Introduction

A viable company might suddenly find itself in a midst of a tough financial condition due to the external unfavourable economic environment or the internal commercial misjudgement.   In today’s fast changing economic environment, this has become more and more common. This article explains how a company facing such a situation could salvage as much value as possible by way of a creditors’ scheme of arrangement (the “Scheme”).   

What is a Scheme?

A Scheme is a statutory compromise or arrangement between a company and its creditors (the “Scheme Creditors”), which becomes binding upon passing by the requisite majority of the Scheme Creditors followed by a sanction of the Court.  As such, a valid Scheme would provide a favourable outcome to the distressed company where the creditors are bound to accept less than the amount they are owed, in full and final settlement of the debt obligation of the company.

A Scheme consists of 3 main stages - Firstly, an application must be made to the Court for an order to call meetings of the respective classes of creditors. Secondly, the Scheme must be approved by a majority in number representing 75% in value of the Scheme Creditors present and voting at their respective meetings. Thirdly, the Court will consider whether the Scheme is fair and subsequently makes an order approving the terms of the Scheme.  We shall illustrate this process by reference to the recent case of Shanell Ltd [2016] HKEC 2214; [2017] HKEC 558 (“Shanell”).

Shanell Ltd

Background

Shanell Limited (the “Company”) is a private company incorporated in Hong Kong. The Company had substantial turnover of over HK$2.3billion as at 31 December 2014. Its shareholders used to be Mr. Chiu (85%), Mrs. Chiu (10%) and Mr. Ng (5%) (collectively the “Shareholders"). In May 2016, Huang Guo-Bin (the “Investor") acquired 51% of the Company's issued share capital from Mr. Chiu in consideration of HK$6 million, thus becoming the majority shareholder of the Company.

The Company started to experience liquidity problem at the end of 2015 due to the unfavourable movements of exchange rates of RMB and other currencies.  It then became heavily insolvent in around April 2016, and had 24 creditors which were all banking institutions (the “Financial Creditors"). The estimated total debt was HK$703.6 million, part of which was personally guaranteed by the Shareholders. Instead of initiating winding up proceedings, the Financial Creditors requested the Company to engage financial advisors to make a debt restructuring proposal.  As such, the Company, together with its advisors, came up the following scheme.

Principal Terms of the Scheme

Under the Scheme, a special purpose vehicle (the “Scheme Co") was set up, which was solely liable for the admitted claims of the Financial Creditors against the Company.  Selected assets of the Company would be assigned to the Scheme Co and realised, and the Financial Creditors would be paid pro rata from the proceeds of the realised assets.  All enforcement actions against the Company or its property would be withdrawn by the Financial Creditors and no Financial Creditors would sue the Company.  For the Financial Creditors who also held personal guarantees against the Shareholders, they would enjoy pro rata distribution out of the share consideration of HK$6 million from the Investor, as well as other assets of the Shareholders including sale proceeds of a flat to be assigned by Mr. and Mrs. Chiu to the Scheme Co.

Stage 1 - Application to convene creditors’ meeting

On 7 June 2016, the Company took out an application to seek an order from the Court to call creditors’ meeting.  In considering whether the Company had properly constituted the class of creditors, the legal principles could be found at the Court of Final Appeal decision of UDL Argos Engineering & Heavy Industries Co Ltd & Others v Li Oi Lin & Others (2001) 4 HKCFAR 358, in which it was held that the test is based on the similarity or dissimilarity of legal rights against the company so that creditors of the same class may sensibly consult together with a view to their common interest.  Au-Yeung J was satisfied that all the Financial Creditors have similar rights so they can consult together with a view to their common interest.  Accordingly, she granted an order for the Company to hold the meeting with the Financial Creditors.

Stage 2 - Creditors’ support

Legally, a Scheme must be approved by a majority in number representing 75% in value of the Scheme Creditors present and voting at their respective meetings in order to be “eligible” for the sanctioning by the Court.  In Shanell, the Scheme was approved by all the Financial Creditors and thus there was no issue on this stage.

Stage 3 - Court’s discretion

After the Scheme is passed by the requisite majority, the Court has the ultimate discretion to sanction the Scheme, thereby making the Scheme binding between the company and the Scheme Creditors.  This sanction hearing is not a rubber stamp.  As Au-Yeung J has pointed out in her judgement, Judge Harris in Re Wheelock Properties Ltd [2010] 4 HKLRD 587 have stated that the Court would have to be satisfied that the Scheme is one that “an intelligent and honest man acting in respect of his interests as a member of the class within which he voted, might reasonably approve”.  Taking into account the fact that the Financial Creditors were all sophisticated banking institutions and they voted unanimously towards the Scheme, on 17 March 2017, Au-Yeung J gave the green light for the Company to carry out the Scheme with the assistance of the scheme administrators.

Caution and consideration

The result of a Scheme is appealing - in Shanell, it avoided the liquidation of the Company, and at the same time, the Scheme Creditors would have an improved recovery as compared to the liquidation of the Company.  However, the Scheme can be time-consuming (in Shanell, the court procedure alone lasts for at least 9 months) and costly, as the process is substantially monitored by the Court with the input of financial and legal professionals.  Another consideration is that even though efforts are made with the hope to rescue the distressed company from insolvency, the Scheme offers no moratorium to protect the company against its creditors.   

Conclusion

The use of a Scheme to save a distressed company is no longer something new in Hong Kong.   In the absence of a formal corporate rescue regime in Hong Kong, it appears to be the only available tool to rescue a company where the management wants to preserve the company as a going concern. The process could be somewhat time-consuming and complicated, when it involves the formulation of scheme terms and seeking sufficient support from the discontent creditors.  However, the decision can go a long way to deciding what a struggling company’s eventual fate will be.

For enquiries, please contact our Litigation & Dispute Resolution Department:

E: insolvency@onc.hk                                   T: (852) 2810 1212 W: www.onc.hk                                             F: (852) 2804 6311 19th Floor, Three Exchange Square, 8 Connaught Place, Central, Hong Kong

Important: The law and procedure on this subject are very specialised and complicated. This article is just a very general outline for reference and cannot be relied upon as legal advice in any individual case. If any advice or assistance is needed, please contact our solicitors.

Published by ONC Lawyers © 2017