Legal Business. Duties Of Directors Of Insolvent Companies And Companies In Liquidation

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1 Memoranda on legal and business issues and concerns for multiple industry and business communities Duties Of Directors Of Insolvent Companies And Companies In Liquidation 1 Rajah & Tann 4 Battery Road #26-01 Bank of China Building Singapore Tel: Fax: rajahandtann.com Website:

2 Duties Of Directors Of Insolvent Companies And Companies In Liquidation INTRODUCTION Directors as the fiduciaries of a company bear many duties and responsibilities. These duties do not end when a company starts to run into trouble. In fact, directors should be conscious that they have moved into new territory with new rules. In their efforts to rescue the company, they should ensure that they do not run foul of these rules. This paper seeks to adumbrate the primary issues that a director should be cognisant of when a company s troubles start, that is, when insolvency sets in, and what liabilities he may face when the company is in the process of being wound up. While the rules relevant to companies facing insolvency may apply to those situations as well, specific issues with regards to directors duties that may be relevant in a situation of judicial management or receivership are not covered here. WHAT AMOUNTS TO INSOLVENCY Under section 254(1)(e) of the Singapore Companies Act, Chapter 50 (the Companies Act ) a court may order a company to be wound up if it is unable to pay its debts. This is the commonest ground on which a petition for winding up is presented. The Singapore High Court in Re Great Eastern Hotel (Pte) Ltd [1988] SLR 841 established two tests for what amounts to an inability to pay debts. These are: an inability to pay debts as they fall due (the cash-flow test); and an excess of total liabilities over total assets (the balance sheet test). While it is for a petitioner to prove that either of the above two tests are satisfied, the law does provide assistance in the form of section 254(2) of the Companies Act, which enumerates certain specific situations where a company will be deemed to be unable to pay its debts. These are: if execution or other process issued on a judgment, decree or order is returned unsatisfied in whole or in part; or if a statutory demand requiring payment of the debt due (of an amount more than S$2,000) is served by a creditor on the company at its registered office and is not paid, secured or compounded within three weeks after service. In addition, it should be noted that the creditor may rely on the company s contingent and prospecti ve liabilities in order to show that the company is unable to pay its debts. Where a company s circumstances are such that either of these two tests are satisfied, or where there is a probability that either of these tests may, in the near future, be satisfied, this should act as a red flag for directors. Under these circumstances, directors should be conscious that a Page 1

3 different regime has or will be about to kick in, and this regime will impose certain specific duties and liabilities that they should take especial care not to breach. These duties and liabilities are dealt with below. UPON INSOLVENCY Duties Of A Director Once insolvency kicks in, a director has additional and somewhat different duties to perform. A number of these duties are set out in the Companies Act, and are intended to ensure that creditors interests in an insolvency are not compromised. These duties are elucidated below. Wrongful Trading Under section 339(3) of the Companies Act, if an officer of the company who was knowingly a party to the contracting of a debt had, at the time the debt was contracted, no reasonable or probable ground of expectation, after taking into consideration the other liabilities, if any, of the company at the time of the company being able to pay the debt, he commits an offence and the officer concerned will be liable to a fine not exceeding S$2,000 or to imprisonment for a term not exceeding 3 months. In addition, if convicted, the officer can be declared to be personally responsible without limitation for the payment of the whole or any part of that debt (section 340(2) of the Companies Act). Unfair preference Section 329 of the Companies Act provides that any transfer, mortgage, delivery of goods, payment, execution or other act relating to property made or done by or against a company that would be void or voidable against an individual in bankruptcy under sections 98, 99 or 103 of the Bankruptcy Act, Chapter 20 (the Bankruptcy Act ) may be void or voidable in the same manner in the liquidation of a company. Under section 99(2) of the Bankruptcy Act, where a bankrupt has given an unfair preference to any person, the court has the power to make such order as it thinks fit for restoring the position to what it would have been if [the bankrupt] had not given that unfair preference. What constitutes an unfair preference is a question to be determined from the facts of each case. In Ho Mun-Tuke Don v Oslo Finans AS [1990] SLR 398, the Singapore High Court stated that the onus is upon the person seeking to avoid the payment to prove that the payment was made with a view to preferring the recipient over other creditors. The Court further held that where there is no direct evidence, it is open to the court to infer such intention from the facts, but such inference should only be drawn if it is the true and proper inference, and it will not be drawn from the mere fact that the creditor was paid when others were not. Although Ho Mun-Tuke Don v Oslo Finans AS was a case that construed the previous section 53 of the Bankruptcy Act which referred to transactions made with a view to giving [a creditor] a preference over the other creditors, these observations remain relevant. Page 2

4 A more recent decision is the case of Re Libra Industries Pte Ltd [2000] 1 SLR 84. In that case, the Singapore High Court held that it was not necessary to establish a dominant intention to prefer, but it was sufficient that the decision was influenced by the requisite desire. In addition, it was no longer sufficient to establish an intention to prefer, but there had to be a desire to produce the effect. In summation, where it is sought to show that an unfair preference has been made, the person seeking to avoid the payment must show that there was a desire to prefer the recipient over the other creditors, and that the transaction was influenced by this desire. It should be noted that a transaction can only be set aside if it is made at the relevant time. What constitutes a relevant time is stipulated in section 100(1) of the Bankruptcy Act as follows: if the transaction is at an undervalue, five years; if the transaction is made with an associate, two years; and in any other case, six months. In addition, it must be shown that the company was insolvent at the time it gave the unfair preference, or became insolvent as a result of the preference (section 100(2) of the Bankruptcy Act). Invalidation of Floating Charges Where a company has gone into liquidation within six months of the creation of a floating charge, that charge is void except to cover the amount of cash advanced to the company at the time of creation or subsequently, together with interest at 5% per annum (section 330 of the Companies Act). This rule does not apply to a company which was solvent at the time of creating the charge. Duty to Creditors These provisions embody a regime designed to protect creditors interests. Accordingly, once a director becomes aware that a company is insolvent or on the verge of insolvency, it behoves him to ensure that care is taken not to run foul of any of the provisions cited above. The principle that creditors interest become pertinent on the onset of insolvency has also been increasingly recognised in case law. The general rule is that directors duties are owed to the company and not to individual shareholders nor to the company s creditors. In Kuwait Asia Bank EC v National Mutual Life Nominees Ltd [1991] 1 AC 187, it was said that, a director does not by reason only of his position as director owe any duty to creditors or to trustees for creditors of the company. Page 3

5 However, upon the onset of insolvency, a major change in interest takes place. The members residual interest in the company s assets is replaced by the interest of the creditors, who will be repaid, if at all, from those assets. This is reflected by a change in the substance of the directors duties; in exercising their functions, they must now have regard to the interests of the creditors. This principle has been recognised in the United Kingdom and in Australia, and is unlikely to be any different in Singapore. In Walker v Wimborne (1975) 137 CLR 1, the High Court of Australia stated: It should be emphasised that the directors of a company in discharging their duty to the company must take account of the interest of its shareholders and creditors. Any failure by the directors to take into account the interests of creditors will have adverse consequences for the company as well as for them. In Winkworth v Edward Baron Development Co Ltd [1987] 1 All ER 114, the House of Lords stated: A duty is owed by the directors to the company and to the creditors of the company to ensure that the affairs of the company are properly administered and that its property is not dissipated or exploited for the benefit of the directors themselves to the prejudice of the creditors. It should be noted, however, that this does not mean that the creditors may sue the directors, and the duty is not owed to any one particular creditor, or even to the creditors as whole (in the sense that they may sue for breach of this duty). UPON COMMENCEMENT OF WINDING UP Duties Of Directors On the appointment of a liquidator in a voluntary winding up (whether members or creditors ), sections 294(2) and 297(4) of the Companies Act provides that the powers of the directors cease except so far as is allowed by the liquidator or the members (or the committee of inspection or the creditors, in the case of a creditors voluntary winding up with the consent of the liquidator). Although there is no express provision in the Companies Act, powers of the directors cease when the court orders the winding up of the company. The court may, however, under section 282 of the Companies Act appoint the directors as special managers to assist the liquidator. However, directors should be aware that they may be required to furnish information to the liquidator to enable him to properly carry out his duties. This is essential in order to enable a liquidator to obtain an idea of the company s position, and there are several provisions in the Companies Act that deal with this. Page 4

6 Under section 336 of the Companies Act, it is an offence for a person who is an officer (whether past or present) of a company in liquidation: to not to the best of his knowledge and belief fully and truly disclose to the liquidator all the property movable and immovable of the company, and how and to whom and for what consideration and when the company disposed of any part thereof, except such part as has been disposed of in the ordinary way of the business of the company; and to not deliver up to the liquidator, or as he directs all the movable and immovable property of the company in his custody or under his control and which he is required by law to deliver up, or all books and papers in his custody or under his control belonging to the company and which he is required by law to deliver up. Under section 285 of the Companies Act, the court has the power to summon and examine on oath, among others, any officer of the company. Such a person may be required to produce any books and papers in his custody relating to the company. The examination is generally conducted in private and may be held before a district judge. Public examinations may also be carried out. Under section 286 of the Companies Act, where the liquidator has reported that in his opinion, a fraud has been committed or some material fact has been concealed by any officer, or that some officer has failed to act honestly or diligently or has been guilty of some impropriety or recklessness, the court has the power to order the public examination of that person. The aim of the inquiry is to discover the facts, and therefore the person who is to be examined cannot have the order for a public examination discharged by alleging that the liquidator s report is false. The aim of a public examination is to elicit evidence that may be used against a miscreant in subsequent proceedings. The court s power to order examinations may also be invoked in a voluntary winding up upon the application of the liquidator or any creditor or contributory (section 310(1)(b) of the Companies Act). Liabilities That Directors May Be Subject To The liquidation of a company also brings with it a regime of offences that, if applicable, will result in the directors being subject to certain specified liabilities. Transaction Entered Into With Directors Before Liquidation Where a company has either bought property from or sold property to a person who was at the time of the transaction a director of the company for cash consideration and the transaction occurred within two years before the commencement of the winding up, the company may recover any amount by which the property was overvalued or undervalued (as the case may be) from the director (section 331(1) of the Companies Act). This also applies to transactions with another company where that company had common directors with the company in liquidation. The liability to account seems to be strict, and there is no provision allowing the members to approve such a transaction. Page 5

7 Offences And Breaches Of Duty A miscellany of offences and breaches of duty become particularly pertinent upon the winding up of a company. These are set out in sections 336, 340 and 341 of the Companies Act. Section 336 of the Companies Act Section 336 of the Companies Act provide that the following acts of an officer (whether past of present) of a company which is being wound up committed within the 12 months next before the commencement of the winding up or at any time thereafter constitute an offence: concealing any part of the property of the company to the value of $200 or upwards, or concealing any debt due to or from the company; fraudulently removing any part of the property of the company to the value of $200 or upwards; concealing, destroying, mutilating or falsifying, or being privy to the concealment, destruction, mutilation or falsification of, any book or paper affecting or relating to the property or affairs of the company; making or being privy to the making of any false entry in any book or paper affecting or relating to the property or affairs of the company; fraudulently parting with, altering or making any omission in, or being privy to fraudulent parting with, altering or making any omission in, any document affecting or relating to the property or affairs of the company; by any false representation or other fraud, obtaining any property for or on behalf of the company on credit which the company has not subsequently paid for; obtaining on credit, for or on behalf of the company, under the false pretence that the company is carrying on its business, any property which the company has not subsequently paid for; pawning, pledging or disposing of any property of the company which has been obtained on credit and has not been paid for, unless such pawning, pledging or disposing was in the ordinary way of the business of the company; attempting to account for any part of the property of the company by fictitious losses or expenses; and making any false representation or other fraud for the purpose of obtaining the consent of the creditors of the company or any of them to an agreement with reference to the affairs of the company or to the winding up, Section 336 of the Companies Act further provides that the following acts of an officer (whether past of present) of a company which is being wound up constitute an offence: making any material omission in any statement relating to the affairs of the company; knowing or believing that a false debt has been proved by any person and failing for a period of one month to inform the liquidator of the same; and preventing the production of any book or paper affecting or relating to the property or affairs of the company. Page 6

8 Each of the above offences will render the officer liable to a fine not exceeding $10,000 or to imprisonment for a term not exceeding 2 years. Section 340 of the Companies Act Section 340(1) of the Companies Act allows a liquidator to apply to court to make any person who was party to carrying on the company s business in a fraudulent manner liable for the company s debts. Section 341 of the Companies Act If the officers of a company have breached their duties towards the company, the liquidator may apply to court to have these duties enforced in a summary way. Section 341 allows the court to assess damages against delinquent officers summarily by means of a misfeasance summons. The section creates no new rights but provides a summary mode of enforcing rights which apart from the section would have to be enforced by an ordinary action in the courts. Rajah & Tann is one of the largest law firms in Singapore. It is a full service firm and given its alliances, including US premier firm Weil, Gotshal & Manges, is able to tap into a number of countries. Rajah & Tann is firmly committed to the provision of high quality l egal services. It places strong emphasis on promptness, accessibility and reliability in dealings with clients. At the same time, the firm strives towards a practical yet creative approach in dealing with business and commercial problems. The information contained in this newsletter is correct to the best of our knowledge and belief at the time of writing. Specific professional advice should be sought before any action is taken. In this regard, you may call the lawyer you normally deal with in Rajah & Tann or e -mail the Knowledge Management team at Rajah & Tann Knowledge Management. All rights reserved. Page 7

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