Opinions and Legal Insights

Case Update: Fraudulent Trading Rebooted

The High Court in the Sulaiman & Taye decision (see the grounds of judgment dated 8 July 2020 of Ong Chee Kwan JC) deals with very significant issues in relation to fraudulent trading. Fraudulent trading is where directors of a company have to bear personal liability for the debts of a company in winding up. This is because the directors carried on the business of the company with the intent to defraud its creditors. In particular, whether the delinquent directors bearing personal liability then has to pay directly to the aggrieved applicant or to pay into the wound up company’s assets for the general benefit of all the creditors.

Summary of the Decision and Significance

Malaysia’s fraudulent trading provision is found in section 304 of the Companies Act 1965 and with identical wording in section 540 of the new Companies Act 2016. All of the Malaysian decisions up to this point had imposed personal liability on the delinquent directors and the directors had to pay directly to the aggrieved creditor who filed the action.

Ong Chee Kwan JC analysed the Malaysian decisions and also the UK decisions applying a similar UK provision. The High Court then set out the guiding principles for the application of fraudulent trading.

First, the court is not confined to making an order directing the delinquent person to make payment directly to the injured party or parties. This is more so when the company is already in liquidation.

Second, and importantly, once the company is wound up, unless there are good reasons, any payments by the delinquent person ought to be paid to the liquidator as contribution to the company’s assets. This ensures an equitable distribution of assets to all the creditors. There will not be a preference of one creditor over others.

Third, even when the company is not wound up, there may be circumstances where an order to pay the injured parties may not be appropriate. An example is when the section is invoked not by a creditor who has been defrauded.

Fourth, when the court makes an order under the fraudulent trading section, the court may order the delinquent to be personally liable not only for the debts or liabilities owed to the creditor who brought the action, but for all or any of the company’s debts or other liabilities. Under such circumstances, it may be more appropriate that the payments be made to the company and not to the aggrieved creditor.

Fifth, it is desirable that a fraudulent trading application should involve the liquidator of the company if the company is wound up at that time of the application. Under the fraudulent trading section, the liquidator may give evidence or call witnesses himself at the hearing.

Background Facts

Bistari Land Sdn Bhd (Bistari Land) owned certain pieces of land. Bistari Land’s two directors were Wong Poh Kun (WPK) and Wong Poh Lum (WPL). Both WPK and WPL were mandatory signatories to the bank accounts of Bistari Land.

The Plaintiff, Messrs Sulaiman & Taye, is a law firm. Sometime in 2010, Bistari Land engaged the Plaintiff to render legal services in relation to various litigation involving Bistari Land’s pieces of land.

In July 2014, the Plaintiff issued a bill of approximately RM5.9 million for these legal services.

In August 2014, the Plaintiff filed a civil suit against Bistari Land to recover this sum and in September 2014, the Plaintiff entered a judgment in default of appearance against Bistari Land.

In December 2014, Bistari Land filed a petition to tax the Plaintiff’s bill as well as to set aside the judgment in default.

Subsequently, parties agreed for the bill to be taxed, and for the judgment in default and the suit to be withdrawn.

The petition for taxation was due to be heard in November 2015. In August 2015, the Plaintiff filed an application in that petition to freeze a sum of RM6 million out of a sum of more than RM32 million that Bistari Land was about to receive in October 2015 out of the sale of its lands. It was in effect an application for a Mareva injunction.

Bistari Land sold its lands for an estimated RM400 million. After Bistari Land settled the sums owing to its bank and another creditor, Bistari Land was due to receive three further tranches of payments amounting to approximately RM71 million.

The Plaintiff filed the injunction application because of concerns that WPK would transfer the monies out of Bistari Land to himself or his companies overseas.

In September 2015, WPL affirmed an affidavit to oppose the Plaintiff’s injunction application. WPL essentially stated that there was no strong prima facie or good arguable case for the Plaintiff’s RM6 million claim, that there was no risk of dissipation of assets and that Bistari Land would not avoid paying its creditors.

The Plaintiff’s injunction application was not successful. Before the petition for taxation of the fees could be heard, Bistari Land’s solicitors wrote to the Court that Bistari Land had been wound up on 29 January 2016 by the Government of Malaysia.

Bistari Land had not informed the Court or any of the parties that much earlier, on 5 May 2010, the Government of Malaysia had obtained summary judgment against Bistari Land for the sum of approximately RM4 million. In April 2015, the Government of Malaysia had served on Bistari Land a statutory winding up demand for the sum of RM5.6 million. On 26 October 2015, the Government of Malaysia filed a winding up petition against Bistari Land.

The Plaintiff then filed an action for fraudulent trading against the two Bistari Land directors, WPK and WPL.

Decision

First, the High Court analysed the requirements for fraudulent trading and whether the Plaintiff had satisfied each of the requirements.

(i) Creditor

The Plaintiff is a creditor of Bistari Land. At the very least, the Plaintiff was a contingent creditor when Bistari Land was receiving the proceeds from the sale of its lands. In any case, at the time the Plaintiff filed this action, the Plaintiff’s proof of debt had already been admitted by the liquidator of Bistari Land.

(ii) Business of the company with intent to defraud the creditors or for other fraudulent purpose

The High Court helpfully set out the different instances where there can be the carrying on the business of the company with intent to defraud the creditors or for some other fraudulent purpose. In brief, this will be referred to as the intent to defraud creditors.

The first scenario that can establish the intent to defraud creditors is when the company continues to carry on business and incur debts at a time when there is, to the knowledge of the directors, no reasonable prospect of the creditors ever receiving payment of those debts.

Applying it to the case at hand, the issue is whether the Plaintiff was engaged and continued to be engaged by Bistari Land, with debts incurred, and the two directors knew that Bistari Land had no real prospect of Bistari Land paying those debts. There was no evidence to establish this scenario.

The second scenario that can establish the intent to defraud creditors is where after the company had incurred the debts, steps are taken with the intent to avoid making payment to those creditors.

The Plaintiff set out certain events post the debts being incurred as its basis to establish this intent to defraud creditors. The Plaintiff relied on the failure to disclose the winding up statutory demand, the summary judgment and the existence of the winding up petition in the director’s affidavit.

The High Court found that the non-disclosures alone would not necessarily be an intention to defraud the creditors. There would need to be further evidence that the two directors had an intention to dissipate the monies that were about to come in. Further, the filing of the affidavit did not fall within the phrase ‘carrying on of the business of the company’.

(iii) Finding of intent to defraud creditors

However, the Plaintiff did establish the intent to defraud creditors in relation to Bistari Land’s receipt of the three tranches of payments amounting to approximately RM71 million. The director, WPL, confirmed that Bistari Land did receive these three tranches of payments. He agreed that the sums received would have been sufficient to pay all of Bistari Land’s creditors including the Plaintiff’s invoice for fees and the debt to the Government of Malaysia.

Here, the High Court went on to make a finding of the intent to defraud creditors through the directors’ lack of explanation of the where the monies went. WPL could not provide any explanation, let alone satisfactory explanation, to account for the RM71 million received by Bistari Land. As the only two directors and cheque signatories to the company’s account, the two directors have direct and personal knowledge as to how this sum was spent. Yet, not a single documentary evidence had been produced to show how the money was spent.

The High Court held that the Plaintiff had established on a balance of probabilities that both the directors, WPK and WPL, had carried on the business of Bistari Land with intent to defraud the creditors of the company or for fraudulent purpose or are persons knowingly parties to the carrying on of the business. The directors shall be personally responsible for both the debt of the Plaintiff and the Government of Malaysia.

(iv) Defendants to Pay the Plaintiff Directly or to the Liquidator

First, the High Court recognised that the wording of Malaysia’s fraudulent trading provision is wider than the provision in the UK Insolvency Act 1986. In the UK, the order would be to hold a person who is guilty of fraudulent trading to make such contributions to the company’s assets as the court thinks proper.

The Malaysian fraudulent trading cases suggest that the persons in breach would assume personal liability and make payment directly to the applicant. The High Court analysed the UK decisions (Re William C Leitch Bros, Ltd (No 2) [1932[ All ER Rep 897, Re Cyona Distributors Ltd [1967] 2 WLR 369, and Re Esal (Commodities) Ltd [1997] BCLC 705).

The High Court set out certain general principles that should be applied for Malaysia’s fraudulent trading section.

First, the court is not confined to making an order directing the delinquent person to make payment directly to the injured party or parties. This is more so when the company is already in liquidation.

Second, and importantly, once the company is wound up, unless there are good reasons, any payments by the delinquent person ought to be paid to the liquidator as contribution to the company’s assets. This is instead of an order for payment directly to the defrauded creditor who filed the claim. This is to avoid a situation where a creditor is preferred over other creditors. This is more equitable as it will avoid a situation where one creditor is paid in full following a fraudulent trading application and as a result of the payment, the delinquent is left impecunious and unable to pay the other creditors. Such order of payment will also avoid a different result when a liquidator applies under the section from when the defrauded creditor makes the application.

Third, even when the company is not wound up, there may be circumstances where an order to pay the injured parties may not be appropriate at all. An example is when the section is invoked not by a creditor who has been defrauded. The provision is widely drafted to permit any creditor, including a creditor who may not be the target of the fraudulent trading, to rely on the section. In all likelihood, a positive finding of fraudulent trading will probably result in an order for the delinquent to make compensation to the company.

Fourth, when the court makes an order under the fraudulent trading section, the court may order the delinquent to be personally liable not only for the debts or liabilities owed to the creditor who brought the action, but for all or any of the company’s debts or other liabilities. Under such circumstances, it may be more appropriate that the payments be made to the company and not to the aggrieved creditor.

Fifth, it is desirable that a fraudulent trading application should involve the liquidator of the company if the company is wound up at that time of the application. Under the fraudulent trading section, the liquidator may give evidence or call witnesses himself at the hearing.

Comments

This decision made a very careful analysis of the case law in Malaysia and the UK. It is a very well-reasoned restatement of the principles to govern such personal actions brought under the fraudulent trading section. There has been more frequent litigation based on this provision.

This decision is significant in two respects.

First, it continues to extend the principle from the fraudulent trading decision of Huatah Sdn Bhd v Yap Chee Kian & Ors [2020] 8 MLJ 98. Essentially, that fraudulent trading could be established through an omission and by drawing an adverse inference. In Huatah, it was the omission of books and records, where the directors admitted to disposing or destroying the books and records of the company. An adverse inference was drawn against the directors in order to establish fraudulent trading.

In this case, there was an omission to explain the missing monies of around RM70 million and a similar adverse inference was made to establish fraudulent trading.

Second, this decision may now discourage creditors from initiating such actions and having to bear all the cost of establishing the case. In all likelihood, if the company is wound up, the delinquent director would pay to the general assets of the wound up company. The general pool of creditors would then benefit.

The liquidator may now be best placed to initiate such a fraudulent trading action. The liquidator can then recover such debts for the general benefit of creditors. However, with an insolvent company, the liquidator may be hard-pressed to have the funds to pursue the action.

 

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