Hong Kong: Judicial guidance on schemes of arrangement in cross-border insolvencies

In brief

On 27 May 2022, the Honorable Mr. Justice Harris sanctioned a scheme of arrangement introduced by Rare Earth Magnesium Technology Group Holdings Limited, which was incorporated in Bermuda, to restructure its debt. The Reasons for Decision handed down on 6 June 2022 contain detailed discussions on, among other things, the use of schemes in cross-border insolvencies.

The principles addressed by the court are particularly relevant to Hong Kong, where many business groups from Mainland China are listed using entities incorporated in offshore jurisdictions, and incur debt governed by multiple jurisdictions' laws.


Contents

Key takeaways

On the issue of a scheme's effectiveness in cross-border insolvencies:

  • A scheme sanctioned by the court of a non-Hong Kong jurisdiction "A" compromising debt governed by Hong Kong law would be treated in Hong Kong as binding on a creditor who submitted to jurisdiction "A". The scheme would not bind a creditor who did not participate in the scheme proceedings or any associated insolvency process in jurisdiction "A".
  • A scheme in a non-Hong Kong jurisdiction "B" purporting to compromise a debt governed by the law of yet another jurisdiction (say, New York) would not be effective in Hong Kong. In such a case, recognition of the scheme under Chapter 15 of the United States Bankruptcy Code ("Chapter 15") does not constitute a compromise of the debt that satisfies the Rule in Gibbs, which is followed in Hong Kong. If the creditor did not submit to jurisdiction "B", the creditor would be able to petition the Hong Kong court for the company to be wound up.

Insolvency practitioners should have regard to these principles when considering whether to introduce parallel schemes in multiple jurisdictions, and whether to seek recognition of a scheme in other jurisdiction(s).

In more detail

The facts

Rare Earth Magnesium Technology Group Holdings Limited ("Company") was incorporated in Bermuda and its shares have been listed in Hong Kong since 1993. The Company's subsidiaries are principally located in Hong Kong, Mainland China, and the British Virgin Islands. Having become (at least cash flow) insolvent, it petitioned the Bermuda court on 3 July 2020 for its own winding-up. That court appointed soft-touch provisional liquidators on 16 July 2020, who obtained recognition in Hong Kong on 25 August 2020.

Upon the application of the Company, assisted by the provisional liquidators, the Hong Kong court ordered on 12 January 2022 that a creditors' meeting be convened to consider a proposed scheme of arrangement for restructuring the Company's debt, which was largely governed by Hong Kong law. The required majority of the creditors approved the proposed scheme on 1 March 2022. Meanwhile, a creditor presented a winding-up petition against the Company in Hong Kong on 22 February 2021.

The Honorable Mr. Justice Harris sanctioned the scheme and dismissed the winding-up petition, while leaving costs of the petition for further consideration.

Impact of the Rule in Gibbs

Although the debt compromised by the scheme in this case was largely governed by the law of Hong Kong, the Company was incorporated and carried on its business in other jurisdictions. The learned judge took the opportunity to discuss the use of schemes in cross-border insolvencies, given that two of the factors taken into account by the court when considering whether to sanction a scheme in an international case are "whether there is sufficient connection between the scheme and Hong Kong" and "whether the scheme is effective in other relevant jurisdictions".

Many business groups in Mainland China are listed in Hong Kong using entities incorporated in offshore jurisdictions. As his Lordship remarked, it is common for such business groups to raise USD-denominated debt and for the relevant agreements to be governed by United States (for instance, New York) law. There appears to be a surprisingly large number of such business groups whose USD-denominated debt has recently been subject to schemes only in offshore jurisdictions (but not Hong Kong) and recognition under Chapter 15. His Lordship explained that such a scheme would not be effective in Hong Kong because there is a distinction between the following:

  1. A court treating a compromise as having the substantive legal effect of altering the legal rights of the parties to an agreement – the issue with which the Rule in Gibbs is concerned
  2. A court within its jurisdiction recognizing, pursuant to a process such as Chapter 15, the purported legal consequence of a foreign insolvency procedure – recognition under Chapter 15 does not compromise the USD-denominated debt, and therefore does not satisfy the Rule in Gibbs

It follows that the offshore scheme and Chapter 15 recognition cannot stop a creditor for the USD-denominated debt from petitioning for the debtor company's winding-up in Hong Kong.

Parallel schemes?

Conversely, his Lordship expected the Company's scheme to be internationally effective – including in Bermuda where the Company was incorporated – notwithstanding the absence of any parallel scheme or recognition application in any jurisdiction, because the scheme has the substantive legal effect of discharging the Company's debt governed by Hong Kong law.

The Company's approach is supported by what has become the generally accepted view, at least in Hong Kong, after the court pointed out – in a series of authorities including Re Grand Peace Group Holdings Limited [2021] HKCFI 3695 and Re China Oil Gangran Energy Group Holdings Ltd [2021] 3 HKLRD 69 – that parallel schemes must not be used unquestioningly. Whether parallel schemes are appropriate is fact-sensitive and must be assessed on a case-by-case basis. For instance, as his Lordship noted, if the amount of debt that is not governed by Hong Kong law is less than the cost of introducing a parallel scheme, it makes more sense to exclude that debt from the scheme and settle it separately if it is ever pursued.

After the Company's scheme, the Honorable Mr. Justice Harris sanctioned a scheme introduced by Hidili Industry International Development Limited to compromise its debt, part of which was governed by New York law. The Reasons for Decision handed down on 17 June 2022 are consistent with those regarding the sanction of the scheme in respect of the Company. Insolvency practitioners would be well advised to bear these principles in mind when formulating a scheme.

Contact Information

Copyright © 2022 Baker & McKenzie. All rights reserved. Ownership: This documentation and content (Content) is a proprietary resource owned exclusively by Baker McKenzie (meaning Baker & McKenzie International and its member firms). The Content is protected under international copyright conventions. Use of this Content does not of itself create a contractual relationship, nor any attorney/client relationship, between Baker McKenzie and any person. Non-reliance and exclusion: All Content is for informational purposes only and may not reflect the most current legal and regulatory developments. All summaries of the laws, regulations and practice are subject to change. The Content is not offered as legal or professional advice for any specific matter. It is not intended to be a substitute for reference to (and compliance with) the detailed provisions of applicable laws, rules, regulations or forms. Legal advice should always be sought before taking any action or refraining from taking any action based on any Content. Baker McKenzie and the editors and the contributing authors do not guarantee the accuracy of the Content and expressly disclaim any and all liability to any person in respect of the consequences of anything done or permitted to be done or omitted to be done wholly or partly in reliance upon the whole or any part of the Content. The Content may contain links to external websites and external websites may link to the Content. Baker McKenzie is not responsible for the content or operation of any such external sites and disclaims all liability, howsoever occurring, in respect of the content or operation of any such external websites. Attorney Advertising: This Content may qualify as “Attorney Advertising” requiring notice in some jurisdictions. To the extent that this Content may qualify as Attorney Advertising, PRIOR RESULTS DO NOT GUARANTEE A SIMILAR OUTCOME. Reproduction: Reproduction of reasonable portions of the Content is permitted provided that (i) such reproductions are made available free of charge and for non-commercial purposes, (ii) such reproductions are properly attributed to Baker McKenzie, (iii) the portion of the Content being reproduced is not altered or made available in a manner that modifies the Content or presents the Content being reproduced in a false light and (iv) notice is made to the disclaimers included on the Content. The permission to re-copy does not allow for incorporation of any substantial portion of the Content in any work or publication, whether in hard copy, electronic or any other form or for commercial purposes.