On 6 June 2022, Mr Justice Harris sanctioned a Hong Kong scheme of arrangement for Rare Earth Magnesium Technology Group (the Company) in re Rare Earth Magnesium Technology Limited [2022] HKFCI 1686 (Rare Earth).
In some obiter remarks made in the course of that decision, Harris J suggested that a common restructuring practice might not have the desired effect in Hong Kong. The practice involves compromising United States (US) law-governed debt through a scheme of arrangement in an offshore jurisdiction coupled with US recognition of that scheme under Chapter 15 of the US Bankruptcy Code. Harris J suggested that a Chapter 15 order of this type may not be sufficient as a matter of law to discharge the debt under US law, and therefore the discharge might not be recognised as effective in Hong Kong for the purposes of the rule in Antony Gibbs & Sons v La Societe Industrielle et Commerciale des Metaux (1890) LR 25 QBD 399 (Gibbs).
However, subsequent to the Rare Earth decision, the US Bankruptcy Court has considered, in the restructuring of Modern Land (China) Co., Limited (Modern Land), arguments as to whether an order made pursuant Chapter 15 can discharge US law-governed debt as a matter of US law. Whilst the decision of the US Bankruptcy Court is still awaited, indications are the Court is likely to rule that such an order can effect a valid discharge.
These developments give rise, for the time being at least, to some potential uncertainty as to the appropriate manner to carry out restructurings of US law-governed debt by Hong Kong based companies incorporated in other jurisdictions. We discuss these issues further in this note.
Background
The Company was a Bermuda-incorporated company with shares listed on the Hong Kong stock exchange. Its principal indebtedness arose from unsecured bonds issued by the Company that were governed by Hong Kong law (the Bonds).
Soft-touch provisional liquidators (the PLs) were appointed to the Company in Bermuda in 2020 to assist with and facilitate a debt restructuring. Those PLs were recognised by the Hong Kong Court (the Court) in August 2020 (see our previous post).
The Company and its PLs pursued a debt restructuring which led to the Company proposing a creditors’ scheme of arrangement (the Scheme) in Hong Kong. The Scheme involved the discharge of the Company’s existing unsecured indebtedness and a release of the scheme creditors’ right to enforce guarantee claims against a related entity Century Sunshine Group Holdings Limited (Century Sunshine). In exchange creditors received modified debt obligations in the form of either the “Term Extension Option” or the “Convertible Bonds Swap Option”.
The Court made the convening order for the Scheme (the Convening Order) on 12 January 2022. The first creditors meeting was held on 15 February 2022. At the adjourned creditors meeting on 1 March 2022, 79.06% of the creditors voted in favour of the Scheme terms (representing 9 out of the 10 scheme creditors). The Company then sought sanction of the Scheme from the Court.
Rare Earth Decision
The Court considered the following factors and sanctioned the Scheme:
- The Scheme was a genuine debt restructuring of a distressed company and it was a permissible to compromise the creditors’ guarantee rights against a third party (Century Sunshine) under the Scheme.
- The Scheme creditors correctly voted as a single class.
- The Convening Order (including its advertisement requirement) has been complied with.
- The Scheme meeting was duly convened in accordance with the Court’s directions.
- The Company made a satisfactory explanatory statement in accordance with section 671(3) of Companies Ordinance (Cap. 622) so as to give creditors sufficient information to make an informed decision.
- The Scheme would provide creditors with a better return than in an insolvent liquidation of the Company and thus an intelligent and honest person could have approved the Scheme in accordance with his or her interests.
A small modification was also sought to the Scheme terms to deal with the comments from Hong Kong Stock Exchange. The Court permitted these modifications because they improved the scheme creditors’ recovery and would not prejudice any Scheme creditors.
Rare Earth did not require parallel schemes
The Court observed that in this case there was no parallel scheme of arrangement in any other jurisdiction, as the Scheme was expected to be internationally effective given all of the debt was governed by Hong Kong law. Harris J noted that this expectation was justified given the rule in Gibbs, which provides that a debt is treated as discharged if compromised in accordance with the law of the jurisdiction which governed the instrument giving rise to its debt. He further noted that to his knowledge the rule in Gibbs was followed in Bermuda and Cayman (being the offshore jurisdictions relevant to the Company).
Obiter remarks on the Gibbs rule in other cases
However, the Court then went on to make some further observations and obiter comments on the application of the Gibbs rule in other circumstances.
The Court noted that mainland business groups commonly raise USD denominated debts governed by US law, and a large number of them have used schemes of arrangement in offshore jurisdictions coupled with Chapter 15 recognition of those schemes to restructure those debts.
The Court stated the following, in respect of a Hong Kong scheme of arrangement:
- It is not inconsistent with the Gibbs rule to introduce a scheme of arrangement in Hong Kong to compromise US law-governed debts, and to seek recognition of that scheme in the US under Chapter 15 of the US Bankruptcy Code.
- A creditor could not take enforcement action within the US as a consequence of recognition of the Scheme under Chapter 15 and granting by the relevant US Bankruptcy Court of ancillary relief which prohibited enforcement in the US.
- Such a scheme would also bind creditors who have submitted to the jurisdiction of the Hong Kong Court, preventing them from taking actions in the Hong Kong Court. However it may not otherwise be effective to compromise the debt of a creditor who has not submitted to the jurisdiction of the Hong Kong Court.
The Court then stated the following in respect of a scheme of arrangement sanctioned in an offshore jurisdiction (such as Cayman or Bermuda) and recognised under Chapter 15 of the US Bankruptcy Code:
- Such a scheme would not be treated by a Hong Kong Court as compromising US law-governed debt.
- The Gibbs rule requires the substantive alteration of contractual rights to be sanctioned by some substantive provision of the relevant law, which he understood to be, in the US insolvency context, Chapter 11 of United States Bankruptcy Code.
- In contrast, his lordship stated that recognition under Chapter 15 operates procedurally to prevent action by a creditor against a debtor’s property in the US, but does not appear as a matter of US law to discharge the debt. The Court drew this conclusion based on its understanding of a US case decided by Judge Martin Glenn in the Southern District of New York (In re Agrokor d.d. 591 BR 163 (Bankr. SDNY 2018) (Agrokor).
- The Court therefore concluded that in such circumstances if the company has a creditor which did not submit to the jurisdiction of the offshore court, that creditor will be able to present a petition in Hong Kong to wind up the company (and it would be entitled to obtain such an order if the debt is not disputed or settled).
Harris J was clearly aware that this view may result in significant disruption to established practice in the Hong Kong restructuring market, stating (at para 37):
I note that there appears to be a surprisingly large number of Mainland groups listed in Hong Kong, whose US$ denominated debt has recently been subject to schemes only in offshore jurisdictions and recognition under Chapter 15. It may be that all the creditors of these companies, which hold debt of any material value have agreed to the terms of the compromise, but if that is not the case such companies, and any that might adopt a similar model in the future, will be at risk of a petition being presented against them in Hong Kong and being wound up here. An offshore scheme and Chapter 15 recognition will not protect them.
Modern Land – developments after the Rare Earth Decision
After the Rare Earth decision, a separate US Chapter 15 recognition case in respect of Modern Land was heard before Judge Martin Glenn in the US Bankruptcy Court.
Modern Land was a Chinese property developer incorporated in the Cayman Islands that had issued US law-governed notes. Modern Land had proposed a Cayman scheme of arrangement to discharge its existing notes and replace them with new notes. Modern Land sought recognition of this scheme before the US Bankruptcy Court and additional relief orders providing that the debt under the notes was discharged as a matter of US federal law and New York state law.
This fact scenario was essentially the same as the offshore scheme scenario described in Harris J’s obiter comments in Rare Earth, in which his lordship suggested that the Hong Kong Court would not treat the debt as being discharged. Judge Glenn was concerned whether Modern Land’s Cayman scheme of arrangement could be effective if it was not recognised and enforced in Hong Kong. He also asked if he should consider whether the Cayman scheme would be recognised in Hong Kong when deciding whether to grant Chapter 15 recognition.
On 17 June 2022, Modern Land filed a supplemental brief with the US Bankruptcy Court which, by reference to precedents relating to Chapter 15 recognition orders and other case law, argued that a Chapter 15 order does constitute a valid and complete discharge of the New York law governed debt. Modern Land pointed to a number of Chapter 15 orders which purported to discharge the US debt, including In re Oi S.A. et al., No. 16-11791 (SHL) (Bankr. S.D.N.Y. 2018) (Dkt. No. 277), In re DTEK Finance PLC, No, 21-10735 (JLG) (Bankr. S.D.N.Y. 2021) (Dkt. No. 15), In re Inversora Eléctrica de Buenos Aires S.A., 560 B.R. 650 (2016) and In re Cell C Proprietary Limited, 571 B.R. 542 (2017).
In addition, the supplemental brief argued that the territorial limitation in Agrokor related to enforcement of a settlement agreement, but (contrary to the suggestion of Harris J in Rare Earth) that Judge Martin Glenn did not in Agrokor court suggest any limitation on the power of the US Bankruptcy Court to discharge US law governed debt under Chapter 15, but instead cited another decision where this has occurred (In re Avanti Commc’n Grp PLC, 582 BR 603 (Bankr SDNY) 2018).
Accordingly, Modern Land argued that jurisdictions that follow the Gibbs rule (such as Hong Kong) should treat debts governed by US law as properly discharged in accordance with the applicable governing law when such debts are discharged pursuant to an offshore proceeding and subsequently recognized and enforced by a United States bankruptcy court through Chapter 15.
At a hearing on 6 July 2022, Judge Martin Glenn indicated that he disagreed with Harris J’s reading of Agrokor in Rare Earth. Judge Martin Glenn also stated that he was “certainly” of the view that as long as due process is observed and other principles for giving comity are satisfied, a foreign court can discharge or modify New York law-governed debt.
Remarks
Mr Justice Harris’s remarks in Rare Earth in respect of the effect of Chapter 15 recognition in respect of an offshore scheme of arrangement are obiter. The facts of Rare Earth involved compromising Hong Kong law-governed debts through a Hong Kong scheme of arrangement, and therefore there was no Chapter 15 recognition sought in that case (for the reasons explained by Harris J).
These remarks on the Gibbs rule are therefore not strictly binding. However, considering Mr Justice Harris’ influence over Hong Kong insolvency practice, his obiter comments are likely to be given considerable weight in Hong Kong.
However, Mr Justice Harris’s obiter remarks were based on his understanding of US case law (in particular the Agrokor decision) on the question of whether a Chapter 15 order constituted a valid and complete discharge of the New York law-governed debt. Ultimately, however, this question is a matter of US law. Judge Martin Glenn’s subsequent comments in Modern Land case are therefore arguably authoritative (Judge Martin Glenn decided the Agrokor case). In Hong Kong, how these comments are to be reconciled with Mr Justice Harris’s obiter remarks in Rare Earth remain to be seen.
In addition, it is important to note that the answer will also depend on the terms of the actual order made in any given Chapter 15 case.
With all that being said, Mr Justice Harris’s remarks do illustrate that careful planning is essential to effectively compromising debt obligations via schemes of arrangement in a cross-border context.
For now, until the position is further clarified, a Hong Kong-based debtor company (that is incorporated offshore as most Hong Kong listed companies are) with New York law-governed debts should carefully consider where it is most appropriate to undertake a scheme of arrangement (and whether a parallel scheme of arrangement is required). It would appear from the Rare Earth decision that, for the time being at least, if such a company undertakes an offshore scheme of arrangement (without a Hong Kong parallel scheme) it could risk creditor action in the Hong Kong court, even if the company has obtained Chapter 15 recognition in respect of that scheme in the US.
For further information, please contact:
Paul Apáthy, Partner, Herbert Smith Freehills
paul.apathy@hsf.com
