SECTION 334 AND THE PARI PASSU PRINCIPLE (original) (raw)

SECTION 334 AND THE PARI PASSU PRINCIPLE

An analysis of Section 334 of the Companies Act and its effect on proceedings for the enforcement of Judgments

DISCLAIMER:

This article seeks to examine the fairness of the principle of pari passu distribution amongst unsecured creditors in insolvency. The question is not about whether equality is equity but rather whether in one particular instance at least, legislation entrenching the pari passu principle should be subject to other equitable considerations. The situation arises where an unsecured creditor who has already taken steps for execution is affected by section 334 of the Companies Act (Cap. 50) whereby the right of a creditor to execution is suspended upon the insolvency of the debtor company to enable distribution of its assets in accordance with the pari passu principle.

Section 334 of the Act provides that where a creditor has issued execution against the goods or land of a company or has attached any debt due to the company and the company is subsequently wound up, such creditor is not entitled to retain the benefit of his execution or attachment against the liquidator of the company unless he has completed the execution or attachment before the date of the commencement of the winding up. This means that when there is a resolution for voluntary winding up of a company or a winding up petition is presented against a company, it effectively prevents an unsecured creditor who has taken steps for execution but who for some reason and through no fault of his own has not yet completed it, from completing his execution thus putting all his efforts for recovery of his debt to naught. The only exception is where the Court deems it fit to set aside the rights of the liquidator under section 334 of the Companies Act 1 .

Here's a scenario: Judgment-creditor A issues a writ of seizure and sale or garnishee proceedings against D company. A proceeds so far as to actually seize the goods or to obtain the garnishee order nisi but before the date fixed for the auction sale or the return date for obtaining the garnishee order absolute, B who is another creditor of D, proceeds in the meanwhile to commence winding up proceedings against D. Since B has commenced winding up proceedings, A's rights of completing his execution are suspended by section 334 of the Act.

Subsequently, A finds that he has to stand in line with the other unsecured creditors of the company in pari passu distribution of the assets of the debtor company D upon its winding up. In the result, A who under the original execution process that he had commenced would have been entitled to full satisfaction of his debt and who has expended time and trouble in commencing execution proceedings now has to be content with possibly just 40 cents to a dollar.

Another situation where A's rights could be denied him would be when there is a delay of execution proceedings under the original writ of execution from an event not within the control of A. This could happen say, if D intending to stave off the completion of such execution proceedings by A and other creditors puts up a section 210 Companies Act scheme of arrangement for creditors as soon as the execution proceedings are commenced by A but with no bona fide intention of actually going through with such scheme.

The Section 210 arrangement has the effect of immediately suspending all execution proceedings and A's completion of his execution process is thus delayed through no fault of his own and in this instance, by the machinations of D. It would be harsh and unsatisfactory to justify the situation by analogy with instances where the creditor is prejudiced by delay occasioned by delay due to the legal process 2. In this situation, the law operates unfairly on A in that while delays in the legal process are transparent to him, the bona fides of D are not.

To this end, the mission here is to reduce the chances of a corporate debtor scheming to deprive A of the fruits of his diligent pursuit and to ask ourselves whether it would be just to let the last man in the race, that is to say, the interests of subsequent less diligent creditors B, C, D, E etc. override A's.

Taking this scenario a step further, persons managing D company can even unscrupulously plot to impede creditors or to obtain discounts on the company�s debts by organising for trusted associate(s) to wind up the debtor company on a bogus debt.

On the one hand, the law seeks to maintain fairness by means of pari passu distribution of a limited resource but this good intention can be exploited and is there an option between the devil and the deep blue sea?

What are the possible options for reform to section 334?

1. The burden be reversed to require the liquidator to ask for a specific order to stay execution proceedings analogous to situations involving possession of premises whereby the liquidator has to obtain an order to gain possession of such premises.

2. Remove the provision for suspension of execution in section 334 altogether.

3. Allow a creditor who has already commenced execution proceedings prior to the commencement of winding up proceedings to complete his execution proceedings.

Rationale for the existing provision

Winding up provisions generally seek to ensure equality among all creditors and to avoid fraudulent betterment of the debtor or other creditors 3. It is therefore comprehensible that execution proceedings commenced after winding up should not be allowed. Priority is then accorded under insolvency law according to security and paramount claims. However, in the above case of partially executed debts, an exception should perhaps be made to protect creditor A from the unfortunate circumstance of winding up proceedings by an unforeseen or even, rigged creditor B. This is particularly so as A would have already invested his time, trouble and money in commencing a suit, obtaining judgment and commencing execution only to find all this wasted at the last moment.

Comparison with section 330

Section 330 invalidates the creation of floating charges within six months of the winding up of a company with the exception of floating charges obtained in exchange for a monetary advance. This provision seeks to preserve the assets of the company for the benefit of all creditors in winding up. On the other hand, fixed charges and other securities obtained against the debtor survive liquidation. In most cases, earlier security undertakings would include negative pledges to prevent subsequent securities taken on the same assets. In the circumstances, save for refinancing, most organisations would be unable to gear beyond the earlier commitments.

In any case, Section 334 takes the protection of creditors one step further still. The pari passu principle is stretched to possibly an inequitable breaking point. The diligent and alert creditor is disadvantaged in pursuit of his debt in circumstances that may not be within his control.

The alternative options

1. Reversing the burden of proof may not seem a distinctly different situation from the existing provision. However, the liquidator is often in a better position than a creditor to assess the financial health of the company he is administering and the true state of the commercial motives behind the various actions by and against the debtor. In this regard, we would not be facing the possibility of extra obligations and duplicity of efforts on the part of the liquidator. From the perspective of creditor A, he is unlikely to want to expend further in pursuit of the debt in particular, to make an application to the Court to set aside the overriding rights of the liquidator under section 334. This is particularly so as it is a discretionary remedy and there is a risk that his application may not succeed so that at the end of the day, he may be out of pocket for further costs and recover just a fraction of his debt. In the circumstances, section 334 as it presently stands would arm-twist such a creditor to writing off his debt instead of proceeding further for recovery.

Meanwhile, it is necessary to note the obligations on the liquidator, i.e. the sanction of personal liability if he exercises his powers in a manner unfavourable to the company and secured creditors 4. This ever present Sword of Damocles may just motivate the liquidator to always err on the side of caution and as such, option 1 may be simply an academic exercise.

2. On the other hand, to remove the provision in section 334 may yet forever lay to rest the outstanding problem portrayed above but perhaps at the risk of turning the commercial sector into a present day �cowboy enterprise�. The law would always presume that businessmen should be diligent and astute, which they are undeniably so. However, justice has the arm of mercy and equity and it is just as well to have the avenue of a possible recourse when circumstances so require.

In Conclusion - A Third Way?

3. It may be drastic to altogether remove section 334 but it is submitted that the section should be replaced by a new provision which at least allows a creditor like A who has already commenced execution proceedings at the time of winding up proceedings to complete his execution proceedings. The burden of showing that creditor A's execution entitlement should cease, should be placed upon the liquidator instead.

Under the existing provision, the circumstances for a successful application for leave by a creditor like A to set aside the liquidator�s right are limited. Weighty considerations are required before the court exercises its discretion to do so 5. Leave to proceed is unlikely to be given and generally only where there is a public interest element 6, or where third party interest is involved 7. The principle of equitable distribution is laudable and the sanction of contempt and cost necessary to give effect to the provision8. However, equitable is not always equity. Some cases have adopted a more liberal approach to the events allowing for setting aside of the liquidator�s right 9 , but the general principle is still one of weighty considerations and diligence alone will not entitle the judgment creditor to relief 10 .

A creditor cannot be expected to know the credit position of the debtor company vis-à-vis other creditors. Perhaps the ideal position would be for all modes of execution or enforcement of debts (including winding up proceedings) up to the date of the winding up order, to be prioritised according to the date of presentation of the process of execution or enforcement, whether that may be a petition for winding up or a writ of execution. If that is too much to ask for, then at the very least, partial executions of judgment debts should be allowed to be completed, notwithstanding the commencement of a winding up.

- Margaret Neo & Celine Hwang

Margaret Neo is a partner of the firm and Celine Hwang was a former legal associate of the firm. This article was first published in �Law Gazette�, the official publication of The Law Society of Singapore in its February 1998 Issue.

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ENDNOTES

1. Section 334(1)(c) Companies Act.
2. Peruvian Guno Co. v Dreyfus Bros., [1892] AC 166
3. (Re Redman (Builders) Ltd., [1964] 1 All ER 851; Mercantile Credits Ltd. v Foster Clark (Australia) Ltd [1965] A.L.R.574
(Full High Court))
4. Re Neon Signs (Australasia) Ltd, Re Melbourne Neon Pty Ltd [1965] VR 125
5. Re Caribbean Products (Yam Importers) Ltd.; Tickler v Swains Packaging Ltd [1966] 1 All ER 181 (C.A.)
6. Pegge v Neath District Tramways Co. [1895] 2 Ch. 508
7. Ex p. Purssell (1887) 34 Ch.D. 646, 660, 662
8. Kerr on Receivers, 15th Edition by R. Walton, Page 155
9. In Re Grosvenor Metal Pte Ltd, [1950] Ch 63, it was held that jurisdiction is not limited as it was formerly to cases where
there had been dishonesty or trickery on the part of the debtor.
10.Re Rainbow Tours Ltd [1964] Ch 66, Magnus & Estrin, Companies - Law and Practice, 5th Edition, Page 321.

© Joseph Hoo Morris & Kumar 1998

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