In Re Leading Holdings Group Limited [2023] HKCFI 1770, the Hong Kong Court for the first time decided on the issue of standing of an investor of a global note (‘Global Note’) who was not a registered holder to present a winding-up petition against the note issuer as a contingent creditor. In his comprehensive 66-page judgment handed down on 18 July 2023, DHCJ Suen SC dismissed the petition.

Before delving into the legal issues, it is important to note the legal structure of the Global Note which is commonplace for this type of debt securities:

1. The Global Note was constituted by an indenture (‘Indenture‘) between Leading Holdings Group Limited (‘Company‘) and the Bank of New York Mellon, London Branch (‘BNYM‘).
2. The Company, as the note issuer, has no contractual relationship with the ultimate beneficial investors of the Global Note (one of which is the petitioner (‘P‘)).
3. BNYM is the sole holder and trustee of the Global Note. As for P, it purchased a portion of the indirect beneficial interests in the Global Note via its intermediary, DBS Bank Ltd, which had accounts with Euroclear which maintained a book-entry system. Transfers of these indirect beneficial interests by the investors may only be effected through such book-entry system.
4. Section 6.06 of the Indenture is the so-called ‘No-Action Clause‘ which provides that the ultimate beneficial investors may not institute any proceeding unless they have, among other things, of at least 25% in aggregate principal amount of outstanding Global Note, made a written request to the trustee in pursuing the remedy. In other words, it is for the trustee to enforce these beneficial investors’ rights in the case of a default.

It is with the above intermediated structure in mind, and in particular, the absence of contractual relationship between P and the Company, that DHCJ Suen SC formulated the following two legal issues in light of parties’ submissions:

1. First, whether a beneficial owner of a debt has standing to present a winding-up petition?
2. Secondly, is P a ‘contingent creditor’ within its meaning in Section 179 of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32) who has standing to present a winding-up petition?

Beneficial Owner of a Debt

The proper approach is to decide whether there is a direct debt (or direct debtor-creditor relationship) between the Company and P in order for P to qualify as a creditor to have standing. In this regard, DHCJ Suen SC relied on Re Uruguay Central and Hygueritas Railway Co of Monte Video (1879) 11 ChD 372 (a case which also featured a bond structure resembling that of the Global Note) to say that (i) P and other beneficial investors do not have any independent right to sue (as opposed to a collective right to make a request to the trustee), (ii) P should not get a judgment in priority to other beneficial investors, and (iii) there should be no duplicity of actions by the trustee and the beneficial investors.

The general position, as noted by DHCJ Suen SC at [75] is that ‘the beneficiary of a trust property has no personal right to sue‘. Since trustees administer the trust fund as principals and not as agent for the beneficiaries, trustees are normally the proper plaintiffs (in this case, proper petitioner) in proceedings against third parties. Of course, there would be cases where the securities instrument expressly confer a direct right of enforcement on the trust beneficiaries, but this is not the case here, especially in light of the ‘No-Action Clause‘ mentioned above.

Contingent Creditor

Under certain specified events, P may be entitled to request the issuance of definitive notes whereupon P could directly enforce its claims against the Company. Thus, P argues in the alternative that it is a contingent creditor as the Company’s liability is contingent on the event of the issuance of definitive notes.

To begin with, the rationale to initially include contingent creditor in the winding-up regime is to address the potential lacuna and abuse whereby a company may be able to dispose of its assets or contract new liabilities even though the company is plainly insolvent upon taking into account not only its current but

also contingent liabilities. On such basis, a contingent creditor should be afforded standing to present a winding petition to protect its interests. Here, what is important is that a contingent creditor denotes ‘a person towards whom under an existing obligation, the company may become subject to present liability upon the happening of some future event. Such formulation requires an existing obligation, even though the liability to pay may only be triggered upon the happening of some future event‘ ([98]).

Citing a number of authorities and especially relying on the recent Cayman decision of Re Shinsun Holdings (Group) Co., Ltd FSD 192 of 2022 (DDJ) (unreported, 21 April 2023), DHCJ Suen SC posits that an existing obligation would provide a legal nexus between a person and a company, such that any liability which will or may arise in a future event under such nexus could be taken into account as contingent liability. Without the requirement of such legal nexus, the test would become unduly wide and far-fetched,

‘For instance, if a company is negotiating a loan with a bank and if there is no need for an existing obligation, it would be open to the bank to claim that it is a contingent creditor in the event of the bank agreeing to advance a loan and the company failing to repay, even though there is at present no legal nexus between the two. That simply cannot be right’ ([108]).

Coming back to our present case, it is P’s standing rather than the liability owed to it which is contingent, upon it succeeding in bringing itself into a direct contractual relationship with the Company (upon the issuance of definitive notes). However, this is not the test. The test is that P must prove, on a balance of probabilities, that it is a contingent creditor. And in doing so, it must show that there is an existing obligation owed by the Company to P which may result in a liability – P simply failed to do so.

Analysis

A number of policy considerations have come into play in this case. Notably, the Court recognised that the purpose of the Global Note regime is to ensure that the class of ultimate beneficial investors all act through the trustee (which is typical). If an individual beneficial investor was free to pursue a claim based on a loss caused to the investors as a class, then either there is the potential for multiplicity of actions (hence floodgate) or for duplication of actions brought by the trustee on one hand and individual beneficial investors on the other, not to mention the potential of double counting if both the debt owed to the investors and the same amount of debt owed to the trustee are to be taken into account in considering the solvency of a company.

By agreeing to the Indenture which includes the ‘No-Action Clause‘, the investors effectively waived their rights to bring claims by themselves, whilst enjoying the increased liquidity and ease of trading offered by the Global Note structure and the intermediation that comes with it. Before a Court of Appeal’s decision to the contrary, ‘one may say that P knowingly traded in interests, not in the underlying securities, and hence should be taken to know and accept the consequence of the global bond structure as a result‘ ([128]).

See the full judgment of Re Leading Holdings Group Limited here: legalref.judiciary.hk/lrs/common/search/search_result_detail_frame.jsp?DIS=153858&QS=%28%7Bleading+holdings%7D+%25parties%29&TP=JU

Our trainee solicitor Alan Sham assisted in preparing this article.

In preparation for the new dual licensing regime for virtual asset trading platform operators (“VATP Operators”) under the Securities and Futures Ordinance (Cap. 571) and the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615) which came into effect on 1 June 2023, the SFC published its Consultation Conclusions on the Proposed Regulatory Requirements for Virtual Asset Trading Platform Operators Licensed by the Securities and Futures Commission on 23 May 2023 in respect of the regulatory requirements applicable to VATP Operators.

Please see our article for more details.

On 30 June 2023, The Stock Exchange of Hong Kong Limited (the “Exchange“) published conclusions to its consultation on Proposals to Expand the Paperless Listing Regime and other Rule Amendments. The Exchange will adopt all the proposals outlined in the consultation paper with minor modifications. The key changes are outlined below:

(i). Reducing documents submission requirements and removing unnecessary signature or certification requirements

The changes include the removal of over 50 documents submission requirements, codification of obligations in various undertakings, confirmations and declarations into the Listing Rules and Guidance Materials, consolidation of submission requirements for personal particulars of directors / supervisors, and the inclusion of overarching obligations in Form A1 for new applicants and sponsors. The signature and certification requirements for certain submission documents have been removed.

(ii). Mandatory electronic only submission

The Exchange now mandates electronic means as the only mode of submission, unless otherwise specified in the Listing Rules or required by the Exchange.

The requirement for submission of multiple copies of certain documents in hard copy has been replaced with a requirement for submission of only one electronic copy.

The Exchange will explore with the Companies Registry the digitalisation of the prospectus authorisation and registration processes and will issue guidance to inform the market of the final arrangements.

(iii). Electronic dissemination of corporate communications by listed issuers

Listed issuers are obliged to disseminate corporate communications electronically to their securities holders if this is permitted by applicable laws and regulations and their constitutional documents, but shall provide hard copies upon holders’ request. If the issuers implement any new arrangements, they must send a one-time notification to their holders individually in hard copy or electronically to inform them of the new arrangements (before implementation) and solicit the email addresses of securities holders.

Listed issuers must send Actionable Corporate Communications, which are “any corporate communication that seeks instructions from issuer’s securities holders on how they wish to exercise their rights or make an election as the issuer’s securities holders” to securities holders individually, either in electronic form if functional electronic contact details have been provided, or in hard copy if not.

The securities holders are responsible for providing functional electronic contact details when solicited by the issuer. If the issuer has made reasonable efforts to contact the securities holders using the electronic contact details provided, the Exchange will consider the issuer to have complied with their requirements.

Implementation dates – minor and housekeeping amendments to the Listing Rules have already come into effect on 8 July 2023, while most of the amended Listing Rules will take effect on 31 December 2023.

Transitional arrangements for electronic dissemination – existing listed issuers and listing applicants need to review their constitutional documents for any provisions that might prevent electronic dissemination of corporate communications to their securities holders in compliance with the Listing Rules before the effective date.

If such provisions are present, issuers must amend their constitutional documents, provided that it is allowed by the applicable laws and regulations. Issuers have until their first Annual General Meeting (“AGM”) after 31 December 2023, to implement the necessary amendments. However, if the restriction is due to a requirement under applicable laws and regulations, they have until their first AGM following the removal of the relevant restriction to implement the necessary amendments.

Listing applicants that are to be listed on the Exchange on or 31 December 2023 must comply with the amended Listing Rules upon listing, as long as they are permitted under their applicable laws and regulations.

A brokerage firm (the “Firm”) has recently been reprimanded and fined $3.4 million by the Securities and Futures Commission (the “SFC“) for various regulatory breaches and internal control failures relating to segregation of client money and provision of statements of accounts to clients.

From May 2015 to August 2017, the Firm:-

(i). under-segregated client money amounting to HK$300 to HK$1.05 million by withdrawing client money held in its segregated client accounts to meet the settlement obligations of five clients when there were negative or insufficient account balances for each of the clients in the segregated client accounts to cover the settlement amounts, in violation of the Firm’s internal policies and the Securities and Futures (Client Money) Rules (the “Client Money Rules”);

(ii). delayed transferring client money from its house account to segregated client accounts, thus breaching section 4(4) of the Client Money Rules which requires client money to be paid into segregated client accounts within one business day of receipt;

(iii).  issued inaccurate statements of accounts to three clients, which the Firm explained was the result of the negligence or inadvertence of the officers who prepared those statements manually; and

(iv). failed to provide statements of accounts to several clients within the prescribed time limit under section 11(4)(b) of the Securities and Futures (Contract Notes, Statements of Account and Receipts) Rules (the “Contract Notes Rules”).

A failure to ensure that client money is protected adequately in accordance with the regulatory requirements is a serious matter. It can be seen from disciplinary actions, including the abovementioned case, relating to segregation of client money and provision of statements of accounts, that the SFC has made it a high priority to ensure that licensed corporations are complying with the Client Money Rules and the Contract Notes Rules. In this regard, it would be prudent for licensed corporations to perform regular reviews on the adequacy of controls to protect client money, identify any deficiencies and put in place measures to ensure full compliance.

Further to our recent news update on the Court of Final Appeal judgment in Re Guy Kwok-Hung Lam [2023] HKCFA 9 (“Guy Lam“), on 30 May 2023, in Re Simplicity & Vogue Retailing (HK) Co., Limited [2023] HKCFI 1443, the Court of First Instance considered the effect of Guy Lam in the context of arbitration clauses in winding up proceedings, and remarked that the ratio in Guy Lam only applies to exclusive jurisdiction clauses, but not to arbitration clauses.

In Re Simplicity & Vogue Retailing (HK) Co., Limited, the subject company acted as the guarantor to discharge obligations of an issuer of certain convertible bonds under a bond instrument. Upon the issuer’s default, the company failed to satisfy a statutory demand within time limit and a petition was presented to wind up the company. The decision by Linda Chan J concerned the application by the company to, among other things, file an affirmation in opposition to the petition out of time and adjourn the petition hearing.

The court held that, as the company failed to demonstrate any good reasons to justify the extension of time or the adjournment sought, there was no proper basis for the court to grant the company’s application, and accordingly, granted a winding-up order. In course of her decision, Linda Chan J also dealt with the grounds raised in the proposed affirmation in opposition, namely:

1. there was a bona fide dispute as to whether the guarantee had been discharged by reason of a variation of the principal contract between the petitioner and the issuer (Discharge Ground); and
2. there were arbitration clauses in both the bond instrument and in the guarantee such that the dispute should be referred to arbitration (Arbitration Ground).

In respect of the Discharge Ground, the court found that it was wholly without merit and consequently there was no proper basis to require the parties to refer the “dispute” to arbitration, even if the approach in Guy Lam were to be applied.

In respect of the Arbitration Ground, the court remarked that the ratio in Guy Lam (namely that in an ordinary case of an exclusive jurisdiction clause, absent countervailing factors such as the risk of insolvency affecting third parties and a dispute that borders on the frivolous or abuse of process, the petitioner and the debtor ought to be held to their contract) only applies to exclusive jurisdiction clauses, but not to arbitration clauses.  As far as arbitration clauses are concerned, the principles set out in the But Ka Chon v Interactive Brokers LLC [2019] 4 HKLRD 85 and Sit Kwong Lam v Petrolimex Singapore Pte Ltd [2019] 5 HKLRD 646 should be followed, namely whether or not there is a bona fide dispute on substantial ground, and in that context, the court will also consider whether the 3 requirements in Lasmos are satisfied. The Court does not read Guy Lam as laying down any general rule that if the agreement which gave rise to the petitioning debt contains an arbitration clause and there are no supporting creditors to the petition, the court must dismiss or stay the winding-up petition. To invariably refuse to consider the merit of the “defence” and require to parties to litigate their dispute in arbitration is to adopt a mechanistic approach and fetter the exercise of the court’s discretion. Absence any genuine “dispute” in respect of the debt, as in this case, there is no proper basis to require the parties to refer their “dispute” to arbitration.

It should be noted that the observations re Guy Lam are, strictly speaking, obiter, as the court has already concluded that there is no proper basis to grant the company’s application to adjourn the petition hearing and the Discharge Ground is without merit. Nevertheless, the arguments on Guy Lam were considered “in view of the importance of the point which arises in many cases coming to the Companies Court.” Given the state of flux in this area of law, it may be expected that more cases concerning the effectiveness of arbitration clauses in winding up proceedings will come to be decided by the courts. Until further deliberation by the appellate courts, it appears that a distinction is drawn in respect of the treatment of exclusive jurisdiction clauses and arbitration clauses in a bankruptcy / winding up context.

For further details, the full judgment can be found here.