Deep impact… (on Malaysia’s bond market?)

The facts: A financing scheme was proposed through the issuance of public Islamic bonds (the Bonds) worth MYR140 million. The appointment of KAF Investment Bank Bhd (KAF) as the lead arranger for the issuance of the bonds was laid out in the subscription and facility agreement (the Agreement), entered into between KAF as the issuer, Pesaka Astana (M) Sdn Bhd (Pesaka), and the primary subscriber (Kenanga). The Due Diligence Working Group (DDWG) gathered all information required for the bonds scheme to formulate the Information Memorandum. The information was provided by Pesaka to the DDWG. It is important to note that the Information Memorandum contained a Notice excluding KAF’s liability.

Under the bonds scheme, all proceeds from the contracts were to be deposited in Syariah Designated Accounts with Maybank Trustees Berhad (MTB). MTB was the sole trustee to manage these Designated Accounts. As the signatory, however, Pesaka, which had complete control over these accounts, utilised the monies paid by the bondholders of the Designated Accounts for its own purposes and failed to redeem the Bonds on the maturity date.

The suit: The aggrieved bondholders commenced action in the High Court against KAF and MTB. The High Court found them both liable for negligence and breach of contract. Indemnity against Pesaka was denied. This was upheld by the Court of Appeal. An appeal was then made to the Federal Court.

The issues: The issues before the Federal Court were as follows, namely (i) whether the notice in the Information Memorandum which excluded KAF’s liability was void, as it contravened (the former) section 65² of the Securities Commission Act 1993 (SCA); and (ii) whether KAF, as the lead arranger, owed a duty of care to the bondholders to ensure that the information in the Information memorandum was neither false nor misleading.

The decision: In allowing the appeal, the Federal Court held that KAF was entitled to exclude liability arising from the exclusion of liability in the Notice.

The reasoning: The basis of the decision was that the word “agreement”, found in section 65 of the SCA, must be given its ordinary meaning. The Information Memorandum, it was held, was not a contractual document. It was issued by KAF on behalf of Pesaka to provide information to potential investors and was not part of the Issue Documents which require the approval of the SC. It was also held that since the bondholders in the present case were sophisticated investors and experienced financial institutions who had a vast experience in bonds, they were expected to act on independent and professional advice from their own sources in respect of the contractual obligations in light of the disclaimer contained in the Notice.

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Section 65 of the Securities Commission Act 1993 – Agreements to exclude or restrict liability void
An agreement is void in so far as it purports to exclude or restrict the liability of a person for contravention of section 55, 57 or 58 or for loss or damage under section 153.
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Section 256 of the Capital Markets and Services Act 2007 – Agreements to exclude or restrict liability void
An agreement is void insofar as it purports to exclude or restrict the liability of a person for contravention of section 246, 248 or 249 or for loss or damage under section 357.
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The implication: The decision raises the issue of the relevance and rationale of section 256 of the Capital Market & Services Act 2007, bearing in mind that the liability of the issuers and their advisors was excluded. Furthermore it is common knowledge that investors rely heavily on what’s provided for in the Information Memorandum, expecting that the information is accurate and verified by the principal advisor.

It is no wonder, therefore, that the decision has been viewed as one that has “rattled the bond market.”

Endnotes
1. An Information Memorandum is a document generally used in syndicate financing of projects to define the work and to detail its financing arrangement.  Its purpose is to provide information to potential buyers to allow them to review the company and decide whether they would like to progress their interest.
2. This provision which renders such agreements (that exclude liability) void, has now been replaced with section 256 of the Capital Markets and Services Act 2007.