Introduction
In most emerging markets, the banking and financing sectors play a critical role in driving the economy. In Malaysia, despite the growing significance of the domestic capital market, the banking and financing sectors remain the predominant sources of investment in our financial system. As this system evolves, it continues to offer increasingly innovative financial solutions to meet the more sophisticated needs of customers and investors.
Recently, Malaysia’s financial environment has become more competitive due to the intensification of the liberalisation and deregulation processes. As a result, domestic banking and financial institutions are expanding beyond national borders to address market demands and contribute to the ongoing development of the banking and finance industry.
Issues to be Considered in Loan Transactions
In undertaking and structuring cross-border lending transactions, there are several issues that financial institutions, borrowers or security parties must consider before making an investment or providing a loan:
1. Compliance of the Financial Services Act 2013 and the Islamic Financial Services Act 2013 Pursuant to Foreign Exchange Policy Notices Issued by the Central Bank of Malaysia (“Central Bank”)
The regulatory and supervisory framework in Malaysia has evolved with the enactment and implementation of the Financial Services Act 2013 (“FSA”) and the Islamic Financial Services Act 2013 (“IFSA”) which came into force on 30 June 2013. These legislations consolidate several existing laws to provide a comprehensive legislative framework for both the conventional and Islamic financial sectors, namely, the Banking and Financial Institutions Act 1989, the Islamic Banking Act 1983, the Insurance Act 1996, the Takaful Act 1984, the Payment Systems Act 2003 and the Exchange Control Act 1953.
With the introduction of the FSA and the IFSA, the Controller of Foreign Exchange (i.e., the Governor of the Central Bank) has revoked all Exchange Control notices and all other related circular letters applicable under the Exchange Control Act 1953. As of today, the Central Bank has issued several notices in the exercise of its power conferred under the FSA and the IFSA in relation to foreign exchange, namely Foreign Exchange Policy Notices which came into operation on 15 November 2024.
For instance, Notice 2 (Borrowing, Lending and Guarantee) states that a resident entity is allowed to borrow in foreign currency at any amount, inter alia, as follows:
(a) from a licensed onshore bank;
(b) from an entity within the resident entity’s group;
(c) from the resident entity direct shareholder; or
(d) through the issuance of foreign currency corporate bond or sukuk to another resident.[1]
In addition to the above, a resident entity is allowed to borrow in foreign currency up to RM100,000,000.00 equivalent in aggregate, inter alia, as follows:
(a) a non-resident outside the resident entity’s group;
(b) a non-resident financial institution; or
(c) a non-resident special purpose vehicle[2] which is used to obtain borrowing from any person outside the resident entity’s group.[3]
Additionally, Notice 2 (Borrowing, Lending and Guarantee) provides that a resident is allowed to give a financial guarantee in any amount in foreign currency or ringgit in favour of a non-resident, except for financial guarantee issued to secure the following:
(a) foreign currency borrowing obtained by a non-resident special purpose vehicle from a non-resident entity outside the resident guarantors’ group, or if the underlying borrowing is ultimately utilised by the resident guarantor, which is subject to external borrowing limit; or
(b) foreign currency borrowing obtained by a non-resident where the repayment of the borrowing will be paid by a resident (other than when the financial guarantee is called upon by the lender in the event of default).[4]
In general, all notices issued set out the provisions that are allowed under the FSA and/or the IFSA. Prior approval from Central Bank needs to be obtained for any proposed transactions that are not allowed or provided by Central Bank.
2. Withholding Tax
The Income Tax Act 1967 stipulates that a person (“payer“) who is liable to make certain payments to a non-resident person (“NR payee”) must deduct withholding tax at the prescribed rate from such payment. Whether the tax is deducted or not, the payer is required to pay that withheld tax to the Director General of Inland Revenue within the prescribed period after the payment has been paid or credited to the NR payee.
The type of income subject to withholding tax under the Income Tax Act are as follows:
(a) Dividend
(b) Contract payment
(c) Interest
(d) Royalties
(e) Fee for technical service
In the context of a loan transaction, the interest payment payable by the borrower to the lender is subject to a prescribed withholding tax rate based on 15%,[5] unless a double taxation agreement between Malaysia and the country where the non-resident (foreign party is a tax resident of) specifies such other rate.
3. Choice of Law and Enforcement of Judgement
Choice of Law
The choice of foreign law to govern the loan documents shall be a valid and binding choice of law and will be applied by the Malaysian courts provided that (i) the choice was bona fide and legal (i.e., not made wholly or mainly for the purpose of avoiding some mandatory provision of Malaysian or other applicable law); (ii) the relevant provisions of the laws of that foreign jurisdiction are proved as a matter of fact by appropriate expert witnesses; (iii) Malaysian law will govern certain procedural matters and the measure of damages for breach of contract; and (iv) when a question of public policy arises, Malaysian law will prevail.
Jurisdiction
The submission to any jurisdiction of the courts contained in the loan documents shall be legal, valid, and binding against the borrower and the security party (as the case may be).
Enforcement of Judgement
The principle governing the enforceability of foreign judgments before the Malaysian courts is generally governed by the principle of reciprocity under the provision of the Malaysian Reciprocal Enforcement of Judgments Act 1958 (“REJA”).
For instance, a valid judgment entered against either the borrower and security party in Malaysia, under the English law loan documents to which it is a party, granted by a superior court (as defined in REJA) in England, shall be, subject to the provisions of REJA, recognised and enforced in Malaysia against either the borrower or security party in Malaysia and would, on registration in accordance with the provisions of the REJA, be recognised and enforced by the Malaysian courts without re-examination of the issues.
Conversely, a judgment rendered by any state or federal court of competent jurisdiction in a country which is not governed by REJA, would form a basis for the institution of a fresh legal action in Malaysia and a judgment of the competent courts of Malaysia obtained in favour of the lender shall be enforceable against borrower and security party in Malaysia.
4. Stamp Duty
The Stamp Act 1949 stipulates that stamp duty is payable by the person offering security or receiving loan services from the lender. Under the recent amendments passed through the Finance Bill (No. 2) 2023, which was approved by the Senate on 13 December 2023, the Stamp Act 1949 has been updated to remove the previous maximum cap of RM2,000.00 on stamp duty for loan transactions involving foreign currency, which will now be subjected to an ad valorem stamp duty amount at the rate of 0.5% of the loan amount.
Stamp duty must be paid within thirty (30) days from the date of the agreement, and failure to do so may result in penalties. The requirement for stamping is essential to ensure the admissibility of the loan documentation before the courts of Malaysia.
5. Other Registrations/Approvals Required For Creation of Security Interest
(a) Companies Act 2016 (“CA”) – Registration of charges pursuant to Section 352(1) of the CA
Save and except for the guarantee (as it is in the form of an undertaking or promise and is not directly supported by the assets of guarantor but only contingent upon the occurrence of certain events which lead to default by the borrower), all the securities created by a Malaysian company is required to be registered under Section 352(1) of the CA. The Statement of Particulars to be lodged with Charge needs to be filed by the company at the Companies Commission of Malaysia (CCM) not later than thirty (30) days from the date of the creation of the security. Failure of which the company and every officer of the company shall be guilty of an offence pursuant to Section 352(1) of the CA.
The registration of the Statement of Particulars to be lodged with Charge confers the secured right/interest of the lender, being the secured creditor, over the security created against the other unsecured creditor of the company.
(b) National Land Code (“NLC”) – Creation of land charge
In the case where the security for the loan services involves the creation of charge over the property in Malaysia, all dealings for land matters are governed by the codified land laws, i.e., the NLC. The NLC is based on the Torrens System of registration with the basic principle that all land dealing must be registered in order to be effective pursuant to Section 206 of the NLC. The registration herein confers indefeasibility of the registered title or interest.
The charge over the land needs to be registered with the relevant land registry. Upon registration, the lender is fully secured and security herein would prevent further dealings whether by way of sale or transfer of that land or the granting of the second charge without the consent of the first lender/chargee.
To effect the registration, the charge must be in the statutorily prescribed form, i.e., Form 16A of the NLC. Failure to comply therewith would result in the instrument not being a registrable instrument and being rejected for registration. When a charge instrument is presented for registration, it must be duly executed and stamped and accompanied by the appropriate registration fees.
On the other note, the order of priority among the registered charges will, subject to any agreement to the contrary, depend on the order of registration thereof.
In addition to the above, Section 433B of the NLC requires prior approval of the State Authority in respect of any dealings as prescribed under Division IV of the NLC (including the creation of legal land charge) on the alienated land or interest in alienated land in favour of a foreign company.
(c) Jabatan Laut Malaysia – Registration of Mortgage Over the Vessel
A legal mortgage over the ship is registrable in the domestic vessel registry (namely, Malaysian Ship Registry — located in Port Kelang, Penang, Kuching and Kinabalu and Malaysian International Ship Register — located in Labuan) pursuant to the Merchant Shipping Ordinance 1952 (“MSO”) and the respective regulations made thereunder. The proper law of the mortgage, in the absence of any indicators, will be presumed to be the law of the vessel flag. The mortgage gives the lender in rem rights over the vessel and priority over other creditors in the event of default.
The legal mortgages rank by the order of their registration and not by their dates or time of creation. This is a statutory rule and is contained in Section 43 of the MSO.
To effect the registration, the mortgage must be in the form as may be prescribed by the Minister, i.e., Form 11a (Mortgage (to secure Principal Sum and Interest)) and need to be lodged with the registrar accompanied by a deed of covenant. Such instruments presented for registration have to be duly executed and stamped and accompanied by the appropriate registration fees.
(d) Filing of Power of Attorney
In order for any power of attorney contained in any security documents to be validly exercised within West Malaysia, such document must first be registered with the High Court of Malaya as an instrument containing a power of attorney and a duplicate of such document must be lodged (together with filing fee) with the Registrar of the High Court of Malaya.
Conclusion
The above discussion only covers some of the main issues which are pertinent for cross-border lending transaction. There might be other issues which are relevant depending on the nature of the loan and the proposed security interest thereof. It is advisable for the interested party to obtain proper advice from a local counsel practising in the relevant jurisdiction to ensure that the proposed transaction is valid and enforceable under the relevant laws and regulations of that jurisdiction.
For further information, please contact:
Farhah Hayati Mamat, Partner, Azmi & Associates
farhah@azmilaw.com
- Notice 2 of the Foreign Exchange Policy Notices, Part B(9) (Borrowing by resident – Borrowing in foreign currency by resident entity).
- Special Purpose Vehicle is defined in the Foreign Exchanged Policy Notes as an entity set up solely for a specific purpose and is not operating a business unit.
- Notice 2 of the Foreign Exchange Policy Notices, Part B(10) (Borrowing by resident – Borrowing in foreign currency by resident entity).
- Notice 2 of the Foreign Exchange Policy Notices, Part G (Giving and Obtaining of Financial Guarantee).
- Income Tax Act 1967, Schedule I, Part II, Section 109.
