On 6 June 2022, Mr Justice Harris sanctioned a Hong Kong scheme of arrangement for Rare Earth Magnesium Technology Group (the Company) in re Rare Earth Magnesium Technology Limited [2022] HKFCI 1686 (Rare Earth).
In some obiter remarks made in the course of that decision, Harris J suggested that a common restructuring practice might not have the desired effect in Hong Kong. The practice involves compromising United States (US) law-governed debt through a scheme of arrangement in an offshore jurisdiction coupled with US recognition of that scheme under Chapter 15 of the US Bankruptcy Code. Harris J suggested that a Chapter 15 order of this type may not be sufficient as a matter of law to discharge the debt under US law, and therefore the discharge might not be recognised as effective in Hong Kong for the purposes of the rule in Antony Gibbs & Sons v La Societe Industrielle et Commerciale des Metaux (1890) LR 25 QBD 399 (Gibbs).
However, on 18 July 2022 (subsequent to the Rare Earth decision) the US Bankruptcy Court held, in the case of re Modern Land (China) Co., Limited (2022) (Modern Land), that an order made pursuant Chapter 15 can discharge US law-governed debt as a matter of US law and that the Court in Rare Earth had misinterpreted US law on this point.
The Rare Earth decision gave rise to some potential uncertainty as to the appropriate manner to carry out restructurings of US law-governed debt by Hong Kong based companies incorporated in other jurisdictions. Hopefully these uncertainties have now been resolved with the Modern Land decision, allowing existing restructuring practice to continue. However, we await a further decision of the Hong Kong court to understand if there are any further nuances to these interactions.
We discuss the issues arising from these cases further in this note.
Background to Rare Earth
The Company was a Bermuda-incorporated company with shares listed on the Hong Kong stock exchange. Its principal indebtedness arose from unsecured bonds issued by the Company that were governed by Hong Kong law (the Bonds).
Soft-touch provisional liquidators (the PLs) were appointed to the Company in Bermuda in 2020 to assist with and facilitate a debt restructuring. Those PLs were recognised by the Hong Kong Court (the Court) in August 2020 (see our previous post).
The Company and its PLs pursued a debt restructuring which led to the Company proposing a creditors’ scheme of arrangement (the Scheme) in Hong Kong. The Scheme involved the discharge of the Company’s existing unsecured indebtedness and a release of the scheme creditors’ right to enforce guarantee claims against a related entity Century Sunshine Group Holdings Limited (Century Sunshine). In exchange creditors received modified debt obligations in the form of either the “Term Extension Option” or the “Convertible Bonds Swap Option”.
The Court made the convening order for the Scheme (the Convening Order) on 12 January 2022. The first creditors meeting was held on 15 February 2022. At the adjourned creditors meeting on 1 March 2022, 79.06% of the creditors voted in favour of the Scheme terms (representing 9 out of the 10 scheme creditors). The Company then sought sanction of the Scheme from the Court.
Rare Earth Decision
The Court considered the following factors and sanctioned the Scheme:
- The Scheme was a genuine debt restructuring of a distressed company and it was a permissible to compromise the creditors’ guarantee rights against a third party (Century Sunshine) under the Scheme.
- The Scheme creditors correctly voted as a single class.
- The Convening Order (including its advertisement requirement) has been complied with.
- The Scheme meeting was duly convened in accordance with the Court’s directions.
- The Company made a satisfactory explanatory statement in accordance with section 671(3) of Companies Ordinance (Cap. 622) so as to give creditors sufficient information to make an informed decision.
- The Scheme would provide creditors with a better return than in an insolvent liquidation of the Company and thus an intelligent and honest person could have approved the Scheme in accordance with his or her interests.
A small modification was also sought to the Scheme terms to deal with the comments from Hong Kong Stock Exchange. The Court permitted these modifications because they improved the scheme creditors' recovery and would not prejudice any Scheme creditors.
Rare Earth did not require parallel schemes
The Court observed that in this case there was no parallel scheme of arrangement in any other jurisdiction, as the Scheme was expected to be internationally effective given all of the debt was governed by Hong Kong law. Harris J noted that this expectation was justified given the rule in Gibbs, which provides that a debt is treated as discharged if compromised in accordance with the law of the jurisdiction which governed the instrument giving rise to its debt. He further noted that to his knowledge the rule in Gibbs was followed in Bermuda and Cayman (being the offshore jurisdictions relevant to the Company).
Obiter remarks in Rare Earth on the Gibbs rule in other cases
However, the Court then went on to make some further observations and obiter comments on the application of the Gibbs rule in other circumstances.
The Court noted that mainland business groups commonly raise USD denominated debts governed by US law, and a large number of them have used schemes of arrangement in offshore jurisdictions coupled with Chapter 15 recognition of those schemes to restructure those debts.
The Court stated the following, in respect of a Hong Kong scheme of arrangement:
- It is not inconsistent with the Gibbs rule to introduce a scheme of arrangement in Hong Kong to compromise US law-governed debts, and to seek recognition of that scheme in the US under Chapter 15 of the US Bankruptcy Code.
- A creditor could not take enforcement action within the US as a consequence of recognition of the Scheme under Chapter 15 and granting by the relevant US Bankruptcy Court of ancillary relief which prohibited enforcement in the US.
- Such a scheme would also bind creditors who have submitted to the jurisdiction of the Hong Kong Court, preventing them from taking actions in the Hong Kong Court. However it may not otherwise be effective to compromise the debt of a creditor who has not submitted to the jurisdiction of the Hong Kong Court.
The Court then stated the following in respect of a scheme of arrangement sanctioned in an offshore jurisdiction (such as Cayman or Bermuda) and recognised under Chapter 15 of the US Bankruptcy Code:
- Such a scheme would not be treated by a Hong Kong Court as compromising US law-governed debt.
- The Gibbs rule requires the substantive alteration of contractual rights to be sanctioned by some substantive provision of the relevant law, which he understood to be, in the US insolvency context, Chapter 11 of United States Bankruptcy Code.
- In contrast, his lordship stated that recognition under Chapter 15 operates procedurally to prevent action by a creditor against a debtor’s property in the US, but does not appear as a matter of US law to discharge the debt. The Court drew this conclusion based on its understanding of a US case decided by Judge Martin Glenn in the Southern District of New York (In re Agrokor d.d. 591 BR 163 (Bankr. SDNY 2018) (Agrokor).
- The Court therefore concluded that in such circumstances if the company has a creditor which did not submit to the jurisdiction of the offshore court, that creditor will be able to present a petition in Hong Kong to wind up the company (and it would be entitled to obtain such an order if the debt is not disputed or settled).
Harris J was clearly aware that this view may result in significant disruption to established practice in the Hong Kong restructuring market, stating (at para 37):
I note that there appears to be a surprisingly large number of Mainland groups listed in Hong Kong, whose US$ denominated debt has recently been subject to schemes only in offshore jurisdictions and recognition under Chapter 15. It may be that all the creditors of these companies, which hold debt of any material value have agreed to the terms of the compromise, but if that is not the case such companies, and any that might adopt a similar model in the future, will be at risk of a petition being presented against them in Hong Kong and being wound up here. An offshore scheme and Chapter 15 recognition will not protect them.
Modern Land - developments after the Rare Earth Decision
After the Rare Earth decision, the separate US Chapter 15 recognition case of Modern Land was heard before Judge Martin Glenn in the US Bankruptcy Court.
Modern Land (China) Co Ltd (MLC) was a Chinese property developer incorporated in the Cayman Islands that had issued US law-governed notes. MLC had proposed a Cayman scheme of arrangement to discharge its existing notes and replace them with new notes. MLC sought recognition of this scheme before the US Bankruptcy Court and additional relief orders providing that the debt under the notes was discharged as a matter of US federal law and New York state law.
This fact scenario in Modern Land was therefore essentially the same as the offshore scheme scenario described in Harris J’s obiter comments in Rare Earth, in which his lordship suggested that the Hong Kong Court would not treat the debt as being discharged. Judge Glenn was concerned whether MLC’s Cayman scheme of arrangement could be effective if it was not recognised and enforced in Hong Kong. He also asked if he should consider whether the Cayman scheme would be recognised in Hong Kong when deciding whether to grant Chapter 15 recognition.
On 17 June 2022, MLC filed a supplemental brief with the US Bankruptcy Court which, by reference to precedents relating to Chapter 15 recognition orders and other case law, argued that a Chapter 15 order does constitute a valid and complete discharge of the New York law governed debt. MLC pointed to a number of Chapter 15 orders which purported to discharge the US debt, including In re Oi S.A. et al., No. 16-11791 (SHL) (Bankr. S.D.N.Y. 2018) (Dkt. No. 277), In re DTEK Finance PLC, No, 21-10735 (JLG) (Bankr. S.D.N.Y. 2021) (Dkt. No. 15), In re Inversora Eléctrica de Buenos Aires S.A., 560 B.R. 650 (2016) and In re Cell C Proprietary Limited, 571 B.R. 542 (2017).
In addition, the supplemental brief argued that the territorial limitation in Agrokor related to enforcement of a settlement agreement, but (contrary to the suggestion of Harris J in Rare Earth) that Judge Martin Glenn did not in Agrokor court suggest any limitation on the power of the US Bankruptcy Court to discharge US law governed debt under Chapter 15, but instead cited another decision where this has occurred (In re Avanti Commc’n Grp PLC, 582 BR 603 (Bankr SDNY) 2018).
Accordingly, MLC argued that jurisdictions that follow the Gibbs rule (such as Hong Kong) should treat debts governed by US law as properly discharged in accordance with the applicable governing law when such debts are discharged pursuant to an offshore proceeding and subsequently recognized and enforced by a United States bankruptcy court through Chapter 15.
At a hearing on 6 July 2022, Judge Martin Glenn indicated that he disagreed with Harris J's reading of Agrokor in Rare Earth. Judge Martin Glenn also stated that he was "certainly" of the view that as long as due process is observed and other principles for giving comity are satisfied, a foreign court can discharge or modify New York law-governed debt.
On 18 July 2022 Judge Martin Glenn issued his decision in Modern Land, confirming this earlier indication. In the decision he said that Harris J had misinterpreted the US case law in the Rare Earth decision, and that it was well settled law that Chapter 15 orders could and did discharge US law-governed debt. Judge Martin Glenn explained the position under US law as follows:
This is a critically important issue. The Scheme in this case, and in many other scheme or restructuring plan cases, modifies or discharges existing debt and related guarantees governed by New York law, and provides for the issuance of new debt and guarantees governed by New York law. An indenture trustee will only take the actions authorized by the scheme or plan if enforceable orders have been entered by the foreign court and a Chapter 15 court.
With great respect for the Hong Kong court in Rare Earth, that court misinterprets this Court's earlier decision in Agrokor, as was as many other decisions in the United States which have recognized and enforced foreign court sanctioned schemes or restructuring plans that have modified or discharged New York law governed debt. Provided that the foreign court properly exercises jurisdiction over the foreign debtor in an insolvency proceeding, and the foreign court's procedures comply with broadly accepted due process principles, a decision of the foreign court approving a scheme or plan that modifies or discharges New York law governed debt is enforceable. Under U.S. law, that is an unremarkable proposition that has been firmly established in the U.S. at least since the Supreme Court decision in Canada Southern Ry. Co. v. Gebhard, 109 U.S. 527 (1883), which granted international comity and enforced a Canadian scheme that discharged New York law governed debt and provided for the issuance of new debt governed by New York law. As Chief Justice Wait said in Gebhard, "the true spirit of international comity requires that schemes of this character, legalized at home, should be recognized in other countries." Id. at 548. Chapter 15 limits a U.S. bankruptcy court's authority to enjoin conduct outside the territorial jurisdiction of the United States, but it does not make a discharge of New York law any less controlling.
To be clear, in recognizing and enforcing the Scheme in this case, the Court concludes that the discharge of the Existing Notes and issuance of the replacement notes is binding and effective.
Remarks
Mr Justice Harris's remarks in Rare Earth in respect of the effect of Chapter 15 recognition in respect of an offshore scheme of arrangement are obiter. The facts of Rare Earth involved compromising Hong Kong law-governed debts through a Hong Kong scheme of arrangement, and therefore there was no Chapter 15 recognition sought in the Rare Earth case (for the reasons explained by Harris J).
The remarks on the Gibbs rule in Rare Earth are therefore not strictly binding. However, considering Mr Justice Harris' influence over Hong Kong insolvency practice, his obiter comments were given consideration attention in Hong Kong (and elsewhere).
Mr Justice Harris's obiter remarks were based on his understanding of US case law (in particular the Agrokor decision) on the question of whether a Chapter 15 order constituted a valid and complete discharge of the New York law-governed debt. Ultimately, however, this question is a matter of US law.
Judge Martin Glenn's subsequent comments in Modern Land, being a decision of the US bankruptcy court, are authoritative on the effect of a Chapter 15 order as a matter of US law (subject to any other US authority to the contrary).
It remains to be seen how the Modern Land decision, and related comments by Judge Martin Glenn will be treated by the Hong Kong court in future cases. Presumably however the Hong Kong court will accept the decision in Modern Land as accurately reflecting the effect of a Chapter 15 order (ie the fact that such as an order can validly discharge US law-governed debt) as a matter of US law. This would, in appropriate cases, allow a return to the existing practice for offshore incorporated entities of compromising the US law-governed debt through a scheme of arrangement in an offshore jurisdiction coupled with US recognition of that scheme under Chapter 15 of the US Bankruptcy Code.
However, it is important to note that the effect of a Chapter 15 order will also depend on the terms of the actual order made in any given Chapter 15 case. In Modern Land Judge Martin Glenn's order will no doubt reflect the statement in his decision that the discharge of the notes in that case is binding and effective.
With all that being said, Mr Justice Harris's remarks do illustrate that careful planning is essential to effectively compromising debt obligations via schemes of arrangement in a cross-border context.
A Hong Kong-based debtor company (that is incorporated offshore as most Hong Kong listed companies are) with New York law-governed debts should carefully consider where it is most appropriate to undertake a scheme of arrangement (and whether a parallel scheme of arrangement is required), and seek advice as to the whether a scheme or parallel scheme in Hong Kong is advisable in its particular context.
[This article was updated on 20 July 2022 to reflect issuance of the decision in Modern Land]
