With China driving new case growth, offshore disputes are increasing among Asian companies, keeping lawyers very busy indeed, finds Christopher Horton

One of the more noticeable trends in the field of offshore legal services in recent years has been the growth in disputes-related work. It should come as no surprise then, that with the growth of demand for offshore legal services in Asia, there has been a parallel increase in demand for offshore litigation services.

Asian Legal Business spoke with leading offshore law firms practicing in the British Virgin Islands, Cayman Islands and Channel Islands to learn more about what is driving Asian demand for offshore dispute services, as well as what makes the Asian market unique.

In conversations with six different offshore firms that shared their experiences, a number of recurring themes emerged. These themes are driving much of the work for offshore firms and include shareholder disputes, debt restructuring, go-private transactions and cross-border enforcement.

SHAREHOLDER DISPUTES

Maples and Calder partner John Trehey heads the firm’s Asian litigation, restructuring and insolvency practice. He has been based in Hong Kong for more than 11 years, which has positioned him well to handle disputes involving clients from China, Asia’s largest economy and a major source of work associated with dispute resolution.

“We are seeing significant growth in shareholder disputes, and an ever-increasing number of those emerging from the PRC,” Trehey says. “A large number of these disputes end up in formal litigation in the BVI where there is a broad and flexible legislative regime for aggrieved shareholders to take action.”

By way of example, the relatively recently introduced “unfair prejudice” remedy, which allows aggrieved shareholders to seek a wide range of relief, has resulted in major growth of shareholder litigation in the BVI and is largely responsible for the increase in the number of offshore litigators in Asia.

Trehey says that Maples has also seen an increase in applications for compliance or restraining orders as a more efficient way of restraining directors from breaching duties or infringing applicable legislation.

“These sorts of applications are often easier to bring than, say, derivative proceedings, which can be time-consuming and otherwise challenging to get off the ground,” Trehey notes.

He is not the only practitioner to have noticed an increase in the number of shareholder disputes coming out of the PRC. Ray Ng, head of dispute resolution for Asia at Ogier, has also seen growing demand for work in this particular space and jurisidiction.

“We are seeing growth in the provision of offshore advice and options in relation to shareholder disputes where the typical structure comprises BVI and/or Cayman companies and there are shareholder agreements that are governed by Hong Kong law and contain Hong Kong arbitration clauses,” Ng says. “Quite often, there are concurrent or consecutive proceedings offshore and onshore — onshore not only in Hong Kong, but often also in PRC.”

Ng said that Ogier frequently works alongside the Hong Kong or PRC legal teams – or both – to provide a combination of both off-shore and onshore strategies and solution.

There is also an increase in some of the less traditional approaches to solving shareholder disputes, says Trehey. His firm is seeing a visible uptick in shareholder disputes in the PRC evolving from being resolved by traditional means, whether through negotiation or the pursuit of traditional causes of action in court proceedings, to the use of formal insolvency proceedings and the making of court-appointments, whether of provisional liquidators or inspectors, whose task is to hold the fort or look into the affairs of certain parties to the litigation.

“Often this is necessary in order to assist litigants in obtaining a clearer picture of things in circumstances where proceedings are issued in haste and where there is little time or other means to obtain a clear picture of all relevant circumstances,” Trehey says.

DEBT RESTRUCTURING

The skyrocketing levels of private debt in China are also driving demand for offshore dispute services. Many estimates place the ratio of private debt to GDP in the PRC higher than 1990s Japan. In the decade to 2014, the level of domestic debt per capita in China grew by more than four times, with GDP per capita almost tripled. By some estimates, China’s total debt adds up to 280 percent of GDP, higher than the U.K.

J. Ross McDonough, senior partner at Campbells and the managing partner of the firm’s Hong Kong office, which opened at the beginning of this year, said there has been major growth in this area recently.

“We are witnessing an increase in multijurisdictional restructuring of debt using a scheme of arrangement by companies which are incorporated in the BVI or the Cayman Islands, but whose operational business is undertaken in Asia and expect this trend to continue,” McDonough says. “Increased activity exists in certain sectors that are facing challenges such as those that are exposed to collapsing commodities markets, a depreciating Chinese renminbi — which is particularly relevant where a company is exposed to USD denominated debt — or a slowdown in China’s growth rate.”

Companies that raised debt by way of bond issues during a buoyant economy with an expectation of continued growth are now defaulting on the interest payments, McDonough notes. This is a fairly new phenomena in the PRC, and one that is partly driven by ongoing reforms and government moving away from implicitly backing the debt of state-owned companies.

“Over the past 12 to 18 months we have seen an increasing number of PRC-based entities defaulting on bonds which some perceive to be only the start of a much bigger trend,” McDonough says. “The elephant in the room is the unprecedented level of debt issued by PRC-based bond issuers which is due to mature in the next five years. It is estimated that by the end of 2021 approximately $206.6 billion of debt issued by these entities is due to mature, approximately US$51.4 billion of which relates to high-yield notes.”

A significant number of these companies will have issued notes using offshore entities, predominantly Cayman and BVI companies. Historically the policy of the Chinese government has been to support these entities where regional economies are dependent upon their continued existence or where state-controlled banks and financial institutions have a significant exposure to the debt. McDonough says that that is no longer the case.

“We are starting to see a more selective approach being taken by the authorities in the PRC as to which entities should be supported and which should be allowed to fail,” he says.

Debt restructuring is also a major driver for Harneys’ Asian business, says Ian Mann, head of Harneys’ offshore litigation and restructuring department in Hong Kong.

“We are seeing an explosion in the amount of high net worth disputes and contentious trusts work concerning BVI, Cayman and Bermuda companies,” Mann notes. “This is because of the massive debt burden, coupled with the slowing of the Chinese economy.”

In terms of restructuring, Harneys has acted for a number of complex and high profile schemes of arrangement including working with Alibaba in a leading decision in 2012 in a $2.2 bn undertaking acting for Alibaba.com; working with LDK Solar to win a number of awards totaling US$450 million at the end of 2014 and acting for a creditor group that accounted for the largest class of senior noteholders; working with global brand L’Oreal in its takeover of household brand Magic Holdings in a $849 million deal in mid-2014; and acted for Kaisa in a fight against a group of creditors in a $2.7bn action in 2016.

These mandates may be the tip of the iceberg. Mann says he expects to see more of such work in Hong Kong and the PRC in the next 12 months.

Ogier’s Ng also notes a pronounced increase in work related to restructuring and insolvency.

“We are seeing increased financial distress in businesses set up through offshore structures, which manifests in receiverships, winding up petitions and provisional liquidations being instigated by creditors,” he says. “There has been a shift from seeking to wind up the company structure in the offshore courts to trying to wind it up in the Hong Kong courts. However, that approach has pros and cons, and we are not infrequently called upon to give the alternative offshore perspective, which sometimes leads to fresh consideration of the offshore route.”

In the case of receiverships, Ogier is seeing many challenges to offshore appointments being conducted in the Hong Kong courts where the applicable law is offshore law, Ng adds.

“Often, because the underlying business is in PRC and the receivers are trying to get through the structure into the business itself, there are also concurrent proceedings in PRC,” he says. “We find that we are increasingly called upon to provide offshore legal advice or expert opinions in relation to such proceedings.”

Another trend in this space is cooperation between company and creditor — one in which creditors are taking an increasingly pragmatic approach — McDonough says.

“Rather than petition for the winding-up of a company which is cash flow insolvent but balance sheet solvent, there is an increasing trend for the company and its creditors to work together to maximize value for both creditors and the company,” he says. “A scheme of arrangement is an extremely flexible tool which can be used to implement a variety of ‘arrangements’ between a company and its creditors or members whilst ensuring the continued viability of the company and its operational business.”

In essence, a scheme is a court approved compromise or arrangement entered into between a company and its creditors or members, or any class of them, which is binding on all creditors/members including any dissenting minorities. The flexibility of a scheme means that it can be used in a wide range of circumstances from amending the terms of an existing debt obligation to implementing a wholesale restructuring of a company’s debt.

“The objective of the scheme is to allow the company to continue as a going concern whilst ensuring a better return to the company’s creditors or members than they would otherwise expect to receive in a liquidation,” McDonough says. “This is particularly the case where the company’s assets are illiquid or difficult to value or where market conditions would result in significantly reduced prices being achieved in a fire sale of assets. There is a growing acceptance by creditors that whilst they may be asked to take a ‘hair cut’ on the debt owed to them, a scheme will often offer the best hope of maximizing their return from a distressed situation.”

GOING PRIVATE

Another area of work that is leading to a visible uptick in mandates for offshore dispute resolution services is go-private transactions.

Gary Smith, partner at Loeb Smith in the Cayman Islands, notes that there are more companies from China that are based in offshore jurisdiction and have listed entities in foreign markets like New York or London.

“There are many going private transactions involving Cayman Islands-domiciled Chinese companies listed in the United States — for example on the New York Stock Exchange or NASDAQ — currently,” Smith says.

“In 2015 alone, there were over 30 such transactions. The trend has continued into 2016. These transactions are effected using the Cayman merger law regime which provide minority shareholders with the right to seek ‘fair value’ for their shares by dissenting to the merger take-private of the relevant listed company. The exercise of dissenting rights has formed the basis for a large number of the disputes.”

Campbells’ McDonough also describes an upward trend of going private transactions in the Cayman Islands, especially by Chinese companies.

“Since the introduction of the statutory merger provisions to the Cayman Islands Companies Law in 2009, there has been a steady increase in Cayman companies listed on major stock exchanges being taken private often with the intention of being relisted on one of the PRC — usually Shanghai — or Hong Kong stock exchanges,” he says.

Driving this trend are the so-called “China orphan” companies, a phrase coined to refer to companies of Chinese origin which listed on major US stock exchanges only to be neglected and undervalued by investors due to their lack of familiarity with the company and its business, he adds.

“There are a number of reasons to explain why a ‘China orphan’ company would want to re-list in Shanghai or Hong Kong but the fundamental reason is that the parties driving the transaction — usually the company’s management, controlling shareholders and/or a private equity fund — believe that the value of the company’s shares will soar either in the short, medium or long term as a result of the company being relisted.”

The merger process is straightforward and typically requires a new Cayman company to be incorporated as the bidder to merge with and be subsumed by the listed Cayman target company. The directors of the companies to be merged are required to approve a written plan of merger which is to be authorised by way of a special resolution of the members.

A shareholder who objects to the merger, prior to its authorization, and who later gives notice of dissent in accordance with the statutory procedure, will be entitled to payment of the fair value of his entire shareholding in a constituent company, McDonough says.

“Once a shareholder gives his notice of dissent in accordance with the statute, the shareholder ceases to have any rights qua shareholder in the constituent company save for an entitlement under the statutory scheme for payment of fair value for his shareholding, as well as certain other rights prescribed by statute,” he says.

The statutory provisions set out the procedural steps to be taken by the company and the dissenting shareholder to determine whether an agreement can be reached on the fair value of the dissenter’s shares, failing which the company is required to file a petition with the Grand Court in the Cayman Islands for the determination of fair value of the shares of all dissenters. The dissenters are entitled but not obliged to participate in the fair value proceedings and can therefore put the company to the cost of satisfying the court that the company’s valuation of the shares is fair.

CROSS-BORDER ENFORCEMENT

Although it is not as big a source of work as debt restructuring or shareholder disputes, cross-border enforcement is also in demand among Asian clients, particularly those in the PRC, says Ng of Ogier.

“We receive a significant number of inquiries about enforcing or resisting the enforcement of Hong Kong or Chinese judgments in BVI or Caymans,” he says. “This is usually after a judgment has already been obtained, but because there is a host of underlying technical issues to consider which we often find have been overlooked, we have also been encouraging those who are about to commence proceedings to first seek our advice on the eventual enforceability of any judgment obtained, and the response to such encouragement has been very positive.”

ASIAN CHARACTERISTICS

At the end of the day, dispute work is much the same, regardless of who it is done for, but the Asian market does have unique features.

“Clients require high quality advice and problem solving at short notice, and Chinese language skills,” says Nigel Meeson QC, partner and head of Asia disputes and restructuring at Conyers Dill & Pearman. Meeson says the firm was continuing to grow its team to meet the demand for its services in Asia. “We have recently recruited a senior associated and mid-level associate, as well as another legally qualified paralegal — who will all be joining our team shortly.”

“BVI and Cayman companies are the vehicles of choice throughout Asia, both for structuring investment into the region and for investment of funds flowing outside of the region,” says McDonough of Campbells. “Unprecedented levels of corporate debt coupled with challenging economic conditions will inevitably result in an increasing demand for litigation and insolvency services in the region.”

Harneys’ Mann says that going forward he sees plenty of room for growth in the Asian market.

“We are seeing the highest growth rate in human history, while at the same time the highest debt burden in human history, combined with a market where people do not necessarily value lawyers or have an in-depth understanding of the services they are able to provide,” he notes.

“Growth for offshore lawyers will continue to come from the established financial centres, however the environment is much more competitive,” Mann says. “Service standards continue to be a differentiator, as does technology. For offshore litigation growth, the use of much better technology must be introduced to the offshore courts of Bermuda, BVI and the Cayman Islands as a matter of urgency. Embracing that technology will in itself drive growth.”

Harneys continues to expand with new lawyers from its offshore jurisdictions, he adds.

“In Asia, we are known for our advice on a growing number of high profile transactions,” Mann says. “In recent years, the firm has grown to become one of the largest offshore firms in Hong Kong, and, combined with its Singapore, Tokyo and Shanghai offices, has a strong presence in Asia.”

Trehey at Maples and Calder notes that once deep-seated notions among Asian clients are beginning to change.

“The traditional view of litigation — whether offshore or onshore — in Asia was that it was destabilising, inharmonious, and very much an avenue of last resort,” he says. “That perception has largely disappeared with the emergence of a new generation of business leaders in Asia who are more open to using the courts to achieve commercial objectives. This has been a key driver of new business. In the context of litigation in the BVI and the Cayman Islands, there is now a long track-record of stability, predictability and commerciality as far as the courts of those jurisdictions are concerned.”

“In addition, there is now a large number of international and domestic law firms throughout Asia that have had considerable experience with litigation in the BVI and the Cayman Islands, and who, through pleasing outcomes using the courts of the BVI and the Cayman Islands, and through increasing familiarity with offshore litigators based in Asia, see litigation in those jurisdictions as a first choice option rather than, as it may have been historically, a lower priority to taking action onshore.”

Given the high amount of Chinese offshore dispute demand, offering services in Chinese and with a Chinese perspective are important, says Ng of Ogier.

“There is clearly a market for experienced offshore litigators who have actually practised in the applicable offshore jurisdiction and who also have Chinese language skills,” he says. “A significant proportion of my caseload has involved dealing with clients in Chinese, reading documents and communications written in Chinese and attending conferences with the client’s Hong Kong or PRC legal teams which are conducted in Cantonese or Mandarin.”

Many Chinese-speaking clients value not just legal expertise and experience, but a lawyer who is also more accessible and user-friendly than an equivalent non- Chinese speaker, Ng adds.

Going forward, it is highly unlikely that China will stop being the dominant source of clients and work for Asian offshore disputes. Most indicators suggest a continued slowdown of Asia’s largest economy, and the massive debt buildup that has accumulated since 2008 has yet to see its day of reckoning.

Nevertheless, practitioners expect to see growing activity in the offshore dispute space in the run-up to this eventuality, and, most likely, in its wake.