By Stephanie Jacob
A recent ruling by the Federal Court that a lead arranger of a bond is not responsible for details contained in an information memorandum (IM) to potential investors is expected to have far-reaching effects on the bond market according to legal sources and industry players.
The Federal Court had instead ruled that the trustee is fully liable to ensure that there is no misuse of funds deposited into the designated accounts in a judgement released last month.
The decision was unexpected among bond market players as well as in the legal community, as it reversed what had been originally hailed as a landmark decision by the High Court, which was then subsequently upheld by the Court of Appeal.
At both those levels, the judges ruled that the lead arranger, in the case KAF Investment Bank (KAF) and the trustee Maybank Trustees Bhd (MTB) were as liable as the issuer (in this case Pesaka Astana Sdn Bhd) for losses suffered by bondholders in the event of a default.
To recap, in 2005 a RM149 million lawsuit was initially brought against Pesaka Astana Sdn Bhd (Pesaka) by 10 financial institutions after bonds issued by the company defaulted.
Uniquely the institutions also filed the suit against the independent advisors for the deal, namely KAF as the lead arranger and MTB as the sole trustee.
The 10 are MIDF Amanah Investment Bank Bhd, CIMB Bank Bhd, Abrar Discounts Bhd, Avenue Invest Bhd, Bank Mualamat Malaysia Bhd, CIMB Aviva Assurance Bhd, Malaysian Assurance Alliance Bhd, SIBB Bhd, Universal Trustee (M) Bhd and BHLB Trustee Bhd.
Pesaka agreed to a consent agreement in 2008, in favour of the bondholders – but the independent advisors chose to go to trial, which continued until mid 2010 as a result of various actions and counter claims by the parties.
The bondholders argued that KAF’s IM was false and misleading and that MTB had failed in their due diligence to ensure that it became the sole signatory of the designated accounts into which Pesaka was to deposit funds to be used as repayment to the bondholders.
Designated accounts were opened by Pesaka to deposit funds that would be eventually used to pay back bondholders. MTB as the sole trustee was tasked with taking control of those accounts, becoming sole signatory of those accounts so that only it could approve the transfer of funds out of the accounts – a practice known commonly as ring fencing.
At the High Court level, presiding judge Justice Mary Lim found that the independent advisors had indeed failed in their duty. As the investment institutions had relied on the information memorandum produced by KAF to make their decision, and that MTB had fail in ring fencing the accounts.
Justice Lim awarded the bondholders RM149 million and divided liability as 60% to KAF and 40% to Maybank.
The Court of Appeal concurred, saying that the details contained in the IM by KAF had been questionable and that MTB had not shown the necessary care and diligence in ensuring that it was in control of the designated accounts.
However the appellate judges chose to divide the liability equally among KAF and MTB instead of 60-40.
In January 2013, the decision was appealed to the Federal Court and was presided over by a five man bench.
Hearing the case was Arifin bin Zakaria, chief justice of Malaysia; Raus bin Sharif, president of the Court of Appeal; Hamid bin Embong, Federal Court judge; Suriyadi bin Halim Omar, Federal Court judge and Ahmad bin Maarop, Federal Court judge.
The justices then reserved judgement for 13 months up until Feb 10 2014, when they ruled that KAF had no liability in the matter and instead held that MTB was fully liable for not ring fencing the accounts and/or not stopping Pesaka from making withdrawals.
The Court said that as KAF had included a portion called important notice in the information memorandum that served as a disclaimer, and that therefore the investors should not have relied solely on the information contained in it to reach their investment decision.
It added that KAF was also not obliged to ensure that MTB carried out its duty and responsibilities in becoming the sole signatory of the account, merely to ensure that Pesaka had opened the designated accounts in the first place.
The decision is raising concerns both in the bond market and among lawyers who say that this can be taken to mean that lead arrangers will have no obligation to ensure that details in its information memorandum is correct.
Among the legal fraternity, the concern is that it sets a precedent in terms of law and also because it is likely to have long-term consequences on the Malaysian bond market, said a corporate lawyer.
He added that a key issue of contention over the judgement, is that so long as there is an important notice included in the information memorandum, the lead arranger is relieved of its liability even if the information is wrong as a result of its negligence.
Furthermore, there is also concern that the important notice disclaimer may be used as an excuse for not carrying out its due diligence – placing all responsibility squarely on the shoulders of the issuer and potential investors, noted another legal expert.
A bond industry expert said that he feared that the decision might cause investors to be reluctant in entering the bond market, because of the limited protection and legal options should there be a default – even if information found to be in the information memorandum is false or misleading.
Legal experts say that it may now be necessary for the Securities Commission to look at ways of strengthening the law, so that those preparing the IM will be subject to liability should the document contain informations that is not accurate.
However said the legal expert, such a law will be prospective in nature, and therefore will not cover bond exercises prior to its implementation.
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