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The Cayman Islands recently introduced rules allowing for the appointment of a dedicated restructuring officer. The new regime resolves some difficulties in the old provisional liquidation regime, simplifying the process, reducing cost and promoting certainty of outcome, but does not materially change the Cayman Islands’ restructuring capabilities or processes.
This article provides a case study on the Luckin Coffee provisional liquidation and an analysis of the new restructuring officer regime as compared to the provisional liquidation process.
- Luckin Coffee Inc restructuring
- New Cayman Islands restructuring officer regime
- Cayman Islands schemes of arrangement
Referenced in this article
- Luckin Coffee Inc restructuring
- Cayman Islands Companies Amendment Act (2021)
- Cayman Islands Companies Act (2022 Revision)
Recent changes to the Cayman Islands’ restructuring regime for companies, which came into force on 31 August 2022, introduced rules allowing for the appointment of a dedicated restructuring officer.
While the changes were much anticipated and welcomed by legal and insolvency professionals in the Cayman Islands, the changes do not represent a restructuring revolution, but the evolution of an existing process.
Prior to the recent reforms, the Cayman Islands had adopted a practice that first developed in the English courts in the early 1990s, where insurance companies, which were not able to take advantage of the administration process, would restructure their liabilities by seeking the appointment of a ‘soft touch’ provisional liquidator appointed following the presentation of a winding-up petition by the company itself, with the effect that a moratorium on claims was imposed while the company, under the supervision of the provisional liquidator, formulated a proposal for its creditors. The practice became so well established in the Cayman Islands that by the 2009 Revision of the Companies Act a specific provision recognising the practice was added by the introduction of a new section 104(3), and the Cayman Islands’ reputation as a flexible restructuring jurisdiction is both well established and well deserved, with numerous high-profile examples of companies successfully restructuring their liabilities.
A good example of the success of the Cayman Islands’ restructuring regime is found, in what was probably the last high-profile restructuring using provisional liquidators, in the case of Luckin Coffee Inc.
The provisional liquidation process – a case study
Luckin Coffee Inc was founded in 2017 by a Chinese entrepreneur, Charles Lu, with the goal of displacing Starbucks as China’s largest coffee chain. By the time of its initial public offering in 2019, it had opened 2,370 stores and with coffee consumption in China estimated to increase from 8.7 billion cups in 2018 to 15.5 billion cups by 2023, the company formulated aggressive expansion plans to open a further 2,500 stores throughout 2019. To fund this expansion, the company’s 2019 initial public offering (IPO), secondary public offering (SPO) and bond issuance raised approximately US$2.2 billion. However, by 2020, cracks had begun to show in Lu’s expansion strategy. Muddy Waters Research published a report alleging that Luckin had been misreporting its sales, and an undercover research firm dispatched more than 1,000 researchers to Luckin stores, uncovering further alleged discrepancies in Luckin’s reporting. Shortly after, and following an independent special committee investigation, Luckin announced that it had suspended Lu after finding that he had exaggerated the company’s 2019 sales by approximately US$310 million. This resulted in the company’s share price collapsing, wiping approximately 70 per cent, or US$5 billion, from its market value and the company being delisted by NASDAQ. Luckin’s bonds fell as low as 10 cents on the dollar.
Litigation followed, with various direct and class action claims being asserted in the United States, a class action claim in Canada, and injunctive proceedings in both the Cayman Islands and Hong Kong. Litigation was complicated by the involvement of various individuals and institutions who were entitled to claim indemnities against Luckin. Luckin’s issues also became political ammunition for US senators who argued that Chinese corporations could not be trusted, fuelling interest in Luckin’s operations from the Securities and Exchange Commission (SEC) and Department of Justice (DOJ). In order to protect Luckin from its creditors while restructuring proposals were considered, a winding-up petition was filed by a former director as a ‘friendly’ creditor. The company then applied for the appointment of provisional liquidators to assist with proposing a compromise or arrangement to the company’s creditors, in the hope that value could be preserved and the company could continue as a going concern.
In July 2020, Alexander Lawson and Tiffany Wong, both of Alvarez & Marsal, were appointed as the joint provisional liquidators (JPLs) and Campbells LLP and DLA Piper were retained as the Cayman Islands JPLs and US counsel respectively. Working collaboratively with the company and its team of advisers, the JPLs’ team addressed a number of complex practical, operational and legal issues, successfully bringing the provisional liquidation to a close in March 2022, putting Luckin in a strong position to continue as a going concern (with its share price steadily increasing post-restructuring). Some of the issues faced and key milestones reached in the provisional liquidation are discussed below.
The powers conferred on provisional liquidators are defined in the order by which they are appointed. While Luckin’s board of directors was empowered to continue managing day-to-day operations, the order required the JPLs to supervise those operations. The company’s aggressive expansion strategy required significant investment, and as a consequence the company was in a loss-making phase of its business plan, posting a net loss of US$85.3 million for quarter one of 2019. In order to mitigate expansion-related losses while a restructuring was in contemplation, the JPLs engaged in a wholesale review of the business plan to rationalise expansion and reduce costs. The JPLs also agreed a comprehensive protocol with the board to ensure effective financial oversight and to minimise disruption to the company’s operations during the restructuring process.
Given the international profile of Luckin’s operations, supply chain and creditors, it was necessary to seek recognition of the JPLs’ appointment in both the United States and Hong Kong.
Despite having no significant assets in the United States, the US-law governed notes, the various litigation claims, the interest of the SEC and DOJ and the present and future need to access US money markets were all factors that the JPLs took into account when determining that recognition in the United States was necessary. The Cayman Islands proceedings were recognised by the US Bankruptcy Court as a foreign main proceeding under Chapter 15 of the US Bankruptcy Code and a stay of proceedings against the company was invoked.
Recognition of the JPLs’ appointment was also sought and obtained from the High Court in Hong Kong, although no moratorium on claims was sought, being considered unnecessary.
The JPLs considered recognition in other jurisdictions, including Canada (to address the class action claim that had been commenced in that jurisdiction) and in the British Virgin Islands (to protect the company’s immediate subsidiaries from direct enforcement action). Ultimately, the Canadian class action claim was stayed by agreement and creditors’ claims compromised such that protection of the Canadian and BVI entities proved unnecessary.
Scheme of arrangement
Luckin’s circa US$470 million of debt to its convertible bondholders was compromised by way of a Cayman Islands scheme of arrangement.
The Cayman Islands scheme of arrangement is a court-supervised process provided for in section 86 of the Companies Act. It allows, once approved, for a compromise of creditor claims or shareholder rights. Where a compromise or arrangement is proposed, the scheme petitioner (in Luckin’s case, the company) can ask the court to direct that a meeting of the stakeholders whose debt the scheme intends to compromise be convened (the convening hearing) to consider and, if thought fit, approve the scheme. If, at that meeting, a majority in number (the head count test) representing 75 per cent by value of those present and voting agree to the compromise then the court can be asked to sanction the scheme (the sanction hearing).
Any stakeholder who could be affected by the scheme is entitled to be heard at the sanction hearing. The Companies Act does not prescribe a test that the court must consider. The court usually considers that the stakeholders are the best judge of their own commercial interests, so will typically sanction a scheme that has the requisite support, unless the court considers that the terms of the scheme are not fair such that an intelligent and honest creditor, being a member of the class concerned and acting in its own interests, would not reasonably vote in favour of the scheme. If the court sanctions the scheme, it will be binding on all creditors in the relevant class, including those who voted against the scheme.
The JPLs and the company negotiated the terms of the scheme with the bondholders. A restructuring support agreement (RSA) was entered into between the company, the JPLs and a large majority of the bondholders. The RSA provided an agreed set of terms that the scheme was to contain and a time frame for the completion of the scheme.
The Cayman Islands Grand Court was then asked to convene a meeting of the creditors whose claims would be compromised by the proposed scheme, which it did. The scheme received support from 97.7 per cent of the bondholders (being 100 per cent of the creditors present and voting at the scheme meeting) and the Grand Court subsequently sanctioned the scheme.
While the scheme of arrangement is a flexible tool in the restructuring context, there were perceived limitations in terms of the ability to effect an enforceable compromise of US class action claims through a scheme.
Instead, a settlement of the US class action claim against Luckin was negotiated by the JPLs and the company with the lead plaintiff in the class action, with the settlement taking place after the expiration of the class action opt-out period, which allowed shareholders to opt out of the settlement in favour of pursuing their own claims. The settlement was conditional on sanction from the Cayman Islands Grand Court and US Bankruptcy Court, both of which were obtained.
The cash sum paid in the settlement was US$175 million, making the settlement one of the largest US securities class action settlements ever entered into by a Chinese company. Ultimately, less than 5 per cent of the affected shareholders (by value of claims) opted out of the class action settlement, meaning the settlement effected a compromise of a significant majority of the company’s contingent litigation risk.
The JPLs and their advisers assisted to keep Luckin’s restructuring on track, notwithstanding the operational challenges presented by the covid-19 pandemic. Luckin has emerged from its restructuring in a position of strength, seeing revenue more than double during the period of the restructuring and its share price increase significantly since the restructuring concluded.
The new regime
Despite its many success stories, the old regime suffered from some distinct disadvantages. The fact that the company had to present its own winding up petition to access the jurisdictional gateway of section 104(3) of the Companies Act and the use, by convention, of the descriptor ‘in provisional liquidation’ after the company’s name, carried more than just optical ramifications. Under the new regime, no winding-up petition is necessary for a stay to be imposed and for restructuring officers to be appointed. Where the objective is not the terminal liquidation of the company’s business, this restructuring-friendly terminology avoids the considerable stigma that might have arisen under the old regime, which in turn has a potential impact on trading activities, relationships with suppliers and other counterparties, financing options and the company’s listing status. It is hoped that, by shifting the focus from liquidation to restructuring, the return to creditors is maximised.
Another positive evolution is in the manner by which the process is commenced. Under the old regime, the question of whether the directors could, or could not, cause the company to present its own petition without the approval of the shareholders (which, in a restructuring scenario, shareholders may be reluctant to give) involved an analysis of the articles of association and, where no specific power was conferred on the directors, the directors were often powerless to commence the process. The novel, but less than ideal, practice that developed in response to this lacuna was to identify a friendly creditor to file a winding-up petition to open the jurisdictional gateway for the company to apply to appoint provisional liquidators. Under the new regime, and subject always to any express provisions included in the articles of association, any doubt about the ability of the directors of a company to present a petition to appoint a restructuring officer without a shareholder resolution or an express power in the company’s articles to do so has been resolved and the role of the friendly creditor in instigating a restructuring process will now likely be consigned to the history books.
In a provisional liquidation, a stay on claims against the company by unsecured creditors is not imposed on the date the winding up petition is filed, but rather when a provisional liquidation order is made. Rushing into court on the date of final maturity to prevent the presentation of a winding up petition the following day had the potential to result in underprepared applications without adequate, or even any, notice being given to creditors. The inevitable erosion of confidence in the process that followed from such circumstances had the potential to cause unnecessary tension between the company and its creditors. Under the new restructuring officer regime, that stay (including a stay on the filing of a petition to wind up the company), will commence on the day the petition to appoint a restructuring officer is filed, which should allow the company the opportunity to fully and properly prepare for the hearing of the application, engage with creditors in advance and provide adequate notice of the hearing of the application to creditors. The restructuring moratorium also purports to have extraterritorial effect, at least as a matter of Cayman Islands law.
The new regime confers a discretion on the court to appoint an interim restructuring officer without notice, who will remain in office on an interim basis pending the hearing of the petition to appoint a restructuring officer, allowing for a restructuring officer to be appointed (and a stay on claims against the company imposed) in short order when necessary. While it has long been the case that a fully formed restructuring proposal is not a prerequisite for the appointment of provisional liquidators, in the case of Midway Resources International, Segal J identified the following factors as being relevant to the court’s exercise of discretion to appoint provisional liquidators:
- the level of information provided to the court;
- the status of discussions with creditors and other parties;
- the process and timetable for the consideration and implementation of the restructuring proposal;
- the level of support from creditors; and
- the position with respect to funding.
It seems likely that the court will apply the same considerations to the question of appointing restructuring officers, but having the flexibility to make an interim appointment might usefully be used to assist the court in forming a view as to whether the circumstances of the company suggest a viable restructuring might be possible. This also mitigates the risk that restructuring proposals might be used as a strategy to avoid a winding-up order where there is no real prospect of formulating a restructuring plan that might be approved by creditors.
Various safeguards for the protection of creditors found in the provisional liquidation process have been preserved. Secured creditors remain able to enforce their security without leave of the court. Creditors have the right to appear and be heard at the hearing of the petition to appoint a restructuring officer, and can also seek leave to file a winding-up petition if the restructuring proposals appear inviable, with the hearing of that petition, where possible, scheduled at the same time as the petition to appoint a restructuring officer. As with a provisional liquidator, a restructuring officer will have the power to carry out the functions that the court confers on them, giving the court the flexibility to adapt the scope of the appointment to the individual circumstances of each case. Restructuring officers will also remain subject to the supervision of the court, and creditors have the right to apply to court to seek a variation or a discharge of the order appointing a restructuring officer.
Given the established practice of restructuring provisional liquidators obtaining recognition of their appointment in other jurisdictions, including the United States, the United Kingdom and Hong Kong, there is no reason to believe that the restructuring officer appointments will not also be recognised in the same way, the process being only marginally different in essence to the former provisional liquidation process or other analogous debtor-in-possession restructuring processes.
The changes are not expected to have any impact on the use of schemes of arrangement as the primary tool for the restructuring of companies in the Cayman Islands. However, such schemes are now likely to be promulgated under section 91I of the Companies Act, being a scheme proposed by a restructuring officer, rather than under section 86 of the Companies Act, as was previously the case. The refinements introduced by section 91I make the scheme of arrangement an even more effective tool for the implementation of a restructuring proposal. The process proceeds by way of an application by the restructuring officer within the wrapper of the restructuring case, such that no separate proceeding is commenced. In addition to the simplification of the process, and the likely consequent reduction in cost, an additional benefit is that it is expected that a restructuring officer scheme would be effective in compromising English law-governed debt without a separate parallel process in the United Kingdom. Also significantly, in the case of a scheme of arrangement requiring the approval of shareholders, there is no longer a headcount test, such that a shareholder scheme will stand as approved if supported by a majority representing 75 per cent by value only.
Considering the example of Luckin through the prism of the new regime, the outcome of the case would undoubtedly have been the same and the differences in approach would be subtle, but important. In terms of the commencement of the process, it would have been possible for the company to commence the process through its own petition, rather than requiring the assistance of a friendly creditor. The more expedient process of the company presenting its own petition seems likely to have been quicker, more cost-effective and to have required less use of court resources.
On the operational side, the role of the provisional liquidators in rationalising the business plan would have no doubt been precisely the same, the role of provisional liquidator and restructuring officer both being defined in the appointment order and under protocols agreed thereunder. However, it seems likely that at least some benefit would be derived by the company being able to conduct its business through the restructuring process without a winding-up petition looming on the horizon and without being tainted by being in a liquidation process.
In relation to international matters, there is no reason to believe that the Hong Kong High Court or the US Bankruptcy Court would have taken a different approach to the recognition applications. The interaction with the SEC and DOJ would have likely proceeded on the same footing and it remains to be seen whether the purported extraterritorial aspect of the restructuring moratorium would have had any impact on the various direct and class action claims pursued in the United States.
The implementation of the restructuring proposals through a scheme, at least as regards the creditors, would still have been necessary where a small non-responsive minority did not participate in the process; however, the process would have been invoked on the application of the restructuring officer without the need to commence a separate proceeding by way of petition. Had the compromise with the shareholder-claimants been managed through a scheme, the disapplication of the head count test would certainly have been an advantage.
While the impact of the changes is not likely to materially alter the ability of a Cayman Islands company to restructure its liabilities by accessing a well-established and flexible restructuring regime, the changes are likely to have a positive impact that should simplify the process, reduce cost and promote certainty of outcome.
 Re Fruit of the Loom Ltd (Unreported, Smellie CJ, 26 September 2000, Cause No. FSD 823 of 1999 (ASCJ)).
 English & American Insurance  1 BCLC 649, per Harman J at page 650c.
 A well-established route to seek the protection of the court in the Cayman Islands, as endorsed by the Grand Court in Re CW Group and in Re CHC Group Ltd.
 See China Shanshui [2015 CILR 255], applying the rule Re Emmadart  Ch 540.
 (Unreported, Segal J, 30 March 2021, Cause No. FSD 51 of 2021 (NSJ)).