Singapore: Covid-19 - Dealing With Counterparties At The Risk Of Insolvency










The COVID-19 pandemic has led to a significant strain in the global markets. As "stay-at-home" orders are implemented globally, many economies have closed off, which has severely impacted numerous businesses. Inevitably, some companies have liquidated and many others are at risk of insolvency. 

We have previously discussed in an article here on how the COVID-19 (Temporary Measures) Act 2020 (the "Act") of Singapore provides temporary relief for financially distressed businesses through increased monetary thresholds for corporate insolvency and a longer time period to satisfy a statutory demand from creditors.

This article discusses and provides an approach for Singapore companies and businesses on the other end of the table on dealing with their counterparts, be they suppliers, customers, debtors or partners facing insolvency risk.

1. Identify the warning signs

Companies should learn to identify early warning signs of financial distress in their counterparties. Early preparation at the first signs of trouble may go a long way to minimise potential losses arising from a counterparty's unexpected insolvency.

Some warning signs are as follows:

  • Repeated payment defaults or delays.

  • Failure to deliver or perform contractual obligations on time.

  • Multiple failed payment attempts – for example, dishonoured cheques.

  • Commencement of legal proceedings against the company as ascertained from public searches.

  • The company's audited accounts suggesting that it may be in financial trouble – for example, failure to file statutory annual accounts or qualified or adverse opinions made by auditors.

  • Difficulty reaching employees or staff of the company.

  • Market surveillance.

  • Other companies in the same industry facing liquidity issues or insolvency events.

These warning signs, alone, may not be conclusive of financial distress. Further, assessment of these warning signs should also be taken in light of the prevailing landscape of the COVID-19 pandemic. For example, a supplier's failure to supply certain goods under a contract may be due to force majeure events, such as unforeseen supply chain delays or intervening government regulations, rather than insolvency. Nonetheless, a cumulative presence of these indicators should set some alarm bells ringing, and the company should start to consider how best to mitigate risks.

It should also be noted that the warning signs frequently manifest in the counterparties’ dealings with the contract managers and operational staff, not necessarily the company’s management. Internal guidelines should be in place to escalate such warning signs to the appropriate managers to appraise the risks once they arise.

2. Consider potential voidable or void transactions and be mindful of forbearance

When a company is aware or has a suspicion that its counterparty may be at risk of insolvency, it should tread carefully in entering into transactions with the counterparty. This will reduce the risk of these transactions being challenged if insolvency proceedings against that counterparty commence. 

Voidable transactions are essentially transactions that can be unwound or reversed, such that any property, money or assets transferred by the company can be 'clawed-back' from the transferee when it files for insolvency proceedings. In Singapore, voidable transactions include the following:

  • Transactions entered into by a company at an undervalue[1] – for example, gratuitous release of debt, gifts or payments to charity.

  • Transactions entered into by a company that unfairly preferences a certain preferred party[2] – for example, payment of a partially secured creditor or payment of an old debt.

It is not every payment made by the debtor to one creditor over another which constitutes undue preference that is subject to claw-back. A transaction actuated only by proper commercial considerations will not constitute a voidable preference. However, this is not a straightforward area of law and care must be taken to minimise allegations of undue preference. 

In addition, any floating charge on the undertaking or property of the company created within 6 months of a winding up application will be invalid.[3] This means, if a company is already close to an insolvency event, seeking security by way of floating charge at this late stage may be futile if the winding up application occurs within 6 months.

The reach of these claw-back provisions is extensive – ranging from 6 months to 5 years before the date of that insolvency proceedings commence, depending on the nature of the transaction. It is therefore important for companies to scrutinise its transactions with a counterparty at the risk of insolvency.

Finally, creditors should be careful when agreeing to a debtor's request to defer, reduce and/or otherwise restructure debts and payments. The legal term for such deferrals is "forbearance" and can be enforceable against the creditor even if the creditor does not get any fresh benefit (consideration) under the forbearance arrangement. Further, it would be prudent for the forbearance arrangement to set out in a written agreement or deed to make clear that any forbearance is temporary and that such forbearance does not constitute a waiver of the creditor's originals rights against the debtor under the original agreement. If a forbearance arrangement is not structured and communicated appropriately, there is a risk of the creditor losing its rights to seek payment after the end of the forbearance period and/or being embroiled in satellite litigation as to the resumption of its right (if any) to seek such repayment.

3. Assess your options under contract

It is not uncommon for contracts in Singapore to provide for express termination right in the event the counterparty commences insolvency proceedings. Alternatively, a contract may also be terminated if the counterparty breaches a contract, and that breach "deprives the innocent party of substantially the whole benefit which it was intended to obtain from the contract"[4]. However, even though termination is a contractual possibility, exercising the right of termination may not always be the solution. For instance, if a distressed counterparty is a key supplier or customer that is facing temporary financial pressures but which may still represent a valuable business proposition in the medium to longer term. In such cases, it might be useful to first consider renegotiating contractual terms to secure as much of the counterparty's obligations under the contract as possible and allow the financially distressed counterparty to rehabilitate.

It is also noteworthy that there will soon be changes to Singapore's insolvency laws that will affect a party's rights to deal with its counterparty after insolvency proceedings have commenced. The Insolvency, Restructuring and Dissolution Act 2018 (No. 40 of 2018), which has been passed but is not yet in force, will prohibit a person from, amongst others, terminating or amending any agreement with the counterparty after the commencement of insolvency proceedings against that counterparty, if such termination or amendment was only because (a) such insolvency proceedings are commenced against the counterparty or (b) that the counterparty is insolvent.[5] It is therefore important that any renegotiations (or contractual termination) be done early and quickly.

4. Defensive mechanism

In addition to renegotiating contractual terms, a company may consider other defensive mechanisms to secure receivables when its counterparty faces impending insolvency.

A company may consider the following options:

  • Purchase insurance on its accounts receivables, so that it may be reimbursed for the insured receivables that cannot be collected when the counterparty defaults.

  • Sell its accounts receivables to a third party, usually at a discount, to pass the credit risk of the counterparty's insolvency to a third party and allow the company to recoup a proportion of its receivables. The company should also consider whether the contract with the counterparty allows reassignment of receivables, or whether the counterparty's consent is required to do so.

  • Obtain personal bonds or guarantees from key persons, such as the directors of the counterparty, though the company should consider whether these key persons are of sound financial standing and capable of fulfilling their obligations thereunder. It is also possible to take security over personal property belonging to such persons.

Not all of the above defensive mechanisms are feasible, depending on the situation at hand, and it is best to adopt a nuanced approach in dealing with a counterparty at the risk of insolvency.

5. Strategy in insolvency proceedings

While the Act may have increased monetary thresholds for corporate insolvency and imposed a longer time period to satisfy a statutory demand from creditors, it does not preclude a creditor from commencing winding up proceeding against a corporate debtor.

First, a creditor can still commence winding up proceedings against a corporate debtor if that company owes S$100,000 or more to the creditor.

Second, the failure to satisfy a statutory demand simply creates a presumption that the corporate debtor is unable to pay its debts. Without such a deeming provision, a creditor is still entitled to prove actual insolvency on the debtor's part. It is thereby not restricted by the Act's new 6 months' time limit (instead of the previous 3 weeks) to satisfy a statutory demand. A company is said to be insolvent if it has failed to meet a current demand for a debt already due (cash-flow insolvent) or where there is a deficit on its overall balance of liabilities against assets (balance sheet insolvent).

Insolvency proceedings can also be a strategic tool to ensure that all unsecured creditors share pari passu and that a corporate debtor's assets are not dissipated through court litigation. After the winding up application is made, the debtor company, its creditors or its shareholders may apply to restrain any pending proceedings against the company. Once the winding up order is made, no action against the company may be commenced or continued without the leave of the court.

Even if another creditor has obtained a court judgment against the debtor, that judgment creditor will still remain an unsecured creditor that ranks pari passu with other unsecured creditors. This will be so unless the judgment creditor is able to complete fully any attachment process (e.g. garnishiee proceedings or writ of seizure and sale). Parenthetically, creditors should also be mindful of certain statutory priority debts in winding up.[6]

Creditors should note that there are statutory provisions which make void any payment which is made by a debtor company in the period between the presentation of a winding up petition and the date which the company actually goes into liquidation.[7]

This is designed to prevent a company from trading and dissipating its assets when there is a winding up application that is outstanding. Practically, however, if the debtor company makes a payment to the creditor after the presentation of a winding up application but prior to its entry into liquidation, such a payment would be void but the burden would be on a subsequently appointed liquidator to challenge the payment. At that stage it would still remain open to the creditor to seek the Court's validation of the payments to it.

Crucially, impugned payments may be validated if it were made and received in good faith in the ordinary course of business, and where the recipient did not have actual notice of the winding up of the debtor company each time the payments were made.

Conclusion

In the current economic climate, it is not uncommon to face a counterparty that is at the risk of insolvency. However, early identification of warning signs coupled with a quick and calibrated approach in dealing with the distressed counterparty can go a long way in managing risks and avoiding losses.

For further information, please contact:act:

Sandra Seah, Partner, Bird & Bird

susan.seah@twobirds.com





[1] Section 89 of the Bankruptcy Act (Cap. 20) read with section 329(1) of the Companies Act (Cap. 50)

[2] Section 99 of the Bankruptcy Act (Cap. 20) read with section 329(1) of the Companies Act (Cap. 50)

[3] Section 330 of the Companies Act (Cap. 50)

[4] RRDC Concrete Pte Ltd v Sato Kogyo (S) Pte Ltd [2007] SGCA 39

[5] Section 440 of the Insolvency, Restructuring and Dissolution Act 2018 (No. 40 of 2018)

[6] See Section 328(1) of the Companies Act (Cap. 50)

[7] Section 259 of the Companies Act (Cap. 50)

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