Directors have to choose which creditors to pay and which to stall as requests, or in the case of more aggressive creditors demands, are made on a company. At times, the considerations that come into play in the decision-making process may be less than proper. For example, the managing director, in arriving at a decision to pay, may have been motivated by the fact that a creditor is a very close personal friend. The law frowns upon such conduct, known as ‘unfair preference’.
The subject of unfair preference by insolvent companies under Singapore law is complex and abstruse. There are two reasons for this. The legal position can only be ascertained by the careful reading and juxtaposing of three different pieces of legislation: the Companies Act (s.329); the Bankruptcy Act (s.99 to s.102) and the Companies (Application of Bankruptcy Act Provisions) Regulations (the ‘Regulations’). The definition of persons who might be considered as being ‘connected with’ the company is broad and intricate.
The aim of this article is to guide readers through the labyrinth of provisions and provide a good overview of the law in this area.
Interplay of legislative provisions
The starting point is s.329 of the Companies Act. This section provides that any payment, transfer of property or other act relating to property which would be void or voidable, as against an individual under, inter alia, s.99 of the Bankruptcy Act, is void or voidable in the same manner in the winding-up of a company. Section 99 deals with unfair preference. Section 329 therefore borrows a provision from the Bankruptcy Act to deal with unfair preference by an insolvent company.
Section 99 and s.100 of the Bankruptcy Act state the key elements of unfair preference, while s.101 details definitions of who may be regarded as ‘associates’ of an individual. Section 102 deals with the orders that a court may make.
The purpose of the ‘Regulations’ is to clarify how the Bankruptcy Act provisions apply to companies by:
The key aspects and issues of unfair preference by a company in the context of the three pieces of legislation are as follows.
The proscribed conduct
The general principle here is that if a company being wound up has given unfair preference to any person, the liquidator of the company may apply to the court for an order to restore the position (s.99(1) Bankruptcy Act). The following scenarios illustrate unfair preference:
Unfair preference is described as doing something that puts a creditor in a better position in the event of the company’s winding-up. The implication is clear. The creditor need not prove they have been paid earlier in the subsequent winding-up, avoiding the prospect of receiving little or no payment. This is a common experience in a winding-up, since there is usually little money left after the statutorily preferred creditors (s.328 Companies Act) are paid.
The provision also requires culpability on the part of the company in that the act must be motivated to some degree by an intention to give preference. The exact words used are ‘influenced by a desire to produce… the effect’ (s.99(4)). This is a significant shift from the previous provision1 which used the words ‘with a view to giving… a preference’. Case law had interpreted ‘with a view’ to mean with the intention or object, and that such intention should have been the principal or dominant intention2. The current requirement ‘influenced by the desire’ is a much lower threshold than dominant intention. The test appears to be whether the act (e.g. payment) was influenced by the desire to prefer or whether it was decided on a purely commercial basis.
It is clear from s.100(2) that the desire to prefer and the effect of giving preference are insufficient to constitute the conduct which the provisions seek to proscribe. Additionally, the company must be insolvent at the time of the act or as a consequence. ‘Insolvency’ is defined as either the inability to pay debts as they fall due or a situation where the amount of the liabilities (including contingent and prospective liabilities) exceeds the value of the assets: s.100(4). Unfair preference by a company, therefore, occurs when the company does an act with the desire and the effect of giving preference to a creditor, and the act was done while the company was insolvent or the act resulted in the company being insolvent.
The provisions set out two different catchment periods – six months and two years respectively, from the commencement of winding-up. The shorter period is for creditors in general while the longer period is for creditors who are ‘connected with’ the company (s.100(1)(b), read with Regulation 4). The rationale for a longer, thus earlier, period is probably that preference usually begins with those creditors who are closer to the company before moving to other creditors.
Section 101 is complex. It deals with the relationships between the bankrupt individual and those whom the law deems are close to him and therefore likely to be favoured by him. The term used is ‘associates’. The long list of persons who are considered associates of a bankrupt includes the following:
Two qualifications are used to ascertain relationships, half-blood relationships are included, and so are step-children, adopted children and illegitimate children: s.101(7). As for companies, a bankrupt is taken to have had control of a company if the directors of a company (or of another company having control of it) are accustomed to act in accordance with his directions or instructions; or if the bankrupt had one-third or more of the voting power of the company (or of another company having control of it): s.101(9). In this regard, control is therefore either at board level or shareholder level.
However, in applying the unfair preference provisions to companies, Regulation 4 states that references to an ‘associate’ of an individual should be read as a reference to a ‘person connected with a company’, except in s.101. Regulation 2 provides its own definition of a ‘person connected with a company’, namely:
Firstly, the definitions of ‘associate’ in s.101, which are outlined above, are relevant to unfair preference by companies. A preference given to a relative of a director, for example, would amount to a preference to a ‘person connected with a company’.
Secondly, Regulation 5 introduces another category of associates – an associate of a company. Regulation 5 provides that a company shall be an associate of another company if:
An associate of a company is therefore a company which is connected by the element of common control.
Viewed as a whole, the picture which now emerges is an elaborate labyrinth of relationships and connections. Depending on the relationship of the particular creditor with the company or its directors, the ascertainment of whether the transaction is caught by the provisions can be a Herculean task. The principle of the matter, however, is simple enough. A company should not give preference to individuals connected to its directors; neither should it give preference to a company connected to it by reason of being controlled by the same person(s).
The longer period of catchment for persons connected with the company are outlined above. There is another legal implication where the creditor is connected with the company. Section 99(4) (read with Regulation 4) provides that where a company has given a preference to a creditor connected with the company, the company shall be presumed, unless the contrary is shown, to have been influenced by the desire to prefer. This effectively reverses the burden of proof – instead of the liquidator having to show influence, the burden now rests on the connected person to show that there was no influence. In practical terms, the difference is very significant.
The provisions surrounding unfair preference by companies can be confusing. However, upon careful reading and analysis, one can arrive at a clear framework of rules on the subject.
Basically, s.329 of the Companies Act borrows from s.99 to s.102 of the Bankruptcy Act while the ‘Regulations’ elaborate on how the bankruptcy sections are to be modified to suit companies; a roundabout process which is less than ideal. Central to this modification is the use of the term ‘person connected with the company’ in place of the term ‘associate’. The objective is to spell out situations where a creditor company is regarded as being an associate of a company. Yet, at the same time, the s.101 definitions of associates of an individual are retained through the inclusion of the associates of directors in Regulation 2’s definition of ‘person connected with a company’.
The essence of unfair preference is putting a creditor in a better position, financially, in the event the company is wound-up. A key element of the current provisions is that the company is ‘influenced by the desire’ to put the creditor in a better position. Of critical significance is the fact that where the preference is to a connected person, the influence is presumed and the catchment period is longer. Another important element is that the company was insolvent when making the preference or as a result of making the preference.