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Cases & Deals

Schemes of Arrangement: KNM Group Berhad and KNM Process Systems Sdn Bhd

On 2 November 2023, the High Court of Kuala Lumpur delivered its decision on a section 366 of the Companies Act 2016 scheme of arrangement, as applied by KNM Group Berhad (‘KNMG’) and KNM Process Systems Sdn Bhd (‘KNMPS’) (collectively, ‘the Applicants’) pursuant to the Applicants’ application for a second extension of a restraining order, a striking-out application by creditors to strike out the Applicants’ leave to convene a creditors’ meeting and restraining order as obtained (respectively ‘the Convening Order’ and ‘the Restraining Order’).

 

After deliberating across four broad aspects, the High Court denied the Applicants an extension of a restraining order for purposes of administering their scheme of arrangement and instead ordered that the Convening Order and the Restraining Order be struck out.

Breaches of section 368 of the Companies Act

Firstly, the High Court found that the Applicants had breached section 368 of the Act, for the requisite statement of affairs was premised on contingent liabilities calculated some three months prior to the scheme of arrangement application as opposed to the statutory requirement of the said statement being made up to not less than three days prior. The High Court further found that the Applicants had breached section 368 of the Act by failing to carry out a fair nomination of their scheme director, one Mr. Ho Soo Woon, owing to him being nominated by the Applicants’ own subsidiaries, holding companies and affiliates. Thus, Mr. Ho could not be said to be independent as subsidiaries of the Applicants would have a special interest in promoting the scheme.

 

Given the aforesaid breaches, the Convening Order and the Restraining Order was deemed obtained unlawfully, leaving the High Court to reject the Applicants’ second extension of a restraining order so as to not ‘permit the Applicants to enjoy the fruit from the poisoned tree’.

Wrongful Classification of Scheme Creditors

Secondly, the High Court held that Applicants’ scheme of arrangement was bound to fail the statutory requirement of obtaining the approval of 75% of creditors in value for each class of creditors. The High Court pointed to the Applicants’ decision to collapse its intercompany creditors together with its non-intercompany creditors into one single classification of ‘Class B’ creditors. In its deliberation, the High Court applied the principles of MDSA Resources Sdn Bhd v Adrian Sia Koon Leng [2023] where the Federal Court held that wholly owned subsidiaries of an applicant to a scheme of arrangement should not be placed into a class with third party creditors as the subsidiary companies have a special interest in promoting the scheme and cannot sensibly consult other creditors with a common interest. Accordingly, the High Court held that the Applicants’ subsidiary companies (constituting 98% of KNMG and 85% of KNMPS Class B creditors respectively) may have a special interest in promoting the Applicants’ scheme and that their votes will overwhelm the rest of the Class B creditors during the voting stage. The Applicants’ decision to merge its intercompany creditors with non-intercompany creditors was found to be ‘not only improper, but also constitutes class manipulation’ notwithstanding the Applicants’ proposition that such intercompany creditors would be paid after the non-intercompany creditors.

 

Overall, the High Court held that class composition goes to the court’s jurisdiction: if class composition is improper at the initial convening stage of a scheme, there is no point in a court granting a scheme meeting to consider the scheme if the court will lack the jurisdiction to sanction the scheme later.

 

The Applicants’ Scheme of Arrangement Remains a ‘Pie-in-the-Sky’

Thirdly, the High Court referred to its earlier order to appoint an independent liquidator (‘Appointed Liquidator’) to report on the viability of the Applicants’ scheme (‘Viability Report’) pursuant to an application under section 367 of the Act by the intervening creditors, Ann Joo Metal Sdn Bhd and Ann Joo Metal (Singapore) Pte Ltd)  (collectively, ‘Ann Joo’).

 

In an explanatory statement and its various amendments explaining the terms of the Applicants’ proposed scheme (‘Explanatory Statement’), the Applicants proposed that proceeds generated by a disposal of four major assets (‘the Assets’) would be distributed to KNMG and KNMPS scheme creditors, with intercompany scheme creditors only being paid until the former creditors were paid in full. The High Court opined that there was basis to the creditors’ complaints of a lack in material information contained in the Explanatory Statement, such as insufficient financial information on the subsidiary companies that hold the Assets who might themselves have their own liabilities and creditors to pay. Further, emphasis was drawn to the non-disclosure of whether a ‘Golden Power Clearance’ as required from the Government of Italy was obtained for one of the Assets, FBM Hudson Italiana SpA for disposal.

 

The High Court further held there was insufficient information in the Explanatory Statement as to how the scheme puts scheme creditors in a better position than in liquidation. This was especially so for KNMPS’ scheme creditors for whom, in a liquidation scenario, a disposal of the Assets would be distributed to them first without any amount going to KNMG, much less KNMG’s scheme creditors. This was because the Applicants had proposed that KNMG scheme creditors would be paid the proceeds of the Assets held by KNMPS prior to KNMPS scheme creditors. As for the disposal of Borsig GmbH, regarded as the Applicants’ crown jewel, the High Court found on a reading of the Explanatory Statement that no firm buyer of Borsig GmbH had been secured to-date. The High Court surmised to hold that the Applicants did not propose a scheme that would result in a better liquidation scenario to the creditors, and that all things considered, ‘the [scheme] in real terms and effect remains a pie in the sky to-date’.

 

Lack of Shareholder’s Approval for Proposed Scheme

Lastly, the High Court observed that the Applicants’ Explanatory Statement did not state whether the scheme was made conditional upon shareholders’ approval. This was critical as the Applicants’ scheme was dependent on a major disposal of the Assets. Given KNMG’s well-publicised shareholders’ tussle, the High Court held that it was all the more imperative to obtain shareholders’ consent to support the proposed scheme. The High Court also dismissed the Applicants’ proposition to terminate the scheme on 30 June 2024 if no payment of a principal had been forthcoming, holding that a termination of a scheme was not in the best interest of the scheme creditors.

 

Analysis

Widely regarded in the industry to be uncommonly applied for, section 367 of the Act allows a Court to appoint an insolvency practitioner to issue a report on the viability of proposed scheme of arrangement (‘s 367 Action’). Here, a s 367 Action was applied for after the Applicants had lodged the terms of their scheme of arrangement per the Explanatory Statement, of which was appended to a notice to convene a meeting of creditors on 12.10.2023. In the s 367 Action, an order that the Appointed Liquidator issue a report on the viability of the Applicants’ scheme, including whether there was a proper scheme warranting the holding of a meeting for voting by scheme creditors on 12.10.2023, was sought for together with an interim order that the chairman be directed to adjourn the meeting with immediate effect. Such orders were granted by the High Court.

 

By applying for a s 367 Action after the lodgement of the Explanatory Statement but before the meeting of creditors on 12.10.2023, the High Court allowed for the meeting to be adjourned until after the Viability Report by the Appointed Liquidator is filed into court. The Applicants subsequently appointed their own liquidator to produce a viability report on the same after the High Court had granted the s 367 Action along with the Appointed Liquidator.

 

The High Court in its decision referred to the report by the Appointed Liquidator as well as the Applicants’ own liquidator. The High Court referred to the Applicants’ own liquidator who opined that the votes of the Applicants’ intercompany creditors ought to be discounted or totally ignored. The Appointed Liquidator’s conclusion that the Explanatory Statement contained speculative statements such as ‘Further developments and/or details in relation to the proposed sale of the Thai Assets will be announced by KNMG where appropriate…’ was also referred to by the High Court in its finding that there was insufficient information contained in the Explanatory Statement.

 

Overall, the s 367 Action saw not just the adjournment of a meeting of creditors under section 366(2) of the Act but it also demonstrated how and when an independent liquidator may facilitate a decision on the merits of a s 366 scheme of arrangement before its sanction altogether.

 

Dato’ Loh Siew Cheang (Nigel William Kraal, Eizlan Farhan Nakhrowi and Claudia Nyon Syn Yue together with him) acted as counsel for two intervening creditors, Ann Joo Metal Sdn Bhd and Ann Joo Metal (Singapore) Pte Ltd, the intervening creditors who had applied for the s 367 Action.

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