07 June 2021
A trio of landmark decisions by Mr Justice Harris have altered and hugely improved the scheme of arrangement practice in Hong Kong. The new scheme practice points are in brief thus:
First, where an offshore incorporated company seeks to restructure its debts by means of a Hong Kong scheme of arrangement, it should not at the same time pursue a parallel offshore scheme just because it is incorporated offshore. Any such parallel scheme must be justified. Pursuing an unnecessary parallel scheme could entail the following consequences:
(a) The company’s directors, provisional liquidators or liquidators may be found to be in breach of fiduciary duties to creditors.
(b) The Hong Kong court may not sanction the Hong Kong scheme.
Secondly, where a listed company is subject to a delisting decision and in the process of appealing the decision through the listing review committee, the Hong Kong court will not sanction the company’s scheme pending the conclusion of the appeal process.
Thirdly, where a listed company is subject to a delisting decision and in the process of appealing the decision, the company may nevertheless apply to convene a scheme meeting, provided the convening application would not prejudice creditors’ interests.
Background to the new practice
In recent years, most restructuring schemes in Hong Kong concern offshore incorporated-entities listed in Hong Kong (with predominantly Mainland operations).
Often the trading of shares in such distressed companies has been suspended before they promote the schemes. Thus the key purpose of the schemes is to rescue the companies’ listing status. It is also common for companies to be already subject to the Hong Kong Stock Exchange’s delisting decision by the time the companies’ schemes get to the sanction stage.
As the companies are incorporated offshore, they would pursue parallel schemes as a matter of course.
The facts and decision in China Oil, Burwill and Grand Peace
All three cases concern distressed offshore incorporated-entities listed in Hong Kong (with predominantly Mainland operations).
In China Oil, the company had been suspended since July 2019 and was subject to Cayman soft-touch provisional liquidation in November 2019. With the provisional liquidators’ assistance, the company promoted parallel schemes in Hong Kong and the Cayman Islands.
More than 98% of the debts compromised under the schemes were governed by Hong Kong law.
Mr Justice Harris sanctioned the Hong Kong scheme, but held that the Cayman parallel scheme was unnecessary and unjustifiable. As most of the company’s debts were governed by Hong Kong law, the compromise under the Hong Kong scheme was already effective in the Cayman Islands under the Gibbs rule. It follows that the Hong Kong scheme was already internationally effective without the Cayman scheme. The Cayman scheme expenses were thus harmful to creditors:
“In the case of a company listed in Hong Kong, whose debt is very largely governed by Hong Kong law, the principle relevant jurisdiction is Hong Kong. It is Hong Kong in which a scheme is necessary and any restructuring should proceed on this basis. It is only necessary to introduce a scheme in the place of incorporation if there is good reason to think that absent a scheme sanctioned in the place of incorporation there is a genuine risk of the company being wound up there. It would not, for example, make any sense to incur more costs in introducing a scheme in the place of incorporation than the amount of the debt that it is thought might not be compromised by a scheme sanctioned in Hong Kong” (at ).
His Lordship reminded the management that incurring parallel scheme expenses unnecessarily would not be consistent with their fiduciary duties to creditors:
“If costs are reduced there will be more available for unsecured creditors. The directors of the Company and the PLs should have been advised that they owe fiduciary duties to protect the interests of the unsecured creditors and that they should aim to ensure that the maximum amount of the gross proceeds of the subscription were available for distribution to Scheme Creditors. Unless a genuine need to introduce a scheme in the Cayman Islands could be identified it was only necessary to introduce a scheme in Hong Kong” (at ).
In Burwill, by the time the company applied to sanction the scheme, the company had already been subject to a delisting decision and was seeking to appeal the decision through the listing review committee.
Mr Justice Harris adjourned the sanction application until the conclusion of the listing review committee’s process. His Lordship reasoned thus:
“There are two reasons for this. The first is that if the listing is to be cancelled, the Scheme will collapse and the application to the court will have been a waste of judicial resources. Secondly, I do not think it appropriate for the court to make a decision which it might be suggested should influence the Listing Review Committee’s deliberations and ultimate decision” (at ).
In Grand Peace, the company had already been subject to a delisting decision and was appealing the decision. Nevertheless the company would like to commence its scheme process.
Mr Justice Harris allowed the company to apply to convene a scheme meeting because convening a scheme meeting is different from sanctioning a scheme. His Lordship reasoned thus:
“I have previously in Re Burwill Holdings Ltd indicated that the court will not hear a petition to sanction a Scheme when a determination by the Listing Review Committee is pending. However, it seems to me that an application for an order that a meeting of creditors is convened will normally fall into a different category, and the court will be amenable to making such an order unless the court is concerned that the interests of unsecured creditors might be prejudiced, which is most likely to arise if the Company proposes to pay the costs itself. Commonly, however the costs will be paid by the prospective investor.”
His Lordship also remarked in obiter that parallel schemes would not be permitted in future without justification:
“Companies such as the present have their assets in Hong Kong and the Mainland, and their debt is normally governed by Hong Kong law. It, therefore, follows that a scheme of arrangement sanctioned in Hong Kong which compromises the debt would normally be expected to be recognised in common law jurisdictions with similar principles to Hong Kong guiding recognition including the well-known English Court of Appeal decision in Antony Gibbs Sons v. La Société Industrielle et Commerciale Des Métaux.
I can see very little justification in most cases for a scheme being introduced in the place of incorporation. In future, I will need to be satisfied by any company or provisional liquidators who propose that parallel schemes are introduced that it is in the genuine best interests of unsecured creditors, that a scheme is introduced in the Company’s place of incorporation” (at -)
These landmark decisions are commendably correct and hugely improve the Hong Kong scheme practice.
The previous auto-pilot practice of pursuing offshore parallel schemes is as outmoded as it is unjustifiable in most cases because (i) the debts subject to the Hong Kong scheme are usually governed by Hong Kong law, and (ii) the offshore jurisdiction of incorporation is merely a letter-box jurisdiction.
Even where cross-border insolvency cooperation is needed, the answer must lie in recognition and assistance, not the commencement of parallel plenary proceedings. For example, it would be unthinkable to commence Chapter 11 proceedings just for the purposes of getting cross-border cooperation in the US. The answer in the US lies in Chapter 15.
If the Hong Kong court is not satisfied that an offshore parallel scheme is justifiable, the Hong Kong court may indeed refuse to sanction the Hong Kong scheme.
The policy decision in Burwill must be correct because it would guard against a company seeking to misuse the court’s scheme sanction decision to influence the company’s listing appeal process.
But it must be correct to permit a company to convene a scheme meeting even though the company is already subject to a delisting decision. The scheme meeting would serve the purpose of allowing the creditors to express their views on the company’s restructuring plan. The listing review committee may then properly take account of the creditors’ views when deciding on the sufficiency of the company’s restructuring plan.
In sum, these decisions make perfect policy sense, comport with international insolvency practice, and ensure that the Hong Kong restructuring practice sufficiently protects creditors’ interests.