Global capital markets and distress investors are responsible for major developments in restructuring across jurisdictions. Frequently, bond debt issued by the holding company of a foreign enterprise and guaranteed by its offshore operating subsidiaries is subject to New York law. If the issuer or guarantors become distressed, the issuer or guarantors often look to restructure in a common law jurisdiction that has schemes of arrangement. Assuming such distressed enterprise can go to a “scheme jurisdiction,” it will attempt a restructuring offshore and then bring the “sanctioned” or approved scheme to the United States for recognition and enforcement under Chapter 15 of the Bankruptcy Code. Most commentators believe that with sufficient process and procedures, a scheme that has features that are permissible under the scheme jurisdiction—but not acceptable under Chapter 11—can be recognized and enforced under Chapter 15 of the Bankruptcy Code.

Although Chapter 11 may be a viable alternative, the perception of schemes as a less costly, less litigious, and more business-determined course of action has attracted bondholders to schemes of arrangement. This phenomenon is notable in the United Kingdom, Hong Kong, Singapore, Australia, and certain island jurisdictions, most of which share a common law heritage and common core concepts, including the ability to effect broad third-party releases. Generally schemes of arrangement have two court-oriented proceedings: (1) the request for “leave” (i.e., permission) to convene a meeting of creditors to vote upon the proposed scheme, which assesses the adequacy of disclosure, jurisdiction and the propriety of creditor classification for the proposed scheme; and (2) the “sanctioning” (i.e., approval) hearing for the scheme after obtaining the requisite creditor votes, which is generally 75% of each class affected by the scheme when measured by value and 50% of the total number of creditors.

In an April 30, 2019 decision authored by Chief Justice of Singapore Sundaresh Menon, Pathfinder Strategic Credit LP v. Empire Capital Resource Pte Ltd [2019] SGCA 29 (Pathfinder), the Singapore Court of Appeal set aside leave granted under §210(1) of the Companies Act for a company to convene a creditors' meeting to consider a proposed scheme of arrangement on the basis that the company had failed to provide the minimal level of financial disclosure reasonably necessary to satisfy the court that fair conduct of the meeting was possible. Chief Justice Menon relied upon precedent from multiple jurisdictions, focusing on the procedural and substantive issues that need to be adequately addressed as a predicate for subsequent international recognition. He agreed with Lord Snowden's ruling in an English High Court of Justice case that “[t]he scheme jurisdiction can only work properly and command respect internationally if parties invoking the jurisdiction exhibit the utmost candour with the court.” Re Indah Kiat International Finance Company BV [2016] EWHC 246 (Ch) (Indah Kiat); [2016] B.C.C. 418, at [40]. In Pathfinder, Chief Justice Menon further reasoned that the “court is not concerned with the merits of the proposed scheme, but rather with the fairness of the context in which the scheme is to be presented to the creditors.” Interestingly, the predecessor to the debtor, Berau Capital, was previously subject to a scheme that was sanctioned in Singapore and subsequently recognized by the U.S. Bankruptcy Court for the Southern District of New York. The bankruptcy court determined that the choice of New York law to govern the debt subject to the scheme was sufficient to establish jurisdiction and grant recognition and enforcement under Chapter 15. See In re Berau Capital Res. Pte Ltd, 540 B.R. 80 (Bankr. S.D.N.Y. 2015).

Background

Corporate Structure. Empire Capital Resources (Empire) was an investment holding company incorporated in Singapore. Empire was a member of the Berau Group, one of the world's largest coal producers based in Indonesia. The Berau Group was also comprised of other entities, including (1) Berau Coal Energy (BCE), the holding company incorporated in Indonesia; (2) Berau Coal, the operating subsidiary incorporated in Indonesia; and (3) Berau Capital Resources (BCR), a Singapore corporation established for the purpose of raising debt for the benefit of BCE.

The 2015 Notes and the 2017 Notes. In 2010, BCR issued US$450 million in guaranteed senior secured notes at a fixed interest rate of 12.5% per year maturing in July 2015 (the 2015 Notes). The 2015 Notes were guaranteed by various entities in the Berau Group, including BCE, Berau Coal and Empire. Subsequently, in 2012, BCE issued US$500 million in guaranteed senior secured notes at a fixed interest rate of 7.25% per year maturing in March 2017 (the 2017 Notes). The 2017 Notes and 2015 Notes (collectively, the “Notes”) had largely the same security package, and, except for the exclusion of BCR, the 2017 Notes had the same guarantors as the 2015 Notes. Other than the Notes, the Berau Group had no material external financial indebtedness.

Procedural History. In late 2014 and early 2015, coal prices declined precipitously on global markets, resulting in severe financial difficulties for the Berau Group, which defaulted on its obligations upon the maturity of the 2015 Notes. The default on the 2015 Notes triggered a cross-default on the 2017 Notes.

Following three failed rounds of proceedings initiated by BCR and BCE aimed at restructuring the group finances, in April 2017 Empire filed an application under §210(1) of the Companies Act of Singapore seeking permission to convene a creditors' meeting to consider and vote on the Proposed Scheme. Notably, the three previous applications were all filed separately by BCR and BCE for the 2015 Notes and the 2017 Notes, respectively, thereby contemplating that the noteholders would vote in different classes. The fourth application by Empire, a guarantor of both notes but not an issuer of either, was the first to propose putting the noteholders in a single class of creditors.

In response to Empire's application, a group of minority creditors, including Pathfinder Strategic Credit LP, objected to the application to convene a creditors' meeting. At the time of Empire's application, the total outstanding principal under the Notes amounted to approximately US$800 million, of which the Minority Creditors held around US$112 million. Such holdings amounted to 25.28% under the 2015 Notes, 4.91% under the 2017 Notes, and 14% of the Notes when aggregated. The lower court judge granted leave to convene, but took the position that the holders of the Notes should be grouped into two classes for the purpose of voting on the Proposed Scheme. The Minority Creditors appealed the granting of the motion to convene, and Empire appealed the decision to classify the creditors into two groups.

The Proposed Scheme of Arrangement. Empire's proposed scheme of arrangement (the Proposed Scheme) provided for the full and final release of all liabilities under the Notes, including the liabilities of BCE, BCR, and all other co-guarantors. Further, all accrued and unpaid interest, principal and other amounts under the Notes would be waived by the noteholders. In exchange for such release and waiver, Berau Coal would issue new notes (the New Notes) on a dollar-for-dollar basis with maturity 10 years from the date of such issuance and would bear interest at LIBOR plus 1%. The New Notes would be guaranteed by BCE, governed by New York law, and redeemable by Berau Coal any time without payment of any penalty or premium. BCE and Berau Coal would then use excess proceeds from the Berau Group's operations to redeem the New Notes through iterative Dutch auctions.

The Decision

The lower division of the Singapore Supreme Court, known as the High Court, confronted three main issues in adjudicating Empire's application: (1) the extent of disclosure that is required of an applicant-company under §210(1) of the Companies Act of Singapore; (2) the validity of third-party releases under a scheme of arrangement; and (3) the proper classification of creditors. As an initial matter, the High Court held that it is primarily concerned at the leave stage with jurisdictional issues in granting leave to convene a creditors' meeting. At such stage, it would generally not consider the merits of the scheme as such consideration is left to the creditors to determine at the scheme meeting.

In short summary, the High Court granted leave to convene the creditors' meeting for the Proposed Scheme to be considered and voted upon. The High Court also found nothing objectionable in Empire's desired third-party releases but held that the 2015 Notes and the 2017 Notes should be grouped into two separate classes

On appeal, Chief Justice Menon, writing for the Court of Appeal, issued a lengthy decision intended to clarify schemes of arrangement under Singapore law. Specifically, the Court of Appeal noted that schemes of arrangement had “become an increasingly popular tool for companies seeking to effect a debt restructuring,” because they “permit[] the debtor to remain in control of the company, and further permit[] a statutory majority of the company's creditors to impose their views even over the objections of a minority group of dissentients.” Nevertheless, the Court of Appeal emphasized the importance of safeguards to protect the interests of minority creditors.

As an initial matter, the Court of Appeal acknowledged that the statutory language of §210(1) of the Companies Act does not explicitly address the principles and considerations underlying the decision to grant leave to convene a creditor's meeting. Relying on case law, the court found that (1) at the leave stage a court should generally consider jurisdictional challenges and not consider merits and reasonableness of a proposed scheme, which are ultimately for the creditors to decide, and (2) as time is ordinarily of the essence in restructuring matters, the leave application should be heard on an expedited basis.

Issue 1: Empire's disclosure was insufficient. On appeal, the Minority Creditors argued that Empire Capital, as well as, the Berau Group, had not disclosed sufficient financial information for the creditors to make a properly informed decision about the Proposed Scheme.

The Court of Appeal emphasized that proper disclosure is a critical component for both the leave and sanction stages. Specifically, during the sanction stage, the applicant must provide sufficient information to ensure that the creditors are able to “exercise their voting rights meaningfully.” At the leave stage, the applicant has the burden of adducing evidence of sufficient quality and credibility to persuade the court that a creditors' meeting can be fairly conducted, an analysis framed by reasonableness, taking into account the size and resources of the company, the size of the debts to be restructured, the urgency of the application and the reasons for the company's inability to provide further information. The company must provide financial disclosure as is reasonably necessary for the court to be satisfied that fair conduct of the creditors' meeting is possible.

Relying on Indah Kiat, the Court of Appeal stated that it would “not [be] bound to accept at face value bare assertions in the evidence in relation to class composition or any other matter.” Pathfinder [2019] SGCA 29 at [55], citing Indah Kiat [2016] B.C.C. 418, at [40]. The Court of Appeal noted that although it understood the difficulties faced by applicants in times of financial turmoil, applicants are still required to unreservedly disclose all material information and act with the utmost candor in seeking to invoke the jurisdiction of the court.

Based on the foregoing standard, the Court of Appeal found that several points demonstrated the insufficiency of Empire's disclosure. First, Empire failed to provide any updated financial information for any member of the Berau Group other than Berau Coal, which in and of itself were sparse and unreliable. Second, the most recent set of audited accounts disclosed was for 2014, which was four years prior to the appeal hearing. As an explanation for the lack of audited accounts, Empire explained that the Indonesian regulatory authorities had not required them. The Court of Appeal found that this explanation suggested that Empire deliberately chose not to audit its financial statements even though it could have. Third, the Deloitte opinion, which stated that creditors stood to recover more under the Proposed Scheme than in a liquidation scenario, suffered from deficiencies because it was based on the same inadequate financial information and presupposed conclusions that the creditors would themselves assess at the meeting once convened. In the face of claims that cash had been diverted away from the collateral bank accounts, there was no information regarding cash collateral. On these points, the Court of Appeal found that Empire's disclosure was wholly inadequate.

The Court of Appeal also briefly addressed the High Court's opinion regarding the Minority Creditors' failure to disclose their expert report. The Court of Appeal stated that because Empire was the applicant, Empire bore the burden of showing that it had discharged its duty of disclosure. The Minority Creditors were not responsible for such showing, and therefore any act on their part could not excuse Empire from failing to meet its obligations.

Issue 2: A court has jurisdiction to determine the validity of third-party releases. Although the Court of Appeal set aside leave to convene solely on the failure to properly disclose, it nevertheless provided its “provisional views” on the subsequent issues, including the issue of third-party releases.

On appeal, the Minority Creditors argued that a court only had discretion to grant leave for a creditors' meeting where the proposed scheme required third-party releases that were “necessary” to give effect to the scheme of arrangement. Specifically, the Minority Creditors argued that because Empire was a guarantor and not the primary obligor in respect to the Notes, the releases given under the Proposed Scheme to third parties were not necessary to effect the restructuring of Empire, the applicant, and therefore, the releases fell outside the scope of the court's statutory powers under §210(1) of the Companies Act. To the Minority Creditors, while a primary obligor could propose a scheme that involved a release of its guarantor's liabilities, a guarantor could not propose a scheme that involved a release of the primary obligor's liabilities because such release was not “necessary” for the compromise.

In response, Empire contended that not only should such issue not be considered only at the sanction hearing, but also that there was no limitation on the jurisdiction of a court to consider sanctioning a scheme under which third parties are released. Empire argued that there was no distinction between “primary” and “secondary” obligations. Moreover, even if third-party releases had to be “necessary” to be sanctioned, the Proposed Scheme satisfied the test because non-release of liabilities owned by other members of the Berau Group would impede the success of the reorganization.

The Court of Appeal turned to case law developments and whether there was a “sufficient nexus” between the release of the third-party liabilities and the relationship between the company and the scheme creditors. Here, the Court of Appeal agreed with the analysis of jurisdiction in Federal Court of Australia in Re Opes Prime Stockbroking Ltd [2009] FCA 813 (Opes Prime), which also addressed the release of claims against third parties, including another company in the corporate group. In Opes Prime, the Federal Court of Australia reviewed case law from the U.K., Canada, Singapore, and the United States to find that the schemes of arrangement should ensure flexibility, and “provided that there is a sufficient nexus between a [third-party] release and the relationship between the creditor and the scheme company, the scheme can validly incorporate the release.” [2009] FCA 813 [55]. Adopting the “sufficient nexus” test, the Court of Appeal found that the Proposed Scheme fell within the scope of §210(1) of the Companies Act since the debts all arose out of the same note issuances, were effectively the same liability since the discharge of one extinguished the right to pursue the other, and the release of the debt owned by other members of the Berau Group was closely related to the creditor-debtor relationship between the noteholders and Empire. The Court of Appeal also noted that even if it had adopted a necessity test, as the Minority Creditors had proposed, it still would have found jurisdiction proper to determine the validity of the third-party releases due to the unfeasibility of effectuating a restructuring without including all members of the Berau Group.

Issue 3: Noteholders may be properly placed in a single class. The Court of Appeal then turned to the issue of whether the holders of the Notes should be classified as a single class of creditors for purposes of considering and voting on the Proposed Scheme. On appeal, Empire argued that the noteholders should be classified into one group, relying on similarities that give rise to a “commonality of interests” between the noteholders, such as the fact that they secured substantially the same assets and the securities are governed by the inter-creditor agreement.

The Minority Creditors responded that the holders of the Notes should be put into separate classes because of four key differences: (1) the holders of the respective Notes had rights against different obligors and different issuers based in different jurisdictions; (2) the Notes had different interest rates; (3) the holders of the Notes would be required to compromise different securities under the Proposed Scheme; and (4) the holders of the Notes had different recovery rates in event of liquidation.

To determine the proper classification, the Court of Appeal utilized the notion of a comparator (i.e., the most likely scenario if the proposed scheme were to fail). Given the inadequate financial disclosure, the Court of Appeal found that the appropriate comparator was liquidation. Comparing the Proposed Scheme with liquidation, the Court of Appeal found that the differences in positions of the holders of the Notes under the Proposed Scheme and in liquidation did not appear material. Further, the other purported differences, such as the different estimated rates of recovery, had little to no material financial impact on the holders of the Notes. Based on this analysis, the Court found that the holders of the Notes should be classed together.

Conclusion

The Court of Appeal's decision in Pathfinder is significant for the approach adopted by the Singapore courts in restructuring a large, cross-border group enterprise with New York law-governed debt. There is little, if any, doubt that Singapore courts will exercise jurisdiction over the members of the group based upon the scheme application filed by one member of the group organized under Singapore law.

After taking into account leading decisions from the United Kingdom and Australia, the Singapore Court of Appeal concluded that schemes are premised upon financial disclosure that demonstrates the good faith of the debtor and that serves to assure the court of the fairness of the creditors' meeting. Notably, Pathfinder could have simply been resolved by denying leave to convene the creditors' meeting for failing to provide adequate disclosure.

Instead, the Court of Appeal went ahead and confirmed broad jurisdiction over a group of companies primarily organized and operating outside of Singapore—including their substantial liabilities—and adopting a “sufficient nexus” test for third-party releases. The Court of Appeal found a sufficient nexus between the creditors' claims on account of the Notes against Empire, the scheme applicant, and the creditors' claims against the non-debtor companies in the group that were issuers or guarantors of the Notes. Indeed, the Court of Appeal suggests that in the context of a group restructuring, “even if it was the guarantor and not the primary obligor [that] was the scheme applicant, a release of the third party debt owed by the primary obligor to the scheme creditors would still be regarded as necessary, since otherwise liability and enforcement risks would merely be shifted between members of the corporate group and the overall restructuring objective would be entirely unmet.” Pathfinder [2019] SGCA 29 at [81]. The decision clears the way for a scheme proposed by one guarantor to resolve entirely the New York law-governed bond debt liabilities of issuers and other guarantors in an affiliated group enterprise.

In requiring fundamental fairness, candor with the court, and meaningful opportunity for creditors to decide whether to pursue a restructuring, the Singapore Supreme Court is embracing core concepts that have long merited comity. The decision in Pathfinder is noteworthy not for the actual result of denying leave to convene a creditors' meeting, but for its public statement of the rationale for Singapore as a restructuring jurisdiction of choice for large, complex cross-border enterprises. It also confirms that Singapore should be a model deserving of international respect and comity, at a minimum from the United States and other common law countries, and perhaps even from all of the 43 other countries that have adopted the UNCITRAL Model Law on Cross-Border Insolvency.

Corinne Ball is a partner at Jones Day.