On 27 September 2022, the plaintiff filed a winding up petition against Leading Holdings Company Limited (company), a company incorporated in Cayman Islands and listed on the Hong Kong Stock Exchange, pursuant to a debt owed under the 12 percent senior notes due 2022 issued by the company, originally in the sum of US$150 million.

The notes were constituted by an indenture governed under New York law and was structured in such a way that the global note had one registered holder which was the trustee and common depositary and investors merely purchased a portion of the indirect beneficial interest in the note. Under the terms of the note, only the holder of the note could exercise any rights under the note, including the institution of legal proceedings.

At issue was whether the plaintiff had standing to petition the company. Specifically, the court was asked to consider (i) whether the plaintiff as a beneficial owner had such standing; and (ii) whether the plaintiff could be treated as a contingent creditor of the company such that it would have a direct claim against the company in the event that it exercised its right under the indenture for definitive notes to be issued to them.

Standing of beneficial owner to petition for winding up

The petitioner cited case law which said that while generally an equitable assignee of part of a debt was required to join all parties interested in the debt in a recovery action, this did not apply to a winding up petition. The equitable assignee could petition for winding up without joining the assignor.

Deputy Judge Jenkin Suen SC however found that such legal principle did not apply to the scenario of a trust beneficiary, which was distinct from an equitable assignee. In the case of a trust beneficiary, the joinder of the trustee in legal proceedings was a substantive requirement under the terms of the note whereas in the case of an equitable assignee of a debt, the joinder of the equitable assignor in debt recovery proceedings was a mere procedural requirement.

The court then relied on a line of authorities including Re Uruguay Central and Hygueritas Railway Co of Monte Video (1879) 11 ChD 372 in concluding that a trust beneficiary is not a creditor and does not have standing to petition for winding up.

Was the plaintiff a contingent creditor?

The terms of the note provided that under certain specified events, the plaintiff may request that definitive notes be issued to the investor whereupon the plaintiff could directly enforce its claims against the company. On this basis, the plaintiff contended it was a contingent creditor. In support, the plaintiff relied on a line of authorities from various common law jurisdictions where beneficial owners of notes were treated as contingent creditors for the purposes of determining voting rights on schemes of arrangement.

The court rejected this argument. The court considered a number of authorities including a recent Cayman decision Re Shinsun Holdings (Group) Co., Ltd (21 April 2023) in which a similar issue on the standing of an indirect investor to present winding up petition arose.

According to the authorities, a contingent creditor denoted a person towards whom under an existing obligation, the company might become subject to a present liability upon the happening of some future event. As such, for a person to qualify as a contingent creditor, there must be an existing obligation, even though the liability to pay might only be triggered upon the happening of some future event.

The court found that, as a matter of construction of the note indenture, the plaintiff had neither an existing contractual relationship with, nor directly enforceable rights against, the company. Therefore, unless or until the plaintiff is issued definitive notes in its name, it is not yet a creditor of the company, be it actual or contingent.

In coming to this conclusion, the court also considered the global note structure and its enforcement mechanism is premised on class action being pursued by the trustee exclusively. By consenting to the "no action clause" under the indenture, individual investors had waived their rights to bring claims that were common to all investors. The purpose of the regime was to prevent the multiplicity or duplication of actions and the court considered it would be anomalous if the plaintiff, who could not proceed directly against the company, could sidestep such constraint by petitioning for winding up.

Further, the court noted that the policy objectives of including contingent and prospective creditors in the meaning of "creditor" was to allow the contingent or prospective liabilities of a company to be taken into account in a winding up petition, and such policy objectives would not be frustrated by the plaintiff not being recognised as a contingent creditor, given that the debt would have been recognised as a liability owed to the trustee.

Another consideration of the court was that the plaintiff's argument could result in potential abuse. Should the plaintiff's argument stand, it would mean that every individual bondholder is already a contingent creditor and can petition for winding up even before the note has matured. This clearly defeats the purpose of the global note structure.

Finally, the authorities cited by the plaintiff in the context of schemes of arrangement were distinguished by the court. These authorities concerned the right of individual bondholders to vote for or against a scheme, which was a less draconian right compared to an individual bondholder's standing to petition for winding up.

Implications

This is the first occasion where the court has been asked to decide on the issue of whether a global note investor had standing to petition for winding up against the issuer. The decision that, under the typical global note structure, only the trustee has standing to petition for winding up against the issuer, will hinder individual investors seeking to take enforcement action directly against issuers unless they have been able to get a definitive note issued to them.

Usually, the terms of a global note will provide for a certain threshold (in percentage of the aggregate principal amount of outstanding notes) which must be met before the trustee can be instructed, prefunded and indemnified to exercise rights under the indenture, including the commencement of proceedings against the issuer. Gathering together sufficient holders to meet this threshold and then addressing the trustee’s prefunding and indemnification requirements can be time-consuming and involve an additional layer of expense.

Customarily, the form of global note contains a right for a Holder to demand that Certificated Notes be issued if the notes have been immediately due and payable and therein lies the problem. If the issuer has already defaulted in its payment obligations, there is little incentive to co-operate with issuing Certificated Notes if this simply serves to make it easier for individual holders to pursue enforcement action against it.

Now the implications of the global note structure in a winding up scenario have been more thoroughly considered by the Hong Kong courts, it remains to be seen whether prospective note investors will in the future insist at the time of subscribing for notes that changes be made to the customary terms of these indentures in order to deal with the issues now being faced by investors.

Authored by Jonathan Leitch, Byron Phillips, Nigel Sharman, and Carrie Yuen.