Hong Kong Court differs from English Courts: related non-Scheme benefits do not fracture a class

In a recent judgment, Mr Justice Harris of the Hong Kong Court of First Instance ("CFI") provided his reasons for sanctioning two schemes of arrangement (the "Schemes") concerning property developer China Aoyuan Group Limited ("China Aoyuan") and its principal subsidiary ("Add Hero") under section 673 of the Companies Ordinance.  The CFI dismissed the objections raised by the opposing creditor, particularly those concerning class determination, maintaining that the English authorities they relied on were inconsistent with the position under Hong Kong law.   

Background

The purpose of the Schemes, which are part of the restructuring of China Aoyuan's offshore debt exceeding US$6 billion, is for each creditor to release China Aoyuan and its offshore subsidiaries from their liabilities in consideration for proportionate entitlements in a set of new (or transferred) securities issued by China Aoyuan.

China Aoyuan and Add Hero have parallel and inter-conditional schemes in the Cayman Islands and the British Virgin Islands, where the companies are incorporated (the centre of main interest, however, was found to be in Hong Kong).  These schemes have already been sanctioned by the courts in both jurisdictions.

Discussion

The principles for sanctioning a scheme are well-established and were recently reaffirmed in Re Sunac China Holdings Ltd [2023] HKCFI 2850.  One key factor is whether the necessary statutory majorities have been obtained.  Section 674 of the Companies Ordinance provides that creditors, or class of creditors, of a company are taken to have agreed to a scheme of arrangement if a majority representing at least 75% in value of the class of creditors present and voting agree to the scheme.  In this case, while the required statutory majorities were obtained, the issue was whether the class of creditors had been properly constituted when the statutory majorities were obtained.  This issue arose as a proportion of Scheme creditors of China Aoyuan had the benefit of guarantees granted by Add Hero, allowing them to vote in both Schemes based on the full value of their claims and receive consideration in both Schemes.

The opposing creditor contended that, in the context of inter-conditional schemes, the creditors' rights under both Schemes as a whole need to be considered when determining the proper constitution of the class, citing English authorities including Re The Baltic Exchange Limited, Re Sunbird Business Services Limited and Re Codere Finance 2 (UK) Limited.  Their view was that the Court should not take a narrow approach and look at the Schemes in isolation.  Instead, any additional rights not derived from the scheme being the subject of sanction, but from another contractual arrangement (in this case, a separate but inter-conditional scheme), should also be taken into account. 

The CFI dismissed the opposing creditor's argument, stating that the English authorities are inconsistent with the principles established by the Hong Kong Court of Final Appeal in Re UDL Argos Engineering & Heavy Industries (2001) 4 HKCFAR 358.  In Re UDL, Lord Millet stated that the test for determining class composition is based on similarity or dissimilarity of legal rights compromised or granted by that scheme.  He emphasized the need to consider "whether the rights which are to be released or varied under the Scheme or the new rights which the Scheme gives in their place are so different that the Scheme must be treated as a compromise or arrangement with more than one class".  The CFI held that the language indicates that only the rights compromised or granted by the subject scheme are relevant to the question of class composition.  Any rights and interests altered outside the subject scheme, even if they form part of the broader restructuring, should therefore not be considered.  The CFI clarified that these rights and interests would only be considered at the discretionary stage, when the Court assesses whether the results of the meeting fairly reflect the view of the creditors, taking into account the "special interest" deriving outside of the subject scheme.

The CFI agreed that the overlapping creditors had a special interest by reason of their ability to vote and receive consideration in both sets of Schemes. However, there was no evidence that the additional benefits obtained from the approval of Add Hero's Scheme were, or were likely to have been, a material reason for the overlapping creditors to vote for China Aoyuan's Scheme.  Consequently, the CFI did not exercise its discretion to refuse sanction of China Aoyuan's Scheme.

Separately, the opposing creditor argued that the explanatory statement contained material mistakes or lacked sufficient information.  As a result, one of China Aoyuan's liquidators and an expert presented by the opposing creditor were cross-examined, which Harris J noted was the first time this has happened in a Hong Kong scheme.  The CFI demonstrated that it would not scrutinise every detail of the explanatory statement, provided it offers enough information for creditors to evaluate the scheme, bearing in mind it must be understandable to the average creditor.

Comments

Judges in the referenced English cases have adopted a broader interpretation of the principles set out in Re UDL, viewing "legal rights" as encompassing those that are conditional upon the implementation of the scheme, even if not strictly within the terms of the scheme itself.  The CFI, however, maintains that they must first be incorporated into the scheme to be taken into account on the question of class composition under Hong Kong law. Whilst those additional benefits would not fracture a class, they may still be relevant in exercising the Court's discretion if they constitute "special interest".

The sanctioning of the China Aoyuan scheme will likely have significance for the restructuring of other Mainland property developers appearing before the Hong Kong Courts in due course, and we await to see how the case law in this area develops.

For more information, please contact Jojo Fan, Managing Partner, Rachael Shek, Partner, Truman Mak, Partner, Jody Luk, Senior Associate, Sara Troughton, Professional Support Lawyer or your usual Herbert Smith Freehills contact.