Cross border insolvencies can pose significant challenges to practitioners aiming to conduct an orderly and cost efficient wind down or restructuring process. A single insolvency process is rarely sufficient to protect assets located outside the local jurisdiction because foreign creditors will not necessarily be bound by the decisions of the local court or subject to any stay on litigation that may be imposed. This can quickly disrupt the universal distribution of the company's estate, with creditors seizing assets or commencing litigation in other jurisdictions. Seeking to implement parallel insolvency proceedings to avoid such consequences is not without its own difficulties. For example, in jurisdictions that have adopted the Model Law, identifying COMI can take considerable time and effort and in general, practitioners often face conflicting insolvency rules and procedures, or worse, antagonistic office holders, with no clear route forward.
Against this backdrop, the Cayman Islands provisional liquidation procedure has proven to be a very useful and flexible tool to assist in cross border liquidations and restructurings, particularly in the context of Cayman Islands incorporated debtors that have entered into Chapter 11 proceedings in the US. As discussed further below, commencing a provisional liquidation of a Cayman Islands incorporated debtor, in conjunction with a Chapter 11 proceeding, will limit the risk of creditors that are not subject to the jurisdiction of the US seeking to disrupt or avoid the Chapter 11 proceedings by taking incompatible steps in the Cayman Islands, as the debtor's country of incorporation.
The provisional liquidation procedure and working in parallel
In the Cayman Islands, there is no restructuring process equivalent to Chapter 11 in the US or administration in the UK. Accordingly where an insolvent Cayman Islands company intends to seek a restructuring, the provisional liquidation procedure is commonly used. In this regard, section 104(3) of the Cayman Islands Companies Law (2013 Revision) allows a company to present a winding up petition and, at the same time, make an application to the Grand Court of the Cayman Islands ('Cayman Court') to appoint provisional liquidators where: (a) the company is, or is likely to become unable to pay its debts; and, (b) the company intends to present a compromise or arrangement to its creditors. A debtor that is proposing to enter into Chapter 11 proceedings will generally meet these requirements and the Cayman Court has appointed provisional liquidators in support of Chapter 11 proceedings on a number of occasions.1
If provisional liquidators are appointed, the winding up petition is adjourned out (either indefinitely or from time to time) and the provisional liquidators are afforded an appropriate period of time to seek to carry out a restructuring. The Cayman Court is flexible in respect of the time period that will be granted, particularly at the outset, where it is acknowledged that the provisional liquidators will necessarily need some time to determine whether a restructuring will be possible. However, if it becomes apparent that a restructuring is not a realistic prospect, then the Cayman Court is likely to list the winding up petition for hearing and make an order winding up the company and appointing official liquidators.
The provisional liquidators must be qualified insolvency professionals, at least one of whom must be resident in the Cayman Islands. However, it is possible to appoint foreign practitioners as provisional liquidators to act jointly with the Cayman Islands practitioners. As such, a chief restructuring officer appointed in Chapter 11 proceedings could be appointed as a joint provisional liquidator. A provisional liquidator is an officer of the Cayman Court and is an agent of the company. He/she owes fiduciary duties to the company to act for proper purposes, in good faith and in the interests of the company as a whole. A provisional liquidator does not represent any creditor or class of creditors or any shareholder or class of shareholders; is required to be independent of the former management of the company and its stakeholders and is required to behave in an even-handed fashion between stakeholders or groups of stakeholders amongst themselves.
However, there are very few statutorily prescribed powers for provisional liquidators and their powers are normally set out in the court order appointing them. This gives the Cayman Court real flexibility to create a suite of powers that is appropriate in any given circumstance.
In particular, the Cayman Islands Companies Winding Up Rules2 expressly acknowledge that the appointment of provisional liquidators need not necessarily displace the powers of the directors. The order appointing the provisional liquidators will set out which powers are to be retained by the company's directors and which powers can be exercised by the provisional liquidators.
The Cayman Court recognises that where a company is acting as debtor-in-possession in Chapter 11, it is not appropriate to divest current directors and officers of their powers or to displace the role of any chief restructuring officer appointed. Instead, the Cayman Court is prepared to put in place a flexible regime for provisional liquidators that suits the factual matrix and mirrors the debtor-in-possession regime of the US courts. For example, all day to day operations and decisions can be reserved to the directors and/or chief restructuring officer with the provisional liquidators in a supervisory or consultative role and with only non-ordinary course transactions (e.g. asset sales and borrowings) requiring the prior consent of the provisional liquidators. To avoid potential disputes, it may be preferable to set out with a degree of specificity what does and does not constitute ordinary course of business.
In these circumstances, cross border protocols or stipulations that are agreed between the officers of the debtor and the provisional liquidators are invaluable to iron out the practicalities of how the parties will co-operate and to ensure efficient administration of the debtor's estate. Ideally, at the outset, Cayman and US practitioners will discuss the potential areas of conflict or jurisdictional tension in the proceedings and seek to deal with these in the protocol. The scope of such protocols is entirely flexible and can be used to set out agreed procedures on important issues, such as exchanging information between the provisional liquidators and the officers of the debtor, co-ordinating applications between the Cayman Court and the relevant US bankruptcy court, filing creditor claims and the subsequent claims adjudication/claims review process, the formulation of restructuring proposals, the preservation and realisation of assets, the conduct of litigation, etc.
To be conclusively binding on all parties, such protocols should be approved by both the Cayman Court and the relevant US bankruptcy court. In this regard, the Cayman Court has strongly endorsed the concept of co-operation and co-ordination in cross border insolvency proceedings3 and has stated that it will continue to work with courts in other jurisdictions, where appropriate, to ensure the fair and efficient management of international insolvency proceedings in the interests of all creditors and other interested persons, including the debtor.4
Indeed, keeping both the Cayman Court and the US bankruptcy court informed and involved in both sets of proceedings on an on-going basis is essential to avoid jurisdictional challenges and conflicting court orders. It is important to recognise that on many occasions, both courts may have jurisdiction over the issue in question, for example, asset sales, approval of legal fees or the creditor claim process. Practitioners will want to ensure the courts make complementary rather than conflicting orders.
In this regard, there is a distinct advantage in commencing both sets of proceedings on the same date. Where all relevant parties, and importantly, both courts are involved from the outset, the focus can be on a collaborative rather than adversarial approach. This avoids the difficulties that can occur when a second court and new office holders become involved at a later date and start to challenge or second guess decisions that have already been made. Commencing both proceedings on the same date also ensures that the universe of pre- and post-petition claims can be referable to the same date which will assist in simplifying the question of priorities.
Trident Microsystems (Far East) Limited – a case study
The liquidation of Trident Microsystems (Far East) Limited ('TMFE'), which is on-going before the Cayman Court and in Chapter 11 before the United States Bankruptcy Court for the District of Delaware ('Delaware Court'), is a prime example of efficient judicial co-operation, using the Cayman Islands provisional liquidation procedure, in a complex cross border matter.
By way of background to this case, the ultimate parent company of the Trident Group was Trident Microsystems Inc. ('TMI'), a Delaware incorporated company, whose shares were listed on NASDAQ. TMI's primary asset was its shares in its wholly owned subsidiary TMFE, a Cayman Islands company.
The numerous operating, manufacturing and distributing companies within the Trident Group were all direct or indirect subsidiaries of TMFE, and they were carrying on business in the US and in various jurisdictions in Europe and Asia. The business of the Trident Group was the development and sale of microchips and related software for use in home-entertainment systems. The Trident Group as a whole employed approximately 1,100 people worldwide.
In addition to acting as an intermediate holding company, TMFE owned the large majority of the Trident Group's intellectual property rights, the majority of its licence agreements with third-party manufacturers, was the contracting counterparty for third-party supply contracts and provided treasury and administrative functions for the Trident Group. TMFE had directors but no employees or premises and contracted with other Trident Group companies to provide services by and to TMFE. TMFE had substantial liabilities to third party suppliers and to companies within the Trident Group, including TMI.
In 2011 the financial position of the Trident Group, and in particular TMFE and TMI, became increasingly distressed. By January 2012, TMFE and TMI had become cash-flow insolvent.
Prior to the commencement of insolvency proceedings, it was recognised that TMFE's assets and contractual rights and obligations would be key to any restructuring of the Trident Group. Given the global nature of TMFE's assets and obligations, an automatic stay on proceedings against TMFE pursuant to a US Chapter 11 proceeding would only be sufficient to protect TMFE against creditors seeking to enforce their rights in relation to its US assets, against US creditors seeking to enforce their rights against its assets outside of the US and (potentially) against creditors seeking to enforce their rights against assets located in jurisdictions that had adopted the Model Law. However, to protect against non-US unsecured creditors seeking to enforce their rights in other jurisdictions, a stay would be required in the Cayman Islands.5
Accordingly, on 4 January 2012, TMFE and TMI filed jointly for Chapter 11 relief in the Delaware Court. On the same day, TMFE filed a winding up petition and applied for the appointment of joint provisional liquidators6 ('JPLs') in the Cayman Court. On 11 January 2012, the Cayman Court appointed JPLs.
Thereafter the Chapter 11 and provisional liquidation proceedings were run in parallel with the benefit of an automatic stay on proceedings in each jurisdiction. From the outset, both courts have been fully involved with all key decisions taken in the proceedings and have taken an active role in ensuring co-operation in and co-ordination of the two proceedings.
Due to the complexity of TMFE's business and its importance to the Trident Group as a whole, the Cayman Court recognised that it was essential for TMFE's directors to remain fully engaged in the day-to-day running of TMFE and its subsidiaries, to assist with the negotiations with potential purchasers of the Trident Group's business units and with implementing the eventual sale of those units.
Accordingly, to co-ordinate the roles and responsibilities of the directors, chief restructuring officer and the JPLs and identify the key issues where immediate collaboration was required, a detailed cross border protocol was put in place and approved by both courts at a joint telephone hearing within 2 weeks of the JPLs' appointment. The protocol set out the following key points:
(a) The directors would be responsible for the day to day operations of TMFE subject to the overall, high-level, supervision of the JPLs;
(b) Substantial sales of business units would have to be approved by each court. On any application for the sale of substantial assets, TMFE would first seek the approval of the Delaware Court and, if the Delaware Court approved the sale, its approval would be conditional upon the JPLs then obtaining the Cayman Court's approval.7 The reason for giving initial priority to the Delaware Court was that more than half of the Trident Group's patents and other registered IP assets were registered in the US in name of TMFE;
(c) The JPLs and TMFE/TMI would file reports with both the Cayman Court and the Delaware Court at regular intervals to ensure that both courts were kept fully up to date;
(d) Identical creditors' committees for TMFE were established in both proceedings;
(e) The JPLs would hold weekly conference calls with the creditors' committee;
(f) TMI, the JPLs, the chief restructuring officer and the directors would meet on a weekly basis to discuss operations; and
(g) The protocol would be kept under review and would be modified as necessary from time to time.
Four of the Trident Group's business units were sold during the provisional liquidation. The procedure outline above was used in each case. The sales of the two larger business units were the subject of auctions (one with, and one without, a 'stalking horse' bidder), and the Delaware Court and Cayman Court were asked to approve both the bidding and auction process and the subsequent sales. To the extent the Delaware Court placed any terms and conditions on its approval, the Cayman Court orders mirrored such terms and conditions.
It was also necessary to give consideration to the process by which unsecured creditors would file their claims against TMFE. It was recognised that it would be unsatisfactory to require creditors to file claims in both TMFE's Chapter 11 proceedings and in the Cayman Islands liquidation. Because the mandatory filing requirements in the Chapter 11 proceedings were more prescriptive, in terms of the time by which claims must be filed and of the details required to be filed, than the corresponding requirements in the Cayman Islands liquidation, an application was made to both courts (again by way of a joint telephone hearing) to revise the protocol to permit the creditor claims information filed in the Chapter 11 proceeding to be deemed as being filed in the Cayman Islands liquidation.
It was expressly acknowledged in the revised protocol, and before both courts that, although claims were being filed in both proceedings, no adjudication process would be commenced at that time. This was partly because, as a matter of Cayman Islands law and procedure, it was unlikely to be appropriate for provisional liquidators (as opposed to official liquidators) to adjudicate on claims, (i.e. as long as there was a prospect that TMFE might emerge from a provisional liquidation and be returned to solvency, an adjudication process may not be necessary). This was also because it was acknowledged that difficult conflicts of law questions could arise in respect of the validity and priority of claims (especially with respect to the creditor claims against TMFE by other Trident Group companies8). It was accepted by both courts that it would be more efficient to collate the information on TMFE's creditor claims at this stage and then, if and when it became necessary to adjudicate the claims, proposals could be made for that process and appropriate revisions made to the protocol.
As the asset sales progressed, it became clear that it would not be possible to restructure TMFE so as to leave it with a functioning business (and thus emerge from provisional liquidation and Chapter 11), and therefore its remaining business units would have to be sold, and the proceeds distributed to its unsecured creditors. Accordingly, on 8 August 2012, the Cayman Court put TMFE into official liquidation. The Cayman Court appointed the JPLs as TMFE's joint official liquidators ('JOLs'). TMFE and TMI remained in Chapter 11 in Delaware.
This brought the adjudication of creditor claims and related conflict of laws issues into sharp focus. Official liquidators have a statutory duty to adjudicate creditor claims under Cayman Islands law and in accordance with Cayman Islands rules. However, it was acknowledged that given TMFE's assets were, for the most part, located in the US, the Delaware Court would expect that assets should be distributed in accordance with the priorities under the Bankruptcy Code.
Ultimately, in this case, a commercial solution was achieved. The JOLS, the directors of TMFE and TMI, the chief restructuring officer, the creditors' committees of TMFE and the equity committee of TMI, agreed to a proposal by which creditor claims would be compromised pursuant to a plan of liquidation in the Chapter 11 proceedings. 9 In order to determine the validity of creditor claims against TMFE for the purpose of receiving a dividend under the plan, it was agreed that the JOLs would adjudicate the claims under Cayman Islands law (i.e. it would be a function of Cayman Islands law as to whether claims should be allowed or disallowed) while the assets, which were located in the US, would be distributed in accordance with the priorities set out in the Bankruptcy Code.10 In the event a creditor's claim was disallowed by the JOLs, the creditor could exercise his statutory right under Cayman Islands law to challenge the JOLs' decision by an appeal to the Cayman Court but could not challenge it in the Delaware Court. This procedure allowed the JOLs to fulfil their statutory obligation to adjudicate on claims but also ensured that assets which were subject to the jurisdiction of the Delaware Court, were not distributed other than in accordance with Bankruptcy Code priorities.
A final joint telephone hearing was held before the Cayman and Delaware courts to approve the plan and the adjudication proposals. At this hearing the Delaware Court approved the plan of liquidation and the Cayman Court authorised the JOLs to compromise the creditor claims by way of the plan.11 Both courts then also approved a final revised protocol which set out the adjudication and distribution procedures.
Since that time, all the creditor claims against TMFE have been finally adjudicated, all the realisable assets of TMFE sold, and the proceeds distributed to creditors according to the priorities set out in the plan. This resulted in a 90% return to all of the third party creditors of TMFE and a significant return to TMI as the equity holder.
While cross border cases by their nature can never be without difficult conflict of laws issues, the Trident case is an excellent example of using the provisional liquidation procedure to ensure a commercial and collaborative approach to a cross border insolvency. It was a true parallel proceeding and it never became necessary to determine COMI or to determine whether the provisional liquidation or the Chapter 11 was the main proceeding. Instead, both courts accepted jurisdiction over the process and the parties and the courts coordinated with each other to ensure that conflict of laws issues were resolved sensibly and in accordance with key requirements of both jurisdictions. The flexibility of the provisional liquidation process allowed this to occur.
1 See for example, Re Fruit of the Loom  CILR N-7; Trident Microsystems (Far East) Ltd  1 CILR 424; Arcapita Investment Holdings Limited, 19 March 2012, Grand Court unrep.
2 Order 4, rule 7(3), Companies Winding Up Rules (2008 Revision) (as amended).
3 See for example, Lancelot Investors Fund Limited  CILR 7 at para. 70.
4 Trident Microsystems (Far East) Ltd  1 CILR 424.
5 As a matter of Cayman Islands law, secured creditors can enforce their rights on a liquidation notwithstanding a stay.
6 The JPLs were both Cayman Islands insolvency practitioners and no application was made for a joint appointment with a foreign practitioner in this case.
7 In practice, the applications were coordinated in advance to avoid any delays so that, for example, the Delaware hearing was listed for the morning and the Cayman hearing was listed for the afternoon.
8 For example, concepts such as equitable subordination do not exist under Cayman Islands law and it was anticipated that third party creditors may seek to challenge the validity of the intra-group claims on this basis.
9 In this case, it was decided that there was no need to carry out a separate Cayman Islands scheme of arrangement (the Cayman Islands equivalent of a Chapter 11 plan) because the majority of significant creditor claims were governed by US law. In circumstances where there are significant creditors whose claims are not governed by US law, and who, under conflict of laws principles, would not be bound by the terms of the plan, a parallel scheme of arrangement may be necessary. Implementing a scheme of arrangement is a power that can be granted to a provisional liquidator.
10 The priorities under the Bankruptcy Code were not significantly different to the priorities under Cayman Islands law. Accordingly, this arrangement was not inconsistent with the principles set out in decisions such as HIH Insurance Ltd  1 WLR 852.
11 Pursuant to section 110(2) and Part 1 of Schedule 3 of the Companies Law, official liquidators have no power to compromise creditor claims without the prior authorisation of the Cayman Court.
This article first appeared in Volume 11, Issue 2 of International Corporate Rescue, published by Chase Cambria Publishing.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.