GRANT OF SECURITY FOR THE EXISTING INDEBTEDNESS OF THIRD PARTY: TRANSACTION AT UNDERVALUE?
The Court of Appeal in Rothstar Group Ltd v Leow Quek Shiong and other appeals [2022] SGCA 25 had the opportunity, for the first time, to consider whether the grant of security for the existing indebtedness of a third party can constitute a transaction at an undervalue within the scope of Section 98 of the Bankruptcy Act (Cap 20, 2009 Rev Ed) (“BA”).
Facts. This case concerned a loan agreement dated 9 April 2019 (“the Loan Agreement”) between Agritrade International (Pte) Ltd (“AIPL”) and Rothstar Group Limited (“Rothstar”), where Rothstar agreed to extend a loan of $5m (“the Loan”) to AIPL (at [6]).
Mr. Ng Say Pek (“NSP”) and his son were the only two shareholders and directors of AIPL (at [4]). NSP was also the sole shareholder and one of the two directors of Pictorial Development Pte Ltd (“Pictorial”), with the other director being his wife.
A residential property that was NSP’s family home (“the Property”) was 99% owned by Pictorial, with the remaining 1% owned by NSP in his own name (at [5]).
As security for the payment and discharge of the Loan, AIPL procured for NSP and Pictorial to grant an equitable mortgage over the Property (“the Equitable Mortgage”) to Rothstar as security for the fulfilment of AIPL’s obligations under the Loan Agreement (at [6]).
When AIPL failed to make repayment of the Loan by the date stipulated under the Loan Agreement, the deadline for the repayment of the Loan was extended twice (at [7]). After the second extension, Rothstar, AIPL, Pictorial and NSP entered into a Deed of Discharge and Termination (“the Deed of Discharge”), under which the Equitable Mortgage was terminated in consideration of NSP and Pictorial agreeing to grant a legal mortgage over the Property to Rothstar. NSP and Pictorial executed the legal mortgage (“the Legal Mortgage”), as security for all sums due and payable by them and/or AIPL to Rothstar. The Legal Mortgage was then registered.
Thereafter, NSP absconded from Singapore and AIPL failed to repay the Loan (at [8]).
AIPL and Pictorial were eventually wound up (at [9]). The Liquidator of Pictorial and the Private Trustees of NSP lodged caveats against the Property.
The Liquidator and the Private Trustees applied for the Legal Mortgage to be set aside on the ground that it was a transaction at an undervalue or a voluntary conveyance to defraud creditors, and for Rothstar to deliver vacant possession of the Property to them (at [10]). In response, Rothstar applied for the Private Trustees to show cause as to why the Private Trustees’ Caveat should not be removed.
As the winding up and bankruptcy applications against Pictorial and NSP respectively were made, and the Legal Mortgage was granted, before the Insolvency, Restructuring and Dissolution Act 2018 (Act 40 of 2018) (“IRDA”) came into operation, the pre-IRDA versions of the BA, the Companies Act (Cap 50, 2006 Rev Ed) (“CA”) and the Conveyancing and Law of Property Act (Cap 61, 1994 Rev Ed) (“the CLPA”) are the applicable statutes (at [11]).
Issues. The issues on appeal were (at [17]):
“(a) First, whether the Legal Mortgage should be set aside on the ground that it was a transaction at an undervalue within s 98 of the BA. This in turn raises three sub-issues:
(i) whether the Legal Mortgage was granted at an undervalue (including whether and when the grant of security for an existing debt can constitute a transaction at an undervalue);
(ii) whether Pictorial and NSP were insolvent at the time of, or became insolvent as a result of, granting the Legal Mortgage; and
(iii) the appropriate order that should be made under s 98(2) of the BA.
(b) Second, whether the Legal Mortgage was a voluntary conveyance to defraud creditors under s 73B(1) of the CLPA.
(c) Third, whether the Private Trustees’ Caveat ought to be removed.”
This article will focus only on the first issue “which lies at the heart of these appeals” (at [18]).
Whether Legal Mortgage was granted at an undervalue. This turned on the proper interpretation and requirements of s 98(3)(c) BA (at [21]).
Leaving aside s 98(3)(b), which deals with transactions entered into in consideration of marriage, s 98(3) provides as follows (at [22]):
“Transactions at an undervalue
(3) For the purposes of this section and sections 100 and 102, an individual enters into a transaction with a person at an undervalue if —
(a) he makes a gift to that person or he otherwise enters into a transaction with that person on terms that provide for him to receive no consideration;
…
(c) he enters into a transaction with that person for a consideration the value of which, in money or money’s worth, is significantly less than the value, in money or money’s worth, of the consideration provided by the individual.”
(Emphasis by Court of Appeal)
The Court of Appeal added that (at [23]):
1. S 329(1) CA extends the application of these principles to companies; and
2. In cases to which the IRDA applies, the analysis should apply equally to transactions at an undervalue under ss 224 (for companies) and 361 (for individuals) of the IRDA.
As between subsections (a) and (c), the Court of Appeal stated that (at [24]):
“Whereas s 98(3)(a) is concerned only with the existence of consideration in the contractual sense, s 98(3)(c) expressly requires a comparison of value between the consideration provided and the consideration received.”
(Emphasis by Court of Appeal)
In undertaking the comparison of value stipulated under s 98(3)(c), two points are key.
First key point. The value comparison exercise must be undertaken from the perspective of the grantor (i.e., the insolvent individual or company) (at [25]).
1. For the purposes of protecting the grantor’s creditors, what is crucial is a diminution in the value of the grantor’s assets.
2. Therefore, the material comparison is between the value received by the grantor and the value provided by the grantor, not the value received or provided by any other party.
3. While the consideration need not have been received by the grantor directly, the value relevant under s 98(3)(c) is the value of that consideration insofar as it accrues to the grantor (at [26]).
4. However, the fact that the value comparison exercise is undertaken from the perspective of the grantor does not mean that the grantor’s mere perception of value will suffice (at [29]).
5. There is no basis in the language of s 98(3)(c) BA for the grantor’s perception of value, whether objectively or subjectively assessed, to be taken into account.
6. Such an approach would also undermine the policy object of s 98 of protecting the grantor’s creditors against a diminution of the grantor’s assets.
7. What matters for this purpose is the actual value received and provided by the grantor.
8. In this regard, this is different from s 99 BA where the party who gives an unfair preference must have been influenced by a subjective desire to prefer the recipient.
Second key point. S 98(3)(c) BA requires both the value of the consideration provided and the value of the consideration received by the grantor to be assessed “in money or money’s worth” (at [30]).
1. In the assessment of value in money’s worth, the Court of Appeal provided a few illustrative examples (at [30] – [33]).
2. These non-exhaustive examples illustrate the general point that the value of the consideration must be quantifiable in monetary terms, even if the precise monetary value of the consideration cannot be immediately determined with certainty (at [34]).
3. Abstract or intangible forms of value which cannot be quantified in monetary terms are of no value to the grantor’s creditors upon its insolvency, and as such have no place in the value comparison exercise.
4. Further, where the value of the consideration is precarious or speculative, some evidence will be needed to establish and quantify its value in monetary terms in order to undertake an objective comparison.
Grant of security for an existing debt. The Court of Appeal expressed preference to adopt the principle in Re MC Bacon Ltd [1990] BCLC 324 (“MC Bacon”) as part of Singapore law over the approach in Hill v Spread Trustee Co Ltd and another [2007] 1 WLR 2404 (“Hill”): the grant of security for the grantor’s existing debt will not, in principle, constitute a transaction at an undervalue (at [35] – [39]).
In this regard (at [40]):
“The principle in MC Bacon has been followed in the UK … It has also received academic support. As Goode explains, the grant of security for a previously unsecured loan is not a transaction at an undervalue because it “does not reduce the net assets of the company but merely attaches an existing liability to an existing asset, leaving the net balance sheet figures unchanged” [emphasis added]. Instead, because its effect is “simply to allocate the asset given in security to a particular creditor instead of leaving it available for creditors generally”, it will be more appropriate to examine the impugned transaction in the context of the principles governing unfair preferences (Goode at para 13–35). Another perspective from which to view this is that, even though the grant of a security interest has value to the chargee (who is placed in a better position on the grantor’s insolvency), there is “no transfer of value” from the grantor’s point of view because its “net position is the same”: prior to the grant of the charge, the company is liable to have its assets seized by execution if it defaults on the underlying debt; and after the charge is granted, it remains liable to have them seized by enforcement of the charge (Bennett & Armour at para 2.91). …”
(Emphasis by Court of Appeal)
The Court of Appeal also stated two further reasons for declining to adopt Arden LJ’s approach in Hill (at [41]), while noting that the common denominator to the approaches taken in MC Bacon and Hill is that a comparison of value must be undertaken (at [42]).
On the other hand, where the relevant security is granted in respect of a third party’s existing debt, the principle in MC Bacon cannot be applied because the grant of the security would reduce the net assets of the grantor (at [43]), which can, in principle, constitute a transaction at an undervalue under s 98(3)(c) BA (at [45]).
Application to the facts. The Court of Appeal stated that the value provided by Pictorial and NSP was twofold (at [47]):
1. First, Pictorial and NSP granted the Legal Mortgage over the Property to Rothstar. This did deplete their assets because the existing debt secured by the Legal Mortgage was a debt owed by a third party (AIPL) and not by Pictorial and NSP themselves.
2. Second, on a proper construction of the terms of the Legal Mortgage, Pictorial and NSP assumed a new primary obligation to repay the Loan which had not been present under the earlier Equitable Mortgage, and which was not contingent on the value of the Property being insufficient to fully discharge the Loan. So Pictorial and NSP gave Rothstar the benefit of an additional personal obligation to repay the Loan which they assumed, secured by the Legal Mortgage, and which gave Rothstar personal claims against them in their insolvency.
As for the value received by Pictorial and NSP (at [48] – [50]):
1. The Loan was indeed disbursed by Rothstar to AIPL (at [48]).
2. The Court of Appeal disagreed with the decision below that the only consideration provided for the Legal Mortgage was the discharge of the Equitable Mortgage under the Deed of Discharge, and not the Loan.
3. The reality of the parties’ arrangement was that both the Equitable Mortgage and the Legal Mortgage that replaced it were granted by Pictorial and NSP in consideration of the Loan extended by Rothstar to AIPL.
4. In considering what the value of the Loan to APIL was to Pictorial and NSP, the Court accepted in principle “that the value of commercial or practical benefits can be taken into account in the value comparison exercise under s 98(3)(c) of the BA in so far as such value is capable of being measured in money or money’s worth”, but on the facts, the alleged benefit was “unparticularised and unsubstantiated … said to accrue to Pictorial and NSP merely by dint of their association with AIPL … such an amorphous benefit (if any) cannot be valued in money or money’s worth, and therefore has no place in the value comparison exercise.” (at [49]; emphasis by Court of Appeal).
5. The Court further stated that “Even if this amorphous benefit could be ascribed value for the purposes of the value comparison exercise, this value would be attenuated by the holding structure of AIPL. While AIPL’s only two directors and shareholders were NSP and his son, with NSP holding approximately 40% to 50% of AIPL’s shares, any indirect value of the Loan to NSP would still be far less than its face value as it would be shared between NSP and his son, instead of accruing solely to NSP. Any value derived by Pictorial from capital injections which might then have been made by NSP would have been even further diminished.” (at [50]; emphasis by Court of Appeal).
Therefore, the Court of Appeal concluded that there is no value received by Pictorial and NSP in money or money’s worth which can be compared with the significant value provided by them, so the Legal Mortgage was a transaction at an undervalue under s 98(3)(c) BA (at [51]).
Instead of finding that the Legal Mortgage was void (as the decision below), the Court of Appeal made an order to discharge the Legal Mortgage with prospective effect to restore the position to what it would have been if Pictorial and NSP had not granted the Legal Mortgage (at [60] – [61]).
Significance. This decision is helpful to show how the value comparison exercise under s 98(3)(c) BA (and its IRDA equivalent) should be analysed.
In this regard, the grantor’s perception of the value is not relevant. This is in line with the policy of protecting the creditors against a diminution of assets, which is concerned with the actual value received and provided by the grantor.
Most importantly, this decision also makes clear that while the grant of security for the existing indebtedness of one’s own debt will not, in principle, constitute a transaction at an undervalue, the grant of security for the existing indebtedness of a third party’s debt can.
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