Restructuring culture needs to change – Hong Kong Court leads the way
In the recent case of In the Matter of China Bozza Development Holdings Limited, Mr Justice Harris of the Hong Kong High Court recognised a Cayman Islands light touch PL but refused to grant that PL assistance. This was because there was no viable restructuring proposal, and there appeared to be a breach of the well-established route to common law recognition and restructuring as developed in Z-Obee, in order to obtain a de facto moratorium of enforcement action by creditors in Hong Kong. The case echoes the recent "scanty in the extreme" restructuring proposal in Lamtex Holdings Limited where a similarly hopeless restructuring proposal led to the application for recognition being flatly refused. Further, the company appeared to have little regard to the interests of creditors in its proposals.
In this case, the Company was incorporated in the Cayman Islands. It was the subject of a petition to wind it up in the Hong Kong Court. The Company subsequently applied to the Grand Court of the Cayman Islands for the appointment of a restructuring PL. The Grand Court granted that application and the PL subsequently sought common law recognition in Hong Kong. In Hong Kong it was held that: “Simply referring to a possible ‘debt restructuring’ and treating the expression as a kind of magical incantation, the recitation of which will conjure up an adjournment of the petition is as inadequate as it is facile”. The Company was given liberty to apply for assistance, but it will undoubtedly have an uphill battle in seeking assistance unless and until a genuine restructuring plan, taking into account the primacy of creditors’ interests, is presented.
Restructuring culture needs to change, and these decisions are a good start to encouraging responsible restructuring behaviour. Boards of directors of insolvent companies owe their duties to creditors, and when a debtor is in the zone of insolvency, transparent communications, provision of detailed accounts, openness and consultation viz any restructuring plan, including the identity of possible “white knight” investors, is paramount. Professional advisors need to be well versed in a play book of openness and dialogue to build trust with creditors and stakeholders, who will ultimately vote on any restructuring proposal possibly by way of a scheme of arrangement. A creditor-approved Chief Restructuring Officer being appointed to the board and who will be given full access to the company is a good place to start. Deviation from these core, and perfectly obvious, modern principles of responsible restructuring, should be discouraged by professional advisors and ultimately, the Courts.
In this case it was held that: “Hong Kong Court will grant an adjournment if it is demonstrated by a company that it has a proposal to address its financial difficulties that is in the best interests of the general body of unsecured creditors, particularly if there is in principle support from sufficient of the creditors in terms of value of the unsecured debt to suggest that if a scheme of arrangement is introduced it is likely to achieve the necessary statutory majority in value (75%) to engage the court’s discretionary power to sanction the scheme”.
Similar to the Hong Kong Courts’ approach, the Cayman Islands Grand Court has recently re-affirmed the need for the presentation of a viable restructuring plan: In the Matter of Midway Resources International it was held (citing Sun Cheong Creative Development Holdings Limited) that in light touch restructuring cases, it was appropriate for the Court to rigorously scrutinise the restructuring proposal: “[There] is a three-stage test…: (i) that the [PLs] should be satisfied that a refinancing and/or sale of the [company’s business] as a going concern is likely to be more beneficial to the creditors than a liquidation realisation of the [company’s] assets; (ii) that there is a real prospect of a refinancing and/or a sale as a going concern being effected for the benefit of the general body of the creditors; and (iii) that in the circumstances it is in the best interest of creditors to try to achieve such a refinancing and/or sale as a going concern.” And “Where the Court is in any doubt as to the viability of such a restructuring plan, it is also well accepted that it can appoint [PLs] for the purpose of preparing a report on the prospects of success of a restructuring plan.”
The Hong Kong Court is correctly setting boundaries as to the highly regarded and successful Z-Obee method of restructuring. It was never intended to be used by a debtor company as a wrongful means of seeking to adjourn a Hong Kong winding up petition presented first in time.
However, there will be a subsequent debate arising from these decisions as to:
- First, the future alignment of the exercise of discretion in each of the Offshore and Hong Kong Courts as to when it is appropriate to allow a company the breathing space to pursue a viable restructuring in the best interest of the stakeholders needs to be considered. Clearly, there is a disconnect in any case where one Court grants the appointment of a light touch restructuring PL, and another Court refuses to recognise it, essentially on the basis that it should not have been granted. As was held in this case: “[I]t would appear that the Cayman Court’s criteria are less onerous and that a proposal does not have to be demonstrated in order to obtain an adjournment of a petition and the giving of time for a company to attempt to restructure its debt through soft-touch provisional liquidation”. Whilst we do not consider that this is necessarily accurate more broadly, practitioners need to be mindful of the differences in the approach of the offshore and Hong Kong Courts and their consequences;
- Second, offshore law as to the appointment of light touch restructuring PLs, legislative in the Cayman Islands, common law in Bermuda and the BVI, has not traditionally required extensive scrutiny of the viability of the restructuring plan at the early stage of seeking an appointment. The practical reality at the early stages is that any plan will change in the future, depending on the outcome of dialogue with stakeholders. An overly dogmatic approach is to be avoided.
- Third, timing. China Bozza is not saying that in every case where a winding up petition is filed first in time, that restructuring may never occur. However, a viable restructuring plan, should be proposed to stakeholders well before any Hong Kong hearing to wind up. Last minute timing adds to the suspicion that there is no viable prospect of a restructuring.