The Cayman Islands as a restructuring centre: Ocean Rig opens the door
Daniel Bayfield QC and Nick Herrod of Maples and Calder, primarily through the lens of the Ocean Rig restructuring, but also with reference to the CHC case, explore the circumstances in which the Cayman Islands may be the jurisdiction of choice in which to restructure the debts of multi-national groups
The complex and fiercely contested Ocean Rig cross-border restructuring is one of the largest ever effected through schemes of arrangement. It created a number of Cayman Islands firsts, including being the first occasion on which the Cayman Islands court has sanctioned schemes of arrangement promoted by foreign incorporated companies.
The Ocean Rig Restructuring
The Ocean Rig group is an international offshore drilling contractor, specialising in the ultra-deepwater and harsh environment segment of the industry. As a result of difficult market conditions (in particular, the fall in the price of oil from US$100 per barrel in March 2014 to below US$30 per barrel in February 2016) and an unsustainable debt burden, the group’s ability to continue to trade was in jeopardy.
The restructuring, which was implemented through four inter-linked Cayman Islands’ schemes of arrangement, affected approximately US$3.7 billion of New York law governed debt, the majority of which was swapped for equity. The Cayman Islands was selected as the jurisdiction within which to implement the restructuring primarily because: (i) a Chapter 11 was seen as potentially too expensive with greater litigation risk; and (ii) English schemes may have resulted in adverse tax consequences because of the need to shift the scheme companies’ centre of main interests (“COMI”) to the UK (to create a sufficient connection with the jurisdiction and/or to ensure that the scheme proceedings would be recognised in the US under Chapter 15).
The four schemes were proposed by the Cayman Islands registered parent (the “Parent Scheme”) and three of its Marshall Islands incorporated subsidiaries (the “Silo Schemes”). To ensure that creditors could not ignore the release of their New York law governed rights orders were obtained from the U.S. Bankruptcy Court (under Chapter 15 of the U.S. Bankruptcy Code) recognising the schemes and giving them full force and effect.
The restructuring and the schemes were substantially pre-packaged, having been pre-negotiated between the scheme companies and an ad-hoc group of lenders. More than 90 per cent by value of the scheme creditors of each of the four companies had entered into a restructuring support agreement, locking-up to support the scheme, prior to the convening hearing.
Prior to the launch of the schemes, joint provisional liquidators (the “JPLs”) were appointed to the four scheme companies who immediately took steps to obtain a temporary restraining order (the “TRO”) from the U.S. Bankruptcy Court. These steps allowed negotiations to take place with groups of opposing creditors, sheltered by the moratorium on creditor action achieved in both the Cayman Islands (through the appointment of the JPLs) and in the U.S. (through the TRO). The JPLs were appointed to create a breathing space for the scheme companies and to ensure that the restructuring received independent scrutiny from officers of the court.
The JPLs’ appointment had the added benefit of introducing an independent party into the negotiations. This undoubtedly helped the scheme companies to strike a deal with one group of dissenting creditors. Further, the JPLs were able to give the court comfort that the schemes were considered fair by the officers appointed by it to consider the merits of what the scheme companies had proposed.
One group of noteholder creditors (“Highland”) opposed the restructuring every step of the way but the restructuring and the Cayman Islands scheme jurisdiction more generally held up to scrutiny.
The composite judgment dealt with the issues argued at both the convening hearing and the sanction hearing (Re Ocean Rig UDW Inc. and others (Unreported, Grand Court, 18 September 2017)).
The ingredients for a successful restructuring jurisdiction
Where consensual deals with creditors are not possible, a viable restructuring jurisdiction needs to facilitate, in appropriate circumstances, the “cramming down” of dissenting creditors. As demonstrated by their use in England over the last ten years, schemes of arrangement are a powerful company restructuring and rescue tool – despite the requirement to secure, when compared to a Chapter 11, a higher level (75 per cent by value, and a majority in number, of those voting) of support from each class of scheme creditor.
Schemes are on the statute book in the Cayman Islands (section 86ff of the Cayman Islands Companies Law (2016 Revision) (the “Companies Law”)); the statutory provisions being substantially the same as those contained in Part 26 of the UK Companies Act 2006. The Cayman Islands, therefore, follows scheme case law from England and the many other common law jurisdictions whose scheme legislation is also modelled on the UK Companies Acts.
The Cayman Islands scheme jurisdiction was heavily stress tested in Ocean Rig. Class composition, the representative nature of the vote and fairness issues generally were all the subject of lengthy written and oral submissions; Highland taking every conceivable argument in an attempt to bring down the restructuring. Notably, the decision of the Cayman Islands court in Ocean Rig confirmed that Cayman Islands law on class composition, blots, lock-ups and consent fees, cross-holdings, modifications to schemes and the approach to the sanction test are the same as in England – providing relative certainty as to legal outcome.
A light-touch provisional liquidation had already been used in the Cayman Islands as a way to protect a company from hostile creditor action during the negotiation phase of a scheme (although the moratorium does not prevent the enforcement of security). The Ocean Rig experience suggests that it can work most effectively and less disruptively than, for example, a UK administration proceeding. Particularly in a contested situation, a light-touch provisional liquidation can provide a helpful wrapper to the scheme process, while not adding significantly or at all to the length of the process. A restructuring centre needs more than an established and certain rulebook. Trusted legal and court systems and professionals who embrace the benefits of a rescue culture are also required. The Cayman Islands ticks these boxes.
- The legal system is an English common law system – a system that is one of the most established and respected in the world.
- The courts are experienced in handling large multi-national financial disputes. Owing to the nature of the Cayman Islands as an offshore jurisdiction, the vast majority of business that flows through the Islands is of a cross-border nature. Further, the judiciary contains a number of highly respected practitioners who have experience of cross-border restructurings in both the English and U.S. markets.
- The professionals are largely made up of experienced ex-City solicitors, barristers and insolvency practitioners who have handled many large and complex restructurings. The professionals’ default setting is not to liquidate but to rescue.
The Cayman Islands is, therefore, a jurisdiction which can be trusted with complex and high-value restructurings as the Ocean Rig case well demonstrates.
Cayman Islands cross-border schemes
Schemes of foreign incorporated companies – a Cayman Islands first
It has become common place over the last ten years for the English courts to “scheme” foreign companies. Ocean Rig highlights the fact that, in the right circumstances, the Cayman Islands offers a viable alternative jurisdiction. In Ocean Rig, the Cayman Islands court confirmed that it has jurisdiction to scheme foreign incorporated companies and will do so in appropriate circumstances.
The test in England and Wales and the Cayman Islands
England and Wales
The English courts have jurisdiction to sanction a scheme in relation to a foreign incorporated company where that company is liable to be wound up by the English court. The English courts will only exercise the scheme jurisdiction in relation to a foreign company where there is a sufficient connection with the jurisdiction, such as the scheme company’s COMI being in the UK. As the law has developed in England, the bar for sufficient connection has been gradually lowered; with the English courts now taking jurisdiction in circumstances where the only connecting factor to England is that the governing law of the debt to be schemed is English and is subject to the non-exclusive jurisdiction of the English courts. This is the case even where those features result from pre-scheme contractual variations (not necessarily consented to by all scheme creditors) designed to satisfy the sufficient connection test1.
Where a foreign company’s COMI is located outside of the UK and a COMI shift is impossible or impractical, absent an English governing law clause or the extreme forum shopping involved in the accession of a UK registered company as a co-obligor to promote the scheme2 , there will be challenges in meeting the sufficient connection test (and the effectiveness of the scheme may, in any event, be in doubt).
The Cayman Islands court also has jurisdiction to sanction a scheme in respect of a company that is liable to be wound up by the Cayman Islands court. In England, the ability to wind up a foreign incorporated company derives from the fact that the court has jurisdiction to wind up unregistered companies (a foreign incorporated company being treated as an unregistered company). Under Cayman Islands law, specific legislative provisions govern when a foreign incorporated company is liable to be wound up by the Cayman Islands court. Section 91 of the Companies Law provides that the Cayman Islands court has jurisdiction to wind up a foreign company which: (i) has property located in the Cayman Islands; (ii) is carrying on business in the Cayman Islands; (iii) is the general partner of a limited partnership; or (iv) is registered as a foreign company with the Cayman Islands Registrar of Companies.
Accordingly, simply registering the foreign company in the Cayman Islands creates the jurisdictional hook for a Cayman Islands scheme of arrangement. As in England, the Cayman Islands court will, as a matter of discretion, need to be satisfied that it should exercise its jurisdiction. One question is whether the Cayman Islands court, in order to exercise its discretion, will, in addition to registration as a foreign registered company, require more. This point was untested in Ocean Rig because, as a result of a shift of the scheme companies’ COMI to the Cayman Islands (see below) each scheme company had a substantial nexus to the Cayman Islands (including assets in the jurisdiction). Accordingly, the weight of the connection to the Cayman Islands required to invoke the discretion of the Cayman Islands court remains an area of Cayman Islands law to be developed. However, given that it is expected that most Cayman Islands restructurings will involve New York law governed debt and therefore would likely require a COMI shift or the creation of an establishment (which of itself creates a jurisdictional nexus), circumstances where there is limited connection with the Cayman Islands at the time schemes are filed are currently expected to be few and far between.
Forum shopping for the most effective restructuring jurisdiction
The Cayman Islands was deliberately selected as the jurisdiction within which to implement the Ocean Rig restructuring. The scheme companies did not have longstanding connections with the jurisdiction. This is not unusual in the restructuring context – restructuring lawyers seek the jurisdiction within which to implement a restructuring in the most efficient and effective manner while returning the greatest possible value to creditors. As the Marshall Islands had no restructuring procedure and both Chapter 11 and English scheme proceedings were unattractive (Chapter 11 because of cost, likely implementation time and litigation risk; English schemes due to adverse tax consequences of a COMI shift) the Cayman Islands was selected as the jurisdiction within which to implement the restructuring.
Creation of the Cayman nexus
The parent was continued3 to the Cayman Islands from the Marshall Islands in April 2016 for reasons unconnected to any restructuring of the group’s debt. Following the continuation, the parent became a Cayman Islands exempted company. The three Marshall Islands subsidiaries were registered in the Cayman Islands as foreign companies in October 2016 and the COMI of each of the scheme companies was shifted to the Cayman Islands between October 2016 and early February 2017.
The Cayman Islands court adopted the approach of the English court that forum shopping is not abusive where it is carried out with a view to achieving the best possible outcome for creditors – this was found to be the case with the Ocean Rig restructuring.
In recognising both the provisional liquidation and the scheme proceedings, the U.S. Bankruptcy Court reached the same conclusion as the Cayman Islands court. It was held that, while the scheme companies purposefully moved their COMI to the Cayman Islands before filing for recognition of the provisional liquidation and scheme proceedings, those actions were taken for legitimate reasons, motivated by the desire to maximise value for creditors and to preserve assets. This was good, as opposed to bad, forum shopping.
Pre-filing COMI shift to the Cayman Islands – another first
Ocean Rig involved the first pre-filing COMI shift to the Cayman Islands. While companies’ COMI have previously been shifted to the Cayman Islands, the shift has always been effected by the provisional liquidator or liquidator once in office. The activities of the provisional liquidator or liquidator (notably communications with creditors and decision making) naturally shift COMI to where the office-holder undertakes his or her activities. Given that: (i) the debt to be compromised was governed by New York law; (ii) there were pending events of default under the credit instruments to be compromised; and (iii) certain creditors were likely to be hostile to the restructuring, a moratorium was required in the U.S. from the time that the scheme companies were placed into provisional liquidation in the Cayman Islands. This required shifting the scheme companies’ COMI to the Cayman Islands (in a similar manner as for an English scheme of arrangement of New York law governed debt). Further, the application for the appointment of the JPLs was on a “without notice” basis so as to prevent hostile creditor action being taken (as had been threatened) in the U.S. prior to the JPLs applying for a TRO.
The steps taken to shift the scheme companies’ COMI ensured that their head office functions were conducted from the Cayman Islands and that this was objectively ascertainable to third parties (in particular creditors). As another Cayman Islands first, a Cayman Islands restructuring subsidiary was established to perform, pursuant to a Cayman Islands law governed services agreement, a number of the head office and front-office administrative functions of the scheme companies in the Cayman Islands.
In recognising the provisional liquidation and the scheme proceedings, the U.S. Bankruptcy Court expressly confirmed that Cayman Islands exempted companies can have their COMI in the Cayman Islands – accepting that exempted companies can be managed from the Cayman Islands (management of the business being a crucial COMI factor). Therefore, any historic doubts in this regard have finally been laid to rest.
Will the schemes be substantially effective?
As with the English courts, the Cayman Islands courts will not act in vain. It will need to be shown that a scheme will be substantially effective in the jurisdictions which matter – in particular, in the jurisdiction where the scheme company is incorporated and in the jurisdiction which governs the liabilities which are to be varied by the scheme. In the same way as in England, this can be demonstrated by expert evidence from the relevant foreign jurisdictions.
One tactic which can complicate (and even derail) a restructuring is for a dissenting creditor to allege that claims exist which would create value for the creditors. The question then becomes how such claims should be treated in the restructuring. In Chapter 11 proceedings, a common way of dealing with such allegations is to create a litigation trust. The restructuring moves forward and the claims are assigned into a trust to be dealt with by a trustee – if claims are successfully pursued the recoveries benefit all creditors.
Due to the limitations of English law purpose trusts, litigation trusts do not readily feature in English restructurings. As a general rule, it is not possible for an English law trust to be constituted to carry out a non-charitable purpose (e.g. the investigation and potential prosecution of causes of action).
A Cayman Islands STAR trust governed by Part VIII of the Cayman Islands Trust Law (2017 Revision) allows for a trust, the object of which is a mix of persons and purposes. As such they are an ideal tool with which to form a litigation trust.
As yet another Cayman Islands first, the STAR trust mechanism was used in the Ocean Rig restructuring to create a trust into which claims that Highland alleged the parent company (and two of its non-scheme subsidiaries) had against third parties were assigned. All the Parent Scheme creditors were beneficiaries under the trust. A corporate trustee company was created of which the JPLs (not in their capacity as such) were the directors. So that the claims could be properly investigated the trust was funded, by the parent company, with US$1.5 million.
The restructuring could therefore proceed on the basis that each Parent Scheme creditor was treated fairly and would recover rateably should any of the claims be successfully brought to fruition. This allowed the restructuring to move forward in the required time period. The litigation trust avoided Highland being able to argue that, in dollar terms, the liquidation outcome might be better than the scheme outcome because a liquidation may result in the claims being pursued by a liquidator whereas (Highland would doubtless have contended) the parent would not pursue them.
Putting a value on litigation is notoriously difficult and it would have been expensive, time consuming and unsatisfactory for the Cayman Islands court to have been diverted by having mini-trials of the claims to enable it to form a view as to their merits and value. Placing them into a litigation trust meant that, whatever the value of the claims (if any), their value would be enjoyed by the creditors in a liquidation or, if the schemes became effective, through the litigation trust. That parallel dictated that there was no need for the court to ascribe any particular value to the claims because their inclusion on both sides of the liquidation outcome versus scheme outcome cancelled themselves out.
Wrapping a scheme within a restructuring provisional liquidation
Specific statutory provisions exist in the Cayman Islands enabling a provisional liquidation to be used to shelter a proposed restructuring. Where a winding-up petition has been presented, provisional liquidators may be appointed under section 104(3) of the Companies Law where the company: (i) is, or is likely to become, unable to pay its debts; and (ii) intends to present a compromise or arrangement to its creditors. This allows a restructuring of the company to be pursued with the benefit of the moratorium on creditor action (although there is no stay on the enforcement of security as there is in English administration proceedings). The restructuring may take the form of a scheme of arrangement (as was the case in Ocean Rig) or a consensual deal with creditors. Further, where a stay on creditor action in the Cayman Islands may be beneficial a provisional liquidation may be used to support restructuring efforts in other countries, for example, a plan of reorganisation in Chapter 11 proceedings (as occurred in Re CHC Group Ltd (Unreported, Grand Court, 24 January 2017) (“CHC”), where a Cayman Islands provisional liquidation supported a Chapter 11 proceeding – see below).
The court has a broad discretion as to what powers to grant a provisional liquidator and as to the scope of his or her role. In the restructuring context it would be usual to allow the existing management to remain in control of the company’s affairs (subject to the supervision of the provisional liquidator). The order will be tailored to the requirements of the case.
The decision in Ocean Rig to use the provisional liquidation wrapper was an important, defensive, strategic decision. While the debtor companies’ management remained in possession, the JPLs were able to provide an independent voice in negotiations with dissenting creditors (assisting one of the silo scheme companies to strike a deal with one group of creditors who could otherwise have vetoed that silo scheme). Further, the JPLs were, as officers of the court, able to provide confirmation that, having subjected the schemes to independent scrutiny (in particular having vetted the liquidation comparator and scheme allocation methodology) that the schemes were fair and should be sanctioned. This meant that the bar for the challenging creditor to surmount was a higher one than if the provisional liquidation wrapper had not been used.
Accessing the restructuring provisional liquidation regime
A feature of Cayman Islands law is that, before provisional liquidation proceedings can be commenced, a winding up petition must be filed. Under the Companies Law (as interpreted most recently by the Grand Court in the case of Re China Shanshui Cement Group Limited  (2) CILR 255), the directors cannot present a petition for the winding up of a company unless expressly authorised to do so under the company’s articles of association or by a shareholder’s resolution. This is known as the Emmadart rule, because the relevant provisions of the Companies Law provide statutory recognition of the principles set out in Re Emmadart Ltd  Ch 540.
The rationale for the Emmadart rule is that directors only have the authority to manage the business. While the object of management is continuing the company’s business, winding-up causes the death of the company. Directors, therefore, need additional authority to commence a procedure that terminates the company’s business. The rule in Emmadart no longer applies in England having been overruled by statute.
In China Shanshui, the company’s directors had presented a winding-up petition (without a shareholder resolution or express authorisation in the company’s articles of association) and applied for the appointment of provisional liquidators with a view to restructuring the company’s debts. The Cayman Islands court dismissed the application on the basis that the directors had no authority to present the winding-up petition, which was a pre-requisite to the application for the appointment of provisional liquidators. CHC confirms the Emmadart work around CHC was the Cayman Islands registered holding company of a multinational helicopter group which was subject to Chapter 11 proceedings. As part of the coordinated effort to successfully restructure the group, provisional liquidation proceedings in respect of CHC, followed by a validation order application relating to transfers of assets to be made pursuant to the Chapter 11 plan, were considered necessary. However, CHC’s articles of association did not expressly authorise the directors to present a winding-up petition and a resolution had not been obtained from its shareholders and, as a matter of practical reality, could not be obtained.
The proposed solution was for a subsidiary of CHC (which was owed money by CHC) to file a “friendly” creditor’s winding-up petition and, thereafter, for CHC’s directors to cause CHC to apply for the appointment of provisional liquidators.
In these circumstances, the Cayman Islands court held that the Emmadart rule did not apply. The rationale underpinning the Emmadart rule (that the directors have no authority to bring about the destruction of the company’s business) has nothing to do with applications for the appointment of provisional liquidators under section 104(3) which does not ordinarily, or of itself, bring about the destruction of the company’s business. Such an application is made for the purpose of saving the business of the company. While this work around (i.e. having a creditor file the petition underpinning the provisional liquidation, not the company) cuts across the wording of Order 4, Rule 6 of the Companies Winding Up Rules (2008) (as amended) (which provides that where a winding up petition has been presented by the company, the company may apply for the appointment of a provisional liquidator), it has, for some time, been recognised by the Cayman Islands legal profession as potentially being available. The CHC case is the first time that the Cayman Islands court has confirmed its validity.
A stand-alone restructuring moratorium?
While the restructuring provisional liquidation wrapper has served the Cayman Islands well, it can suffer optically – it is counter-intuitive to initiate a liquidation proceeding in order to facilitate a restructuring. For this reason (and others), reforms to introduce a stand-alone restructuring moratorium to replace the light-touch restructuring provisional liquidation are on the agenda. Importantly, the new proceeding will not be connected to the winding up regime. A qualified insolvency practitioner (restructuring officer) will take on an equivalent role to that currently performed by a provisional liquidator appointed under section 104(3). The Emmadart rule will not apply to the standalone restructuring moratorium and the moratorium will: (i) apply from the date of filing (rather than the date that restructuring officers are appointed by the court); and (ii) be expressed to be extra-territorial.
It is, as matters stand, hoped that the reforms will be passed into Cayman Islands law in the first half of 2018.
When to select a Cayman Islands restructuring
It is clear that the Ocean Rig restructuring sets a precedent for the use of the Cayman Islands as a centre within which to conduct modern, complex cross-border restructurings. But when will a Cayman Islands scheme be the right tool in the toolbox for the restructuring lawyer to reach for?
Given the rule in Gibbs (broadly that English law debt can only be compromised through an English proceeding) it is likely that Cayman Islands schemes will be most appropriate in order to amend or compromise New York law governed debt. It is unlikely (but not impossible) that it will be commercially palatable to change the governing law of the debt from English to Cayman Islands law.
A restructuring of New York law debt requires recognition and enforcement pursuant to U.S. law. This is likely to require a Chapter 15 filing. Accordingly, either the COMI of the debtor will need to be shifted or an establishment created. Shifting COMI to England (or creating an establishment in England) is likely to result in adverse tax consequences. The Cayman Islands is a tax neutral jurisdiction – there are no Cayman Islands tax consequences of a Cayman Islands COMI shift; indeed if the debtor is paying tax in its current jurisdiction there may be a tax benefit to the COMI shift. This means that where the debtor is either in a no or low tax jurisdiction, a Cayman Islands scheme of New York law debt may be particularly attractive.
Chapter 11 is the other likely alternative. While there are advantages to Chapter 11 (notably that, in particular situations, it permits the cramming down of a class) the cost of a Chapter 11 case tends to be very substantial and the greater ability of creditors successfully to stall progress may militate in favour of looking elsewhere.
As the success of the Ocean Rig restructuring demonstrates, a Cayman Islands scheme, with or without a restructuring provisional liquidation wrapper, is a restructuring tool that, in the right circumstances, offers a real alternative and should not lightly be discounted.
Daniel Bayfield QC and Maples and Calder acted for the successful scheme companies in Ocean Rig and Daniel also acted for CHC.
1/. See, for example, Re Apcoa Parking Holdings GmbH  BCC 142.
2/. See, for example, Re Codere Finance (UK) Limited  EWHC 3778 (Ch).
3/. Continuation allows a company incorporated in one jurisdiction to be seamlessly transferred to the Cayman Islands. There are a number of requirements that need to be fulfilled before a company can be “continued” to the Cayman Islands which are beyond the scope of this article.