Restructuring of US Law–Governed Debts in Jurisdictions Applying the Rule in Gibbs 

By | July 14, 2023

With globalized finance and trade, it has become common for multinational corporations to tap US debt capital market for finance. Despite US law governing the debt, the issuer’s place of incorporation would typically remain in other jurisdictions, such as some offshore “letterbox” jurisdictions (the Cayman Islands, BVI, Bermuda, etc.). The cross-border nature of this structure gives rise to interesting legal and policy issues when such companies restructure their US law-governed debts in a jurisdiction that applies the so-called rule in Gibbs (a Gibbs jurisdiction), an archaic rule followed in commonwealth jurisdictions such as England, Hong Kong, and some other offshore jurisdictions. The rule in Gibbs provides that a debt is only treated as discharged if it is compromised under the law of the jurisdiction governing the instrument giving rise to the debt. Hence, a New York law-governed debt could only be treated as discharged, from a Gibbs jurisdiction’s perspective, if it is compromised under the law of New York. In a restructuring of US law-governed debt of corporations in a Gibbs jurisdiction, could a scheme of arrangement (a common statutory restructuring mechanism) commence in a court of the offshore jurisdiction, coupled with a recognition order under Chapter 15 of the US Bankruptcy Code, be effective to compromise the US law-governed debts in a Gibbs jurisdiction? From a policy perspective, should such a structure be effective? 

In a forthcoming paper in the International Company and Commercial Law Review, I consider certain legal and policy issues arising from a market practice developed in Hong Kong and some offshore jurisdictions, whereby a debtor seeks to restructure and compromise US law-governed debts by an offshore scheme of arrangement coupled with recognition under Chapter 15 of the US Bankruptcy Code, in the hope of satisfying the rule in Gibbs. In a typical cross-border insolvency case in Hong Kong, the debtor would be incorporated in an offshore “letterbox” jurisdiction (say, the Cayman Islands, BVI); it would have US law-governed debts; its main assets and operating business would be in mainland China. Recently, a structure has been developed in Hong Kong and the offshore jurisdictions to overcome Gibbs in compromising US law-governed debts. The debtor would commence a scheme of arrangement in an offshore jurisdiction, typically where it is incorporated, and would simultaneously seek a recognition order of the foreign proceeding under Chapter 15 of the US Bankruptcy Code. The rationale behind obtaining Chapter 15 recognition of the offshore scheme of arrangement is that the Chapter 15 proceedings, being a US law proceeding, should be able to compromise US law-governed debts to the satisfaction of Gibbs. The debtor hopes that, with this structure, the Hong Kong court will recognize the compromise of its US-governed debts without commencing a full Chapter 11 case. 

Nonetheless, in the recent Hong Kong Court of First Instance decision in Re Rare Earth Magnesium Technology Group Holdings Ltd. [2022] HKCFI 1686, Justice Harris opined, in obiter, that in cases where a scheme is sanctioned in an offshore jurisdiction and recognized under Chapter 15, it is not effective to compromise the US law-governed debts in Hong Kong: “[a] scheme sanctioned in an offshore jurisdiction and recognized under Chapter 15 in the United States will not be treated by a Hong Kong court as compromising US$ debt. The Rule in Gibbs requires the substantive alteration of contractual rights to be sanctioned by some substantive provision of the relevant law. In the insolvency context in the United States this is I understand is achieved under Chapter 11 of United States Bankruptcy Code.” 

The above-quoted obiter comments implied that a company that has commenced a scheme in an offshore jurisdiction to comprise US law-governed debts would be at risk of dissenting creditors presenting a winding-up petition in Hong Kong, despite the company having obtained recognition of the scheme under Chapter 15 of the US Bankruptcy Code. 

Central to Justice Harris’s doctrinal argument is that Chapter 15 of the Bankruptcy Code is merely procedural and does not operate as a discharge of debts; only Chapter 11 could achieve a discharge under US law. In my forthcoming paper, I argued that contrary to Justice Harris’ doctrinal reading, Chapter 15 of the US Bankruptcy Code does provide reliefs that involve substantive alteration of contractual rights. Further, from a principled and policy standpoint, the rule in Gibbs does not serve cross-border restructuring in increasingly globalized financing structures and should no longer be rigidly followed. 

From a doctrinal standpoint, I provide an analytical framework for “recognition” and “assistance” in cross-border insolvency. In this context, “recognition” and “assistance” are often confusing. When one talks about “recognition” and “assistance,” it can mean recognition of foreign insolvency proceedings, upon which assistance is given based on modified universalism and the principle of comity with foreign courts. On the other hand, “recognition” can also mean recognition and enforcement of foreign insolvency judgments under private international law; in this strict sense, “recognition” of foreign judgments occurs where a country’s law directly affects another country’s legal provisions. The former category can be regarded as more procedural, while the latter could involve a substantive alteration of contractual rights. 

One can categorize the reliefs provided under §§ 1520 and 1521(a) in the Bankruptcy Code as falling under “recognition” and “assistance” in the former category. § 1520 provides that upon recognition of the main foreign proceedings, the automatic stay under §362 would apply to the debtor’s property in the US. § 1521 further provides that, upon recognition of a foreign proceeding, whether main or nonmain, the court may grant appropriate relief, including a stay on proceedings (§ 1521(a)(1)) or entrusting the administration or realization of the debtors’ asset to the foreign representative (§ 1521(a)(5)). On the other hand, however, § 1507 provides that “. . . the court, if recognition is granted, may provide additional assistance to a foreign representative under this title . . . .” In Re Agrokor, Glenn J explicitly refers to § 1507: “section 1507 also deals with additional discretionary relief, which may include recognition and enforcement of a plan reached in a foreign proceeding [emphasis added].” Further, Glenn J, in the same judgment, also refers to the power of the US bankruptcy courts to recognize and enforce foreign insolvency judgments under § 1521: “[a]s with section 1521, relief under section 1507 may include recognition and enforcement of a plan approved by a foreign court [emphasis added].” If both §§ 1507 and 1521 allow the Bankruptcy Court to recognize and enforce foreign insolvency judgments, it is unclear why Justice Harris thinks that chapter 15 is only procedural and could not achieve a substantive discharge of debt through various contractual rights. 

Moreover, from a principled and policy standpoint, I argue that the practical effect of Justice Harris’s obiter comments is that companies could no longer utilize Chapter 15 to overcome the rule in Gibbs to discharge US-governed debts, at least under Hong Kong law. For companies that have US-governed debts and assets in Hong Kong, as is typically the case, to preserve their assets in Hong Kong, they are practically left with two options. They can either commence a scheme of arrangement in Hong Kong or a Chapter 11 case. As Justice Harris noted, a scheme of arrangement in Hong Kong, if sanctioned by a Hong Kong court, would be effective as a matter of Hong Kong law to prevent action being taken within the jurisdiction of the Hong Kong courts, regardless of the governing law of the debt. On the other hand, a Chapter 11 case, being a substantive US law proceeding, according to Justice Harris’ obiter comments in Re Rare Earth, could compromise US law-governed debts to the satisfaction of the Hong Kong courts, which apply Gibbs. 

Both options, nonetheless, would greatly increase the cost of insolvency proceedings. In the former case, if there is a main proceeding elsewhere, such as in the company’s place of incorporation, a parallel proceeding would need to be commenced in Hong Kong to prevent creditors from pursuing assets in Hong Kong under US law-governed debts. If other Gibbs jurisdictions follow Justice Harris’s obiter comments, multiple parallel proceedings would need to be commenced to prevent actions on US law-governed debts in those jurisdictions. This would be against recent common law developments based on modified universalism. In the latter case, commencing Chapter 11 proceedings often has cost implications and complexity beyond the parties’ contemplation. A Chapter 11 case is notoriously time-consuming and costly, and it is also a transparent process whereby the Chapter 11 debtors are obliged to file various disclosure materials on the Chapter 11 case dockets, which are publicly accessible. Such disclosure materials would include the debtors’ business and capital structures, cash flow forecasts, and schedules of assets and liabilities. The high costs and full transparency of Chapter 11 proceedings may not be something debtors in other jurisdictions are used to. In any case, it would be unreasonable to expect debtors with few ties to the US, other than the governing law of the debts being US law, to undergo such a proceeding just to satisfy Gibbs in a Gibbs jurisdiction like Hong Kong. 

Justice Harris should have taken the opportunity to examine the rule’s rationale in Gibbs and develop the common law to facilitate cross-border restructuring. The rule in Gibbs has been widely criticized and sits increasingly uneasily with developments in common law that recognize the need to offer cross-border assistance based on modified universalism. There have been calls for an approach focusing on the legitimate expectations of the affected parties, which are not unique here. It has been argued that the rule in Gibbs should yield to a test based on the parties’ legitimate expectations. Suppose one of the parties to the contract is the subject of insolvency proceedings in a jurisdiction with which they have an established connection based on residence or ties of business. In that case, the possibility of such proceedings must enter into the parties’ reasonable expectations in entering their relationship and, as such, may furnish a ground for the discharge to take effect under the applicable law. 

Perhaps Justice Harris reached his obiter comments after considering the legitimate expectation of the creditors choosing US law as the governing law of the debt instrument and not expecting the US law-governed debt to be discharged by foreign insolvency law and proceedings. But the decision, on its face, did not engage with this line of reasoning. Conversely, it could be argued that given the company is incorporated in a jurisdiction other than the United States, with its center of main interest, also outside the US, and given the sophistication of commercial parties, who are often well-advised, despite the governing law of the debt instruments being US law, they ought to expect foreign insolvency law to govern variation and discharge of their debts. In any case, whether one agrees with Justice Harris’ approach to Gibbs and Chapter 15, obiter comments as significant in practice as Justice Harris’s in Re Rare Earth should be based on sound principles and policies. 

Given that there is room to develop the common law to accommodate modified universalism, perhaps Justice Harris should engage with the policy and principles underpinning this subject. In a situation where there is no existing law on a particular subject and nothing in the existing law, policy, or principle to the contrary, common law ought to be developed to deal with a problem, and the cross-border nature of the debt restructuring in Hong Kong, in particular, calls for a more reasoned and nuanced judicial approach. If a case similar to Re Rare Earth arises, perhaps the Hong Kong court can examine whether the rule in Gibbs still serves any useful purpose in cross-border restructuring. The court can also adopt a more functional approach to Gibbs by asking what the legitimate expectations of the parties to the contract are as to which country’s insolvency proceeding can discharge the contract. 

 

Jason Fu is a Yale Law School graduate and a restructuring attorney based in Hong Kong. 

This post is adapted from his paper, “The Rule in Gibbs and Chapter 15 of the US Bankruptcy Code,” available on SSRN. 

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