Wong Chee Lin and Claudia Cheah examine the Federal Court’s decision in the Pesaka Astana Case.

On 10 February 2014, the Federal Court delivered a landmark decision which may have a significant impact on the bond market in Malaysia.
 
BRIEF FACTS
 
Pesaka Astana Sdn Bhd ("Pesaka") was awarded three contracts by the Government of Malaysia ("contracts"). It decided to issue Al-Bai Bithaman Ajil bonds ("bonds") to part-finance the execution of these contracts.
 
To facilitate the issue of the bonds, Pesaka appointed KAF Discounts Berhad ("KAF") as the lead arranger, facility agent and issue agent and Maybank Trustee Berhad ("MTB") as the trustee for the bonds.
 
An Information Memorandum (“IM”) was prepared by KAF based on information provided by Pesaka. The IM contained a notice of disclaimer which expressly stated that a recipient is urged to make such independent investigation as it deems necessary on the information provided in the IM (“Important Notice”).
 
The IM stated that various syariah compliant bank accounts ("Designated Accounts") would be established under the control of MTB as the sole signatory. The revenue from the contracts ("Assigned Revenue") would be deposited into the Designated Accounts to be controlled by MTB and be applied to redeem the bonds. This arrangement, often described as "ring fencing", would in effect put the Assigned Revenue beyond the control of Pesaka to protect the interest of the bondholders.
 
The bonds were to be issued to a primary subscriber, namely K&N Kenanga Bhd ("Kenanga"), who would then sell the same to other investors.
 
Various transaction documents were entered into in relation to the bonds, including a Subscription and Facility Agreement between Pesaka, KAF and Kenanga, a Trust Deed whereby Pesaka appointed MTB as trustee for the bondholders ("Trust Deed") and an Assignment and Charge whereby Pesaka assigned to MTB, as trustee for the bondholders, the Assigned Revenue that would be deposited into the Designated Accounts maintained by Pesaka with CIMB Bank Berhad ("CIMB")("Assignment").
 
The bonds were issued and the proceeds were disbursed by KAF to Pesaka on the same day. Upon Pesaka’s request, instead of opening new accounts, the existing conventional accounts maintained by Pesaka with CIMB were used as the Designated Accounts to receive the Assigned Revenue. As MTB was not made the sole signatory, Pesaka retained complete control over these accounts and withdrew the Assigned Revenue for its own purposes. Although CIMB was aware of the Assignment, it did not stop Pesaka from withdrawing the Assigned Revenue from these accounts.
 
Pesaka failed to redeem the bonds and repay the bondholders on the maturity date. The bondholders filed a claim in the High Court against various parties including Pesaka, KAF and MTB. Arising from this proceeding, KAF filed a claim for an indemnity against Pesaka. On the other hand, MTB filed an indemnity claim against Pesaka and other parties, namely the Amdac Group, Dato’ Mohamad Rafie (“Rafie”) and his wife, Datin Murnina (“Murnina”) who both held a total of 90% of the shares in Pesaka. MTB also filed a claim against CIMB seeking damages on grounds that CIMB had breached its duties as a constructive trustee of the Assigned Revenue.
 
HIGH COURT
 
The bondholders entered into a Consent Judgment against Pesaka, Rafie and the Amdac Group for a sum representing the redemption value of the bonds.
 
Instead of executing the Consent Judgment, the bondholders proceeded to trial against KAF and MTB. The High Court found for the bondholders against MTB and KAF for breach of contract and negligence. The Judge denied KAF any indemnity and apportioned liability between KAF and MTB on a 60:40 basis.
 
COURT OF APPEAL
 
On appeal by various parties, the Court of Appeal affirmed the findings of the High Court but re-apportioned liability between KAF and MTB on a 50:50 basis. The Court of Appeal further ordered Pesaka to indemnify KAF but only for 2/3 of the sum claimed, on the ground that MTB was guilty of gross negligence. CIMB was ordered to indemnify MTB to the extent of 1/3 of the liability that MTB would have to bear, that is after deduction of the sum to be indemnified by Pesaka, Rafie, Murnina and the Amdac Group.
 
FEDERAL COURT
 
The Federal Court in its 115 page judgment dealt in depth with various issues raised by the parties. The salient findings of the Federal Court are set out below.
 
KAF’s liability under the IM
 
The Federal Court held that the IM was not a contractual document and did not form part of the Issue Documents which required the approval of the Securities Commission. KAF was free to include the Important Notice in the IM to exclude all liability for any claim which may arise from the IM. Further, the IM contained information belonging to Pesaka and thus was Pesaka’s document and not KAF’s document. The Important Notice must be given effect and KAF could not be held liable for any information found in the IM. In coming to this decision, the Federal Court referred to IFE Fund SA v Goldman Sachs International [2007] EWCA Civ 811 and a series of other English cases where the courts upheld similar disclaimer notices.
 
According to the Federal Court, both the courts below had erred by holding that there existed a duty of care on the part of KAF based on the principles of ‘foreseeability’, ‘proximity’, ‘neighbourhood’ and ‘fairness’. In fact, KAF owed no duty of care to the bondholders, who were all sophisticated investors and experienced financial institutions and were therefore expected to act on independent and professional advice from their own sources in respect of the contractual obligations in the light of the disclaimer contained in the Important Notice.
 
Ring fencing
 
Both the High Court and the Court of Appeal held that KAF as lead arranger, facility agent and issue agent had to independently verify that the Designated Accounts were ring fenced before issuing the bonds.
 
However, the Federal Court held that KAF had no contractual duty to independently verify that MTB had been made the sole signatory to the Designated Accounts. The fact that there was a confirmation letter from the transactional solicitor along with confirmation from Pesaka meant that KAF could be fully satisfied that all conditions precedent had been complied with.
 
Proximate cause of loss
 
The Federal Court disagreed with the Court of Appeal that the most proximate cause of the loss was the issuance of the bonds by KAF without the ring fencing in place. From the evidence, Pesaka was the direct cause of the loss as they had misappropriated the funds.
 
MTB, being the trustee, had wide powers and rights under the Trust Deed and the power of attorney to take the necessary action to ring fence the Designated Accounts, or alternatively, to stop Pesaka from operating the Designated Accounts. However, instead of being proactive, MTB did nothing and had behaved “like a mannequin”. Thus, MTB was wholly to blame for the loss and not KAF.
 
In the premises, KAF’s appeal against the decision of the Court of Appeal on all three grounds mentioned above was allowed.
 
Quantum recoverable against MTB
 
The Federal Court held that MTB was neither the primary debtor nor the guarantor of the bonds. As such, MTB should only be liable to the bondholders for the actual sum received and dissipated by Pesaka i.e. RM107 million and not the full redemption value of the bonds of RM149,315,000.00.
 
Pre-judgment interest
 
The Federal Court held that the Court of Appeal had erred in allowing pre-judgment interest as it was contrary to the express agreement of the bondholders in the trust deed that no interest shall be payable. Thus, the pre-judgment interest awarded against MTB was set aside.
 
Indemnity from Pesaka
 
The Federal Court disagreed with the Court of Appeal’s decision in only granting MTB a 2/3 indemnity against Pesaka. According to the Federal Court, it would not be just and equitable for Pesaka, the real fraudster, to retain any part of its ill-gotten gains. This was especially so when the bondholders had not taken any step to enforce the Consent Judgment entered between Pesaka and the bondholders. Thus, the Court, following the decision of the House of Lords in Dubai Aluminium Company v Salaam & Ors [2003] 1 All ER 98, allowed MTB’s cross appeal and ruled that Pesaka should fully indemnify MTB.
 
Constructive trustees
 
MTB also claimed for indemnity against Rafie, Murnina and Amdac Group on the basis that they were constructive trustees of the monies in the Designated Accounts and which they had dominion over by virtue of being the directors or chief executive officer and signatories to the Designated Accounts. The Federal Court found that all three parties had acted dishonestly and that the directors could not rely on the corporate veil as a defence to the claim for indemnity by MTB. Therefore, the Federal Court ordered Rafie, Murnina and Amdac Group to fully indemnify MTB for the loss.
 
CIMB’s liability
 
The Federal Court agreed with the High Court that CIMB was only complying with instructions given in the banker-customer relationship when it followed Pesaka’s instructions in the management of the Designated Accounts. Based on the subjective test of dishonesty laid down by the House of Lords in Twinsectra Ltd v Yardley and others [2002] 2 All ER 377, the Federal Court held that CIMB could not be construed as being dishonest in the ordinary standards of reasonable and honest people. Thus, MTB’s claim against CIMB was dismissed.
 
COMMENTARY
 
By allowing the lead arranger to exclude liability relating to the veracity of information contained in an information memorandum, the burden of verifying the contents of the information memorandum falls squarely on potential investors. This may have a negative impact on the bond market as potential investors would incur time and expense to conduct their own due diligence on the financials and the quality of the management and shareholders of the issuer.
 
Bonds issued by private companies may become less attractive, as information relating to these companies is not easily available from the public domain.
 
The Pesaka decision is also a wake-up call for investment banks and bond trustees to tighten their risk management procedures.