What Duties Does A Creditor Owe To His Fellow Creditors?

Transcription

1 Lunchtime Seminar Series What Duties Does A Creditor Owe To His Fellow Creditors? By Business Finance & Insolvency Lee Eng Beng SC Partner, Rajah & Tann LLP 15 & 16 May Introduction 1

2 Introduction Generally, a creditor who exercises his rights against the debtor does not owe any duty to the debtor. to pursue a substantial claim in accordance with the procedure provided and in the normal manner, even though with personal hostility or even venom, and from some ulterior motive, such as the hope of compromise or some indirect advantage, is not an abuse of the process of the court or acting mala fide but acting bona fide in accordance with the process. (Mann v Goldstein [1968] 1 WLR 1091) 3 Introduction When acting individually, a creditor can exercise all his rights in order to get a better recovery than his fellow creditors. Established exception in the case of enforcement of security a secured creditor has a general duty to act in good faith and to take reasonable steps to obtain a proper price for the security. Breach of this duty can render the secured creditor liable to the debtor and any subsequent encumbrancer. 4 2

3 Introduction Outside of this situation, the conventional wisdom is that an unsecured creditor does not owe any duties of good faith or care to his fellow unsecured creditors. However, it is becoming increasingly clear that inter-creditor duties do arise when creditors act collectively. 5 The Rise Of Collective Creditor Action 3

4 The Rise Of Collective Creditor Action Formal insolvency proceedings have become a last resort - much of the value in modern business enterprises reside in soft assets which tend to be seriously eroded upon the onset of formal insolvency proceedings. Displacement of management in favour of a court-appointed officer and the absence of efficacious legal mechanisms to deal with cross-border issues add to unattractiveness of formal insolvency proceedings. 7 The Rise Of Collective Creditor Action Strong preference for debt restructuring by way of private agreements with creditors collectively. Increased use of cram-down procedures where majority creditors can approve a composition or arrangement, subject to court supervision. Even in formal insolvency proceedings, collective creditor actions and decisions are important for court directions, appointment of voluntary liquidator, appointment of representative committees, approval of statement of proposals in judicial management etc 8 4

5 The Rise Of Collective Creditor Action Courts have also recognised that, as the insolvency of a company deepens, its creditors displace its shareholders as the primary stakeholders. Generally, under our insolvency regime, the majority interests, views and decisions of the body of creditors are now accorded critical, if not decisive, weight in determining the fate of the debtor, working out the terms of a debt restructuring or compromise plan, and fixing the level of recovery that can be enjoyed by the creditors. 9 The Forgotten Cases 5

6 The Forgotten Cases Old English cases laid down a principle that if a debtor makes a proposal to his creditors, any undisclosed arrangement entered into with a particular creditor to receive more than the other creditors, for the purpose of securing that creditor s approval, is void for illegality and a fraud on the other creditors. Cockshott v Bennett (1788) 2 TR debtor made a proposal to pay 11 shillings in the pound to his creditors, but one of the creditors refused to execute the deed of composition until the debtor issued a promissory note to him for the payment of the remaining 9 shillings in the pound. The court held that the promissory note was void. 11 The Forgotten Cases The cases also made it clear that the additional benefit need not come from the debtor himself it is wrongful for a third party to confer or promise to confer an undisclosed additional benefit on a particular creditor in exchange for his support for the proposal. It follows that it is not necessary to show that the other creditors would have received more if the undisclosed additional benefit had not been given. 12 6

7 The Forgotten Cases Statement of law in McKewan v Sanderson (1875) 20 Eq 65: Now I take it to be thoroughly settled, both in Courts of Law and Equity, that where there is a bankruptcy, or an arrangement with creditors by composition or insolvency, when insolvency exists as contradistinguished from bankruptcy, it is the duty of all creditors who have once taken part in the proceedings of bankruptcy or composition to stand to share and share alike. Equality is the only principle that can be applied, and if one creditor, unknown to the other creditors not unknown to one or two, but to the general body enters into an arrangement by which he gets 13 The Forgotten Cases for himself from the debtor, or from any one on behalf of the debtor, any collateral advantage whatsoever, that is a fraud upon the other creditors; and, although the money has been paid, the Court will enforce its repayment. That principle cannot be too well understood. I am sorry to find that it is not better understood; and I hope this will be a lesson to bankers, whether joint stock or private bankers, that where there is once a bankruptcy of a customer, they are not to stipulate for a private advantage to themselves, but must stand with the other creditors and participate equally with them. 14 7

8 The Forgotten Cases But cases became obscure after 1915 the cases seemed to have dropped out of sight, and faded from the consciousness of practitioners, judges and textbook writers. 15 The Revival 8

9 The Revival Principle in old cases being revived in more recent cases in 1990s and 2000s, with some modifications to cater for features of modern insolvency regimes. Principle applied to private debt compositions as well as cram-down procedures. New challenges need to be addressed reconciliation with statutory schemes, effect of disclosure, distressed debt trading, indirect benefits, remedies 17 The Revival But it is clear that the old principle is still alive. In 2001, English courts reviewed the old cases and confirmed that they apply in the context of individual voluntary arrangements under the Insolvency Act High Court in Somji v Cadbury Schweppes plc [2001] 1 BCLC 498 summarized the principles: (1) any secret deal made in connection with a composition or arrangement for the settlement of debts, whereby a creditor was to receive more than the other creditors in return for supporting (or not opposing) the composition or arrangement, was illegal and void; 18 9

10 The Revival (2) the existence of such a deal rendered the composition or arrangement voidable at the instance of an aggrieved creditor; (3) moreover, such a deal was wholly unenforceable as between the parties to it; (4) the principle was of entirely general application, and covered all forms of composition or arrangement, whether statutory or otherwise; 19 The Revival (5) the principle was based on the fundamental rule that there should be complete good faith between the debtor and his creditors, and between the creditors inter se. It was therefore irrelevant that the inducement to the creditor came from a third party and not out of the debtor s estate; (6) if the secret deal was not made by the debtor himself, all that was required was that it should have been made to his knowledge, and therefore with his concurrence, since concurrence must obviously be inferred where the debtor knows of the deal and does nothing either to stop it, or to inform the creditors of it

11 The Revival Court condemned the giving of secret benefits: Such an act is morally wrong, not just in the eyes of commercial men who are disposed to entertain high notions of credit and of character in their dealings, but those of any man of common sense with the ordinary instincts of morality. 21 The Basis For The Rule 11

12 The Basis For The Rule Uncertainty over the basis for the rule. Fraud on other creditors? (a) (b) (c) Not consistent with modern meaning of fraud and too restrictive Implies that there is some misrepresentation at the time of the debt composition, but this is not in line with the cases Full disclosure is not a defence in cram-down cases 23 The Basis For The Rule Probably more accurately defined as a duty to maintain equality. it is the very essence of a composition that the creditors who come under it assume an obligation between themselves to be on a footing of equality and that there is no private bargain with any of the creditors which will destroy this equality; this equality is implied by law from the very nature of the transaction. (Ex parte Milner (1885) 15 QBD 605 at ) 24 12

13 Application To All Collective Creditor Actions? Application To All Collective Creditor Actions? No reason why the duty should not apply in other situations where a body of creditors act collectively to make a decision or take a step in relation to their debtor s insolvency - no justification for a creditor receiving or agreeing to receive an undisclosed and additional benefit in consideration of taking a certain position or exercising his vote in a particular manner in a creditors collective forum? 26 13

14 Application To All Collective Creditor Actions? Principle applied outside of debt composition cases: (a) (b) (c) supporting discharge from bankruptcy or annulment of bankruptcy supporting extension of time to make payment raising opposition to winding up application 27 Application To All Collective Creditor Actions? Must it involve the debtor? Cases are not settled as to whether a secret benefit given to a creditor to support a third party s proposal to acquire debtor s assets was held to be subject to the rule (Brigham v La Banque Jacques-Cartier (1900) 30 SCR 429 yes; Scuderi v Morris (2001) 309 ACSR 592 no)

15 Debt Assignments Debt Assignments An assignment of debt can be caught by the rule! Question is whether the principal aim and object is to procure approval of the proposal. Somji v Cadbury Schweppes plc [2001] 1 WLR debtor s friend, with the knowledge of the debtor, acquired the debts of the two bank creditors for a sum which was about five times what they could expect to receive under the debtor s individual voluntary arrangement rule held to be infringed and bankruptcy application against debtor was allowed

16 Debt Assignments Newlands Textiles, Inc v Carrier (1983) 21 ACWS (2d) 69 - chairman of the debtor company purchased a creditor s claim by, inter alia, issuing a promissory note to the creditor, for the purpose of removing the creditor s opposition to the debtor company s proposal court noted that there was nothing clandestine about the matter in which the promissory note was issued and that the parties acted in good faith however, court dismissed the creditor s action on the promissory note on the basis that was a fraud on the other creditors. 31 Debt Assignments Valuation of benefits under the proposal or composition may be relevant to determine whether the assignment consideration includes a secret benefit difficulties of valuation if proposal or composition is complicated. What if assignment takes place prior to the conclusion of the proposal or composition? Should court attempt to assess the uncertain value of the proposal or composition? Is there a defence of genuine commercial interest in the success of the proposal or composition? A shareholder, an investor or a business associate may all have such an interest

17 Incidental Benefits Incidental Benefits Too slippery to bring within the rule? Examples promise of increased orders from supplier, reduced prices to customer, more favourable settlement proposal from parent company or sister company for its own restructuring 34 17

18 Remedies Remedies Any contract to give the secret benefit will be void. If debtor is involved, the composition or proposal will be discharged. If it is a cram-down scheme, the court is unlikely to sanction it. Can a person who has given the secret benefit recover it from the creditor? Or should the creditor who has received the secret benefit be compelled to share it with his fellow creditors? 36 18

19 Other Inter- Creditor Duties Other Inter-Creditor Duties If a creditor has exposure to two companies in the same corporate group, both of which are making proposals, can it take into account considerations relating to one proposal, for the purpose of voting on the other proposal? Can the creditor use information obtained in its capacity as the creditor of another company? Does a creditor have to declare any conflict of interest to his fellow creditors? 38 19

20 Other Inter-Creditor Duties Does a creditor have to declare any inside information which it has concerning the proposal to be voted upon by the creditors? Is there any principle of fair dealing between creditors, analogous to the rules governing shareholder dealings? 39 Thank You! For more information, please contact: Lee Eng Beng SC DID: Fax: eng.beng.lee@rajahtann.com Website: