Malaysia: High Court finds that arbitral tribunal has jurisdiction to determine insolvency set-off

In UDA Land Sdn Bhd v Puncak Sepakat Sdn Bhd [2020] MLJU 892, the High Court was required to determine whether an award should be set aside because the sole arbitrator (“Arbitrator”) wrongly concluded that it had no jurisdiction to determine a counterclaim and insolvency set-off raised in the arbitration.  The High Court set aside the award on the basis that the Arbitrator made an error of law in finding that it had no jurisdiction to hear the counterclaim and set-off.

Background

In January 2010, UDA Land Sdn Bhd (“UDA”) appointed Puncak Sepakat Sdn Bhd (“Puncak”) as its main contractor to carry out and complete a housing project in Hulu Langat, Selangor ( “Project”).  In April 2011 and prior to the completion of the Project, Puncak was wound up by a third party.  This led to UDA terminating Puncak’s appointment and the subsequent appointment of a substitute main contractor to complete the Project which caused UDA additional expense.

In June 2013, UDA claimed for losses of RM7,140,877,03 from Puncak as a result of additional costs incurred in having the Project completed by the substitute main contractor.  In October 2013, Puncak disputed the claim and referred its own claim against UDA for the sum of RM3,370,402.58 and refund of RM487,200 in liquidated ascertained charges levied against it to arbitration under the then Kuala Lumpur Regional Centre for Arbitration (now Asian International Arbitration Centre).  Following the appointment of the Arbitrator, UDA obtained leave from the winding up court to advance a counterclaim against Puncak in the arbitration proceedings.

In the course of the arbitration, the Project was completed and a final account of UDA’s costs incurred to complete the Project following its termination of Puncak’s appointment was set out in a Final Certificate of Termination Costs issued on 25 April 2016.

At the heart of this dispute was whether UDA was entitled to advance its counterclaim and insolvency set-off against Puncak’s claims in the arbitration, given that the claims arose from the Project.  In particular, section 41 of the then Bankruptcy Act 1967 (“Bankruptcy Act”) provided that where there were mutual dealings in an insolvency, an account had to be taken of what was due from each party to the other so that the claims could be set off against one another.  Puncak’s defence to the insolvency set-off centred on the applicable date of the set-off under section 41 of the Bankruptcy Act, and that the set-off would accord UDA’s claims undue preferential payment to a creditor, in breach of section 293 of the then Companies Act 1965.  Importantly, UDA relied on the judgment of the Federal Court in Sime Diamond Leasing (M) Sdn Bhd v JB Precision Moulding Industries Sdn Bhd (in liquidation) [1998] 4 MLJ 569 which affirmed that insolvency set-off legitimises a system of accounting whereby a party which successfully asserts the set-off is accorded preference over the general body of creditors in a manner akin to a secured creditor (“Sime Diamond Leasing”).

In March 2019, the Arbitrator rendered its final award which declared that he had no jurisdiction to determine the UDA’s counterclaim and insolvency set-off, for the following reasons:

1. It was not legitimate for UDA to characterise its claim under the Certificate of Termination Costs as a single continuing transaction which accrued before Puncak’s insolvency which continued to subsist after Puncak was wound up in order to rely on section 41 of the Bankruptcy Act to obtain preferential payment.
2. A tribunal appointed under the Arbitration Act 2005 (“Arbitration Act”) cannot be conferred – even with the agreement of the parties – the powers of the winding-up court or the liquidator, which was the power to take account of what was due from each party to the other so that the claims could be set off against one another.
3. The appropriate forum to advance an insolvency set-off would be in a winding-up court or before a liquidator only, because section 41 of the Bankruptcy Act provides a proof of debts procedure which is only available through judicial insolvency procedures.
4. Insolvency set-off under section 41 of the Bankruptcy Act cannot be invoked where a creditor already had notice that the debtor company was being wound up. Here, the Final Certificate of Termination Costs was long after Puncak had been wound up, and UDA was fully aware of this.
5. Section 41 of the Bankruptcy Act cannot be applied to debts claimed under contract to be set-off against any claim by Puncak.

Having disregarded UDA’s counterclaim and set-off, the Arbitrator in its final award allowed Puncak’s claim without abatement.

Aggrieved, UDA applied to set aside the award under section 37(1)(a)(iv), (v) and (2)(b) of the Arbitration Act on the basis that (1) the award deals with a dispute not contemplated by the terms of the submission to arbitration; (2) the award contains decisions on matters beyond the scope of the submission to arbitration; and (3) that the award is in conflict with the public policy of Malaysia where a breach of the rules of natural justice occurred during the arbitral proceedings or in connection with the making of the award.  UDA argued that the Arbitrator’s refusal to consider and determine its counterclaim and set-off is a serious error of law causing a breach of natural justice which conflicted with the public policy of Malaysia.  Apart from the error of law, UDA contended that the Arbitrator could not conclude that it had no jurisdiction to determine the counterclaim given that the parties agreed to have the claim and counterclaim determined by arbitration which was sanctioned by the winding-up court.

Decision of the High Court

Though highlighting that Malaysian courts have only a narrow discretion to set aside an arbitration award for breach of Malaysian public policy, the High Court allowed UDA’s application to set aside the Arbitrator’s findings.

1. The Arbitrator failed to consider whether Puncak’s claim and UDA’s counterclaim constituted a single transaction within the contract, nor explained the reasons for not doing so. The Arbitrator did not see the claim and counterclaim as an accounting exercise arising from a single transaction of mutual dealings.  However, he did not explain why it did not constitute mutual dealings, and instead allowed the Puncak’s claim without abatement.
2. The Arbitrator failed to apply the principles in Sime Diamond Leasing, which legitimises the aim of section 41 of the Bankruptcy Act in giving preferential payment for insolvency set-off where mutual dealings arise under the same contract.

The gravity of the Arbitrator’s errors of law, which caused it to disregard UDA’s counterclaim in its entirety, was sufficient to satisfy the requirements to set aside the final award under section 37 of the Arbitration Act.

The High Court also made an important determination on the intersection between insolvency law and arbitration.  Though the High Court noted that Arbitrator’s jurisdiction to deal with insolvency set-off was not challenged by Puncak in the arbitration proceedings, it found that:

“[i]t is certainly not provided in section 41 of the [Bankruptcy Act] that mutual set offs must be dealt only by the winding-up court or the liquidator.  Ordinarily, if a creditor’s claim made against a wound-up company is disputed, then it has to be resolved by a civil action either in the civil or commercial courts. It is not to be resolved in the winding-up court which is already functus officio after the winding-up order has been made save for ancillary matters provided in the [Companies Act] such as application for leave to commence proceedings against the wound-up company.  On the facts here, the liquidator of [Puncak] chose to sue [UDA] to recover unpaid payments via arbitration based on the arbitration agreement in the Contract.  It is therefore unsurprising and certainly not wrong of [UDA] to seek to set off its counterclaim for the loss and damages suffered against [Puncak] in the same arbitration with the leave of the winding-up court.  It follows that the arbitrator would be clothed with the jurisdiction and power to deal with mutual set offs pursuant to section 41 of the [Bankruptcy Act].”

Comment

The High Court’s decision indicates that insolvency set-off is arbitrable in Malaysia, which is consistent with recent decisions in England which considered the availability and interaction of insolvency set-off in arbitration (which was considered here) and construction adjudication (the impact of which we considered in detail here).

It is possible that there are gaps in the judgment which may require clarification.  For example, the High Court did not appear to consider in detail whether UDA had notice of Puncak’s insolvency, and whether this would have barred the operation of insolvency set-off under the statutory scheme of section 41 of the Bankruptcy Act, nor was it considered (or argued by either parties) in the wider context of the arbitrability of insolvency-related issues.

On that note, this decision adds an interesting contrast to other first-instance decisions in Malaysia dealing with whether mandatory stay provisions in section 10 of the Arbitration Act should apply to winding-up petitions brought on the basis that a company is unable to pay its debts where the dispute relates to whether the company is, in fact, unable to pay its debts.  Like many other jurisdictions, the interaction between various different aspects of insolvency law and arbitration in Malaysia is a developing area of law, defined by various first-instance decisions of the High Court (though we understand that the issue surrounding the arbitrability of disputes which underlie a winding-up petition is now the subject of an appeal in the Court of Appeal).  However, a prior determination of the Federal Court (discussed here) may hint at a trend against the arbitrability of such disputes.

Nevertheless, this decision makes it clear that there is no reason why book debts cannot be quantified in arbitration.  This decision may, however, be a source of some uncertainty for insolvency practitioners in Malaysia, who will need to consider the circumstances in which they should apply to the court to supervise certain procedures where the parties have submitted disputes to arbitration.

For further information, please contact Peter Godwin, Partner, Head of Disputes Asia, Daniel Chua, Associate or your usual Herbert Smith Freehills contact.

Disclaimer

Herbert Smith Freehills LLP is licensed to operate as a Qualified Foreign Law Firm in Malaysia. Where advice on Malaysian law is required, we will refer the matter to and work with licensed Malaysian law practices where necessary.