High Court: Creditors cannot approve capital reduction of company under judicial management

“…creditors cannot displace the rights of the members to its shares even in a judicial management regime. – per Nadzarin Wok Nordin, JC
 
Synopsis
 
In Neptune Asia Services Sdn Bhd & Anor v Trans Fame Offshore Sdn Bhd; Awgku Mohd Reza Farzak Awg Daud & Ors (Interveners) [2022] 3 CLJ 692, the High Court had to consider the interplay between the provisions on reduction of capital and judicial management in the Companies Act 2016.
 
Key Points 
  1. A company may reduce its share capital by, among others, a special resolution and subject to confirmation by the Court pursuant to section 116 of the Companies Act 2016. The reduction of capital under section 116 of the Companies Act 2016 is a right given to the company itself and not any other parties. 

  2. Where an order for a reduction of capital is sought, it must not only be just and equitable to the creditors of the company but also to its shareholders and to the public at large. 

  3. Section 414 of the Companies Act 2016 and the Ninth Schedule to the Companies Act 2016 do not provide any creditor and/or judicial manager with the power to reduce the share capital of a company. 

  4. Parliament would not have envisaged section 414(9) of the Companies Act 2016 to be utilised in such a manner so as to take away the rights of the existing shareholders of a company by way of a judicial management process. 

  5. A company’s constitution is a contract between the company and each member and between the members inter se. As such, creditors are not entitled to call for a special resolution to amend the company’s constitution. Any attempt to alter the company’s constitution must be exercised with caution and the Court must exercise its discretion properly by balancing the interests of all affected parties. 
Brief Facts
 
The Applicant, Neptune Asia Services Sdn Bhd, a creditor of the Respondent company, Trans Fame Offshore Sdn Bhd, a company under judicial management, applied to the Court pursuant to section 414(3)(b) and section 414(9) of the Companies Act 2016 (“Application”), seeking among others, an order to amend the constitution of the Respondent company which would allow the creditors of the Respondent company to cancel existing shares and allot new shares by way of a resolution approved by not less than 75% of the Respondent company’s creditors whose claims have been accepted by its judicial manager, present and voting at a meeting convened by the court or the judicial manager of the Respondent company.
 
It was argued on behalf of the Applicant that the proposed alterations to the Respondent company’s constitution are reasonable and required for any proposal or scheme of arrangement to succeed. In this regard, a white knight in this case had specified the amount of monies it is prepared to fund and one of the important questions raised by the white knight is whether it is entitled to become a new shareholder of the Respondent company. It was further argued that the only viable option in this case is for the Respondent company to seek fresh funds from the white knight in order to bargain with the creditors while continuing to extract value from its ongoing contracts. This can only be achieved by a reduction of the issued and paid-up capital of the Respondent company to make way for the white knight to inject fresh capital. It was also argued on behalf of the Applicant that sections 414(3)(b) and 414(9) of the Companies Act 2016 read together with the Respondent company’s constitution, allow the Court to alter the constitution.
 
The Application was opposed by among others, the first and second interveners, both existing shareholders of the Respondent company, on various grounds, including the following: 
  1. the Applicant has no locus to file the Application; 

  2. the alteration being sought under the Application essentially confers rights to the creditors to allot new shares and to cancel existing shares after reducing the share capital by way of wiping out capital of RM8 million belonging to the second intervener, and RM5 million of preference shares, which has no benefit to the Respondent company; 

  3. there is no valid justification for the prayers sought in the Application and that the same will remove the existing shareholders and preference shareholders without any remedy; 

  4. the interveners’ refusal to inject further capital into the Respondent company is not a valid basis to remove them and to extinguish their shareholdings; 

  5. the amendments sought under the Application are solely to empower creditors and third parties to control and manage the Respondent company; and 

  6. the Application is not within the ambit of the judicial management regime. 
Decision of the High Court
 
The law
 
The High Court began by explaining the law on capital reduction under section 116 of the Companies Act 2016 in the judicial management setting.
 
First, in law, a company may reduce its share capital inter alia by cancelling any paid-up share capital that is lost or unrepresented by available assets by way of a special resolution and subject to the confirmation of the Court pursuant to section 116 of the Companies Act 2016. This right is given to the company itself and not to any other parties.
 
Second, where a reduction of capital is sought, it must not only be just and equitable to the creditors of the company but also to its shareholders and to the public at large.
 
Third, none of the said provisions in section 414 of the Companies Act 2016 and the Ninth Schedule to the Companies Act 2016 provide any power to creditor(s) and/or judicial manager to reduce the share capital of a company.
 
Fourth, the judicial management regime was introduced to rehabilitate companies where there is a reasonable prospect of reviving the company as a going concern as opposed to a winding up scenario where the object is to preserve the company’s assets for the fair distribution amongst the creditors and to protect the interest of creditors and the public. As such, Parliament would not have envisaged section 414(9) of the Companies Act 2016 being exercised in such a manner so as to take away the rights of the existing shareholders of the company by way of a judicial management process.
 
Fifth, a company’s constitution is a contract between the company and each member and between members inter se, which by law, only gives the members the right to amend the constitution.
 
Sixth, a judicial manager’s powers under sections 414(3)(b) and 414(9) of the Companies Act 2016 are not unlimited. In enacting the judicial management regime, it is not Parliament’s intention for shareholders to lose control of the company in the manner envisaged in the Application.
 
Seventh, any attempt to alter a company’s constitution must be exercised with caution and the Court must exercise its discretion properly by balancing the interests of all parties affected, i.e. the creditors and members/contributories. In essence, the Court must be slow in allowing an alteration to a company’s constitution.
 
Eighth, the phrase “Any alteration in the constitution made by virtue of an order under paragraph 3(b)” in section 414(9) of the Companies Act 2016 is only intended to be applicable where the Court had made an order under section 414(3)(b). Section 414(9) of the Companies Act 2016 is not meant to be applied in cases where there is no prior Court order.
 
The decision
 
Ultimately, the Application was dismissed by the High Court on, among others, the following grounds: 
  1. the alterations to the Respondent company’s constitution will be of no benefit to the Respondent company and its existing shareholders. In this regard, the proposed alterations would effectively confer rights to the creditors to allot new shares and to cancel existing shares by reducing the share capital and wiping out RM8 million in capital belonging to the second intervener, and the sum of RM5 million of preference shares. Furthermore, the proposed alterations would also result in the Respondent company’s shareholders being deprived of their legitimate ownership over their shares. Ultimately, the Applicant has failed to prove that the Application is for the benefit of the Respondent company as a whole; 

  2. neither the Applicant nor any other creditors have a right to or is entitled to call for a special resolution to amend the Respondent company’s constitution. The proper party here to file the Application is the judicial manager; 

  3. the Court has no power under sections 414(3)(b) and 414(9) of the Companies Act 2016 to remove the rights of the shareholders in the circumstances as prayed for under the Application. The creditors cannot displace the rights of the members to its shares even in a judicial management regime; 

  4. the Application may ultimately result in the current shareholders being removed and for third parties to take control, resulting in the shareholders and preference shareholders losing all their rights as shareholders permanently; 

  5. in the present case, any alteration to the Respondent company’s constitution pursuant to section 414(3)(b) of the Companies Act 2016, if permissible, should have first been brought before a creditors’ meeting held under section 420(1)(b) of the Companies Act 2016.
Comments
 
The High Court’s decision in Neptune Asia Services sheds light on the operation of sections 414(3)(b) and 414(9) of the Companies Act 2016 when a company is placed under judicial management. It also makes it clear that the right to undertake a capital reduction under section 116 of the Companies Act 2016 is vested in a company’s shareholders and that the creditors of a company cannot expropriate this right even under a judicial management regime. This decision will serve as a useful guidance for companies under judicial management intending to undertake a capital reduction exercise.
 
Case commentary by Wong Chee Lin (Partner) and Janice Ooi (Senior Associate) of the Restructuring and Insolvency Practice of Skrine.
 

This alert contains general information only. It does not constitute legal advice nor an expression of legal opinion and should not be relied upon as such. For further information, kindly contact skrine@skrine.com.