Judicial management as a corporate rescue tool: A call for balance between secured and unsecured creditors

Dr Sujata Balan / The Edge Malaysia 7 October 2024

The judicial management scheme, introduced by Malaysia’s Companies Act 2016 (CA 2016), represents a significant shift in the nation’s corporate rescue framework. The scheme presents a new way to help financially-distressed companies rehabilitate without going into liquidation. Rooted in Singaporean and UK laws, the scheme is detailed in sections 403 to 430 of CA 2016 and is regulated by the Companies (Corporate Rescue Mechanisms) Rules 2018. The law on judicial management became effective in Malaysia on March 1, 2018.

The main goal of judicial management is to give a company the chance to survive and to continue operating. It seeks to provide a better outcome for creditors than if the company were liquidated, or to achieve a more favourable realisation of the company’s assets than through a compulsory winding-up. Judicial management is essentially a court-supervised process. The financially troubled company itself or its creditors can apply to court for a judicial management order if they believe the company can be rehabilitated. The court will grant the order if it believes that one of the goals of judicial management can be achieved. When the court grants the judicial management order, the court will appoint an independent manager who is usually an experienced insolvency practitioner. This person is called the judicial manager. The judicial manager takes over the management of the company from its directors and is responsible for formulating and executing a plan to financially rehabilitate the company. This plan is to be presented to the company’s creditors. The company’s creditors play a crucial role in the judicial management process. They can approve or reject the judicial manager’s plan. The plan must be approved by at least 75% of the company’s creditors. If the plan is successful, the company may return to profitability and exit judicial management. If not, the company may be liquidated.

The secured creditor’s ‘veto right’
A key aspect of Malaysia’s judicial management scheme is a “veto right” given to a company’s secured creditors. The veto right allows the company’s secured creditors to effectively block the making of a judicial management order. This right has sparked debate regarding its impact on the balance of rights between secured and unsecured creditors in accessing the judicial management scheme. It is important to ask whether this veto right undermines the scheme’s goal of rescuing companies, and if reforms are needed for a fairer system.

The secured creditor’s veto right is found in section 409 of CA 2016. In effect, the veto right allows secured creditors to oppose the making of a judicial management order, which then forces the court to disallow the application for a judicial management order. This veto right was confirmed by the Malaysian High Court in cases like Tidal Marine Engineering Sdn Bhd v Portneka Sdn Bhd and Re Scomi Group Bhd.

Undoubtedly, the veto right gives secured creditors a strong advantage over unsecured creditors when it comes to judicial management applications. If the company’s secured creditor opposes a judicial management order being made, the court must dismiss the application and the company cannot be placed under judicial management. Further, the unsecured creditors cannot challenge or override this veto right. As a result, the rights of unsecured creditors are significantly limited, and they face a major obstacle in accessing the judicial management process. To put it simply, the judicial management scheme becomes immediately unavailable to unsecured creditors as soon as the secured creditors exercise their veto right. This situation persists even if a judicial management order would benefit the unsecured creditors or help rehabilitate the company. There is, however, a particular instance where a court can issue a judicial management order even if a secured creditor opposes it. This is in cases where “public interest” justifies it under section 405(5)(a) of the CA 2016. Nevertheless, the “public interest” ground has a limited and uncertain scope and the courts rarely invoke it. As a result, the veto right of secured creditors remains strong.

Thus, the secured creditors’ veto right has significant implications. It grants a company’s secured creditors complete control over judicial management applications, prioritising their interests over those of unsecured creditors and the broader goal of ultimately rescuing or rehabilitating the financially distressed company. This situation leads to an imbalance, as unsecured creditors are left with no say at all on whether a judicial management order should be made, even though they might benefit more from the company’s rehabilitation. In sum, if the secured creditors’ veto is exercised, the unsecured creditors will be effectively shut out from accessing the judicial management scheme.

Reforms in Singapore: A model for Malaysia
Singapore has faced similar issues and has evolved its approach to judicial management. The Insolvency Law Review Committee (ILRC) in Singapore recommended reforms to balance the rights of secured and unsecured creditors in judicial management. This led to an amendment that allows the courts in Singapore to override the secured creditor’s veto in particular circumstances. In essence, a Singaporean court may override the veto if it is satisfied that dismissing the judicial management application would unfairly harm unsecured creditors more than granting the application would harm the secured creditor opposing it. This process in some way facilitates a balancing of interests of both secured and unsecured creditors, aiming to achieve a fairer balance in judicial management applications. This approach is now outlined in section 91(6) of Singapore’s Insolvency, Restructuring and Dissolution Act 2018.

Malaysia could benefit from adopting Singapore’s approach. In Malaysia, secured creditors have strong incentives to use their veto right to block judicial management orders. These creditors invariably prefer appointing a receiver or manager of their choice to realise their security, rather than allowing an independent judicial manager to be appointed to act in the interests of all creditors. This often makes judicial management applications futile, as secured creditors will likely block them to protect their rights.

Conclusion
Judicial management aims to rescue Malaysian companies that are financially distressed, benefitting the broader economy by preserving businesses and jobs. For the courts to make fair decisions about whether or not a judicial management order should be made, they must consider the interests of both secured and unsecured creditors. Given that the secured creditor’s veto right can block judicial management orders even when such an order might benefit all creditors and ultimately help rescue the company, it is evident that this right does not fit well with the goals of a corporate rescue mechanism. As a mechanism intended to facilitate a corporate rescue, judicial management should consider the collective interests of all creditors.

It is time to rethink whether the balance between secured and unsecured creditors under the Malaysian judicial management scheme needs to be adjusted. Malaysia should seriously consider the Singaporean approach, which allows the courts to override the secured creditor’s veto after a balanced consideration of all creditors’ interests. Introducing such a balancing test would allow the Malaysian courts to consider the interests of both secured and unsecured creditors before making a judicial management order, promoting fairness and increasing the likelihood of successful corporate rescues. This approach is worth emulating in Malaysia, potentially through legislative amendments to section 409 of the CA 2016, similar to section 91(6) of Singapore’s Insolvency, Restructuring and Dissolution Act 2018.

Dr Sujata Balan is an associate professor at the Faculty of Law, Universiti Malaya.

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