What is a scheme of arrangement?
Schemes of arrangement are frequently used by companies to give effect to a debt restructuring. Importantly, a scheme is neither an insolvency nor a bankruptcy process, and are relatively low profile in terms of publicity.
A scheme of arrangement enables a company to agree with its creditors, or one or more classes of its creditors, a compromise in respect of its debts owed to those creditors. Significantly, a scheme of arrangement can be used to implement a restructuring where not all creditors agree to the compromise proposed.
A company in financial difficulties, with the assistance of its professional advisors (usually specialist lawyers and financial advisors) will put together a proposal to be presented to the company's creditors. The proposal will usually set out proposed terms for a compromise of the company's debts, such that the creditors are required to accept less than the amount they are owed, in full and final settlement of the debt obligation.
Frequently, it will be possible for the company to enter into a standstill arrangement with all or key creditors while negotiations take place, and generally, creditors are often willing to agree to a compromise, especially where they understand that the alternative may be an insolvency process.
Although the substantive terms of the restructuring proposal are negotiated between the company and key creditors, the procedure for approving the scheme of arrangement is substantially driven by the court.
The scheme of arrangement process:
In Hong Kong, a scheme of arrangement requires the following to occur in order to become legally binding:
(a) approval from the Hong Kong Court to convene a meeting of creditors to vote on the scheme (first court hearing);
(b) the calling of a meeting of the company's creditors (or classes of its creditors) in accordance with directions given by the Hong Kong Court;
(c) for the creditors to vote in favour of the scheme: at the meeting of creditors (or each meeting if there is more than one class of debt), a majority in number representing at least 75% in value of the creditors who vote must vote in favour of the scheme; and
(d) the approval of the Hong Kong Court by the making of an order sanctioning the scheme of arrangement, which will involve the Court considering whether the scheme is fair (second court hearing).
One of the key advantages to a scheme of arrangement is that it only requires the approval of 50% in number and 75% in value of the creditors who actually vote. Once approved by the court (at the second court hearing), a scheme of arrangement will bind all creditors, irrespective of whether they voted. As such a compromise can be effected without the consent of 100% of the creditors.
In order to have the scheme approved by the Hong Kong Court, the company is required to satisfy the Hong Kong Court that certain procedural steps have been met and that the scheme is fair. If creditors are to receive less than they are owed, the company will invariably need to demonstrate that the creditors will receive a better return under the scheme than in a liquidation scenario.
Who can use a Hong Kong scheme to restructure their debt?
Companies registered in Hong Kong can use the scheme of arrangement procedure in Hong Kong. However they are not the only type of company to which this process is available. The Hong Kong Court is able to approve schemes of arrangement if there is a 'sufficient connection' with Hong Kong. Therefore, the Hong Kong Court can approve (and has approved) schemes of arrangement in respect of foreign companies, such as those incorporated in Bermuda, the BVI or the Cayman islands, provided thay have a 'sufficient connection' with Hong Kong. Connecting factors may include a listing on the Hong Kong Stock Exchange ("HKEX"), creditors located in Hong Kong and/or all or part of the management of the company being based in Hong Kong.
Where a scheme of arrangement is in respect of a foreign company, and/or deals with foreign law governed debt, it is usual to seek recognition of the scheme in appropriate jurisdictions. Legal advice is need to determine where recognition should be obtained and what legal structure should be used for the debt restructuring to ensure necessary recognition is granted.
Case study of a scheme of arrangement: Winsway Enterprises Holdings Limited now known as E-Commodities Holdings Limited ("Winsway")
Winsway is one of China’s biggest coking-coal companies. Whilst it carries out its underlying business via its subsidiaries in the PRC, it is listed on the HKEX and is incorporated in the British Virgin Islands ("BVI").
Winsway issued US$500 million of New York law governed notes in 2011 ("Notes"), which matured in April 2016 when around US$350 million of debt (principal and interest) remained outstanding.
Due to the unfavourable market and industry environment, Winsway's business volume and margins significantly eroded, resulting in cash outflows and reduced liquidity. As a result the company faced liquidity challenges and needed to restructure its obligations to holders of the Notes.
Stephenson Harwood advised Winsway on the restructuring of its Note obligations. This involved determining a suitable legal structure to implement the restructuring, as well as advising throughout the process on the terms of the restructuring, the negotiations with the Noteholders, the entry into standstill arrangements and the entry into a restructuring support agreement by which key Noteholders promised to vote in favour of the scheme in return for a (relatively) small 'consent fee'. Under the restructuring, Noteholder claims were to be written off in exchange for cash, post-restructuring equity and contingent value rights, with the cash consideration being funded by a rights issue.
The restructuring was implemented through a scheme of arrangement in Hong Kong, supported by suitable processes in other jurisdictions, including a parallel scheme of arrangement in the BVI and recognition proceedings in the US.
The restructuring of Winsway's Note obligations via a scheme of arrangement enabled Winsway to use a process which was binding of all persons holding Notes, whether or not they supported the restructuring. As such, Winsway was able to resolve its financial difficulties and continue business without the burden of the debt due to Noteholders.
If you would like to discuss any of the points raised in this briefing or have any questions please contact Jamie Stranger.
The contents of this note do not constitute legal advice.