The A&O Shearman team, together with counsel Michael Lok and Jasmine Cheung, acted for the opposing creditor in these Scheme proceedings.
This decision contains important and insightful observations on how best to ensure that creditors are properly and sufficiently protected and well-informed in arriving at their decision as to whether to vote for the scheme.
It is another useful reminder to practitioners, following from another recent decision by the Honourable Madam Justice Linda Chan in which sanction was also refused [1].
The background
Shortly stated, the company applicant ("Company"), professing to be insolvent, put forward a creditors’ scheme of arrangement with a view to restructuring its indebtedness. The Company had raised funds through equity and debt financing from high net worth individuals, private equity, venture capital as well as the Company’s key strategic partner and the largest shareholder (§10). The scheme sought to compromise the Company’s liabilities owed to various creditors ("Scheme Creditors") which consisted mainly of holders of certain convertible notes issued by the Company ("CN Holders") (§12).
Of particular interest is that at the time of the petition for sanction, there had been ongoing arbitral proceedings between the Company and one of the CN Holders ("Opposing Creditor") ("CN Arbitration") (§17). The CN Arbitration resulted in an award which ordered the Company to pay, amongst others, default interest on the relevant convertible note(s) (§18).
As explained by the Court, although the Company described the scheme as one which extends the terms of loans owed and postpones some of the Company’s liabilities, and the Scheme Creditors would likely be paid in full in a Trade Sale or IPO. But on closer analysis, what the Scheme also sought to achieve was to re-write the contractual entitlements of CN Holders under the convertible notes in multiple aspects (§22). Importantly, the Scheme proposed to remove the right of CN Holders to receive default interest, and replace it with a right to receive interest at much lower rates.
The Convening Hearing
Perhaps somewhat unusually in Hong Kong, the Opposing Creditor appeared at the Convening Hearing. The objective was to register its concerns in respect of the terms of the scheme as they stood before the Court at that point in time. In particular, it was identified on behalf of the Opposing Creditor that there was inadequate or unclear explanation as to the treatment of default interest arising out of the convertible notes. This suggested that if the Opposing Creditor succeeded in the CN Arbitration, it would not get any compensation for default interest (§46(1)). The Court likewise expressed concerns that the draft Scheme appeared to have the effect of removing Scheme Creditors’ entitlement to default interest, and there was some uncertainty or ambiguity arising out of, for instance, the definition of “Claims” under the draft scheme document (§46(2)). Accordingly, the Court was assured by the Company that revisions would be made to reflect the Company’s intention regarding the treatment of default interest under the Scheme (§46(3)).
The Sanction Hearing
Between the two hearings, a revised scheme document was circulated and duly voted upon. The requisite statutory majority was obtained.
However, it was considered that the concerns raised by the Opposing Creditor (and indeed the Court) remained inadequately addressed and, perhaps, even intensified. Accordingly, the Opposing Creditor filed evidence and submissions and appeared at the Sanction Hearing in due course. After a one-day hearing with full arguments advanced on both sides, the decision was reserved by the Honourable Madam Justice Linda Chan.
The decision
By decision dated August 26, 2024, the Honourable Madam Justice Linda Chan refused to sanction the scheme. This was primarily on two grounds, notwithstanding the Court’s satisfaction that the scheme had been propounded for a permissible purpose, complied with the relevant directions, and had obtained approval by the requisite majorities, in accordance with the well-established principles (§34).
Class constitution
First, her Ladyship accepted the Opposing Creditor’s submission that in view of various substantial differences between some of the scheme creditors inter se, the Court did not think that they can “sensibly consult together with a view to their common interest at a single meeting” (§52). As such, the Court lacked jurisdiction to sanction the scheme.
As a useful reminder, the principles governing constitution of classes are of course most aptly summarised by Lord Millett NPJ in UDL Argos Engineering & Heavy Industries Co Ltd (2001) 4 HKCFAR 358, §27 as follows:-
- The Company is responsible for deciding whether to summon one single meeting or more than one scheme meeting.
- This depends on whether the creditors have sufficient similar rights that they can sensibly consult together with a view to their common interest.
- The test is based on similarity or dissimilarity of legal rights against the company, not on similarity or dissimilarity of interests not derived from such legal rights.
- The Court has no jurisdiction to sanction a Scheme which does not have the approval of the requisite majority of creditors voting at meetings properly constituted in accordance with these principles.
In this case, her Ladyship found that the rights of the Opposing Creditor, who was entitled to default interest, were significantly different from the rights of the other CN Holders who were not entitled to default interest. Given that the Scheme proposed a compulsory waiver of default interest, this meant that (1) the Opposing Creditor was required to give up its right to claim default interest, while the other CN Holders did not have to give up such a right; and (2) the Opposing Creditor would receive a discounted payment under the Scheme as compared to other CN Holders.
As a result, her Ladyship found that there was a “material” “inequality in treatment” between the Scheme Creditors, such that they could not sensibly consult together with a view to their common interest (§49).
Sufficiency of information
Secondly, her Ladyship further accepted that the Company had failed to “comply with the duty to provide proper explanation on the material aspects of the scheme and its effect on the scheme creditors” as well as having “failed to comply with the duty to provide accurate information in the scheme document” (§68). As such, quite apart from the first ground above, her Ladyship would still have refused to sanction on this basis.
Again, it is trite that the Company comes under well-established duties to provide proper explanations about material aspects of the scheme [2], and to provide accurate information [3].
Here, the Scheme did not contain information about the Scheme Creditors’ entitlement to default interest (and the extent thereof), yet such information was relevant and necessary for Scheme Creditors to determine how to vote at the Scheme Meeting (§61). Without knowing such information, the Scheme Creditors were simply not in a position to assess the impact of the deprivation of default interest on their recovery rates under the Scheme (§62).
Key takeaways
As mentioned above, this decision serves as a useful reminder for a number of helpful takeaways, both in terms of preparing for (as well as opposing) a scheme of arrangement.
First, if opposing creditors choose to appear at the convening hearing to register their areas of concern and such concerns are not rectified, this may become a relevant consideration when it comes to the sanction hearing. In the meantime, it would be prudent for the company to meaningfully consider such concerns and to make corresponding changes as appropriate. Where changes are not implemented – perhaps for good reasons – those should be drawn to the attention of creditors with an accompanying explanation and justification.
Secondly, in identifying the relevant number of class(es), it would be important to fully appreciate whether there exist differences in terms of the existing versus new rights of the creditors which make it impossible for creditors to consult together. This includes having regard, in an appropriate circumstance, to the economic and business impact of the proposals. And where it is contended that the rights are indeed sufficiently similar, it would be prudent to disclose and/or place in evidence any such supporting analyses.
Third and finally, it again[4] reminds practitioners of the utmost importance to ensure that the scheme document – including in particular the explanatory statement – spells out and elaborates on the core features of the scheme in a way that is comprehensible, accessible and fair. This will ensure that creditors are given the relevant information to make an informed choice in casting their vote at the scheme meeting. This is especially so where one is dealing with an important feature or consideration of the scheme which would affect the creditors’ decision as to whether or not to vote for the scheme at the relevant meeting.
Indeed, following from the above, the Court also emphasised that it may even be necessary to update creditors in the scheme document on latest developments, such as matters that transpired at the convening hearing. As such while the Company naturally need not regurgitate every matter discussed at the convening hearing, an assessment needs to be made on the materiality of any matters discussed therein. If it is believed that a concern or comment raised by the Court is a material one and/or requires an amendment, this is a matter that should be drawn to the creditors’ attention. This enables creditors to be apprised of such concern and to decide for themselves whether the Company has indeed addressed and catered for the same.
This article was co-authored by Michael Lok (Barrister, Des Voeux Chambers Hong Kong; Associate Member, South Square London), Jasmine Cheung (Barrister, Des Voeux Chambers Hong Kong), Sheila Ahuja (Partner, A&O Shearman) and Heidi Li (Of Counsel, A&O Shearman).
Footnotes
[1] Re Sino Oil and Gas Holdings Ltd [2024] 2 HKLRD 1084
[2] Re Heron International NV [1994] 1 BCLC 667
[3]Re South China Strategic Ltd [1997] HKLRD 131; In re Dorman, Long & Co [1934] Ch 635
[4] Re Sino Oil and Gas Holdings Ltd [2024] 2 HKLRD 1084
