Hong Kong Airlines — A Restructuring Unparalleled

In December 2022, Hong Kong Airlines’ Hong Kong scheme and English restructuring plan were sanctioned by the respective courts, which will restructure approximately US$6.2 billion of debt and allow the business to take off again with a reduced fleet. Over 90% of the airline’s financial and operating liabilities (including bank debts, leases, and trade creditors, amongst others) will be affected alongside a new equity investment of HK$3 billion. The compromised debts are governed by a mix of Hong Kong, PRC, and English law.

The restructuring was novel in a number of ways:

• It was the first parallel scheme and restructuring plan.
• “Secured unsecured” creditors were included in a general unsecured creditor class.
• The majority of compromised debt was governed by law other than English law.

Parallel Proceedings a Necessity

The restructuring was implemented using a parallel Hong Kong scheme of arrangement and UK restructuring plan. This structure was required to ensure that the Hong Kong law-governed liabilities were compromised by the Hong Kong scheme, and the English law governed liabilities were compromised by the restructuring plan, as both jurisdictions apply the Rule in Gibbs.Anthony Gibbs & Sons v. La Societe Industrielle et Commerciale des Metaux (1890) 25 QBD 399. See In Defence of “Gibbs”?.

The Hong Kong scheme had two classes of creditors: (i) “critical lessors/financiers” whose aircraft were to be retained by the group on amended terms; and (ii) “unsecured creditors” which included aircraft lessors and secured financiers whose aircraft would be returned, as well as other unsecured lenders and trade creditors. The English restructuring plan had those same two classes, plus a third one: the “perpetual noteholders”, whose claims were governed by English law.

Class Composition

Certain creditors challenged the proposed classes at the English convening hearing. This challenge was based on the inclusion of secured financiers within the unsecured creditor class whose aircraft would be returned to them pursuant to the plan but who would, having realised the value of their security, nevertheless have a residual claim against the company. At first glance, this treatment appears unusual: secured and unsecured creditors typically form separate classes because they have different priorities and likely have materially different outcomes in the relevant alternative (i.e., different “rights in”). However, on closer examination of the facts, the English court held that this criticism was unfounded.

Under English law, conventional class analysis requires consideration of “rights in” (i.e., existing rights of creditors against the company, by reference to the “relevant alternative” in the event the scheme/plan is not implemented) and “rights out” (i.e., the rights conferred by the scheme/plan).

The company identified liquidation as the relevant alternative (what the court considers would be most likely to occur if the plan were not sanctioned). In terms of “rights in”, the unsecured creditors would all have the right to submit a proof of debt in the liquidation of the company and share pari passu in any distribution of its assets. Similarly, the secured financiers, after having realised their security, would also have had an outstanding residual unsecured claim (a “deficiency claim”).

At sanction, when considering class composition, the English court asked whether it was impossible for those secured creditors with deficiency claims to meet together with creditors whose debts were not secured at all with a view to considering their common interest. The judge considered that it was not impossible and was careful to point out that the plan did not compromise security rights: the target of the compromise was the deficiency claim alone. As between the holders of deficiency claims and other unsecured creditors, there was an "identity of interest", with the implication being that, as a matter of principle, those members of the class could consult together. The judge also accepted that this was consistent with earlier English scheme cases concerning insurance companies from the early 2000s, in which policyholders were permitted to submit proofs for their claims net of any security or right of set-off to which they were entitled. Furthermore, the inclusion of (under)secured creditors in the unsecured class is common practice in Hong Kong schemes, and given the parallel nature of the proceedings, there were good reasons for the English court to mirror this approach.See, for example, Re Hawk Insurance Co Ltd. [2001] EWHC Civ 241 (CA) and Re Anglo American Insurance Ltd. [2001] 1 BCLC 755.

“Swamping” of Unsecured Creditors?

At the convening hearing, the challenging creditors argued that including secured creditors within the unsecured creditor class risked skewing the voting outcome both because of their relative weight and their alleged conflicting interests as secured creditors. The court noted that it “must be astute, particularly with applications under Part 26A, to see whether the conventional class composition rules are being manipulated so as to constitute a single assenting class or to dilute the votes of potential dissenting creditors.” The votes representing the deficiency claims of the secured creditors were in fact immaterial to the outcome of the unsecured creditor class meeting, and so on no basis could they be said to have “swamped” the voting. Further, even if they had been critical in obtaining the consent of the unsecured creditor class, the judge found that it would not have affected his decision to sanction the plan, given that the classes had been correctly composed.

The “swamping” question might become more complex if there are sustainable grounds for challenging the valuation placed on the security. For Hong Kong Airlines, clear market benchmarks and third-party reports were available to value the secured aircraft and so the scope for dispute was narrow. As other restructuring plans have shown, valuation of a whole business or business unit can be far more controversial and reasonably held opinions may differ.

Minority of Debt Governed by English Law

The plan company was an overseas company registered in the UK. The perpetual notes were governed by English law and could therefore be compromised only under an English law process, and 42% of the company’s total indebtedness was governed by English law. The judge confirmed that there is no requirement that a majority of the compromised debt be governed by English law provided that there were other connections with the jurisdiction. Other helpful factors included (among others) the active participation in the plan of a very significant portion of creditors with non-English law-governed debt, and the fact that the plan was proceeding “hand-in-glove” with the Hong Kong scheme, which meant that the court was satisfied that it was simply playing its part in cross-border proceedings.