Did you know that a scheme of arrangement can be used to reduce the creditor constituency in a liquidation, so that time and costs can be saved for the benefit of all parties?

The Honourable Mr. Justice Ng of the Hong Kong High Court made an Order sanctioning a scheme of arrangement (Scheme) proposed by the Joint and Several Liquidators (Liquidators) of Lehman Brothers Asia Holdings Limited (LBAH) to be implemented between LBAH and certain of its unsecured creditors (Scheme Creditors).

LBAH is one of the Hong Kong-incorporated subsidiaries in the Lehman Brothers group, of which the ultimate holding company is Lehman Brothers Holdings Inc (LBHI). LBHI and certain affiliates controlled by it (together, LBHI and Affiliates) collectively hold most of the unsecured claims admitted in the LBAH liquidation. Of the balance of the admitted claims (Scheme Claims), a large part is held by other members of the Lehman Brothers group, and the rest by third parties. These latter two categories are the Scheme Creditors.

The liquidation has reached an advanced stage. It is considered that all assets of LBAH have been identified and their expected value assessed, based on reasonable assumptions. Certain distributions and payments from LBAH’s debtors remain outstanding and may take a further two years to be collected.

The Scheme was proposed with the objective of reducing LBAH’s creditor constituency and thereby simplifying its liquidation and reducing costs. In broad terms, the Scheme provides for the full and final discharge of the Scheme Claims by the Scheme Creditors in return for them receiving a payment which, together with the interim dividends in the past, will give them the anticipated total recovery (calculated on a best case basis) much earlier than if the liquidation were to continue without the Scheme.

The Scheme also operates to impose a cut-off date by which creditors must, if not already admitted in LBAH’s liquidation, submit claims against LBAH, failing which they will be barred from participating in the Scheme or the liquidation.

LBHI has contractually agreed to fund the payments to the Scheme Creditors. Upon discharge of the Scheme Claims, LBHI and Affiliates will remain as creditors of LBAH and continue to be dealt with in the ordinary course of its liquidation.

A meeting of the Scheme Creditors was held to consider and approve the Scheme as required by the Companies Ordinance (Cap 622). A resolution approving the Scheme was passed unanimously by the Scheme Creditors present and voting in person and by proxy.

The next step was to obtain sanction of the High Court. At the hearing of the Liquidators’ application in this respect, the key legal issue was whether it was permissible to have a scheme of arrangement between LBAH and only some, not all, of its unsecured creditors, having regard to the principle of pari passu distribution in insolvency law.

The Liquidators relied on English and Hong Kong authorities to the effect that a scheme of arrangement can be used to achieve a departure from the pari passu principle in a liquidation and, although all creditors in a class must have similar rights, not all creditors with similar rights have to be joined in a class, notwithstanding the insolvency of the debtor. There exist good commercial reasons that the Scheme Creditors in the present case do not include LBHI and Affiliates.

In sanctioning the Scheme, the learned Judge had regard to the fact that funding is to come from an external source instead of the LBAH estate, and the excluded creditors have agreed to the arrangement.

When the Scheme is fully carried out, advantages are:

  1. The Scheme creates a deadline for persons to submit their general unsecured claims and seek recognition as Scheme Creditors, thereby bringing certainty and finality to the process after several years.
  2. The Scheme Creditors will in effect receive the anticipated total liquidation distributions much earlier.
  3. LBHI and Affiliates will benefit in that a reduced creditor constituency means lower administrative costs of, and potentially an earlier conclusion to, the liquidation.

The flexibility of a scheme of arrangement has made it a powerful tool for the innovative liquidator, and the Scheme illustrates that benefit. Mayer Brown JSM advised the Liquidators on the Scheme and acted for them in the court applications.