Singapore - Judicial Management – The Effect Of Creditors’ Third-party Security On Their Voting Rights.
Legal News & Analysis - Asia Pacific - Singapore - Insolvency & Restructuring
1 Septemer, 2018
Bank creditors often take security in the form of guarantees or mortgages given by the borrower’s parent or affiliated companies. Such creditors enjoy a privileged position vis- à-vis unsecured creditors and there are rules to maintain fairness between these classes of creditors when a borrower in put into liquidation. However, as the recent case of Re Swiber Holdings Ltd shows there was until recently some uncertainty as to the application of such rules in the case of judicial management. The issues were complicated by the fact that, to some extent, the two companies under judicial management were borrower and guarantor. How are the votes of creditors to be counted?
When a defaulting borrower is put into liquidation, a bank creditor may generally maintain a proof of debt for the full amount of the debt, notwithstanding the existence of security from a third party. However, what is the position where the defaulting borrower is put under judicial management and meetings are to be called and votes taken?
Should the creditor’s vote be taken to represent the full value of the debt or only so much, if any, as is unsecured even by a third-party? In the judicial management of Swiber Holdings Ltd and Swiber Offshore Construction Pte Ltd, this question arose because regulation 74 of the Companies Regulations (“reg 74”) states:
For the purpose of voting, a secured creditor shall, unless he surrenders his security, state in his proof the particulars of his security, the date when it was given and the value at which he assesses it, and shall be entitled to vote only in respect of the balance (if any) due to him after deducting the value of his security. If the creditor votes in respect of his whole debt, he shall be deemed to have surrendered his security unless the court, on application, is satisfied that the omission to value the security has arisen from inadvertence.
The questions arose because unlike the corresponding provision in the Bankruptcy Rules which governs the personal bankruptcy regime, the term “secured creditor” is not defined by the Companies Regulations. For reference, section 2 of the Bankruptcy Act defines “secured creditor” as “a person holding a mortgage, pledge, charge, lien or other security on or against the property of the debtor or any part thereof as a security for a debt due to him from the debtor”. Therefore, a creditor whose claim is secured by third-party security is not a “secured creditor” under the bankruptcy legislation.
The judicial managers applied to the Court for directions. The Judge phrased the questions he had to answer as follows:
first, is a creditor who holds a third-party security a “secured creditor” for the purpose of reg 74? If not, is the creditor entitled to vote for the full value of the third-party security? (“1st Issue”);
second, is a creditor required to deduct the value of a third-party security for the purpose of voting in potential schemes of arrangement under s210 read with s227X of the Companies Act (“Act”)? (“2nd Issue”); and
third, how does the analysis change, if at all, where the creditor has realised the security after lodging the proof of debt? (“3rd Issue”).
The 1st Issue
4. The Judge answered the first part of this question in the negative. First, he relied on the words of reg 74 itself. As a matter of construction, a creditor can only be said to have surrendered his security when the effect is to augment the debtor’s estate, ie, increasing the pool of assets available for distribution to the general body of creditors. Further, an asset provided by a third party to secure the debts of the debtor is not an asset of the debtor, and the debtor is not party to the arrangement between the creditor and the
owner of the asset. Reg 74 could not have been intended to interfere with and abrogate the rights of the creditor arising from an arrangement to which the debtor is not a party and over an asset which does not belong to the debtor.
This construction of reg 74 was also consistent with the personal bankruptcy regime and the purpose of the legislation. The secured creditors are in a privileged position in respect of those assets, vis-à-vis the general pool of unsecured creditors who would otherwise be able to share those assets rateably among themselves.
Therefore, it would be unfair that such secured creditors had an equal say with regards to unsecured assets of the debtor which are available to the general pool of creditors. Therefore, reg 74 was intended to redress this unfairness by permitting creditors to participate in decisions on the debtor’s proposals, only to the extent their debts were not secured over the debtor’s property. In such circumstances, if a secured creditor wanted to vote for the full value of its debt, it would have to surrender its security.
Accordingly, a creditor with third-party security was not a “secured creditor” under reg 74 and could vote for the full value of its claim against the debtor without deducting the value of the security. This would be the position even where the third party who gave the security was a subsidiary or an associate of the debtor company simply because such entities are distinct and separate legal persons.
The 2nd Issue
This issue was easier to answer than the 1st Issue. Regulation 61 of the Companies Regulations (“reg 61”) provides:
Except where and so far as the nature of the subject-matter or the context may otherwise require, the regulations relating to meetings hereinafter set out shall apply to the first meeting and the judicial manager’s meetings of creditors but so that those regulations shall take effect subject and without prejudice to any express provisions of the Act.
Therefore, reg 74 would only apply to creditors’ meetings called for the approval of a scheme of arrangement under s210 read with s227X of the Act, if such meetings fell within the meaning of “the first meeting” or “the judicial manager’s meetings of creditors” under reg 61.
Regulation 54 of the Companies Regulations defines “first meeting” as the “meeting of creditors under s227N(1) of the Act”. However, where a creditors’ meeting is called to vote on a scheme, this is done under s227X(a) read with s210 of the Act. As such, if a meeting is not called under s227N(1) of the Act, it cannot be a “first meeting” under reg 61.
Does such a meeting fall within “the judicial manager’s meetings of creditors” under reg 61? The answer is found in regulation 60 of the Companies Regulations, which defines this term as meetings that “the judicial manager ... may himself from time to time ... summon, hold and conduct ...”. Therefore, the reference is to discretionary meetings. However, meetings called under s227X(a) read with s210 of the Act are ordered by the court and therefore do not fall within reg 61.
Therefore, reg 74 did not apply to such meetings and creditors are not required deduct the value of third- party securities for the purpose of voting in potential schemes of arrangement under s210 read with s227X of the Act.
The 3rd Issue
The question here is, what is the position where the creditor realises its third-party security after lodging its proof of debt? Would he still be able to vote for the full value of the debt as filed or would he have to account for the amounts recovered through realisation of the security? There are two situations to consider. First, the insolvency of the principal debtor. Second, the insolvency of the guarantor.
Therefore, In the case of the insolvency of the principal debtor, a creditor is entitled to maintain a claim for the proof filed unless the debt is paid in full. The creditor is not required to reduce its proof of debt to reflect part-payments by a surety unless such payment extinguish the surety’s obligations.
This is because until the surety’s obligations are discharged in full it may not file its own proof of debt against the principal debtor. Therefore, if the guarantee is construed to be for the whole sum of the principal debt, the surety cannot file its proof of debt until the whole sum of the principal debt is paid to the creditor. This is the case even where the guarantee is limited in quantum. However, if the guarantee is only for part of the principal debt, the surety may file a proof of debt upon payment to the creditor of that part of the principal debt. Thereafter, the creditor will only be able to maintain its proof of debt up to the remaining balance due.
The rationale for these rules was explained in Goode on Legal Problems of Credit and Security:
... the rule has a sound policy base. It is a well settled principle of equity that until the creditor has received payment of the guaranteed debt in full the surety cannot prove in the debtor’s estate for a sum paid by him to the creditor. The reason for this is that he has, expressly or by implication, undertaken to be responsible for the full sum guaranteed, including whatever remains due to the creditor after receipt of dividends by him out of the bankrupt’s estate, and thus has no equity to prove for his right of reimbursement in competition with the creditor. If a creditor were required to give credit for a pre-bankruptcy part of payment by the surety, neither of them could prove for the amount of such payment and the general body of creditors would thus be unjustly enriched.
The Judge added that there ought to be a cut-off date for updates on proofs that have been filed and this date should be the day before the date of payment of dividends. The liquidator or judicial manager ought to set a time on the cut-off date by which all updates on the proofs of debt must be submitted.
In the case of the insolvency of the guarantor where the creditor has security over the principal debtor’s property, the Judge declined to follow the English position affirmed in In re Amalgamated Investment and Property Co Ltd, which allows a creditor to maintain the proof of debt it filed, even where it subsequently realises its security over the principal debtor’s property and obtained partial satisfaction for its debt.
The Judge thought this position was untenable because:
- the liability of a guarantor is co-extensive with that of the principal debtor. Therefore, if the principal debt is discharged in part, the liability of the guarantor reduces accordingly;
- following from this, if the creditor realises its security over an asset of the principal debtor after filing its proof of debt in the insolvency of the guarantor, it should update its proof accordingly. If it were otherwise, the creditor would command disproportionate voting power in creditors’ meetings; and
- it was not “convenient and fair” to adopt the date of filing of the proof of debt as the cut-off date. The cut-off date should be the day before the date of the payment of the dividends. Therefore, a creditor should continue to update its proof until the day before the date of payment of dividends, if any.
This decision provides a very clear guide to insolvency professionals who may find themselves in the position of the judicial managers of Swiber. The interpretation of reg 74 aligns our corporate insolvency regime with the personal bankruptcy regime and protects the rights of creditors who took the benefit of third-party security.
The law recognises the right of a surety for a debt to be subrogated to the creditor’s rights once the surety pays the creditor what is owed by the debtor. This is found in the Mercantile Law Amendment Act. Therefore, a creditor should not continue to pursue remedies against the debtor once it has been fully paid by the surety. Instead, the surety may do so, but until the surety fully pays the creditor, it cannot be said to have discharged the debtor’s debt and become entitled to the remedies of the creditor, including filing its own proof of debt against the debtor. Therefore, partial payments by the surety even where such payment is up to the full monetary limit of the guarantee where it is so limited, would not suffice to require the creditor to reduce its proof of debt filing.
The position is not the same when it is the surety who is insolvent. The Mercantile Law Amendment Act does not apply. Instead, the principle that a surety’s obligation is co-extensive with that of the debtor applies and, if the debtor’s obligation is reduced by the creditor realising its security against the debtor’s property, the obligation of the surety is reduced accordingly and the creditor should reduce its proof of debt against the surety.
As a practical matter, it is also very welcome that the Judge clarified that the cut-off for updating proofs of debt is a time fixed by the liquidator or judicial manager on the day before the date of payment of dividends, if any.
Thus, the case of Re Swiber Holdings Ltd  SGHC 180 is a welcome addition to the body of case law that complements and supplements the insolvency legislation of Singapore.