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Malaysia | Auspicious Journey: The Federal Court decides on minority shareholders rights

Introduction

The Federal Court (“FC”) in Auspicious Journey Sdn Bhd v Ebony Ritz Sdn Bhd¹ has affirmed in its reasoning on whether the remedy in section 181 of the Companies Act 1965 (“CA 1965”) (now section 346 of the Companies Act 2016 (“CA 2016”)) in a case where an organ of a company is exercising its power in an oppressive manner to the minority that liability may be imposed onto parties other than the majority shareholders.

In essence, the FC held that directors and third parties may be held liable personally in actions of oppression depending on the facts and circumstances of the case.

Main parties in the proceedings

The appellant, Auspicious Journey Sdn Bhd (“AJ”), was a 20% minority shareholder in the 1st respondent, Ebony Ritz (“ER”).

The 2nd respondent, Hoe Leong Corporation Ltd (“HLC”), was the 80% shareholder of ER. The Kuah Brothers, 3^rd and 4^th respondents, were common directors of HLC and ER.

Material facts

ER is a joint venture company (“JV”) between AJ (holding 20%) and HLC (holding 80%). ER was formed to acquire 49% of the total shares in Semua International Sdn Bhd (“Semua”).

The remaining 51% shares in Semua were held by Sumatec Resources Berhad (“Sumatec”).

ER, Sumatec and AJ had entered into an Options and Financial Representation Agreement (“OFRA”) and the salient terms included:

an unconditional and irrevocable guarantee was given by Sumatec to ER to make good any shortfall if Semua’s audited profit after taxation falls short (“Profit Shortfall Guarantee”);
Sumatec would grant an irrevocable call option to ER and in the event of shortfall, ER may exercise the call option to require Sumatec to sell not less than 2% of the issued and paid up capital of Semua to ER (“2% Call Option”). If exercised, this would give ER a majority stake and control over Semua; and
Sumatec would grant an irrevocable call option to AJ which if exercised by AJ would require Sumatec to sell not less than 49% of the shares in Semua to AJ (“49% Call Option”).

Semua faced financial distress that resulted in a profit shortfall which Sumatec had to make good under the OFRA. Arising from this, ER gave notice to Sumatec to make good the sum but Sumatec was unable to do so. Sumatec also failed to comply with its obligations under the OFRA in relation to the Profit Shortfall Guarantee.

AJ then discovered that HLC had entered into a conditional sale and purchase agreement (“Conditional SPA”) with Setinggi Holdings Ltd (“Setinggi”), ER and Sumatec for the disposal of the entire retained 51% equity interest of Sumatec in Semua which AJ was not aware of previously.

The effect of the Conditional SPA was that 2% was to be purchased by HLC and 49% was to be purchased by Setinggi. Therefore, the entire retained 51% would be held by HLC as Setinggi was in effect its nominee.

HLC justified its actions as when Sumatec and Semua had run into financial difficulties, the JV fell apart due to AJ wanting to withdraw. HLC alleged that it was necessary to enter into the Conditional SPA, which was termed as effectively a “salvage and warehousing arrangement”. Nonetheless, the Conditional SPA was never completed.

HLC had maintained that it was prepared to place the all-important 2% shareholding in Semua into ER, provided AJ came up with its proportionate contribution but this was refused by AJ.

The High Court (“HC”) decision

AJ brought an action against HLC as the majority shareholder and the Kuah brothers as directors, contending that both HLC and the Kuah brothers have:

conducted the affairs of ER in an oppressive manner to AJ, disregarding its interests as minority members of ER; and
caused/threatened actions against ER that would unfairly discriminate/be prejudicial to AJ as a member of ER.

HLC on the other hand, contended that AJ brought this action to recover the money that AJ has placed as its investment into Semua, by inter alia, having its 20% shareholding in ER bought over by HLC, thus seeking a buy-out.

The HC found there was oppression and ordered ER to be wound-up. However, the HC dismissed AJ’s claim and refused to hold the Kuah Brothers personally liable as directors. The HC mentioned that this was an arrangement whereby the Directors breached the respective contracts in the best interest of the company (ER) in relation to its investment in Semua. The HC held that directors are agents of the company and are not liable for the company’s actions.

The Court of Appeal (“COA”) decision

The COA held (which the FC affirmed) that an unavoidable inference to be held from the circumstances of this case is that AJ did not wish to throw good money after bad, as it was not prepared to come up with the requisite funds to purchase either its share of the 2% call option available to ER, far less the 49% call option in its own favour. In essence, the COA held that to order a buy-out would unjustly enrich AJ, and that it should not be allowed to use these proceedings to divest itself of a bad bargain.

On AJ’s attempt to extend liability to the directors of HLC, the COA affirmed that the directors could not be held personally liable for the acts of the company, unless it was a personal act or wrongdoing by the directors and that act is outside its obvious agency.

FC decision

The FC read section 181(1)(a) CA 1965 together with section 181(2) and held that it is granted wide discretion to bring oppressive conduct to an end, or to remedy the minorities’ grievances.

Therefore, there is no prohibition against a Court granting a remedy which encompasses the directors of the company personally. Instead, the legislature intended to allow the Court freedom to determine a remedy it thinks fit.

The FC noted that section 181(1) limb (b) appears to concentrate on acts of the company and its members as compared to limb (a) which refers to the company as well as the directors’ personal exercise of their powers. The latter construction would allow for liability to devolve onto the directors personally.

The series of acts in section 181(2) are not exhaustive to circumscribe the powers of the Court. The Court may order remedies including imposing liability on other persons, including directors, who have perpetrated acts giving rise to the oppressive conduct.

The FC adopted the legal test in the Canadian Supreme Court decision of Wilson v Alharayeri²:

There should be evidence of deliberate involvement or participation in, or sufficiently close relationship to the oppressive, detrimental or prejudicial conduct that the minority complains of, to warrant attribution of liability to a director or third party;
The imposition of liability should be fair or just;
Liability may be more easily assessed where a director has breached his duties, acquired personal benefit or prejudiced other shareholders. However, these are not exhaustive and the assessment is dependent on the facts, undertaken on an objective basis.
The attribution of liability should be circumspect, only to remedy the breach or to stop the oppressive or prejudicial conduct.
Such imposition must be reasonable, to alleviate the legitimate concerns of the shareholders of the company;
In exercising its powers the Court should bear in mind general corporate law principles, such that director liability does not become a substitute for other common law or statutory relief; and
Is the defendant so connected to the oppressive, detrimental or prejudicial conduct that it would be fair and just to impose liability for such conduct.

The FC acknowledged that the Kuah brothers and HLC effected the Conditional SPA in the best interests of ER as AJ had expressly refused to further finance ER in contrast to HLC’s having injected no less than RM38 million into Semua to keep it afloat.

The applicability of the “fair and just” test, requires all these matters to be taken into consideration in determining whether liability ought to be imposed upon the directors personally.

Whilst the acts may be categorised as prejudicial and detrimental to the minority shareholder AJ, they weres ultimately related to salvaging ER. Therefore, this weighs in favour of the Kuah brothers and HLC in these circumstances.

AJ’s appeal was thus dismissed.

Remedies — winding up order maintained, buy-out request dismissed

Section 181(2) CA 1965 grants the Court an open-ended range of remedies.

“… (2) If on such application the Court is of the opinion that either of those grounds is established the Court may, with the view to bringing to an end or remedying the matters complained of, make such order as it thinks fit and without prejudice to the generality of the foregoing the order may—

1. direct or prohibit any act or cancel or vary any transaction or resolution;
2. regulate the conduct of the affairs of the company in future;
3. provide for the purchase of the shares or debentures of the company by other members or holders of debentures of the company or by the company itself;
4. in the case of a purchase of shares by the company provide for a reduction accordingly of the company's capital; or
5. provide that the company be wound up.”

This includes the discretion to refuse relief the Court feels inappropriate. Whilst winding up may be considered drastic, the Court has an unfettered discretion which ought not to be restricted by a general rule.

The remedy granted would depend on the complaint and the circumstances prevailing at the time of the hearing, not at the start of the proceedings. As there is a deadlock between the parties such that the business cannot effectively continue, coupled with a potential statutory contravention if AH was bought out and ER’s insolvent state, the FC decided that winding up is justified.

From seeking a buy-out of its shareholding in ER, AJ seems to be seeking to escape a bad bargain or to recoup its investment. This is contrary to the intention of section 181. The FC concluded that whilst a buy-out may be most practical and efficacious in many oppression cases, winding up is not precluded.

Conclusion and orders granted

Personal liability on the directors and third parties may be imposed in oppression actions although it will ultimately depend on the circumstances of a particular case.

This is a favourable development in the law that further focuses on improving minority shareholder’s rights. As decided by the FC, there is no longer a blanket immunity for directors and third parties in relation to personal liability in oppression actions.

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