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Case Commentary
Winding Up To Unlock Deadlock: A Cautionary Tale
By Alexander Pang on March 28, 2018 • ( Leave a comment )
As published by the Singapore Academy of Law on Singapore Law Watch on 23 March 2018. A link to the PDF version of the published article is available here.
Winding Up To Unlock Deadlock: A Cautionary Tale[i]
The recent Singapore Court of Appeal decision in Perennial (Capitol) Pte Ltd and Anor v Capitol Investment Holdings Pte Ltd and Ors [2018] SGCA 11 (the "Judgment") is notable – in this author's view – for several reasons. Apart from addressing what constitutes "deadlock" in cases where winding up applications are filed on just and equitable grounds, the Judgment also serves to highlight the importance of the contents of a company's constitution in joint venture companies.
This case commentary serves to set out the salient takeaways from the Judgment, as well as offer practical and commercial considerations to professionals and business people alike. Also examined are the potentially disastrous effect the filing of a winding up application may have on a company in cases where the company's solvency is not dispute. This is because certain statutory provisions in the Companies Act (Cap. 50) (the "Act") automatically take effect upon the filing of a winding up application.
The legislative intention behind these provisions is generally the preservation of an insolvent company's assets. However, where the winding up application is premised solely on just and equitable grounds, these provisions nonetheless apply, with the result that a company's business activities may be paralyzed whilst the winding up application is lis pendens.
A copy of the Judgment is available on Singapore Law Watch here.
Meaning of "Deadlock" In The Context Of Applications To Wind Up Companies On Just & Equitable Grounds
First, Singapore's apex court endorsed the view that the definition of what constitutes "deadlock" between shareholders did not require "true or absolute" deadlock in the sense of equal shareholding between two parties which had fallen out.
What is required to constitute "deadlock" – at least for the purposes of determining whether "unfairness" exists such as to justify an order to wind up a company on just and equitable grounds (Section 254(1)(i) of the Act – is a shareholder's inability to exit the company (or inability to exit an untenable relationship, in the words of the Judge in the court below).
In this respect, Judith Prakash JA – delivering the Court of Appeal's judgment – noted at [45] of the Judgment as follows:-
"A close examination of the cases reveals that the Judge was right in finding at [40]–[44] of the GD, that in situations of deadlock between the shareholders of a company, unfairness stems from the shareholders' inability to exit rather than the deadlock per se."
[emphasis added in underline]
It is therefore pleasing to see an emphasis on substance rather than form in determining whether "deadlock" exists, rather than just a consideration of management or shareholder impasse.
The Availability of a Viable Exit Mechanism Will Vitiate Purported "Unfairness" In A Section 254(1)(i) Application
Second, the Court held that the existence of an exit mechanism – subject to certain exceptions (as set out in the Singapore Court of Appeal's decision in Ting Shwu Ping (administrator of the estate of Chng Koon Seng, deceased) v Scanone Pte Ltd and another appeal[2017] 1 SLR 95 ("Ting Shwu Ping") at [107(b)] – would negate any "unfairness", since the parties had a pre-arranged, agreed method to exit the company.
For completeness, the exceptions cited by the Court in Ting Shwu Pingand again endorsed by the Court in this case were where – although an exit mechanism exists:-
"(a) the disaffected shareholder had a legitimate expectation that he was entitled to have his shares valued in some other way;
(b) there was relevant bad faith or impropriety in the respondents' conduct which had affected the value of the shares; or
(c) the articles provided an arbitrary or artificial method of valuation."
See [24] of the Judgment.
In the present case, the Court found that the exit mechanism existed in the respondent companies' respective constitutions. In particular, on the present facts Article 22(A) of the articles of association (which form part of the constitution), provided as follows:-
"22.(A) Every Member who desires to transfer any share or shares (hereinafter called "the vendor") shall give to the Company notice in writing of such desire (hereinafter called "the transfer notice"). Subject as hereinafter mentioned, a transfer notice shall constitute the Company the vendor's agent for the sale of the share or shares specified therein (hereinafter called "the said shares") in one or more lots at the discretion of the Directors to the Members other than the vendor at a price to be agreed upon by the vendor and the Directors or, in case of difference, at the price, which the Auditor of the Company for the time being shall, by writing under his hand, certify to be in his opinion the fair value thereof as between a willing seller and a willing buyer, and such sum shall be deemed to be the fair value, and in so certifying the Auditor shall be considered to be acting as an expert and not as an arbitrator and accordingly the Arbitration Act, Cap. 10 shall not apply. A transfer notice shall not be revocable except with the sanction of the Directors." ("Article 22A")
It is therefore apposite at this juncture to highlight what is a trite, but often overlooked legal principle, namely that a company's articles of association constitute a statutory contract between the company and its members, as well as its members inter se.
Accordingly, the Court of Appeal held that Article 22A constituted an acceptable exit mechanism thereby precluding the appellants (the plaintiffs in the winding up applications) from alleging unfairness as a basis to justify their application for winding up orders pursuant to Section 254(1)(i) of the Companies Act (Cap. 50).
In this respect, the Court held at [59] of the Judgment as follows:-
"It was abundantly clear – and this was an observation made by the Judge too at [86] of his decision – that applying the principles in Ting Shwu Ping led to the conclusion that the just and equitable ground under s 254(1)(i) had not been made out on the present facts. That the shareholders of the respondent companies were mired in a deadlock was not disputed by Chesham. However, given that Art 22 allowed a shareholder to "exit" the respective companies, there was no situation of "lock-in" on which a finding of unfairness could be made."
Article 22A was therefore central to the dismissal of the appeal.
Analysis and Practical Considerations
Insofar as legal principle is concerned, the decision is a welcomed one as it demonstrates that the Singapore Courts will take a practical approach to what constitutes "deadlock" in the context of shareholder fall-outs and applications to wind up companies on just & equitable grounds.
As a matter of practice, it is a cautionary tale to would be joint venture partners to pay particular attention to the articles of association determined at the time the joint venture company is incorporated. This is especially so if no contemporaneous shareholders' agreement is executed.
This is because the articles of association will take precedence until such time as a shareholders' agreement is signed, and the articles consequently amended to reflect the parties' intentions. It would also be prudent for legal professionals to specify whether the articles of association or the joint venture agreement is to take precedence in the event of conflict.
As observed by the Court at [67] of the Judgment:-
"We certainly did not think it appropriate that shareholders be allowed to march into the court with a winding-up application because they held the view that it was unfair for them to be bound to apply a contractual mechanism that they had agreed to when drafting their company's constitution."
The lesson here is that a company's constitution (which includes its articles of association), is the default contractual agreement binding the company's shareholders, until and unless a subsequent joint venture agreement is signed. Any subsequent execution of a joint venture agreement should be carried out concurrently with the passing of the appropriate shareholder resolutions to amend, supplement and/or modify the company's constitution.
The Judgment is also a further reminder that an application to wind up a company on just and equitable grounds should not be made lightly. Such applications – even if no order is eventually made – have potentially draconian economic and social consequences by virtue of the filing of the application.
Although not discussed in the Judgment, it should be noted that upon the filing of a winding up application, certain statutory provisions automatically come into force.. One particularly difficult provision is Section 259 of the Act, which provides:-
"Avoidance of dispositions of property, etc.
Any disposition of the property of the company, including things in action, and any transfer of shares or alteration in the status of the members of the company made after the commencement of the winding up by the Court shall unless the Court otherwise orders be void."
[emphasis in underline; bold in original]
Whilst the purpose of the provision is the preservation of a company's assets whilst a winding up application is lis pendens, this assumes that a winding up order is eventually made.
Perhaps more critically, the legislative purpose of Section 259 of the Act is more relevant in situations where the company's solvency is in doubt, hence the need to protect the creditors' interests. However, where the winding up application is premised on just and equitable grounds, a strong argument may be made that Section 259 of the Act essentially cripples the company where the application is opposed.
This is because, without knowing whether or not a winding up order will eventually be made, the operation of Section 259 of the Act puts the company in the unenviable position of being unsure and unclear as to whether it may enter into any particular transaction constituting a "disposition" within the meaning of section.
This usually results in applications having to be made to Court – whilst the winding up application is lis pendens – to seek validation orders authorising such "dispositions", even where such dispositions are those made in the ordinary course of the company's business and/or for the company's benefit. In such a scenario, such applications cause the incurrence of unnecessary cost and expense.Conclusion
Ultimately, the author submits that the key takeaway from the Judgment is consistent with an established principle of insolvency law, namely that winding up applications ought not to be commenced for collateral purposes.
This is true in the case of applications to wind up companies on the grounds of alleged inability to pay debts, and ought to apply equally to all winding up applications.
[i] The contents of this article are owned by author and subject to copyright protection under the laws of the Republic of Singapore (as may from time to time be amended). Save for the Singapore Academy of Law and/or its affiliates, no part of this update may be reproduced, licensed, sold, published, transmitted, modified, adapted, publicly displayed, broadcast (including storage in any medium by electronic means whether or not transiently for any purpose save as permitted herein) without the prior written permission of the author. Please note that whilst the information in this article is correct to the best of the author's knowledge and belief at the time of writing, it is only intended to prove a general guide to the subject matter and should not be treated as a substitute for specific professional advice for any particular course of action as such information may not suit the reader's specific business, operational and/or commercial requirements. The reader is therefore urged to seek legal advice for your specific situation. All the author's rights are expressly reserved and nothing herein shall be construed as a waiver thereof.
*************************************************************************************
*The contents of this article represent the views and observations of the author alone from a Singapore law perspective and are subject to copyright protection under the laws of the Republic of Singapore (as may from time to time be amended). No part of this article may be reproduced, licensed, sold, published, transmitted, modified, adapted, publicly displayed and/or broadcast (including storage in any medium by electronic means whether or not transiently for any purpose save as permitted herein) without the prior written permission of the author.
Please note that whilst the information in this article is correct to the best of the author's knowledge and belief at the time of writing, it is for academic reference, does not constitute legal advice and is only intended to provide a general guide to the subject matter. It should therefore not be treated as a substitute for specific professional advice for and/or in respect of any particular course of action as such information may not suit your specific business, operational and/or commercial requirements. You are therefore urged to seek legal advice for your specific situation. All the author's rights are expressly reserved and nothing herein shall be construed as a waiver thereof.
Categories: Case Commentary, Company Law, Cross-Border, Law, Liquidation & Bankruptcy, Restructuring & Rescue, Singapore
Tagged as: Analysis, articles of association, Capitol, Capitol Investment Holdings, Case Commentary, chesham, Company Law, Just & Equitable Winding Up, Legal Developments, meaning of unfairness, patina, perennial, Perennial (Capitol), Shareholders' Disputes, Singapore
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