Insolvency of Crowdfunding

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Insolvency Section Scholarship

Danny Quah
Providence Law Asia, Singapore
danny@providencelawasia.com

In recent times, physical crowds are frowned upon, lest it spark the inadvertent transmission of the deadly Covid-19 virus across social groups. However, it is precisely in times like these that the true value of the crowd has emerged. This is because the disproportionate effect of state-wide Covid-19 self-isolation policies on businesses is stark.^[1] Businesses that can go online, such as legal services, continue to thrive. However, businesses that require physical presence such as restaurants and retail shops are devastated. 

This author has personally seen his sister-in-law’s bakery experience a precipitous 95 per cent drop in sales since the start of February 2020. If not for the Singapore government’s unprecedented SGD 60bn intervention in the economy^[2] and the rapid implementation of the Covid-19 (Temporary Measures) Act 2020, which has provided temporary relief for the fulfilling of contractual obligations,^[3] many Singaporean small and medium enterprises (SMEs) would likely become insolvent by mid-2020. 

In view of the disproportionate impact to the economy, the author posits that crowdfunding will emerge as another pillar of support for businesses undergoing severe financial strain. As certain individuals work from home and continue to generate an income, they are in a position to support businesses who are unable to do the same. For example, this author was subscriber number one to his sister-in-law’s bread subscription scheme: ordering one loaf of bread and four pastries every two weeks for SGD 50 a month. As word of the availability of the bread subscription scheme spread across social media, people from across Singapore began signing up. In just over a week after launching, her bakery had enough subscriptions to cover its costs. This is a timely example of crowdfunding playing a powerful and effective role in today’s Covid-19 crisis.

However, not all businesses will survive the Covid-19 crisis. When crowdfunded businesses go insolvent, is there anything that the funders can do to recover their invested funds? Are they resigned to the fact that they are last-in-priority as an unsecured creditor? Does the fact that the crowdfunded entity resides in a different country from the funder raise insurmountable difficulties in cross-border recovery? 

This article seeks to explore the following three issues: 

• Is there is any legal recourse available to investors who are seeking recovery from insolvent crowdfunded businesses? 
• Is third-party financing available for class-action asset recovery actions brought by the liquidators of insolvent crowdfunded businesses? 
• Can Singapore be used as a nodal jurisdiction for the liquidators of insolvent crowdfunded businesses’ asset recovery actions across Australasia? 

The short answers to the questions above are: yes, yes, and yes.

Brief overview of crowdfunding 

Crowdfunding typically involves the raising of small amounts of funds from a large number of people, usually via the internet or social media.^[4] The matching of investors and investees is conducted directly on established crowdfunding platforms. 

There are two main types of crowdfunding models:

• rewards-based crowdfunding, where the platform matches investors with companies/people who are launching projects/new products (such as 3D printers) in return for certain perks on pledged amounts. Such platforms include Kickstarter, Indiegogo and Moolah Sense; and
• lending-based crowdfunding, where the platform matches investors with corporates in return for an interest on the loan or where the investor purchases a debenture or bond, to be paid a specified interest rate during the term of the loan (‘debt-based crowdfunding’) or where the investor purchases equity issued by the company, to be paid a dividend on the shares (‘equity-based crowdfunding’). Such platforms include Lending Club, Beehive, and Fundnel. 

Excluding the outliers, recent statistics show that crowdfunders’ non-performing loans are generally lower than banks (1.3 per cent versus 4.6 per cent in 2018).^[5] As such, the global community has not considered it a pressing need to develop an internationally agreed regulatory approach to crowdfunding.^[6]

Further, due to the small size of the crowdfunding market globally, crowdfunding does not pose systemic risk to the global financial system. The risks posed by crowdfunding mainly affects investors themselves. Hence, most regulators have adopted a light-touch approach in regulating crowdfunding activities. For example, the Monetary Authority of Singapore has merely provided in the Securities and Futures Act (Cap 289) that securities-based crowdfunding platforms only need to maintain a base capital requirement of SGD 50,000 and minimum operational risk requirement of SGD 50,000. Other than this, there are no other statutory reporting or operational obligations for crowdfunding platforms. 

Legal recourse available to crowdfunders

In light of the light-touch regulation applied to crowdfunding platforms, investors are largely on their own when the businesses that they invest in become insolvent. 

In Singapore, as is the case across most of the Commonwealth, debt-based crowdfunders are treated as unsecured creditors and they rank pari passu with all other unsecured creditors of the insolvent company. Equity-based crowdfunders have an even lower priority as they rank after the unsecured creditors. They may even have to contribute unpaid capital on their shares if the shares are not fully paid-up. 

As a result, given the small amount of money that most investors contribute to a crowdfunded entity, there is little incentive for any single crowdfunder to fund any recovery action as the fruits of such action (if any) will be shared pro rata among all the other unsecured creditors. In other words, the benefits will be unlikely to be commensurate with the risk and expense of funding any recovery action. 

Hence, there is a tremendous financial barrier for a single crowdfunder to even consider commencing recovery action in the absence of any consumer protection regulation. 

Third-party funding of recovery actions

There is, however, strength in crowds. In Singapore, it is possible for crowdfunders to band together to fund a liquidator’s recovery action. Over the last five years, the Singapore courts have approved at least three litigation funding agreements in the insolvency context. 

In Solvadis Commodity Chemicals Gmbh v Affert Resources Pte Ltd [2018] SGHC 210, the Singapore High Court was asked to consider an application by a liquidator under Section 273(3) of the Companies Act (Cap 50) to sell and assign certain properties and things in action of the insolvent company to a recovery vehicle funded by a third-party litigation funder. The funding agreement in question involved the third-party funder making an initial contribution of SGD 50,000 (to pay the liquidator’s and lawyer’s fees), and the third-party funder paying 40 per cent of the first US$10m that the liquidator recovered to the company, and 50 per cent of any further sums recovered (less costs and expenses incurred for the recovery process). 

In construing the relevant provisions of the Companies Act, Justice Aedit Abdullah found that a liquidator was statutorily empowered to assign a company’s causes of actions because they formed part of its property. The only requirement is that the assignment must specifically identity the subject-matter of the assignment. From a policy perspective, Abdullah J made it clear that such third-party litigation funding should be encouraged to allow insolvent companies to pursue meritorious claims for the benefit of creditors. 

Similarly, in Re Vanguard Energy Pte Ltd [2015] 4 SLR 597, the Singapore High Court was asked to consider an application by a liquidator to approve a litigation funding arrangement. The funding agreement in question involved the shareholders of the company funding 50 per cent of the costs of the company’s litigation for the first SGD 300,000 and 100 per cent of any excess. Any recovery would be first paid towards the amounts that the company funded, followed by the amounts the shareholders funded, and any surplus thereafter would go back to the company. 

Judicial Commissioner Chua Lee Ming (as he was then) held that Section 272(2) of the Companies Act permits the sale of the fruits of a cause of action that belongs to the company. Such an assignment will not be struck down as savouring of maintenance if the assignee had a genuine commercial interest in taking the assignment and in enforcing it for his own benefit. Chua JC further observed that the purity of justice would be protected as the liquidators had full control of the legal proceedings and the funders could only influence the choice of solicitors and on any settlement or discontinuance of any claim. There is a public interest in liquidators being able to satisfactorily carry out the duties which the statutory scheme confers on them. 

Most recently, in Re Fan Kow Hin [2019] 3 SLR 861, Abdullah J of the Singapore High Court added that the same principles that apply in the case of an insolvent company similarly apply to an individual bankrupt. As such, Abdullah J approved a third-party funding arrangement that gave the trustees in bankruptcy sufficient funding to pursue litigation against the bankrupt’s debtors. 

In light of the above, this author recommends that crowdfunders consider engaging the services of a third-party litigation funder to first fund a liquidator’s investigation into the insolvent company’s / bankrupt’s financial affairs and assets. If there is any basis to commence asset recovery efforts or litigation, then further commercial discussions can be had with the third-party funder to provide additional funding. Crowdfunding platforms are well placed to consolidate such class-action efforts and would do well to provide such support to its users where possible. 

Multijurisdictional asset recovery actions

One additional layer of difficulty that crowdfunders may face in seeking to take out recovery action is the fact that they not be in an ‘insolvency-friendly’ jurisdiction and/or may not be familiar with the insolvency regime of the jurisdiction where the insolvent entity is located in. Furthermore, it may not be readily apparent where the assets of the insolvent entity (if any) may be located.

Thankfully, there is increasing global effort to harmonise and universalise the divergent insolvency regimes across the world. While a universally ratified international insolvency treaty may still be an impossibility today, the international insolvency community has devised a practical mechanism to: (a) facilitate greater cooperation between courts; (b) promote greater legal certainty; (c) improve the fairness and efficiency of the administration of cross-border insolvencies; (d) protect and maximise the value of the debtor’s estate; and (e) advance successful rehabilitations to preserve economic value.^[7]

UNCITRAL has come up with a Model Law on Cross-Border Insolvency (‘Model Law’) to provide ‘a framework for cooperation between jurisdictions’ to ‘facilitate and promote a uniform approach towards cross-border insolvency’. Its lynchpin is the recognition of foreign insolvency proceedings and the grant of appropriate relief, depending on whether the foreign proceedings is classified as main or non-main proceedings.^[8]

The increasing global acceptance of international soft laws like the Model Law has given creditors (and debtors) an opportunity to ‘forum-shop’. Forum-shopping, in its non-pejorative sense, simply entails a creditor making a strategic decision to select a forum that offers it the best tactical advantage and outcome for its case.^[9]

Forum-shopping, in the insolvency context, is not new. By way of example, in 2008, Vinashin, a Vietnamese state-owned enterprise which at its peak was the world’s fifth largest shipbuilder, fell into financial difficulty and defaulted on the payment of loan facilities totalling US$600m. It sought to restructure its debts not in Vietnam, but in England through a scheme of arrangement. Even though Vinashin had no assets in England, the English High Court held that the matter bore a ‘sufficient connection’ with England as the loans to be restructured were governed by English law. Thus, the English High Court held that it had jurisdiction to call for a meeting of creditors and to sanction the scheme (which was successfully implemented).^[10]

Another example is the case of Garuda, the Indonesian national carrier. During the height of its troubles resulting from the 1997 Asian financial crisis, Garuda elected to restructure in England and Singapore rather than in Indonesia. While Indonesian law allowed companies a moratorium against legal proceedings while they proposed a composition plan, the company would be declared bankrupt if the plan was not approved. This, and the advantages afforded by the scheme of arrangement regime in England and Singapore, led Garuda to forum-shop outside Indonesia.^[11]

That said, given the heterogeneity of insolvency regimes across the world, very different results could ensue depending on where proceedings are undertaken. As such, creditors may elect to commence insolvency proceedings in certain ‘nodal jurisdictions’, using these as a base from which to coordinate multijurisdictional asset recovery efforts. This would allow creditors to extract maximum value by coordinating cross-border efforts. Singapore is one such nodal jurisdiction.

The use of Singapore as a nodal jurisdiction for Australasian-wide asset recovery actions 

Assuming that the jurisdictional requirements are met, liquidators commencing litigation in the Singapore courts have a number of options available to them. In addition to straightforward debt recovery actions, liquidators can also consider taking out unfair preference actions under Section 99(2) of the Bankruptcy Act (Cap 20) read with Section 239(1) of the Companies Act^[12] or against the directors of the insolvent company for breach of fiduciary duties/duties of skill and care.^[13]

If the liquidator succeeds in his claim and obtains a money judgment in the Singapore courts, he can then seek recognition and enforcement of the Singapore judgment in certain other Australasian jurisdictions. 

According to a survey done by the Asian Business Law Institute,^[14] Singapore money judgments are relatively valuable. Singapore money judgments can be registered and enforced (subject to the usual applications to set aside) under the domestic legal regimes of the following Australasian countries: Australia,^[15] Brunei,^[16] India,^[17] Malaysia^[18] and Myanmar.^[19] Singapore money judgments can also be recognised via bilateral judicial assistance regimes based on the concept of reciprocity in the following countries: China,^[20] Japan,^[21] the Philippines,^[22] South Korea^[23] and Vietnam.^[24]

Only the following countries do not appear to permit the recognition and enforcement of Singapore money judgments without the commencement of local proceedings: Cambodia,^[25] Indonesia,^[26] Laos^[27] and Thailand.^[28]

While it may still be some time away, this author is encouraged by the efforts of the global community to harmonise the rules on recognition and enforcement of foreign judgments. Efforts such as the Judgments Project by the Hague Conference on Private International Law, the Hague Convention of 30 June 2005 on Choice of Court Agreements, Model Law on Recognition and Enforcement of Insolvency-Related Judgments and Asian Principles of Private International Law^[29] are commendable and will only be beneficial for creditors seeking recovery across multiple jurisdictions. 

Conclusion 

In conclusion, this author believes that insolvency of crowdfunding does not necessarily result in a dead-end for crowdfunders’ recovery efforts. There are steps that can be taken to recover assets across multiple jurisdictions. All that is required is the collective will of crowdfunders (and third-party funders), and a wise commercial decision in choosing where to take out asset recovery proceedings.