In a sign of what may be to come, a number of recent judgments have been handed down in the BVI, the Cayman Islands and Hong Kong dealing with the ability of ultimate beneficial noteholders to petition for the winding up of the issuer of US law governed notes. Given the current economic climate, with expected increases in high yield bond defaults, it seems certain that more investors will be looking at their enforcement options in the near future. Furthermore, as the judgments to date are all first instance decisions, it is likely that we will see authority at the appellate level sooner rather than later.
In this article we address the recent decisions in this area. The key takeaways are as follows:
- Demonstrating the relationship between those involved at all levels of the structure between the petitioner and the issuer is critical. There is a lengthy and complex chain of parties involved in any note issuance, with different agreements and arrangements governing each relationship in the chain. For ultimate beneficial noteholders seeking to bring winding up proceedings, it will be important to ensure that there is clear evidence of the relationship at every level of the various participants in the chain. In the recent Cayman decision in Re Shinsun discussed below, it appears that there was a missing link in the chain of authority between the registered holder and Euroclear, whereas that chain was complete in the more recent Cithara proceedings in the BVI.
- Each case will turn on its facts. Whilst the overall structure is often similar in numerous bond issuances, there are often bespoke provisions and/or drafting nuances. At the outset of structuring transaction documents, it is important for issuers, trustees and all other parties to consider the ability (or otherwise) of individual noteholders to take enforcement action unilaterally. In the case of individual noteholders considering their enforcement options once a default has occurred, they will need to review the indenture and other documentation very carefully.
- English authority on the application of the case law on contingent creditors for the purposes of schemes of arrangement to winding up petitions issued by underlying noteholders is going to be carefully scrutinised. Whereas Doyle J considered in Re Shinsun that he was "not persuaded" that the English authorities on voting rights in schemes of arrangement could be applied by way of analogy, in the very recent BVI decision in Cithara (discussed below) Mangatal J held that such case law was "helpful in construing the meaning of "creditor" and "contingent creditor"".
The Cayman Islands
In Re Shinsun Holdings (Group) Co., Ltd,1 the Grand Court of the Cayman Islands ruled that an ultimate beneficial holder of notes did not have standing to commence winding up proceedings against the issuer.
In Re Shinsun, the petitioner had a 25% interest in certain senior notes due 2023 (the Notes) issued by Shinsun Holdings (Group) Co., Ltd (Shinsun, a Cayman incorporated exempted company). The Notes were governed by New York law, and the sole registered holder of the global note was CCB Nominees Limited (CCB Nominees). Shinsun defaulted on the payment of interest due under the Notes, and the petitioner therefore instructed the trustee (China Construction Bank (Asia) Corporation Limited) to issue a notice of acceleration. Shinsun failed to settle the outstanding debt and the petitioner therefore filed a winding up petition against it in the Cayman Islands.
Having obtained expert advice on New York law, and applying the legal principles of construction of contracts under New York law as agreed between the experts, Doyle J applied the "no look through" principle of English law (equivalent to the US doctrine of privity of contract) and found that there was no contractual relationship between Shinsun and the ultimate beneficial holder of the Notes. In doing so, the Court held that the petitioner was not a contingent creditor, as there was "no obligation, upon the Company to the Petitioner, whether in contract, tort, equity or otherwise". The Court also held that the petitioner had not obtained proper authorisation from CCB Nominees as the registered holder to bring the winding up petition, and that it therefore lacked authority (and standing) to commence the winding-up proceedings. As only the registered holder (CCB Nominees) was permitted to authorise a person to take actions which the holder was permitted to take, the petitioner had no standing to pursue the winding up petition.
Importantly, Doyle J also held that the debt had not been duly accelerated in accordance with the terms of the Indenture. This was on the basis that the evidence showed that the Trustee was acting on the instructions of the petitioner (rather than CCB Nominees as the registered holder) when it issued the acceleration notice.
Furthermore, whilst the petitioner may have had a right to require the delivery of certificated notes, it had not done so. The best that the petitioner had was therefore "contingent standing", which was insufficient for the purposes of bringing a winding up petition.
This decision followed a similar ruling of the Supreme Court of Bermuda.2
There have been two decisions this year in which the Hong Kong court has addressed the standing of ultimate beneficial noteholders to issue a winding up petition. In both cases, the Court has held that the petitioner did not have standing to present a winding-up petition as a contingent creditor. In doing so, the Hong Kong courts have held that a petitioner needs to have an existing legal relationship with the company or an existing obligation owed by the company.
The first decision was In the Matter of China Oceanwide Group Limited.3 In that case, the petitioner sought the winding up of a company incorporated in Hong Kong which had guaranteed certain notes issued by its BVI subsidiary. In a (relatively) short judgment, Linda Chan J held that the petitioner was not a "holder" of the notes and therefore had no right to commence proceedings under the indenture or to seek the enforcement of payment under the notes.
More recently, Deputy High Court Judge Suen SC handed down judgment in the case of In the Matter of Leading Holdings Group Limited.4 As with Re Shinsun, the structure involved the issuance of senior notes under a New York law governed indenture. The issuer failed to pay interest and principal on the dates on which they were due. The petitioner held the beneficial interest in US$1.3 million of the notes through an intermediary bank which held a Euroclear account, and filed a winding up petition on the grounds that it was a contingent and prospective creditor.
The Court dismissed the petition on the following grounds:
- In the absence of the issuance of definitive notes, the petitioner had no direct rights under the indenture. In accordance with the "no look through" principle, only the trustee had direct enforcement rights against the issuer. The petitioner therefore had no right to commence enforcement proceedings (and therefore could not issue winding up proceedings).
- Individual noteholders could not (in their capacity as beneficial owner of the notes) act independently in commencing proceedings directly against the issuer.
- Following Re Shinsun, an individual noteholder is not a contingent creditor and has no standing to present a winding up petition (on the basis that it had no direct contractual relationship with the issuer). The court noted that this would potentially lead to a duplicity of actions by the trustee and individual noteholders at the same time).5 Notably, the Judge held that "there has to be an existing legal relationship or obligation between a person and a company before such person may qualify as a creditor of the company".6
The British Virgin Islands
The BVI Court has taken a different approach. In Cithara Global Multi-Strategy SPC v Haimen Zhongnan Investment Development (International) Co. Ltd,7 Mangatal J held that an ultimate beneficial noteholder under a New York law governed note structure is a contingent creditor and therefore had standing to apply for the appointment of liquidators in the BVI. In doing so, the Judge said that the BVI should not follow the Cayman decision in Re Shinsun.8
In Cithara, the petitioner held the ultimate beneficial interest in certain notes issued by Haimen Zhongnan Investment Development (International) Co Ltd, an offshore financing vehicle for a construction group based in the PRC. The issuer failed to pay interest and principal on the maturity date of the notes, and the petitioner therefore issued a statutory demand and subsequently filed a winding up petition against the issuer.
The BVI Court held that the petitioner was a contingent creditor and therefore able to apply for the winding up of the issuer (in accordance with applicable BVI law). Notably, the BVI Court took a different approach to the Cayman Islands Court on the applicability of the English case law on the voting rights of ultimate beneficial noteholders for the purposes of schemes of arrangement. The English courts have enabled ultimate beneficial owners of notes to be treated as contingent creditors and therefore entitled to vote at scheme meetings. By analogy, and consistent with the wider approach taken to liabilities for the purposes of English insolvency law set out by the UK Supreme Court in In Re Nortel GmbH,9 the petitioner as an ultimate beneficial holder of notes had standing to apply for the winding up of the issuer. This is in contrast to Shinsun, where the court held that the English scheme cases did not apply in this context, and that the phrase "contingent creditor" could mean one thing in one context and another in another context.
Whilst in Re Shinsun the Court had placed emphasis on the fact that the petitioner had not requested certificated notes, in Cithara the court noted that "it is unarguable that Cithara has the right to receive the Certificated Note and become the registered Holder itself".10
There are two key issues that come out of the recent decisions and suggest that the decisions in the BVI and Cayman Islands may not be as contradictory as may initially be thought. Indeed, it is notable that Mangatal J found that Re Shinsun could be distinguished on the facts.
First, demonstrating the link (or otherwise) at every stage in the chain between the issuer and the ultimate beneficial noteholder will be crucial. In Re Shinsun, the petitioner had failed to evidence the necessary authority and ability to issue winding up proceedings in accordance with the terms of the contractual documentation. On the other hand, in Cithara, the petitioner had been expressly authorised by Euroclear to bring the winding up proceedings which reflected the terms of Euroclear's operating procedures. It is therefore going to be necessary for a petitioner to demonstrate that the Euroclear operating procedures have been incorporated by reference into the indenture.
Second, a key issue will be the position as to the underlying debt as at the date of the winding up petition. In Cithara, there was no dispute that the payment of principal and interest on the notes was outstanding. As Mangatal J explained, "the debt arising under the relevant documents is undisputed".11 On the other hand, in Shinsun, the Cayman court expressly considered the question of whether or not the debt had been accelerated, and in light of the fact that the notice of acceleration had come from the trustee on the instructions of the petitioner (rather than the holder of the notes) the Court held that "the acceleration is not valid". Accordingly, there was a question as to whether the petitioner was actually a creditor at all.
The recent Hong Kong decisions seem to elide these (fine) distinctions. In Leading Holdings, the Court (despite appearing to have been addressed on the issue)12 did not consider the situation to be different if there was an event of default, as at that time "no definitive notes have been issued". However, that does not address the question of whether or not, under the relevant contractual arrangements, the underlying noteholder had an unfettered right to obtain definitive notes. If it does, then providing the chain of authority is complete, the Court in future cases (and given the reasoning in Cithara) may consider that the petitioner has the ability to issue winding up proceedings. This was what was found in Cithara, whereas in Re Shinsun the petitioner had failed to overcome the evidential hurdle on that specific issue. Relatedly, it is notable that the decision in Leading Hotels did not consider the specific Euroclear arrangements (unlike Cithara), suggesting that the Court was not addressed on this issue and/or that the petitioner in that case simply failed or was unable to provide the necessary evidence to demonstrate the link at every stage of the chain (as in Re Shinsun). However, it is important to bear in mind that even if the noteholder is able to obtain definitive notes (which in many instances will require the issuer's involvement, which may not be forthcoming in circumstances in which the noteholder is in default), there may be other restrictions on individual noteholders from taking action on a unilateral basis. The full contractual arrangements will therefore need to be considered carefully on a case by case basis.
Until there is appellate authority on the ability of underlying beneficial noteholders to petition for the winding up of an issuer, it is likely that we will see increased litigation in this area. Petitioners will rely on the (more recent) BVI decision in Cithara (and the English case law dealing with the concept of "contingent creditor" for the purposes of voting on schemes of arrangement), whereas issuers will rely on the recent Hong Kong and Cayman Islands authorities. However, there may be a (narrow) route through these competing authorities, as explained above.
An issue for the courts to grapple with moving forward is whether the decision of the UK Supreme Court in Re Nortel has overruled the decision in Re William Hockley Ltd.13 In the recent Cayman Islands and Hong Kong decisions the Court placed significant weight on Re William Hockley and found that to be a contingent creditor the petitioner must have an existing obligation from the company, whereas Mangatal J appeared to be of the view in Cithara that the decision in Re William Hockley is of questionable authority following the judgment in Re Nortel.
In the meantime, it will be important for individual noteholders considering enforcement action to consider carefully the terms of the relevant documentation alongside the insolvency laws in the jurisdiction in which the issuer is incorporated. As Mangatal J noted in Cithara, the issue of whether an individual noteholder has standing as a creditor under the BVI insolvency Act is "a mixed question of New York law and BVI law". Once the Court has determined the nature and extent of the parties' rights and obligations under the law applicable to the notes, it then has to determine whether this is sufficient to make the noteholder a creditor under the applicable legislation in the jurisdiction in which the issuer is incorporated. In Cithara, therefore, the Court had to look at "the interpretation of a BVI statute to determine whether Cithara falls within the set of persons on which the statute confers jurisdiction to wind up the Company".14 This will be the case regardless of which offshore jurisdiction the issuer is incorporated in, and so early and expert advice on the applicable insolvency laws will be crucial.
1. FSD 102 of 2022 (DDJ), 21 April 2023. Appleby acted as offshore counsel for the Company. Our earlier article on this case can be found at: Can An Ultimate Beneficial Holder Of Notes Present A Winding-Up Petition Against The Issuer?
2. Bio-Treat Technology Limited v Highbridge Asia Opportunities Master Fund LP  SC (Bda) 26 Civ (28 May 2009).
3.  HKCFI 455.
4.  HKCFI 1770.
5. Reflecting similar comments by the English Court of Appeal in Elektrim SA v Vivendi Holdings 1 Corp  EWCA Civ 1178 where Lawrence Collins LJ explained that "If an individual bondholder were free to pursue a claim based on a loss caused to the bondholders as a class, then either there was the potential for multiplicity of actions or for duplication of actions brought by the Trustee on the one hand and individual bondholders on the other".
6. Para 102.
7. Claim No. BVIHC(Com) 2022/0183.
8. The company has filed an appeal against the judgment, but its application for a stay of execution pending the appeal has recently been dismissed by the Court of Appeal of the Eastern Caribbean Supreme Court.
9.  UKSC 52.
10. Para 172.
11. Para 129.
12. See para 110.
13.  1 WLR 555.
14. Para 134.
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.