Overview of the restructuring legislation landscape

The Cayman Islands remain at the forefront of developments in offshore restructuring and insolvency law, benefiting from a well established and dynamic financial and legal sector. During 2022, the long anticipated Restructuring Officer Regime was enacted and came into effect, further enhancing the reputation of the Cayman Islands as a modern and sophisticated restructuring jurisdiction and a leader in global insolvency and business rescue practices.

In addition to the recent introduction of a formal Restructuring Officer regime, we have also seen the implementation of the Private Funding of Legal Services Act 2020 which provided mechanisms for liquidators to utilise litigation funding and agree contingency fee arrangements, if appropriate, as tools for financing and bringing litigation claims. This legislation has effectively removed the offence of champerty and maintenance under common law which previously existed in the Cayman Islands, and is a further example of how the Cayman Islands have continued to evolve to accommodate developing trends in the wider litigation and restructuring markets.

The restructuring and insolvency regime in the Cayman Islands has its roots in the English legal system. The main legislation governing insolvency procedures is as follows:

• Companies Act (2022 Revision) (the “Companies Act”);
• Companies Winding Up Rules 2018; and
• Insolvency Practitioners’ Regulations 2018 (“IPR”).

During 2022, the Insolvency Practitioners’ Regulations (Amendment) Regulations 2022 (“IPAR”) also became effective, and provided for an uplift in the prescribed rates of remuneration for official liquidators with effect from 1 September 2022. This was the first revision to the minimum and maximum rates which can be charged by official liquidators and their staff in the Cayman Islands since 2013.

The Restructuring Officer regime

Historically in the Cayman Islands a provisional liquidation was the principal statutory restructuring tool available to a company in financial difficulty. Whilst not strictly intended for the purpose of facilitating a restructuring, the practice of presenting a winding up petition in the Cayman Islands combined with the appointment of what has been termed “light-touch” provisional liquidators for restructuring purposes became the commonly used tool for facilitating a financial restructuring in the jurisdiction.

While the “light-touch” provisional liquidation procedure has often been used to good effect to implement a restructuring plan, it was far from ideal as it required the simultaneous presentation of a winding up petition which had the ability to create reputational and commercial issues for a company looking for a way through short term financial difficulties.

The new Restructuring Officer regime came into effect in the Cayman Islands on 31 August 2022 after an extensive period of consultation between legislators and industry members. The new regime will significantly enhance the existing provisions under Cayman Islands law by:

• Removing the need to fi le a winding up petition in order to obtain a stay on creditor action;
• Providing for the stay to arise automatically on fi ling the papers without the need for any Grand Court (“Court”) hearing (under the prior law the moratorium only came into effect on the appointment of provisional liquidators);
• Providing that, as a matter of Cayman Island law, the stay will have extraterritorial effect; and
• Including provisions which provide the potential for Cayman Islands schemes of arrangement to compromise debt governed by English law.

The new Restructuring Officer regime will enable a company to seek the appointment of a Restructuring Officer (“RO”) by the Court and to allow the company breathing room to pursue a restructuring plan. The test for the appointment of an RO will be substantially the same as for an application for the appointment of provisional liquidators under the old legislation, namely that the company is or is likely to become unable to pay its debts and intends to present a compromise or arrangement to its creditors. It should be noted that the new regime supplements the provisional liquidation process as opposed to replacing it in its entirety.

Practically, under the new Restructuring Officer regime the company itself will be able to apply to Court for the appointment of an RO, and a winding up petition does not need to be issued against the company. This removes the prior difficulty of a company needing to fi nd a friendly creditor to bring a winding up petition, or to obtain a shareholder resolution placing the company into liquidation, both of which have practical drawbacks.

Whilst the new RO regime undoubtedly introduces additional debtor protections in comparison to those available under the previous legislation, in particular the imposition of an automatic stay with extra-territorial effect upon fi ling, it also preserves and enshrines certain creditor rights. Key protections include the following:

• a) there remains no stay in any Cayman Islands insolvency or restructuring procedures on the enforcement of security by secured creditors; and
• b) the default position remains that all restructuring petitions must be advertised and heard on notice to all stakeholders.

There are further safeguards built into the new legislation which provide protection for creditors from debtor companies that may seek to use the statutory moratorium to buy time, without properly progressing the application, or that do not have a genuine intention to restructure the company. These safeguards include a requirement for petitions to be heard within 21 days (subject to order of the Court), the prescription of specific matters which must be addressed in a debtor company’s affidavit filed in support of a petition, and the requirement for the RO to report to the Court within 28 days of their appointment. These provisions within the legislation are designed to ensure that creditors are protected from potential abuses of the process that might otherwise have occurred.

From an implementation and reorganisation perspective there are further benefits to both debtors and their stakeholders from the new RO regime. Notably, an application may be made to sanction a compromise or arrangement with the creditors or members of a company, without the need to commence separate proceedings to sanction the scheme of arrangement under section 86 of the Companies Act. Alongside these cost savings and efficiency benefits, there is also no longer a requirement to comply with the “headcount test”. A members’ scheme of arrangement will be deemed to be binding on the members of a company if the scheme is approved by a majority of 75% of members in value and no longer also requires the approval by the majority of members in number.

The new legislation is in its infancy and its full impact is yet to be seen. Nevertheless it represents a clear commitment to the continued evolution of the Cayman Islands legal system to meet the complexities and challenges of cross-border restructurings and business turnarounds in the modern global economy and is a welcome addition to the insolvency practitioner’s tool kit.

General Restructuring and Insolvency Market Trends

Like many jurisdictions, the restructuring and insolvency market in the Cayman Islands has been impacted by the global economic challenges arising from the coronavirus (COVID-19) pandemic and more recently the war in Ukraine. We have also felt the effects of a growing debt issue in the People’s Republic of China (“PRC”) and the knock on impact of these macro-economic events on capital markets, monetary policy and supply chains around the world.

Despite these strong headwinds, the number of formal insolvency appointments in the Cayman Islands has remained fairly modest in the first three quarters of 2022 and is tracking behind pre-pandemic levels. Unsurprisingly, the principal activity in the market has been a focus on debt restructurings which will no doubt continue given the pessimistic general global economic outlook for 2023/24.

Notwithstanding the above, we are fortunate to have been involved with a number of interesting new appointments in the last 12 months. HQP Corporation Limited (“HQP”) is one such engagement which involved an initial provisional liquidation appointment with the aim of determining whether a restructuring of a wider group structure was appropriate. HQP is a Cayman Islands holding company with subsidiary entities in Hong Kong and the PRC. It was set up as a financing vehicle for the purpose of raising capital for the operating entity of the group, a company developing a business to business auto parts trading platform in the PRC. A group structure of this nature and purpose is relatively common in the jurisdiction.

Following allegations of fraud, the shareholders of the company fi led a petition with the Grand Court to have the company placed initially into provisional liquidation to explore the possibility of restructuring the group, however, after several months of financial analysis it was determined that a restructuring would not be viable and that a winding up order should be made.

Given the increasingly pessimistic global economic outlook it is likely that we will see more engagements featuring misfeasance in the future which we expect to lead to an increased need for specialist forensic investigations and reviews to be performed by office holders as they look to trace and recover funds and other assets which have been misappropriated.

Often this recovery and investigation work takes place in the context of an official liquidation and we are increasingly seeing the benefits of using new technology to assist with the preservation and reconstruction of company records to assist with both physical asset recoveries and also the pursuit of claims via litigation. The ability to fund such actions is key to the successful outcome and recovery of assets for the benefit of creditors and the market has seen an inflow of third party litigation and insolvency funding options in recent years. Overall we see this as a positive trend if it allows office holders to pursue claims and advance matters that might otherwise not have been possible due to a lack of funding. We have seen the direct benefit of such funding in the well-publicised case of Platinum Partners Value Arbitrage Fund L.P.

Another ongoing trend in the jurisdiction is the bringing of claims under section 238 of the Companies Act, which involves the Court in determining fair value of shares following a merger or consolidation. These cases are typically brought by disenfranchised shareholders who feel “squeezed out” and not adequately compensated for their investment and often lead to significant disputes over valuation and competing expert opinions as to fair value.

Cross border recognition and challenges

With the cross border nature of insolvency proceedings often seen in the Cayman Islands, stakeholders regularly need to consider the most appropriate venue or jurisdiction in which to fi le their claim or fi le a winding up proceeding. This can sometimes lead to confusion and conflicting officeholders in different jurisdictions appointed over the same company and assets.

Recently, we have seen a trend in Hong Kong where the High Court has granted winding up petitions in respect of entities incorporated in the Cayman Islands where the principal operations of the company are conducted in the PRC. The basis of these orders is often that the centre of main interests (“COMI”) of the company is located in Hong Kong, whereas the law in the Cayman Islands is based on the seat of a company’s incorporation.

Historically we have also seen a significant number of provisional and official liquidations of Cayman Islands incorporated entities with operations in the PRC and listed on the Hong Kong Stock Exchange. The Hong Kong court’s recent resistance in recognising Cayman officeholders in Hong Kong and a developing trend to make winding up orders in Hong Kong despite the appointment of restructuring professionals in the Cayman Islands has raised significant hurdles for liquidators looking to carry out their duties in a meaningful way. This approach has resulted in parallel proceedings being conducted in two jurisdictions over the same entity, often leading to a duplication of costs and challenges for office holders looking to protect the interests of the same group of creditors.

This topic continues to evolve and is not isolated to the Cayman Islands. Nevertheless, recent judgments concerning Silver Base Group and GTI Holdings Limited suggest that we will continue to see parallel proceedings occurring in Hong Kong and jurisdictions such as the Cayman Islands, at least in the short term.

On a more positive note, we have seen some useful clarification from the US Bankruptcy Court in the recent Modern Land (China) Co. Ltd (“Modern Land”) case which confirmed that a Cayman Islands scheme of arrangement recognised as a main proceeding under Chapter 15 would constitute a substantive discharge of New York law governed debt. This followed the Rare Earth Magnesium Technology Group sanction order, issued by the Hong Kong court earlier in the year, which seemed to suggest that an offshore scheme of arrangement recognised in the US might not bind a creditor say in Hong Kong, who did not participate in the scheme of arrangement process.

Future Drivers to the Market

The global economy has been shaken by the war in Ukraine at the start of 2022. The war shows no sign of being concluded in the short term and has compounded the challenges already faced by markets and economies looking to recover from the well documented impacts of the COVID pandemic.

Rising energy and food prices as a result of the war and associated sanctions introduced both against and by Russia, have now combined with global inflationary pressures as businesses have looked to pass on higher energy, transportation and labour costs to consumers. We have also continued to see supply chain issues caused by China’s now seemingly abandoned zero COVID-19 policy which has further impacted and exacerbated these inflationary pressures and had the effect of putting the brakes on global economic growth in 2022.

This has resulted in a general tightening of monetary policy in the second half of 2022 as economic activity has struggled to rebound in line with projections post pandemic, whilst global GDP growth has stagnated in Q2 2022. Capital markets have inevitably tightened as a result of the darkening economic outlook and the low costs of borrowing which many businesses have become accustomed to since the 2008 financial crisis are potentially a thing of the past.

Rising interest rates, inflationary pressures across the board and continuing supply chain issues coupled with a more fractious geopolitical environment mean that many businesses will face significant challenges over the next few years. This will no doubt have an impact on the funds market as well as traditional asset holding companies which are popular in the jurisdiction.

Given the attraction of the jurisdiction to crypto funds and other blockchain start-ups we would expect to see further fallout from the cooling off in this particular market after its staggering expansion in recent years. A number of high profile crypto-related companies are having well publicised financial difficulties following the collapse of exchanges like FTX in December 2022 and the turbulence and general devaluation experienced in many cryptocurrencies over the last 12 months. Our view is the challenges and contagion caused by recent failures in the market will continue into 2023.

Another potential driver to general trends in the market place might be the recent decision from the Supreme Court in England in BTI v Sequana which has clarified when directors owe duties to the company that should take into account creditors’ interests. The decision will be highly persuasive in the Cayman Islands and should be borne in mind by companies and their directors, particularly in the current economic environment.