Tunghsu Group’s bondholders appear to have found the magic formula for enforcing the terms of New York law-governed bonds in Hong Kong – head to New York first.

Bond investors Zhang Rui Kang and Le Huan-Hsin have been attempting to enforce their rights ever since BVI-incorporated bond issuer Tunghsu Venus Holdings Limited and PRC-incorporated parent guarantor Tunghsu Group failed to redeem their USD 342m (outstanding) 7% guaranteed bonds due Jun-2020 in suspicious circumstances.

First they wound-up Tunghsu Venus in the BVI. Then, they obtained a default judgment in New York against both Tunghsu Venus and Tunghsu Group for the outstanding principal and interest owed under the bond/guarantee. Finally, they commenced two sets of proceedings in Hong Kong – the first to recognize the New York judgement (so that it could be enforced against any assets in Hong Kong) and the second to sue Tunghsu Group and various directors for: (i) breach of the guarantee; and (ii) inducing or procuring the companies to breach their payment obligations under the notes by allowing Tunghsu to siphon off USD 6.4bn of cash prior to the notes maturing in breach of their fiduciary duties.

In late July, the Hong Kong proceedings took centre stage as Tunghsu Group attempted to set aside previous orders the bondholders had obtained allowing them to serve their claims on Tunghsu Group and the directors outside of Hong Kong. If the orders were set aside, the claims could not proceed.

The good news for the bondholders was that their judgment recognition claim survived the test. Deputy High Court Judge MK Liu readily accepted that bondholders stood to receive a legitimate benefit if the New York judgment was ultimately recognized (in that they could, for instance, use it to seek examination orders against the directors, or to seize any undisclosed assets which might at some point flow through Hong Kong) and granted leave.

But bondholders weren’t so lucky in respect of their second set of claims. In short, Judge Liu concluded that their claims against Tunghsu Group and the directors failed to show a serious issue to be tried. In respect of the guarantee claim, that was because -- just like in the controversial Leading Holdings decision released only days earlier -- the court concluded that the bondholders – as beneficial holders of the bonds -- had no rights under the bond indenture to sue for payment. Only the registered “Holder” of the notes could do so because Tunghsu Group had only guaranteed Tunghsu Venus’ obligations to Holders.

If that sounds like an odd conclusion, there’s good reason. In finding that bondholders had no rights against the guarantor, the Hong Kong court essentially ignored or discounted the fact that a New York court had already concluded that Tunghsu Group was liable to bondholders Zhang and Le under the very same guarantee set out in the very same New York law-governed indenture.

On the face of it, that’s a crazy result. But it does help to delineate a clear enforcement path for holders of New York law-governed bonds in Hong Kong. Head straight to the Hong Kong courts and you’ll find out you have no rights against an issuer or guarantor. But make a detour to the New York courts first and you’ll most likely be able to then waive your New York judgment in front of the Hong Kong court with glee.

A messy default 

Tunghsu Venus’ USD 342m (outstanding) 7% guaranteed bonds due June 2020 were issued in 2017 under a New York law-governed indenture and guaranteed by its PRC-incorporated parent, Tunghsu Group Co. As is customary, a single global note was executed and registered in the name of a nominee of the common depositary for Euroclear and Clearstream – initially Citivic Nominees Limited. The trustee of the bonds was Hong Kong-incorporated Citicorp International Limited.

Shortly before the bonds were due to mature, the Shijiazhuang, Hebei-incorporated conglomerate announced that it had insufficient resources to repay them. Then, on 30 June 2020, Tunghsu’s 2019 financial statements were issued with a qualified audit opinion (along with those of its Shanghai-listed controlled-affiliate Tunghsu Optoelectronic) due to their inability to verify 97% of the group’s (apparent) liquid assets thanks to unexplained advance payments, accounts receivables and bad debt provisions.

Not surprisingly, that caused bondholders to act:

1. first, two investors -- Zhang Rui Kang and Le Huan-Hsin -- took steps in the BVI to liquidate Tunghsu Venus so that the flow of the bond proceeds within the group could be examined. Statutory demands were issued on 16 June and 14 July 2020 and a winding-up petition presented on 4 December 2020 (after Tunghsu Venus unsuccessfully challenged the statutory demands). The BVI court would up Tunghsu Venus in February 2021 (apparently without any concern as to whether the bondholders had standing to petition as a contingent creditor);
2. next, Zhang and Le sued Tunghsu Venus and Tunghsu Group in New York, seeking damages for their failure to pay outstanding principal and interest under the bonds and guarantee. The New York court granted both bondholders a default judgment on 1 September 2021 (NY Judgment);[i] and
3. finally, Zhang and Le commenced two sets of proceedings in Hong Kong. The first sought recognition of their New York judgment (so that it could be enforced in Hong Kong against any assets of Tunghsu Venus and Tunghsu Group in the jurisdiction. The second was filed by Zhang, Le and four other (related) bondholders -- Creative Hub Limited, Alliance Jumbo Limited, Le Yi-Ting and Peak Equity Group. In those proceedings: (i) the four ‘new’ bondholders sought damages from Tunghsu Group for breaching its obligations under the guarantee (Zhang and Le not needing such a judgment because they had already obtained one from the New York Court); and (ii) each of the bondholders sought damages from Tunghsu and various directors for inducing or procuring Tunghsu to breach its payment obligations under the notes and guarantee by allowing the company to siphon off USD 6.4bn in funds prior to the bonds maturing in breach of their directors’ duties.

As those enforcement proceedings rumbled on, Tunghsu engaged Admiralty Harbour Capital and announced a restructuring proposal (in December 2020) which called for 15% of all outstanding principal to be repaid upfront, with 79% to be amortized over three years (with a personal guarantee from 49.06%-shareholder Chairman Li Zhaoting) and the remaining 6% principal and all unpaid accrued interest to be written off. The restructuring collapsed, however, after a Kirkland & Ellis-advised ad-hoc group (which included Zhang and Le) remained unconvinced of the group’s ability to meet the proposed amortization payments and continued to press for better terms.

Suing PRC residents in HK

With no feasible restructuring on the horizon, bondholders had little option but to push forward with their enforcement efforts. To do so in Hong Kong, they needed to serve their two sets of Hong  Kong proceedings on Tunghsu Group and the directors where they resided (in the PRC), something which required leave of the court.

The bondholders obtained leave from a Master of the High Court in 2021. But Tunghsu then filed two applications to set aside the Master’s orders. It was those applications which were heard by Deputy High Court Judge MK Liu on 21 July.

Bondholders may seek recognition of a New York judgment 

First up, Deputy Judge Liu considered whether Zhang and Le should be granted leave to serve their writ seeking recognition of their New York judgment on Tunghsu in the PRC.

To be granted leave, Zhang and Le needed to demonstrate that there was a real prospect of them receiving a legitimate benefit if leave was granted and the writ was served on Tunghsu. That benefit need not be monetary or tangible in nature; it could be indirect or prospective, provided that it served some useful purpose.

Tunghsu argued that no such benefit arose because the bondholders would never be able to enforce the judgment in Hong Kong – Tunghsu had no Hong Kong assets and none of its subsidiaries had any real business operations or assets in Hong Kong. But Deputy Judge Liu agreed with the bondholders that: (i) Tunghsu might have assets in Hong Kong at some juncture in the future (after all, the group had raised capital in Hong Kong in the past and continued to be served by advisers in the jurisdiction); and (ii) enforcing the judgment could allow further investigations to take place with a view to locating assets, including by seeking to examine the directors. Those two factors, together with the inference to be drawn from the fact that Tunghsu had considered it necessary to spend substantial time and money resisting enforcement of the New York judgment in Hong Kong, were sufficient to show that a benefit arose.

Accordingly, the judge dismissed Tunghsu’s setting-aside application and left the bondholders free to serve the proceedings in the PRC.

But they can’t sue a bond guarantor in Hong Kong

Next, Deputy Judge Liu considered whether to grant leave for the second set of Hong Kong proceedings commenced by the bondholders to be served on Tunghsu and the directors in the PRC. That’s when things got more controversial.

In order for leave to be granted, bondholders needed to demonstrate a serious issue to be tried. That’s because courts will be reluctant to force foreign parties to litigate in Hong Kong if the case argued against them is hopeless or lacks reality. Unfortunately for the bondholders, that’s exactly how the court felt about both their guarantee claim against Tunghsu Group and their claims against the directors.

Critically, Deputy Judge Liu concluded that the bondholders had no standing to enforce the guarantee. Why? Because under the terms of Tunghsu’s indenture:

1. Tunghsu Group guaranteed the obligations of Tunghsu Venus to each “Holder of a Note… and to the Trustee and its successors and assigns”; and
2. for so long as the notes were held in global form:
   1. the common depositary (or its nominee) would be considered as the sole Holder and owner of the note, and parties holding book-entry interests in the notes (i.e., bondholders) either directly (as clearing system participants) or indirectly through participants would not be considered Holders;
   2. to exercise any rights of Holders under the indentures, indirect holders of book-entry interests would need to rely on the procedures of their participants, and those participants would in turn need to rely on the operating procedures of Euroclear and Clearstream.

To Deputy Judge Liu, those provisions made it clear that bondholders were not Holders and therefore could not could not pursue Tunghsu Group under the guarantee. Only if definitive notes were issued in accordance with the terms of the indenture would they become a Holder, but that hadn’t occurred. Beyond that scenario, it made no sense for beneficial holders of book entry interests to have an unrestricted right to sue the guarantor when even the rights of Holders to sue were limited under the standard no action clause set out in the indenture.

If that reasoning sounds familiar, it’s because it largely mirrors that of: (i) Justice Doyle of the Grand Court of the Cayman Islands in his April Shinsun Holdings decision; and (ii) Deputy Judge Suen of the Hong Kong High Court in the Leading Holdings decision, released only days before the Tunghsu decision. In those cases, the courts concluded (inter alia) that bondholders had no standing to present a winding-up petition either under the terms of the indenture (because only a Holder had such rights) or as a contingent creditor (because there was no pre-existing relationship between the beneficial holders and the issuer upon which a potential liability was based).

Interestingly though, Deputy Judge Liu didn’t seem to consider one of the key issues in Shinsun Holdings, Leading Holdings and the subsequent BVI decision in Haimen Zhongnan Investment Development, namely whether the Euroclear’s operating procedures – which contain a global authorization permitting bondholders to act as agent of the Holder under the terms of any bond indenture – had been incorporated by reference into the indenture (under New York law). That was a point the three other courts had disagreed on -- the BVI court accepted that under New York law the Euroclear procedures had been incorporated, allowing bondholders to step into the shoes of a Holder and sue for payment; the Cayman and Hong Kong courts concluded they hadn’t, leaving bondholders reliant on the common depositary’s nominee taking such action for them, but without any ability to instruct it to do so. 

Who cares what a New York court said about this New York indenture, this is Hong Kong

But the real surprise for bondholders was that the Hong Kong court refused to accept they could sue Tunghsu Group to enforce the guarantee contained in the indenture despite the New York court having already ruled that two of the bondholders could do so.

That’s right, when interpreting what rights a bondholder had under a New York law-governed indenture, Deputy Judge Liu was happy to ignore or discount the findings of the New York court that Tunghsu Group was liable to bondholders Zhang and Le under the very same indenture. The judge even dismissed the bondholders’ argument that expert evidence on New York law should be adduced, finding that the approaches of the New York court and Hong Kong court to interpreting the indenture would be essentially the same. Apparently not!

In fairness, the New York judgment was a default judgment, issued after Tunghsu chose not to defend the proceedings. In turn, that meant the New York court was not called upon to consider detailed argument as to whether or not the bondholders had standing to sue Tunghsu Group. But presumably the court still needed to be confident that the bondholders had standing to sue and that their claim had merit. For some reason, the Hong Kong court didn’t care.

Your other claims are also flawed

Finally, Deputy Judge Liu took aim at the bondholders’ claim against the directors, once again concluding that there was no serious issue to be tried.

In short, the judge concluded the claims were a long shot. If they had been raised under Hong Kong law, they would have fallen foul of the reflective loss principle which prevents shareholders and creditors recovering loss which was actually suffered by a company. In this case, the bondholders had essentially argued that the directors had wrongfully misappropriated Tunghsu’s assets or recklessly allowed Tunghsu to make the outbound cash flow in breach of their fiduciary duties, which left the company unable to pay the amounts due under the notes. That meant the loss suffered by the bondholders really only reflected the loss suffered by Tunghsu because of the alleged wrongful acts of the directors. And while it was PRC law, not Hong Kong law, which would determine whether the directors had in fact caused loss, the bondholders could not demonstrate that the reflective loss principle wouldn’t also defeat their claim under PRC law.

And just to rub salt into the wounds a little more, the judge also concluded that it was unclear whether Hong Kong was the most appropriate forum in which to hear the bondholders’ claims, given that they involved issues of PRC law (such as whether the reflective loss principle applied), all directors were ordinarily resident in the PRC, and the alleged wrongful acts of the directors (if true) were committed in the PRC. For that reason alone, the court would have refused to grant leave to serve the proceedings outside of Hong Kong.

To enforce in Hong Kong, bondholders must act in New York first

For Tunghsu’s bondholders, the path to enforcing their rights is now clear – push forward with having their New York judgment recognized in Hong Kong and then seek to enforce it against any assets in Hong Kong and/or by serving a statutory demand and winding-up petition against Tunghsu Group itself. Each step of that process will no doubt be opposed by Tunghsu, but may exert enough pressure to extract a better restructuring offer.

More broadly, Deputy Judge Liu’s decision once again highlights that bondholders will face a struggle to enforce their New York law-governed bonds in Hong Kong other than through their trustee. But it also illustrates the way around that quagmire. First, approach the New York courts and obtain a default judgment. Then, bypass any question as to whether or not you have standing to commence proceedings against an issuer or guarantor in Hong Kong by simply seeking recognition of your New York judgment. The path might be a little longer, but it seems that giving the Hong Kong courts less to think about is the best way forward.  

[i] Another bondholder, Asia-focused hedge fund BFAM Asian Opportunities Master Fund LP, took a similar approach to enforce its rights in respect of the USD 100m of notes it held. On 24 July 2020, it commenced proceedings in New York against the issuer and guarantor for the principal and interest outstanding. Then, on 23 September 2020, it filed a motion seeking default judgment, which the court granted on 17 December 2020. Judgment was then entered for the sum due and owing on 16 February 2021.