"NOTES HOLDERS" WITH INDIRECT BENEFICIAL INTEREST HAVE NO STANDING TO WIND UP ISSUER COMPANY

In Re Leading Holdings Group Limited [2023] HKCFI 1770, the Hong Kong Court has made it clear for the first time that, based on a construction of the contractual documentation, investors with an indirect participation in notes issued by a company have no standing to petition for winding up of the issuer, despite their obvious commercial interest in the credit of the issuer.

BACKGROUND

Leading Holdings Group Limited (the "Company"), a Hong Kong listed company, issued certain 12% Senior Notes (the "Notes").

The structure of the Notes, as summarised below, is very commonly seen in the bond market:

• The Company's books showed only one registered global note (representing the total of the issued Notes) and one registered holder of the global note (the "Note Holder"). The global note was delivered to the trustee, being the Bank of New York Mellon, London Branch ("BNYM") who also served as the common depositary.
• The global note was registered in the name of the nominee of the common depositary for the accounts of Euroclear and Clearstream and the Company would make payments due in respect of the global note to the common depositary, which would then distribute the relevant share of the payments made to the investors.
• End investors did not acquire the title of the global note or receive the physical copy of the note certificate. Instead, they purchased a portion of the indirect beneficial interest in the Notes through third-party banks and brokers who had accounts with Euroclear or Clearstream.

In the Petitioner's case, DBS Bank Ltd ("DBS") held the Petitioner's beneficial interest in the Notes via an Euroclear account, as a custodian.

When the Notes became due and the Company failed to make repayment, the Petitioner, as one of the end investors, sought to wind up the Company in Hong Kong (the "Petition").

It was not disputed that the Petitioner was the indirect owner of the Notes via DBS, and in turn, Euroclear and ultimately, the Note Holder. However, central to the dispute was the question of whether an investor with such indirect beneficial interest in the Notes through a book-entry system could petition for the winding up of the notes issuer.

The Petitioner argued that it had standing to issue a petition to wind up the Company for two reasons:

• First, the Petitioner as a beneficial/equitable holder/owner of the Notes was entitled to present a winding-up petition (the "Beneficial Owner Argument"); and
• Alternatively, the Petitioner claimed that it was a contingent creditor of the Company and could directly enforce its rights against the Company (the "Contingent Creditor Argument"). This argument was based on the Petitioner's entitlement to request for issuance of definitive notes to it in certain specified circumstances.

JUDGMENT

Having considered the relevant contractual documentation, statutory provisions, and the recent judgment handed down by the Grand Court of the Cayman Islands (Re Shinsun Holdings (Group) Co., Ltd (21 April 2023)), Deputy High Court Judge Suen SC of the Court of First Instance rejected both these arguments and held that the Petitioner did not have standing to present the Petition.

First, the Court rejected the Beneficial Owner Argument because:

• the Indenture by which the Notes were constituted expressly provided that only the Note Holder as the trustee of the Notes had direct right to enforce the Notes against the Company, and "holders" of book-entry interests only would not be considered as owners or holders of the Notes for any purpose;
• the regime operated on the basis of a "no look through" principle, such that the Petitioner only has rights against its own immediate counterparty (i.e. its custodian DBS) instead of the Company;
• if investors wished to sue the Company, they must act through the trustee as the exclusive enforcement channel, either by convincing the trustee to act or having likeminded Notes holders of at least 25% in aggregate principal amount of the outstanding Notes to make a written request to the trustee per the relevant contractual provision in the Notes to pursue a remedy (see, for example, the case in Bank of Communications Trustee Limited v China Energy Reserve and Chemicals Group Overseas Company Limited [2022] HKCFI 795). These arrangements were designed to prevent a multiplicity of actions (i.e. individual investors and trustees bringing multiple actions at the same time); and
• different from an equitable assignee of property, the beneficiary of a trust property had no standing to present a winding-up petition.

The Court also rejected the Contingent Creditor Argument and held that the Petitioner was not a contingent creditor because:

• to qualify as a company's contingent creditor, a person must have an existing legal relationship or obligation with the Company. However, in the present case, no contractual relationship existed between the Company and the Petitioner;
• unless and until the Petitioner obtained definitive notes in its name, it could not establish its standing as a creditor, either actual or contingent;
• before the Petitioner acquired directly enforceable rights, its economic interest was taken care of by the Note Holder or the trustee (i.e. BNYM in this case). This was consistent with the framework of the global note structure, which is premised on a class action to be pursued by the trustee exclusively. If the Petitioner could not sue the Company to enforce the debt, it would appear anomalous if the Petitioner could then sidestep such constraint by petitioning for winding up instead;
• there were also policy reasons to prevent floodgates and duplicity of actions; and
• authorities relating to schemes of arrangements (where beneficial owners of interests in similar notes were treated as contingent creditors) were of little relevance in a winding-up petition. The former concerned economic interest and voting rights; the latter was more draconian right.

The Court considered in detail Re Jinro (HK) International Ltd (No 2) [2003] 4 HKC 637 ("Jinro") in which Herbert Smith Freehills acted for the successful petitioner. Both cases relate to winding-up petition brought by an investor against an issuer company under the global note structure. However, in Jinro, the contractual documents expressly provided that if the definitive notes were not issued within a specified period of time, the global note would become void and individual account holders would acquire direct rights against the issuer company (and they therefore had standing to petition for the issuer company's winding up). In this case, no equivalent contractual provisions existed to give standing to the Petitioner.

In light of the above, the Court struck out the Petition for lack of standing.

KEY TAKEAWAYS

There is no universal structure in the bond or notes market. The terms of the bond documentation will be crucial to determining what rights a particular investor has, against whom and when the investor has acquired or accrued such rights.

In some cases, the terms of the bond documentation require the bondholder or the trustee to act against an issuer company in default at the behest of a certain percentage of the underlying investors acting together (for instance, the 25% threshold in Re Leading Holdings Group Ltd). In such cases, building a bloc of likeminded bondholders will be important.

For more information, please contact Gareth Thomas, Partner, Alexander Aitken, Partner, Jojo Fan, Partner, Peter Ng, Senior Associate, Jody Luk, Senior Associate, Marcus Wong, Senior Associate, or your usual Herbert Smith Freehills contact.