Global note structures: can a bondholder directly wind up the company?

In the recent decision of Re Leading Holdings Group Limited [2023] HKCFI 1770, the Hong Kong Court of First Instance struck out the winding-up petition presented by an investor in a global note structure (the "Petitioner") on the basis that the Petitioner lacks the locus to present a winding-up petition against Leading Holdings Group Limited (the "Company").

We discuss below the key issues in the judgment of Re Leading Holdings, and the implications of this judgment on seeking to directly enforcing rights and presenting winding-up petitions against companies issuing debt securities with a global note structure.

Is the Petitioner a contingent or prospective creditor?

The Petitioner sought to wind-up the Company through Section 179 of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32), on the basis that it is a "contingent or prospective creditor" of the Company by holding book-entry interests of US$1.3 million notes (the "Notes") issued by the Company. The Notes were structured as a global note, where the registered holder (i.e. the nominee of the common depositary for the accounts of Euroclear and Clearstream) is the direct owner of the Notes, and the Petitioner purchased a portion of the indirect beneficial interest in the Notes through its intermediary. A key issue before the Court was whether or not the Petitioner as an indirect owner of the Notes has the locus to present the winding-up petition.

The Court held that the Petitioner has failed to demonstrate that it is a contingent creditor of the Company. In examining the definition of "contingent or prospective creditor", the Court acknowledged that there is no such definition in both Hong Kong and English statutes. In its ruling, the Court applied the decision of the Grand Court of the Cayman Islands in Re Shinsun Holdings (Group) Co, Ltd. FSD 192 of 2022 (DDJ) (21 April 2023) (unreported), and concluded that for a person to qualify as a contingent creditor: (1) there has to be an existing legal relationship or obligation between the person and the company (such that the person may qualify as a creditor); and (2) there is a liability that may become due in the future under such an existing relationship or obligation.

The Court found that the Petitioner failed to satisfy the first requirement as there is no legal relationship between the Company and the Petitioner. Unless and until the Petitioner obtains the definitive notes in its name, as it has no existing contractual relationship and obligation with the Company and no directly enforceable rights against the Company, it is not a creditor (actual or contingent) of the Company. As the Petitioner has no existing contractual relationship with the Company, including the right to commence the winding-up petition.

Framework of global note structure

In coming to its decision, the Court considered the framework of the global note structure, which is designed for the bondholders to act as a class and through the trustee as the "exclusive channel" of enforcement. Giving the Petitioner the right to bring a direct action against the Company will defeat the purpose of such design, and potentially lead to competition with other bondholders and duplicity of actions, if both the trustee and the bondholder can pursue winding-up relief simultaneously.

The Court also made a comment that the Petitioner's position is safeguarded under the global note structure and sufficient protection is offered to the bondholders regarding their economic interests. This is because the trustee can petition on behalf of the Petitioner as a contingent creditor (before the maturity of the note), or as an actual creditor (after the maturity of the note). The Petitioner can then petition as an actual creditor upon the issuance of definitive notes.

Deviation from Re China Cultural

The Court did not follow the decision in Re China Cultural City Limited [2020] 4 HKLRD 1, which held that an equitable assignee of a beneficial interest under a trust had standing to petition for winding-up without the need to join the trustee.

The Court considered the principles in Re China Cultural do not apply to the trust beneficiary, as distinguished from the equitable assignee, a trustee on behalf of all the beneficiaries can petition for winding-up alone. The need for joinder of the trustee in the winding-up proceeding has a substantive basis, as opposed to a mere procedural requirement in the case of an equitable assignee.

Contrasting view from the BVI Court

On 19 July 2023, the British Virgin Islands Commercial Court (the "BVI Court") delivered its decision in Cithara Global Multi-Strategy SPC v Haimen Zhongnan Investment Development (International) Co. Ltd. (BVIHC(COM) 2022/0183, 19 July 2023). The key issue was whether the petitioner in a similar position as that of Re Leading Holdings has standing for an application for the appointment of liquidators under BVI Insolvency Act.

Notably, the BVI Court in its ruling deviated from Re Shinsun and concluded that a direct contractual relationship between the contingent creditor and the debtor is not necessary. The debtor must take steps that may make it liable to a creditor subject to a contingency. The bond structure can be equated and is analogous to the steps taken by a debtor that make it liable to a creditor, subject to a contingency.

The BVI Court followed the UK Supreme Court decision in Re Nortel [2013] UKSC 52, which emphasizes that the modern trend is to give an expanded definition of contingent obligation and that contract is not the only basis upon which contingent obligations may arise. The petitioner was found to be a contingent creditor under the BVI Insolvency Act and therefore has standing for the applicable application in liquidation proceedings.

Observations

Before the present case, it was thought that the Court may apply the reasoning from scheme of arrangement cases, which regarded beneficial bondholders as "contingent creditors". The Court however differentiated the winding-up petition from the scheme of arrangement, as the latter only concerns voting right, but the locus to present a winding-up petition is a more "draconian right".

We have seen an increasing number of individual bondholders commencing winding-up petitions against the issuing company. For example, in the recent case of Re Jiayuan International Group Limited [2023] HKCFI 1254, the winding-up petition was first presented by a bondholder, as the company could not present a credible and realistic restructuring proposal.

This trend will likely persist, as the bondholders are concerned about the trustees' slow actions and the company's prolonged debt-restructuring process. Individual bondholders are therefore more prone to applying to Court for quicker debt recovery, or as a strategy to exert pressure on the company. Bondholders might often find it challenging to meet the threshold for the trustee's support level as the interests of the majority and minority may not necessarily align.

In light of the above, bondholders should ensure that the documentations record their intended rights and obligations, and that they are enforceable under the chosen governing law. Given the collective nature of winding-up proceedings, the bondholders will need to cooperate with each other to achieve the benefit of the class as a whole, through instructing the trustee as their "exclusive" enforcement channel.