- Victims of fraud often face an uphill battle in seeking restitution for their loss. While claims grounded in contract, tort, and equity are available to such victims, the reality is that direct enforcement of such claims against fraudsters is difficult, since “fraudsters often end up in jail, and their larceny-riven estates in bankruptcy.” Additionally, the insolvency and liquidation of companies ran by fraudsters further complicates the restitution and recovery process.
- This article examines the impact of insolvency and liquidation on claims involving commercial fraud. In particular, it examines:-
- proofs of debt involving fraud;
- the pari passu principle of distribution in claims involving fraud; and
- how liquidators can recover the company’s assets where there is fraud.
- The insolvency regime in Singapore is governed by the Insolvency, Restructuring and Dissolution Act 2018 (“IRDA”), which came into force on 30 July 2020.
- Commonly, companies associated with fraudulent activities are wound up upon the unravelling of fraud. When a winding up order is made, a moratorium on legal and enforcement proceedings is imposed, and the company’s board of directors becomes functus officio. The authority and duty to run the company falls to the liquidator, whose role is to (i) recover and realise the company’s assets in the most advantageous manner to the company’s creditors and (ii) adjudicate the claims of the creditors and ensure an equitable distribution of the company’s assets in accordance with the provisions of the IRDA. In cases where there is an allegation of impropriety as to the cause of a company’s insolvency, the liquidator’s role takes on the added dimension of an investigator, on top of his administrative function as a collector of assets.
Proof of debt involving fraud
- We first examine how fraud victim’s claims are proven in liquidation.
- The usual course of action is for victims of fraud to submit their proof of debt to the liquidator within the prescribed timelines.
- Generally, claims involving fraud fall within the ambit of “provable debts” defined by S218 IRDA. S218 IRDA states:-“Section 218(3): Demands in the nature of unliquidated damages arising otherwise than by reason of a contract, promise, breach of trust, tort or bailment, or an obligation to make restitution, are not provable in the judicial management or insolvent winding up of a company.”
- However, in order for the proof of debt to be accepted, such claims must be genuinely enforceable against the company, as “only the true liabilities of a company should be met”. As such, where an alleged debt or liability arises from a contract which is vitiated by fraud or illegality thus rendering it unenforceable against the company, this alleged debt of liability is not provable in the company’s liquidation.
- The creditor bears the burden of proving the debt on a balance of probabilities, and the liquidator will assess every proof of debt lodged and may call for further evidence in support of the claim. Critically, in considering a proof, the liquidator has wide powers to consider matters holistically, and for instance is not bound by the audited accounts or audit confirmations entered into by the company, and is entitled to go behind them to determine the veracity of the debt claimed. If there is some reasonable basis to be suspicious about the genuineness of the documents and/or the legal validity of the debt, a liquidator could look behind the documents in its investigations of the companies’ affair.
- Having investigated the matter, the liquidator will then decide to either accept or reject the proof of debt. Claimants who are dissatisfied with the liquidator’s decision may appeal under Section 190 of the IRDA. The general position is that the Court does not readily interfere with a liquidator’s discretion, and will only consider whether the liquidator was acting bona fide or in good faith. However, the threshold for judicial intervention when considering a liquidator’s adjudication of a debt is lower. In MWACapital Pte Ltd v Ivy Lee Realty Pte Ltd (in Liquidation)  SGHC 216 (“MWACapital”), the High Court drew a distinction between the commercial decisions of a liquidator (which would generally be upheld where the liquidator acted bona fide) and quasi-judicial functions. The Court held that:-“ Where a liquidator adjudicates on the validity or quantum of a debt claimed by a creditor, he is not making a commercial decision. He is exercising a quasi-judicial function. If a court’s decision on a similar issue may be set aside on the basis that the decision was wrong, I see no reason why a similar approach should not be adopted for a liquidator’s adjudication.”
- Nevertheless, some ambiguity as to the applicable threshold remains, as the Court in the earlier case of Re Mohamed Yunus Valibhoy, ex parte Bank of Credit and Commerce Hong Kong Ltd  3 SLR(R) 504 differed from MWACapital in accepting a higher threshold (i.e. the bona fides standard) to be met for challenges to a liquidator’s adjudication of claims. It is thus uncertain whether the Court will interfere in an incorrect adjudication, made bona fide, by a liquidator. However, in light of the complexity and value inherent in fraud claims, it is submitted that the Court should apply the standard set out in MWACapital in respect of challenges to a liquidator’s adjudication.
The pari passu principle of distribution and priority
- Assuming that a debt can be proven, the next question relates to the order of priority of the debt.
- The starting point is the pari passu principle of distribution, which is codified in section 172 of the IRDA. The pari passu principle of distribution states that “all persons similarly situated are entitled to equality in treatment in the distribution of the assets of the insolvent company.” Creditors will typically be entitled to a pari passu distribution of the Company’s assets in accordance with their rank. Generally, all unsecured creditors will share ratably in the assets of the company subject to the rights of secured creditors and preferential creditors.
- In this regard, the type of claim the victim brings against the fraudster could alter his priority in insolvency, and consequently, the victim’s potential recovery. As mentioned, claims in contract, tort and equity are available to victims of fraud, depending on the circumstances of the case. However, claimants who seek proprietary remedies (through equity or otherwise) appear to be better placed than claimants who only seek personal remedies.
- For instance, a claimant who succeeds in a claim in contract or tort would generally only be entitled to a personal right of damages against the company. Such a claimant would join the pool of unsecured creditors, who rank after secured creditors and preferential creditors. On the other hand, a claimant who succeeds in a, for example constructive trust claim, would be entitled to proprietary rights over the assets. The imposition of a constructive trust would remove the asset from the insolvent estate, thereby placing the assets beyond the reach of the general body of creditors. Armed with an appropriate judgment, the claimant would be entitled to trace the fraud proceeds, and would rank higher in priority than other unsecured creditors.
- Given the obvious benefits of a proprietary remedy, it was observed that “the insolvency courts in Singapore will undoubtedly continue to be faced with parties attempting to “skip the queue” of creditors by seeking to establish a proprietary remedy over their claims.” Given the scarcity of judicial guidance in this area, there remains much uncertainty on the intrusion of proprietary remedies in a liquidation scenario. Issues which will arise include the competing interests of various creditors, and considerations as to proprietary remedies as tools to effectively circumvent the statutory scheme of distribution.
Recovery and realisation of company’s assets by the liquidators
- Finally, we turn to examine the pool of assets available for distribution to the creditors where a company’s activities have been tainted by fraud.
- In the liquidation of a company tainted by fraud, the pool of assets available for distribution is usually limited. Liquidators usually rely on the usual provisions in such scenarios: the avoidance of transactions made at an undervalue (S224 IRDA), transactions involving unfair preference (S225 IRDA), extortionate credit transactions (S228 IRDA), transactions involving fraudulent trading (S238 IRDA), transactions involving wrongful trading (S239 IRDA) and seeking damages against delinquent officers (S240 IRDA).
- Of particular relevance in the context of commercial fraud is that individuals will be held responsible for the fraudulent trading of a corporate entity. Under S238 of the IRDA, a liquidator could seek to recover the company’s liabilities from any person who was a party to the fraud.
- The liquidator must prove the following under S238 of the IRDA:-
- that the business of the Company has been carried on with intent to defraud the creditors of the Company or of any other person or for any fraudulent purpose; and
- that the defendants were knowingly parties to the carrying on of the business in that manner.
- S238 of the IRDA was recently applied in Tendcare Medical Group Holdings v Gong Ruizhong  SGHC 80. In the case, the company had raised funds for a purported IPO that never existed. Instead, the funds were misappropriated by the company’s director, Mr Gong, using a series of transfers through a separate company, HXTJ. The High Court found that Mr Gong and HXTJ were jointly and severally liable for fraudulent trading, and that they were liable for substantially all the debts of the company in the sum of US$65,207,538.03.
- Additionally, injunctions are also useful in such situations. For instance, in the course of suing the directors for fraudulent trading, the liquidators of Hin Leong successfully obtained a $3.5 billion worldwide Mareva Injunction freezing the assets of the said directors pending the outcome of the suit.
- Of course, the utility of these provisions may well be limited if the directors have absconded, and the ill-gotten gains long dissipated.
- Various challenges arise when a company’s liquidation involves claims tainted with fraud. While there are avenues available under the IRDA for the recovery of assets, the utility of such provisions are usually diminished where fraudulent directors have absconded, or where assets have been dissipated. Nevertheless, a coordinated use of the various avenues, as seen in recent cases against errant directors, will bolster the chances of fraud victims recovering their assets.
PDLegal LLC thanks and acknowledges Practice Trainee Tricia Ong for her contributions to this article.