How about putting the subsidiary into liquidation? The consequences for the nominee directors appointed by headquarters
At a time when Groups are considering a geographical reorganization of their global workforce, made possible by remote working connecting continents, or simply for the sake of cost savings and the repatriation of resources to headquarters, closing foreign subsidiaries may be considered, whereas this would not have been the case in the pre-COVID context.
Compliance with liquidation procedures under local law is not the only aspect to consider from the perspective of HR and Corporate departments.
These Groups cannot ignore the risks to which they are thus exposing those ("directors") to whom they have entrusted the responsibility of sitting on the board of directors of these subsidiaries.
Their liability may be called into question from various angles:
- Personal liability for the company's debts;
- Liability in the conduct of liquidation operations;
But also, and above all:
Liability for management decisions that may have led to the liquidation decision.
This last category will be examined in greater detail as it can generate the greatest financial risks for the directors concerned.
The Newsletter will focus on Australia and Malaysia, since these two jurisdictions have adopted in legislative form the fundamental concept of the "Business Judgment Rule," inspired by US law, particularly the State of Delaware, but the principles developed apply to all Asia-Pacific common law.
Newsletter No. 8 - August 2021
I - Unlimited Liability for Company Debts
Unlike present and past shareholders (referred to as "contributors"), whose liability is in principle limited to their contribution, the directors of a limited liability company are indefinitely liable with their own assets if the company's assets prove insufficient. With some exceptions, for example, in Malaysian law, in relation to decisions taken since the termination of their duties or for directors whose term of office expired more than one year ago [Companies Act section 435 (4)].
II - Liability during dissolution
Directors must be personally involved in the liquidation process; they cannot rely entirely on colleagues or external professionals. Or, at the very least, receive very close advice from them.
In the case of voluntary liquidation ("winding up"), the company must, of course, not be in a state of suspension of payments. This requires an assessment and a personal commitment from each of the directors, who must ensure the company's ability to meet its debts.
Under Malaysian law, where the maximum repayment period is twelve months, any director who lacks reasonable grounds to issue a declaration of solvency is liable to imprisonment for up to five years and/or a fine of up to €600,000.
III - Liability for management decisions preceding the liquidation decision and for the decision itself
The liquidation of a company opens a Pandora's box where directors' decisions can be reviewed, potentially challenged, and potentially lead to liability being held by a shareholder (who may be a local shareholder), an uncompensated creditor, or the liquidator himself.
The possibility for directors to be exempt from liability is based on the concept of the Business Judgment Rule, derived from the case law of the Delaware courts, which reflects a principle ("duty of loyalty") specific to US law: independence, information about the decision, and good faith toward the company.
The concept is present, with variations, in almost all jurisdictions governed by common law in case law, but only some outside the United States, including Australia and Malaysia, have introduced it into their legislation.
The Business Judgment Rule is not intended to impose an additional constraint but, on the contrary, to offer protection to company directors.
The fundamental principle in this area, as expressed in particular in the landmark decision of the High Court of Australia in Harlowe's Nominees Pty Ltd v Woodside (Lake Entrance) Oil Co NL (1968) 121 CLR 483 at 493, is that the court has not intended to assess the validity of decisions of a board of directors, provided only that this decision-making power is exercised in good faith and in the interest of the company.
In Malaysia, the concept of the Business Judgment Rule was introduced in Section 214 of the Companies Act, a near-identical reproduction of Section 180(2) of the Australian Corporations Act 2001.
Under the Companies Act, a director exercises his or her duties in accordance with section 214 and the general principles of common law and equity when:
- He or she makes the decision in good faith and for a legitimate reason;
- He or she has no personal interest in the decision;
- He or she informs himself or herself as much as appears reasonable about the matter submitted for decision; and
- He or she rationally believes that the decision is in the best interests of the company, which is presumed to be the case unless the decision is of a nature that no rational person would have made it.
To comply with Malaysian law, directors must inform themselves about the circumstances of the decision, and whether they rely on external advice (from an expert or other professional) or internal advice (from a company executive, another director, or a specialised committee within the board), they must satisfy themselves of the person's expertise in the relevant field and assess the value of the advice given, drawing on their knowledge of the company and taking into account the complexity of its structure and operations.
Failure to comply with this requirement may result in a fine of up to €600,000 or imprisonment for up to five years.
Another condition, precedent to those indicated above, is that there must be a genuine judgment; in other words, the director must consider their decision thoroughly before making it. This may seem obvious but must be emphasised: the Business Judgment Rule concerns the decision to take or not to take an action, which is distinct from the duty to keep oneself continuously informed of the state of the company's affairs [see the decision of the Supreme Court of New South Wales in Australian Securities and Investments Commission v Rich 2009].
Furthermore, the judgment leading to the decision must be personal and autonomous. This principle is indirectly alluded to in the Malaysian Companies Act (Section 217(1)), which states that a director appointed by a shareholder must not subordinate the shareholder's interests to those of the company. However, the principle is consistently affirmed in a broader sense by Australian and Malaysian case law: a director cannot make a decision on the mere instruction of the majority shareholder without making the effort of his own reflection. [See the decision of the Supreme Court of New South Wales in Blackwell v Moray & Anor 1991].
Provided that the conditions are met, the good faith of the director is presumed, this being considered a fundamental principle of "natural justice" established, for example, in a leading decision of the Malaysian courts: Petra Perdana Bhd v Tengku Dato' Ibrahim Petra bin Tengku Indra Petra [2014]. For this presumption to be rebutted, except for self-interest, which is self-evident, it would be necessary to demonstrate that no reasonable person would have taken the relevant decision [see Loh Siew Cheang's comments in Corporate Powers].
IV - The Business Judgment Rule and the Financial Difficulties of a Subsidiary
A decision by the Federal Court, Malaysia's highest court, sheds light on this application of the Business Judgment Rule [Tengku Dato' Ibrahim Petra bin Tengku Indra Petra v Petra Perdana Bhd [2018]].
A company that sold blocks of shares held in another company by shareholders' decision granting a mandate to the board nevertheless found itself in a difficult financial situation, including cash flow.
After considering various options, the directors decided to sell another available block of shares to the same buyer, which enabled the company to repay bank loans and improve its rating.
Since the buyer of these shares had become the majority shareholder, the directors made a majority decision, based on their general mandate from the now minority shareholder, to sell the very last available block of shares.
A liability claim was brought against them on the accusation that the real objective of the directors in question was to enable the third-party company to take control of the subsidiary.
Before the High Court, the Business Judgment Rule was considered to be satisfied, and the decision was upheld as being in good faith, made after sufficient analysis, and demonstrating "due care and diligence."
On appeal, the Court of Appeal took the opposite view, finding that the directors, having exceeded the limits of the mandate entrusted to the Board, had not acted in the best interests of the company.
Eighteen different legal arguments were presented to the Federal Court, allowing it to reaffirm several fundamental points that should serve as guidance in circumstances where a locally incorporated company is in a critical financial situation:
- Determining whether a decision is in the company's best interests is not only to be assessed by reference to a "reasonable person" (an objective test) but also to a judgment made on the facts presented to it by the director (a subjective test), and the court must not substitute its own judgment for that of the director;
- Considering the objective test, the Court reaffirmed the Court of Appeal's conclusion in another Malaysian case, Pioneer Haven Sdn Bhd v Ho Hup Construction Bhd & Anor [2012], that it must be assessed whether an intelligent and honest person faced with the same circumstances in a capacity as a director would have considered the transactions in question to be in the company's best interests.
In this case, the Federal Court considered that the sale of the shares below their real value was justified and a normal management action, since the directors had been informed that the cash position would deteriorate and become very critical within the next twelve months.
In light of the Business Judgment Rule, the Court reached the same conclusion, holding that it was not for it to substitute its own assessment of the situation for that of the directors.
It therefore ultimately rejected the Court of Appeal's position and upheld that of the High Court.
Once again, as repeatedly emphasised (at the risk of becoming boring!) in these Newsletters, particular attention must be paid to the interaction between common law jurisdictions within a homogeneous community (despite important differences) in Asia-Pacific and South Asia (Australia/New Zealand; Singapore/Malaysia/Hong Kong/India), but in this case, even US law was used as a reference.
The influence of Delaware court decisions (Court of Chancery and Delaware Supreme Court) on all aspects of corporate law is well established, and even less so, needs to be emphasised. This influence is particularly evident in the area of governance as it relates to the exercise of the powers and responsibilities of directors and officers, and even more so through the emergence of the concept of the Business Judgment Rule, which serves as a test to assess directors' management and decision-making (as well as potential liabilities) during the period preceding liquidation.
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The content above is purely for informational purposes, relating to a selected overview of legislative, regulatory and case law developments in the relevant geographical area, which is not and does not claim to be exhaustive.
It does not constitute legal advice in relation to any particular case and should not be regarded as such. A more detailed doctrinal study on any of the topics mentioned may be requested.
Philippe Girard-Foley is a Registered Foreign Lawyer accredited by the Supreme Court of Singapore before the Singapore International Commercial Court – Certificate of Full Registration under Section 36P Legal Profession Act (Chapter 61).