Singapore Court of Appeal allows claw back of payments made to holding company on grounds of unfair preference | Practical Law

Singapore Court of Appeal allows claw back of payments made to holding company on grounds of unfair preference | Practical Law

This article is part of the PLC Global Finance November 2010 e-mail update for Singapore.

Singapore Court of Appeal allows claw back of payments made to holding company on grounds of unfair preference

by Allen & Gledhill LLP
Published on 30 Nov 2010 • Singapore
This article is part of the PLC Global Finance November 2010 e-mail update for Singapore.
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The Singapore Court of Appeal decision of Chee Yoh Chuang & Anor (as Liquidators of Progen Engineering Pte Ltd (in liquidation)) v Progen Holdings Ltd considered how the law ought to balance the rights of creditors with the company directors' desire to keep the company afloat when the company has financial difficulties and when payments were made to creditors. In this case, the court found that payments made by the company in liquidation to a related creditor, its sole shareholder and holding company, at a time when the company was insolvent, constituted unfair preferences under section 99(2) of the Bankruptcy Act read with section 329(1) of the Companies Act.
The Singapore Court of Appeal decision of Chee Yoh Chuang & Anor (as Liquidators of Progen Engineering Pte Ltd (in liquidation)) v Progen Holdings Ltd considered how the law ought to balance the rights of creditors with the company directors' desire to keep the company afloat when the company has financial difficulties and when payments were made to creditors. In particular, the court considered the different approach when the beneficiary of the payment is a related creditor, and when the beneficiary is an unrelated creditor.
In this case, the court found that payments made by the company in liquidation (the Company) to a related creditor, its sole shareholder and holding company, at a time when the Company was insolvent, constituted unfair preferences under section 99(2) of the Bankruptcy Act read with section 329(1) of the Companies Act. The court's conclusion was supported by the finding that the Company's directors had made false assurances which created the expectation that all debts owed to unrelated creditors would be paid in priority to related debts, when in fact the Company was paying off the related creditors first. The court also held that a creditor cannot simply evade the statutory presumption of unfair preference when a payment is made to a related creditor merely by labelling a transaction as "past practice".

The parties

The Company was part of the Progen Group (the Group), which included the Respondent and a stable of 10 subsidiaries, including the Company and Progen Pte Ltd (PPL). The shareholders and directors of the Company and the Respondent were similar. The Respondent was the Company's sole shareholder and holding company. The chairman and founder of the Group (the Founder) was the managing director of the Respondent. The Founder and his wife together owned the largest block of shares in the Respondent during the material period and they were also the directors of the Company at the material time. The Company and the Respondent shared three common directors at the relevant time.
In February 2007, the Company was wound up by a court order and liquidators were appointed. The liquidators of the Company brought the present action against the Respondent alleging that certain monies paid by the Company to the Respondent constituted unfair preferences under section 99(2) of the Bankruptcy Act read with section 329(1) of the Companies Act. When the liquidators' application was dismissed by the High Court, the liquidators appealed to the Court of Appeal.

Payments made to the respondent

As of 31 December 2004, it was clear that the Company's balance sheet indicated that it was already insolvent and had substantially unsatisfied debts. Nonetheless, between 31 January 2005 and 30 June 2005, the Company made payments to the Respondent in 10 separate transactions. The liquidators alleged that such payments constituted unfair preferences. In summary, the payments may be classified as follows:
  • Repayment of loan. The most significant payment was the transfer of S$10,987,960.85 to the Respondent as repayment of a loan given by the Respondent to the Company. The Respondent wanted to use the repaid amount to make special dividend payment and capital distribution to the Respondent's shareholders.
  • Payment of salaries and expenses. The Company's payment of the salaries and expenses of the Respondent's employees which amounted to S$347,144.16.
  • Reimbursement of purchases. The Company's payment to the Respondent for reimbursement of iron ore purchases amounting to S$105,000.
  • Set-off. A debt of S$7,538,243.15 owed by the Company to the Respondent was discharged by setting off against the sum of S$9,027,964.19 owed by another company in the group, PPL, to the Respondent.

Presumption of unfair preference

The court noted that payment by a liquidated company to a connected party within the two years prior to liquidation, at a time when the liquidated company was insolvent or became insolvent as a result of the payment, is presumed to be an unfair preference (the statutory presumption). It is for the "connected" company to rebut that presumption.
It was undisputed that the Company was "connected" with the Respondent through the common directors for the purpose of triggering the statutory presumption. The main issue in the present appeal was whether the Respondent had rebutted the statutory presumption in relation to the payments in question. The court of Appeal noted that the Respondent must show that the payments were not influenced at all by any desire on the Company's part to place the Respondent in a preferential position in the event of an insolvent liquidation. The court highlighted that it would never be sufficient, where there was objective evidence of a preferential payment to benefit a related party in the event of an insolvent liquidation, for the directors to simply deny the existence of such a desire. The statutory presumption could be reinforced or rebutted on the basis of direct evidence and/or on inferences drawn from the circumstances. If the Respondent could establish that the transactions were underpinned by proper commercial considerations and not by a positive desire to prefer it in the event of an insolvent liquidation, the transactions would not be impugned.

Repayment of loan

On the established facts, in so far as the repayment of loan was concerned, the court found that the Respondent had failed to rebut the statutory presumption for the following reasons:
  • The Company's directors had provided false assurances in publicly filed statements that the debt owed to the Respondent would be repaid much later and that all debts owed to unrelated creditors would be paid in priority to related debts, to convince the court to sanction the Respondent's special dividend and capital distribution exercise. However, in breach of the assurances, the Company's directors allowed the repayment of monies owed by the Company to the Respondent before settling significant debts owed to unrelated creditors. The court concluded that the false assurances were given to buy time for the Respondent to siphon monies from the Company to pay itself and other related creditors to the detriment of the Company's unrelated creditors.
  • When a company is insolvent, or even in a parlous financial position, directors have a fiduciary duty to take into account the interests of the company's creditors when making decisions for the company. This fiduciary duty requires directors to ensure that the company's assets are not dissipated or exploited for their own benefit to the prejudice of creditors' interests. The court emphasised that a breach of directors' duties reinforces the statutory presumption. In the present matter, the Company's directors had breached their duties to consider the interests of the Company's creditors when they allowed the repayment of the loan. The loan proceeds were to be returned to the Respondent's shareholders, directly benefitting the Chairman and his wife, who owned 29.24% of the Respondent's shares. The court was of the view that the repayment of the loan was undoubtedly orchestrated by the Company's principal director to benefit the Respondent's principal shareholder, who was essentially one and the same person.
  • The Respondent had explained that the loan was advanced by the Respondent to the Company for the purpose of taking advantage of higher interest rates in the Company's fixed deposit accounts. The court was of the view that the commercial reason for making the advance (to take advantage of higher interest rates), without more, would not explain the presumption that the repayment of the advance was influenced by a desire to prefer the creditor. The monies loaned were unsecured loans which could not thereafter be repaid in priority relative to other outstanding liabilities of the Company, when the company itself was insolvent. In any case, the court was satisfied that the loan was made to dress up the Company's accounts and the court may not have sanctioned the Respondent's special dividend and capital distribution exercise if it had known this.

The other payments

In relation to the other payments to do with the salaries, employees' expenses, reimbursement of iron ore purchases and the set-off, the court held that the Respondent failed to rebut the statutory presumption by arguing that such payments were part of the Company's established practice. The key issue in rebutting the statutory presumption was to show that the particular transactions were not influenced by the requisite desire to prefer the Respondent. There was existing case authority that an establish past practice of similar payments indicated no intention to prefer a creditor. However, the court emphasised that the existence of an established course of dealings, or "past practice", was only relevant in showing no intention to prefer if those past practices showed that the creditor had been providing new value by granting new credit to the company to purchase supplies and items (for example) to keep its business going.
As regards the set-off transaction, the court decided that it clearly constituted an unfair preference, even without the aid of the statutory presumption. The set-off placed the Respondent in a better position in the event of the Company's insolvent liquidation than if the transaction had not been carried out. The set-off transaction employed an asset (the Company's chosen action against PPL) that could have been distributed to the Company's unsecured creditors (the Company's claim against PPL for the debt owed) to discharge the Company's debt owed to the Respondent.

Conclusion

The court allowed the liquidators' appeal and set aside the repayment of the loan and the other payments relating to salaries, employees' expenses and reimbursement of iron ore purchases. The set-off was declared void such that the debt owed by the Company to the Respondent continued to subsist.