Zenrock’s creditors, which it has been revealed are owed over US$165 million, have sought to place the company under judicial management (JM), a Singapore pre-insolvency regime where an independent manager is appointed by the court to run the affairs of a financially distressed company. Following an application by its creditors on 8 May 2020, Zenrock was placed under ‘interim’ judicial management (IJM). An application for the full-fledged JM is scheduled to be heard on 21 May 2020.
Further details of Zenrock’s IJM and imminent JM are available at straitstimes.com.
As with all distressed commodities traders, placement under IJM and then JM will trigger concerns for counterparties with open trading positions. Should counterparties continue to perform or require performance under their contracts? Can they terminate their contracts on the basis of the supervening insolvency event?
This client alert considers the meaning of a company’s placement under IJM and JM under Singapore law. It then considers the effects of insolvency on a counterparty’s right to terminate a contract, under both Singapore and English law (a common contract-governing law). This last issue is very much a hot topic in the insolvency world, and companies should watch out for legislative changes under way, as also outlined in this client alert.
Singapore’s judicial management regime
A company will be placed under JM either by its own application or its creditors’. From the date of the application a moratorium will be automatically granted, preventing, amongst other things, the commencement of legal proceedings against the company.1 A judicial manager will be brought in to take control of the company and propose a plan to restructure or compromise the company’s debts and obligations with its creditors. This plan will have to be formulated in line with the statutory objectives of judicial management, namely to achieve (i) the survival of the company, or the whole or part of its undertaking, as a going concern; (ii) the approval of a compromise or arrangement between the company and any such persons (e.g., creditors) as are mentioned in the relevant section of the plan; or (iii) a more advantageous realisation of assets than would be effected on a winding up.
Interim judicial management
Before the JM application can be heard, a first application is often taken out for the company to be placed under IJM – typically by creditors moved by a sense of urgency to preserve the company’s assets. This is in effect an application to place the company under judicial management in the period pending the hearing for the JM application.
The court has wide discretion to place a company under IJM, “if the Court sees fit”.2 Circumstances where the court would agree to place a company under IJM include:
- where the company’s assets or business are at risk of being dissipated or deteriorated;
- where the court considers that interim judicial managers would be better placed to continue the company’s affairs so as to safeguard its and its creditors’ interests; or
- where there is evidence that the company has behaved fraudulently at its creditors’ expense.
Once an IJM application is granted, the company is managed and controlled by interim judicial managers appointed by court order. Their powers and duties will be as specified in the court order of appointment. In most instances, the interim judicial managers will be given the same broad powers as are usually conferred to judicial managers.3 In addition, the automatic moratorium will come into place and remain until the JM application is heard.
An IJM and a JM have the same effects in terms of transferring the company’s management to the judicial managers. The company’s board of directors becomes functus officio, and all functions and powers are transferred to the judicial managers.
Once a company is placed under JM proper, the automatic moratorium over the company is extended to last so long as the company remains under JM.4 A company’s placement under JM will also kick-start various obligations for the judicial managers which interim judicial managers do not have, such as:
- sending a statement of proposal to the court registrar, setting out how it is intended for the company to achieve the purposes of the JM (the Proposal).5
- presenting such Proposal at a meeting of the company’s creditors within 60 days of the JM being ordered;6 and
- sharing the Proposal with the company’s shareholders.7
The judicial managers do not have the power to disclaim contracts, although they may choose to adopt them or not, in the latter case, opening the counterparty to a potential claim for damages against the company.8 The judicial managers have a period of 28 days from when the JM has been ordered to review the company’s existing contracts to that effect, during which time they are not taken to have adopted any contract by reason of anything done or omitted.
Separately, the judicial managers may set aside certain transactions entered into by the company, including those that constitute an unfair preference or a transaction at an undervalue.9
The JM will remain in force for a period of 180 days from the day it is ordered, unless extended by the court.10
The effects of insolvency on contractual obligations governed by English law
Where a company is subject to an insolvency event such as its placement under IJM or JM, its counterparties will often want to protect their business interests by terminating their contracts with live obligations. The principal risk is that of non-performance, and a failure to deliver or to take delivery in particular. All the more where they are unsecured, claims against an insolvent company may have very little commercial worth.
There is no common law right for a party to terminate a contract for reasons of its counterparty’s insolvency. For this reason, contracts will invariably include a clause allowing a party to terminate the contract upon an insolvency event affecting its counterparty (an Insolvency Termination Clause).
A typical Insolvency Termination Clause would read along the following lines:
“Without affecting any other right or remedy available to it, either party may terminate this agreement with immediate effect by giving written notice to the other part if:
- the other party suspends, or threatens to suspend, payment of its debts or is unable to pay its debts as they fall due or admits inability to pay its debts; or
- the other party commences negotiations with all or any class of its creditors with a view to rescheduling any of its debts, or makes a proposal for or enters into any compromise or arrangement with any of its creditors; or
- a petition is filed, a notice is given, a resolution is passed, or an order is made, for or in connection with the winding up of the other party; or
- an application is made to the court, or an order is made, for the appointment of an administrator, or an administrator is appointed over the other party.”
Typical examples include clause 68.1.1 of the BP Oil International Limited general terms & conditions for sales and purchases of crude oil and petroleum products 2015 edition (or clause 26 of GAFTA’s Contract No.100).
A close reading of the Insolvency Termination Clause will determine the precise trigger for a party’s right to terminate the contract. A careful factual analysis will also be required, as the wrongful termination of a contract would constitute a repudiatory breach by the party seeking to rely on the Insolvency Termination Clause, and open the other party’s right to termination and damages.
Whether an Insolvency Termination Clause is valid and enforceable, however, is subject to much discussion and varies considerably between jurisdictions. This is because it may effectively undermine the viability of the business which the insolvency process may be seeking to preserve.
The current position under English law is that Insolvency Termination Clauses are valid and enforceable. In particular:
- The English court has found that an administration moratorium does not prohibit the serving of a contractual termination notice on the party under moratorium, which moratorium prevents, rather, the commencement of proceedings and the enforcement of security.11
- The English court has gone further and upheld a party’s right to serve a contractual termination notice on a party that is subject to foreign insolvency proceedings, even though such termination would be inoperative or invalid under the law governing the insolvency itself.12
- There are certain narrowly defined instances where an Insolvency Termination Clause may be invalidated under English law, such as in a contract for the supply of essential services (e.g., utilities or IT services).13
Importantly, a party may lose its right to enforce an Insolvency Termination Clause should it fail to exercise its right relatively swiftly following the occurrence of the insolvency event. Under English law, where the right has opened to a party to terminate a contract, it is required to exercise that right or, instead, affirm the contract. Affirmation can be inferred from a party’s actions, typically if it continues to perform and/or demand its counterparty’s performance. The trigger for the requirement to affirm or terminate is the knowledge of the right opening up. English law on this issue ties together principles of waiver (where the party has waived its ability to rely on its contractual right) and equitable estoppel (where the party has led the other party, by its actions, to believe that it will not terminate the contract, in circumstances such that it would be unfair to allow that party to go back on its word).
Commercially, a party may want to give some thought as to whether to affirm or terminate the contract. It may want to write to its counterparty and reserve its right to terminate the contract. Whilst this may buy it some time, in reducing the risk of having waived its right to terminate, it will not, however, remove the risk entirely.
Other than in reliance on its contractual right to terminate the contract, a party may seek to argue that an insolvency event affecting its counterparty constitutes an ‘anticipatory breach’ of the contract, opening its right to terminate the contract at law. Reliance on an anticipatory breach would require the demonstration that its counterparty has clearly demonstrated an intention to renounce the contract and to not perform it in some essential respect. Importantly, it is a long-lasting principle of English law that insolvency in itself will not amount to the renunciation of a contract.14 Positive evidence of an intention not to perform would be required.
The effects of insolvency on contractual obligations governed by Singapore law
The position under Singapore law is broadly similar to that under English law, and Insolvency Termination Clauses purport to operate in a similar way as described above.
Insolvency Termination Clauses are enforceable, and a party seeking to rely on its counterparty’s insolvency to terminate its contract would be required to do so fairly swiftly. The trigger for the requirement to either affirm or terminate the contract is the knowledge of the facts giving rise to the right to terminate.15
A failure to unequivocally terminate the contract, or acting in a manner inconsistent with having terminated the contract, may result in a finding that the contract was in fact affirmed.16 However, the Singapore courts have cautioned that an election has to be made in clear and unequivocal terms before it is found to bind the parties (even where such an election is implied).17
As under English law, a party’s insolvency will not in itself be deemed to amount to an anticipatory breach of the contract. In a recent decision, however, the Singapore Court of Appeal considered circumstances in which a party’s (or its closely-linked parent’s) insolvency may evidence an anticipatory breach, in particular where the contract has become impossible to perform. In this case the party would have been prevented from making timely payment under a bunker supply contract. The court emphasised, however, that each case should be considered independently and on its own facts.18
Imminent insolvency reforms in the UK affecting contractual termination rights
The COVID-19-related economic crisis has hastened the UK government’s plans to reform the corporate insolvency regime under the Insolvency Act 1986. As announced on 28 March 2020,19 the proposed reforms will implement the government’s plans following a 2018 consultation,20 and will include new restructuring and temporary moratorium procedures. For further analysis of the proposed reforms, please see our previous alert.
Importantly, the reforms seeks to broaden the range of supplies and services that are protected from an Insolvency Termination Clause, in addition to the existing ‘essential services’ exception referred to above. The reforms would apply to existing supply contracts, as well as contracts entered into after the reforms are implemented. Following the reforms, the supplier in a contract for the supply of goods and services may be prevented from relying on an Insolvency Termination Clause to terminate the contract, albeit with narrow exceptions, and it is anticipated that certain contractual relationships and counterparties will be excluded from the scope of the restriction. It is presently unclear when the reforms will be implemented, although the UK government announced that the legislation required to introduce the reforms would be introduced in Parliament “at the earliest opportunity”. We expect the draft legislation to be published within the coming weeks, and we will report on its contents in due course.
Imminent insolvency reforms in Singapore affecting contractual termination rights
Singapore is making a similar move towards restricting the effectiveness of Insolvency Termination Clauses.
The Insolvency, Restructuring and Dissolution Act 2018 (IRDA) is the latest piece of insolvency legislation to have been introduced in Singapore. Although the IRDA received the president’s assent on 31 October 2018, it is yet to be gazetted, as the final step for it to have force of law in Singapore.
Amongst other key reforms which it will introduce, the IRDA will restrict the ability of a contractual party to enforce an Insolvency Termination Clause. In particular, where a company enters into a JM, a scheme of arrangement or any other insolvency-related proceedings, its counterparties may no longer “terminate or amend, or claim an accelerated payment or forfeiture of the term under, any agreement (including a security agreement) with the company; or terminate or modify any right or obligation under any agreement (including a security agreement) with the company”, by reason only of the insolvency event affecting the company.21
Importantly, the IRDA has sought to carve out certain types of contracts to which the restriction on the effectiveness of an Insolvency Termination Clause would not apply. These include “any eligible financial contract as may be prescribed” (clarification of which is awaited), “any contract that is likely to affect the national interest, or economic interest, of Singapore, as may be prescribed” and “any commercial charter of a ship”.22
We will provide an update once the IRDA becomes Singapore law and relevant secondary legislation implementing the IRDA is proposed.
For some time now the use of Insolvency Termination Clauses has been a controversial feature of parties’ freedom of contract. This is because the termination of key contracts with an insolvent company will often disrupt the insolvency process, and undermine the ability of the company to be rescued. It may appear somewhat inconsistent for a moratorium to restrict the enforcement of security or the commencement of proceedings, but not the termination of contracts that are key to the insolvent company’s survival.
Legislation restricting the effectiveness of Insolvency Termination Clauses already exists in the United States and was recently implemented in Australia, in 2017. It is unsurprising that the UK and Singapore are moving in a similar direction, all the more so with the COVID-19 crisis centring the governments’ focus on rescuing companies under financial distress.
Reed Smith LLP is licensed to operate as a foreign law practice in Singapore under the name and style, Reed Smith Pte Ltd (hereafter collectively, "Reed Smith"). Where advice on Singapore law is required, we will refer the matter to and work with Reed Smith's Formal Law Alliance partner in Singapore, Resource Law LLC, where necessary.
- Section 227C of the Companies Act (Cap.50).
- Section 227B(10) of the Companies Act (Cap.50).
- Eleventh Schedule to the Companies Act (Cap.50).
- Section 227D(4) of the Companies Act (Cap.50).
- Section 227M(1) of the Companies Act (Cap.50).
- Section 227M(1) of the Companies Act (Cap.50).
- Section 227M(2) of the Companies Act (Cap.50).
- Section 227I of the Companies Act (Cap.50).
- Sections 98 and 99 of the Bankruptcy Act (Cap.20) read with Sections 329 and 227T of the Companies Act (Cap.50).
- Section 227B(8) of the Companies Act (Cap.50).
- Re Olympia & York Canary Wharf Ltd  BCC 154.
- Fibria Celulose S/A v. Pan Ocean  EWHC 2124 (Ch).
- Section 233A of the Insolvency Act 1986.
- Morgan v. Bain (1874) LR 10 CP 15.
- Strait Colonies Pte Ltd v. SMRT Alpha Pte Ltd  2 SLR 441.
- Jurong Town Corp v. Wishing Star Ltd  3 SLR(R) 283.
- Jurong Town Corp v. Wishing Star Ltd  3 SLR(R) 283.
- The “STX Mumbai”  3 SLR 111.
- Available at www.gov.uk/.
- See the UK government’s response to the 2018 consultation at www.gov.uk/.
- Section 440(1) of the IRDA.
- Section 440(5) of the IRDA.
Client Alert 2020-326