Singapore Court of Appeal clarifies test for inability to pay debts in winding up proceedings

29 June 2021

In Sun Electric Power Pte Ltd v RCMA Asia Pte Ltd [2021] SGCA 60, the Singapore Court of Appeal clarified that the cash flow test should be the sole and determinative test under section 254(2)(c) of the Companies Act (now section 125(2)(c) of the Insolvency, Restructuring and Dissolution Act 2018 (“IRDA”)) to determine whether a company is unable to pay its debts. The Court of Appeal also provided guidance on issues relating to statutory demands under section 254(2)(a) of the Companies Act (now section 125(2)(a) of the IRDA) including partial payments on statutory demands, and on who should control the conduct of an appeal against a winding up order and at whose cost.

Background

In December 2019, the respondent applied to the Singapore High Court for an order that the appellant be wound up, relying on three grounds. The first ground was section 254(1)(e) of the Companies Act (now section 125(1)(e) of the IRDA), which provided that the court may order the winding up of a company if the company is unable to pay its debts. Among other things, the respondent contended that the appellant should be deemed unable to pay its debts pursuant to section 254(2)(c) of the Companies Act as the appellant was cash flow insolvent and balance sheet insolvent. Section 254(2)(c) provided that a company shall be deemed to be unable to pay its debts if it is proved to the satisfaction of the court that the company is unable to pay its debts; and that in determining whether a company is unable to pay its debts, the court shall take into account the contingent and prospective liabilities of the company.

The second ground relied on by the respondent was section 254(2)(a) of the Companies Act, which provided that where a creditor has served on the company a statutory demand for a debt exceeding S$10,000, the company will be deemed as unable to pay its debts if, within the period of three weeks from the service of the demand, it neglects “to pay the sum or to secure or compound for it to the reasonable satisfaction of the creditor”. The basis of the respondent’s reliance on this ground was the failure of the appellant to pay S$11,500 in costs and interest thereon to the respondent, following a failed application by the appellant for a judicial management order. The appellant paid S$3,000 into the respondent’s solicitors’ client account on the 22nd day after the statutory demand was served, reducing the balance to S$8,568.88 (“Outstanding Costs”).

Lastly, the respondent argued that it would be just and equitable to wind up the appellant pursuant to section 254(1)(i) of the Companies Act (now section 125(1)(i) of the IRDA).

The Judge in the High Court (“Judge”) accepted all three grounds for winding up relied on by the respondent. First, the Judge found that the appellant was unable to pay its debts pursuant to section 254(2)(c) of the Companies Act as the appellant was cash flow insolvent and balance sheet insolvent. Second, the appellant was deemed unable to repay its debts pursuant to section 254(2)(a) of the Companies Act as the appellant had not repaid the Outstanding Costs in spite of the statutory demand. Although the appellant had repaid S$3,000 such that the Outstanding Costs fell below S$10,000, this was not to the reasonable satisfaction of the respondent. The Judge also held that it was just and equitable to wind up the appellant.

In the Court of Appeal, the appellant appealed against the finding that the appellant was unable to pay its debts and against the winding up order. The respondent sought to affirm the Judge’s findings and also raised the new argument that the appellant’s director and its solicitors did not have the authority to act for the appellant in the appeal.

Decision of the Court of Appeal

Test under section 254(2)(c) of the Companies Act

The Court of Appeal agreed with the respondent that the cash flow test should be the sole and determinative test under section 254(2)(c) of the Companies Act for the following reasons:

• First, the plain words of the provision do not envisage two or more different tests being applied but imply only a single test, namely, whether “it is proved to the satisfaction of the Court that the company is unable to pay its debts”. In contrast, where Parliament intended to have separate insolvency tests, it has explicitly stated so in the statute, such as in section 100(4) of the Bankruptcy Act, which explicitly provided for two tests, i.e. that “(a) he is unable to pay his debts as they fall due; or (b) the value of his assets is less than the amount of his liabilities, taking into account his contingent and prospective liabilities”. 
• Second, this interpretation is supported by UK case law. Section 254(2)(c) of the Companies Act was in pari materia with section 518(3) of the UK Companies Act 1985, which was interpreted by the UK courts as requiring a single test of commercial insolvency, which assessed the company’s present capacity to meet its liabilities as and when they became due (not a balance sheet test). It was only when section 123 of the UK Insolvency Act 1986 was enacted that the two separate insolvency tests came about.
• Third, the single test intended by section 254(2)(c) of the Companies Act was not a balance sheet test. The balance sheet test, which compares the company’s total assets with its liabilities, has no direct correlation with whether a company “is unable to pay its debts”. The total assets and liabilities of the company are only relevant insofar as they shed light on the quantum of debts which will soon be due and the quantum of assets which may be realised in the near future. Parliament could not have intended the balance sheet test as the test for section 254(2)(c) of the Companies Act as it is not a good indicator of the company’s present ability to pay its debts.

The Court of Appeal set out a non-exhaustive list of factors that should be considered under the cash flow test. The factors include:

• the quantum of all debts which are due or will be due in the reasonably near future; 
• whether payment is being demanded or is likely to be demanded for those debts; 
• whether the company has failed to pay any of its debts, the quantum of such debt, and for how long the company has failed to pay it; 
• the length of time which has passed since the commencement of the winding up proceedings; 
• the value of the company’s current assets and assets which will be realisable in the reasonably near future; 
• the state of the company’s business, in order to determine its expected net cash flow from the business by deducting from projected future sales the cash expenses which would be necessary to generate those sales; 
• any other income or payment which the company may receive in the reasonably near future; and 
• arrangements between the company and prospective lenders, such as its bankers and shareholders, in order to determine whether any shortfall in liquid and realisable assets and cash flow could be made up by borrowings which would be repayable at a time later than the debts.

Applying the cash flow test and considering the evidence, the Court of Appeal found that there was no reason to disturb the Judge’s findings that the appellant was insolvent.

Observations on section 254(2)(a) of the Companies Act

The Court of Appeal also set out the following observations regarding section 254(2)(a) of the Companies Act:

• The term “to the reasonable satisfaction of the creditor” applied to “secure or compound for it” only, and not to “pay the sum”. 
• A company which makes partial payment of the debt demanded in a statutory demand within the prescribed three-week period such that the remaining amount payable falls below S$10,000 should not be deemed to be unable to pay its debts pursuant to section 254(2)(a) of the Companies Act.

The Court of Appeal reserved its decision on the issue of whether a company will still be deemed to be unable to pay its debts if it pays part of the debt after the expiry of the prescribed period (i.e. three weeks), such that the remaining sum falls below S$10,000.

In light of the above, the Court of Appeal came to no conclusion on whether the appellant could have been wound up pursuant to section 254(2)(a) of the Companies Act. 

Appealing a winding up order

The Court of Appeal held that a company has the right to appeal a winding up order regardless of whether a stay order is granted, and that it is a necessary corollary of the company’s right to appeal that its directors be allowed to control the conduct of the appeal. However, the Court of Appeal was of the view that it is impermissible for the directors and/or shareholders to whittle down the company’s funds to pursue an unmeritorious appeal when these funds should be reserved for payment to the creditors. To address this concern, the Court of Appeal set out two general rules:

• The directors and/or shareholders controlling the conduct of the appeal should expect to pay any costs incurred by the company in prosecuting the appeal out of their own pockets, instead of using the funds of the company. 
• The directors and/or shareholders controlling the conduct of the appeal should also expect to be personally responsible for the payment of any party and party costs awarded in favour of the respondent if the appeal fails. However, the directors and/or shareholders can be given liberty to apply to seek an indemnity from the company.

Reference materials 

 The Court of Appeal judgment is available on the website of the Supreme Court of Singapore www.supremecourt.gov.sg.