BBA legality challenge: Lessons from Low Chin Meng v CIMB Islamic

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1. BBA legality challenge : Lessons from Low Chin Meng v CIMB Islamic By: Abdullah Abdul Rahman This is a commentary on the Malaysian Court of Appeal decision in Low Chin Meng v CIMB Islamic Bank Berhad [2015] 5 CLJ 324. In this case, a guarantor challenged legality of the Bai’ Bithaman Ajil (BBA) financing facility between the bank and the borrower on several grounds, two of which are discussed here. First, the transactions forming the financing infringed the principles of BBA and therefore invalid for non compliance with the Shariah. Second, the transactions infringed section 67(1) of the Companies Act 1965 which prohibits a company from purchasing or dealing, in any way, in its shares. As against the borrower, judgment had been entered and was not challenged further. As against the guarantor, the court decided that as long as the judgment against the borrower stood, the guarantor had no right to challenge the validity of the BBA based financing agreement involving the borrower and he remained liable to the bank as the guarantor. Although the illegality points raised by the guarantor do not appear to form the basis of the court's decision, these were discussed at length in the judgment. This article deals with the discussions on the illegality points. The material facts The factual matrix before the Court of Appeal in Low Chin Meng v CIMB Islamic Bank Berhad [2015] 5 CLJ 324, involved a claim by the bank against a public listed company, LCL Corporation Berhad (‘LCL Corp’), and its major shareholder and managing director, Mr. Low Chin Meng. The bank had granted LCL Corp the financing facility styled as BBA with Mr. Low as the security provider. Under the financing arrangement, Mr. Low executed a Letter of Hibah (Gift) to convey his 16 million shares in LCL Corp, by way of gift, to LCL Corp. The company then entered into an Asset Purchase Agreement with the bank where the bank purchased the shares for RM12,125,000.000. The bank then sold the shares back to LCL Corp pursuant to an Asset Sale Agreement at RM16,087,500.00 payable in monthly instalments. By way of another Letter of Hibah, LCL Corp conveyed the shares, by way of gift, back to Mr. Low. All these documents were dated 24 April 2009. The Asset Purchase and Asset Sale Agreements dated 24 April 2009 constitute what the parties called the BBA transaction. It is important to highlight that pursuant to the Asset Sale Agreement, LCL Corp basically purchased shares in itself from the bank. The aforesaid transactions which took place on 24 April 2009 were repeated three more rounds on the same day using the same 16 million shares. So altogether, on 24 April 2009, the respective parties executed four Letters of Hibah by Mr. Low in favour of LCL Corp, four Asset Purchase Agreements between LCL Corp and the bank at RM12,125,000.000 each, four Asset Sale Agreements between the bank and LCL Corp at RM16,087,500.00 each and four Letters of Hibah by LCL Corp back to Mr. Low. The result at the end of 24 April 2009 was
2. that LCL Corp was under an obligation to pay the bank RM64 ,350,000.00 in monthly instalments. Mr. Low then executed a Memorandum of Deposit of Securities dated 24 April 2009 in favour of the bank (‘Memorandum’). Under the Memorandum, Mr. Low charged the same 16 million shares as a security for LCL Corp’s obligations to the bank. LCL Corp defaulted on its monthly instalments and the bank eventually exercised its rights under the Memorandum by selling the charged shares at RM3,666,822.80. This was not sufficient for the bank to recover its selling price under the Asset Sale Agreements. Consequently, the bank filed a suit against LCL Corp and Mr. Low claiming for RM54,442,744.78. 1st Issue – Guarantee within the Charge document The claim against Mr. Low was based on a guarantee. The bank took the position that the Memorandum contained a guarantee by Mr. Low in favour of the bank where in the event of any deficiency after the sale of the charged shares, Mr. Low must, on demand, pay the bank the deficiency. Mr. Low’s counsel argued that under the Memorandum, Mr. Low’s liability was to the extent of the charged shares and nothing more. The recourse for any shortfall after the sale of the charged shares should have been against LCL Corp. Further, there is a clause in the Memorandum which states that LCL Corp must pay for the deficiency. This, Mr. Low contended, was inconsistent with the guarantee. The court found that pursuant to the Memorandum, Mr. Low had charged the shares to the bank as a security for the payment and satisfaction of the indebtedness of LCL Corp. The court also found that the Memorandum contained a ‘power of sale’ clause under which the bank may, in the event of default by LCL Corp, sell the charged shares. The same ‘power of sale’ clause also stated that in the event of any deficiency after the sale of the charged shares, Mr. Low agreed to make good and pay on demand to the bank the deficiency. The court therefore held that the agreement to make good and pay on demand the deficiency amounted to a guarantee as defined in section 79 of the Contracts Act 1950. The court held that it was not bound by the label the parties affixed to their document and went on to decide Mr. Low had given a guarantee in favour of the bank. The clause in the Memorandum which requires LCL Corp to pay for the deficiency after the sale of the charged securities was held to be consistent with the guarantee clause as the former merely reaffirmed LCL Corp’s obligation as the principal debtor and was actually, superfluous. Judgment had been entered prior to the trial against LCL Corp. This was not challenged any further by LCL Corp as it was wound up soon after that. Therefore, at the trial the bank’s claim was opposed only by Mr. Low. The High Court held that as long as the judgment stood, Mr. Low had no right to challenge the validity of the agreements involving LCL Corp and its liability. It followed that the liability of Mr. Low as a guarantor also remained. The Court of Appeal agreed with the High Court on this point.
3. 2nd issue – Illegality due to Shariah non compliance Next, Mr. Low’s counsel attacked the manner the BBA arrangement was carried out as illegal for non compliance with the Shariah. The specific feature assailed was the fact that the block of shares sold to the bank and bought back by LCL Corp had been ‘recycled’ three times. As a result, although the asset was worth merely RM9,440,000.00, it was ‘recycled’ three times so that LCL Corp could effectively raise RM48,500,000.00. Similarly, the ‘recycling’ process enabled the bank to sell the asset at a total of RM64,500,000.00 instead of RM16,087,000.00 if it was done only once. The High Court referred this issue to for the determination by the Shariah Advisory Council of the Central Bank of Malaysia (‘SAC’) pursuant to section 56(1)(b) of the Central Bank Act 2009. This provision requires the court, whenever there is any question concerning a Shariah matter in any proceedings relating to Islamic financial business, to take into consideration any published rulings of the SAC on that matter or to refer the question to the SAC for its determination. Under section 57 of the same statute, the ruling made by the SAC is binding on the court making the reference. The Shariah question was referred to the SAC on the basis that the financing arrangement had been based on the bai’ inah principle. The SAC eventually held that the use of the asset repeatedly was valid under the Shariah. The High Court applied the SAC’s ruling to the facts and rejected Mr. Low’s contention that the BBA arrangement was illegal for non-compliance with the Shariah. The Court of Appeal found no reason to disturb the decision of the High Court. The Court of Appeal also added that the SAC’s ruling pursuant to the reference by the High Court was binding on ‘the Court’ by virtue of section 57. 3rd issue – Illegality due to LCL Corp’s purchase of own shares Mr. Low also took issue with LCL Corp’s purchase of the shares under each of the Asset Sale Agreements due to these being shares in LCL Corp. He contended that this amounted to LCL Corp purchasing or dealing in its own shares which contravened section 67(1) of the Companies Act 1965. In essence s. 67(1) prohibits a company, except as otherwise expressly provided by the Act, from: (a) giving any financial assistance for the purchase of its shares; or (b) in any way purchase or deal in its shares. The court found no evidence of any financial assistance given by LCL Corp to enable the purchase of its own shares. Accordingly, the court held that the aforesaid limb (a) of s. 67(1) did not apply. On limb (b), the court also held that it did not apply. The court held that LCL Corp had not purchased or dealt with the shares. According to the court, what had been carried out (in each round of the transactions) had been a simultaneous sale and purchase of the shares for the sole purpose of conforming with the Islamic financing requirements of BBA.
4. In coming to the conclusion that LCL Corp had not purchased the shares , the court relied on the cases which set out the aims of the prohibition under s. 67(1). The aims are the preservation of the company’s assets and the avoidance of reduction of capital by returning the company’s assets to the shareholders. The court found that the Asset Sale Agreements did not result in the depletion of LCL Corp’s capital and asset. These conclusions will potentially be looked at closely in future cases. First, real purchase is required for the Shariah validity of BBA and bai’ inah. The SAC itself, in the ruling it had made in this case, held that the conditions for a valid bai’ inah contract include the following: (a) the Asset Purchase Agreement and the Asset Sale Agreement are two distinctly separate contracts; (b) the contracts must be executed at different times; (c) the proper sequence of the execution of the separate contracts must be observed; (d) there must not be a buy back condition in the first contract; and (e) there must be a transfer of the ownership of the asset and of the possession over the same which are valid both according to the Shariah and current business practice. The full text of the SAC ruling, which is in the Malay language, may be found in the High Court’s Grounds of Judgment of this case at [2015] 8 MLJ 832. However, the conclusion that LCL Corp had not purchased or dealt with the shares appears to contradict the SAC ruling that there must be a distinct and separate contract under which LCL Corp had purchased the shares and that LCL Corp must validly own and possess the shares. Any suggestion that LCL Corp did not purchase the shares will adversely affect the Shariah validity of the transaction. In the circumstances, the conclusion that LCL Corp actually had not purchased the shares is fraught with difficulties. The Asset Sale Agreements by themselves express the intention of the parties that LCL Corp should purchase the shares. Next, the conclusion that there had been a simultaneous sale and purchase of the shares (in each round of the transactions) does not sit well with the SAC ruling which requires the sale and purchase contracts to be distinct and separate, executed at different times and in proper sequence. Again, the High Court’s finding of a simultaneous sale and purchase is problematic. This is not only because it cannot be supported on facts but because it negates the Shariah validity of the transactions. Further, pursuant to each purchase of the shares, LCL Corp had to make deferred payment in instalments. So obviously, the assets of LCL Corp will be depleted as a result of the purchases. As such, the reasoning that the purchases are not caught by s. 67(1) because they did not result in the depletion of LCL Corp’s assets is factually incorrect. Consequently, English cases where acquisitions of own shares have been held to be valid because the company did not part with any money should be distinguished from the present case. Non parting with money will of course not result in depletion of assets. These include cases of forfeiture of shares for non-payment of calls and acquisition of beneficial interest in own shares held by nominees pursuant to the terms of the will of a deceased member. In any event, these cases cannot be said to involve a purchase although they may involve acquisitions. Some examples of these cases include Re Castiglione’s Will Trusts ; Kirby v Wilkins and Trevor v Whitworth.
5. It is also pertinent to take into account that s . 67(1) prohibits a company ‘except as otherwise expressly provided by the Act’ ‘in any way’ from purchasing or dealing in its own shares. The point to note is that the purchase of own shares pursuant to an Islamic financing transaction is not otherwise expressly provided by the Act. Secondly, the section prohibits purchase of own shares ‘in any way’. It is suggested that the phrase ‘in any way’ has been used in s. 67(1) to prohibit purchase of own shares in the widest manner ‘except as otherwise expressly provided by the Act’. Therefore, there is no room to interpret the word ‘purchase’ in s. 67(1) as excluding purchase of own shares that is pursuant to an Islamic financing transaction. Cases where the prohibition was held not to apply must be examined as to whether these are cases on limb (a) of s. 67(1) namely, on financial assistance, as opposed to cases on limb (b) namely, on purchase of own shares. In many cases on financial assistance, the prohibition has been held not to apply where the assistance arose as a mere side effect of genuine commercial transactions. The Singapore Court of Appeal judgment in Intraco Ltd v Multi-Pak Singapore Pte Ltd is one such case. However, the phrase ‘in any way’ is not present in limb (a) of s. 67(1). As such, cases on financial assistance should not be applied to cases on purchase of own shares. This is not only because cases on financial assistance should be distinguished from cases on purchase of own shares but because of the more restrictive statutory wording with regard to the latter. In coming to the conclusion that the purchases of shares under the BBA transactions had not infringed s. 67(1), the court applied that part of the case of Dato’ Hj. Nik Mahmud bin Nik Daud v Bank Islam Malaysia Bhd where the equitable principle which requires the court to look to the true intention of the parties in signing the agreements was applied. The true intention of the parties being to transact in the Islamic financing concept of BBA, the Court of Appeal held that Mr. Low could not seek to escape liability by raising ‘some technical arguments’ which were without basis. This is probably based on the equitable principle which says equity looks to the intent rather than the form. However, this principle is not applicable where the form is expressly set out in the agreement except where a party is seeking rectification of the document. Further, there is also the principle of equity which says equity follows the law. The effect is that the principle of equity on the true intention of the parties cannot excuse a statutory infringement. In this regard, Nik Mahmud may be distinguished. In that case, the plaintiff alleged that the execution of the property purchase agreement showing a purchase of the plaintiff’s land by the bank was void. This was because the land was a Malay Reserve land and the state enactment prohibited any transfer or vesting of any right or interest in such land to a Non-Malay. The bank was not a Malay under the state enactment. The court held that the definitions of ‘transfer’ and ‘vesting’ of right or interest under the state enactment required these to be effected by registration with the appropriate authority pursuant to the prescribed statutory instruments. As there was no registration, there was no transfer as defined under the state enactment. So in Nik Mahmud, while there was a purchase, there was no transfer. On the other hand, s. 67(1) does not speak about any transfer. It prohibits a purchase and that purchase could be ‘in any way’. On the other hand, an acquisition not
6. involving a purchase is not invalid under s . 67(1). Hence, the application of equitable principle in Nik Mahmud is not suitable to be followed in this case. Reference was also made to section 67(6) of the Companies Act 1965. It was highlighted that under this provision a person is not prevented from recovering any loan made in breach of s. 67(1) or any amount for which it becomes liable in breach of s. 67(1). It is sufficient to state that the wording of s. 67(6) shows that it is not applicable to a company’s purchase of its own shares. Rather, the transactions validated by s. 67(6) are confined to those under the so-called limb (a) of s. 67(1) where financial assistance is prohibited and to lending by a company on its own shares under limb (b). The case of Lori (M) Bhd v Arab-Malaysian Finance Bhd is an example where a financial assistance prohibited under limb (a) was saved by s. 67(6). In particular, it must be pointed out that the BBA financing is not a loan. Further, in this case, CIMB Islamic has not become liable for any amount to enable it to make recovery under s. 67(6). As such, s. 67(6) is not applicable. Conclusion In Low Chin Meng, challenges were made to the legality of the BBA transaction both for non-compliance with the Shariah and for infringing the company law rule against the purchase of own shares by a company. However, it was the decision on the guarantee issue that conclusively decided this case in favour of the bank. This is because the guarantor did not even have the right to launch the legality challenges in view that the judgment against principal debtor still stood. Consequently, under the doctrine of stare decisis, only those parts of the grounds of judgment of the Court of Appeal relating to the guarantee issue have become binding precedent for future cases except at the Federal Court level. The rest is persuasive but may be departed from. As such, legality challenges such as those taken in this case remain live issues in future cases. Abdullah Abdul Rahman is a Partner (Dispute Resolution & Islamic Finance) at Chooi & Company + Cheang & Ariff, Kuala Lumpur. He may be contacted at abdullahrahman@ccalaw.com