It is still too early to tell how many restructurings, insolvencies and other financial casualties there will be around Asia as a result of the current market turmoil stirred up by COVID 19 and the near collapse of some of the resource and commodity markets and related consequences. But it seems increasingly likely that more restructurings will need to take place in Asia, in particular for corporates and funds. Indeed, many of us are fielding tell-tale calls from market participants on a daily basis where the topics range from short-term queries around waivers, reservation of rights and potential forgiveness of liability, to early stage strategic discussions which may culminate in consensual or, occasionally, full-blown non-consensual restructurings.
Non-consensual restructurings are sometimes referred to by the restructuring community as “Plan B” and basically entail creditors letting go of consensual options and, instead, attempting to use a variety of statutory and contractual insolvency remedies and procedures to realise value from debtors and assets in distress, including (depending on the jurisdiction) such things as enforcement of security, liquidation and schemes of arrangement. Those practitioners with experience of previous market turmoil and restructurings will appreciate the importance of being able to visualise non-consensual situations in advance: even though the majority of solutions will turn out to be consensual whereby debtors and creditors renegotiate everything from overall deal structures to troublesome individual covenants. But one thing is for sure - creditors find consensual discussions much more difficult where there is no real belief that, if all else fails, a non-consensual restructuring by way of Plan B will ever really provide them with adequate recompense.
When it comes to the important task of analysing non-consensual scenarios, there are many moving parts. Two of the most important matters to establish will include:
(i) how vulnerable to attack is the creditor’s collateral package – what, if any, challenges may be raised against such things as sales of assets and making demands under guarantees ?; and
(ii) will the debtor have the benefit of any rescue procedure or moratorium whereby senior creditors’ rights are, at best, suspended or potentially their value is entirely compromised ?
This article briefly summarises how these two important aspects of restructurings will typically play out in the Asian markets but it will then go on to describe the impact of some of the surprising infiltrations of foreign and extra-territorial laws in these scenarios.
1. Remedies which may be challenged upon insolvency
The usual position
Where a corporate obligor in an Asian financing finds itself approaching a formal insolvency process, many jurisdictions will apply the concept of pari passu distribution of assets but in doing so, most types of credit support will be reviewable to ensure there is fair distribution of assets between those creditors with beneficial, prior ranking rights and those merely with general unsecured claims. It is common for transactions to be cross-border and therefore the insolvency analysis to determine which senior claims are robust and which should properly be overridden may involve several governing laws. The jurisdiction of the debtor will almost always be relevant. The governing law of any security, guarantee or other finance document will also be relevant - and so too will be the jurisdiction of any other participants or assets involved in the insolvency.
Jurisdictions such as Hong Kong and Singapore have insolvency legislation which, whilst different in several important details, broadly follows the architecture of the UK’s Insolvency Act 1986. Hence, courts or insolvency practitioners in sophisticated Asian jurisdictions will generally have powers to set aside certain classes of transaction upon application by an insolvent entity’s liquidator or other manager/administrator. They generally retain wide discretion to grant orders and decisions restoring the parties to the position they would have been in had such transactions not occurred. Depending on the applicable laws and detailed circumstances, ‘reviewable transactions’ commonly include:
- Transactions at an Undervalue – transactions for which the obligor received no consideration or where the value of the consideration received is significantly less than that provided by the obligor;
- Preferences – if the obligor does anything which at the relevant time puts one of its creditors in a better position in an insolvent liquidation than it would otherwise have been;
- Certain Dispositions – any disposition of an obligor’s assets (including the grant of security) made after the presentation of a winding up petition against the obligor (unless the court otherwise orders);
- Floating Charges – a floating charge created in exchange for past consideration – such as to secure loans previously advanced – and made within a specified period before the onset of the obligor’s insolvency; and
- Extortionate Credit Transactions – a transaction which, having regard to the credit risk accepted by the creditor, would be considered extortionate – whether by requiring grossly exorbitant payments for the provision of credit or otherwise grossly contravening the ordinary principles of fair dealing.
For each type of reviewable transaction, additional statutory factors must be considered to determine if a transaction is to be unwound or varied. From the senior creditor’s point of view, it is critical that their legal counsel consider all these matters in advance, as best they can, and that the finance documentation and the manner in which the collateral package is put in place, anticipates these matters and includes all the usual safeguards – such as, by way of example, documentation to show that those entities granting security and guarantees had sufficient corporate benefit and, the very basic point around assurances, that the entities providing such credit support were not insolvent at the time they entered into the relevant finance documentation.
But, the question arises – how many of these senior creditors and their legal counsels consider and carry out due diligence in respect of certain extra-territorial bankruptcy laws outside of Asia which, on the face of all the usual tests, may have nothing to do with the financing, such as US laws ?
Surprising infiltration of US law
The geographical prerequisites for filing a bankruptcy petition in the United States under the United States Bankruptcy Code (Code) are minimal; they require only that the debtor “resides or has a domicile, place of business, or property in the United States”. The filing of a petition creates a bankruptcy estate that consists of the debtor’s property, wherever located, and the bankruptcy court has jurisdiction over that property. Because there are practical limits on the ability of a court in the United States to exercise control over assets and creditors located outside the United States, supplemental proceedings in other nations are often required and would be instigated on the principle of comity. Therefore the scope for an obligor in an Asian financing to find itself in a US bankruptcy and for its assets including subsidiary shareholdings to be subject to that process is unexpectedly heightened. This is especially the case given the debtor friendly Chapter 11 regime under the Code.
Furthermore, a United States court’s disposition of a debtor’s bankruptcy can have significant effects on foreign transactions which, at first glance, appear distinct from the debtor. For instance, the Code permits a debtor’s trustee to avoid and recover any transfer the debtor made within two years of filing for bankruptcy, if the debtor made the transfer with the intent to “hinder, delay, or defraud” its creditors or if the transfer occurred at a time when the debtor was in financial distress and insufficient value was provided. The Code also permits the trustee to avoid and recover any transfer the debtor made to a creditor within 90 days of filing for bankruptcy where such transfer benefits the creditor, is made in respect of existing debt and in circumstances where the debtor is insolvent. These clawback proceedings could extend to recovering funds or property from foreign entities in certain instances.
All these extra-territorial possibilities are supported by the broad discretion granted to bankruptcy courts pursuant to Section 105 of the Code whereby courts may “issue any order, process, or judgment that is necessary or appropriate to carry out the provisions” of the Code. Whilst intended to protect the court’s jurisdiction, pragmatically there is scope in the appropriate circumstances for parties to request that the court exercise its equitable powers to grant an array of creative orders particularly where the Code neither specifically prohibits nor provides for these.
Senior creditors would therefore be well advised to consider, on an ongoing basis, whether their financings with Asian obligors are in any way connected to a company that has recently entered bankruptcy in the United States or may enter bankruptcy in the future, and whether US bankruptcy laws may be applicable to a given transaction. For example, the federal Court of Appeals in New York recently held that the trustee for Bernard L. Madoff Investment Securities LLC — the investment firm at the center of Bernie Madoff’s Ponzi scheme — could use these bankruptcy provisions to recover funds that were transferred to feeder funds located in the Cayman Islands and Bermuda, and which were then subsequently transferred to foreign investors of the feeder funds. See In re Picard, Tr. for Liquidation of Bernard L. Madoff Inv. Sec. LLC, 917 F.3d 85 (2d Cir. 2019). The trustee was permitted to recover the funds from the foreign investors because the initial transfer — i.e., from the debtor to the feeder funds — took place within the US, even though the subsequent transactions between the feeder funds and investors were completed outside the US. This is a telling example.
US bankruptcy laws in action in Asia – a cautionary tale
One important recent example which our team worked on in Asia involved a distressed loan to a Cayman parent secured among other things by share security over an indirect subsidiary which owned profitable resource assets in India. When it came to a default on the parent company loan and potential enforcement against the share security became an option, senior creditors began to run due diligence on the prospect of such enforcement and attempts to realise value in that security so as to repay the parent company debt. For a period of time, it seemed that the corporate group of the debtor companies may have had a distant connection with certain US assets and bank accounts. Whilst these appeared to have no bearing on the relevant security documents – which involved English law security over a Cayman entity owning assets in India – because of that far off US connection, US lawyers were retained by the debtors and there was the prospect of that “tree” of the borrower group entering into a Chapter 11 rescue process.
Senior creditors were not immediately concerned because their security had been well structured and all the usual precautions had been taken. But concerns heightened when it became apparent that the US court might apply US style bankruptcy laws retrospectively to determine whether or not the share security could be challenged and discharged. The specific point in this circumstance was that the senior creditors had taken account of all relevant local laws as to whether the security might be challenged and vulnerable under what appeared to be the only relevant local laws – but the test which would be required by US law (with which the senior creditors were now seemingly faced) would be on the basis of the much stricter and less creditor friendly test of fraudulent conveyance – which meant that the security could potentially be annulled and overridden unless it could be shown that the security grantor received full and calculable benefit from granting the security.
Happily for the senior creditors involved, the situation did not progress. A consensual solution was found for the restructuring and the parties did not end up needing to consider US laws. But there are plenty of examples of Asian restructurings which have fallen foul of US bankruptcy laws and which have, effectively, dispossessed secured creditors who, save for such infiltration, would have had robust claims against assets and debtors in Asia.
2. Rescue procedures which restrict remedies
The usual position (and some debtor friendly developments)
As with the area of reviewable transactions in insolvencies summarised above, a number of Asian jurisdictions, such as Hong Kong and Singapore, have an insolvency regime which, whilst these days differs in a number of important respects from the UK, can be said to have a broadly similar historical background and architecture to the UK insolvency laws and procedures. Overall, such jurisdictions are considered to be creditor friendly, at least in part because they have a strong rule of law, based on a common law system which respects property rights and important devices such as the law of trusts and pari passu distribution of assets. Historically they also provided for relatively few circumstances in which a creditor would be prohibited for enforcing its claims against a debtor’s assets or taking other action against the debtor, one such exception being the Singapore statutory moratorium in judicial management. Notwithstanding this general approach, there have been indications in recent years that these Asian jurisdictions are increasingly looking to the US as they develop a more debtor friendly corporate rescue toolkit of their own.
In the case of Hong Kong, there have been a number of proposals to introduce rescue and moratorium type procedures along the lines of those found in the United States and certain other notable jurisdictions which, whilst preserving property rights, are considered to be less favourable for senior creditors as they introduce increased uncertainty and potential delays in realisation of assets. In the face of recent market turmoil, the Hong Kong legislature is once again considering a bill to introduce a rescue procedure. Whilst the details are still developing, if based on the immediately prior proposal, the debtor-led out of court ‘provisional supervision’ process would include a moratorium on civil proceedings, permitting the provisional supervisor to formulate a voluntary proposal to creditors and restructure the debtor’s finances. It is worth noting that the consent of its ‘major secured creditor’, being a creditor with a charge over all or substantially all of the debtor’s assets, is expected to be required for the rescue process to commence. It is also anticipated that the moratorium will not apply extra-territorially – that is, creditors may still commence proceedings against the debtor in jurisdictions other than Hong Kong and the debtor’s offshore assets will likewise not be shielded.
In the case of Singapore, US style corporate rescue procedures have been on the statute books for a couple of years positioning it as a regional hub for restructuring. Singapore supplemented its existing scheme of arrangement mechanism with several Chapter 11 style features including super-priority debtor-in-possession financing and pre-packaged restructuring plans. Debtors who have taken the scheme route may also avail themselves of the Singapore courts’ power to order a worldwide moratorium, theoretically extending to the debtor’s related entities in certain instances, provided that the creditor is within the Singapore court’s jurisdiction. It has been established that a creditor may apply to the court for this moratorium to be terminated.
Surprising infiltration of English insolvency laws
As with the infiltration of US bankruptcy laws referred to in the first half of this article, increasingly in Asia, parties are considering whether or not they may be able to utilise and profit from restructuring procedures from outside of Asia, such as schemes of arrangement sanctioned by the English courts. It is well known that the English process allows broad flexibility to present proposals for different classes of creditors which may be very convenient for complex debt structures and not otherwise available in respect of certain jurisdictions in Asia ( although going forward consideration should be given to whether there would be a sufficient nexus to other mature Asian jurisdictions so that their respective scheme procedures might similarly apply). Perhaps of most importance is that this English procedure allows certain dissenting creditors and other parties to be crammed down and silenced, allowing the proposing party’s priorities to be followed.
In order to arrange a restructuring via a scheme of arrangement before the English courts, the relevant creditors or debtor company would need to establish a sufficient connection with England and show that there would be a purpose served by the English court sanctioning the scheme. Pertinent questions may be – are any of the creditors English – such as an English financial institution ? Does the debtor have assets in England? Did the parties originally provide that the finance documents are governed by English law and do they include an exclusive jurisdiction clause in favour of the English courts ? The parties will need to bear in mind that the English scheme will only usually restructure debts which have arisen under English law documents and arrangements – hence, foreign debts may not form part of the same scheme of arrangement. But this is usually not so problematic as it is possible to structure the scheme around this anomaly and, also, in practice, so many cross-border financings in Asia are governed by English law (although it is notable that certain types of capital markets documentation have traditionally been structured under US style 144A offerings which might usually involve New York laws). In a similar way, if the scheme purports to involve debt for equity swaps involving non-English companies, those are likely to require separate consents and approvals from relevant shareholders and potentially from other participants in the transactions rather than being ‘crammed down’. The English style scheme of arrangement does not need to be recognised by the law of the jurisdiction of the debtor but, under the rules a foreign company would need to establish that the scheme of arrangement sanctioned by the English courts would have practical consequences in the jurisdiction of the foreign debtor. Recognition of English schemes of arrangement in foreign jurisdictions differs depending on the jurisdiction. But precedent shows that even in respect of a number of jurisdictions which do not formally recognise the English scheme, dissenting creditors may find it challenging and potentially impossible to disrupt the scheme in their foreign jurisdiction. With respect to documents governed by English law, foreign states will invariably need to apply English law.
An example of English schemes in action in Asia
English schemes of arrangement have become part of the Asian insolvency scene and amongst the first situation to experience them was the Vietnamese shipping group known as Vinashin. In 2013, in a well publicized case, Vinashin successfully applied to the English High Court for a sanction of a scheme of arrangement to restructure a loan facility. Vinashin had no known assets outside of Vietnam. Its loan documents were governed by English law, the debts to be compromised were governed by English law. The loan documents also contained a submission to the non-exclusive jurisdiction of the English courts. As a matter of policy, cramming down may curtail creditors’ rights, so the courts generally ensure there is a real threshold before English courts will entertain this procedure. Commentary at the time explained that the English court found it important that the foreign entities were genuine in wanting to restructure along the lines of an English scheme of arrangement.
English schemes of arrangement can still challenge Chapter 11 as a global restructuring option especially since they are a solvent process avoiding some of the stigma of other, alternative insolvency processes. Recent legislative proposals for a ‘super scheme’ may soon provide an additional enhanced restructuring tool modelled on the scheme of arrangement but with Chapter 11 inspired features. The ‘super scheme’, which is potentially available to companies that have encountered or are likely to encounter financial difficulties that affect their ability to carry on business as a going concern, permits cross-class cram downs and the exclusion of ‘out of the money’ creditors, among other attributes. Secured creditors should be aware that the English scheme (or, potentially, the ‘super scheme’) may be one of a series of options that they and their Asian debtors may have available to them, especially if they are familiar with their success in previous financial crises, where more immediately obvious, local processes could yield a more uncertain result or where English law governed debts form a significant proportion of a debtor’s liabilities to be restructured.
In summary, when it comes to cross-border collateral arrangements – which are commonplace with Asian financings for a variety of reasons – secured creditors would do well to retain experienced advisors on their side to help them navigate the unexpected vagaries of cross-border insolvency. This is true in any potential restructuring phase of a financing but also at the outset where mitigants and defensive strategies can potentially be put in place.
As we have sought to highlight, secured creditors not only need to cover all the usual bases and cover off legal risks to ensure that their collateral package is robust in accordance with all usual laws but they should also be prepared to “expect the unexpected” or, at the very least, to “think outside the box” and consider the possible application of extra-territorial insolvency laws – whether those be US, English or otherwise.