Shinsun Holdings (Group) bondholder Shenwan Hongyan Strategic Investments received some rather startling news from Justice David Doyle of the Grand Court of the Cayman Islands on 21 April: despite holding 25% in value of Shinsun’s USD 200m 12% due-2023 senior notes, Shenwan was not a creditor of Shinsun (contingent or otherwise), not entitled to present a winding-up petition and not even entitled to instruct its bond trustee (China Construction Bank (Asia)) to accelerate the bonds.

Savvy bond investors might not be surprised that Shenwan was prevented from taking enforcement action; bond indentures typically limit the right of individual bondholders to enforce bonds and instead grant the bond trustee such rights. But Justice Doyle’s interpretation of Shinsun’s indenture arguably left underlying bondholders with no ability to enforce their bonds whatsoever – individually or collectively. And if his reasoning is adopted elsewhere, that might also be the case for holders of bonds across the market.

Bondholders typically assume that if a default occurs, any ad hoc group that holds 25% in value of the outstanding bonds has the right to instruct the trustee to accelerate their bonds. But according to Justice Doyle, that wasn’t the case under Shinsun’s indenture. Thanks to the indenture defining “Holders” as registered holders, it was only registered holders (not underlying beneficial holders) holding 25% in aggregate principal amount of outstanding bonds who could instruct the trustee to accelerate. Similarly: (i) only registered holders had the right to take individual action to seek the payment of overdue principal and interest; (ii) only a registered holder could authorize an underlying bondholder to take enforcement action in its place (underlying bondholders not being entitled to rely on the terms of Euroclear’s operating procedures to provide indirect authorization); and (iii) only a registered holder could request the issuance of certificated notes in place of beneficial holdings (thereby enabling bondholders to become registered holders).

The upshot was that Shenwan had no rights under the indenture at all. To enforce their bonds, either: (i) the registered holder of the bonds (CCB Nominees Limited) had to instruct the trustee to accelerate, directly authorize a bondholder to enforce, or directly request that certificated notes be issued; or (ii) trustee CCB Asia needed to accelerate the bonds. With no ability to instruct either of those parties to act, bondholders’ would simply have to persuade them to do so on their own volition, despite those parties having no economic interest in the bonds. A tough sell.

To make matters worse, Justice Doyle also concluded that Shenwan could not bypass those restrictions in the indenture by simply arguing it was a contingent creditor of Shinsun under Cayman law (and therefore entitled to present a winding-up petition). To be a contingent creditor, Shenwan needed to be owed an existing obligation by its issuer, an obligation which might result in the issuer becoming subject to a present liability upon the happening of a future event. But Shenwan was owed no existing obligation whatsoever. Only upon it receiving certificated notes would it have a direct relationship with Shinsun and become a contingent creditor (notwithstanding the standard practice of common law courts treating underlying bondholders as contingent creditors for the purposes of voting on schemes of arrangement).

Ultimately, a simple definition in Shinsun’s bond indenture, used throughout the document, ultimately deprived bondholders of any real ability to enforce the bonds in a timely manner. Not all bond indentures contain precisely the same language contained in Shinsun’s, but where they do, bondholders could face the same fate. It might be time to check that bond documentation.

Shinsun’s notes and winding-up proceedings

Shinsun’s USD 200m 12% senior notes due August 2023 were issued in August 2021 under a New York law-governed indenture, with CCB Asia acting as trustee and the global note being registered in the name of CCB Nominees, the nominee of the common depositary for Euroclear and Clearstream. Shinsun’s legal counsel for the bond offering was Sidley Austin and Ogier.

Shenwan acquired a 25% holding of the bonds through its custodian (and Euroclear participant) the Hong Kong Monetary Authority. After Shinsun defaulted on its February 2022 interest payment, Shenwan instructed CCB Asia to issue a notice of acceleration, which the trustee did on 1 April 2022. Then, after Shinsun failed to comply with the acceleration notice, Shenwan (represented by Walkers) filed a Cayman Islands winding-up petition.

The conventional approach would have been for Shenwan to instruct the trustee to commence those proceedings. But, as is often the way, the trustee wanted a substantial upfront retainer (USD 500,000) before it would take action. Being unwilling to provide those funds, Shenwan took matters into its own hands, claiming that it was entitled to do so because: (i) it was a contingent creditor of the issuer; and (ii) it had been authorized to take such steps by Euroclear, which had issued a statement of account letter to HKMA authorising beneficial owners to commence proceedings.

Shinsun, represented by Appleby (Cayman), opposed the winding-up petition on the basis that Shenwan had no standing to file it.

Key terms of the Indenture

Shinsun’s indenture was structured like a conventional global bond:

1. its notes were registered in the name of a “Holder” as nominee for the common depositary (CCB Nominees), which would be treated in all respects as the owner of the note and would be entitled to grant proxies or authorize any person to take actions which it, as “Holder”, could take under the indenture (sections 2.04, 2.05(c) and 2.06(d)). As registered holder, CCB Nominees had no economic or voting interest in the notes; its role was simply to facilitate paperless transactions of the dematerialised securities between persons which hold interests in the notes as account holders;
2. beneficial holders were entitled to receive certificated notes in an aggregate principal amount equal to and in exchange for the global note (and thereby become a “Holder”) if: (i) any notes were immediately due and payable; and (ii) the issuer had received a written request to deliver certificated notes from a “Holder” (section 2.04(e)); and
3. it was the trustee, rather than beneficial holders, which was to lead any enforcement efforts upon an event of default:
   1. events of default were defined to include (inter alia) uncured payment defaults and the commencement of involuntary insolvency proceedings which remained on foot for 60 days (section 6.01);
   2. upon an event default occurring, all principal and interest could be declared immediately due and payable (i.e. the notes could be accelerated) in two ways – either: (i) the trustee would be required to declare the notes immediately outstanding if instructed to do so by “Holders” of 25% in aggregate principal amount of the outstanding notes (subject to being indemnified and/or secured to its satisfaction); or (ii) either the trustee (without such an instruction) or “Holders” of 25% in aggregate principal amount of the outstanding notes (directly) could accelerate the notes by written notice to the issuer (section 6.02);
   3. alternatively, if an insolvency filing remained on foot for 60 days, the notes were automatically accelerated (section 6.02);
   4. during the continuance of an event of default, the trustee was only required to act upon the written direction of “Holders” of 25% of aggregate principal outstanding subject to receiving indemnity and/or security to it satisfaction (section 7.01); and
   5. “Holders” could not institute any proceedings in respect of the indenture or the notes unless: (i) the Holder had previously given the trustee written notice of a continuing event of default; (ii) the Holders of at least 25% in aggregate principal amount of outstanding notes directed the trustee to pursue a remedy; (iii) such Holder or Holders offer the trustee indemnity and/or security satisfactory to the trustee; (iv) the trustee did not comply with the request within 60 days; and (v) during that 60-day period, the Holders of a majority in aggregate principal amount of the outstanding notes did not give the Trustee a written direction that is inconsistent with the request. However, those limitations do not apply to the right of any Holder to receive payment of the principal, premium and interest on the notes, or to bring suit for the enforcement of any such payment, which right shall not be impaired or affected without the consent of the Holder (sections 6.06 and 6.07).

You’re not a registered holder, you have no rights

Shinsun had two broad arguments.

First, it said that Shenwan’s winding-up petition was a nullity because the bonds hadn’t been validly accelerated and were not immediately due and payable. Under the indenture, only “Holders” (i.e. registered holders, meaning CCB Nominees) could instruct the trustee to accelerate. As a result, the purported acceleration of the notes in April 2022 on the basis of Shenwan’s instruction was improper; the trustee having seemingly acted under the misapprehension that Shenwan was a “Holder”.

Second, it said that beneficial bondholders such as Shenwan had no right to commence winding-up proceedings, under the indenture or otherwise, because:

1. under sections 6.06 and 6.07 of the indenture, only a “Holder” (i.e. CCB Nominees) had the right to commence proceedings for the repayment of principal and interest (or winding-up proceedings);
2. similarly, only a “Holder” – CCB Nominees – could authorize another person to take those steps; no such authorization had been provided by CCB Nominees;
3. Shenwan would only be able to take such steps if it first obtained certificated notes (and therefore became a “Holder”) under section 2.04 of the indenture, which first required notes to be outstanding and that a current “Holder” request the issuance of such notes. Yet no notes had been validly accelerated and no such request had been made by CCB Nominees; there was therefore no valid basis upon which certificated notes could be issued; and
4. the possibility that Shenwan might at some point acquire certificated notes did not render it a contingent creditor of the issuer, entitled to commence winding-up proceedings. That’s because to be a contingent creditor, Shenwan needed to already be in a debtor-creditor relationship with the issuer. In this case it wasn’t; only upon certificated notes actually being issued would such a relationship be created.

Shenwan essentially argued the opposite. In its view:

1. the notes had been validly accelerated and were now due and payable. That was the case even if the trustee’s acceleration notice was defective, because the continuation of the Cayman insolvency proceedings had triggered an automatic acceleration;
2. Shenwan had in fact been authorized by the “Holder” to file winding-up proceedings in accordance with section 2.06 of the Indenture. That authorization hadn’t been provided by CCB Nominees directly, but via Euroclear’s operating procedures which expressly authorized beneficial holders to pursue any claims that Euroclear, the common depositary or the common depositary’s nominee (i.e. CCB Nominees) were entitled to bring;
3. Shenwan, as a beneficial holder, had also been authorized by the registered holder (CCB Nominees) under the express provisions of the Euroclear operating procedures to exercise the registered holder’s right to request the issuance of certificated notes under section 2.04(e). That made Shenwan a contingent creditor: (i) under Cayman law, because it had a contingent right to receive certificated notes; and (ii) under New York law, because Shenwan had a right to sue the company under the Euroclear operating procedures; and
4. finally, as a practical matter, bondholders must be entitled to rely on Euroclear’s operating procedures to step into the shoes of the registered holder and instruct the trustee – otherwise there was no party with an economic interest in the notes that would ever take action to enforce payment.

Bondholders are not contingent creditors

Justice Doyle started by considering whether Shenwan was entitled to present a winding-up petition on the basis that it was a contingent creditor of Shinsun.

Bondholders would be familiar with that argument, at least in a scheme of arrangement context. Post UK bond restructurings such as Castle Holdco No 4 (2009) and Gallery Capital (2010), courts in the UK, Asia and the Caribbean have pragmatically recognized bondholders as contingent creditors entitled to vote on schemes (provided that the relevant bond documentation contains a mechanism by which they can become a direct creditor of the issuer via the issuance of certificated notes) given their economic interests in the bonds.

But to Justice Doyle, the courts’ acceptance of bondholders as contingent creditors in such cases didn’t mean a lot because the issue was never contested or fully considered. The same could be said for the limited number of Cayman cases where bondholders had been permitted to present winding-up proceedings – the unopposed cases of China Forestry Holdings (2015) and LDK Solar (2016), neither of which had resulted in reasoned judgments being issued by the court.

Instead, Justice Doyle preferred the reasoning of Justice Geoffrey Bell of the Bermudan Supreme Court in his 2009 Bio-Treat Technology decision. In that case, Justice Bell had concluded that bondholders were not contingent creditors – even though they had already requested that certificated notes be issued – because there was no direct relationship between them and the issuer. To Justice Bell, the issuer in that case had no existing obligation to bondholders which might give rise to a liability; all it had was an existing obligation (to issue certificated notes) which would lead to the creation of a new contractual relationship between the issuer and bondholders which, once established, may give rise to a liability. That wasn’t sufficient to render bondholders contingent creditors; as things stood, they were not creditors at all.

Justice Doyle thought Shenwan’s position mirrored that of Bio-Treat’s bondholders. The highwater mark of Shenwan’s argument was that it had a present right under the terms of the indenture to require the delivery of certificated notes, via an instruction to its custodian HKMA, which could then instruct Euroclear, which would eventually (if everything went to plan) then result in certificated notes being issued and bondholders becoming registered holders. But that didn’t mean they had standing to present a winding-up petition. You can’t backdate standing; you need it at the date the petition is heard. And as at that date, the issuer owed no obligation whatsoever to Shenwan or other bondholders. Only after Shenwan obtained a certificated note would it had a direct relationship with the issuer, become a creditor, and have standing to present a winding-up petition. Shenwan therefore wasn’t a creditor, contingent or otherwise.

A dead end for bondholders

Alarmingly though, that wasn’t the end of the pain for Shenwan. Justice Doyle went further, concluding that, under the terms of the bond indenture:

1. CCB Nominees was the “Holder”;
2. Shenwan had not been duly authorized to enforce. Section 2.06 of the indenture only permitted the “Holder” to grant authorization and CCB Nominees had not done so. Further, Shenwan could not rely on Euroclear’s operating procedures to suggest it had been granted authorization – the express provisions of the indenture could not be modified or overridden by Euroclear’s operating procedures when those were not expressly incorporated into the indenture;
3. there was no valid acceleration of the notes because there was no evidence of CCB Nominees, as “Holder”, instructing the trustee to do so; and
4. there was no merit to Shenwan’s complaint that if they couldn’t rely on Euroclear’s procedures to obtain authorization, then there would be nobody with an economic interest in the bonds entitled to enforce payment. The procedures in the indenture needed to be followed without impermissible shortcuts.

In short, that left Shenwan without any real ability to take action. It could not instruct the trustee to accelerate or enforce – only a registered holder could do so. It could not take action under section 6.07 of the indenture to recover principal and interest – those provisions only provided registered holders with a right to do so. It could not file a winding up petition because it was not a contingent creditor. It could not become a registered holder (and then seek to take such actions) without the existing registered holder first instructing the trustee to accelerate the bonds and then requesting that certificated notes be issued. And it could not rely on Euroclear’s procedures to step into the shoes of the registered holder and take action.

In other words, Shenwan (and other underlying bondholders) had no direct ability – individually or collectively – to enforce the bonds or instruct others to do so. The only way enforcement steps could be taken is if: (i) CCB Nominees (as registered holder), of its own volition, either directly authorized a bondholder to take action, instructed the trustee to accelerate, and/or requested that certificated notes be issued; or (ii) CCB Asia (as trustee), of its own volition, accelerated the notes and enforced. Persuading either of those parties to take such action could be costly and inefficient. At best, the parties might reach agreement to do so (upon being suitably indemnified). But with neither VVB Nominees of CCB Asia having an obligation to take such steps – even if indemnified – it might be a tough sell.

Time to check your indentures

For bondholders, the result isn’t a great one. Bondholders being prevented from going rogue and taking independent enforcement action is one thing. But interpreting an indenture in a manner that prevents underlying bondholders holding 25% of an issuer’s outstanding bonds from instructing a trustee to accelerate could have significant consequences across the market. At the very least, it significantly reduces the leverage of offshore bondholders in negotiations with onshore defaulters by reducing any risk of such bondholders efficiently winding-up a group’s offshore issuers and/or guarantors, taking control of assets, and/or lodging onshore claims PK Founder-style.

Of course, not all indentures are the same (even if they are pretty similar). Take Sands China’s due-2026 3.8% senior notes or due-2030 4.375% senior notes. Under the indenture constituting those notes, the “Holder” is once again defined as the registered holder, making it difficult (at least on the Cayman court’s interpretation) for bondholders to take action or instruct the trustee. But section 2.06 of Sands’ indenture provides that certificated notes may be issued following a default where “any person having a beneficial interest in a global note” requests such notes. That would seem to suggest that there is no roadblock to a group of underlying bondholders enforcing their rights, at least if they are sufficiently aggrieved to request certificated notes.

Bondholders, it might be time to check your indentures to see what rights you really have.