From Gloom to Bloom: Peking Founder ruling on keepwell deeds overturned on appeal

The Beijing No.1 Intermediate People’s Court (“Beijing Court”) ordered the commencement of reorganisation proceedings of PUFG in February 2020. After the commencement of reorganisation, Nuoxi and Kunzhi defaulted on their payment obligations under the Bonds. The liquidators of the PUFG Obligors submitted claims in respect of the keepwell deeds[7] relating to the Bonds to the court-appointed administrators. All claims were rejected by the administrators without giving reasons, save for one submitted by JHC, which was not adjudicated on the basis that it was submitted out of time.

In 2021, the liquidators of the PUFG Obligors sought declaratory relief from the CFI in respect of the rights of such PUFG Obligors under the keepwell deeds. In May 2023, the CFI handed down the CFI Judgment, which recognised the binding effect of keepwell deeds, and declared that PUFG had breached one of the keepwell deeds because Founder Information had failed a net worth requirement and PUFG had not used its best efforts to obtain relevant governmental approvals to remit funds to Founder Information prior to the commencement of reorganisation. The CFI granted declaratory relief of approximately US$167 million for losses incurred by Founder Information. On the other hand, in respect of Nuoxi, Kunzhi and JHC, which defaulted under the Bonds after the commencement of reorganisation but with no evidence of other relevant breach prior to the commencement of reorganisation, the CFI found that there was no realistic likelihood of obtaining the relevant governmental approvals for PUFG to remit the funds offshore after the commencement of reorganisation, and thus the failure to take any steps by PUFG to obtain relevant governmental approvals did not breach the “best efforts” undertakings. Hence, the claims under those Bonds of Nuoxi, Kunzi and JHC were rejected by the CFI. Nuoxi, Kunzhi and JHC (collectively the “Appellants”) appealed the CFI Judgment.

Please refer to our article Are Keepwell Deeds Keeping Well?  for more details of the CFI Judgment.

2.   Decision and rationale of the CA Judgment

The only ground of appeal[8] that was successful in the CA centered around clauses 2.2 and 4.1(ii) of the relevant keepwell deeds:

Clause 2.2 provides that if and to the extent that PUFG is required to obtain necessary approvals, consents, licenses, orders, permits, or any other authorisations from the relevant Approval Authorities[9] (“Relevant Approvals”) in order to comply with its keepwell deed obligations, then PUFG’s performance shall always be qualified by, and subject to, PUFG having obtained the Relevant Approvals. PUFG undertakes to use its best efforts to obtain the Relevant Approvals within the time stipulated by the relevant Approval Authorities, if applicable.

Clause 4.1(ii) provides that PUFG shall ensure that the PUFG Obligors have sufficient liquidity to ensure timely payment of any amount payable under or in respect of the Bonds or the relevant guarantees (the “Liquidity Support Undertaking”).

The CA agreed with the submission by the Appellants that on the proper construction of clause 2.2, to perform PUFG’s obligations under the keepwell deeds, Relevant Approvals might, but not necessarily will, be required. This is borne out by the words in clause 2.2 of the keepwell deeds:

“if and to the extent that [PUFG] is required to obtain necessary approvals”     

The CA Judgment referred to modes of performance by which PUFG could fulfill its obligations under the keepwell deeds without the necessity of obtaining Relevant Approvals, such as asking a third-party entity not restricted by PRC law to provide financial support to PUFG, utilising offshore assets, or engaging in offshore refinancing. Such modes of performance do not involve cross-border remittance from the PRC to offshore. As PUFG had provided no evidence at all on its intended mode of performance of its keepwell obligations, and that its intended mode of performance was one which required Relevant Approvals, PUFG could not establish that it had satisfied the “escape clause” under clause 2.2 that it had used its best efforts to obtain Relevant Approvals.

In light of that reasoning, the CA allowed the appeal and ruled in favour of the Appellants, concluding that PUFG had breached the keepwell deeds and granted declaratory relief amounting to approximately US$1.7 billion in favour of the Appellants.

3.   Comparison with the CFI Judgment

The table below summarises the main differences between the CFI Judgment and the CA Judgment:

4.   Potential future development

a.  Possibility of further appeal

Hong Kong has a “three-instance” judicial system[10], where parties may be permitted to appeal a case twice when certain conditions are met. Cases heard by the CA, such as the Peking Founder case, may be permitted to be further appealed to the Hong Kong Court of Final Appeal (the “CFA”) when prescribed conditions are met. Market participants should therefore continue to pay close attention to any possible appeal of the CA Judgment to the CFA, and any possible appeal to the CFA may yield a ruling which may or may not differ from the CA Judgment.

b.  Enforcement in the PRC

In both the CFI and the CA, the PUFG Obligors sought declaratory relief[11], as opposed to a monetary judgment, for the purpose of proving their debts in connection with the keepwell deeds in the reorganisation of PUFG.  

It is reported that the Beijing Court had decided to hear a petition filed on behalf of some holders of the Bonds to recognise the CFI Judgment. Following the CA Judgment, it may be anticipated that the Appellants may apply to the Beijing Court for the recognition of the CA Judgment after it becomes legally effective pursuant to the Arrangement on Reciprocal Recognition and Enforcement of Judgments in Civil and Commercial Matters by the Courts of the Mainland and of Hong Kong[12].

c.  Stare decisis

Under the common law system in Hong Kong, the doctrine of stare decisis (a Latin term which means “let the decision stand”) requires courts to follow the ratio decidendi (a Latin term which means “the reason for deciding”) of prior similar cases when making their decisions.

Generally speaking, the decision of the CA is binding on itself as well as the lower courts (such as the CFI), and the decision of the CFI is binding on the lower courts only, but not itself (its decisions are only persuasive on itself). Therefore, the CA Judgment has set a binding precedent with more extensive authority and binding effect for similar cases concerning keepwell deeds.

d.  Tsinghua Unigroup case

We looked into another CFI case on keepwell deeds, the Tsinghua Unigroup case[13], in our article Are Keepwell Deeds Keeping Well?. Is there any implication of the CA Judgment on the Tsinghua Unigroup case?  

 In the Peking Founder case, the Appellants on appeal were the three plaintiffs who defaulted under the Bonds after the commencement of reorganisation but with no evidence of other relevant breach prior to the commencement of reorganisation. The CA held that:

• PUFG failed to object to the submission that there were alternative modes of performance of its keepwell obligations not requiring Relevant Approvals, and PUFG did not establish that it would come within the “escape clause” regarding using its best efforts to obtain Relevant Approvals; and
• the argument that using no efforts to obtain Relevant Approvals was no longer relevant.

In the Tsinghua Unigroup case, Justice Harris ordered PUFG to pay the plaintiff approximately US$480 million, which consisted of the principal, interest, and related expenses of the bonds as a result of a payment default by the bond issuer prior to the commencement of reorganisation. Therefore, the argument in the Peking Founder case that using no efforts did not breach the best efforts obligations because approvals would never have been obtained after the commencement of reorganisation was not applicable to the Tsinghua Unigroup case.

As such, the CA Judgment does not appear to have any impact on the Tsinghua Unigroup case because of the different factual background.

5.   Future use of keepwell deeds

We set out six key takeaways in our article Are Keepwell Deeds Keeping Well?, which remain relevant. Taking into account the rulings in the CA Judgment, we update two of the key takeaways as follows:

a.  The fourth takeaway: timing is key when evaluating the “best efforts” provisions in keepwell deeds, if the only mode(s) of performance require(s) regulatory approvals

The CA Judgment overturned the CFI Judgement primarily because PUFG failed to object to the notion that there are alternative modes of performance of its keepwell obligations not requiring Relevant Approvals. If Relevant Approvals may not be necessarily required, the “escape clause” under clause 2.2 of the keepwell deeds was not engaged. The essence of this argument rests on the opening phrase of clause 2.2 of the keepwell deeds which reads: “if and to the extent that [PUFG] is required to obtain necessary approvals." (please see section 2 above (Decision and rationale of the CA Judgment)).

Based on the reasoning of the CA Judgment:

• the “best efforts” qualification in keepwell deeds is only relevant when obtaining regulatory approvals to fulfil keepwell obligations is the only mode of performance. If the modes of performance of keepwell obligations are not limited to those requiring regulatory approvals, the “best efforts” to obtain regulatory approvals qualification may not be relied on by the keepwell provider to avoid its keepwell obligations
• whether keepwell obligations are triggered prior to or after the commencement of reorganisation may not have a bearing on the keepwell provider’s obligations if obtaining regulatory approvals to fulfil keepwell obligations is not the only mode of performance

It is important to note, however, that if the fact pattern is different in another scenario such that a keepwell provider’s only mode of performance involves cross-border remittance of funds or other means which requires regulatory approvals, any qualification regarding using best efforts to obtain regulatory approvals would become relevant and the dichotomy between triggering of keepwell obligations prior to or after the commencement of reorganisation would become the focal point of contention. 

b.  The fifth takeaway: scrutinise the keepwell obligations and how the keepwell obligations are intended to be fulfilled

Following from the previous takeaway, when drafting or reviewing keepwell deeds, focus should be placed on specifying the keepwell obligations, the triggers of the keepwell obligations, and how the keepwell obligations are intended to be fulfilled. Where feasible, offshore creditors should consider setting out different modes of performance of the keepwell obligations. This does not only facilitate the enforcement of keepwell obligations, it could potentially reduce the possibility of the keepwell provider’s reliance on the “escape clause” relating to the taking of best efforts in obtaining necessary governmental approvals.

Conclusion

The CA Judgment represents a significant development of the enforcement of keepwell deeds. It is recommended that offshore creditors who are beneficiaries of keepwell deeds thoroughly understand the ramifications of the CA Judgment and continue to monitor its development. The application of the decision reached in the CA Judgment is highly fact specific. In new deals with keepwell support, offshore creditors should pay close attention to the terms of the keepwell obligations as well as how such keepwell obligations are intended to be fulfilled.