To be held Solvent or Insolvent: This is the Test
22 July 2021
In its recent decision, Sun Electric Power Pte Ltd v RMCA Asia Pte Ltd (formerly known as Tong Teik Pte Ltd)  SGCA 60, the Singapore Court of Appeal had occasion to clarify the applicable test for determining whether a company is insolvent/ unable to pay its debts under Section 254(2)(c) of the Singapore Companies Act 1967 (“Companies Act”) (which is in pari materia with Section 466(1)(c) of our Companies Act 2016). The Court of Appeal also dealt with the issue of the relevant personality who should control the conduct of an appeal against a winding up order, and provided guidance on whether a company is still deemed to be unable to pay its debts under Section 254(2)(a) of the Companies Act (which is in pari materia with Section 466(1)(a) of our Companies Act 2016) if it makes part payment of the amount stated in the statutory demand such that the remaining debt falls below the statutory threshold amount.
It should be noted at the outset that the relevant proceedings had been commenced before the coming into force of Singapore’s Insolvency, Restructuring and Dissolution Act 2018 on 30 July 2020. Therefore, the provisions of the Companies Act were applicable to the dispute.
The Commencement of Proceedings
Shortly after successfully resisting Sun Electric Power Pte Ltd (“Sun Electric”)’s application for judicial management, the Respondent (“RMCA Asia”) issued a statutory demand to Sun Electric’s registered office for the amount of costs awarded, and the accrued interests, arising out of the dismissal of the judicial management application. The total amount demanded was $11,568.88, which was just above the statutory threshold of $10,000.00.
Sun Electric admitted the debt and proposed to make payment thereof by three instalments over a period of one month. RMCA Asia rejected this proposal. However, Sun Electric disregarded the rejection of its proposal, and made payment of the first instalment, amounting to $3,000.00, 22 days after the statutory demand had been issued. No further payments were made.
This resulted in RMC Asia commencing winding up proceedings less than a week later, premised, among others, on whether the grounds under Section 254(2)(a) and/or Section 254(2)(c) of the Companies Act had been met.
The Parties’ Arguments
In arguing that Sun Electric should be wound up, RMCA Asia took two primary arguments. First, RMCA Asia argued that Sun Electric should be deemed to be unable to pay its debts pursuant to Section 254(2)(a) of the Companies Act as it had not paid the debt in full, despite having been served a statutory demand. Second, RMCA Asia submitted that Sun Electric should also be deemed to be unable to pay its debts pursuant to Section 254(2)(c) of the Companies Act as it was both cash flow insolvent and balance sheet insolvent.
Sun Electric on the other hand adduced a balance sheet, allegedly prepared by a qualified chartered accountant, which it claimed showed that it was solvent, and therefore had satisfied the balance sheet solvency test. Sun Electric also argued that the outstanding debt owed had now fallen below the statutory threshold in light of the part payment following the issuance of the statutory demand, and that it had sufficient balance in its bank account to pay the same.
The High Court found that the requirements of both Section 254(2)(a) and Section 254(2)(c) of the Companies Act had been fulfilled and ordered Sun Electric to be wound up. Sun Electric, through its sole director, appealed.
Issues before the Court of Appeal
The Conduct of Proceedings remain in the Directors’ Control
At the appeal, RMCA Asia raised a new argument, namely that Sun Electric’s solicitors did not have the authority to act in the appeal. This was on the basis that upon a company’s liquidation, its directors are functus officio and have no authority to give instructions on behalf of the wound-up company, even in respect of controlling the conduct of the appeal, unless the winding up order had ben stayed.
This argument was given short shrift by the Court of Appeal. The Court of Appeal held that the governing principle is that a company has an inalienable right to appeal against a winding up order, regardless of whether a stay order is granted. It is therefore a necessary corollary of the company’s right to appeal that its directors and/or shareholders be allowed to control the conduct of the appeal. In setting out this principle, the Court of Appeal highlighted that while an appeal against a winding up order is a matter of right, a stay of a winding up order is not a matter of right but is in fact discouraged in the situation of a winding up order (relying on Re A. & B.C. Chewing Gum Ltd.; Topps Chewing Gum Incorporated v Coakley and others  1 WLR 579, and KTL Sdn Bhd v Azrahi Hotels Sdn Bhd  3 CLJ 49). Therefore, given that a company has a right to appeal regardless of whether a stay is granted, it was opined to be only logical that the directors have control of the conduct of the same as otherwise the appeal would be entrusted to the liquidator, whose appointment was the very subject of the appeal, and who would lose his position and remuneration if the appeal succeeds.
This position is in line with the Malaysian position as set out in the Supreme Court case of Sri Hartamas Development Sdn Bhd v MBF Finance Bhd  3 MLJ 325 and the Court of Appeal cases of Fairview Schools Bhd v Indrani a/p Rajaratnam & Ors (No 1)  1 MLJ 99 and American International Assurance Bhd v Coordinated Services L Design Sdn Bhd  1 MLJ 369.
Having held that control of the conduct of the appeal remained in the hands of the directors, the Court of Appeal went further to address the question of the party responsible to bear the costs of an appeal against the winding up order. The Court of Appeal took the view that it would be against the interests of the creditors to allow the directors and/or shareholders to whittle down the company’s funds to pursue an unmeritorious appeal. In order to address this, two general rules were set out. First, the directors and/or shareholders controlling the conduct of the appeal should expect to pay any costs incurred by the company in prosecuting the appeal out of their own pocket, instead of using the company’s funds. Second, the directors and/or shareholders controlling the conduct of the appeal should also expect to be personally responsible for the payment of any costs awarded if the appeal is unsuccessful. However, the directors and/or shareholders can be given liberty to apply to seek an indemnity from the company.
Applicable Test Under Section 254(2)(c) of the Companies Act
The Court of Appeal next dealt with whether RMCA Asia had satisfied the test under Section 254(2)(c) of the Companies Act. Here, the Court of Appeal was faced with the question of whether the cash flow test or the balance sheet test was applicable. The High Court Judge had relied on both tests in winding up Sun Electric at the first instance. Before the Court of Appeal, RMCA Asia took the position that both tests were disjunctive, and therefore a party can be wound up as long as it is proven insolvent on either test. RMCA Asia went on to narrow this further by stating that the cash flow test should be the dominant test and that as long as this was satisfied, the company should be deemed to be unable to pay its debts regardless of the result of the balance sheet test.
The Court of Appeal held that the cash flow test is the sole and determinative test under Section 254(2)(c) of the Companies Act. The Court of Appeal explained that the cash flow test assesses whether the company’s current assets exceed its current liabilities such that it is able to meet all debts as and when they fall due. These terms refer to assets which will be realisable and/or debts which will fall due within a 12-month timeframe. The Court of Appeal went on to opine that it was necessary to have a flexible timeframe in mind when assessing the currents assets and liabilities of a company as a consideration of only present and/or a limited period of assets or liabilities could potentially lead to absurd situations.
The reasons were as follows:
- First, the plain words of the provision imply only a single test, namely, whether “it is proved to the satisfaction of the Court that the company is unable to pay its debts”, as opposed to two or more different tests being applicable. The Court of Appeal held that had Parliament intended to have separate tests to determine insolvency, it would have explicitly stated so in the statute;
- Second, this interpretation was supported by case law from the United Kingdom (“UK”). Section 518(e) of the UK Companies Act 1985 (which was in pari materia with Section 254(2)(e) of the Companies Act) was interpreted by the UK Courts as requiring only a single test of commercial insolvency which assesses a company’s present capacity to meet its liabilities as and when they became due. The UK position also allowed the Courts to consider the company’s contingent and prospective liabilities as this would affect whether the company could pay its debts as and when they became due; and
- Lastly, Parliament could not have intended that the single test envisaged under Section 254(2)(c) of the Companies Act would be the balance sheet test, which compares a company’s total assets with its total liabilities. This test, it was held, had no direct correlation with whether a company “is unable to pay its debts”. It was opined that it was not the total asset to total liability ratio which mattered. Instead, commercial insolvency is to be determined by the liquidity of the assets as and when the debts fall due. The total assets and liabilities of a company were only relevant in so far as they shed light on the quantum of debts which will soon be due and the quantum of assets which may be realised in the near future.
The Court of Appeal also clarified that the cash flow test does not require the debts to be already due or demanded, nor does it require the assets to be immediately available. Instead, the correct position was whether the company’s assets were realisable within a timeframe that would allow each of the debts to be paid as and when it became payable, and whether the liquidity problem could be cured in the reasonably near future. In determining this, the Court of Appeal set out a list of eight non-exhaustive factors for the Courts to consider when faced with a similar situation:
- The quantum of all debts which are due or will be due in the reasonably near future;
- Whether payment is being demanded or is likely to be demanded for those debts;
- Whether the company has failed to pay any of its debts, the quantum of such debt, and for how long the company has failed to pay it;
- The length of time which has passed since the commencement of the winding up proceedings;
- The value of the company’s current assets and assets which will be realisable in the reasonably near future;
- The state of the company’s business, in order to determine its expected net cash flow from the business by deducting from projected future sales the cash expenses which would be necessary to generate those sales;
- Any other income or payment which the company may receive in the reasonably near future; and
- Arrangements between the company and prospective lenders, such as its bankers and shareholders, in order to determine whether any shortfall in liquid and realisable assets and cash flow could be made up by borrowings which would be repayable at a time later than the debts.
By applying the cash flow test, the Court of Appeal upheld the High Court’s findings that Sun Electric was insolvent and dismissed the appeal.
The principles discussed above are consistent with the Malaysian jurisprudence where the phrase ‘inability to pay its debts’ has been interpreted to be ‘commercial insolvency’ as held in Sri Hartamas Development v MBF Finance Bhd  1 MLJ 313, Hotel Royal Ltd Bhd v Tina Travel & Agencies Sdn Bhd  1 MLJ 21, and Lafarge Concrete (M) Sdn Bhd v Gold Trend Builders Sdn Bhd  6 MLJ 827. More recently in KNM Process Systems Sdn Bhd v Mission Biofuels Sdn Bhd  9 CLJ 1003, the High Court held that under Section 218(2)(c) of our Companies Act 1965 (now Section 466 (1)(c) of the Companies Act 2016), the Court has to consider both the company’s contingent and prospective liabilities in determining whether the company was unable to pay its debts as and when they became due. The onus was on the creditor to prove to the satisfaction of the Court that the company was unable to pay its debt, but it matters not whether the assets exceed the liabilities.
Effect of Part Payment on Enforceability of Statutory Demand
The Court of Appeal then went on to deal, obiter dicta, with the issue of whether part payment of a statutory demand, causing the outstanding debt falling below the statutory threshold, would result in Section 254(2)(a) of the Companies Act no longer being a valid ground to wind up a company.
The Court of Appeal considered the question of whether a company which pays the statutory demand in part such that the remaining sum falls below the statutory threshold can still be considered to have “neglected to pay the sum” from two angles:
- Where the part payment was made within the prescribed period of three weeks; and
- Where the part payment was made after the expiry of the prescribed period.
In respect of the first angle, the Court of Appeal went through the legislative history of the provision and found support for the view that the company will not be deemed to be unable to pay its debts as long as the outstanding debt fell below the statutory threshold during the prescribed period. This inference was drawn from the successive and continual increments of the statutory threshold legislated by Parliament which showed that Parliament did not want companies to be deemed to be unable to pay their debts if the outstanding debt was too low in light of current economic conditions and inflationary trends. Therefore, as long as the amount owed by the company was below the statutory threshold at the end of the prescribed period, the company would not be deemed to be unable to pay its debts. This meant that a company would be able to defeat the presentation of a winding up petition purely by making part payment of the debt within the prescribed period so that the outstanding amount fell below the statutory threshold. In this situation, the company would not be deemed to be unable to pay its debts pursuant to Section 254(2)(a) of the Companies Act.
In respect of the second angle, the Court of Appeal reserved its decision on this issue as it was not argued in full by the respective parties. However, the Court of Appeal observed that where a debtor company only made part payment of the debt after the expiry of the prescribed period, the creditor would have already acquired the right to apply for the winding up of the company under Section 254(2)(a) of the Companies Act by the time of the part payment. If the right is exercised by the creditor and only at that point was the debtor company to make a part payment to bring the debt below the statutory threshold, this may be an insufficient rebuttal to the deeming effect of Section 254(2)(a) of the Companies Act.
This issue does not seem to have been considered in any reported decisions of the Malaysian Courts. This is likely due to the previous relatively low statutory thresholds of RM 500.00 and RM 10,000.00 under our Companies Act 1965 and Companies Act 2016. However, with the increase of the statutory threshold to RM50,000.00 in the past year, it is likely that similar arguments and considerations may arise before our Courts following attempts by parties to prevent the filing of a winding up petition against them while at the same time refraining from making full payment of the debt owed.
The Singapore Court of Appeal’s decision has clarified the position in Singapore by taking into account the practical realities and determining that the cash flow test is the sole applicable test for winding up petitions premised on Section 254(2)(c) of the Companies Act. Closer to home, this would likely see the Malaysian Courts maintaining the same position should similar arguments be canvassed before it in the future on the applicable test to be applied for our rarely used Section 466(1)(c) of the Companies Act 2016.
For a more direct impact on the development of the Malaysian jurisprudence, it would be interesting to see whether our Courts would adopt the Singapore Court of Appeal’s findings vis-à-vis:
- Whether part payment of a statutory demand within the prescribed period would be sufficient to fend off a winding up petition where the outstanding debt falls below the statutory threshold in Malaysia of RM50,000.00; and
- Whether the Courts would order that costs be borne by the directors and/or shareholders of a company personally where appeals against a winding up order are unsuccessful, and if so, what the considerations of the Courts would be.
As there is a likelihood of an increase in the number of winding up petitions being filed in the near future due to the economic realities caused by the Covid-19 pandemic, we may soon see the Malaysian edition of these arguments taking place in our Courts. The Singapore Court of Appeal’s decision is therefore a welcomed addition.
Case commentary by Nimalan Devaraja (Partner) of the Dispute Resolution Practice of Skrine