Cayman Islands: Restructuring in the Past, Present and Future

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In summary

In this article, we explore the development of the Cayman Islands as a restructuring jurisdiction, the significant cases that demonstrate the sophistication and flexibility of the jurisdiction and our expectations for the future of restructuring and insolvency in the medium to long term.


Discussion points

  • Evolution of the Cayman Islands’ restructuring regime
  • Schemes of arrangement
  • Restructuring officers
  • Funding of restructurings
  • The likely impact of macroeconomic factors on insolvency and restructuring in the Cayman Islands

Referenced in this article

  • In the Matter of Ocean Rig UDW Incorporated, Drill Rigs Holdings Incorporated, Drillships Financing Holdings Incorporated and Drillships Ocean Ventures Incorporated (each in Provisional Liquidation)
  • In the Matter of LDK Solar Co, Ltd (in Provisional Liquidation)
  • In the Matter of Arcapita Investment Holdings Limited (in Provisional Liquidation)
  • In the Matter of Luckin Coffee, Inc (in Provisional Liquidation)
  • BTI 2014 LLC v Sequana SA
  • In the Matter of Oriente Group Limited
  • Cayman Islands Companies Act (as revised)

Introduction

If you want to know the future, look at the past.

Albert Einstein

The Cayman Islands continues to be at the forefront of developments in restructuring and insolvency law offshore and among common law jurisdictions. Many companies have chosen the Cayman Islands as an effective and efficient jurisdiction within which to restructure their debt, but as the economic landscape has shifted towards a period of higher interest rates and higher inflation, with bearish markets, what does the future of restructuring in the Cayman Islands hold? In this article we consider what lessons can be learned from the significant restructuring cases the jurisdiction has seen previously, which might be indicative of the issues and solutions that are likely to be seen in future cases.

Past

Prior to recent reforms, the Cayman Islands had adopted a practice that first developed in the English courts in the early 1990s. Insurance companies, which were not able to take advantage of the administration process, would restructure their debt by seeking the appointment of a provisional liquidator 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 procedure has been regularly applied since at least In Re Fruit of the Loom Ltd (Grand Court, unreported, 26 September 2000). Thereafter, a well-developed body of jurisprudence has shaped the role provisional liquidators play in the process, ranging from having full control of the process to having a ‘soft touch’ supervisory role only, where the promulgation of the restructuring plan remains under the control of the directors of the company, with the provisional liquidators supervising the process to ensure the proper application of the company’s assets.

Following the adoption of this process as a means of restructuring, the Cayman courts have gained considerable experience with the efficient management of large debt restructurings, proving the regime to be an effective and adaptive means of restructuring debt in relation to Cayman companies, as well as foreign companies that are re-domiciled to, or registered as foreign companies in, the Cayman Islands for the specific purpose of restructuring debt. For example, Ocean Rig (as discussed further below), an oil services group, transferred and shifted the centre of main interest (COMI) of four group companies from the Marshall Islands to the Cayman Islands and successfully restructured over US$3.7 billion of debt through four inter-related Cayman Islands schemes of arrangement. The COMI shift was necessary to access the Cayman Islands scheme of arrangement process and for the successful application for Chapter 15 recognition.

The principal debt (and equity) restructuring tool in the Cayman Islands was, prior to the introduction of the restructuring officer regime (as set out below), the scheme of arrangement implemented by a provisional liquidator under section 84 of the Companies Act (as amended) (the Act). It is now the scheme of arrangement implemented by a restructuring officer under section 91 of the Act. The principles that apply to Cayman Islands schemes are based on the well-established principles of English schemes, so the law and at least some of the procedure will be familiar to practitioners experienced in the English process. The scheme process is a court process that is initiated by the filing of a scheme petition. There is then a directions hearing for the purpose of ordering the convening of scheme meetings, followed by one or more meetings where creditors consider and vote on the restructuring plan, and (if approved at all meetings) a second hearing where the court considers whether or not to sanction the scheme. If sanction is granted by the court, the scheme takes effect on the filing of the order, and the scheme terms are then implemented, usually without further reference to the court.

For group debt, each individual company with debt that needs to be restructured must be the subject of separate scheme proceedings and meetings. To streamline the process, however, the Grand Court manages the related proceedings together. Scheme terms are often inter-conditional so that one does not take effect unless all are sanctioned by the Grand Court. The restructuring can be completed quickly, but the more complex the scheme or the more vocal any dissent, the more likely it would be that the process would run its course over a longer period of time.

Examples of successful Cayman Islands restructurings

Following the 2008 global financial crisis, many companies were left with an unmanageable debt burden, with limited liquidity. To reposition themselves to take advantage of improving economic conditions through the 2010s, many companies took advantage of Cayman’s restructuring regime. Some of those key cases are discussed below.

Arcapita Investment Holdings Limited (AIHL)

Arcapita was a leading global manager of shariah-compliant alternative investments and operated as an investment bank. One of its subsidiaries, AIHL, was incorporated in the Cayman Islands as an exempt company for the purpose of holding Arcapita’s ownership interests in various investments.

Arcapita was adversely impacted by the 2008 global economic downturn, particularly by the debt crisis in the Eurozone. This hampered its ability to obtain liquidity through capital markets and resulted in a reduction in asset values (and concomitant difficulties in monetising certain of the illiquid and complex assets owned by its affiliated portfolio companies).

In this context, the Arcapita Group was unable to refinance a syndicated facility worth US$1.02 billion that was due on 28 March 2012. Accordingly, voluntary bankruptcy proceedings were filed under Chapter 11 of the United States Bankruptcy Code in respect of six ‘debtors’ of the Arcapita Group (including AIHL) and a restructuring plan was prepared.

In addition to the syndicated facility, the indebtedness of the debtors prior to implementing the plan included more than US$96 million in secured debts to a bank and more than US$1.19 billion in unsecured debt.

In effect, the plan involved restructuring the existing shariah-compliant debt and equity arrangements through the issuing of new shariah-compliant debtor-in-possession financing to fund the reorganisation and to allow operations to continue during the asset disposition process. This method: provided for the reorganisation of the existing debtors into new entities with new holding companies; provided working capital to fund the emergence from the Chapter 11 proceedings and to capitalise the new entities and holding companies; maintained control of the debtors’ assets to allow value realisation; and facilitated the wind-down of the debtors’ existing investments.

Proceeds from the asset dispositions were first applied to repay the new secured facility that was used to provide working capital for the plan and second to an unsecured facility subordinate to the new secured facility.

LDK Solar (LDK)

LDK is a producer of components used in the generation of solar energy.

Between 2011 and 2013, following the introduction of anti-dumping laws in the EU and a general reduction in the availability of government subsidies following the global financial crisis, the solar power industry suffered significant financial challenges associated with the reduction of the price of solar panels and the declining price of polysilicon, a key raw material used to manufacture solar panels. Already overburdened with debt taken on to fund the expansion programmes of earlier years, LDK was not able to sustain these operating losses. Accordingly, with maturity dates on debt burdens looming, LDK sought to restructure.

Prior to the restructure, LDK’s debt included borrowings from Chinese institutions of approximately US$2.9 billion, secured against LDK group companies based in China, and non-Chinese based lending and security burdens of US$1.1 billion that included:

  • US$293 million to senior note holders of senior notes issued by LDK;
  • US$390 million worth of redeemable preferred shares issued by LDK Silicon & Chemical Technology Co, Ltd (a subsidiary of LDK); and
  • inter-company creditors and unsecured creditors of LDK made up predominantly of professional advisers.

With the sanction of the Grand Court, restructuring support agreements were entered into with a majority of senior note holders and preferred shareholders, which required the promulgation of various separate but inter-conditional schemes of arrangement in the Cayman Islands and Hong Kong, as well as a related Chapter 11 plan in respect of a key trading subsidiary in the United States.

The nature of the restructuring was to extend the maturity of LDK’s offshore debt by converting (to the extent agreed by the holders) the senior notes and preferred shares into convertible bonds, and exchange some of the debt arising under the senior notes and preferred shares into equity, thereby reducing the offshore debt by approximately 10 per cent.

Ocean Rig

The restructuring of the Ocean Rig Group was one of the largest successful contentious restructurings in the Cayman Islands and involved the exchange by creditors of approximately US$3.7 billion of debt for new equity, US$288 million in cash and US$450 million of new secured debt.

Ocean Rig is an international offshore drilling contractor that provides oilfield services for offshore oil and gas exploration, development and production drilling and specialises in the ultra-deep water and harsh-environment segment of the offshore drilling industry. Due primarily to the fall in the price of oil between March 2014 and February 2016 and an increasing debt burden, four companies within the Ocean Rig Group (Ocean Rig UDW Inc (UDW), the parent entity; Drillships Financial Holdings Inc (DFH); Drillships Ocean Ventures Inc (DOV); and Drill Rigs Holdings Inc (DRH)), sought sanction from the Grand Court of a compromise between each of the companies and their creditors.

Prior to the restructuring, the companies’ debt comprised the following:

  • UDW owed US$131 million to senior unsecured noteholders and US$3.56 billion under guarantees provided in respect of the debt of its subsidiaries. Its guarantee was secured against its shares in the subsidiaries;
  • DRH owed US$459.7 million under secured notes;
  • DFH owed US$1.83 billion under secured term loans; and
  • DOV owed US$1.27 billion under secured loans.

Schemes were proposed (and ultimately sanctioned) in respect of each entity. The schemes in respect of UDW, DFH and DOV were inter-conditional upon each being approved. The DRH scheme was conditional upon the UDW, DFH and DOV schemes being approved.

The effect of the restructuring was to reduce the Ocean Rig Group’s financial indebtedness from approximately US$3.7 billion (plus accrued interest) to US$450 million pursuant to a new credit facility (generating interest at 8 per cent per annum) provided by the existing lenders in exchange for either ordinary shares in UDW or cash.

Luckin Coffee

The Luckin Coffee restructuring is one of Cayman’s most recent restructuring success stories.

Luckin Coffee 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 (IPO) 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 IPO, secondary public offering 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 US Securities and Exchange Commission and Department of Justice. 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.[1] 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, provisional liquidators, working collaboratively with the company and its team of advisers, 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).

Prior to implementing its restructuring, Luckin Coffee’s potential liabilities included US$460 million 0.75 per cent convertible senior notes due in 2025 and claims by various of its shareholders, in the range of US$2–3 billion.

The restructuring involved the injection of US$250 million from existing shareholders, a settlement of the class action shareholder claims for US$187.5 million and cancellation of the notes in exchange for:

  • US$151 million in cash;
  • US$63 million in one-year notes with an enhanced interest coupon;
  • US$142 million in five-year notes with an enhanced interest coupon; and
  • US$9 million of new American depository shares.

These cases all involved several common themes. First, the requirement to raise new money to fund the restructuring, discharge some or all of the companies’ presently due and payable liabilities, and to fund working capital requirements post-restructuring. Second, these cases tended to focus on the need to manage the relationships between competing groups of stakeholders to ensure a fair outcome for each separate stakeholder group. Third, these cases invariably involved releases of claims against management and management incentive provisions aimed at ensuring continuity and stability of management post-restructuring.

Present

The relatively recent changes to the Cayman Islands’ restructuring regime for companies, which came into force on 31 August 2022, represent an evolution (rather than revolution) of the process described above. The new regime allows for the appointment of a dedicated restructuring officer, who fills a role similar to that of a provisional liquidator but avoids the stigma of a winding up petition, the appointment of provisional liquidators and the potential triggering of ipso facto clauses when restructuring a company in the Cayman Islands. The ability of the company to present its own petition for the appointment of restructuring officers also avoids the need to adopt the developed practice of working around the restriction[2] preventing the company from presenting its own petition without shareholder approval by finding a ‘friendly’ creditor to petition on behalf of the company. The changes were much anticipated and welcomed by legal and insolvency professionals in the Cayman Islands as representing an incremental improvement of the existing process while continuing to allow for flexible restructuring options in the Cayman Islands.

Oriente Group Limited (Oriente)

The first Cayman Islands restructuring officers were appointed in relation to Oriente in late 2022. Oriente is the parent company in a group that operates a financial technology platform providing alternative sources of credit in Southeast Asia. The Oriente group’s performance was heavily impacted by a drastic increase in consumers defaulting on loans and interest rate increases by central banks during the covid-19 pandemic.

Oriente attempted to engage in discussions with its creditors, but two creditors filed a winding up petition in the Grand Court in September 2022. Shortly thereafter, in October 2022, Oriente filed a petition in the Grand Court seeking the appointment of joint restructuring officers pursuant to section 91B of the Act, on the basis that Oriente was unable to pay its debts as they fell due and intended to present a compromise or arrangement to its creditors.

The Grand Court appointed restructuring officers in relation to Oriente, and handed down a written judgment (In re Oriente Group, FSD 231 of 2022, unreported, 8 December 2022), which provides welcomed guidance in relation to the appointment and role of restructuring officers.

The judgment reinforces that the restructuring officer regime is an evolutionary development, which retains the majority of the aspects of the provisional liquidation regime that have worked well over many years, rather than the ground-breaking revolution some have attempted to paint it as.

The Grand Court held that, given the similarity of the legislation in relation to provisional liquidators and restructuring officers, case law relating to provisional liquidations will be persuasive in relation to the restructuring officer regime. Kawaley J said ‘the cases under the former regime record valuable judicial and legal experience in essentially the same commercial sphere . . .’ and went on to say that In re Sun Cheong Holdings [2020 (2) CILR 942] (a well-known judgment of Chief Justice Smellie (as he was then)) ‘lucidly paints an instructive portrait of the old statutory scheme which applies with equal force to the restructuring officer regime’.

Kawaley J’s judgment does emphasise a notable improvement introduced as part of the restructuring officer regime, being that the statutory moratorium on claims applies from the date of the petition to appoint restructuring officers, as opposed to the date on which the provisional liquidators were appointed (as the petitioning creditors unsuccessfully argued). Kawaley J described the change in relation to when the moratorium comes into force as a ‘significant innovation . . . which might be said to turbo-charge the degree of protection filing a restructuring petition affords to the petitioning’ and went on to describe the filing of a petition by the petitioning creditors in Hong Kong shortly before the appointment of restructuring officers as a ‘flagrant breach’ of the moratorium.

Future

Where the fundamental objective of a restructuring process is to offer a better return to stakeholders than could be achieved through a terminal liquidation of the business, certain minimal criteria must be present before a restructuring can reasonably be considered. First, the company must have a viable future as a going concern – a company whose business is no longer viable due to, for example, technological advances or cultural shifts, achieves little by restructuring where reducing demand over time means that a restructuring serves to only delay the inevitable. Second, the company must have assets of real value where the ability to realise or exploit that value over time results in a better outcome than a terminal liquidation. A company whose assets have or are about to lose significant value that is unlikely to be recovered over time, an example being intellectual property rights where patent protection is about to expire, can offer little to stakeholders through a restructuring that could not be achieved in a terminal liquidation. Contrast that situation with, for example, a mining company extracting iron ore where iron ore prices drop temporarily but are likely to recover in the medium term, where a restructuring would likely offer a better outcome for stakeholders and allow the company to trade through short-term cyclical or industry specific challenges.

Where the company can satisfy these criteria, it should have the ability to offer a better return to stakeholders through a restructuring, either by using assets of value to raise new money to discharge creditors, or alternatively by using the perceived value in the business to discharge creditors by issuing new shares in satisfaction of creditor claims (ie, a debt for equity swap). However, with rising interest rates, reduced consumer spending, soaring inflation and the withdrawal of pandemic-related government support schemes all starting to take effect, resulting in projected global economic growth for 2023 of just 1.7 per cent, current economic circumstances seem likely to impact the ability of companies to easily offer these alternatives. The cost of borrowing, particularly in circumstances of distress that often justify a funding premium, is or may become prohibitive for many companies, who must also weigh in the balance their ability to service that debt over time after emergence from a restructuring process in a more challenging economic environment. This is particularly so in the context of increasing operating costs, generally reducing consumer demand and increasing late payments by customers. These factors would also need to be carefully considered by stakeholders when contemplating an offer to accept equity in exchange for debt.

The examples of restructuring cases addressed above all involved an injection of new funding. Now, where such funding may not be affordable (or even available at all) in the short to medium term, success in restructuring cases is likely to be more difficult to achieve. This is perhaps reflected in the Allianz Global Insolvency Index suggesting that global insolvencies have increased 21 per cent in 2023, with a further 4 per cent increase in global insolvencies projected for 2024.

In this environment, insolvency practitioners are likely to have to be more cautious before recommending or supporting a restructuring plan. The restructuring process, which is often a complex exercise involving legal and financial advice in multiple jurisdictions and various competing stakeholder groups all defending their respective economic interests, can involve significant expense. Professional fees and expenses can and typically run into the millions, and that value is entirely lost to stakeholders where the restructuring does not succeed. Insolvency practitioners who support a restructuring plan with limited or no real prospect of success are likely to face criticism and potential liability for those costs if they have the effect of reducing the company’s assets to no purpose. It is also likely that the liquidation analyses usually required to support a scheme of arrangement will need to be more robust and demonstrate an appropriate degree of scepticism around asset valuations and revenue or cash-flow forecasts.

Insolvency practitioners are likely to come under greater pressure to consider maximising recoveries from all available sources, including potential claims against directors and others involved in company management. The reported increase in focus on directors’ conduct by the UK’s Insolvency Service is unlikely to be a jurisdiction-specific trend. The recent case of BTI 2014 LLC v Sequana SA [2022] UKSC 25, in which the English Supreme Court said that the directors’ duty to creditors modulated depending on the probability of insolvency, with the interests of creditors becoming paramount when an insolvency filing was inevitable or unavoidable, also seems likely to prove to be more of a bright-line test when it comes to the question of directors’ breaches of duties to creditors.

In circumstances where many directors have been faced with difficult trading conditions arising from the impact of the global pandemic, it seems likely that there will be an increase in cases involving at least wilful neglect or default, and even outright fraud and dishonesty, representing a potentially valuable source of recovery in a liquidation. As described above, where previous restructuring plans have typically involved management incentives and releases, it seems likely that such releases or incentive plans will be less attractive to stakeholders versus the prospect of a potential litigation recovery.

It follows from the above that directors and others involved in management will need to be conscious of these challenges as they consider the best way to manage economic distress. Company directors will need to ensure they have up to date and accurate financial information, be quick to focus on early indicators of distress, and act decisively when in circumstances of approaching or impending insolvency. Directors will need to be more proactive about seeking solutions if a liquidation is to be avoided and more philosophical about situations where a liquidation cannot.

Creditors of companies in distress are likely to be more sceptical about the benefits of accepting long positions in companies seeking to restructure. Debt for equity swaps may be less attractive where share values are likely to be suppressed and where the prospect of dividends being paid is greatly reduced by the increased operating and financing costs.

However, this heavy note of caution should not be misconstrued as despair – things could be worse. There is still greater liquidity in the market than there was in 2008, and as a result there remains significant capital available to exploit the right opportunities. The slowing of global growth, particularly in developing jurisdictions, has not yet turned to a global recession, which may be likely but is by no means inevitable. The Cayman Islands restructuring regime remains a valuable tool for those managing corporate debt and distress.

Conclusion

While the level of financial distress has certainly increased, and is reflected in increased insolvencies globally, the Cayman Islands restructuring regime may still offer solutions to those who act cautiously, take advice quickly and are prepared to be creative and pragmatic about restructuring solutions. The approaches that have worked in previous cases are instructive, but may not be as effective in a changing and more challenging economic environment.


Notes

[1] 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 Holdings Limited (Grand Court, unreported, 3 August 2018) and in Re CHC Group Ltd (Grand Court, unreported, January 24, 2017).

[2] The position at common law following Re Emmadart Ltd [1979] 1 Ch 540, as reapplied in the Cayman Islands following Re China Shanshui Cement Group Limited [2015 (2) CILR 255].

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