Hong Kong’s restructuring scene is one of the most cross-border in the world, with three-quarters of its listed companies incorporated offshore and most restructurings having a mainland China connection. But the territory still lacks a statutory regime for cross-border recognition – as recently brought into focus in the restructuring of Singaporean engineering company CW Group. What does this mean for international insolvencies in the region?
“In this part of the world every restructuring and every cross-border case that we do has some connection with mainland China,” said Aisling Dwyer, partner at Maples Group in Hong Kong and co-chair of GRR Live Hong Kong. Many Hong Kong-listed companies conduct business in the mainland or have employees, directors, or assets located there.
Many Chinese restructurings also have an offshore connection. In some cases, “you may have an offshore company at the top of the structure which is providing an offshore angle to the whole piece,” Dwyer said.
Joanne Collett, partner at Walkers in Hong Kong, said these offshore connections reflect the fact that around 40% of the companies on the main board of the Hong Kong Stock Exchange are incorporated in the Cayman Islands, 33% are incorporated in Bermuda and just over 1% are incorporated in the British Virgin Islands (BVI).
Collett added that she expected things to stay that way. She said she had found that of the 100 initial public offerings in Hong Kong in 2018 up until the November conference, 82 were Cayman-incorporated. “So that shows it’s generally the structure for the corporate or the listing groups” in Hong Kong, she said.
Close to US$100 billion of Chinese offshore debt is due to mature by the end of 2020, Latham & Watkins partner Howard Lam said. Given the downward pressure on economic growth in the second half of 2018, the market had already seen several defaults on Chinese offshore bonds, he added.
“The structure of the debt that we are dealing with in restructuring or insolvency has been evolving, in the way that this debt has been issued and the way that the group is organising themselves,” he said. Many companies have a holding company at the top of their structure and their assets at the bottom, he explained.
Lam said there have recently been many instances where a Chinese parent company has established an offshore finance vehicle to issue bonds with credit support from its parents. If not a parent guarantee, the credit support sometimes comes in the form of a keepwell deed – an equity interest purchase undertaking where the parent undertakes to purchase certain subsidiaries from the offshore issuer sufficient to pay off the bond – or a standby facility to the issuer.
This means “creditors are now increasingly looking at possible recourse against the parent or the larger onshore group, which might not sit under the issuing entity”, Lam said.
He added there have been recent cases of bond defaults by several entities that operate under this kind of structure, including Chinese oil and gas provider China Energy Reserve & Chemicals Group. But he said it is too soon to tell what exactly would happen if an entity with this structure were to go into liquidation or a restructuring.
“I think the latest batch of offshore bond debts might include direct issuance by Chinese companies, and any workout would involve negotiation with the onshore stakeholders and possibly an onshore process” he said. He used the example of Huachen Energy, a Chinese power company which issued New York law-governed bonds.
Lam said that, if there were offshore assets “there could be competition as to who is going to drive what in which jurisdiction,” said Lam.
One case in particular – the restructuring of engineering company CW Group – has raised questions over how to restructure offshore companies in Hong Kong.
CW’s headquarters are in Singapore, its holding company is registered in the Cayman Islands, and it is listed on the Hong Kong Stock Exchange. The company filed for a moratorium in Singapore in June, and petitions were filed for the appointment of provisional liquidators in Hong Kong and the Cayman Islands a month later.
Hong Kong High Court companies judge Mr Justice Jonathan Harris appointed the provisional liquidators, but in the absence of a request for recognition of the Singapore moratorium he did not have the opportunity rule on whether the court could do so. In his decision, he warned that Hong Kong urgently needed a cross-border restructuring regime. The Grand Court of the Cayman Island appointed “soft-touch” provisional liquidators over the company in August.
Manoj Pillay Sandrasegara, partner at WongPartnership in Singapore, noted that the company decided to file for a moratorium in Singapore and to restructure there, despite not being incorporated in the city-state, and despite its links to Hong Kong.
CW filed an application under section 211b of the Singapore Companies Act, which gives a company an automatic 30-day moratorium. Companies then have to go back to the court before the end of the 30 days to request an extension.
Sandrasegara said the group decided during that period to request the appointment of a provisional liquidator in Hong Kong over locally domiciled subsidiary CW Advanced Technologies. Bank of China, a creditor, objected to the application, as it did not approve of the identity of the provisional liquidator. The application was adjourned in large part, Dwyer explained, because Mr Justice Harris wanted to consider the impact in Hong Kong of the Singapore moratorium. Ultimately, in Hong Kong CW withdrew its application and Bank of China filed its own application for provisional liquidators in Hong Kong, which Mr Justice Harris approved.
Meanwhile, the case was also playing out before courts in the Cayman Islands, where the CW Group had a holding company that had issued bonds and guaranteed the debt of several of its subsidiaries. “Losing control of the top company potentially enables a provisional liquidator to change the boards of the structure throughout the group,” Collett explained.
“The question was what needed to be done, if anything, to protect control of the Cayman entity to enable a restructuring proposal to be formulated with the creditors,” she added.
She said it was not known at the time “whether or not a creditor would take action in Cayman, and the question was whether or not the Singapore moratorium would operate extraterritorially.” Another question was whether or not the directors had the power to file a winding-up petition.
She said the prevailing position in the Cayman Islands was that, absent authority in the company’s articles, the directors did not have the power to present a winding-up petition even if the company is insolvent without a resolution from the shareholders.” But she said it can take time to get such a resolution.
Collett said companies have worked around that position in the past by persuading a friendly creditor to file the petition for the winding up of the company, then to support a summons for the appointment of soft-touch provisional liquidators. CW followed this example.
She explained that there ended up being two competing applications. One was filed by a friendly creditor looking to have soft-touch provisional liquidators appointed, and the other was filed by the Bank of China, which wanted provisional liquidators appointed “on a more traditional basis.” The court accepted the soft-touch application.
But she said that, while some questions of jurisdiction did arise in the Cayman court, “nobody went to the Singapore court and said ‘can you enforce your stay’ and, similarly, in Cayman nobody asked them to enforce the stay”.
She said it remained an open question whether the Cayman court would recognise the Singapore moratorium.
Nick Stern, counsel at Freshfields Bruckhaus Deringer in Hong Kong, added that the CW case had left a number of questions unanswered. He said the application to the Hong Kong court was relatively straightforward and was accepted, “but the most interesting thing about the judgment was the issues that weren’t addressed but which people want addressed.”
“The key issues really come from the lack of a framework in Hong Kong about how to deal with some of these difficult situations where you have different jurisdictions, and in this situation particularly whether or not a moratorium in Singapore would be recognised in Hong Kong.”
Look Chan Ho, a barrister at Des Voeux Chambers and co-chair of GRR Live Hong Kong, noted that the multijurisdictional nature of the restructuring also led to an interesting timetabling decision from the Hong Kong court. The Hong Kong court heard CW Advanced Technologies’ application for provisional liquidators just a few hours before an application for provisional liquidators was due to be heard in the Cayman Islands, after Justice Harris declined to adjourn the Hong Kong application for the outcome of the Cayman hearing.
Tools for Chinese restructurings
The panellists considered what tools offshore practitioners could use with regard to the Chinese elements of a restructuring.
Sandrasegara explained that Singapore’s recent insolvency legislation kept the foundation of its existing scheme of arrangement while adding some elements from US law such as an automatic moratorium once a company files. He said these changes had been made based on looking at what had not worked so well in past cases.
He said that although he had yet to see a private Chinese company’s restructuring filed in Singapore, he and his team have noticed more interest from Chinese parties in filing in Singapore, where they usually would have only considered filing in the US or the UK.
“Hopefully, it is just a question of time that we are going to see one of those within our shores,” he said.
“When the only tool you have is a hammer, every problem looks like a nail,” Lam reflected. He explained that a lot of Chinese offshore debt has been restructured using schemes. ”The stock standard approach is you find a connection with a jurisdiction, use a Hong Kong scheme to deal with the Gibbs principle, maybe run a parallel scheme in the place of incorporation and get Chapter 15 recognition,” he said.
Lam said this works well with regard to offshore debt, in terms of binding creditors or shareholders in the US or Hong Kong, but “when it goes across the border into China, it is often beyond our control as professional advisors”.
He said the Chinese government or Chinese regulators often coordinate the mainland restructuring process, so “rarely are the legal tools that we try to use offshore driving the real solution”.
“It is often the case that you must use that as your way to get a seat around the table and be part of that discussion and influence the process, but it is always driven by actually what happens onshore.”
He said there are number of ongoing cases of this kind at the moment, but that the Chinese government seems to take a different approach to each of them.
“I agree that is helpful sometimes to have the government involved, but it is not a very predictable outcome when it depends on the government to get involved to provide the solution,” Lam said.
Foreign recognition in China
Ho said that there has been much discussion in mainland China about the recognition of foreign proceedings, as judges, academic and practitioners are “extremely aware of the cross-border issues” of restructuring. He asked Wang Lingqi – counsel at Fandga Partners in Shanghai – whether there was a disconnect in China between its understanding of cross-border insolvency and the way it applies that understanding.
Wang explained that China’s Enterprise Bankruptcy Law has a provision – article 5 – for cross-border recognition which relies on treaties or reciprocity.
“The traditional Chinese view on reciprocity is that the Chinese court won’t take the first step, the counterparty in the other jurisdiction has to first recognise the Chinese proceeding,” he said.
He explained that there have been recognition cases outside of this provision, such as a 2014 case when the Supreme People’s Court found that it could recognise a liquidator appointed by a Singaporean court over a Singaporean company with Chinese subsidiaries.
“So this kind of power is recognised in China because Chinese courts can simply apply Singaporean law in this kind of question and, without relying on article 5, recognise the liquidator’s power to act for the foreign company.”
But he said there have recently been developments in relation to article 5 as well. He said a US court had recently recognised a Chinese proceeding, opening up the possibility for a Chinese court to recognise proceedings in the US, and that the Supreme People’s Court has encouraged lower courts to consider taking the first step in recognising proceedings elsewhere.
Wang also noted that the Supreme People’s Court recently signed a memorandum of understanding with Singapore on the enforcement of money judgments. He said that although there are questions about its legal effect, lower courts in China are expected to follow it.
He explained that the prevailing view is the memorandum does not stretch to cross-border insolvency judgments and proceedings. But he said some judicial assistance treaties China has signed with western countries have not explicitly explained whether insolvency proceedings are included or excluded, and lower courts have relied on these treaties to recognise foreign bankruptcy proceedings.
Looking ahead, Wang said that if a lower court decides to follow the Singaporean memorandum, it could open the door for “competition between Singapore and Hong Kong in terms of serving as a forum for China-related commercial litigations, similar to the competition in the arbitration field.”
He noted recent talk about adoption of the UNCITRAL Model Law in China, but that this would probably require new legislation. “Article 5 is so general that the Supreme People’s Court has to stretch its power in order to incorporate the whole Model Law system by issuing a traditional interpretation,” he explained.
“The Supreme Court has been stretching its limit in the past in other areas,” he said. The court is “working on a traditional interpretation of cross-border insolvency, but we don’t know whether it will go as far as basically adopting the Model Law.”
Wang believes there may be legislative developments on the horizon as well. “The legislature has kicked off a project on amending the bankruptcy law and, hopefully, there will be more clarity on the cross-border issues.”
Challenges posed by fraud
When asked about the key challenges to restructuring in mainland China for outside practitioners, Stern said he had recently heard in a speech from the head of enforcement at Hong Kong’s Securities and Regulatory Commission that fraud was effectively the biggest challenge to Hong Kong’s financial position, with 50 companies suspended from the Hong Kong Stock Exchange in 2017. Most of those were Chinese businesses.
“I would say a significant minority of the work that I see has a fraud element to it,” said Stern. One of the main difficulties he faces when dealing with fraud is that “it is quite hard to get to the bottom of it and to get the evidence to find out what actually happened”.
He said the result is that “you are often working with the management who were there at the time when the fraud occurred, but who are trying to get through a restructuring in those circumstances.”
This leads to “a difficult dynamic because you are trying to have some credibility with your creditors but at the same time seeing that the people who were in charge when the fraud happened are still in charge, so how do you deal with that?”
Ted Osborn, head of China and Hong Kong restructuring and insolvency at PricewaterhouseCoopers in Hong Kong, said that in many of the situations PwC works on, “one of the primary reasons we get involved is because there has been an allegation of fraud and particularly when the banks find out, they petition to get someone else to oversee the situation.” He said an increasing number of those cases that come his way are related to Chinese companies.
“A lot of it has to do with fraud just to raise money” such as fictitious sales, he explained.
But he said “at the end of the day, most situations like that get resolved somehow in some way.” Sometimes the situations are dealt with because “new investors come in and all that goes away, but there is no easy solution in those sorts of cases.”
The 2nd annual GRR Live Hong Kong took place on 6 November. The panel on restructuring in China from the outside looking in followed a panel on the view from the ground in mainland China. The conference also included keynote speeches from Mr Justice Jonathan Harris and Dinny McMahon, a fellow at the Chicago think tank MacroPolo who worked as a financial journalist in China for 10 years.