The Wrecking Ball vs the Crystal Ball – planning a parallel scheme of arrangement

This follows on from the earlier obiter dicta  judgment of In the Matter of Grand Peace Group Holdings Limited  which noted that practitioners should, citing Re Da Yu Financial Holdings Limited, be cognisant that parallel schemes of arrangement in both the company’s place of incorporation and Hong Kong, where the offshore company was listed in Hong Kong, would seem generally to be unnecessary. The real answer is that it depends on the facts of every case, and the level of creditor support in a scheme. In turn, the point in time in which the risk assessment is made as to whether a parallel scheme is necessary is a notorious crystal ball gazing exercise. The wrecking ball and crystal ball are not happy bed-fellows. Identifying highly experienced professional advice is paramount to a successful scheme in the best interests of creditors.

The company was governed by the laws of the Cayman Islands by virtue of its incorporation, and light-touch liquidators had been appointed; and part of the debt being schemed was Hong Kong law debt. In the Matter of China Oil Gangran Energy Group Holdings Limited,  Justice Parker of the Grand Court of the Cayman Islands had approved the scheme days before, and the parallel scheme of arrangement in Hong Kong was similarly approved by Mr Justice Jonathan Harris.

The obiter dicta  in both cases are consistent with the well-established Drax  point. A scheme company will want to ensure that the compromises are effective not only in the Cayman Islands (as the jurisdiction of incorporation) but in other jurisdictions where its assets are located. A comparable situation arose in Re Drax Holdings  [2004] 1 WLR 1049, which concerned parallel Cayman Islands, Jersey and English schemes in respect of Cayman and Jersey incorporated entities. As Lawrence Collins J explained at [30]: “In the case of a creditors’ scheme, an important aspect of the international effectiveness of a scheme involving the alteration of contractual rights may be that it should be made, not only by the court in the country of incorporation, but also where (as here) by the courts of the country whose law governs the contractual obligations. Otherwise dissentient creditors may disregard the scheme and enforce their claims against assets (including security for the debt) in countries outside the country of incorporation”.

In China Oil Gangran Energy Group Holdings Limited, the Learned Judge noted that: “Clearly if a creditor, whose debt is governed by Hong Kong law, agrees to the terms of a scheme there is no need to be concerned about enforcement in another jurisdiction and, if the Rule in Gibbs  is applied in that other jurisdiction, participation in the scheme process provides an exception to the Rule”. This is of course correct only as far as those creditors who submit to the jurisdiction by voting in favour are concerned. This is the effect of the Gibbs  rule on the Drax  point. It may nevertheless be desirable for the scheme company to take additional steps in the Cayman Islands for commercial or strategic reasons. For example, it may prefer the certainty of taking the proactive step of promulgating a parallel scheme to cut-off potential disruptive action to the less certain and more reactive approach of relying on the application of the “rule in Gibbs” as a defence against any disruptive action in the future. Indeed, it is often the case that the scheme company will determine that the additional costs of a parallel scheme in the jurisdiction of incorporation represent a relatively modest price to pay for the delivery of day one execution certainty for the proposed restructuring.

As will be familiar to restructuring practitioners on the ground, at the coal-face, who assess whether a parallel, second or even third, scheme of arrangement is necessary, the exercise takes place over many months of complex negotiations and strategic positioning. In the vast majority of cases, creditor support builds up over time, and at the early stages, creditors and stakeholders jockey in negotiations for better terms, reluctant to make a binding commitment through increasingly complicated “lock-up letter” arrangements. Creditor “hold-out” is the norm and the demands for “sweeteners” go to the wire. On the day of the vote, and even the day of a scheme sanction hearing, the wrecking ball can hang over the restructuring professional team. The Drax  point is the incontrovertible foundation of this exercise. Any assessment as to whether the parallel scheme was necessary should apply a legal test in “real-time”, based on evidence adduced for the dedicated purpose of determining that issue.

The use of parallel schemes of arrangement in such circumstances is common standard practice for Cayman Islands incorporated entities and this continues to be the position. Parallel schemes of arrangement should only be pursued where they are necessary, and in China Oil Gangran Energy Group Holdings Limited, such a scheme was required.