Legal Update: Obtaining Validation Orders to pay restructuring costs

INTRODUCTION

Tanner De Witt successfully assisted China Singyes Solar Technologies Holdings Limited (“Singyes”)[1] in obtaining a validation order that enabled Singyes to pay certain operation expenses and professional fees incurred for the purpose of a substantial restructuring exercise notwithstanding the existence of a winding up petition.

Deputy High Court Judge William Wong SC (“DHCJ William Wong SC”) granted the validation order on the basis that the payments would enable Singyes to progress the restructuring which would be in the interest of Singyes’ creditors generally. 

THE ISSUE

In recent years, it has been popular for certain companies in distress to promulgate schemes of arrangement to restructure their debts.[2] Common features of these companies are as follows: (i) they are often incorporated in a foreign jurisdiction;[3] (ii) are listed on the Stock Exchange of Hong Kong; and (iii) have entered into contracts or debt instruments that are governed by foreign law (often New York). Such restructuring exercises have typically involved cross-border elements such as parallel schemes in Hong Kong and the company’s place of incorporation and recognition proceedings in the jurisdiction of the debt instruments’ governing law. The exercise can therefore be an expensive one requiring a wide spectrum of professionals.

During the restructuring process, a creditor (perhaps one not involved in the restructuring) may present a winding up petition against the company. This could be problematic for the company. Pursuant to section 182 of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32), dispositions of the company’s assets after the commencement of winding up (i.e. the date of the presentation of the winding up petition) are void unless the Court grants an order validating the dispositions. For example, after the presentation of the petition against a company, a bank which honours a cheque for a company could face a direct claim from the liquidators who are subsequently appointed for the same amount.[4] As such, to avoid these claims, banks in Hong Kong will usually freeze a respondent company’s bank account once it is made aware of the petition. This would prevent a company from paying professional fees for the restructuring and jeopardise the restructuring entirely.

The case is important to illustrate how the Court may exercise its discretion to allow a company to make payments such as professional fees for restructuring notwithstanding section 182. The case elaborates on the position stated in China City Construction (International) Co., Limited v Value Partners Hong Kong Limited.[5]

FACTS

Singyes is incorporated in Bermuda, registered in Hong Kong as a non-Hong Kong company and is listed in Hong Kong. Singyes and its group operates a renewable energy business in Hong Kong, Macao and the Mainland. It has, in recent years, issued various debt securities instruments that are governed by foreign law.

Singyes underwent a restructuring of various onshore and offshore debt and in this regard promulgated a scheme of arrangement to restructure certain offshore debt securities (“Debt Restructuring”).  During the Debt Restructuring, a creditor presented a winding up petition against Singyes based on certain fees that were alleged to be payable to the petitioner. Singyes opposed the petition. However, given the effect of section 182, its bank accounts were frozen and it was prevented from making certain payments that were required for the purpose of the Debt Restructuring, hence the need for a validation order.

THE JUDGMENT

DHCJ William Wong SC analysed the Court’s discretionary powers by reciting the general position that the Court would have to be satisfied that the payments to be sanctioned will be beneficial and advantageous to the company and its creditors.[6] The judge identified the following issues that the Court would take into account when exercising its discretion:

• The Court’s discretion is entirely at large and is not confined to or by any express statutory requirements;

• The policy which underlies section 182 is to ensure that the assets of the insolvent company would be distributed pari passu amongst creditors on its winding up. However, the policy is not of invariable application. The overriding consideration is what is in the best interest of the creditors. A company can continue to make dispositions for the purpose of carrying on its business after the presentation of a winding up petition if doing so would be beneficial for the company and its creditors;

• In exercising its discretion, the Court should endeavour to ensure that the interests of the unsecured creditors are not prejudiced;

• Whether it is desirable that the company should be able to carry on its business involves a certain degree of speculation. The Court would carry out a balancing exercise. The Court should not validate any transaction where the result would be that one or more pre-liquidation creditors get paid in full at the expense of other creditors. 

• In considering whether a validation order is likely to be beneficial to the creditors of the company, the Court will have to take into account the interest of all creditors, not just the petitioner or the creditors supporting the validation application. The Court would take into account whether the absence of a validation order would destroy the company’s hitherto widely–accepted restructuring efforts, to the detriment of all stakeholders.[7]

On the basis that Singyes had received overwhelming support from the scheme creditors affected by the Debt Restructuring and that the success of the Debt Restructuring would result in Singyes receiving HK$1.53 billion by way of share subscription proceeds (hence enabling Singyes to continue to operate and repay its financial obligations) DHCJ William Wong SC was satisfied that the payments to be sanctioned will be beneficial and advantageous to Singyes and its creditors.

REMARKS

There are not many obstacles to prevent a creditor to present a winding up petition against a company that is undergoing a restructuring (the monetary threshold only requires the debt to be more than HK$10,000). The effect of the petition on the other hand is critical. Although the petition can be opposed, it will have an immediate effect in freezing the company’s bank account which can jeopardise the wider restructuring exercise. This decision offers a welcome guidance to restructuring practitioners who may face uncertainty and problems caused by the presentation of a winding up petition during a restructuring. Hopefully, this decision will encourage practitioners to agree on validation orders by consent in order to cause minimal disruption to any restructuring exercise. 

However, care must still be taken when considering the expense being incurred in relation to a restructuring exercise. After the validation order was granted in favour of Singyes on 12 September 2019, DHCJ Wong SC handed down a further decision, in Re Da Yu Financial Holdings Limited [2019] HKCFI 2531, which indicates that the Court may scrutinise the reasonableness of restructuring costs at the validation order stage.

Da Yu Financial Holdings Limited was promulgating a scheme of arrangement in Hong Kong. At the sanction hearing of the scheme, DHCJ William Wong SC did not find the disclosure in the explanatory statement to be satisfactory as regards the restructuring and other expenses. He commented that the Court will expect there to be a detailed breakdown of restructuring costs so that both scheme creditors and the Court can meaningfully assess the reasonableness of such costs. In those circumstances, DHCJ William Wong SC imposed a condition on the sanctioning of the scheme that all of the restructuring any other expenses will be subject to taxation (i.e. assessment by the Court) and any subsequent cost savings resulting from taxation would be distributed to the scheme creditors.

Re Da Yu emphasises the position that the Court will scrutinise and assess professional fees with the interest of creditors in mind. This case will likely have an important impact in the context of validation order applications involving restructuring costs. An applicant in the future could be required to provide further and more detailed disclosure regarding the restructuring costs. The Court could also be more involved at the validation stage to assess the restructuring costs and to limit the amount that could be paid by the company at an early stage.

Robin Darton and Tim Au

The above is not intended to be relied on as legal advice and specific legal advice should be sought at all times in relation to the above.

If you would like to discuss any of the matters raised in this article, please contact:

Robin Darton: [email protected]

Tim Au: [email protected]

Disclaimer: This publication is general in nature and is not intended to constitute legal advice. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.

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[1] [2019] HKCFI 2559

[2] See Re LDK Solar Co., Ltd [2015] 1 HKLRD 458, Re Winsway Enterprises Holdings Ltd [2017] 1 HKLRD 1, Re Kaisa Group Holdings Limited [2017] 1 HKLRD 18, Re Mongolian Mining Corporation [2018] 5 HKLRD 48, Re Da Yu Financial Holdings Limited [2019] HKCFI 2531

[3] Predominantly in Bermuda, BVI or the Cayman Islands

[4] Osman Mohammed Arab and Wong Tak Man Stephen, Joint and Several Liquidators of AGI Logistics (Hong Kong) Limited (in compulsory liquidation) v Commissioner of Inland Revenue [2016] HKCA 524 which deviated from the English position (see for example Coutts & Co v Stock [2000] 1 WLR 906) that banks honouring a cheque merely acts as an “intermediary” and thus such action is not a “disposition” that is caught be section 182. Liquidators in Hong Kong are entitled to go after the bank directly and not the payee.  

[5] [2018] HKCFI 2316

[6] Re Luen Cheong Tai Construction Co Ltd [2004] 1 HKLRD 735

[7] Referring to Re Reveiler Skin-Pro Ltd (unreported, HCCW 82/2010, 1 March 2010, To J)