01 August 2022
The Cayman Islands restructuring regime: A new dawn?
The Cayman Islands restructuring regime is poised to undergo a significant development that will allow companies to explore restructurings under the supervision of a Court-appointed company restructuring officer (CRO), rather than under a provisional liquidation proceeding which is the usual approach currently. The change is expected to make it easier for companies to obtain breathing room to explore a restructuring with the protection of a moratorium on claims compared to the current regime, and is designed to be more user-friendly than the current regime. Importantly, the current requirement for a winding up petition to be issued against the company to commence a provisional liquidation proceeding will not apply for the appointment of CROs, and companies themselves will be able to bring the application for CROs to be appointed.
The current regime
Under the current regime in the Cayman Islands, the only option for a company to obtain a moratorium on claims, and to benefit from what is often seen as necessary breathing room to explore a restructuring, is for a winding up petition to be issued against the company and for the company to be placed into provisional liquidation, with provisional liquidators (JPLs) appointed over the company on a light-touch basis with the mandate to explore a restructuring of the company’s liabilities.
The provisional liquidation regime is generally seen as effective and flexible, and is frequently used by companies seeking to pursue a restructuring in the Cayman Islands. It has, in particular, been effectively used by Cayman Islands companies facing winding up petitions in other jurisdictions, and there is a strong track record of JPLs appointed in the Cayman Islands being recognised in other key jurisdictions such as the UK, the US, and Hong Kong. Provisional liquidation can also be used to support a restructuring taking place in another jurisdiction, such as Chapter 11 proceedings in the US.
However, there are certain issues that companies in financial distress face with the provisional liquidation regime. The main difficulty under the current regime is that a winding up petition must be issued against the company in order for the company to then bring an application for JPLs to be appointed, in effect piggy- backing on the petition. However, directors of Cayman Islands companies are typically precluded from issuing a winding up petition against the company itself, unless they are expressly authorised to do so in the company’s articles of association, following the rule in Re Emmadart  Ch. 540 as applied in the Cayman Islands in China Shanshui [2015 (2) CILR 255]. If, as is usual, the company’s articles of association do not bestow such a power on the directors, then (absent a shareholder resolution, which may not be practical in the time available) only the company’s creditors, the shareholders, or the Cayman Islands Monetary Authority have standing to issue a winding up petition against the company.
Therefore, a company that wishes to explore a restructuring with the protection of a moratorium on claims is currently required to find a ‘friendly’ or ‘connected’ creditor to issue the winding up petition against the company. The company can then apply (ex parte, in the appropriate circumstances) for the appointment of JPLs on the grounds that the company is or is likely to become unable to pay its debts, and the company intends to present a compromise or arrangement to its creditors. JPLs appointed in this manner are usually appointed on a light-touch basis, with the directors retaining control of the company and its day-to-day operations, subject to the oversight and monitoring of the JPLs. It is also possible for JPLs to be appointed with ‘full powers’, supplanting the powers of the directors, for example if there are allegations that the directors have acted fraudulently or there are concerns that the company’s assets may be dissipated.
However, this approach can be difficult and cumbersome to apply in practice. It requires the cooperation of a friendly creditor from the outset, and runs the risk that other, unfriendly or less cooperative, creditors may seek to take control of the winding up process by substituting into the position of the petitioner. This can give the creditor that is substituted on the petition leverage over the company in negotiations, or even provide a platform for the creditor to seek to place the company into official liquidation if it is not prepared to agree to the restructuring terms on offer. Furthermore, the moratorium on claims only arises once the company has been placed into provisional liquidation, and not upon the filing of the winding up petition or the provisional liquidation application, which means that the company remains subject to other claims being filed in the meantime.
A case study: Luckin Coffee Inc
As one recent example of how the current regime operates, in the recent Luckin Coffee Inc case the company (a large scale coffee retailer incorporated in the Cayman Islands with operations in the PRC) faced a deluge of litigation in various jurisdictions, including the Cayman Islands and the USA, following an announcement in April 2020 that revenues of over USD 300 million had been fabricated in the company’s financial statements that had been published in the lead up to a USD 460 million convertible bond issue and IPO in January 2020. The claims included proceedings commenced by certain holders of the convertible bonds as well as investors who had purchased shares in the company.
In order to obtain a moratorium on claims and allow the company to explore a restructuring without simultaneously having actively to defend numerous claims across several jurisdictions, in July 2020 one of the directors of the company issued a winding up petition based on unpaid directorship fees of just US$13,000. The company issued an application for JPLs to be appointed on a light-touch basis with a restructuring mandate on the same day that the petition was filed The Cayman Islands Grand Court appointed JPLs over the company, with the result that the various legal proceedings against the company were stayed and the company was able to obtain some breathing room.
One of the holders of the convertible bonds was subsequently substituted in as the petitioner on the winding up petition in place of the director. This creditor was able to take control of the petition process while the restructuring negotiations were ongoing, and the hearing of the petition was adjourned on several occasions to allow the negotiations to progress.
Under the supervision and with the involvement of the JPLs, the company was ultimately able to conclude a successful restructuring with the holders of the convertible bonds through a scheme of arrangement sanctioned by the Cayman Islands Grand Court in December 2021 – 18 months after the JPLs had been appointed. The bondholders received a mixture of cash, new bonds, and shares in the company under the restructuring. As the bonds were governed by New York law, the restructuring was also given effect in the US through Chapter 15 proceedings which recognised the Cayman Islands scheme.
CROs: the new regime
The new regime will enable a company to seek the appointment of a CRO from the Court to allow the company breathing room to pursue a restructuring. The test for the appointment of a CRO will be substantially the same as for an application for the appointment of JPLs, namely that the company is or is likely to become unable to pay its debts and intends to present a compromise or arrangement to its creditors.
There are two key practical differences with the CRO regime compared to the JPLs regime. First, the company itself will be able to apply to Court for the appointment of a CRO, and a winding up petition does not need to be issued against the company. This removes the difficulty under the provisional liquidation regime of a company needing to find da friendly creditor to bring a winding up petition, or to obtain a shareholder resolution placing the company into liquidation. The new regime may also result in companies being increasingly open to exploring restructuring in the Cayman Islands due to the reputational issues and lack of control that can result from a company being placed into provisional liquidation. Indeed, the new regime seeks to distinguish between restructuring and liquidation.
Second, the moratorium on claims will arise from the point that the company applies for the CRO to be appointed. This will mean that the moratorium commences earlier than under the provisional liquidation regime whereby the moratorium only arises upon the appointment of the JPLs. The moratorium will prevent domestic or foreign proceedings being commenced or continued against the company, including winding up petitions, and no resolutions can be passed for the company to be wound up once the moratorium is in place. As with the moratorium that arises on the appointment of JPLs, as a matter of Cayman Islands law the moratorium has extra-territorial effect.
There will, however, be several similarities between the CRO regime and the JPLs regime. In particular, both regimes will require an application to Court, and both CROs and JPLs are appointed by the Court. As with restructurings in provisional liquidation, the Court will expect to see some elements of a restructuring plan at the time of the application, but the plan does not need to be overly detailed or developed. Rights of secured creditors will not be compromised by a CRO-led restructuring, which maintains the position that secured creditors of companies in either provisional or official liquidation can enforce their rights outside of the liquidation or restructuring process.
As with JPLs, CROs must be qualified insolvency practitioners, and at least one CRO must be resident in the Cayman Islands. Whilst it will remain a fact-specific determination as to the extent of the CRO’s powers in any one case, it is expected that the CRO’s role will typically be light-touch, with management continuing the day-to-day operations of the company and the CRO having an independent oversight role over the restructuring negotiations. The legislation introducing the CRO regime was passed by the Cayman Islands Parliament in December 2021. The legislation is not as yet in force, however, and is expected to become operational by mid-2022.
Anticipated effects of the CRO regime
As the process for appointing CROs may be more streamlined than provisional liquidation and can be commenced by a company itself, the introduction of the CRO regime is expected to lead to an increase in Court sanctioned restructurings. The regime can be used to restructure debt that is governed by either Cayman Islands law or foreign law, and may most commonly be used to restructure the debt of a Cayman Islands holding or finance company. Despite the introduction of the CRO regime, it will remain possible for JPLs to be appointed over companies on a restructuring basis. There is a long-standing practice of JPLs appointed by the Cayman Islands Grand Court successfully obtaining recognition in key jurisdictions such as the US, the UK, and Hong Kong, and for such jurisdictions to enforce the Cayman Islands restructuring (as occurred with the Luckin Coffee case described above). It is expected that such jurisdictions will recognise the appointment of CROs in a similar manner, and the legal and financial community will watch for the first appointment of a CRO with keen interest.
This article first appeared in Volume 19, Issue 4 of International Corporate Rescue and is reprinted with the permission of Chase Cambria Publishing.