expressly provides that Subdivision 2 shall not apply to companies licensed or regulated under laws enforced by Bank Negara Malaysia and companies subject to the Capital Markets and Services Act 2007 (“CMSA”).

Notwithstanding, and following an application for a JMO made by a group of companies which included a public-listed company (which is subject to the CMSA) and its non-listed subsidiaries, the Malaysian courts are currently considering the extent of the statutory limits to the availability of JM. 

In any event, JM would appear to be available to a wider swathe of companies than CVA (which is further limited to only private companies which have not given a charge or debenture over their assets).

Unlike the CVA mechanism however, JM envisages the eventual relinquishment of control by incumbent management to a court appointed officer (the Manager) and this may prove a stumbling block to widespread adoption of JM as a rescue mechanism. 

Moratoriums

As alluded to above, under the JM framework, there are 2 different ‘species’ of moratorium which may come into play. 

Limited Moratorium

The Limited Moratorium takes effect upon the making of an application for a JMO and lasts until either a JMO is made or the application is dismissed. 

The scope of the Limited Moratorium as expressed in the Act is as follows:

“(a) no resolution shall be passed or order made for the winding up of the company;

(b) no steps shall be taken to enforce any charge on or security over the company’s property or to repossess any goods in the company’s possession under any hire purchase agreement, chattels leasing agreement or retention of title agreement, except with leave of the Court and subject to such terms as the Court may impose; and

(c) no other proceedings and no execution or other legal process shall be commenced or continued and no distress may be levied against the company or its property except with leave of the Court and subject to such terms as the Court may impose.

Crucially, from a creditor’s perspective, how long a Limited Moratorium remains in effect may be a particular cause for concern, because whilst the company enjoys protection from creditors, control of the company over this period remains in the hands of existing management.

To an extent, this concern is addressed in the Rules which stipulate that a court must fix the JMO application for hearing within 60 days of its filing. 

The Rules do not however stipulate a time frame within which the courts must dispose of a JM application and thus existing management may retain control for an extended period (by employing strategies to protract the hearing of the application for the JMO) whilst enjoying protection from creditors.

The situation for creditors, and secured creditors in particular, during the initial stage of court proceedings involving applications for a JMO, is complicated by the provisions of Subdivision 2 and the Rules which distinguish between a company’s secured creditors and those secured creditors who may appoint (or indeed who have appointed) a receiver over substantially the whole of a company’s property under the terms of a debenture (“Debenture Creditors”). The distinction manifests under inter alia the provisions of the Act which require that:

  1. a company applying for a JMO need only serve the application on Debenture Creditors (although the application must be advertised in one widely circulated newspaper in the national language and one widely circulated newspaper in the English language); and
  1. courts dismiss a JMO application if satisfied that a receiver has been or will be appointed and if the making of the order is opposed by a secured creditor (unless there are public interests at stake).

At least 2 first instance decisions of Malaysian courts have interpreted these said provisions to mean that only Debenture Creditors can object to the making of a JMO during the hearing of an application for such order.

These decisions suggest that the current approach adopted by the courts is to confine creditors (other than the Debenture Creditors) to only being heard in respect of the proposed nominee for the Manager at the hearing of the JM application.

In respect of other matters it appears that the courts will only “hear” non-Debenture Creditors after the grant of a JMO,  either under the express provisions of the Act which provide for the protection of creditors’ interests or (more controversially) on applications to set aside a JMO on the basis that any proposal to rehabilitate the company would fail for lack of sufficient support from creditors.

This approach to dealing with applications for JMOs and treatment of different creditor classes has attracted some controversy and whilst certain criticisms appear justified, not least that the Rules appear to allow for secured creditors (not just Debenture Creditors) to object to the making of a JMO, the main benefit of this approach is to allow courts to dispose quickly of applications for JMOs and thus limit the period within which the company remains in management control whilst being protected from its creditors under the Limited Moratorium. 

Full Moratorium

A more extensive moratorium takes effect for the period over which a JMO remains in force, which is for 6 months unless sooner discharged or extended (by order of court) on the application of the Manager for a further 6 months. During this period, when a Manager is in control of the company, 

“(a) no resolution shall be passed or order made for the winding up of the company;

(b) no receiver or receiver and manager of the kind referred to in section 374 shall be appointed;

(c) no other proceedings and no execution or other legal process shall be commenced or continued and no distress may be levied against the company or its property except with the consent of the judicial manager or with the leave of the Court and, if the Court grants leave, subject to such terms as the Court may impose;

(d) no steps shall be taken to enforce security over the company’s property or to repossess any goods in the company’s possession under any hire purchase agreement, chattels leasing agreement or retention of title agreement, except with consent of the judicial manager or leave of the Court and subject to such terms as the Court may impose; and

(e) no steps shall be taken to transfer any share of the company or to alter the status of any member of the company except with the leave of the Court and, if the Court grants leave, subject to such terms as the Court may impose.”

Notice of Moratorium

The application for a JMO must be served on Debenture Creditors and notice of the application and its hearing date must be advertised in the local dailies 14 days before the hearing date fixed by court. 

As the Limited Moratorium takes effect upon the filing of the application for a JMO there may be a lag before creditors become aware of the commencement of Limited Moratorium period.

In the event a JMO is made by the court, the Manager must publish notice of the order (and hence notice of the coming into effect of the Full Moratorium) in the local dailies and give notice to all creditors of the company within 30 days of the making of the order unless otherwise directed by the court. 

Unsecured creditors and secured creditors who are not Debenture Creditors must put in place or bolster existing monitoring protocols involving daily sweeps of advertisements in local dailies to alert them at the earliest juncture of an application for a JMO involving a borrower or debtor. 

Limitation continues to run during the periods when a Limited and Full Moratorium are in effect save that if a Full Moratorium is extended for a further 6 months, the extension shall not be taken to be part of any limitation period. 

Manager

From some perspectives, a Manager may appear similar to a receiver or liquidator. For instance, the Manager essentially has control of the company, taking over from the incumbent management team and the board and may have to answer to a committee of creditors. 

Unlike either a liquidator or a receiver, however, the Manager’s principal function is to achieve the JM Objectives. In order to facilitate this function, the Act gives the Manager powers which are unique, including the power to deal with and even dispose of property which is subject to a charge or comprise of stock or equipment which does not form part of the assets of the company. 

In respect of property subject to security (other than floating charges) and goods or equipment under hire purchase, leasing or retention of title agreements, the Manager may by order of court dispose thereof as if the property were not subject to any security or as if the company were vested with all the rights of the actual owner of the property. The security holders or owners are given a measure of protection under the Act in that the Manager must give prior notice of an application for such order and the net proceeds of any disposal are to be applied towards discharging the secured indebtedness or the amounts payable under the hire purchase, leasing or retention of title agreements as the case may be.  

In light of inter alia the powers available to a Manager, the selection of the appropriate qualified person for such role may prove particularly important to creditors. As such, all creditors (not just the non-Debenture Creditors) ought to avail themselves of the right to be heard on this issue during the hearing of an application for a JMO. 

Manager’s Proposal and Creditors’ Meeting

A key element of the JM process involves the Manager laying before the creditors, at a meeting summoned for such purpose (“Creditors’ Meeting”), a statement of his or her proposal (“Manager’s Proposal”) for how the JM Objectives may be achieved. This must be done within 60 days after the making of the JMO.

At the said meeting, the creditors will decide on whether to approve the Manager’s Proposal which, in order to be approved, requires 75% of the total value of creditors present and voting (“Requisite Majority”), either in person or by proxy, to vote in favour of the said proposal. Modifications to the Manager’s Proposal may be made subject to the Manager’s consent.

If the proposal garners the Requisite Majority, it is binding on all other creditors, regardless of whether the creditors voted in favour of the Manager’s Proposal.

As with meetings held under a CVA, creditors should arrange to attend the Creditors’ Meeting. Arguably it is even more important that all creditors attend under a JM scenario, as the Act allows for the establishment of a committee of creditors following the approval of the Manager’s Proposal. Such a committee, if established, has the power under the Act to exercise a measure of control over the Manager by requiring him or her to attend before creditors and furnish information relating to his functions.

Corporate Rescue Mechanisms: Conclusion 

More than 2 years have elapsed since the coming into force of legislation relating to CVA and JM, and there have been few reported instances of either rescue mechanism being utilised by distressed enterprises. The key issue in respect of the CVA mechanism appears to be the limitations to its availability, whilst in respect of JM, incumbent management must contend with the prospect of losing control of the company.

 The global business environment has however changed significantly in more recent times and as the effects of various temporary strategies employed by the government to support businesses begin to abate, there may well be a rise in the number of distressed enterprises seeking the protections offered by either CVA or JM. 

There are also other options available to distressed companies which may instead choose to enter into schemes of arrangement and compromise with their creditors and to avail themselves of the provisions in the Act which allow for the courts to grant restraining orders to protect such companies from their creditors.  

The key ‘take-away’ for creditors is that they must vigilantly monitor their debtors and put in place protocols which enable an immediate and effective response in the event a debtor company opts for either of the corporate rescue mechanisms discussed in this series. 

Contributed by the Dispute Resolution Practice Group of Raja, Darryl & Loh.

Ng Sai Yeang (Partner)
(E): [email protected]
(T):+603-2632 9877

Mark La Brooy (Partner)
(E): [email protected]
(T): +603-2632 9865

Teoh Chye Yi (Senior Associate)
(E): [email protected]
(T): +603-2632 9913

Wong Chee Chien (Associate)
(E): [email protected]
(T): +603-2632 9930

The articles published on our website do not constitute legal advice and are only intended for general information.

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