Recent decision on Scheme of Arrangement: Re Rare Earth Magnesium Technology Group Holdings Ltd. [2022] HKCFI 1686

Schemes of Arrangement are used to compromise debts, as a way to restructure an insolvent company.  In the case of a listed company, a Scheme could assist it to lift its trading suspension and avoid delisting.  However, a question arises as to what debts are being compromised by the Scheme.  Pertinently, could a creditor with a debt governed by foreign law, nevertheless, present or continue a winding-up petition in Hong Kong?

The recent case of Re Rare Earth Magnesium Technology Group Holdings Ltd. [2022] HKCFI 1686 considered these questions.

Rare Earth Magnesium is a typical offshore (Bermuda) incorporated entity, whose shares are listed on the Main Board of the Hong Kong Stock Exchange. Soft-touch provisional liquidators were appointed to the Company in Bermuda in July 2020 and were subsequently recognised by the Hong Kong Court in August 2020.

The Company’s principal indebtedness arose from its unsecured interest-bearing bonds, which were governed by Hong Kong law.  It sought to avoid liquidation and return it to a solvent going concern, by discharging its unsecured indebtedness and restructuring its debts by way of a Scheme of Arrangement. The Scheme was approved by the requisite majority creditors.

In considering whether or not to sanction the Scheme, Harris J considered the principles in Re China Singyes Solar Technologies Holdings Ltd [2020] HKCFI 467, in particular:-

 whether the Scheme was for a permissible purpose;

  • whether creditors who were called on to vote as a single class had sufficiently similar legal rights such that they could consult together with a view to their common interest at a single meeting;
  • whether the meeting was duly convened in accordance with the Court’s directions;
  • whether creditors had been given sufficient information about the Scheme to enable them to make an informed decision on whether or not to support it;
  • whether the necessary statutory majorities had been obtained;
  • whether the Court would be satisfied in the exercise of its discretion that an intelligent and honest man acting in accordance with his interests as a member of the class within which he voted might reasonably approve the Scheme; and
  • in an international case, whether there was sufficient connection between the Scheme and Hong Kong, and whether the scheme was effective in other relevant jurisdictions.

 The Judge was satisfied with the Scheme meeting the requirements, and consequently, sanctioned the Scheme.

 Of interest is the Judge’s discussion of the debts that were being compromised by the Scheme and whether parallel Schemes were necessary elsewhere.  This issue raises the rule in Gibbs (named after the English case).

The Rule in Gibbs 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 the debt. Harris J held that the scheme would therefore be recognised and effective abroad given that the debt to be compromised by the scheme was largely governed by Hong Kong law, i.e. the discharge would occur as a matter of substantive Hong Kong law, and therefore no parallel scheme of arrangement would be required in any jurisdiction. In addition, the Judge noted that Bermuda, Cayman Islands and other offshore jurisdictions all follow the Rule in Gibbs, making the scheme effective in these jurisdictions as well.

Harris J further added that if a creditor submits to the jurisdiction of a foreign insolvency process, he is taken to have accepted that his contractual rights will be governed by the law of the foreign insolvency process. Consequently, a scheme sanctioned by the court of an offshore jurisdiction compromising debt governed by Hong Kong law will be treated in Hong Kong as binding on a creditor, who submitted to the foreign jurisdiction. It will not bind a creditor who did not participate in the scheme proceedings or any associated insolvency process in the foreign jurisdiction.

But, what about a creditor whose debt is governed by, say, US law and who has not submitted to the US insolvency process or participated in the Hong Kong Scheme of Arrangement?  Can he still present or continue a winding-up petition against the company in Hong Kong?

Notably, it is common for Mainland business groups listed in Hong Kong to raise debts governed by US law, and then using schemes of arrangement in offshore jurisdictions recognised by Chapter 15 of the US Bankruptcy Code to compromise the debt.  In such circumstances, Harris J considered (in obiter) that, as recognition under Chapter 15 merely operates procedurally to prevent any action by a creditor against a debtor’s property in the US and it does not discharge the debt (as opposed to Chapter 11), it does not prevent that creditor from presenting a winding-up petition against the company in Hong Kong.

Subsequent to Harris J’s obiter comments in Rare Earth Magnesium, the case of Re Modern Land (China) Co. Ltd 2022 WL 2794014 in the US considered the issue.  In that case, Judge Martin Glenn held a different view on the effect of Chapter 15.  There, the company sought recognition of a scheme of arrangement sanctioned by the Cayman Islands Court which modified or discharged New York law governed debts.

In deciding whether the Cayman Scheme could be recognised and enforced abroad, Judge Martin Glenn referred to Harris J’s obiter in Rare Earth Magnesium, and was of the opposing view that debts governed by US law, of which the discharge was recognised and enforced by a US bankruptcy court through Chapter 15 could be treated as properly discharged abroad, provided that:

  • the foreign court properly exercises jurisdiction over the foreign debtor in an insolvency proceeding; and
  • the foreign court’s procedures comport 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.

In addition, Judge Martin Glenn stated that “Chapter 15 limits a US 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 governed debt any less controlling [sic].”

Given that the US Court has confirmed that Chapter 15 procedure could compromise or discharge debts governed by US law, it would appear that a creditor with such a debt should not be able to petition for winding-up in Hong Kong.

16 September 2022
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