Keepwell deeds: A pathway for enforcement

Recently, a PRC court has recognised and enforced a Hong Kong default judgment relating to a breach of a keepwell deed, which was governed by English law.  This is a welcomed decision which should enhance the confidence of bondholders in relying on keepwell deeds as a form of credit enhancement.  However, as we will explain below, it is also important to recognise the context and limitations of the decision.

What is a keepwell deed?

Keepwell deeds are a common and popular form of credit enhancement used by PRC companies to facilitate the issuance of offshore bonds by their subsidiaries.  According to S&P Global Ratings, as at 2 September 2020, about 15% of the existing overseas bonds of Chinese-funded enterprises are accompanied by a keepwell deed, involving around USD$93 billion of bonds issued mostly between 2016 and 2017, and generally maturing in the coming 36 months.

Under a typical keepwell deed, the onshore parent company usually undertakes to ensure that its offshore subsidiary issuer remains solvent and has sufficient liquidity to pay the interest and principal of the bonds.  Keepwell deeds usually also contain a provision expressly stating that they do not constitute a guarantee.

The keepwell structure is often adopted as a device to handle the difficulties posed by PRC regulatory requirements on guarantee provided by PRC companies to offshore entities. As such, there are concerns that the keepwell structure would not be upheld in the PRC as a matter of public policy.  This concern was highlighted in the PUFG case.

PUFG case: Rejection of keepwell-backed claims in a PRC restructuring

In the Peking University Founder Group (PUFG) case, a Chinese bank made a petition to the Beijing court to reorganise PUFG.  The Court granted the petition and a bankruptcy administrator was appointed.  PUFG's creditors were then invited to submit their claims to the administrator.  A bondholder submitted its claim against PUFG based on a keepwell deed.  Under that keepwell deed, PUFG undertook that it would hold not less than 85% of a related company and would cause that company to hold all outstanding shares of the issuer of the bonds.  The keepwell deed was governed by English law.

The bondholder's claim under the keepwell deed was rejected by the bankruptcy administrator of PUFG, on the ground that the validity and effectiveness of keepwell arrangements have not been established in the PRC.  The administrator's decision has cast significant doubts concerning the validity and enforceability of keepwell agreements, at least under the PRC restructuring process.  

The bondholder could challenge the administrator's decision in the Beijing Court, but there are no public records of this to-date. We will be monitoring further developments with interest.  For more details about the PUFG case, please refer to our previous article.

CEFC case: Enforcing a Hong Kong default judgment relating to keepwell arrangement

More recently, on 23 November 2020, the Shanghai Financial Court recognised a default judgment issued by the Hong Kong High Court against CEFC, in relation to a claim alleging breach of a keepwell deed.  As far as we are aware, this is the first time that a PRC court has recognised a Hong Kong judgment relating to a keepwell arrangement.

In this case, CEFC (a PRC company) entered into a keepwell deed to support the issuance of offshore bonds by its subsidiary.  Specifically, CEFC undertook to the bondholders that it would ensure its subsidiary would remain solvent with sufficient liquidity to meet its payment obligations.  The keepwell deed also states that such undertaking does not constitute a guarantee, but CEFC would bear legal responsibility if CEFC fails to perform its obligations under the keepwell deed.  The keepwell deed in the CEFC case is governed by English law, and provides that Hong Kong courts have exclusive jurisdiction to adjudicate disputes.

The issuer defaulted and the bondholder filed a claim in Hong Kong against CEFC for breach of the keepwell deed.  The bondholder subsequently obtained a monetary default judgment in Hong Kong against CEFC.  As CEFC did not make payment, the bondholder then applied to the Shanghai Financial Court for recognition and enforcement of the Hong Kong default judgment, pursuant to the Arrangement on Reciprocal Recognition and Enforcement of Judgments between the PRC and Hong Kong (the Arrangement).

In trying to resist enforcement, CEFC contended that, as the keepwell deed was in reality a guarantee, it should be regulated by the relevant PRC authorities.  Giving effect to the Hong Kong default judgment would harm the social and public interest of the PRC, which is a ground for resisting recognition and enforcement under the Arrangement.  The Shanghai Financial Court rejected this argument.  The court held that the keepwell deed in question was not governed by PRC law, and thus the validity of the keepwell deed under PRC law was not a relevant consideration.  The Shanghai Financial Court decided to recognise the Hong Kong default judgment under the Arrangement. 

Observations

It appears that PRC courts have more leeway to recognise foreign judgments relating to the enforcement of keepwell deeds governed by a foreign law, as demonstrated by the CEFC decision.  However, where the PRC insolvency and restructuring regime is engaged, there still exists considerable uncertainties regarding the validity and enforceability of keepwell deeds in the PRC, as highlighted by the PUFG case.  Under PRC law, there is no precedent system, so it is not certain that future PRC court decisions will necessarily follow the reasoning of the CEFC decision.

To maximise the chances of enforcement, to the extent permitted by law, bondholders should ensure that the keepwell deed is governed by a foreign law, and provides for disputes to be adjudicated in a foreign jurisdiction.  

The following points are also pertinent:

• Firstly, not all judgments made by courts in foreign jurisdictions can be recognised and enforced in the PRC.  Only judgments made by courts in jurisdictions which have reciprocal arrangements or treaties with the PRC may be recognised by and enforced in the PRC.

• Secondly, if bondholders wish to submit disputes to the Hong Kong court, and enforce any judgment in their favour in the PRC, they must ensure that the requirements imposed by the Arrangement are complied with, including stipulating in the keepwell agreement that Hong Kong courts have exclusive jurisdiction to deal with any disputes.  Be aware also that only monetary judgments could be enforced under the Arrangement.  This means that if the Hong Kong court grants specific performance or injunctive relief, that could not be recognised and enforced in the PRC under the Arrangement.

(Note: The Arrangement will be superseded by a new arrangement for the reciprocal recognition and enforcement of judgments between Hong Kong and the PRC.  The new arrangement, which has not yet come into effect, will have a much wider scope of application.  For more information, please refer to our previous alert.)

• Thirdly, bondholders should check with their legal advisers to make sure that the obligations under the keepwell deeds are in fact legally enforceable under the chosen foreign governing law.  The CEFC case relates to the enforcement of a default judgment, which means the Hong Kong court did not actually determine the substantive merits of the case prior to granting judgment.  Applying contract law principles under Hong Kong, Singapore, and English law, the issues are likely to revolve around ascertaining the parties' intention to create binding legal relations, and whether the relevant provisions were drafted with sufficient certainty and precision to amount to legally enforceable obligations.

Taking heed of the above matters will improve a bondholder's chances of successful enforcement in respect of a keepwell deed issued by an onshore company.