RE HONG KONG AIRLINES LTD

HCMP 1474/2022

[2022] HKCFI 3792

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 1474 OF 2022

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REASONS FOR DECISION

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Introduction

1.  The Company seeks the Court’s sanction under Section 673 of the Companies Ordinance (Cap. 622) (“Ordinance”) of a scheme of arrangement between the Company and holders of unsecured debt. After an adjournment, the Scheme Meetings were duly convened on 1 December 2022. The resolutions of the Scheme Meetings were carried by a majority in number of the Scheme Creditors present and voting, in person or by proxy, holding 90.04% of the Unsecured Scheme Claims and 100% of the Critical Lessors Scheme Claims voted.[1]

2.  The Scheme seeks to restructure the Company’s indebtedness in order to return the Company to a solvent going concern. Absent restructuring, the Company would be liquidated. A successful restructuring would give the Scheme Creditors a higher recovery:

(a)  For the Unsecured Creditors, recovery under the Scheme is estimated to be 5.1%-8.7%, whereas recovery in the Company’s liquidation is estimated to be 0.7%-1.3%.

(b)  For the Critical Lessors, recovery under the Scheme is estimated to be 5.1%-10.1%, whereas recovery in the Company’s liquidation is estimated to be 4.1%-5.8%.

3.  The Company is a Hong Kong-incorporated entity and is part of a group of 51 companies (“Group”). The Group’s key businesses consist of providing air passenger transport, air cargo transport, and other airline-related services. As its name suggests it is based in Hong Kong and operates regionally.

4.  Badly hit by the pandemic, the Company is cash-flow insolvent. The Company’s audited accounts for the year ended 31 December 2021 show the Company having a net current liability of approximately HK$10,748,219,000. As of 31 December 2021, the Company's total indebtedness amounted to approximately HK$49.064 billion, comprising reported liabilities of approximately HK$39.768 billion and guarantee liabilities of approximately HK$9.296 billion.

5.  The Company’s creditors include the following categories:

(a)  bank lenders and financial creditors;

(b)  financial and operating lessors of aircraft and aviation parts;

(c)  airport authorities;

(d)  hundreds of trade creditors;

(e)  holders of the US$683,000,000 7.125% Senior Perpetual Securities ISIN XS1526108235 (“Perpetual Notes”) issued by Blue Skyview Company Limited and guaranteed by, among others, the Company; and

(f)  other creditors, excluding the Perpetual Noteholders, with guarantee claims against the Company.

6.  The bulk of the Company’s debts are governed by Hong Kong law, while the remaining debts are governed by Mainland law and English law (such as the Perpetual Notes). The Company is very likely to go into liquidation, unless its current indebtedness can be restructured.

7.  To return the Company to being a solvent going concern, the Company is pursuing a Group-wide debt restructuring consisting of the following:

(a)  raising HK$3 billion from Hong Kong Air Limited (“New Investor”) through the issuance of new shares to the New Investor;

(b)  the Scheme;

(c)  a restructuring plan under Part 26A of the UK Companies Act 2006 (“UK Plan”), which will compromise the same debts as the Scheme Claims and, in addition, the indebtedness in respect of the Perpetual Notes and the associated guarantees; and

(d)  consensual restructurings to resolve certain secured liabilities and other liabilities excluded from the scope of the Scheme and the UK Plan.

8.  The Scheme covers most of the Company’s unsecured creditors, other than the Perpetual Notes Creditors to be covered by the UK Plan. The Scheme seeks to discharge the Company’s unsecured indebtedness within the concept of Scheme Claims, which would also entail releasing the Related Debtor and the Related Guarantor (Clause 15 of the Scheme). In return, the Scheme Creditors will be given the following Restructuring Consideration depending on which class the Scheme Creditors fall into:

(a)  One class of the Scheme Creditors are the Critical Lessors which are in essence the owner or secured financier of aircraft which the Company plans to retain after completion of the Restructuring (“Retained Aircraft”). Each Critical Lessor will receive (Clause 13 of the Scheme):

(i)  In respect of its Reduction Portion, the Cash Option or the Equity Option as selected by the Critical Lessor prior to the Voting Record Time, and a Replacement Claim against AssetCo2;

(ii)  In respect of the Reduced CL Debt Amount, fixed monthly instalments, the amount of which depends on the model of the Retained Aircraft. As this is in effect an extension of the Retained Aircraft leases or loan, the Critical Lessor must consent to this treatment of the Reduced CL Debt Amount.

(b)  The other class of the Scheme Creditors are the Unsecured Creditors. Each Unsecured Creditor will receive a Replacement Claim against AssetCo1 (Clause 12 of the Scheme).

9.  The Scheme Creditors’ recovery analysis is as follows:

(a)  For the Unsecured Creditors, recovery under the Scheme is estimated to be 5.1%-8.7%, whereas recovery in the Company’s liquidation is estimated to be 0.7%-1.3%.

(b)  For the Critical Lessors, recovery under the Scheme is estimated to be 5.1%-10.1%, whereas recovery in the Company’s liquidation is estimated to be 4.1%-5.8%.

10.  The Scheme and the UK Plan are in essence inter-conditional because the approval of both are conditions precedent to the New Investor’s investment. On 9 December 2022, the English court sanctioned the UK Plan, which was unopposed. Sir Alastair Norris handed down his reasons on 14 December 2022.

Criteria which guide the Court in determining whether to sanction a scheme

11.  In considering whether to sanction a scheme, the Court applies some well-established principles which I recently summarised in Re China Singyes Solar Technologies Holdings Ltd [2]. The Court considers in particular the following:

(a)  whether the scheme is for a permissible purpose;

(b)  whether creditors who were called on to vote as a single class had sufficiently similar legal rights such that they could consult together with a view to their common interest at a single meeting;

(c)  whether the meeting was duly convened in accordance with the Court’s directions;

(d)  whether creditors have been given sufficient information about the scheme to enable them to make an informed decision on whether or not to support it;

(e)  whether the necessary statutory majorities have been obtained;

(f)  whether the Court is satisfied in the exercise of its discretion that an intelligent and honest man acting in accordance with his interests as a member of the class within which he voted might reasonably approve the scheme; and

(g)  in an international case, whether there is sufficient connection between the scheme and Hong Kong, and whether the scheme is effective in other relevant jurisdictions.

Permissible purpose

12.  As in Singyes, the Scheme is a genuine debt restructuring of a distressed company. As part of the debt restructuring, it is a permissible purpose for a scheme to release obligations of third parties, such as the scheme company’s guarantors and joint obligors. Where the scheme company is a guarantor, the scheme may release the principal obligors. See Re Unity Group Holdings International Ltd [3] .

13.  The Scheme seeks to discharge Related Guarantors and Related Debtors. The Related Debtors are primary obligors where the Company is a guarantor. In order to permit the Scheme to discharge debts owed by the principal obligors (i.e. the Related Debtors), the Company has entered into a number of deeds of contribution, whereby it agreed to be liable to each of such Group Companies (as primary debtors / obligors) to make, on demand, a contribution in respect of any amounts that are paid by that Group Company towards the discharge of its primary liabilities. Accordingly, those Group Companies will have rights of contribution against the Company in respect of their primary liabilities. The use of a deed of contribution to permit a guarantor’s scheme to discharge debts owed by the principal obligors is a well-established technique in England, although the technique is not needed in Hong Kong (Re Unity Group Holdings International Ltd[4]). As there is a parallel UK Plan, the Company consistent with UK practice entered into deeds of contribution.

Class considerations

14.  In considering whether creditors are properly classified, the test is whether creditors who are called on to vote as a single class have sufficiently similar legal rights that they could consult together with a view to their common interest at a single meeting. The relevant principles may be summarised thus:

(a)  The overarching question is whether the pre and post-scheme rights of those proposed to be included in a single class are so dissimilar as to make it impossible for them to consult with a view to their common interest. If that is the case, separate meetings must be summoned.

(b)  The second principle is that it is the rights of creditors, not their separate commercial or other interests, which determine whether they form a single class or separate classes. Conflicting interests will normally only ever arise at the sanction stage as a question for consideration.

(c)  The third principle is that the court should take a broad approach to the composition of classes, so as to avoid giving unjustified veto rights to a minority group of creditors, such that the test for classes becomes an instrument of oppression by a minority.

(d)  The fourth principle is that the court has to consider, on the one hand, the rights of the creditors in the absence of the scheme and, on the other hand, any new rights to which the creditors become entitled under the scheme. If, having carried out that exercise, there is a material difference between the rights of the different groups of creditors, they may, but not necessarily will, constitute different classes. Whether they do so depends on a judgment as to whether such a difference makes it impossible for the different groups to consult together with a view to their common interest.

(e)  In applying the above test, the starting point is to identify the appropriate comparator: that is, what would be the alternative if the scheme does not proceed.

See Re China Oil Gangran Energy Group Holdings Ltd [5].

15.  In my view the Scheme properly placed the Scheme Creditors in two classes, namely the class of the Unsecured Creditors and the class of the Critical Lessors. The classification is consistent with the above principles for the following reasons. First, the Unsecured Creditors are properly placed in one class. They hold Unsecured Scheme Claims which are the ordinary unsecured debts of the Company and they are given the same Restructuring Consideration. Although certain Unsecured Creditors have Claims against the Company which are in part secured, the Scheme will only apply to the Unsecured Portion of their Claims. This an established practice in Hong Kong: see Re I-China Holdings Ltd [6]; Re Dickson Group Holdings Ltd[7]; Re Century Sun International Ltd[8]. Secondly, the Unsecured Creditors and the Critical Lessors need to be in different classes because they are given different Restructuring Consideration. Thirdly, the Critical Lessors are properly placed in one class because there are 13 Critical Lessors, namely: China Development Bank (“CDB”) who is a financier and holds security in respect of six Retained Aircraft owned by six of the SPV Borrowers and leased to the Company; and twelve lessors (“Lessors”) in respect of the remaining 14 Retained Aircraft leased to the Company. CDB and the Lessors’ pre-scheme rights are essentially identical because in the event of the Company’s liquidation. The Lessors will have unsecured claims against the Company in respect of payments due under the leases. CDB will have claims against the Company in respect of payments due under the loans taken out by the SPV Borrowers (“SPV Loans”) and in respect of which the Company had assumed liability pursuant to a covenant to pay. Although CDB holds security over the Company’s shares in the SPV Borrowers, the security is valueless. Therefore, CDB’s claims against the Company are in reality unsecured. The technical existence of worthless security would not render CDB a secured creditor for classification purposes: Re Metinvest BV.[9] Upon the Company’s default, CDB and the Lessors can terminate the leases and recover the aircraft.

16.  The Restructuring Consideration given to the Critical Lessors is similar in principle, but is different in terms of the length of the lease or loan extension at the Critical Lessors’ option. The difference is necessitated by the different models of the Retained Aircraft held by each Critical Lessor. Such necessary differences would not fracture the class. Zacaroli J considered class classification in a scheme also restructuring the debt of an airline group in Re MAB Leasing Ltd[10]. His analysis of the classes in that case is instructive:

“Turning to the rights conferred by the scheme, all creditors are given the same four options. One option is to terminate the lease, recover the aircraft and receive a one-off termination payment. That payment will be calculated as 115% of what the creditors would have received from the company in its liquidation, assuming that a dividend would be paid at the upper-end of the range of estimated outcomes.

Alternatively, creditors can opt to continue the lease, in which case they will be entitled to receive a substantially reduced rent for 2021, calculated by reference to how much the aircraft has used, subject to both a floor and a cap. This is called a ‘power by the hour basis’, which differs for each of the three types of aircraft under lease, together with one of the following three options –

1. After 2021, the lease rentals will be reset to market rates. The market rates have been arrived at through negotiation, but have been confirmed by expert valuation evidence, which indicates that the rates to be offered are within the range of market rates for each aircraft.

2. After 2021, the lease rentals will be reset to an amount slightly uplifted from market rates, but with the company having the option to defer payment and with the option to extend the agreement for a further defined period, both depending on certain conditions being satisfied.

3. The third of these options is that after 2021, the lease rentals will be reset to market rent plus an uplift by reference to the higher of the multiple of 1.25 or the company’s EBITDA, again, with an option for the company to defer payment.

Since in each scenario the rent is to be set by reference to market rates, it will differ for each aircraft, depending on its type and vintage.

The first point to note is that the mere fact the scheme creditors may end up with different rights under each of the four options does not fracture the class. The difference in rights is as a result of the election they make. As far as rights conferred by the scheme are concerned, they are all given precisely the same right to choose between the four options.”

17.  The fact that Critical Lessor’s new rights differ by virtue of the commercial characteristics of the underlying commercial transaction does not in my view make it impossible for the Critical Lessors to consult together with a view to a common interest.

18.  Fourthly, although the class of the Unsecured Creditors will include members of the Class of the Critical Lessors because the latter also hold some Unsecured Scheme Claims, such cross-holdings would not fracture the class: Re Steinhoff International Holdings NV[11].

Meeting

19.  I am satisfied that the Convening Order has been complied with. During the Scheme Meetings held on 1 December 2022, the Scheme Creditors in each class duly voted in favour of the Scheme: see the Chairperson’s Report. The requirements under section 674(1)(b) of the Ordinance that the Scheme be approved by a majority in number representing at least 75% in value of the Creditors present and voting in person or by proxy have been satisfied.

Explanatory Statement

20.  After the Scheme and Explanatory Statement were circulated to the Scheme Creditors in accordance with the Convening Order, the Company provided two supplements to the Scheme Creditors. On 17 November 2022, the Company circulated to the Scheme Creditors the first supplement to the Explanatory Statement (“First Supplement to the Explanatory Statement”). The First Supplement to the Explanatory Statement arose out of discussions between the Company and some creditors concerning, inter alia, some additional consideration to be provided to the Scheme Creditors, a proposed amendment to the definition of “Excluded Claim” requested by CDB, a significant claim made by a creditor which exceeded the claim recorded in the Company’s books (but which adverse effect on Scheme Creditors is mitigated by an anti-dilution mechanism introduced by the Company in the Restructuring Documents), and some timetabling changes. On 25 November 2022, the Company circulated to the Scheme Creditors the second supplement to the Explanatory Statement (“Second Supplement to the Explanatory Statement”). The Second Supplement to the Explanatory Statement explained some clarificatory amendments to be made to the Scheme.

21.  It is well-established that there is nothing objectionable for a scheme document to be amended after its circulation, as long as those who would be called upon to vote on it are giving adequate notice of the changes: Re Hidili Industry International Development Ltd[12]. Here the Scheme Creditors were given sufficient notice of the amendments to the Scheme because the Scheme Meetings were adjourned to 1 December 2022.

22.  To satisfy the requirements of section 671(3) of the Ordinance, an explanatory statement must be sufficiently informative:

“A company is under a duty to include in the explanatory statement all the information necessary to enable the creditors to form a reasonable judgement on whether the scheme is in their best interests or not, and hence how to vote. The extent of the information required to be provided will, of course, depend on the facts of the particular case. Necessarily, the duty extends to the company providing up to date information, or an adequate explanation of why it has not done so, that will allow a creditor to contrast what is to be anticipated if the scheme is approved, and the outcome if it is not. A company is required to provide specific financial information to support its predicted outcomes, and I would normally expect it to have its views independently verified by an insolvency practitioner or other suitable professionals”[13].

23.  In my view the Explanatory Statement clearly satisfies the requirements of section 671(3).

Court’s Discretion

24.  Even if the requirements that I have addressed above are met, the Court has a discretion to decline to sanction a Scheme if it is not satisfied that it is one an intelligent and honest man would approve. Formulating the criteria in less technical language: is it broadly fair? However, the Court should be slow to differ from the majority views, as the Court normally acts on the principle that businessmen are much better judges of what is to their commercial advantage than the court could be: Re Allied Properties (HK) Ltd [14].

25.  The primary object of the Scheme is that, upon the Scheme becoming effective, the Scheme Claims will be discharged and in return the Scheme Creditors will be entitled to the relevant Scheme consideration. The evidence supports the view that the Scheme consideration provides the Scheme Creditors with a better return than in an insolvent liquidation of the Company. The Scheme is thus the one that an intelligent and honest creditor can sensibly be expected to approve.

26.  The Scheme’s effectiveness is subject to Restructuring Conditions, namely:

(a) the Scheme Effective Date having occurred;

(b) all necessary consents, approvals or authorisations for the effectuation of the Scheme and the Restructuring having been obtained, including, without limitation, all necessary consents, approvals or authorisations from any and all relevant governmental bodies;

(c) the New Investor having paid, in cleared funds, an amount of HK$3,000,000,000 to the Company, in exchange for the issuance of the New Investor Shares;

(d) each of the Restructuring Documents having been executed by or on behalf of each of the parties thereto;

(e) at least two Critical Lessors having given their consent, whether actual or deemed, to the Proposed Modifications in accordance with Clause 13.21 of the Scheme; and

(f) the Company having paid, or caused to be paid, all outstanding fees, costs and expenses of the Company Advisers reasonably incurred in connection with the Restructuring, and duly invoiced to the Company at least five Business Days before the Restructuring Effective Date or such later date as may be agreed by the Company with the relevant Company Adviser, provided that the Restructuring Effective Date shall not be delayed solely by reason of any non-payment of professional fees (in the nature of success fees or otherwise) to the extent the quantum can only be calculated, or will only become due and payable, at a later date, in accordance with the relevant engagement letter.

27.  This is not uncommon and the Court may sanction a scheme which is subject to conditions. The principles are well established:

“[The authorities] discuss and confirm three important principles which are of more general application.

The first is that the court will always wish to ensure that it does not act in vain.

That is not to say that the court requires certainty that a condition will be satisfied, a principle which is illustrated by Sompo Japan Insurance Inc v Transfercom Ltd [2007] EWHC 146 (Ch) in which the court was prepared to sanction a business transfer scheme even though David Richards J was, as he put it at paragraph 26 of his judgment ‘less than convinced’ that the scheme once sanctioned will definitely be effective. The degree of assurance the court requires will depend on all the circumstances of the case. Thus, it is relevant that in Sompo the scheme was in any event going to be effective in part, because the question that arose related to its recognition in another jurisdiction, not whether it might be ineffective more generally.

The second principle is that the court will be unlikely to sanction a scheme if the condition is one which gives a discretion to a third party as to whether or not they will take some step necessary to render the scheme effective. Henderson J made this clear in the passage from Lombard Medical that I have already cited. In my view what he said was consistent with sound principle. If the satisfaction of a condition to the effectiveness of the scheme as a whole is left to the ultimate discretion of a third party, it is capable of cutting across the requirements of creditor approval, court sanction (in which the court not any other person is required to exercise a discretion) and registration, which are the three steps for plan effectiveness for which the statute provides.

The third important principle of more general application is one of clarity and certainty. Provided that clarity and certainty are present on the face of the scheme or plan and no further decision-making process is required, in other words it is self-executing without the further intervention of an interested third party, there is much less likely to be a problem”[15].

28.  Having regard to these principles it does not seem to me that the conditions represent any impediment to the Court sanctioning the Scheme:

(a) a number of the conditions are within the Company’s control, such as the occurrence of the Scheme Effective Date;

(b) all relevant parties are committed to the successful implementation of the Scheme; and

(c) the Company does not expect any insuperable difficulties in terms of authorisations from the relevant governmental bodies.

29.  Therefore, in sanctioning the Scheme, the Court would not be acting in vain. It will be facilitating the restructuring, which given its complexity unsurprisingly contains components which have a degree of uncertainty attached to them; but not in my view sufficient to constitute a reason for the court to withhold sanction.

International effectiveness

30.  In an international case, the Court will consider whether the scheme is effective in other foreign jurisdictions of practical importance. It would not be a proper exercise of discretion to sanction a scheme that serves no purpose. In practice whether or not a jurisdiction is of practical importance to the efficacy of a scheme sanctioned in Hong Kong will commonly be determined by the following considerations:

(a) Is a material amount of debt to be compromised by the scheme governed by the law of a jurisdiction other than Hong Kong?

(b) Even if there is some doubt as to whether or not a scheme will compromise a proportion of the debt, is there any reason to think that the creditors will take action in a jurisdiction which will not recognise a scheme as compromising the debt?

(c) The amount of the debt involved. If, for example, the amount of debt that is not governed by Hong Kong law is less than the cost of introducing a parallel scheme it makes more sense to exclude that debt from the scheme and settle it separately if it is ever pursued. See China Oil at [21]-[23].

31.  As mentioned above, most of the Company’s debts are governed by Hong Kong law, while the remaining debts are governed by Mainland law and English law (such as the Perpetual Notes). As regards debts governed by English law, they are subject to the UK Plan. As regards debts governed by Mainland law, the Scheme is expected to be internationally effective because no holder of any Mainland law debt has come forward to oppose the Scheme or the UK Plan. Further, the Company has no meaningful assets in the Mainland. The risk of adverse enforcement by any hold of the Mainland Law debt is remote. A remote risk of adverse enforcement by creditors would not hamper the effectiveness of the Scheme : See Re Century Sun International Ltd[16].

Conclusion

32.  For the reasons I have explained I will make an order sanctioning the Scheme.