Keepwells considered

In the context of Chinese-funded U.S. dollar-denominated debt, a keepwell agreement usually refers to an agreement between an onshore parent company and its offshore subsidiary, in which the parent company promises to maintain the liquidity and solvency of the subsidiary without formally guaranteeing repayment in the event of a default (indeed, they usually expressly state that they are not guarantees).

Where there is an offshore guarantor, the keepwell agreement may provide for the onshore parent to continue to maintain a significant equity interest in the offshore guarantor.

Background

To recap, Peking University Founder Group Limited（北大方正集團有限公司） (PUFG, the Company) had entered into keepwell agreements with two bond-issuing subsidiaries, Nuoxi Capital Limited (Nuoxi) and Kunzhi Limited (Kunzhi) (the issuers) within the Peking University Group, their two Hong Kong-incorporated direct parents, who had guaranteed the issuers' obligations under the bonds (the guarantors), and the bond trustee.

Kunzhi was a wholly owned subsidiary of Founder Information (Hong Kong) Limited (FIHK), which pursuant to the trust deeds to which it was also a party, guaranteed Kunzhi's obligations under the bonds issued by Kunzhi.

The bonds in question were issued in April and May 2018, amounting to a total value of approximately US$1.7 billion.

The keepwell agreements contained identical material terms, which required PUFG to cause each of the issuers and guarantors to have sufficient liquidity to ensure timely payment of any amounts payable under the bonds.

In addition to the keepwell agreements, the parties had entered into various Deeds of Equity Interest Purchase Undertaking (EIPUs). The contractual documents were governed by English law and had Hong Kong exclusive jurisdiction clauses.

The issuers defaulted on their payment obligations, and the guarantors failed to honour the guarantees that were called under the bonds.

PUFG had commenced reorganisation on 19 February 2020 pursuant to an order issued by the Beijing court under the Enterprise Bankruptcy Law (EBL), and subsequently the issuers and the guarantors (each of which are in liquidation in their respective jurisdictions), sought to submit claims in the reorganisation. The administrators rejected each of their claims save for that of one of the guarantors.

Hong Kong proceedings

The issuers and guarantors brought claims against PUFG in Hong Kong for breach of the keepwell agreements.

At first instance, the Honourable Mr. Justice Harris recognised the administrators but rejected their claims for a stay of the Hong Kong proceedings, in so doing upholding the exclusive jurisdiction clauses in the keepwell agreements.

Harris J disagreed with the administrators' suggestion that the Beijing court was just as well placed to determine the issues as a Hong Kong court, noting that the court had agreed to have disputes concerning the deeds determined by a court able to apply English law (see Hogan Lovells alert Bond defaults – Hong Kong court tells mainland administrators: we recognise you, but you can't "stay" here).

The Hong Kong Court of Appeal subsequently dismissed a challenge to the decision (see Hogan Lovells alert Hong Kong Court of Appeal gives boost to bondholders in significant "keepwel" victory).

With the jurisdictional issue finally resolved, four actions came to trial in January 2023 before Harris J. The action brought by FIHK succeeded, whilst the other three actions were dismissed.

Timing is everything

Harris J took the view that there was a "material difference" between what the company had to show in respect of a failure to comply with the keepwell agreements or the EIPUs before the reorganisation commenced on 19 February 2020 and after it had commenced.

Harris J commented that "once the Company was in reorganisation there was no realistic likelihood of approvals being given to transfers out of the Mainland. This would simply have depleted assets available to the Administrators and the Company, which would otherwise be available to Mainland creditors or financing and implementing the reorganisation." This finding proved fatal to the claims in three of the actions.

Harris J found however that the position before the reorganisation took place, was different. He found that FIHK had a deficit of approximately US$167 million as at 31 December 2019. It therefore followed that PUFG "was in breach of the Keepwell Deed at that date and, presumably, for at least sometime before."

Harris J found that PUFG had taken "no steps at any time to obtain the approvals, consents, licences, orders, permits or any other authorisations as might prove necessary" for complying with PUFG's obligations under the keepwell agreements or under the EIPUs.

As such, PUFG "had failed to prove that it used its best efforts to obtain the necessary approvals and, as clearly it had not complied with its obligations under the Keepwell Deeds and the EIPUs", and consequently PUFG had breached its obligations.

Loss

Harris J found that PUFG was only liable for a breach of the keepwell arrangements in respect of the claim brought by FIHK. As a consequence of the breach, Harris J found that PUFG "caused loss to FIHK by the amount it should have, but did not receive, namely RMB1,154,012,000" (approximately US$164 million).

All parties will be reviewing the decision carefully.