Despite the absence of a formal restructuring regime, the Courts in Cayman (and latterly by way of the Companies Law) have developed a flexible and pragmatic approach, deploying provisional liquidators to provide breathing space for a company in distress. A recent decision may well limit that ability for many Cayman incorporates.
“China Milk” spilt; tears may follow
In the absence of an equivalent to an administration or Chapter 11 type regime, Cayman companies have often sought “light touch” provisional liquidation orders to give them some safety and latitude while they restructure. The recent decision of the Grand Court in Re China Shanshui Cement Group Limited (unreported, 25 November 2015) however may have reinstated a rather unhelpful roadblock for most Cayman companies seeking protection pending a restructuring.
China Shanshui was incorporated as a Cayman exempt company in April 2006 as a holding company for a group of operating subsidiaries in the PRC, primarily engaged in the production and sale of cement. Its principal debt of US$500m Senior Notes were listed on the Hong Kong Stock Exchange and issued to some 300 institutions through a New York indenture trustee.
Unable to pay a debt said to be immediately due under the Notes but being balance sheet solvent, the Company’s directors presented a winding-up petition and applied for the appointment of provisional liquidators to effect a restructuring (a so-called “light touch” provisional liquidation). The company’s majority shareholders opposed the petition (as did a number of the Noteholders, none of whom had been consulted in advance about it) and applied to have it struck out on the basis that the directors did not have the authority to present the petition without first having obtained the approval of the company’s shareholders.
Section 94(2) was enacted for the first time in the Companies (Amendment) Law 2007 and provides that:
Where expressly provided for in the articles of association of a company the directors of a company incorporated after the commencement of this Law have the authority to present a winding up petition on its behalf without the sanction of a resolution passed at a general meeting
It came into force in March 2009 as one of a number of measures designed to assist with the response to the financial crisis. However, it was argued that the provision did not apply to China Shanshui which had been incorporated before 1 March 2009, and therefore the directors required members’ approval to present the petition (even if there was specific power given to the directors in the articles of association to petition to wind up).
Alternatively, could the directors apply pursuant to section 94(1)(a) as “the company”? In Re China Milk Products Group Ltd  (2) CILR 61 the court concluded that the reference to the company in section 94(1)(a) included, in the case of an insolvent company, its directors. The judge in China Milk construed the words “the company” to include its directors:
“In my view, there are sound policy reasons why the board of directors of an insolvent company should be allowed to present a winding-up petition…..When a company becomes insolvent, its shareholders cease to have any economic interest and the directors must act in the interests of its creditors. In my view, it is wrong in principle that the directors’ ability to commence insolvency proceedings, and seek the protection of the automatic stay [of proceedings] imposed by s.97 [of the Companies Law], should be dependent upon the terms of the company’s articles of association or the co-operation of shareholders who no longer have any economic interest.”
The consequence was that section 94(2) only authorised the directors of a solvent company incorporated after 1 March 2009 to apply for a winding up if that was expressly provided for in the company’s articles of association
The majority shareholders in China Shanshui argued that China Milk was wrongly decided. The terms of section 94(1) of the Companies Law had not been altered and thus remained unaffected by the review mentioned by the judge in China Milk. The position was supported by the pre-1986 English authority (Re Emmadart Ltd  1 Ch 540).
Notwithstanding the company’s valiant struggle, the judge agreed with the majority shareholders that China Milk was wrongly decided and struck out the petition.
Repercussions for Cayman restructuring
In summary, directors of insolvent companies incorporated before 1 March 2009 cannot present winding up petitions in the Cayman Islands in aid of a restructuring effort without seeking shareholder approval. This is likely to have serious repercussions for restructurings going forward. First, the decision prevents the boards of most Cayman Islands companies from petitioning to wind up unless they have shareholder consent. In the case of listed companies such consent may not be easy to obtain and will involve high transaction costs as the EGM seeking such consent will need to be notified to the relevant Stock Exchange.
If the board cannot petition then there is a risk that a salvageable company will be lost: if a creditor petitions to wind up the company there is no clear basis at present for the company to cross-apply for the appointment within that petition of a restructuring provisional liquidator. The creditor is entitled to his winding up order ex debito justitiae so long as he can prove his debt, the company is or is deemed insolvent and there is not overwhelming opposition from other creditors. China Shanshui may lead companies to solicit groups of friendly creditors to oppose a creditors’ petition on the basis that it is premature to wind it up without first considering a restructuring.
Further, if a company cannot petition for its own winding up to explore restructuring and obtain the appointment of light touch PLs there is no clear road map in the legislation at present showing how a provisional liquidator might come to have his powers extended for that purpose. The only party at present who can apply for a restructuring provisional liquidator is the company itself (with shareholder backing); creditors and shareholders can apply only for the traditional “asset preservation” provisional liquidators. In Re China New Lumena Materials Ltd (Unreported, Grand Court, August 2015) the court extended the scope of an order extending the appointment of asset preservation provisional liquidators so they could also promote a scheme of arrangement, but this was supported by the company as it was common ground from the outset that restructuring PLs were necessary and the dispute was really only about who should take the provisional liquidator appointment.
At a time when there are many restructurings of Cayman companies already on foot or being actively considered, the decision in China Shanshui for all of its correctness may come quickly to be regarded as an unhelpful impediment to effective restructuring efforts. If that is the consensus then it is to be hoped that, consistent with the position taken in England 30 years ago, the Companies Law will be amended swiftly to overrule it.
Other notable Cayman decisions
Non-petition clause upheld in partnership agreement
China Shanshui is not the only notable decision to have been produced by the Cayman Islands courts in the last few months. There have been two others of significance. In Re Rhone Holdings LP (unreported, Court of Appeal, 19 November 2015) the Cayman Islands Court of Appeal dismissed an application for leave to appeal a decision of the Grand Court striking out a petition as an abuse of process where the constitutional documents of the partnership concerned included a clause prohibiting the limited partners to commence winding up proceedings. This is likely to come as a surprise to Cayman practitioners who had previously thought that section 95(2) of the Companies Law, which gave statutory recognition to non-petition clauses, was intended only to apply to contracts with third parties, not constitutional documents.
Loss of substratum (again)
The debate continues in the offshore world as to whether it is appropriate to wind up a company for loss of substratum when it ceases to be viable, rather than when it becomes impossible for the company to carry out its objects. In Re Harbinger Class PE Holdings (Cayman) Ltd (unreported, Grand Court, 10 November 2015), a case concerning a company that was not an open ended Cayman mutual fund, the Grand Court distinguished the line of Cayman authority that had invented the viability test and held that the impossibility test applied.
The acceptance of the impossibility test by the Grand Court in Re Harbinger may reopen the debate as to whether the viability test for loss of substratum – unique to Cayman open ended mutual funds – is appropriate. The Cayman Islands Court of Appeal expressly left the point open in ABC Co SPC v J & Co Ltd [2012 (1) CILR 300] when considering the different positions taken in Cayman and the BVI. Even though an appeal has been filed in Re Harbinger it is unlikely that the issue will arise for decision on the appeal due to the way the case was argued at first instance.