An "Escape" from Bankruptcy?

Are you at the brink of bankruptcy? Or is there already a bankruptcy proceeding initiated against you? If the answer is yes to either questions, you might have a second chance to “escape” from being declared a bankrupt.

This ‘saving grace’ comes in the form of a pre-bankruptcy rescue mechanism: the voluntary arrangement (“VA”). This mechanism was introduced to the Insolvency Act 1967 in 2017 (“the Act”)[1], and should not to be confused with a corporate voluntary arrangement scheme provided under the Companies Act 2016.

In this article, the author will briefly walk through the process of obtaining a VA, examine its legal effect and weigh the benefits of entering into a VA against its setbacks.

What is a Voluntary Arrangement?

The Act defines the VA as a “composition in satisfaction of a debtor’s debt or a scheme of arrangement of a debtor’s affairs”[2]. In simple terms, the VA mechanism gives debtors the opportunity to negotiate for a debt repayment plan with, and can be activated any time before a debtor is adjudged a bankrupt[3]. It is a second chance to help individuals at the brink of bankruptcy tackle their debts better and hopefully, be debt free in a few years.

However, do note that the VA mechanism does not apply to an undischarged bankrupt and a limited liability partnership[4].

Process of VA

The infographic below simplifies the process of a VA mechanism:

(1) Appointment of a Nominee

A debtor who intends to propose a VA must first appoint a nominee to supervise the implementation of the VA[5]. The nominee will also work with the debtor to formulate and present debt proposals to the creditors. The nominee may be a registered chartered accountant, a lawyer, or other persons as may be determined by the Director General of Insolvency (“DGI”) such as an officer of the Debt Management and Counselling Agency (AKPK)[6].

(2) Application for Interim Order

Next, the debtor must make a court application for a voluntary arrangement interim order, and submit a copy of the same to the DGI[7]. The application consists of two documents[8]:

(i) summons in chambers – found in Form 4 of the Insolvency (Voluntary Arrangement) Rules 2017 (“VA Rules”); and

(ii) affidavit – found in Form 5 of the same VA Rules.

A list of the debtor’s creditors, the estimated debt and copy of nominee’s consent form shall also be exhibited in the affidavit[9].

(3) Interim Order

When the court receives an application for interim order (Step 2 above), the court will ensure that the debtor meets two requirements:

(i) the debtor has not filed a similar application within the last 12 months immediately preceding the date of filing; and

(ii) the nominee is willing to act on the debtor’s proposal[10].

If the above two requirements are met, the court shall make an interim order for VA[11]. The interim order is valid for 90 days only and cannot be further extended[12]. The debtor is required to notify the nominee of the commencement of the interim order within 7 days. Thereafter, the nominee shall within 7 days, notify the debtor’s creditors of the commencement of the interim order[13].

Most importantly, the interim order stays lawsuits filed against a debtor within its 90-day lifespan. No bankruptcy petition, legal proceedings or execution process can be commenced or continued against the debtor, except with the court’s permission[14].

(4) Meeting of Creditors

The nominee must hold a creditors meeting within the 90-day period of the interim order. The purpose of this meeting is to convince the creditors to approve the debtor’s proposal for a VA[15].

The nominee must secure creditors approval by way of special resolution. In other words, more than 50% in number and at least 75% in value of the creditors present, either personally or by proxy and voting on the resolution must approve the proposed VA[16]. However, this creditors meeting shall not affect the rights of secured creditors without their consent[17].

Debtors should be warned that obtaining creditor’s approval by false representation or fraud is a criminal offence. The offence upon conviction, is punishable by imprisonment not exceeding 2 years or fine not exceeding RM5,000 or both[18].

(5) Report of Decisions to Court

After the conclusion of the creditors meeting, the nominee shall report the decision of the meeting to the court[19].

Legal Effects of an Approved VA

Once the VA is approved, it shall bind every person who has notice of and was entitled to vote at the creditors meeting regardless of whether such person was present or represented at the meeting[20]. Of salient, the approved VA binds the creditors. Furthermore, a bankruptcy petition that was previously stayed by the interim order (see step 3) would also be deemed to have been dismissed, unless the court orders otherwise[21].

Additionally, the nominee has the duty to supervise the implementation of the VA. The nominee’s acts, omissions and decisions regarding the implementation of the VA are under scrutiny of the debtor and creditors. Such actions, omissions and decisions are open to review by the courts[22].

If the creditors do not approve the debtor’s proposal, the court may set aside the interim order[23]. The debtor are then exposed to the risks of facing bankruptcy petitions and legal proceedings.

Failure to Comply with VA

A debtor who fails to comply with the obligations under the VA is again, at risk of being adjudged bankrupt. In this event, a creditor bound to that VA may file or proceed with a bankruptcy petition against the debtor[24].

Benefits vs Setbacks

As enticing as a ‘second chance’ or ‘escape’ sounds, it is important to weigh the pros and cons before opting in for a VA. Some benefits that debtors may stand to gain are:

• Pay back only part of your debt: debtors may propose to pay back only an agreed portion of their debt, which of course is subject to creditors’ approval. Debtors might also be able to pay back debts faster if creditors agree to freeze the contractual interest and charges on their debt.

• Legal effect: an approved VA is legally binding. Unsecured creditors (i.e. landlords, credit card companies etc.) who approved the VA cannot take further legal actions to recover their money, apart from what was stipulated in the VA. Only secured creditors who expressed their consensus will be legally bound to the VA.

• Tailored repayment scheme: the VA nominee can assess a debtor’s monthly repayment amount to ensure that repayment is within the debtor’s means.

• Nominee fees: VA Nominee fees are pre-determined and prescribed by law[25]. This allows debtors to have an estimation of expected nominee fees. Notwithstanding that, debtors may be required to pay for costs and out-of-pocket expenses.

Conversely, some hindrance to the VA mechanism includes:

• Weaker re-negotiation power: debtors are left with less repayment or re-negotiation flexibility as they are bound to the terms of the VA once it is approved.

• Disclosure: the Act requires debtors to disclose their assets, creditors, debts and other liabilities to their nominees[26] (e.g. property, vehicles, stock in trade, inheritance, deficiency account etc.)[27]. This information will then be circulated to the creditors prior to the creditors meeting[28].

• Credit score: although uncertain, entering into an individual VA might carry the risk of affecting credit scores.

Conclusion

Unfortunately, bankruptcy cases in Malaysia has been on the rise between 2015 and 2019. To exacerbate the situation, experts are forecasting that the current pandemic triggered economic downturn will be worse than expected. While large corporations has the option to reevaluate their operational viability and implement risk management plans, many individuals are likely at risk of bankruptcy. Entering into a VA can be an avenue to avoid bankruptcy, and may be suitable for those whose debts are piling up and in need of restructuring.

Written by Alyson Phung.

[1] Sections 2A to 2Q of the Insolvency Act 1967 [2] Section 2A of the Insolvency Act 1967 [3] Section 2C(1) of the Insolvency Act 1967 [4] Section 2B of the Insolvency Act 1967 [5] Section 2C(2)(a) of the Insolvency Act 1967 [6] Section 2G(1)(a) of the Insolvency Act 1967 [7] Section 2C(2)(b) of the Insolvency Act 1967 [8] Rule 7 of the Insolvency (Voluntary Arrangement) Rules 2017 [9] Rule 7(2) of the Insolvency (Voluntary Arrangement) Rules 2017 [10] Section 2D(2) of the Insolvency Act 1967 [11] Section 2D(1) of the Insolvency Act 1967 [12] Section 2D(3) of the Insolvency Act 1967 [13] Section 2D(4) and (5) of the Insolvency Act 1967 [14] Section 2E of the Insolvency Act 1967 [15] Section 2I(1) of the Insolvency Act 1967 [16] Section 2 of the Insolvency Act 1967 defines “special resolution” as a resolution decided by a majority in number and at least three-fourths in value of the creditors present personally or by proxy at a meeting of creditors, or in writing, and voting on the resolution [17] Section 2I(3) of the Insolvency Act 1967 [18] Section 2I(5) of the Insolvency Act 1967 [19] Section 2J(1) of the Insolvency Act 1967 [20] Section 2K(1) of the Insolvency Act 1967 [21] Section 2K(3) of the Insolvency Act 1967 [22] Section 2N(2) of the Insolvency Act 1967 [23] Section 2J(2) of the Insolvency Act 1967 [24] Section 2O(1) of the Insolvency Act 1967 [25] Rule 21(2) and Third Schedule of the Insolvency (Voluntary Arrangement) Rules 2017 [26] Section 2I(2) of the Insolvency Act 1967 [27] Rule 9 and Form 7 of the Insolvency (Voluntary Arrangement) Rules 2017 [28] Rule 12(3) of the Insolvency (Voluntary Arrangement) Rules 2017