Managing misconceptions: Hong Kong court issues dual warnings over cross-border insolvency

Raising the alarm

China Huiyuan Juice Group Ltd. (Huiyuan) is a Cayman Islands-incorporated company listed in Hong Kong which carries on its business operations in mainland China through companies incorporated in the mainland and held indirectly through intermediate holding companies incorporated in the British Virgin Islands.

SDF III Holdings Ltd. (SDF) brought a winding-up petition against Huiyuan on the grounds of insolvency – the debt relied on by SDF was in relation to Huiyuan's default under a convertible bond for the principal amount of HK$1 billion. Neither the debt nor the fact that Huiyuan was insolvent was in dispute.

Huiyuan, seeking to progress a restructuring of its onshore and offshore debt and maintain its listing status, sought an adjournment of the petition. SDF opposed Huiyuan's efforts calling them unrealistic, lacking in detail, and said that Huiyuan's listing would almost certainly be cancelled. Indeed, Huiyuan was delisted by the Listing Committee of the Hong Kong Stock Exchange (HKEx) in February 2020 due to its non-compliance with listing rules, and is presently appealing the decision.

Mr. Justice Harris granted an adjournment to the winding-up petition, finding that SDF had failed to demonstrate it could satisfy the second of the three core requirements outlined in Kam Leung Sui Kwan v. Kam Kwan Lai [2015] 18 HKCFAR 501. The three conditions are: (i) the presence of a sufficient connection with Hong Kong but not necessarily through the presence of assets in the jurisdiction; (ii) a reasonable possibility that the winding-up order will benefit the applicants; and (iii) the ability of the Hong Kong court to exercise jurisdiction over one or more persons in the distribution of the company's assets.

Harris J. noted that notwithstanding the first and third core requirements were plainly satisfied (by the listing of Huiyuan in Hong Kong in respect of the first and the likely presence of having more than one creditor subject to the Hong Kong Court's jurisdiction in respect of the third), consideration of the second core requirement was not straightforward. His Lordship rejected SDF's argument that the protection of Huiyuan's listing status for the benefit of its creditors was of sufficient benefit to SDF to satisfy the second requirement.

On the basis of the numerous petitions he had seen in the past few months, he thought it highly unlikely that the listed status of the company if it were wound up would have any residual value. We had now "reached a stage where the court will require evidence to demonstrate that there is a real prospect of a material financial benefit to creditors from realization of a listing in order to satisfy the second core requirement."

Given Huiyuan's own case was that it controlled a valuable business in the mainland that was worth restructuring, Harris J. went on to comment on the possibility of SDF being able to access Huiyuan's onshore assets once Hong Kong liquidators were appointed.

Citing his decision in the case of Re CEFC Shanghai International Group Ltd. (Mainland liquidation) [2020] 1 HKLRD 676 , Harris J. noted that it was unlikely that Hong Kong liquidators of an offshore company would be recognized in the mainland.

The mainland courts had yet to grant an order formally recognizing the authority of a foreign liquidator to act as an agent for a foreign company within the mainland, and it was also unlikely that the mainland courts would recognize a liquidator appointed by the courts of a place other than the relevant company's place of incorporation, in this case, the Cayman Islands.

In granting the adjournment, His Lordship concluded with what was essentially a warning that:

… [such complex offshore structuring of mainland business groups] creates a significant barrier to steps being taken by creditors and shareholders to enforce rights using the courts of Hong Kong, which is the legal system that they have probably assumed they will be able to access if they need to take steps to enforce their legal rights against a company listed here.

The realization by creditors and shareholders of the impact of these structures along with the increasing familiarity of the advantages of the Z-Obee technique [essentially the involvement of soft-touch provisional liquidation in the place of incorporation as the vehicle for restructuring explained in Z-Obee Holdings Ltd. [2018] 1 HKLRD 165] risks significantly reducing the role of the courts of Hong Kong in regulating insolvency and the protection of shareholders' rights.

Don't expect a stay

Although unrelated, the decision in FDG Electric Vehicles was handed down concurrently with Re China Huiyuan.

FDG Electric Vehicles Limited (FDG) is a Bermuda-incorporated company. Its joint and several provisional liquidators (PLs), appointed in Bermuda, sought an order for recognition of their appointment and assistance from the Hong Kong court. Although the court said making the order itself would be uncontroversial, Harris J. focused on two particular issues: (i) whether the order should give the provisional liquidators (PLs) the power to take control of all subsidiaries of FDG, and (ii) whether it would include a stay order in respect of existing or prospective proceedings against FDG in Hong Kong.

The first issue was dispatched quickly; as it was obvious the order should not grant the PLs power to take control of subsidiaries incorporated in other jurisdictions. On the second issue, Harris J. was firm in his comments that the standard order does not impose a stay; rather it requires appropriate applications to be made in High Court proceedings. The court would then make an assessment after having the benefit of hearing arguments from any parties affected.

The order that Harris J. said he would grant in respect of FDG, and would be amenable to grant in future, is as follows:

If the Provisional Liquidators wish to apply for a stay or other directions in respect of proceedings in the High Court of any sort as a consequence of the recognition of their appointment by this order such application shall be listed before the Honorable Mr. Justice Harris or such other judge as he shall direct. The Provisional Liquidators shall write to the clerk to the Honorable Mr. Justice Harris seeking case management directions for the determination of any application that they wish to make pursuant to this order.

A quandary

The court's comments in Re China Huiyuan on the complex structures of mainland-business groups should act as a warning to creditors that the Hong Kong courts may not be able to help in the enforcement of their rights in an insolvency scenario.

As outlined in the ruling, in order to obtain control of a Hong Kong listed company's mainland subsidiaries, a liquidator appointed by the Hong Kong court would first need to be appointed as liquidator of the mainland subsidiaries' immediate holding company. It seemed clear from the authorities that a court in the Cayman Islands would be unlikely to recognize a liquidator appointed in Hong Kong to wind-up a Cayman incorporated company other than for restructuring or for introducing a scheme of arrangement.

Liquidators appointed by a Hong Kong court would likewise be stymied in efforts to take control of the company's BVI subsidiaries, the intermediate holding companies of the mainland subsidiaries. Even if they did achieve recognition offshore, the companies are likely only to maintain a "letterbox" presence, making the task of enforcement doubly challenging.

Where the company in question is incorporated in Hong Kong, the prospects seem brighter, with the courts being ready to appoint PLs for the express purpose of allowing the liquidators to seek mainland recognition.

It's clear however that, with similar cases in the pipeline, the Hong Kong courts may not have reached the end of their exploration on how assistance can be extended to officeholders in dealing with the challenges they face in cross-border insolvencies. An element of possibly welcome judicial activism cannot be discounted.

Authored by Jonathan Leitch and Nigel Sharman.