It is well known that directors have a duty to act in good faith and in a company's best interests. This duty takes centre stage, especially in times when a company's survival is threatened.
However, to what extent are directors expected to exercise such duties? When a company is in distress, are directors entitled to exploit and abuse statutory restructuring mechanisms at the expense of its creditors even though it serves the larger purpose of ensuring a company's survival?
The recent case of CIMB Islamic Bank Bhd v Wellcom Communications (NS) Sdn Bhd & Anor(1) suggests that there are limits to the way in which directors can act when taking steps to protect a company. In this case, the Court of Appeal clarified that where statutory moratorium regimes are abused, the courts will not hesitate to remedy the abuse of process.
The respondents, Wellcom Communications and Rangkaian Mining, applied to be placed under judicial management and for a judicial manager to be appointed.
The judicial management mechanism under Section 410 of the Companies Act 2016 provides for a statutory moratorium between the filing and disposal of a judicial management application. While the statutory moratorium is in effect, no proceedings can be brought or continued against the company. Creditors are also not permitted to enforce any charges or seek any order to wind up the company without leave from the court.
Thus, this statutory moratorium is a powerful weapon in a director's arsenal to allow a company to restructure without having to withstand a barrage of attacks from creditors, which could potentially jeopardise the company's continuance.
Although the respondents had initially secured a moratorium with the filing of the judicial management application, such moratorium came to an end when the relevant high court dismissed the application. The respondents naturally appealed against the high court's dismissal.
However, what happened next was rather curious. Although no orders had been granted by the high court (since the application for judicial management had been dismissed), the respondents applied for a "stay" of the dismissal. If a stay were allowed, it technically meant that the judicial management application had yet to be disposed of – thereby extending the statutory moratorium despite there being no pending application in the high court.
Despite the unusual nature of this stay application, the high court granted the stay. CIMB Islamic appealed against this order.
The Court of Appeal found that the high court's stay order was unprecedented because, following the dismissal of the judicial management application in the lower court, the originating process had ended. As such, the stay application had been filed for the collateral purpose of re-activating the statutory protection under Section 410 of the Companies Act.
This would effectively allow the directors to retain full control of the respondents while remaining immune from legal action, even though the lower court had found that the requirements for a judicial management order, and by extension, the protection it afforded had not been met.
Consequently, the Court of Appeal held that the stay application had constituted an abuse of process and the moratorium regime under this mechanism should not have been entertained by the high court in the first instance, since it was not moved in good faith.
The Court of Appeal also cautioned the lower courts to be wary about succumbing to a company's "sympathy evoking stories" to ensure that creditors are not defrauded by way of the statutory moratorium. In short, it is imperative that any orders made under or in connection with the judicial management mechanism be carefully considered strictly on cogent evidence and not mere conjecture.
While a director's paramount duty is to act in the company's best interests, it is important to bear in mind that such duty must be carried out in good faith.
Directors cannot be said to be acting in good faith if they deliberately take advantage and abuse the legislative intent of the statutory moratorium regime to prejudice creditors' rights.
As such, this case is a useful reminder that while directors may avail themselves of the shield provided by the judicial management regime in order to allow the company time to regain its footing, the courts will not hesitate to put a check and balance in place to prevent the misuse of such legislation, albeit for the purpose of safeguarding the company's survival.
This article was first published by the International Law Office, a premium online legal update service for major companies and law firms worldwide. Register for a free subscription.