Schemes of Arrangements - An Overview

Section 210 of the Companies Act (Cap 50) gives companies saddled with debts, a brief respite from their daily struggles of managing their affairs and the demands of their creditors. This article proposes to cover some aspects relating to the law on statutory schemes, in particular three of its more critical aspects, and recent judicial pronouncements on s 210 and its equivalent in the United Kingdom.

When a debtor company's financial health begins to deteriorate, the interests of the company and the creditors become diametrically opposed. The company has little to gain from undertaking immediate liquidation proceedings; indeed, business usually continues in the hope of a return to solvency.

Creditors, on the other hand, bear the downside risk if such optimism is ill founded and the company's assets are further depleted. Some creditors may be persuaded by the company that the business may still be viable and that it may be in their interest to compromise their debts, instead of enforcing their debts or winding up the company. As a result, the creditors will accept less than the full amount in final satisfaction of their debts or, alternatively, they may agree to a debt payment deferral. Experience has shown that in the absence of any statutory or judicial empowerment, any such debt-restructuring proposals are likely to be ineffective unless there is unanimous consent by all creditors of the company.¹

Towards this end, the company that seeks to come to a compromise with its creditors can have recourse to s 210 of the Companies Act (1994 Ed) (Cap 50) ('the Act'). The company can enter into a compromise with its creditors and - subject to approval at a creditors' meeting by creditors who represent both a simple majority in number and 75% in value of the voting creditors (whether voting in person or by proxy) - coupled with the sanction of the court, the scheme will be binding on all creditors, including dissentients and abstainees.² Apart from this 'clamp down' mechanism afforded by statute, other advantages of a s 210 scheme, as compared to other insolvency regimes like judicial management, are: (a) there is less publicity; and (b) the existing management will not necessarily be displaced.

Court's Sanction of the Proposed Scheme
When a scheme falling within s 210 is proposed between the company and its creditors (or any class of them), the court may, on the application of the company or any creditor of the company, order a meeting of the creditors or class of creditors (s 210(1) of the Act). In practice, this application is made ex parte by way of originating summons.³ Before a scheme can be binding on the company and the creditors (or class of them):

• it must be supported by a majority in number of the creditors representing three-fourths in value (of a class) of creditors present at this court-summoned creditors' meeting (s 210(3) of the Act);
• it must be sanctioned by the court (s 210(3) of the Act); and
• a copy of the order of court sanctioning the scheme must be lodged with the Registrar of Companies (s 210(5) of the Act).

The court, in deciding whether to sanction the scheme, will have to consider: (a) whether the statutory procedure prescribed by s 210 has been complied with and that the resolutions are passed by the requisite majority in value and in number at meetings duly convened and held;⁴ and (b) that it is satisfied that the proposed scheme is fair and reasonable.⁵ In this regard, it may be instructive at this juncture to refer to Buckley on the Companies Act⁶ where the learned author succinctly laid out the duty of the court in sanctioning a scheme of arrangement:

In exercising its powers of sanction, the court will see, firstly, that the provisions of the statute have been complied with, secondly, that the class was fairly represented by those who attended the meeting and that the statutory majority are acting bona fide and are not coercing the minority in order to promote the interests adverse to those of the class concerned whom they purport to represent, and thirdly, that the arrangement is such as an intelligent and honest man, a member of the class concerned and acting in respect of his interest, might reasonably approve. The court does not sit merely to see that the majority are acting bona fide and thereupon to register the decision of the meeting, but, at the same time, the court will be slow to differ from the meeting unless either the class has not been properly consulted, or the meeting has not considered the matter with a view to the interests of the class which it is empowered to bind, or some blot is found in the scheme.

The above excerpt, though extracted from a reasonably archaic text, has since been affirmed judicially in recent decisions;⁷ most recently, the passage from Buckley was affirmed by the English High Court in Re Anglo American Insurance Ltd [2001] BCLC 755.

In deciding whether the statutory procedure has been complied with, the court will, in particular, ensure that the meetings of separate 'classes' of creditors affected have been held, and a scheme will not be approved if the promoters of the scheme have not correctly identified the separate classes.⁸ The problem then is how the different classes of creditors should be delineated. As a general rule, the judgment of Bowen J in Sovereign Life Assurance Co v Dodd⁹ sets out the following principle:

It seems plain that we must give such a meaning to the term 'class' as will prevent the section being so worked as to result in confiscation and injustice, and that it 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 interests.

More recently, the English High Court in Re Anglo American Insurance (supra), when called upon to sanction a scheme of arrangement, had the opportunity to express its views on the principles governing how one should decide if creditors constituted a 'class' that should have had separate meetings. Briefly, the scheme that was proposed was applicable to all unsecured creditors and it was to co-exist with a liquidation of the insurance company if a liquidation was commenced. Disputes would be dealt with under the scheme's dispute resolution procedure, which would provide for a very limited stay of proceedings against the company to reduce the costs to the company of participating in litigation, and to allow time for an agreement of a scheme claim. The precise nature of the stay was to differ, depending on whether the scheme creditor's claim was in respect of a common liability (ie where the company was co-insurer) or was in respect of a claim where the company was the sole insurer. In the former case, the terms of the scheme prevented them from bringing proceedings against the company to establish the existence or amount for a period of six months after obtaining judgment against or reaching settlement with the company's co-insurers and giving notice to the company; in the latter case, the stay of proceedings was simply for six months after giving notice of their claim to the company. Further, on the facts of the case, the creditors could conceivably have been divided according to whether they were: (a) long-term and short-term creditors; (b) creditors who were in the United States and those in the United Kingdom; and (c) common liability creditors. The court, after affirming Bowen J's test enunciated in Sovereign Life Assurance, held that whether a group constitutes a separate class must depend on the particular facts of the case and on the nature of the differences said to exist between the two alleged classes and the relevant terms of the particular scheme. Further, the court is to bear in mind the following factors when deciding on whether the alleged classes in fact constitute separate 'classes':

• the fact that the statutory provisions enable the majority to exercise a most formidable compulsion upon dissentient or would-be dissentient creditors and are, therefore, required to be construed with care;
• the fact that the court has the power and duty not to approve a scheme which is, or perhaps, unfair in its terms or by virtue of the way in which it was arrived at; and
• practical considerations, that is the fact that if one gets too picky about the minute differences between alleged potential classes, one could end up with virtually as many classes as there are creditors.

With the above considerations in mind, the court then held, firstly, that the long-term and short-term creditors were not different classes as the assets would not be divided into two parts for each (on the terms of the scheme). Secondly, although many of the United States creditors would have had a right to make a claim against a fund in the United States, this did not put them into a different class. Last but not least, as regards the common liability creditors, the court found the difference in their rights, as opposed to those of sole liability creditors, was not substantive. Although there was an extra hurdle to their right to pursue their claims, both were, in substance, similarly subjected to a six- month moratorium before they were entitled to proceed with their claims.

The Judicial Moratorium

Pursuant to s 210(10), the court has the power, when a scheme of compromise or arrangement is proposed, to impose a legal moratorium to restrain any further proceedings against the company. Further, proceedings can only be commenced/continued with leave of the court. This provision does not appear in the United Kingdom legislation, but was added to our local provisions on statutory schemes because of the recognition by our local legislators of a flaw in the regime¹⁰ - in the eight weeks or so between the initial formulation of a scheme and approval by the court, the company is vulnerable to attempts by its creditors to enforce their debts. Thus, it was 'extremely difficult for even the most complicated scheme or arrangement to be launched'.¹¹ On a literal reading of the provision, the legal moratorium can be imposed by the court so long as 'such compromise or arrangement has been proposed'; there is no need for the court to have ordered a meeting pursuant to sub-s (1) of the same provision. However, as the law stands, it has been held that, before the court will make a s 210(10) restraining order, the proposal should be known publicly, or at least to one or more of the creditors likely to be affected. It is not necessary for it to be known to all creditors likely to be affected or that the scheme be in complete form ready for consideration. However, its general principles must have at least been defined and it must be at a stage where a meeting of creditors can be ordered.¹² In the Malaysian High Court case of Re Kuala Lumpur Industries Bhd [1990] 2 MLJ 180, Justice VC George, after considering the Malaysian equivalent of s 210(10), held:

For there to be a proposal within the meaning of [s 210], it is not necessary that there should be a scheme in a complete form capable of being presented to the creditors for being voted on ... In my view, what must be available to the court when considering a [s 210(10)] ... application must be a proposal of a scheme of compromise or arrangement not necessarily ready for presenting to the creditors or voted upon, but with sufficient particulars to enable the court to assess that it is feasible and merits due consideration by the creditors when it is eventually placed before them in detailed form. Further, the court has to be satisfied that there is or that there would be a bona fide [s 210] application.

As an illustration of the application of the principles above, it may be instructive to refer to the New South Wales Supreme Court case of RG Supplies Pty Ltd v Allfox Building Pty Ltd.¹³ At the hearing of the application, the company had merely considered a proposal under which the creditors would receive a percentage of their debt by instalments (ie a 'haircut'). The funds which the company proposed to utilise would originate from another company. However, it was unclear as to which company this would be. The only evidence proffered to the court of the scheme's existence was by one Mr Byrnes who testified that he had received verbal indications from several creditors that they were prepared to 'receive something rather than nothing'. The court held that there was no arrangement proposed between the company and the creditors at that stage as there was no evidence that any creditors had been told anything more than that they will receive 'something' under the scheme.¹⁴

Third Party Rights
On the express wording of the provision, a scheme of arrangement or compromise is an agreement that is, prima facie, binding only on the company and its creditors or members (s 210(1) and (3) of the Act). The question then is whether it is permissible to incorporate a term into a scheme of arrangement so that third party rights are affected.

This issue arose before the Singapore Court of Appeal in the recent case of Daewoo Singapore Pte Ltd v CEL Tractors Pte Ltd.¹⁵ CEL Tractors Pte Ltd (CEL) had presented a scheme of arrangement to 10 of its creditors whereby it would make certain payments and grant share options to the creditors. In return, the creditors were to release both CEL and its guarantors (third parties to the scheme agreement) from all further claims. The scheme was approved by the requisite majority of creditors and CEL applied to the High Court for sanction of the scheme. One of its creditors, Daewoo, objected on the ground that the terms of the scheme would amount to a discharge of guarantee given by one of the directors of CEL in respect of a loan which Daewoo had given to CEL. Daewoo contended that the scheme bound only the company and its creditors and, therefore, could not discharge or affect the liability of a third party guarantor to the debts of the company. It wanted the court to sanction a proviso that the scheme was not to affect the director's guarantee. The learned Chief Justice accepted counsel for Daewoo's argument and held that it is settled law that a scheme of arrangement or compromise made between a company and its creditors in relation to its debts and liabilities, approved by the requisite majority of creditors and by the court, affects only the rights of the creditors against the company and does not affect the rights of the creditors against a third party, such as a guarantor. However, he went on to hold that, notwithstanding the general rule, there was no reason, in principle, why a scheme cannot incorporate such a term expressly. He was of the opinion that s 210 is no more than a proposal by the company to vary or modify its obligations with its creditors (or class of creditors) on certain terms and conditions. Hence, in seeking to vary its obligations, there is nothing to prevent the company from proposing, as part of a wider scheme, inter alia, a term that discharged not only the debts and liabilities of the company, but also the liabilities of the guarantors for the same debts and liabilities of the company. Although the terms bind only the company and the creditors, it was held that there was no reason why the company cannot in principle enforce the terms of the scheme as against its creditors. Should the creditors take legal proceedings to enforce their guarantees, the company was entitled to seek equitable reliefs in the form of an injunction and specific performance against the creditors. This is because if the creditors sought to enforce their guarantees, the guarantors of the company will inevitably seek recourse against the company for indemnity.

The author submits that the approach taken by the Court of Appeal is a sensible one. In the absence of any unfairness, discrimination or bad faith and provided the statutory majority has been obtained, it is difficult to see why a scheme of arrangement cannot provide for the release of guarantors in respect of the debts which are sought to be discharged or restructured under the scheme. However, as pointed out by the Court of Appeal, as guarantors are not ordinarily parties to the company's scheme of arrangement, the guarantors will have to rely on the company to enforce the provisions of the scheme. If the guarantors are not in control of the company, there is no certainty that the company will take steps to protect the guarantors' rights. In such a case, guarantors may wish to be expressly included as parties to the scheme so as to be in a position to enforce the scheme against the creditors subject to the scheme.

Conclusion
In light of the recent economic downturn, Singapore's financial scene will probably experience an increased reliance on statutory instruments akin to the s 210 schemes of arrangement in a bid to restructure their debts. The suitability of reliance on a s 210 scheme, as opposed to other insolvency regimes such as judicial management and liquidation, has to be determined, of course, on a case by case basis. Nevertheless, this article has sought to provide a brief review of the s 210 procedure and recent judicial pronouncements on its efficacy.

Chua Eu Jin
Rajah & Tann

Endnotes