Prequel
 
In our case commentary dated 3 May 2023, titled “Court of Appeal: High Court is the final safeguard in approving a scheme of arrangement”, our Janice Ooi had analysed the Court of Appeal’s decision in MDSA Resources Sdn Bhd v Adrian Sia Koon Leng [2023] 3 CLJ 191. The Court of Appeal had held, among others, that the classification of the Scheme Creditors, comprising the Third-Party Creditors and the Hatten Group Creditors (being the Appellants’ related party creditors), in a single class was unfair, uneven, and downright lopsided. The Court of Appeal had therefore upheld the High Court’s decision to dismiss the application by MDSA Resources Sdn Bhd for an order sanctioning the scheme of arrangement.
 
Trailer
 
On 11 July 2023, the Federal Court delivered its decision in MDSA Resources Sdn Bhd v Adrian Sia Koon Leng [2023] 1 LNS 1386. The case presented the Federal Court with a rare opportunity to develop the law surrounding schemes of arrangement in Malaysia as there had not been many schemes of arrangement which had previously come before it. This opportunity was particularly opportune given that there has been an increase in parties applying for schemes of arrangement pursuant to Section 366 of the Companies Act 2016, after having suffered from the effects of the Covid-19 pandemic.
 
The Federal Court ultimately dismissed the appeal by a 2-1 majority. In coming to its decision, the majority judgment only addressed the first two of the ten questions of law for which leave was granted on. They are as follows:
 

 
Both questions were answered in the affirmative by the Federal Court. This article shall therefore be largely confined to analysing the Federal Court’s findings on the same.
 
The Theme
 
Before delving into the arguments put forth by both parties, the Federal Court outlined the theme of the dispute before it, namely the purpose and implementation of a proposed scheme of arrangement.
 
The Federal Court recognised that the purpose of a scheme of arrangement was to assist companies heavily burdened with debts to survive and manage their affairs and avoid liquidation. This would be achieved by the said companies reaching an arrangement with the creditors to restructure and compromise on their debts, thereby enabling the creditors to recover part of the debt owing to them while ensuring that the company is able to stave off liquidation.
 
The Federal Court further recognised the role of the Court in acting as the  final safeguard before sanctioning a proposed scheme of arrangement. In carrying out this role, the Federal Court emphasised that there were four pertinent questions that must be considered by the Court:
 

 
The Major Plot: Analysis of the Majority Decision
 
1^st Storyline: The Classification of the Creditors
 
In addressing the 1^st question of law, His Lordship, Nordin bin Hassan FCJ, recognised that the primary issue before the Court was whether the classification of the Third-Party Creditors together with the Hatten Group Creditors would enable a fair representation of the class of creditors.
 
At the outset, His Lordship made clear that in determining the classification of creditors, it was insufficient to only give due consideration to the legal rights of the creditors to the scheme. On the contrary, in determining the classification of creditors, equal regard must also be given to the interests derived from the said legal rights. This would to ensure that the group of creditors would uphold a common interest thereby enabling them to be fairly represented at the court-convened meeting of a proposed scheme.
 
With the groundwork laid, His Lordship recognised that related party creditors, such as the Hatton Group of Creditors, may have a personal or special interest in seeing the proposed scheme of arrangement passed considering their relationship with the applicant company. This would naturally result in the related party creditors legal rights or interest diverging from and/or being dissimilar to that of the third party creditors. The result of this dissimilarity is clear - the related party creditors and third party creditors would be unable to sensibly consult together on the proposed scheme with a view to their common interest. The related party creditors would likely disregard the interest of the class of creditors as a whole when voting on the proposed scheme of arrangement due to its special interest in assisting its relate party to have the scheme passed.
 
Considering the above, His Lordship held that relate party creditors should not be placed in the same single class of creditors as third party creditors. This was as the single classification of creditors with potentially competing interests would not be fairly representative of the scheme creditors.
 
2^nd Storyline: Weight to be given to Votes of Related Party Creditors
 
The Learned Judge then went on to consider the treatment to be given to the votes of related party creditors. The issue here was:
 

 
Ultimately, His Lordship adopted the first position aka the Singapore Courts position as set out by the Singapore Court of Appeal in Royal Bank of Scotland NV v TT [2012] SLR 213, SK Engineering & Consortium Co Ltd v Conchubar Aromatics Ltd and another appeal [2017] 2 SLR 898 and Wah Yuen Electrical Engineering Pte Ltd v Singapore Cables Manufactures Pte Ltd [2003] 3 SLR 629. In essence, this would result in:
 

 
Unfortunately, the Federal Court did not take the opportunity to set out the factors and/or considerations to be taken into account in determining the discount which should be imposed on the votes of the other related party creditors.
 
The Minor Plot: Analysis of the Minority Decision
 
1^st Storyline: The Classification of the Creditors
 
Her Ladyship, Zabariah binti Mohd Yusof FCJ, started her analysis by going back to the governing statute, the Companies Act 2016. Her Ladyship noted that the statute did not make any mention of ‘related party creditors’ in the scheme of arrangement provisions. Premised on this,  Her Ladyship held the Court should exercise caution in drawing a distinction between ‘related party creditors’ and ‘third party creditors’ where there was no statutory basis to do so.
 
In light of this, Her Ladyship held that the classification of creditors should be based on the similarity, or dissimilarity, of the legal rights of the creditors against the applicant company in determining the classification of creditors. While the ‘special interests’ of the creditors may affect the Court’s decision on whether to sanction the scheme, Her Ladyship opined that it was fundamental that the Court should confine itself to assessing the strict legal rights, and not the subjective interests or benefits which a creditor may claim from the proposed scheme, when determining the classification.
 
Her Ladyship adopted this approach as she felt that a balance must be struck between the risk of the majority oppressing the minority, and the risk of the minority thwarting the wishes of the majority. This is given that each different class of creditors would have the power to veto the scheme in its entirety, thereby enabling a minority class (whether in number or value) to have an unbalanced influence on the scheme. Therefore, care must be taken to ensure that creditors are classified in accordance with their rights and/or common interest to ensure that they can properly consult together without the applicant company having to also determine the private motives or extraneous interest of each creditor.
 
2^nd Storyline: Weight to be given to Votes of Related Party Creditors
 
Her Ladyship acknowledged that it was not automatic that the votes of related party creditors and third party creditors should be given equal weight merely because they were in the same class and/or had similar legal rights.
 
However, unlike the majority of the Federal Court which adopted the Singapore Courts approach discussed above, Her Ladyship adopted the second position, namely the “but for” test, as applied by the English Courts and Hong Kong Courts. The “but for” test places a burden on the opposing creditor, in trying to discount the vote of a related party creditor, to show that an intelligent and honest member of the class, without the collateral interests brought by the related party status, could not have voted in the way that it did. This collateral interest must be shown to clash with, be in conflict, or adverse to the interest of the class as a whole. There must be a strong and direct causative link drawn, supported by strong and cogent evidence, in order for an uneven weight to be given to the votes of the related party creditors as compared to the third party creditors.
 
Her Ladyship’s preference for this approach stemmed from an intention to preserve the discretion of the Court at the sanction hearing to determine whether the vote of the related party creditors ought to be discounted and/or disregarded as opposed to the relatively blanket approach adopted by the Singapore Courts.
 
The Side Show: Duty of Disclosure
 
Aside from the classification of creditors, the Federal Court also had occasion to consider the duty on the applicant company to disclose material facts in the Explanatory Statement. The Federal Court took the view that all material information necessary for the creditors to make an informed and meaningful decision must be revealed by the applicant company at the meeting stage, and to the Court at the sanction stage. This was to enable the creditors to assess the scheme independently and make an informed and meaningful decision before voting on the proposed scheme. The applicant company must not withhold any material information that would affect the creditors’ decision when casting their vote as this would be prejudicial to the creditors. The prejudice was envisioned to extend even to those creditors who, having reviewed the contents of the Explanatory Statement that had been circulated to them, chose not to attend the creditors’ meeting without being aware of the amendments to be made and/or the material information which had been withheld. Therefore, the duty imposed on the applicant company was to disclose all material information at the outset, and not withhold the same until the creditors’ meeting, or even later.
 
The Review: Moving Forward Post-MDSA Resources
 
Moving forward, the Federal Court’s decision in MDSA Resources will have ramifications for proposed schemes of arrangement, specifically in determining the classification of creditors.
 
In structuring future schemes of arrangement, applicant companies must ensure that all related party creditors are placed in a different class(es) of creditors to their third party creditors. This would undoubtedly place a bigger obligation on applicant companies to meet and persuade their third party creditors on the benefits of supporting the proposed scheme of arrangement to garner their support. Applicant companies can no longer rely on the  support of their related party creditors to get the proposed scheme of arrangement past the voting threshold of 75% without paying equal, if not more, attention to employing the art of persuasion to the third party creditors.
 
Furthermore, it seems from the Federal Court’s decision that the treatment of the votes of related party creditors, especially those which are not wholly-owned subsidiaries and/or a holding company that holds all the issued shares of the applicant, would still need to be determined by the Courts vis-à-vis the application of discount and/or different weightage to be given to the same. This would still be relevant even though they are in a separate class from the third party creditors as there may be competing interests even between the related party creditors based on the extent of their relationship with the applicant company and their own financial obligations. While there was limited guidance provided on the manner in which the treatment to related party votes will be applied, some considerations which can be seen from the line of Singapore Court of Appeal authorities are as follows:
 

 
There is therefore scope for the Courts to further develop the law on schemes of arrangement in Malaysia by providing detailed guidance on the principles to be applied in determining the weightage or discount to be given to the votes of related party creditors of the applicant company under a scheme.
 
Lastly, applicant companies should ensure that they make full disclosure of all material information at the earliest opportunity. At the very least, full disclosure should be made in the Explanatory Statement sent out together with the notice(s) for meetings of creditors. A failure to make full and frank disclosure of the material facts pertaining to the scheme of arrangement (both in terms of circumstances that resulted in the applicant company needing to propose the scheme of arrangement, and the method of implementation of the same) would render the proposed scheme of arrangement susceptible to being challenged at the hearing for an order to sanction the same. The likely outcome thereafter would be a dismissal of the application for a sanction order and/or a further order by the Court for the Court-convened meeting to be reconvened after a revised Explanatory Statement has been issued to the creditors with full disclosure of all the material information.
      
Case commentary by Nimalan Devaraja (Partner) of the Restructuring and Insolvency Practice of Skrine.