The British Virgin Islands Court has reached a different conclusion to the courts of Bermuda, Cayman Islands and Hong Kong in holding that, in certain circumstances, ultimate beneficial bondholders have standing as contingent creditors to make applications for the appointment of liquidators to bond issuers, without the need to show a direct pre-existing contractual relationship with the issuer.
Haimen Zhongnan Investment Development (International) Co Ltd. (the Company) is a company incorporated in the British Virgin Islands that is part of a group of entities that has been in the business of property development in the People’s Republic of China for over 30 years. The group is ultimately held by Jiangsu Zhongnan Construction Group Co, Ltd. (the Parent). The Company itself is a financing vehicle of the Parent that issues and holds certain offshore notes and other indebtedness and debt instruments.
On June 9, 2021, the Company, as issuer, authorized the issuance of up to US$150,000,000 aggregate principal amount of 12 percent guaranteed senior notes due in 2022, pursuant to a New York law-governed indenture dated June 9, 2021, entered into between the Company, the Parent as guarantor and Citicorp International Limited (the trustee). The notes were issued subject to an offering memorandum dated June 3, 2021 (the Offering Memorandum).
The notes were to mature on June 8, 2022 (the maturity date), and interest was to be paid on the notes on Dec. 9, 2021, and June 8, 2022.
The notes were structured in a manner common to New York-governed note-issuances, as follows:
(1) Global Note: The Company was permitted to execute and deliver to the trustee one or more global notes. The global note was delivered to and registered in the name of the common depository (which was Citibank Europe PLC) or its nominee for the accounts of Euroclear and Clearstream. The nominee was Citivic Nominees Limited: Indenture, §2.4.3 This is the noteholder as defined: Indenture, §§1.1, 2.6.
(2) Participants: Participants that held accounts with Euroclear and/or Clearstream could buy and sell beneficial or economic interests in the notes in dematerialized form through their Euroclear and/or Clearstream accounts; these were reflected in book-entry registrations: Indenture, §2.6.
(3) Indirect Participants: An investor who was not a participant with an account in Euroclear or Clearstream could buy and sell interests in the notes through a participant that held the notes on its behalf: Indenture, §2.6; Offering Memorandum, §232.
Section 2.6 of the Indenture relevantly provided:
So long as the Notes are held in global form, the Common Depositary (or its nominee) will be considered the sole holder of the Global Notes for all purposes under this Indenture and “holders” of book-entry interests will not be considered the owners or “Holders” of Notes for any purpose. As such, participants must rely on the procedures of Euroclear and Clearstream and indirect participants must rely on the procedures of the participants through which they own book-entry interests in order to transfer their interests in the Notes or to exercise any rights of Holders under this Indenture….
The key term of the Euroclear Operating Procedures, which were referenced in §2.6 of the Indenture, was the following:
5.3.1.3 Services for securities in default
(a) We will not take any action, legal or otherwise, to enforce your rights against any issuer or any guarantor in respect of a security. We authorise you and/or the underlying beneficial owners of such securities to maintain proceedings against issuers, guarantors and any other parties. This is to the extent that we, our nominee, a Depository or their nominee acts as registered owner of any security held in the Euroclear System, or in any other relevant situation.
…
(c) Upon your request, we will issue a statement of account for the purpose of the filing of a claim.
Cithara Global Multi-Strategy SPC held the ultimate beneficial interest in the notes in the principal sum of US$7,000,000. It held its interest in the notes as an indirect participant through participants with book-entry interests registered in the Euroclear System.
Although the first interest payment, which fell due on Dec. 9, 2021, was paid, the Company failed to make payment of either the second interest payment or the principal on the maturity date. Those sums remained outstanding, and there was no dispute that the nonpayment constituted Events of Default under the Indenture.
On Aug. 19, 2022, Cithara served a statutory demand for payment of the outstanding debt on the Company. When the Company failed to comply with that demand (or apply to set it aside), Cithara issued an application for the appointment of liquidators to the Company on Oct. 10, 2022. For the purposes of the application, Euroclear had issued three statements of account to Cithara authorizing it to maintain proceedings against the issuer.
The Company nevertheless opposed the application on the basis that Cithara lacked sufficient standing as a “creditor” to make the application.
The Statutory Framework
Under section 162(1) of the Insolvency Act, 2003 (the Act), the court may appoint a liquidator of a company if the company is insolvent. Pursuant to section 8, a company is insolvent if:
(a) it fails to comply with the requirements of a statutory demand that has not been set aside (as was the case here); or
(b) either:
(i) the value of the company’s liabilities exceeds its assets (balance sheet insolvency); or
(ii) the company is unable to pay its debts as they fall due (cash flow insolvency).
An application for the appointment of liquidators may be made by a “creditor”; under section 9(1), a person is a creditor of another person (the debtor) if he or she has a claim against the debtor, whether by assignment or otherwise, that is, or would be, an admissible claim in the liquidation of the debtor company.
The meaning of “liability” is defined in section 10 as follows:
(1) For the purposes of this Act, “liability” means a liability to pay money or money’s worth including a liability under an enactment, a liability in contract, tort or bailment, a liability for a breach of trust and a liability arising out of an obligation to make restitution, and “liability” includes a debt.
(2) A liability may be present or future, certain or contingent, fixed or liquidated, sounding only in damages or capable of being ascertained by fixed rules or as a matter of opinion.
Admissible claims are the subject of section 11 and include liabilities of the company as of the date of the commencement of the liquidation, and those arising after the commencement of the liquidation by virtue of any obligation incurred before the commencement of the liquidation.
Was Cithara a Creditor?
The BVI court accepted that the issue of whether Cithara had standing as a creditor under the Act was a mixed question of New York law and BVI law.
The question of the nature and extent of the parties’ rights and obligations under New York law arising from the notes and the indenture was the first consideration. The second question was whether this was sufficient to make Cithara a creditor under the Act. That was a question of BVI law, since it would involve the interpretation of a BVI statute to determine whether Cithara fell within the class of persons on which the statute confers standing to wind up the Company.
The Position Under New York Law
Both parties adduced expert evidence of New York law. Ultimately, after applying New York rules of contractual construction (which are very similar to BVI principles), the court held that the plain and ordinary meaning of the words in §2.6 of the Indenture were clear in that the Euroclear Operating Procedures were incorporated by reference into the Indenture.
The court accepted that the decision of the New York court in Cortlandt St Recovery Corp v. TPG Capital Mgt LP was directly on point. That case had involved a very similar structure such as in the present case. The New York court held that as a result of Rule 5.3.1.3(a) of the Euroclear Operating Procedures, the beneficial holder was authorized to bring claims on behalf of the registered holders as soon as it became a beneficial owner.
The court also held that Cithara would be a contingent creditor of the Company under New York law, as the U.S. Bankruptcy Code defines “claim” to include a right to payment that is “contingent,” and under §2.4.5 of the Indenture, Cithara is a contingent creditor because it could receive the certificated note and become the registered holder itself.
The Position Under BVI Law
In resisting the application, the Company had relied heavily on a 2009 decision of the Supreme Court of Bermuda in Bio-Treat Technology Ltd v. Highbridge Asia Opportunities Master Fund, and a very recent decision of the Grand Court of the Cayman Islands in In the Matter of Shinsun Holdings (Group) Co Ltd., which had been delivered on April 21, 2023, after the BVI court had heard argument on the application but before it delivered judgment. In both cases, the Bermudan and Cayman courts had taken the view that a pre-existing direct contractual relationship between the contingent creditor and the debtor was required in order to establish standing. That view had been reached in reliance upon earlier English and Australian authorities that had suggested a narrower meaning of contingent liability.
However, the BVI court accepted that the U.K. Supreme Court’s decision in In re Nortel GmbH; Bloom v Pensions Regulator had overruled the earlier line of authority “without qualification.” In particular, the Supreme Court had held that the modern trend is to give an expanded definition of “contingent obligation.” In addition, the Supreme Court had held that direct contractual claims are not the only legal basis upon which a contingent obligation may arise.
The BVI court also considered that Bio-Treat and Shinsun were both distinguishable on the facts. It was not clear from either judgment whether the indenture under consideration in those cases contained a term such as §2.6 that incorporated by reference an equivalent to rule 5.3.1.3(a) of the Euroclear Operating Procedures.
The BVI court accordingly concluded that Bio-Treat and Shinsun should not be followed in the BVI. The court held that the broad definitions in the Act were more consistent with the wider approach to contingent obligations in Nortel, and that this being the case, Cithara would be treated as a contingent creditor.
Insolvency
Having found that Cithara had standing as a contingent creditor, the court accepted that the Company was plainly insolvent on the basis that it had failed to comply with the requirements of the statutory demand. It was also plainly insolvent on a cash-flow basis, having failed to make the required payments of principal and interest on the Maturity Date. The court also was satisfied that there was no real prospect of the Company being able to restructure its debt.
An order was therefore made appointing liquidators to the Company.
In the Matter of Leading Holdings Group Ltd.
Almost simultaneously with the delivery of the judgment of the BVI court, the Hong Kong Court of First Instance delivered its judgment in In the Matter of Leading Holdings Group, in which it struck out a petition for the winding up of an issuer made by the beneficial holder of notes, following the approach taken by the Cayman court in Shinsun.
Conclusion
The decision of the BVI court reaffirms its reputation as a progressive and creditor-friendly jurisdiction. However, it does not necessarily mean that an ultimate beneficial bondholder will have standing to apply to appoint liquidators to an issuer in every case. As this case demonstrates, the rights of the ultimate beneficial bondholder under the contractual documents will be of critical importance.
Nevertheless, the findings of the BVI court signal a divergence from the approach that has to date been taken by the courts of Bermuda, Cayman Islands and Hong Kong. As the Company has appealed against the decision of the BVI court, the issue is likely to be considered at an appellate level by the Eastern Caribbean Court of Appeal in the not-too-distant future.
Mourant Ozannes acts on behalf of Cithara and instructed Peter Burgess of South Square for the hearing.