- Victims of fraud often face an uphill battle seeking redress for their loss. While claims based on contract, tort and equity are available to these victims, the reality is that the direct enforcement of such claims against fraudsters is difficult because “fraudsters often end up in jail and their property torn apart by bankrupt theft. “ In addition, the insolvency and liquidation of businesses run by fraudsters further complicate the process of restitution and collection.
- This article examines the impact of insolvency and liquidation on claims involving commercial fraud. In particular, it examines: –
- evidence of debt involving fraud;
- the pari passu principle of allocation of fraudulent claims; and
- how liquidators can recover company assets in the event of fraud.
- Singapore’s insolvency regime is governed by the Insolvency, Restructuring and Dissolution Act 2018 (“IRDA“), entered into force on July 30, 2020.
- Typically, companies associated with fraudulent activities are liquidated as soon as the fraud is dismantled. When a liquidation order is issued, a moratorium on legal and enforcement proceedings is imposed, and the board of directors of the company becomes funtus officio. The authority and the duty to manage the company rests with the liquidator, whose role is to (i) recover and realize the assets of the company in the most advantageous way for the creditors of the company and (ii) rule on claims creditors and ensure a fair distribution of the company’s assets in accordance with the provisions of IRDA. In cases where there is an allegation of irregularity as to the cause of the insolvency of a company, the role of the liquidator takes on the additional dimension of an investigator, in addition to his administrative function of collector of assets.
Proof of Debt Involving Fraud
- We first examine how the claims of victims of fraud 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 time limits.
- Generally, claims involving fraud fall within the scope of “provable debts”Defined by S218 IRDA. S218 IRDA states: – “Subsection 218 (3): Claims for unliquidated damages arising other than by reason of a contract, a promise, a breach of trust, a tort or bond, or an obligation of restitution , are not provable in the judicial management or insolvent liquidation of a company.“
- However, for the proof of the debt to be accepted, these claims must be really enforceable against the company, because “only the real liabilities of a company should be respected”. Thus, when an alleged claim or liability arises from a contract tainted with fraud or illegality thus rendering it unenforceable against the company, this alleged liability claim is not provable in the context of the liquidation of the company.
- The creditor has the burden of proving the debt on a balance of probabilities, and the liquidator will assess each proof of debt filed and may request additional evidence to support the claim. Above all, when examining evidence, the liquidator has broad powers to consider matters holistically and, for example, is not bound by audited accounts or audit confirmations concluded by the company, and has the right to follow them to determine the veracity of the debt. claims. If there is a reasonable basis for doubting the authenticity of the documents and / or the legal validity of the debt, a liquidator could look behind the documents in his investigations into the corporate matter.
- After investigation, the liquidator will then decide to accept or reject the proof of debt. Applicants who are not satisfied with the decision of the liquidator can appeal under Article 190 IRDA. The general position is that the Court does not easily interfere with the discretion of a liquidator and will only consider whether the liquidator has acted authentic or in good faith. However, the threshold for judicial intervention when reviewing a decision of a debt liquidator is lower. In MWACapital Pte Ltd v Ivy Lee Realty Pte Ltd (in liquidation)  SGHC 216 (“MWACapital“), the High Court distinguished between the business decisions of a liquidator (which would generally be upheld when the liquidator acted authentic) and quasi-judicial functions. The Court held that: – “ When a liquidator decides on the validity or the quantum of a debt claimed by a creditor, he is not making a commercial decision. It performs a quasi-judicial function. If a court’s decision on a similar issue can be overturned on the grounds that the decision was in error, I see no reason why a similar approach should not be taken for a liquidator’s decision.. “
- Nevertheless, a certain ambiguity as to the applicable threshold remains, since the Tribunal 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 by accepting a higher threshold (i.e. the in good faith standard) to be observed in order to challenge the decision of a liquidator on claims. It is therefore not certain that the Court will interfere in an erroneous decision, rendered authentic, by a liquidator. However, in light of the inherent complexity and value of fraud allegations, it is proposed that the Court apply the standard set out in MWACapital with regard to appeals against the decision of a liquidator.
The pari passu principle of distribution and priority
- Assuming a debt can be proven, the next question is about the priority of the debt.
- The starting point is the pari passu principle of distribution, which is codified in article 172 of the IRDA. the pari passu principle of distribution states that “all persons in a similar situation have the right to equal treatment in the distribution of the assets of the insolvent company. “ Creditors will generally be entitled to a pari passu distribution of the Company’s assets according to their rank. As a general rule, all unsecured creditors will share the assets of the company on a pro rata basis subject to the rights of the secured creditors. and preferred creditors.
- In this regard, the type of action brought by the victim against the fraudster could change his insolvency priority and, therefore, the potential recovery of the victim. As mentioned, contract, tort and equity claims are available to victims of fraud, depending on the circumstances of the case. However, claimants who seek exclusive remedies (through equity or otherwise) appear to be in a better position than claimants who only seek personal remedies.
- For example, a successful plaintiff in a contract or tort claim would generally only be entitled to a personal right to damages against the business. Such a claimant would join the group of unsecured creditors, who rank after secured creditors and preferred creditors. On the other hand, a successful plaintiff, for example in a constructive trust claim, would be entitled to property rights over the assets. The imposition of a constructive trust would remove the assets from the insolvent estate, thus placing the asset beyond the reach of all creditors. Armed with an appropriate judgment, the plaintiff would be entitled to trace the proceeds of the fraud, and would have a higher priority than other unsecured creditors.
- Considering the obvious advantages of an exclusive remedy, it has been observed that “Singapore’s insolvency courts will undoubtedly continue to face parties attempting to “skip the line” of creditors by seeking exclusive remedy over their claims. “ Given the scarcity of judicial guidance in this area, there remains great uncertainty as to the intrusion of property recourse in a liquidation scenario. Problems that will arise include the competing interests of various creditors, and considerations of proprietary remedies as a tool to effectively circumvent the legal distribution regime.
Recovery and realization of the company’s assets by the liquidators
- Finally, we look at the pool of assets available for distribution to creditors when a company’s operations have been tainted with fraud.
- When winding up a fraudulent company, the pool of assets available for distribution is usually limited. Liquidators generally rely on the usual arrangements in such scenarios: avoidance of transactions made at undervaluation (S224 IRDA), transactions involving unfair preference (S225 IRDA), exorbitant credit transactions (S228 IRDA) ), transactions involving fraudulent transactions (S238 IRDA), transactions involving illicit transactions (S239 IRDA) and the search for damages against delinquent agents (S240 IRDA).
- It is particularly important in the context of commercial fraud that individuals are held accountable for fraudulent transactions by a legal person. Under article S238 of the IRDA, a liquidator could seek to recover the obligations of the company from any person who participated in the fraud.
- The liquidator must prove the following under S238 of the IRDA: –
- that the activities of the Company have been carried out with the intention of defrauding the creditors of the Company or any other person or for fraudulent purposes; and
- that the defendants were knowingly parties to the operation of the business in this manner.
- IRDA S238 was recently applied in Tendcare Medical Group Holdings v Gong Ruizhong  SGHC 80. In the case, the company had raised funds for an alleged IPO that never existed. Instead, the funds were embezzled 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 transactions, and that they were liable for substantially all of the company’s debts in the amount of $ 65,207,538.03.
- Moreover, injunctions are also useful in such situations. For example, in a lawsuit against directors for fraudulent transactions, the liquidators of Hin Leong successfully obtained a global Mareva injunction of $ 3.5 billion freezing the assets of said directors pending the outcome of the lawsuit.
- Of course, the usefulness of these provisions may well be limited if the directors have run away and the ill-gotten gains have long since dissipated.
- Various challenges arise when the liquidation of a business involves debts tainted with fraud. While there are avenues available under IRDA for asset recovery, the usefulness of such provisions is generally diminished when fraudulent administrators have run away or when assets have been dissipated. Nonetheless, a coordinated use of the different avenues, as seen in recent cases against wandering administrators, will increase the chances of victims of fraud to recover their assets.
PDLegal LLC thanks and acknowledges Practice Intern Tricia Ong for her contributions to this article.