What is the Liquidation Expenses Principle

Published: Feb 23, 2023
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By Jonathan Ong and Debby Lim

Introduction

It is trite that once a company goes into liquidation, the proper expenses and liabilities incurred by its liquidators may be accorded priority over the company’s other unsecured liabilities. This is known as the liquidation expenses principle (the “Principle”).

The theoretical underpinnings of the Principle are that existing creditors in general benefit from the actions of the liquidator because of the beneficial effect on the estate, and therefore priority should be accorded to the “new creditor.” The courts generally take the view that the Principle ought to be restrictive in its application, since it derogates from the pari passu principle. It is for the party seeking to rely on the Principle to show why it should have priority over the other creditors.

Although this Principle was first developed in the context of liquidation, it also applies by extension to judicial management (the Singapore equivalent of the English administration), where new funding (such as litigation funding) and expenses and liabilities incurred by the insolvency practitioner in attending to these matters may be accorded priority status if it is of beneficial effect to the estate. In the context of judicial management, expenses and liabilities are incurred by a company’s judicial managers (”JMs”) for the benefit of the company. This was first recognized in Singapore by Justice Kannan Ramesh in Re Swiber Holdings Ltd [2018] 5 SLR 1358 (Swiber Holdings) at [89] and is statutorily embedded in Section 104(3) of the Insolvency, Restructuring and Dissolution Act 2018. ^[1]

The issue therein is whether the expenses and liabilities incurred by the insolvency practitioner are for the benefit of the estate and hence should be accorded priority status. In the High Court decision Re Ocean Tankers (Pte) Ltd [2022] SGHC 55 and the subsequent Court of Appeal decision in An Guang Shipping Pte Ltd (under judicial management) and others v Ocean Tankers (Pte) Ltd (in liquidation) [2022] SGCA 69, we have the opportunity to explore the jurisprudence in the Singapore insolvency arena. ^[2]

Background Facts

The claimants/appellants are 40 vessel-owning subsidiaries of Xihe Holdings (Pte) Ltd (“the XH Companies”), while the respondent is Ocean Tankers (Pte) Ltd (“OTPL”).

Both the XH Companies and OTPL were under judicial management and were represented in the proceedings by their respective JMs. Central to the parties’ dispute is the question whether the XH Companies’ claims under various bareboat charters (which OTPL had entered into with the XH Companies prior to being placed into interim judicial management) fall within the scope of the Principle so as to enjoy priority in OTPL’s judicial management.

The obvious impact to the XH Companies is that if these claims do not enjoy any priority, these claims would only stand pari passu with OTPL’s other unsecured creditors and therefore the XH Companies would be in the unenviable situation of not being able to fully recover the expenses and liabilities incurred.

The Decision

Both the High Court and the Court of Appeal concluded that that the Principle would generally not apply to the XH Companies’ claims, subject to certain exceptions based on how specific vessels were used.

The Court of Appeal also agreed with the High Court Judge that the OTPL JMs generally did not retain the vessels for the benefit of OTPL’s estate. Also, the Court below was correct in requiring the XH Companies to prove that their ancillary claims for repair costs were linked to the period that these vessels were retained by the OTPL JMs for the benefit of OTPL’s estate. In this regard, the Court of Appeal dismissed the XH Companies’ appeal and affirmed the High Court decision.

The Honorable Justice Kannan Ramesh in the Court below held that a “clear line” had to be drawn between vessels for which Notices of Non-Adoption were issued from August 31, 2020 to September 3, 2020, and vessels in respect of which no such notices were issued. The Notices of Non-Adoption were an unequivocal statement by the OTPL judicial managers that they did not wish to retain possession of the vessels for the benefit of the estate and wished to redeliver them.

However, Kannan Ramesh J also held that the Principle would generally not apply even during the period before the Notices of Non-Adoption were issued. The Judge found that the facts generally demonstrated that the OTPL JMs had been compelled to retain the vessels, at first due to extraneous circumstances, and later due to the actions of the XH JMs (see the GD at [35]):

Nevertheless, Kannan Ramesh J went on to hold that this general conclusion was subject to certain exceptions. Several categories of vessels had been used for various purposes, and the Judge’s conclusions on each of these categories were as follows:

The first category comprised vessels in respect of which the OTPL JMs had issued Notices of Adoption, and which were thus not the subject of SUM 2085. The Principle applied to any claims arising out of the use of these vessels, which would thus be accorded priority (see the GD at [59]). ^[3]This category is straightforward and uncontentious given that the OTPL JMs had agreed to adopt and continue incurring these liabilities.
The second category comprised vessels which had been used by the OTPL JMs to store and transport cargo prior to the Notices of Non-Adoption, and this use continued after the issuance of the Notices of Non-Adoption (from May to early December 2020) (the Second Category). The Principle applied to both Charter hire Claims and Ancillary Claims for expenses for the period of use of these vessels, though not to repair costs as it was “difficult to establish a link between the repair costs which ought to be borne by OTPL and the use of the vessels in the period of use” (see the GD at [60]–[64]). ^[4]In the Second Category, the OTPL JMs appear to have continued to use the vessels in questions for the benefit of OTPL despite issuing Notices of Non-Adoption. While it appeared to be fair that OTPL should be liable given that it benefitted from using the vessels, the dispute was only resolved in court proceedings and the repair costs which were needed for the continued use of the vessels were not accorded priority solely due to difficulties in establishing the link.
The third category comprised vessels which had been used by the OTPL JMs to store and transport cargo after applying for leave in interpleader proceedings (from May to late September or early October 2020) (“the Third Category”). The Principle did not apply as the OTPL JMs needed to retain the vessels to hold on to their cargo while creditors resolved their competing claims in interpleader proceedings, and they thus did not retain these vessels for the benefit of the estate (see the GD at [65]–[66]).^[5]The Third Category applied the Principle differently from the Second Category. While under both circumstances the OTPL JMs retained the vessels to store and transport cargo for different purposes, an assessment had to be made whether it is for the benefit of the estate. It would be interesting to consider whether the third category resulted in mitigation of liabilities/reduction of liabilities for OTPL which may be deemed to be beneficial for OTPL’s estate as a whole and/or the competing creditors are liable for the costs of the vessels incurred during the period before the dispute is resolved.
The fourth category comprised vessels which were deployed on sub-charters by the OTPL JMs, and which were used at various times before and after the issuance of the Notices of Non-Adoption (the Fourth Category). The Principle applied to both Charter hire Claims and Ancillary Claims for expenses for the period of use of these vessels after the relevant Notices of Non-Adoption were issued (albeit not to repair costs), because being deployed in sub-charter was clearly for the benefit of the estate. For the five vessels within this category which stopped operating for months at a time, the period of use would not include such periods of inactivity; and whether the Principle applied to the period of use resuming after the Notices of Non-Adoption were issued would depend on why the deployment of these five vessels resumed (see the GD at [67]–[71]).

The Fourth Category is similar to the Second Category in the application given that the OTPL JMs have issued Notices of Non-Adoption but continued to use the vessels for the benefit of their estate and excludes repair. However, the Principle did not apply to the period of inactivity where the vessels were not deployed, presumably due to the sub-charters having expired and there were no new sub-charters entered into. The judgment suggests that if new sub-charters were entered into for the vessels, the Principle will apply from thereon. However, this does not appear to address the issue that the relevant XH Companies would have lost the opportunity to take control of these vessels and in turn able to utilize the vessels for their estate.
The fifth category comprised vessels deployed by the OTPL JMs for various in-house services (the Fifth Category). The Principle applied to both Charter hire Claims and Ancillary Claims for expenses arising out of these vessels after the relevant Notices of Non-Adoption were issued (albeit not to repair costs), because if the OTPL JMs had redelivered these vessels, they would have needed to secure other vessels to achieve the same purpose, in which case they would have incurred expenses under post-insolvency contracts which would then have enjoyed priority as judicial management expenses. Notably, the Principle also applied to expenses incurred during the periods of downtime when the vessels were not used, because these vessels were nevertheless retained for a purpose regarded as being beneficial to the estate (see the GD at [72]–[74]).^[6]The Fifth Category is similar to the Fourth Category with the exception that under the Fourth Category, the vessels in questions were used for sub-charters while in the Fifth Category, the vessels were retained by the OTPL JMs for various in-house services. However, under the Fifth Category, the expenses incurred during the downtime was allowed whereas under the Fourth Category, a separate assessment will have to be made on whether it was beneficial to the estate.

Key Takeaways

The issuance of a Notice of Non-Adoption suggest that an insolvency practitioner had on the onset determined that adopting the contract will not be beneficial to the estate. However, if the contract in question was continued by way of the insolvency practitioner’s conduct, the issue of whether to accord priority to these liabilities would have to be determined ex post by the Court.

The critical question is whether the property was retained and used “for the benefit of” the estate. This will depend on the purpose of the insolvency practitioners in retaining possession of such property. The insolvency practitioners’ purpose, in turn, will be objectively found or inferred by the Court from what they in fact did, rather than being dependent on the subjective processes in their mind.

More often than not, the intended results from incurring these expenses and liabilities may not be consistent with the prior assessment made by the insolvency practitioner at the outset. In this regard, there may be a chasm between the insolvency practitioner’s and the Court’s views as to whether the expenses in question benefit the estate. There appears to be little room for the Court to consider the commercial judgment of the insolvency practitioner. This does not give any certainty to the stakeholders impacted by the insolvency proceedings on whether their claims incurred post-insolvency (or part thereof) would be accorded priority. Perhaps this could be addressed in future case law or legislation if more disputes arise from the uncertainty of the highly fact-sensitive inquiry as to whether the Principle is applicable in a given case.

[1] https://www.elitigation.sg/gdviewer/s/2018_SGHC_211

[2] https://www.singaporelawwatch.sg/Portals/0/Docs/Judgments/2022/[2022]%20SGCA%2069.pdf

[3] https://www.singaporelawwatch.sg/Portals/0/Docs/Judgments/2022/[2022]%20SGCA%2069.pdf

[4] https://www.singaporelawwatch.sg/Portals/0/Docs/Judgments/2022/[2022]%20SGCA%2069.pdf

[5] https://www.singaporelawwatch.sg/Portals/0/Docs/Judgments/2022/[2022]%20SGCA%2069.pdf

[6] https://www.singaporelawwatch.sg/Portals/0/Docs/Judgments/2022/[2022]%20SGCA%2069.pdf

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