Singapore Court of Appeal issues seminal decision on financial disclosure requirements and third party releases in group restructurings
27 June 2019
Pathfinder Strategic Credit LP & Anor v Empire Capital Resources Pte Ltd & Anor  SGCA 29
An increasingly common device in schemes of arrangement is for a single company in a corporate group to apply for a scheme of arrangement, and therein seek third party releases in favour of the entire corporate group and its directors. This device is of serious concern to creditors, and raises issues including what financial disclosure should be given of the other entities in the corporate group, classification of creditors of the different entities, and the extent to which the law on schemes of arrangement can cover such a group scheme.
The recent decision of Pathfinder Strategic Credit LP & Anor v Empire Capital Resources Pte Ltd & Anor sets out what is now the leading analysis in such “group schemes” and its requirements. In this case, the Singapore Court of Appeal declined the scheme application due to “woefully inadequate” financial disclosure by the applicant.
Since 2015, the Berau Coal group has commenced four separate rounds of restructuring applications before the Singapore courts to restructure debts owed under two tranches of notes totalling US$950 million (“Notes”), issued by:
- US$450 million Notes due 2015 (“2015 Notes”) issued by Berau Capital Resources Pte Ltd (“BCR”). BCR did not owe any obligations under the second tranche of Notes below.
- US$500 million Notes due 2017 (“2017 Notes”) issued PT Berau Coal Energy Tbk (“BCE”), previously listed on the Indonesian stock exchange, but subsequently de-listed in 2017 for non-compliance with financial reporting obligations. BCE was also the guarantor of the 2015 Notes.
In each previous round of restructuring proceedings, BCR and BCE proposed two separate schemes of arrangement to their respective creditors, thereby separating the 2015 Notes and 2017 Notes into different schemes. Each previous round of proceedings failed because a blocking vote of creditors voted against the scheme.
In this fourth round of proceedings, the Berau Group commenced one combined scheme application seeking leave to convene one scheme meeting of creditors under section 210(1) of the Companies Act for both sets of Notes, using a S$2 special purpose vehicle (“Empire Capital”) as the applicant. Empire Capital’s link to the above restructuring was that it was one of 10 subsidiaries guarantors of the Notes.
Empire Capital’s scheme application was objected to by two creditors, Pathfinder Strategic Credit LP and BC Investment LLC.
The Court of Appeal dismissed Empire Capital’s scheme application, and held in favour of Pathfinder Strategic Credit LP and BC Investment LLC.
The basis for the above decision was that Empire Capital had failed to provide sufficient financial disclosure to the court to justify granting leave to convene scheme meetings.
The law on financial disclosure
In reaching this decision, the Court of Appeal held that a less onerous standard of disclosure is required of a scheme applicant at the leave stage (where the court is asked to grant leave to convene scheme meetings) as compared to the sanction stage (where the court is asked to approve a scheme which has been passed by the requisite majority of creditors). At the leave stage, the scheme applicant bears a duty of unreserved disclosure to:
- assist the court in determining whether and how the creditors’ meeting is to be conducted.
- provide sufficient disclosure as would enable the court to determine the issues that it must properly consider at this stage, such as the classification of creditors, the proposal’s realistic prospects of success, and any allegation of abuse of process. This included information reasonably necessary for the
- court to be satisfied that fair conduct of the creditors’ meeting is possible, that the proposed scheme, though lacking in finality and detail, is at least “feasible and merits due consideration by the creditors”, and to enable the court to assess the fairness and adequacy of the explanatory statement.
The court nonetheless emphasised that it is only in clear and obvious cases that the court should intervene at the leave stage solely on the ground of inadequate disclosure. Relevant factors which would affect the scope of disclosure include the size and resources of the company, the size of the debts to be restructured, the urgency of the application, and the reasons for the company’s inability to provide further disclosure. The court is also not precluded from re-examining the same issue of disclosure at the sanction stage under the applicable standard at that stage.
Berau’s failure to provide proper financial disclosure
The Court of Appeal noted that Empire Capital had initially claimed it could only provide audited accounts of BCE up to December 2014, because Indonesian law did not permit it to disclose anything further. However, upon the court expressing concern about the limited extent of such financial disclosure, and despite Empire Capital’s initial claims above, it then purported to provide further financial information to the court.
In relation to this further financial information, there was a “complete lack” of updated financial information about the companies whose debts were sought to be compromised under the scheme. Even though the scheme sought to release debts owed by 11 entities in the Berau Group, no financial disclosure had been made in relation to any member of the Berau Group besides the operating company, PT Berau Coal (“PT Berau”).
Further, little weight could be placed on a “position assessment” provided by Empire Capital’s financial advisors, which suggested that creditors would recover more from a scheme than it would in liquidation. This was because it was prepared primarily based on PT Berau’s unaudited management accounts, without regard to other entities in the Berau Group. Further, the assessment assumed “the very issues that the creditors should be in a position to assess”, in this case that the Berau Group was unable to pay its debts or carry on business, thereby resulting in a forced enforcement sale in liquidation.
The Notes were secured by a comprehensive security package comprising more than 30 security documents. Most notably, the Berau Group agreed to deposit all revenue and receipts into specific charged accounts (“CAMA Accounts”), which were shared between holders of the 2015 Notes and 2017 Notes in distinct proportions. The Court of Appeal noted that there was an absence of information concerning secured funds which ought to have been paid into the CAMA Accounts, which had not been paid into the said CAMA Accounts “for some time”. These CAMA Accounts were an essential security right under the Notes, which the proposed scheme required creditors to surrender. Further, allegations of the improper use of these secured funds had been clearly put into issue in the proceedings, and Empire Capital had not provided any meaningful response besides a bare denial.
Third party releases in schemes of arrangement
The Court of Appeal indicated that its decision was based on the lack of financial disclosure, but nonetheless briefly stated provisional views on the other issues raised in the appeal.
On the issue of whether a proposed scheme could release third party liabilities, the court held that:
- At the leave stage, the court would determine the jurisdictional issue of whether the third party releases falls within the scope of section 210(1) of the Companies Act. A proposed scheme which included such third party releases would be jurisdictionally permissible if there is a sufficient nexus or connection between the release of the third party liability and the relationship between the company and the scheme creditors.
- At the sanction stage, the court’s focus will primarily be on the merits and the reasonableness of the inclusion of such third party releases in the proposed scheme, although jurisdictional challenges on the issue may also be raised then.
On the facts, the Court of Appeal provisionally noted that the third party release in this case appeared to fall within the jurisdiction of section 210(1). This was because Empire Capital was a guarantor for the Notes, such that the debt owed by Empire Capital and the debt owed by the other Berau entities sought to be released were effectively the same liability.
Classification of creditors in group restructurings
The next issue was whether holders of the 2015 Notes and the 2017 Notes should be classified as a single class of creditors for purposes of voting on the scheme.
Among other things, it was argued that the holders of different Notes should be placed into separate classes, because BCR was only an obligor under the 2015 Notes, and not under the 2017 Notes. Accordingly, the scheme required holders of the 2015 Notes to give up different rights against different entities, as compared to holders of the 2017 Notes.
The Court of Appeal held that there are three broad steps to analyse creditor classification:
- First, identify the comparator against which creditors’ rights under the scheme should be compared against.
- Second, assess whether the relative positions of the creditors under the proposed scheme mirror their relative positions in the comparator.
- Third, if there is a difference between the creditors’ relative positions identified in the second step, assess whether the relative positions are so dissimilar that they cannot sensibly consult together with a view to their common interest
Applying the above steps, the Court of Appeal noted that:
- Due to Empire Capital’s inadequate financial disclosure, the court could not conduct its analysis of classification of creditors. This was because it was unclear what the appropriate comparator to the scheme (i.e. the most likely alternative to the scheme) should be.
- On the assumption that the proper comparator is insolvent liquidation, then the holders of the 2015 Notes and the 2017 Notes would be affected differently, but the differences are not significant enough to require separate classes of creditors.
Abuse of process by the Berau Group
Finally, it was argued that the Berau Group was abusing the process of the court; among other things, this scheme application was the Berau Group’s fourth set of restructuring proceedings in Singapore.
The Court of Appeal held that the threshold for a finding of abuse of process is necessarily a high one, particularly due to “the inherently dynamic nature of the restructuring process”. The court concluded that there was insufficient evidence in this case to meet this high threshold of abuse of process, because there had been genuine changes in the restructuring plans put forward by the Berau Group, and because the creditors opposing the scheme had changed over time.
The decision in Pathfinder Strategic Credit LP & Anor v Empire Capital Resources Pte Ltd & Anor provides useful guidance to creditors and scheme companies alike on the scope and ambit of third party releases, the financial disclosure and the creditor classification issues which might arise in such schemes, and the test for abuse of process in schemes of arrangement.
Allen & Gledhill Partners Andrew Chan and Alexander Yeo, together with Senior Associate Jo Tay, represented the successful creditors opposing the scheme application.