Noteholder Litigation: Investors Beware | Cayman Islands

In a judgment delivered on 23 April 2023 (Re Shinsun Holdings (Group) Co., Ltd.FSD 192 of 2022 (DDJ)), the Grand Court of the Cayman Islands (“Cayman Court”) determined that the ultimate holder of a beneficial interest in notes did not have standing to pursue winding up proceedings against the defaulting notes issuer.

This judgment is an important reminder that investors must carefully consider the structure and underlying documents that govern their investments before seeking to enforce their rights. 

In February 2022, Shinsun Holdings (Group) Co., Ltd (the “Issuer”) defaulted on the payment of interest on its 12% Senior Notes Due 2023 (“Notes”). The Notes were issued pursuant to a New York law-governed indenture (the “Indenture”). Pursuant to the Indenture, China Construction Bank (Asia) Corporation Limited was appointed as Trustee and Common Depositary, and the Notes were registered in the name of CCB Nominees Limited as nominee for the Common Depositary (the “Noteholder”).

The Notes were traded by the Noteholder through Euroclear. The petitioner, Shenwan Hongyan Strategic Investments (H.K.) Limited (“Shenwan”), obtained its 25% interest in the Notes through its account with Euroclear participant, the Hong Kong Monetary Authority (the “Custodian”).

Upon the Issuer’s default, Shenwan directly instructed the Trustee to issue a notice of acceleration in respect of the Notes. Shenwan thereafter directly pursued its winding-up petition against the Issuer (the “Petition”) arguing that it was a contingent creditor or was otherwise duly authorised to commence the proceedings. The Cayman Court rejected both arguments.

Shenwan argued that it was a contingent creditor of the Issuer since it had a present right, exercisable through the procedures and systems adopted by the Custodian and Euroclear, to instruct the Noteholder either to substitute Shenwan’s economic interest in the global note for certificated notes or to provide Shenwan with a proxy to pursue enforcement proceedings against the Issuer.

This argument was rejected by the Cayman Court on the basis that a person is a contingent creditor only if there is an existing obligation from which a liability may or may not arise. The Cayman Court referred to a wealth of jurisprudence on this issue and confirmed that, on the facts of this case, no such obligation existed – Shenwan was not a party to the Indenture and the Indenture contained no provisions enabling underlying investors to enforce the Notes directly against the Issuer. The “no look through principle” therefore applied, meaning only the Trustee and registered noteholders had direct enforcement rights against the Issuer. The existence of a contractual mechanism for Shenwan to obtain certificated notes, and thereby bring itself into a direct contractual relationship with the Issuer, was insufficient to confer standing on Shenwan. The Cayman Court observed that Shenwan’s arguments to the contrary erroneously conflated the concept of contingent standing with the status of being a contingent creditor. The Court was unpersuaded by Shenwan’s attempts to argue that an analogy could be drawn with decisions concerning schemes of arrangement whereby underlying investors are given standing to vote on a scheme.

Shenwan also argued that it had in fact been authorised to pursue the Petition by reference to a written communication issued by Euroclear to the Custodian authorising beneficial owners of the Notes to commence proceedings against the Issuer. The Cayman Court also rejected this argument since, under the terms of the Indenture, only the Noteholder could authorise some other person to take enforcement steps and there was no evidence that such authorisation had been given. Euroclear’s written confirmation was therefore not sufficient to establish Shenwan’s authority to pursue the Petition. Shenwan could have followed Euroclear’s procedures to obtain proper authority from the Noteholder in accordance with the terms of the Indenture, but had failed to do so.

Following the conclusion that Shenwan was neither a contingent creditor nor a person with authority from the Noteholder to pursue the proceedings, the Cayman Court dismissed the Petition.  

This decision makes clear that the Cayman Court will look closely at the terms of documents governing debts in deciding who has standing to pursue their enforcement by way of winding up proceedings. Investors who, like Shenwan, only have book-entry interests in global debt instruments need to think carefully before taking steps to enforce their interests and must ensure that procedures set out in governing documents are properly followed. In this case, Shenwan’s decision not to take the usual approach of instructing the Trustee to commence the proceedings was a “high-risk strategy” that ultimately did not pay off.  

For completeness, the Cayman Court also recorded in its judgment its conclusion that only the Noteholder could instruct the Trustee to accelerate the Notes. Since the instruction had come directly from Shenwan, the debt had also not been validly accelerated. The Court reached this conclusion notwithstanding that the Issuer made public announcements that the Notes had been accelerated. 

Accordingly, investors should carefully review the underlying documents at the outset and certainly before taking any enforcement steps to ensure they have the ability to take action unilaterally. They should also make sure they follow the procedures set out in the documents which enable them to take such steps. 

There have been a number of recent first-instance decisions dealing with these exact issues in other jurisdictions. The Hong Kong Court followed the approach taken by the Cayman Court in Shinsun, finding that an individual noteholder is not a contingent creditor and so does not have standing to present a winding-up petition where there is no direct contractual relationship with the issuer (Re Leading Holdings Group Limited [2023] HKCFI 177). The BVI Court, on the other hand, took a different approach, finding that the petitioner was a contingent creditor on the basis that it had the right to receive the certificated note and become the registered holder itself (Re Cithara Global Multi-Strategy SPC v HaimenZhongnan Investment Development (International) Co Ltd BVIHC(COM) 2022/0183). We will no doubt see appellate authority on these issues in the not-too-distant future.