Wu Yang v Mao Yong Hui

In PP v Lew Syn Pau [2006] 4 SLR(R) 210. Sundaresh Menon JC stated (at [151]) as follows:

“Accordingly, I conclude that in order to establish that a company has given financial assistance it will be necessary to establish that there has been a depletion of the assets of the company….. But this may not always be sufficient to warrant the conclusion that the transaction is in substance one involving the giving of financial assistance…(emphasis in original).

Discuss in the light of the Court of Appeal’s decision in Wu Yang Construction Group Ltd v Mao Yong Hui [2008] 2 SLR(R) 350.

Introduction

Human ingenuity is well nigh boundless and the more it is thought that the ambit of the prohibition is obscure, the more this will encourage the wasteful application of such ingenuity in search of a design that might be passed off as defensible [emphasis added].

Lew

Section 76 of the Companies Act, [1] which essentially prohibits a Singapore company from giving any financial assistance for the acquisition of its own shares, has vexed many lawyers and Companies alike as it is shrouded in much uncertainty. It is problematic mainly because of its indeterminate scope; and this is further complicated by the increasing scepticisms on its underlying rationale which is traditionally thought to be the rule of capital maintenance.

Accordingly, several cases have attempted to delineate the ambit of s 76 and the first notable endeavor was made in Intraco Ltd. v. Multi-Pak Singapore Pte. Ltd [[1995] 1 S.L.R. 313 “Intraco”. After a hiatus of approximately ten years since Intraco, Lew Syn Pau and Wu Yang came to the fore to further clarify the scope of s 76.

The two decisions of PP v Lew Syn Pau [2006] 4 SLR(R) 210 (“Lew Syn Pau”) and Wu Yang Construction Group Ltd v Mao Yong Hui [2008] 2 SLR(R) 350 (“Wu Yang”) are significant in illustrating the nuanced judicial attitudes in determining the scope of s 76. Although both decisions underscore the need to appreciate practical commercial realities in deciding if a transaction falls within the purview of the prohibition, they differ on what should be the rationale underlying s 76.

Rationale of s 76

Recognising that the prohibition in s 76 is “fraught with uncertainty and amenable to reform”, [2] several amendments to existing exceptions have been made, together with the introduction of new exceptions. While these amendments have undoubtedly alleviated the unfortunate state of affairs with respect to s 76, the spirit and intent of s 76 continue to remain elusive.

Although the decisions of the Singapore courts clearly adopt the traditional view that s 76 is concerned with the objectives of capital maintenance and the protection of creditors, [3] it has been suggested that the scope of s 76 is far wider than what is necessary to achieve these objectives. [4] Namely, innocent “provision of representations, warranties and indemnities by target companies and the payment of dividend at the conclusion of a take-over” [5] may potentially fall within s 76.

Thus, the traditional view that the rule of capital maintenance underpins the financial assistance prohibition in Singapore is questionable. And it follows that without even a clear understanding of or a common consensus on the rationale of s 76, one would have to fiddle in the dark in an attempt to determine the scope of s 76.

Lew Syn Pau

Accordingly, I conclude that in order to establish that a company has given financial assistance it will be necessary to establish that there has been a depletion of the assets of the company … But this may not always be sufficient to warrant the conclusion that the transaction is in substance one involving the giving of financial assistance [emphasis in original] …

Menon JC in Lew Syn Pau [6] 

In this case, the learned Sundaresh Menon J.C. affirmed the traditional view that the underlying rationale of s 76 was the rule of capital maintenance: “the legislative objective in enacting s 76… ‘is to ensure that the capital of the company is preserved intact.’ Such statements can illuminate the search for the proper meaning to be placed upon an enactment” [7] [internal citations omitted].

On this premise, Menon JC went on to make important observations on the financial assistance rule; and more importantly, to attempt to limit the catch of s 76 in two ways.

Firstly, through his review of s 76(2) (which sets out the instances of financial assistance within the meaning of s 76), Menon JC made the observation that the “common thread that runs through each of these instances of prohibited assistance and that is that the act in question actually or contingently depletes the assets of the assisting company”. [8] Essentially, Menon JC inferred a requirement that the financial assistance must result in depletion or a risk of depletion of the corporate assets.

Relatedly, Menon JC qualified the earlier requirement of depletion of assets by holding that “this may not always be sufficient to warrant the conclusion that the transaction is in substance one involving the giving of financial assistance” [emphasis in original]. [9] 

Ostensibly, it was recognised that the mere depletion of assets would not ipso facto constitute financial assistance and that a finding of financial assistance would ultimately turn on some other requirement. Indication of this other requirement can be found in Menon J.C.’s orbiter endorsement of Buckley L.J.’s bid to limit the catch of the prohibition:

I note that Buckley LJ in Belmont Finance in fact put forward the tentative view that a company which genuinely entered into a transaction in its own commercial interest and not merely to put the intending purchaser in funds would not be contravening the prohibition. I endorse this. [10] [italic emphasis in original, bold emphasis added]

Further illumination is provided in the preceding statements of this endorsement as Menon J.C. stated: “equally important fact that the company may have entered into the transaction for perfectly good and legitimate commercial reasons” [emphasis added].

Explicably, such a qualification is necessary to prevent legitimate transactions that were made in good faith from becoming “by-catch” of the prohibition where there is a depletion of the assets of the company. In the words of Menon J.C.:

It would neither be desirable from the perspective of promoting legitimate enterprise nor necessary from that of protecting the company and its creditors, since some risk is inevitable in free enterprise, to lean in favour of invalidating such transactions without regard to the real commercial interests that caused the company to enter into the transaction [emphasis added].

This second observation, albeit obiter (as it was found on the facts that there was no depletion of the company’s assets), affirms Intraco v that the key in finding financial assistance was whether it was “bona fide in the commercial interest of the company”. [11] 

In all, Menon JC was of the view that:

It would be wrong then to approach the section in away that would stifle legitimate commercial activity that is in the interests of the very company the section is meant to protect, or that would encourage creative but ultimately pointless efforts to get out of transactions that were entered into in good faith but which turn out later to have been less beneficial than expected, Multi-Pak being perhaps the clearest illustration of this.

Wu Yang

Intent of s 76?

The Court of Appeal in Wu Yang dismissed the proposition (first made in Intraco and later affirmed in Lew Syn Pau) that a transaction could be saved from s 76 by reason only that the transaction was in the commercial interest of the company. Rejecting such a proposition, Chan Sek Keong CJ said of Intraco:

The court appeared to lay down the principle that if an equity-debt swap was in the commercial interests of the target company, s 76(1) of the 1990 CA would not be breached. If that was indeed what the court in Intraco meant, the proposition laid down would be too wide and would also be inconsistent with the language of s 76(1) [emphasis added]. [12] 

Wu Yang corrects the misconception which was occasioned in Intraco and subsequently cited and affirmed in its High Court decision and in Lew Syn Pau. Thus, it is clear from Wu Yang that bona fides and commercial interest could not always excuse a transaction from offending the prohibition of financial assistance.

Additionally, Chan CJ went on to explain that “commercial interest is only relevant in the context of examining the purpose for which the target company enters into a transaction”. [13] He was also of the view that the court in Intraco had confused the “reason” with the “purpose” and had consequently reached the wrong conclusion on the scope of s 76(1). [14] 

Elaborating on the distinction between the purpose of and the reason for a transaction, Chan CJ cited Lord Oliver of Aylmerton in Brady:

The reasons why that course is considered desirable may be many and varied …These may be excellent reasons but they cannot, in my judgment, constitute a “larger purpose” of which the provision of assistance is merely an incident. The purpose and the only purpose of the financial assistance is and remains that of enabling the shares to be acquired and the financial or commercial advantages flowing from the acquisition, whilst they may form the reason for forming the purpose of providing assistance, are a by-product of it rather than an independent purpose of which the assistance can properly be considered to be an incident. [15] 

Thirdly, Wu Yang rejected its High Court holding that “in connection with” in s 76(1)(a) should be read restrictively to be consistent with “for the purpose of”.

In essence, Wu Yang expanded the scope of s 76 which was narrowed in its High Court decision and in the preceding cases. It also implicitly endorsed the two-step approach [16] (that was carried out in Intraco) by approving its application in its High Court decision. Wu Yang (HC) described this two-step process by citing the English High Court decision of Charterhouse Investment Trust Ltd v Tempest Diesels Ltd [1986] BCLC 1:

There are two elements in the commission of an offence under s 54 [of the then UK Act and corresponding, in substance at least, to s 76 of the CA]. The first is the giving of financial assistance and the second is that it should have been given ‘for the purposes of or in connection with’ … a purchase of shares. [17] 

Depletion or risk of depletion of assets

It is said that the requirement of the depletion of assets, whether actual or contingent, is judicial writing as no where in s 76 is it stated that such a depletion is required. However, this rule is questionable when it is considered that Lew Syn Pau, which first pronounced this requirement, was decided on the basis of capital maintenance. Explicably, as mentioned earlier, the nexus between the prohibition of financial assistance and capital maintenance has become increasingly uncertain.

Furthermore, the inference that the depletion of assets is necessary for establishing financial assistance is inconsistent with the interpretation of the equivalent section (section 677) of the U.K. Companies Act 2006. Except for the last description of financial assistance in s 677(1)(d) of the U.K. Companies Act 2006 – “where the company has net assets which are thereby reduced to a material extent” – there is no apparent requirement for the depletion of assets or detriment that can be surmised from the other descriptions. U.K.’s interpretation of the instances within the meaning of financial assistance, does not evidence a requisite depletion of assets to the assisting company. Namely, in the case of Chaston v SWP Group Plc, Arden LJ held that “there were the categories of financial assistance in s.152(1)(a)(i)–(iii) [of the U.K. Companies Act 1985; which contains transactions similarly stated in s 76(2) of the Singapore Companies Act i.e. giving of a guarantee, provision of security] prohibited whether or not there was any diminution of assets” [emphasis added]. [18] 

Hence, the financial assistance could in fact positively benefit (as opposed to detriment) the company providing financial assistance. [19] The defect in the rule of asset depletion is manifest when for instance, a company, to its benefit, gives a loan “where the borrower from the company is a good credit risk and the interest rate is favourable” [20] but it would nonetheless be caught under s 76. Similarly, it has been contended that the provision of a security does not diminish or risk diminution of the company’s assets where the security is unlikely to be implemented. [21] 

Although these innocent transactions may ultimately be absolved from the financial assistance prohibition because it was not “for the purpose of, or in connection with” the acquisition of its shares, it still does not justify having this non-commercially realistic requirement of an actual or risk of depletion of assets. In fact, it underscores the redundancy of such a requirement, since what eventually matters is the substance and reality of the alleged financial assistance. Supporting this, Menon JC in Lew Syn Pau cited Mahoney JA’s judgment in Burton v Palmer, and held that for a provision of warranty to constitute assistance that is “financial” in nature, there must have been an “intention that the company will be called upon to pay damages and to provide funds in connection with the transfer of its shares will contravene the section” [emphasis added]. [22] This highlights the point that it is the purpose/intention that will render a transaction “financial” or otherwise, and not a depletion or risk of depletion of assets.

Similarly, this was acknowledged in Lew Syn Pau where Menon JC said:

In getting to the substance of the matter, there is always a danger that focusing on the fact that the company’s assets might have been depleted, one loses sight of the equally important fact that the company may have entered into the transaction for perfectly good and legitimate commercial reasons rather than to deplete its assets in aid of the intended acquisition of its own shares. [23] [emphasis added]

Although it is now established that it should be the purpose (and not reasons) that determines financial assistance, it still holds sway that there should not be an over-emphasis on a depletion of assets. A fortiori, a depletion of assets should not be a necessary requirement to find financial assistance.

Additionally, it is suggested that the depletion test is meaningless as risk is inevitable in all transactions. Lastly, the test is appreciably flawed when one questions why contingent assets are not taken into account while contingent liabilities are.

While the depletion or risk of depletion of assets should not be necessary, it remains a helpful indication in determining financial assistance.

For the purpose of or in connection with

This paper submits that Wu Yang inappropriately transposed Brady’s distinction between “reason” and “purpose” as the latter was decided on the premise of a purpose exception (i.e. s 153(2) of the U.K. Companies Act 1985 at that time) of which there is no equivalent in s 76 of the Singapore Companies Act. [24] The exception is essentially similar to the later s 678(2) of the U.K. Companies Act 2006 which provides that financial assistance is not prohibited where “the giving of the assistance for that purpose is only an incidental part of some larger purpose of the company and the assistance is given in good faith in the interests of the company [emphasis added].” [25] The purpose exception necessitates object or intention to provide financial assistance; mere financial assistance in connection with as the result of the acquisition is insufficient.

Critically, there was found to be financial assistance in Brady even in the context of a purpose exception. The House of Lords recognized that while the corporate restructuring was for “the best of reasons” (i.e. to break the deadlock between the brothers), it could not be said to be the "larger purpose" of Brady's financial assistance. [26] Such a restrictive interpretation of the “purpose” requirement effectively expanded the application of the prohibition.

Therefore, it is submitted that a fortiori, s 76 – without a larger purpose exception – runs a higher risk of being undesirably over-inclusive. That is, s 76(3) only requires a substantial purpose of the assistance as opposed to a larger purpose; therefore, many innocent transactions might potentially be caught under s 76. Compounding this, s 76(3) provides little assistance in defining “purpose” insofar as it is a tautological provision. Indeed, Lord Oliver in Brady acknowledged the ambiguity of the purpose exception in the U.K. Companies Act as “not altogether easy to construe”; [27] and it follows that s 76(3) is substantially more challenging to interpret.

Unfortunately, Wu Yang, which made the distinction between “purpose” and “reason”, also does not expound on how the distinction could be drawn in reality. Moreover, it is contended that such a distinction is artificial and impractical in commercial activities. [28] 

Lastly, increasing the ambit of the already potentially over-extensive scope of s 76, s 76(4) prohibits financial assistance as long as the company is aware that the financial assistance would result in the acquisition of its shares. Contrastingly, in U.K, the scope of the prohibition was cut down by the removal of “in connection with” that was in s 54 of the Companies Act 1948.

The Way Forward

It is difficult to evaluate if s 76 is useful when the very purpose or policy that is seeks to achieve is obscure. Such uncertainty is illustrated by the diverse approaches to the interpretation and application of s 76. Resultantly and unfortunately, companies and lawyers spend disproportionate amounts of time and resources in ensuring that innocuous transactions do not unwittingly come within the financial assistance prohibition, only to sometimes find themselves still caught by s 76.

Accordingly, it should be considered whether s 76 is still necessary today, given that there are better mechanisms in place to address financial assistance. There are more targeted legal provisions such as the remedies for wrongful trading, directors’ fiduciary duties, improved derivative action remedies, rules on conflicted transactions by directors and their associates, and minority shareholder oppression remedies. [29] Furthermore, where it has been suggested that the rationale for the ban on financial assistance is to prevent bidders or target companies from engaging in price support schemes for their shares, this can be managed by rules concerning market manipulation in the Securities and Futures Act. [30] In this view, it is proposed that we ought to repeal s 76 with regards to the acquisition of shares in private companies, as what UK has done.

Alternatively, s 76 could be reformulated to elucidate a clearer policy direction and to define the conduct which it seeks to prohibit more precisely, and not to further complicate matters by merely adding on to its numerous exceptions. [31] Importantly, the reforms for the prohibition of financial assistance must be able to adapt to and accommodate existing commercial realities.

Particularly, the applicability of the depletion of assets rule warrants a re-examination for reasons stated above. Similarly, the problematic distinction between “purpose” and “reason” requires much exposition in order for it to be meaningful and to convince people that such a distinction is not an artificial and unintelligible one. To this, it has been recommended that a possible reform would be substituting the “purpose rule” in section 76(3) with the larger and principal purpose exceptions in the U.K. Companies Act. [32] While this may not completely resolve the issue, it will in the very least restrain the unnecessarily expanded scope of s 76. It has also been suggested that the “substantial purpose” in s 76(3) could be replaced with “predominant reason” lest an overly restrictive interpretation of the purpose exception (like that in Brady) be adopted. [33] Additionally, the removal of the “in connection with” extension as attempted in the High Court decision of Wu Yang, would effectively and judiciously confine the prohibition’s reach and bring about much-needed certainty to the scope of the prohibition.



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