In Re Rare Earth Magnesium Technology Group Holdings Ltd [2022] HKCFI 1686, the Honorable Mr Justice Harris recalled his 2020 judgment recognizing the Bermuda-appointed provisional liquidators and granting them assistance (see Hogan Lovells alerter Call for consistency – Hong Kong court delivers double message to insolvency practitioners).
Harris J was now asked to sanction a scheme of arrangement between Rare Earth and its scheme creditors. The scheme sought to restructure the debts of the company and recover an estimated 100 per cent of the principal amount owed to the scheme creditors.
In deciding whether to sanction the scheme, the court applied principles from Re China Singyes Solar Technologies Holdings Ltd [2020] HKCFI 467 considering, amongst other:
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Whether the scheme is for a permissible purpose;
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Whether creditors voting with the same class had sufficiently similar legal rights that they could consult together with a view to a common interest;
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Whether the meeting was duly convened in accordance with the court’s directions;
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Whether creditors had been given sufficient information about the scheme to enable them to make an informed decision as to whether or not to support it;
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Whether the necessary statutory majorities had been obtained;
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Whether the court was satisfied in the exercise of its discretion that an intelligent and honest class member man acting in accordance with their interests might reasonably approve the scheme; and
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In an international case, whether there is sufficient connection between the scheme and Hong Kong, and whether the scheme is effective in other relevant jurisdictions (see Hogan Lovells alerter Hot on the heels - Hong Kong court continues to favour corporate restructuring of overseas entities).
In the case of Rare Earth, the court found that the scheme was for a genuine debt restructuring of a distressed company, which was a permissible purpose; the creditors had sufficiently similar legal rights to Rare Earth’s general unsecured debt claims and they all received the same distribution options under the scheme; the necessary majority was satisfied at the scheme meeting; and the scheme would be effective internationally, including in jurisdictions such as Bermuda (where Rare Earth is incorporated) and the Cayman Islands (where Rare Earth’s ultimate parent is incorporated) under the “Rule in Gibbs”.
Rule in Gibbs
The long established “Rule in Gibbs” (taken from the case Antony Gibbs & Sons v La Société Industrielle et Commerciale des Métaux (1890) LR 25 QBD 399) provides that the jurisdiction of the governing law of a debt instrument determines whether a debt is compromised and effectively discharged in such jurisdiction.
Put simply, according to the rule, a Hong Kong law governed debt may not be discharged by virtue of an offshore insolvency proceeding, unless a creditor voluntarily submits to the offshore insolvency proceeding.
In the case of Rare Earth, the court noted that since majority of the debts to be compromised were governed by Hong Kong law, the debts would be compromised and effectively discharged in Hong Kong, which was consistent with the Gibbs rule. Harris J also permitted proposed amendments to terms of the scheme, as the modifications would not prejudice any scheme creditors, but improve their recovery under the scheme.
Chapter 11 vs Chapter 15 scheme proceedings under the US Bankruptcy Code
In the judgment, Harris J also observed that there are a significant number of Hong Kong listed companies whose business operates in mainland China with US-denominated and U.S. law governed debts, and that since about 2016, a technique had been established to compromise such debt by introducing a scheme in Hong Kong that would be recognized in the United States.
In obiter remarks, Harris J said that “a scheme sanctioned in an offshore jurisdiction and recognized under Chapter 15 in the United States will not be treated by a Hong Kong court as compromising US$ debt.” This is because it is a procedural relief limited to the U.S. territory only to prevent actions being brought against the subject company’s assets within the U.S.
Harris J took the viewed that a debtor would not be protected by an offshore scheme recognized under Chapter 15 and a creditor who did not participate in the offshore insolvency proceedings would still be able present a winding up petition against the debtor in Hong Kong.
A creditor bondholder, for example, whose debt was not disputed would be able to obtain a winding up order in Hong Kong unless the debt is settled, whereas a confirmed Chapter 11 plan “operates to discharge the existing debt of a debtor and replace it with a right to receive a distribution in accordance with the confirmed plan”. In the view of Harris J, a Chapter 11 plan, unlike a Chapter 15 plan, “purports to have worldwide effect”.
However, in the recent U.S. Bankruptcy Court case in re Modern Land (China) Co., Ltd, Chief United States Bankruptcy Judge Martin Glenn appeared to disagree with Harris J’s commentary when granting a motion for recognition and related relief (including enforcement of a Cayman scheme) for a Hong Kong-listed, Cayman Island-incorporated Chinese property developer.1
In response to Harris J’s judgment in Rare Earth, Judge Glenn said that “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”.
The apparently diverging views as to whether a Chapter 15 recognition will effectively discharge US-denominated debts under U.S. law and prevent individual creditors from presenting winding-up petitions in Hong Kong may leave some areas of doubt and it remains to be seen how the decision in Modern Land will be interpreted by the Hong Kong court in future cases.
Authored by Jonathan Leitch, Ronald Silverman, Nigel Sharman, and Fiona Wong.
