The vast majority of corporate debt issuances are made pursuant to a trustee structure. This approach affords investors the advantage of uniformity of treatment and facilitates collective action, as opposed to the alternative 'fiscal agency' or direct issuance structure. But what happens when an individual investor in a global note structure seeks to take direct enforcement action against an issuer?
The standing of an investor in a global note structure to petition for the winding-up of an issuer is a hot topic in international debt capital markets circles.
In the past six months, conflicting decisions have been handed down by the courts of Hong Kong,1 the Cayman Islands2 and the British Virgin Islands3 on the question of the standing (or locus standi) of a beneficial holder of a global note to present a winding-up petition against an issuer as a contingent creditor.
This is a rapidly developing area of law. As of today’s date, the position in Hong Kong and the Cayman Islands is that a beneficial holder of a note (who, typically through an intermediary, holds a book-entry interest in a global note through a clearing system) does not have standing as a contingent creditor to petition for the winding-up of the issuer. However, in the very recent decision In the Matter of Haimen Zhongnan Investment Development (International) Co. Ltd, the Eastern Caribbean Supreme Court took a different approach, ruling that the ultimate beneficial owner in a global note structure is entitled to enforce a claim against the issuer and can therefore be considered a contingent creditor of the issuer.
In a global note structure, the Trustee is the primary conduit through which enforcement action may be taken against an issuer. This promotes uniformity of treatment amongst holders. Although individual holders are prevented from acting unilaterally, this approach ensures that any moneys recovered from a defaulting issuer are distributed to all holders in accordance with a pre-defined waterfall (and on a pro rata basis), thereby avoiding the risk that some holders recover, and others do not. A global note trustee structure also facilitates the granting of a security interest over bond collateral, preserving the ability of holders to transfer their notes without having to re-execute security documents for the benefit of incoming transferees.
"A hallmark of a global note structure with a trustee is the concept of collective class action through which enforcement may only be pursued by the trustee, on behalf of all holders. Recognition of an individual beneficial holder as a 'creditor' brings with it the risk of duplicity of actions, 'double-counting' of creditor votes in restructuring arrangements, and other potential abuses. It also raises questions regarding the standing of individual holders for actions outside the context of winding-up petitions."
In a typical corporate debt issuance, a global note is delivered to and registered in the name of a common depositary, which holds the global note on behalf of a clearing system such as Euroclear in Brussels, Clearstream in Luxembourg or The Depository Trust Company in the United States, each of which in turn operates accounts on behalf of their accountholder participants. Those participants may be large financial institutions who in turn hold the investments on behalf of the ultimate beneficial owners. Clearing system participants have a 'book-entry' interest in the notes in their accounts with the clearing system. Beneficial holders, on whose behalf the clearing system participants hold, have a contractual interest in the notes through their arrangements with the clearing system participants. The terms of the global note provide that the issuer will pay the registered holder (i.e., the common depositary or its nominee) the principal and interest due from time to time. The registered holder acts on behalf of the clearing system which will take steps to ensure that the principal and interest is passed on to its accountholder participants who in turn will pass such payments on to the ultimate beneficial owners pursuant to their prevailing contractual arrangements.
An example of a conventional global note structure is set out in the adjacent diagram.
The Hong Kong court has described the global note structure as a "seamless regime". It is estimated that approximately 95% of US issuers and 90% of UK issuers, respectively, use a corporate trustee structure.4
The Decision in Leading Holdings
In 2021, Leading Holdings Group Limited (the "Issuer") issued 12% senior notes due 2022 (the "Notes") under a New York law-governed indenture (the "Indenture"). The notes were certificated in the form of a global note, which was held by a common depositary for Euroclear and Clearstream. The Petitioner was a beneficial holder who had invested in the notes through an intermediary bank as a clearing system participant with a Euroclear account.
The Issuer failed to make payment of an interest amount due under the Notes. The Petitioner (which held in excess of 25% of the outstanding aggregate principal amount of the Notes) instructed the Trustee to accelerate the Notes.
The Trustee accelerated the Notes, and the Issuer failed to pay. The Petitioner, in its own name, subsequently commenced winding-up proceedings against the Issuer. The Petitioner chose to proceed in its individual capacity, notwithstanding the terms of the "no action" clause in the Indenture.5
The Issuer opposed the winding-up proceedings, on the basis that the Petitioner did not have the requisite standing as a creditor to present the winding-up Petition.
Deputy High Court Judge Suen SC agreed with the Issuer and struck out the Petition. Crucially, the judge concluded that only the common depositary (or its nominee) would be considered a 'Holder' of the Notes while they remained in global form and only such Holder has standing to take enforcement action in connection with the Notes against the Issuer. The decision was consistent with Linda Chan J's earlier ruling in In the matter of China Oceanwide Group Limited,6 where the Court held that a beneficial holder was not a 'capital-H' holder of notes in global form and was not entitled to commence proceedings for the winding-up of an issuer.
The High Court's ruling endorsed the "no look through" principle applied by the English Court of Appeal in Secure Capital SA v. Credit Suisse AG,7 with the judge concluding that there was no contractual relationship between the Petitioner (the beneficial owner) and the Issuer.
The Petitioner further contended that it was a contingent creditor because under certain specified events, the Petitioner would be entitled to request the issuance of definitive/certificated notes, once in possession of which the Petitioner could directly enforce its claims against the Issuer.
The Court did not agree that the Petitioner was a contingent creditor, holding that "there has to be an existing legal relationship or obligation" between a person and a company before such person may qualify as a creditor of the company.
In this respect, the judge adopted the same reasoning as the Cayman Islands Court in the Shinsun Holdings matter, where it was held that:
"The Petitioner appears to have fundamentally misunderstood the legal position in respect of its investment and the terms of the indenture".8
"The Petitioner has not received the Certificated Notes and does not appear to have taken any proper steps to obtain them and to obtain legal standing. I agree with the Company that unless or until the Petitioner obtains Certificated Notes in its name it cannot establish it is a creditor, either actual or contingent…It is insufficient in law to have "contingent standing" in respect of winding up petitions in this context".9
The Hong Kong Court was not persuaded by the Petitioner's argument that English authorities in connection with schemes of arrangement (where it has been held that beneficial owners of notes are entitled to vote on schemes in their capacity as contingent creditors) should be adopted by analogy to permit an underlying noteholder to petition for the winding-up of an issuer. The judge distinguished these authorities on the basis that they were "different", suggesting that the right to vote or to exercise a vote on a scheme of arrangement was a less "draconian right" than the right to petition for the winding-up of a company.10 In doing so, the Court aligned itself with the decision in Shinsun Holdings, where the Court ruled that the "commercially pragmatic judicial decisions at first instance on voting rights and schemes" need to be "treated with caution and confined to their context".11
It is unfortunate that neither decision properly articulates the legal distinction drawn between lacking standing to pursue a winding-up petition on the one hand, and having standing to vote in a scheme of arrangement, on the other. The jurisdictional basis for sanctioning schemes of arrangements is that creditors, in the requisite majorities in their respective classes, have voted to approve the scheme. It is not a question of commercial pragmatism, but rather one of legal precision and certainty.
The Decision in Haimen Zhongnan Investment Development (International) Co., Ltd
In July 2023, after the decisions of the Cayman Islands and Hong Kong Courts in Shinsun Holdings and Leading Holdings had been handed down, the Eastern Caribbean Supreme Court released its ruling in the matter of Haimen Zhongnan Investment Development (International) Co., Ltd.
Departing from the precedent set in Shinsun and Leading Holdings, the BVI Court, also with the benefit of expert evidence as to New York law, determined that an underlying holder of a global note does, in fact, have standing, as a matter of BVI law, to petition for the winding-up of a BVI issuer.
In reaching her conclusions, Justice Mangatel determined that:
- The "no look through" principle espoused in Secure Capital SA v. Credit Suisse AG was not applicable, and was only relevant in the context of direct contractual claims.12
- The English decision in Nortel GmbH; Bloom v. Pensions Regulator,13 as applied in Bermuda in Bio-Treat Technology Ltd v. Highbridge Asia Opportunities Master Fund14, had been wrongly decided, in that it improperly narrowed the concept of a 'contingent creditor' and conflated the concepts of a prospective creditor and a contingent creditor.
- The precedent set by Bio-Treat and Shinsun Holdings, in Bermuda and the Cayman Islands, respectively, should not be followed in the BVI.15
The consequence of the BVI Court's decision in Haimen Zhongnan is that, as things stand today, an underlying holder is entitled to petition for the winding-up of a BVI issuer. That stands at odds with the position in Hong Kong and in the Cayman Islands. It may also complicate the process of having a BVI Court-appointed liquidator recognised in Hong Kong.
The Haiman Zhongnan ruling has been appealed.
Takeaway for Noteholders and Corporate Trustees
The Hong Kong and Cayman Islands courts have made clear that it is only the legal holder of notes which has the requisite standing to petition for the winding-up of a defaulted issuer.
Shinsun and Leading Holdings provide comfort that long-established principles promoting fair treatment across all holders of the same series will be upheld through coordinated action by the trustee on behalf of holders. Haiman Zhongnan calls this into question in the British Virgin Islands, and (until the appeal has been decided) trustees should be mindful of the jurisdictional divergence.
As such, the safest option for holders remains to take enforcement action by instructing the trustee via the pre-established mechanism set out in the indenture. However, depending on the jurisdiction of incorporation of the issuer (and depending on whether Haiman Zhongnan is upheld on appeal), it may, in certain jurisdictions, be possible for holders to take direct action as a creditor.
1 In the matter of Leading Holdings Group Limited  HKCFI 1770 (18 July 2023).
2 In the matter of Shinsun Holdings (Group) Co., Ltd (FSD 192 of 2022) (21 April 2023). The Shinsun opinion also explored other aspects of the ultimate relationship between a beneficial owner, the clearing systems and the issuer, several of which appear to contravene well-established practices in the international debt capital markets. However, many of these observations were in the form of judicial commentary / obiter dicta not relevant to the contingent creditor question, and therefore beyond the scope of this client alert.
3 In the matter of Haimen Zhongnan Investment Development (International) Co., Ltd (BVIHC (Com) 2022/0183).
4 According to the International Capital Market Association, as disclosed in its working paper "International Practices of Bond Trustee Arrangements" tabled at the 9th UK-China Economic and Financial Dialogue.
5 A "no action" clause provides that no one besides the registered holder of the bond may bring an action against the issuing company, and that bondholders cannot proceed directly against the issuer unless the trustee fails to take action in accordance with the bond documentation.
6  HKCFI 455.
7  EWCA Civ 1486.
8 At .
9 At .
10 At .
11 At .
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13  1 WLR 953.
14  Bda LR 29.
15 At .