During the first quarter of 2024, appellate and bankruptcy-specialized courts worldwide set significant precedents in several high-profile cases. In the US, the Court of Appeals for the Third Circuit reversed a decision issued in the FTX Trading Chapter 11 case, finding that a bankruptcy court must grant a request by the US Trustee to appoint an examiner in large Chapter 11 cases in which there is suspected fraud or misconduct. In the UK, in an appeal filed by Adler bondholders, the English Court of Appeal overturned a restructuring plan sanction order after finding that the plan violated the pari passu principle. 1Q24 was also marked by a decision issued by the Hong Kong High Court to wind-up the ultimate holdco of China’s Evergrande and a decision by the Brazilian bankruptcy court concerning unprecedented provisional prepackaged plans and other matters of first impression in Unigel’s challenged restructuring process.

Given the importance of these cases and the unprecedented nature of some of the holdings, these rulings are expected to guide strategic decisions and impact prospective rulings to be issued in similar disputes in the future in their respective jurisdictions. In this quarterly report, the Debtwire legal analyst team takes a closer look at these bankruptcy-related decisions issued across the US, the United Kingdom, the Asia-Pacific (APAC) and the Latin America (LatAm) regions.

Source: Debtwire’s Restructuring Database

North America – Third Circuit appellate court decision ensures that examiner appointment is mandatory in large Chapter 11 cases involving allegations of management misconduct

In the first quarter of 2024, the US Court of Appeals for the Third Circuit issued an important decision that will affect bankruptcy cases filed in some of the most popular restructuring jurisdictions in the US – ie Delaware and the increasingly busy jurisdiction of New Jersey, as well as the state of Pennsylvania. The court held that in large Chapter 11 cases, a bankruptcy court must grant a request by the US Trustee to appoint an examiner in cases that involve allegations of fraud or misconduct by the debtor and its management. As Delaware has been one of the main venue choices for large Chapter 11 filings, the decision has the potential to impact some of the most significant bankruptcy cases involving allegations of fraud and/or mismanagement filed in the US.

Background

In November 2022, cryptocurrency company FTX Trading experienced a “catastrophic” value crash after it came to light that FTX had used software to transfer customer funds to another allegedly independent company, Alameda Research.[1] In the wake of that revelation, customers withdrew billions of funds from FTX, which caused a severe liquidity crisis for the company. In response to the crash, Samuel Bankman-Fried, who was the primary owner of both FTX and Alameda, appointed a new CEO, John J. Ray, III. Soon after his appointment, Ray put the company in Chapter 11.

In a report issued after the bankruptcy filing, Ray, who previously served as president of Enron Creditors Recovery Corp, lambasted the debtors’ prepetition management, stating that he had never “seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information.” He criticized the company’s lack of appropriate corporate governance and its “cash management failures,” which included failures to centralize control of its cash, keep an accurate list of bank accounts or accurate financial statements, and implement a proper cash disbursement system. He also identified unauthorized cryptocurrency transfers in the hundreds of millions of dollars and the unauthorized minting of USD 300m in cryptocurrency.

A few weeks after the filing of the bankruptcy petitions, the US Trustee filed a motion for the appointment of an examiner pursuant to section 1104(c) of the US Bankruptcy Code, which provides that:

“[i]f the court does not order the appointment of a trustee under this section, then at any time before the confirmation of a plan, on request of a party in interest or the United States trustee, and after notice and a hearing, the court shall order the appointment of an examiner to conduct such an investigation of the debtor as is appropriate, including an investigation of any allegations of fraud, dishonesty, incompetence, misconduct, mismanagement, or irregularity in the management of the affairs of the debtor of or by current or former management of the debtor, if—

(1) such appointment is in the interests of creditors, any equity security holders, and other interests of the estate; or

(2) the debtor’s fixed, liquidated, unsecured debts, other than debts for goods, services, or taxes, or owing to an insider, exceed $5,000,000.” (emphasis added)

The US Trustee argued that an examiner could investigate the actions of the company’s prepetition management in a faster and more cost-effective manner than the debtors and could expose the “wider implications” of FTX’s collapse for the cryptocurrency market. He argued that the appointment was mandatory upon request based on the plain meaning of section 1104(c)(2).

The debtors and the official committee of unsecured creditors (UCC) objected to the motion, arguing that because of the inclusion of the phrase “as is appropriate” in the statute, the appointment of an examiner was a matter of the Bankruptcy Court’s discretion. They contended that, in the case of FTX, the appointment of an examiner was unwarranted because it would impose additional costs, interfere with the efforts to stabilize the debtors, and duplicate the previous findings of wrongdoing by management.

The Bankruptcy Court agreed that the appointment of an examiner was discretionary and declined to appoint one. The US Trustee then appealed the decision to the US Court of Appeals for the Third Circuit (Appellate Court).

Third Circuit Appellate Court decision

In a decision issued on 19 January, the Appellate Court held that section 1104(c)(2)’s “plain language” mandated that an examiner be appointed upon request of the US Trustee or a “party in interest,”[2] provided that the debtor meets the statutory debt minimum. In so ruling, the Court placed a strong emphasis on the phrase “shall order the appointment of an examiner to conduct such an investigation of the debtor as is appropriate,” concluding that “shall” is an unambiguous “word of command . . . that normally creates an obligation impervious to judicial discretion.” The Court rejected the debtors’ argument that the phrase “as is appropriate” gives a bankruptcy court discretion to appoint an examiner if it decides an investigation would “suit the circumstances” because that phrase applied only to the nature of the examination and not the appointment of the examiner in the first instance.

The Appellate Court also held that interpreting the statute to find that the appointment of an examiner is discretionary would require the Court to “disregard[] direct evidence of Congress’s intent.” Looking to the Congressional Record, the Court found that Congress had wanted an examiner to be appointed “automatically” in large cases to preserve the interests of debtors, creditors, and the public interest and to ensure that there would be an adequate investigation that would ferret out any fraud or wrongdoing by a company’s management. According to the Court, the speed and fairness of the examination would be ensured by separating the investigation from the reorganization process and preventing the examiner from profiting from the results of their work.

Although the Appellate Court found that the appointment was mandatory, it emphasized that the statute leaves room for discretion. First, it noted that the filing of a motion to request an examiner was still a discretionary act. The Court was not swayed by the debtors’ argument that granting this discretion to every “party in interest” would “encourage abuse,” and concluded that the fact that the statute left open the potential for abuse did not make the grant of discretion “absurd.” Second, the Court held that the phrase “as is appropriate” leaves a bankruptcy court with “broad discretion” to direct the scope, degree, duration and cost of the examination. It explained that “by setting parameters, the bankruptcy court can ensure that the examiner is not duplicating other parties’ efforts and the investigation is not unnecessarily disrupting the reorganization process.” The Appellate Court further noted that a bankruptcy court can counter attempts to invoke the appointment of an examiner as a delay tactic by proceeding with the confirmation process before it receives the examiner’s report.

The Appellate Court responded to arguments by FTX and the UCC that an examiner’s investigation would be wasteful and duplicative of their own investigations by explaining how an examiner’s investigation is unique. Specifically, it noted that an examiner must be “disinterested,” must not have any interest that is “materially adverse” to the bankruptcy estate, and answers “solely” to a bankruptcy court. The Court further reasoned that the disinterestedness requirement was “particularly salient” in the FTX case because the question regarding the disinterestedness of Sullivan & Cromwell (S&C), the debtors’ prepetition and bankruptcy counsel, had been “raised repeatedly.” The Court also emphasized that, unlike a debtor-in-possession or an official committee of unsecured creditors, an examiner must make its findings public, which furthers Congress’s intent to protect the public interest.

FTX aftermath

Shortly after the Appellate Court issued its decision, the battles among counsel for FTX, the US Trustee and the UCC shifted, predictably, to the questions regarding the timing and scope of the examination.

At a status conference on 24 January, counsel for FTX and the UCC pressed to have the scope and cost of the examination determined as soon as possible to avoid any interference with the plan confirmation schedule, whereas the US Trustee expressed a preference to wait until the appellate court’s mandate was issued and the examiner was appointed. While Delaware Bankruptcy Court Judge John Dorsey agreed with the US Trustee on the procedures for appointing the examiner, he also stated that he did not want to “reinvent the wheel” with respect to the scope of the examination. To avoid this, he proposed that the examiner review prior and existing examinations of FTX, issue an initial report within 30-45 days after appointment, and make recommendations for any further examination, including the nature of the investigation, process, and costs.

On 26 February, Judge Dorsey entered an order directing the US Trustee to appoint an examiner and two days later, on February 28, the US Trustee moved to appoint Robert Cleary as examiner. The cost of the examination was estimated to range between USD 1.1m and USD 1.6m. On 20 March, Judge Dorsey approved the motion and ordered a 60-day review of the investigations conducted by the debtors, the UCC and any other third parties and the issuance of a report summarizing the findings and making recommendations for additional investigations. Judge Dorsey also ordered the examiner to review (i) his ruling approving the hire of S&C as debtor’s counsel, including any previously unaddressed conflicts of interest,[3] (ii) whether the previous investigations sufficiently addressed fraud by the debtors’ employees and whether the employees involved in that fraud were still employed by the debtors, and (iii) whether the prior investigations adequately addressed the debtors’ use of its cryptocurrency to inflate the value of FTX and Alameda.

Going forward

The FTX decision places courts within the Third Circuit firmly in the camp of the majority of courts, including the US Court of Appeals for the Sixth Circuit,[4] that have held that the appointment of an examiner is mandatory upon request in large bankruptcy cases.[5] Going forward in that jurisdiction, parties involved in Chapter 11 cases in which management misconduct or fraud is suspected can be assured that, if they cannot satisfy the exacting “for cause” requirement for the appointment of a Chapter 11 trustee, an examiner will be appointed upon request by the US Trustee. Because the examiner’s report is public, creditors and other parties will have a tool to ensure that any management misconduct will be exposed. In addition, an investigation may unearth potential misconduct by, and claims against, previously unidentified parties that could provide additional avenues for recovery by creditors.

The increased availability of an examiner could also impact the litigation dynamics in Chapter 11 cases. As shown above, in FTX, the debtors expressed concern that the examiner’s investigation would impact the timeframe for confirming a Chapter 11 plan. Findings in the examiner’s report could also potentially influence creditor voting on plans, particularly plans that propose third party releases of suspected wrongdoers and would thereby extinguish claims that could be a source of recovery for creditors.

The fact that an examiner is available upon request in large cases arguably could enable a party in interest to abuse that power to gain a litigation advantage. However, the Court found that much of this potential for abuse can be mitigated by the bankruptcy court’s “broad discretion to direct the examiner’s investigation, including its scope, degree, duration and cost.” This was demonstrated in the FTX case, where, to keep costs down, Judge Dorsey limited the scope of the examiner’s initial investigation to a review of the prior investigations and to make recommendations as to what supplemental investigation may be needed.

UK – Court of Appeal’s inaugural consideration of restructuring plan tool sends ripples through the process  

In the UK, the most notable decision of 1Q24 came in relation to German real estate group Adler’s UK restructuring plan. The decision made legal history in January as the English Court of Appeal (CoA) allowed an appeal by a group of disgruntled noteholders, and ultimately overturned the High Court’s April 2023 decision to sanction the plan.

Source: Debtwire’s Restructuring Database

This was the first time the UK’s restructuring plan tool – which came into force in 2020 – has been considered by the appellate court. In his detailed judgment, the ever-scrupulous Lord Justice Snowden offered a wealth of essential guidance for practitioners – unpacking past restructuring plan cases along the way. The judgment is now the leading authority on UK plans and will shape the future of the tool – heralding a shift in the way future plans are dealt with. In particular, the court’s approach to the exercise of its discretion to sanction a plan now differs according to whether or not a cross-class cram down (CCCD) is sought. The impact of the Adler judgment has already been felt in several significant cases, noted below.

In the first of a two-part analysis, Debtwire’s legal team recapped the background before considering key points and lessons from the judgment in relation to the court’s discretion to sanction plans in cases involving CCCD, including looking at the pari passu principle, vertical and horizontal comparisons, fairer plans and shareholder retention of equity.

In Part 2, we examined the CoA’s guidance on procedural matters, including timetabling, appeals and documents – all of which is essential reading for practitioners in the restructuring field.

We also discussed the judgment with Freshfields’ Craig Montgomery and Lindsay Hingston in this podcast. The following tables summarize the key terms of the plan and grounds for appeal.

The appeal centered around the pari passu principle. The CoA ultimately concluded that due to the sequential payment of the different series of notes (as opposed to imposing uniform maturity dates), the plan departed from the pari passu distribution of the group’s assets to noteholders that would have applied in the relevant alternative (insolvency) without adequate justification. This, the appellants had argued, placed a materially greater risk of non-payment to the 2029 noteholders than to other noteholders, without good reason.

A further argument was that the plan was unfair to the 2029 noteholders because it required them to bear the greatest risk of non-payment, while leaving the parent company’s shareholders (who would of course rank below them in a formal insolvency) still holding their shares (albeit diluted to 77.5% due to the additional 22.5% of new shares issued to the new money providers). Snowden LJ rejected this aspect of the appeal.

Market players were not kept waiting long for the impact of the Adler judgment to play out in practice. The following month, the English High Court sanctioned international engineering, procurement and construction group McDermott’s UK restructuring plan following a heated six-day trial in February. The court’s verdict was eagerly anticipated in restructuring circles, given it was the first UK restructuring plan to be sanctioned following the CoA’s landmark decision in Adler, as well as the longest restructuring plan sanction hearing to date. In his judgment, Mr Justice Michael Green applied some of the points raised in the Adler judgment in sanctioning McDermott’s plan – although much of his judgment relates to the rather unique circumstances of the case.  Our analysis is HERE.

The judge – who was critical of the conduct of dissenting creditor Refinería de Cartagena SAS (Reficar) and considered it “unfortunate” that Reficar was unable to agree to a deal that would have shortened the trial – ultimately accepted the company’s case that the “relevant alternative” to the plan was liquidation. Reficar’s failure to accept a deal that was essentially what it had been negotiating for fatally undermined its arguments on the point. The judge also concluded that Reficar’s treatment under the plan was fair. The case serves as a warning to dissenting stakeholders who are essentially trying to put a gun to plan companies’ heads – without actually proposing a sensible alternative solution.

A further standout point was the judge’s admission that he was “horrified” by the company’s USD 150m fees, which is notable given concerns to date of the costs of UK restructuring plans, with associated question marks over the suitability of the procedure for smaller entities.

Significantly, the plan, which was proposed by McDermott group entity CB&I UK Limited, was part of a wider restructuring effort involving two parallel restructuring plans for the group in the Netherlands under the new Dutch Wet Homologatie Onderhands Akkoord process (WHOA plans) promoted by Dutch group companies, McDermott International Holdings BV (MIH) and Lealand Finance Company BV (LFC). The purpose of the WHOA plans is to ensure that the plan is binding and effective on the creditors of MIH and LFC. The UK plan and the WHOA plans were inter-dependent upon each other.

The Adler judgment also had a knock-on effect on Aggregate Holdings’ restructuring plan, after it was handed down mid-way through Aggregate’s process. Mr Justice Richards finally signed off on a restructuring plan for a subsidiary of the German real estate company in March after having refused to sanction the plan following the original sanction hearing.

The High Court had earlier refused to sanction the plan, proposed by subsidiary Project Lietzenburger Straße Holdco SàrL, in the form it had been presented and voted upon. Nor would the judge sanction it there and then in a revised form. Rather, the court convened a new plan meeting to consider an amended plan, ordering under s.901C(4) of the Companies Act 2006 that so-called Tier 2 and junior creditors be disenfranchised from voting on the basis that they had no genuine economic interest in the company. The judge proceeded on the basis that, should the amended plan be approved by the senior creditors class, then it could be sanctioned without any need for a CCCD.

Significantly, the original convening order had been made, and the vote had been held, before the CoA gave its landmark judgment in Adler. The plan contained a provision under which certain subordinated debt was to be cancelled for no consideration, giving rise to the issue as to whether the plan constituted a “compromise or arrangement” with subordinated creditors such as to engage the court’s jurisdiction to sanction it; hence the later amendments to the plan to ensure that it did embody a “compromise or arrangement” with subordinated creditors.

Our analysis of the judgment is HERE.

APAC – Evergrande’s Hong Kong liquidation set to test PRC/HK cooperation

One event stood out above all others in APAC’s Q1 debt restructuring sector – the Hong Kong High Court’s bold decision to wind-up the ultimate holdco of the People’s Republic of China’s (PRC) second largest real estate group, China Evergrande Group (Evergrande).

Source: Debtwire’s Restructuring Database

Evergrande’s collapse captured worldwide attention. Understandably so – the numbers are startling: 1,300 projects in more than 280 cities across the PRC; total liabilities of over USD 330bn; nearly USD 25bn owed to offshore investors; combined losses of USD 81bn in 2020 and 2021; and (allegations of) up to USD 78bn of inflated revenue. But the real intrigue lay in the geo-political context to its collapse. How would foreign creditors be treated in a restructuring of such a systemically and socially important Chinese housing provider? Would creditors dare to enforce their rights offshore? Would a Hong Kong court be so brave as to cast the world’s most indebted property developer into liquidation? And if it did, how would the PRC authorities and courts react?

On 29 January, we got the answer to the first two of those questions when Justice Linda Chan of the Hong Kong High Court appointed Edward Simon Middleton and Wing Sze Tiffany Wong of Alvarez & Marsal Asia as liquidators. Globally, that might have come as a surprise. But in truth, the writing had been on the wall for months. The Hong Kong court had repeatedly warned Evergrande that it needed to make tangible progress toward a viable, creditor-supported restructuring or face liquidation. The company seemingly avoided that fate in December thanks only to a last-minute change of heart by petitioning creditor Top Shine Global Limited (which decided to support the company’s request for more time). But by end-January, enough was enough. Evergrande’s failure to put forward any semblance of a plan was the final nail.

Now we wait to see what Evergrande’s liquidators can achieve. Meaningful recoveries for offshore creditors remain a longshot – a sale of offshore assets is unlikely to offer significant returns, and, for the most part, the group’s onshore assets (accounting for 90% of total assets) will likely remain legally, practically, and politically out of the liquidators’ reach. But there is hope. Evergrande’s liquidators will no doubt look to resurrect an offshore restructuring with the cooperation of the group’s existing management. That restructuring might even involve creditors receiving a sizeable equity stake in whatever “new” Evergrande emerges from the ashes. And then there are the likely third-party claims against auditors, advisers, related entities, and directors. They won’t be resolved quickly, but could eventually boost recoveries (and cover liquidation costs).

Three strikes and you’re out

Fearing the worst, offshore creditors were initially reluctant to cast Evergrande into the liquidation abyss. Top Shine’s June 2022 winding-up petition was adjourned for over a year – hanging like the sword of Damocles – while Evergrande (advised by Sidley Austin and Houlihan Lokey) looked to pull together a comprehensive restructuring of the group’s offshore debts, supported by creditors including an ad hoc group (AHG) holding more than USD 2bn in aggregate outstanding principal of Evergrande’s offshore notes and USD 1 bn of subsidiary Scenery Journey’s offshore notes (advised by Kirkland & Ellis and Moelis & Co). By mid-2023, significant progress had been made. Term sheets were signed in March, and in April, the AHG signed off on a restructuring support agreement. In July, the company provided all scheme creditors with information in respect of its three proposed schemes of arrangement, and creditor meetings were scheduled for late August, with sanction hearings to follow in early September (if creditors approved the schemes).

But then things fell apart. First, Evergrande adjourned the proposed scheme meetings. Then, in late September, it cancelled them. Not only had sales results been weaker than expected (requiring the company to re-assess the terms of the schemes), but Evergrande had also received news that it would be unable to procure the regulatory approval required to issue new debt instruments as scheme consideration because of ongoing regulatory investigations into its affairs. Let’s call that strike one.

For the time being, however, the AHG remained supportive of Evergrande’s efforts to negotiate a revised restructuring proposal. So in October, the court agreed to once again adjourn the winding-up petition, this time until December 2023. Justice Linda Chan, however, was already losing patience, and expressly put Evergrande on notice that if it failed to work with creditors to come up with a viable plan before the next hearing, the company would be wound up.

For whatever reason, Evergrande didn’t seem to heed the court’s warning. By early December, little progress had been made. The company claimed it was discussing a new framework that would bypass its regulatory roadblock by providing creditors with (inter alia) scheme consideration in the form of: (i) 17.8% of Evergrande’s post-restructuring equity, plus roughly half of Evergrande’s holdings in two offshore subsidiaries – China Evergrande New Energy Vehicle Group (NEV) and Evergrande Property Services Group (PSG); and (ii) non-tradeable certificates backed by offshore assets representing the remainder of their claims, which would be redeemed upon the successful disposal of those assets (but would not constitute debt instruments requiring regulatory approval). But Justice Chan was again unimpressed. In her view, the framework fell well short of a fully-formulated restructuring proposal, and there was no analysis – legal or financial – confirming its viability or estimated creditor returns. Strike two.

Evergrande could well have been wound up on the spot if it wasn’t for a last-minute change of heart by Top Shine. Top Shine had initially indicated that it would push for Evergrande’s liquidation at the December court hearing. In its view, insufficient progress had been made: there was no confirmation that the certificates could be issued without regulatory intervention; there was no evidence the company could be returned to financial viability in the short or medium term; there was no evidence as to what would happen to the group’s PRC assets (and whether equity holders would benefit from those post-restructuring); and there was no evidence that the restructuring would yield a better result than liquidation. But Top Shine then changed its stance without warning, catching everyone off guard and causing Justice Chan to reluctantly grant Evergrande an eight-week reprieve.

For the second time, however, Justice Chan made it clear that Evergrande must make real progress if it wished to avoid liquidation. To that end, the judge directed Evergrande to provide the court with an update seven days before the next petition hearing demonstrating: (i) a refinement of its restructuring proposal; (ii) evidence of support from the requisite majorities of scheme creditors; (iii) an independent legal opinion on the regulatory issues which were said to have prevented the issuance of new shares or debt instruments; and (iv) full transparency on its broader restructuring efforts. The judge also directed Top Shine to give seven days’ notice whether it intended to seek a winding up-order at the next hearing.

In short, if the writing wasn’t on the wall before the December hearing, it certainly was after it. And yet Evergrande still failed to comply with Justice Chan’s directions. No revised restructuring proposal was provided to the court and no disclosures were made seven days before the hearing. Strike three.

All the company did was belatedly ask the court for another three months to formulate a plan based upon a new, ten-page outline of a restructuring proposal which indicated that: (i) the composition of the creditor classes would be changed so that there would only be a single class of creditors (to address concerns previously raised by the likely-dissenting class as to their differing treatment); (ii) instead of there being parallel Hong Kong and offshore schemes, there would be a dual scheme structure, with Evergrande pursuing a scheme and subsidiary Anji (BVI) Ltd pursing a scheme in the BVI; and (iii) creditors would be offered all of Evergrande’s equity in NEV and PSG.

For Justice Chan, that wasn’t good enough. Evergrande had deliberately and without explanation defied the court’s directions. It had apparently held off-the-record discussions with Top Shine about a new restructuring proposal, but had ignored the AHG. And above all else, there remained no viable restructuring plan, no funding for a proposed restructuring, no timetable for implementation, no evidence of substantial in-principle creditor support, and no evidence that an adjournment would serve any useful purpose. In those circumstances, no further adjournment would be granted. The interests of creditors would likely be better protected if the company was wound up, so that independent liquidators could take control, secure and preserve assets, and review and formulate a restructuring proposal if appropriate.

The picture remains bleak for offshore creditors

Of course, liquidation will be no silver bullet.

Cayman-incorporated, Hong Kong-listed Evergrande is the property group’s ultimate offshore holdco and financing vehicle. As you would expect, it holds very few assets directly – some small cash balances and around RMB 131.2bn (USD 18.1bn) of receivables due from its onshore and offshore subsidiaries (with presumably dubious recovery prospects). The company also (indirectly) holds offshore assets which Debtwire estimates to be valued at around CNY 8.97bn (USD 1.25bn).[6] But over 90% of the group’s assets are located in the PRC, held by indirectly-owned PRC-incorporated subsidiaries. And many of those project-level assets will be encumbered.

The upshot is that Evergrande’s liquidation is unlikely to change the fact that offshore creditors face fairly bleak recovery prospects. Their most obvious source of recovery – a sale of Evergrande’s offshore assets – is likely to generate only miniscule recoveries (perhaps as little as 3% according to Evergrande’s analysis).

Then there’s the really bad news – notwithstanding the appointment of liquidators at the holdco level, the group’s onshore assets will most likely remain out of reach of offshore creditors for legal, practical, and political reasons. In theory, Evergrande’s liquidators could seek to take control of those assets by exercising Evergrande’s shareholder rights to replace the board and legal representatives of its subsidiaries, eventually working their way down to take control of the PRC subsidiaries holding the group’s assets. To support that process, they could probably seek recognition of their authority to act on behalf of Evergrande from courts in Shenzhen, Shanghai, and Xiamen under the cross-border cooperation arrangement in place between the Mainland and Hong Kong. But the reality is that most of Evergrande’s assets lie outside those jurisdictions and, to be blunt, any attempt to take over Evergrande’s onshore operations would likely be met with opposition from not only existing management, but also government authorities whose priority remains the delivery of unfinished apartments to homeowners.

In short, if there is any conflict, there will be only one winner. Homeowners and other onshore creditors will recover ahead of offshore creditors from the group’s onshore assets. The best hope for offshore creditors is that Evergrande’s liquidators can resurrect an offshore restructuring with the cooperation and support of existing management (or a bankruptcy administrator if the group enters bankruptcy onshore), which might even see them emerge with a significant equity stake in whatever “new” Evergrande emerges from the ashes of its onshore restructuring exercise. The liquidators signaled their wish for such cooperation immediately upon their appointment, announcing that Evergrande’s liquidation will have no direct impact on the operations of its PRC subsidiaries, and that the liquidators intend to work with existing management to achieve a resolution that minimizes disruption for all stakeholders. But, as things stand, the company’s schemes of arrangement have been shelved and its US Chapter 15 recognition proceedings have been terminated.

Finally, there is also the prospect of recoveries being boosted by the proceeds of potential claims against auditors, advisers, related entities and directors. The liquidators have already engaged lawyers Clifford Chance, Tanner De Witt, and Karas So to advise on the liquidation process and investigate potential evidence of wrongdoing and/or negligence that might have contributed to Evergrande’s failure to meet its debt obligations. And with good reason. In March, news emerged that the China Securities Regulatory Commission had accused Evergrande’s main onshore operating entity of inflating its revenue by USD 78 bn, and fined the company USD 583m. Chinese authorities are also apparently investigating the role of auditor PricewaterhouseCoopers in that fraud. But recoveries won’t be quick; negligence and fraud claims are notoriously difficult to prosecute and tend to be defended vigorously.

So now we wait and watch . . .  much like we did before liquidators were appointed.

LatAm – Unigel restructuring challenged by uncertainties over pre-insolvency proceeding, provisional plans, and risk of judicial recovery filing

Unprecedented disputes related to Unigel’s debt restructuring process made it the most interesting case in Latin America during 1Q24. Following months of out-of-court negotiations that ultimately failed to result in a deal, in late 2023 the Brazilian petrochemical producer filed a precautionary measure with a Sao Paulo bankruptcy court seeking the suspension of all individual debt enforcement to allow the company to conduct a mediation process with creditors to address its financially distressed situation without the need to file for bankruptcy. The company’s capital structure is set forth in the following table.

Source: Debtwire’s Restructuring Database

The Sao Paulo bankruptcy court initially denied Unigel’s request for an injunction  on the grounds that Unigel failed to adequately prove that it meets the requirements provided for in the law, finding that the arguments Unigel brought were excessively “generic.” At the same time, holders of Unigel’s BRL 500m (USD 102.2m) in domestic bonds (debentures) approved the enforcement of their debt, via an authorization for trustee Vortx to file an execution lawsuit against the company. That scenario opened room for speculation over a potential judicial recovery filing, but the bankruptcy court later reconsidered its decision and awarded the company a 60-day relief against individual debt collection measures.

The following table sets forth LatAm cases involving challenges to proposed restructurings.

Source: Debtwire’s Restructuring Database

This protective ruling, however, was made public on the last day before Brazilian courts’ activities were suspended due to year-end holidays, which resulted in questions regarding when the 60-day protective measure started counting. Due to this and other uncertainties regarding the country’s counting methodology rules, the 60 days become approximately 90 days, making it hard to determine when exactly the injunction would expire.

Discussions about the end date of the injunction became moot on 20 February, when Unigel filed for extrajudicial recovery (the Brazilian reorganization proceeding based on a plan reached with a subset of creditors in advance of the filing) to restructure roughly BRL 3.9bn (USD 783m) in international and domestic bond debt. The court admitted the protection request and provided the company with 90 days to obtain the support of more than 50% of its creditors for its restructuring proposal.

Interestingly, Unigel is the first case in which an extrajudicial recovery filing has come along with “provisional plans” that do not lay out a final and definitive repayment proposal, as many of the relevant clauses – including those regarding the newly issued debt instruments, newly issued convertible participating titles and related guarantees – refer to certain “definitive documents” that had not yet been filed.

The court rejected the request from Vortx to review the decision that admitted Unigel’s extrajudicial recovery request based on the alleged illegal provisional plans, noting that the provisional plans could be changed as a result of debt restructuring negotiations. Vortx appealed that decision and obtained an injunction pursuant to which the company may move forward with the process by obtaining the requisite creditor support for plan approval, but no plan may be sanctioned while the appeal is pending.

Meanwhile, holders of claims not affected by the extrajudicial recovery proceeding, including XP Investimentos and Banco Haitong, have recently obtained favorable decisions in individual execution lawsuits filed against the petrochemical company, ordering the company to pay BRL 25.5m and BRL 32m, respectively. Additionally, another bank is in the process of enforcing approximately BRL 100m in debt against the Brazilian chemical producer.

These debt enforcement measures could force the company to file for judicial recovery, which it has been avoiding since it began engaging in restructuring talks. It is questionable whether a judicial recovery process would apply to the restructuring of claims stemming from derivative contracts, which are held by XP and Banco Haitong. However, in contrast to the protection stemming from the extrajudicial recovery process, the stay period protection granted in a judicial recovery request could provide the company with short-term relief against those creditors, especially if the court rules that the claims they hold are capital goods considered essential to the business activity of the company, as set forth in Section 49, § 3 of Brazilian bankruptcy law.

Conclusion

The cases discussed above demonstrate that, while economic terms and conditions of debt restructuring negotiations remain a prerogative of creditors, debtors, investors and other involved stakeholders, bankruptcy and appellate courts worldwide have been taking an active role in controlling in-court restructuring and liquidation proceedings and insuring that those proceedings are transparent

In the UK, the Adler decision, which is now the leading authority on UK plans, has already started to shape the future of the UK’s restructuring plan tool. In particular, the court’s approach to the exercise of its discretion to sanction a plan now differs according to whether or not a CCCD is sought. Additionally, the rulings issued in Unigel show that Brazilian courts do wish to incentivize the use of the extrajudicial recovery process, provided that they are not filed only as an attempt to extend the stay without real efforts to reach an agreement with impaired claimholders and obtain their support on the proposed restructuring measures. These precedents illustrate courts’ concerns to ensure that reorganization processes are exclusively used to optimize capital structures and allow viable companies to emerge from distressed situations.

In the APAC region, the Hong Kong court’s move to step in and assert control over the restructuring of one of the PRC’s most socially, structurally and politically important distressed groups in the name of creditor interests was a brave move – even if it remains to be seen what is achieved. Finally, in the US, the FTX decision ensures that creditors and other parties in interest can seek transparency in large bankruptcy cases in the Third Circuit in which fraud, mismanagement, and/or misconduct is suspected and in which there is no Chapter 11 trustee.

Endnotes

[1] The facts are taken from the Third Circuit appellate court’s decision.

[2] Although the Bankruptcy Code does not define “party in interest,” the Third Circuit has interpreted it to mean “anyone who has a legally protected interest that could be affected by a bankruptcy proceeding.” In re Global Indus. Tech., Inc., 645 F.3d 201, 210 (3rd Cir. 2011).

[3] Back in January 2023, the US Trustee initially objected to the hire of S&C due to insufficient disclosures, questions about the disinterestedness of S&C because it had served as FTX’s prebankruptcy counsel, and questions about whether S&C’s investigatory role would overlap with the requested examiner. In February 2024, Edwin Garrison et all sued S&C in a class action lawsuit that accused the firm of having knowledge of the fraud and contributing to the company’s collapse. The complaint alleges that S&C gained knowledge of FTX’s misrepresentations to customers and failures to disclose that it represented FTX in acquisitions and regulatory matters, structured transactions that helped FTX to evade regulatory scrutiny and expand its product offerings (and thus the reach of FTX’s fraud), and benefitted financially from FTX’s misconduct. The various claims asserted against S&C include civil conspiracy, Racketeer Influenced and Corrupt Organizations Act claims (RICO), and aiding and abetting fraud and breaches of fiduciary duty.

[4] The US Court of Appeals for the Sixth Circuit comprises jurisdictions sitting with the states of Michigan, Ohio, Kentucky, and Tennessee.

[5] Morgenstern v. Revco D.S., Inc. (In re Revco D.S., Inc.), 898 F.2d 498, 500-01 (6th Cir.1990).

[6] Those assets include: (i) a 52% holding in Cayman-incorporated, Hong Kong-listed Evergrande Property Services Group (EPS), which manages a portfolio of residential and commercial properties in the Mainland and Hong Kong; (ii) a 59% holding in Hong Kong-incorporated and listed China Evergrande New Energy Vehicle Group (NEV), a company focused on new energy vehicles and health management; (iii) the Emerald Bay residential project in Hong Kong; and (iv) an unsecured interest free loan of HKD 2.07bn advanced to China Ruyi Holdings.

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