Berau Coal: CoA's Empire ruling shows Singapore's reluctance to impose precise disclosure obligations and investigate suspicious activity at early DIP stage

On 30 April 2019, Singapore’s Court of Appeal delivered its much-awaited decision on Empire Capital Resources Pte Ltd’s proposed scheme of arrangement. On the surface, the Court’s decision to prevent Empire – a Berau Coal Group company – from convening a creditor meeting due to what the court called “woefully inadequate” financial disclosure is a win for the noteholders who opposed the scheme and a positive sign for creditors in Singaporean restructurings. However, a closer review of the decision might leave both the opposing noteholders, as well as creditors involved in similar situations, with cause for concern.

 

Not only does the decision potentially leave room for the Berau Group to commence a fifth round of proceedings, it also illustrates two emerging themes in Singaporean DIP proceedings. The first is a reluctance on the part of Singaporean courts to impose onerous or exacting disclosure obligations on a scheme debtor. The second is a reluctance to investigate or give any weight to dissenting creditor concerns of class manipulation, voting irregularities or ulterior motives on the part of a debtor – at least prior to a sanction hearing. Both trends should be of concern to creditors in a region where accounting irregularities, questionable transactions and improper debtor motives are a common feature of restructurings.

 

A controversial scheme
Empire’s proposed scheme was controversial in many respects.

 

To start with, the scheme represented the fourth round of Singapore court-supervised restructuring proceedings commenced by the Berau Coal Group since 2015. Over that time, the Group had benefitted from close to two years of moratoriums, notwithstanding that each set of proceedings was ultimately withdrawn by Berau or dismissed by the Singapore High Court due to a lack of creditor support.

 

To make matters worse, Berau refused to disclose any meaningful financial information post-2014 in support of the proposed scheme. This left the opposing noteholders to question: (i) why they were being offered such a limited recovery in circumstances where coal prices had improved significantly since 2015; (ii) whether Berau’s financial position was actually better than disclosed; and (iii) why any noteholder would possibly vote to approve the proposed scheme, unless they were somehow affiliated with Berau.

 

Finally, the proposed structure of the scheme was unusual in that it was being proposed by Empire as guarantor of two distinct note issuances, rather than by the two issuers of those notes – Berau Capital Resources (BCR) and Berau Coal Energy (BCE). Unapologetically, the Berau Group had settled upon this structure in order to ensure that it could procure releases for each issuer’s debt without having to convene separate scheme meetings for each issuance. If separate meetings were convened, the opposing noteholders, which hold a blocking stake of the BCR notes, would be able to veto the scheme. However, if grouped together, they had no such ability.

 

In the view of the opposing noteholders, which are two funds controlled by Argentem Creek Partners, these factors pointed to the Berau Group cynically taking advantage of Singapore’s DIP regime. Berau had commenced multiple proceedings to prevent creditors enforcing their rights, provided creditors with only limited financial information and proposed a scheme which seemed to prefer the interests of equity-holders over those of creditors. All at a time when creditor interests should be paramount.

 

An abusive history of failed restructuring attempts?
The Berau Group first sought and obtained a six-month moratorium under section 210(10) of the Singapore Companies Act in July 2015 to facilitate a restructuring of the group's indebtedness under two sets of notes. The notes in question were: (i) an issuance of USD 450m, 12.5% guaranteed senior secured notes due 2015 by Berau Capital Resources Pte Ltd (BCR), a Singaporean finance vehicle, in 2010; and (ii) an issuance of USD 500m, 7.25% guaranteed senior secured notes due 2017 by PT Berau Coal Energy Tbk (BCE), the Indonesian group holding company, in 2012.

 

The proposed restructuring was, at that juncture, premised on a USD 150m shareholder loan that was to be extended by Berau’s new owner, Asia Coal Energy Ventures Limited (ACE), an entity effectively controlled by Widjaja family-controlled Sinar Mas Group (SMG).

 

Noteholders had initially supported a restructuring, with holders of approximately 24% in aggregate principal amount of the 2017 Notes and holders of approximately 28% in aggregate principal amount of the 2015 Notes executing a restructuring support agreement with Berau Coal, BCE and ACE in July 2015.

 

The situation changed in September 2015, however, when SMG sought to renegotiate the terms of Berau’s restructuring. Suddenly, the proposed USD 150m injection disappeared, leaving noteholders with substantially downgraded recoveries under the proposed scheme. This ultimately led to the noteholders opposing, and the High Court rejecting, the extension of Berau’s moratorium in March 2016.

 

Not deterred by the lack of creditor support, the Berau commenced a second round of proceedings in June 2016. This time, BCE sought a moratorium from creditor action under section 210(10) of the Act, while BCR was forced to seek a judicial management order, having already had the benefit of a section 210(10) moratorium. Of course, even with the appointment of a judicial manager, existing management would retain control of Berau because BCR was merely a financing vehicle.

 

Having benefitted from another four months of protection from its creditors, in November 2016, BCR and BCE withdrew their respective moratorium applications. In their place, each entity commenced a third round of proceedings by seeking leave to convene creditors’ meetings to vote upon a scheme under section 210(1) of the Act. These proceedings were then withdrawn when it became clear that opposing noteholders – Pathfinder Strategic Credit and BC Investment – held a sufficient majority to veto the proposed scheme.

 

Finally, in April 2017, Berau commenced the current proceedings, with Empire the proponent of the scheme in its capacity as guarantor of both note issuances. Under the proposed terms, the 2015 and 2017 noteholders were grouped as a single class of creditor in what appears to be another attempt to prevent the opposing creditors from again vetoing the scheme.

 

Structural Issues - class manipulation, abuse of process or legitimate debtor tactics?
In the view of the opposing noteholders, the newly proposed scheme structure was objectionable for three reasons. First, as a matter of law, they argued that the holders of the 2015 Notes and the 2017 Notes should be in separate voting classes – thereby protecting their ability to veto the scheme. Second, they argued that the court had no power to approve a scheme which released third parties from liability unless such a release is necessary – here it was not. Finally, they argued that the history of the matter demonstrated that the current proceedings constituted an abuse of process by the Berau Group.

 

Click here for the ruling.

 

Classes
As to classes, Empire asserted that the 2015 and the 2017 noteholders should be classified into a single group because the two sets of notes were substantially similar. Noteholders had the benefit of security over substantially the same assets, the security was granted to a common security agent and was governed by a single inter-creditor agreement and both sets of noteholders had the benefit of Cash and Accounts Management Agreement (CAMA) accounts held by the same bank and the same trustee. Each group of noteholders also benefited from guarantees provided by various group entities, including BCE, Berau Coal and Empire, with the 2015 Notes also being guaranteed by BCR.

 

The opposing noteholders, however, argued that the 2015 and the 2017 noteholders should be put into separate classes because: (i) they had rights against different obligors and different issuers based in different jurisdictions; (ii) the notes had different interest rates; (iii) they would each be required to compromise different securities; and (iv) they would each have had different recovery rates in a liquidation scenario.

 

The Court of Appeal found (on a preliminary basis) that even though there were differences between the relative positions of the 2015 and the 2017 noteholders under the proposed scheme and in the appropriate comparator of an insolvent liquidation, those differences were not significant enough to require them to vote in separate classes. In the Court’s view, if a scheme treats a group of creditors as against other creditors differently from how they would have been treated under the most likely comparator situation, then that group of creditors should be classed separately. In practical terms, the Court noted that there are three broad steps to creditor classification:

  1. first, the appropriate comparator must be identified. In most cases, that will be an insolvent liquidation;
     
  2. second, it should be assessed whether the relative positions of the creditors under the proposed scheme mirror their relative positions in the comparator; and
     
  3. third, if there is a difference between the creditors' relative positions identified in the second step, it should be assessed whether the extent of the difference is such as to render the creditors' rights so dissimilar that they cannot sensibly consult together with a view to their common interest.

 

In this case, Empire’s proposed scheme would not affect the 2015 and the 2017 noteholders to the same extent. If the scheme was sanctioned, the rights of all noteholders would be uniform (given they were each to be issued new notes), but their positions under the appropriate comparator – an insolvent liquidation – were not identical as they would receive different estimated rates of recovery. Nevertheless, given that the difference was only around 3%, there was no reason to suggest that the 2015 and 2017 noteholders could not sensibly consult together with a view to their common interest.

 

Accordingly, the Court of Appeal found that the 2015 and 2017 noteholders would likely form a single class of creditors for the purposes of voting on the proposed scheme. From a legal perspective, there is nothing earth-shattering in that outcome – provided that the liquidation analysis considered by the Court was correct.

 

Third-Party Releases
In any event, the real issue of contention for the opposing noteholders was the reason for the proposed voting structure. In the view of the noteholders, the whole scheme was structured so that Empire could combine the holders of each note issuance into a single class for the sole reason of diluting the voting power of the opposing noteholders. Why else would a guarantor such as Empire propose a scheme to compromise its secondary indebtedness and obtain third-party releases for the actual issuers of the primary debt, rather than the issuers proposing a scheme themselves?

 

Unfortunately for the opposing noteholders, any argument based upon apparently improper motives of the Berau Group goes to the very heart of the fairness or reasonableness of the proposed scheme – two issues which the Court of Appeal was keen to point out will not be considered until sanction stage. Accordingly, the Court would only consider the appropriateness of the scheme’s structure from the viewpoint of: (i) its jurisdiction to permit third-party releases; and (ii) whether the structure amounted to an abuse of process.

 

In short, noteholders argued that while an issuer could propose a scheme that released a guarantor's secondary liability, a guarantor could not propose a scheme that released an issuer’s primary liability because such a release is not necessary for the compromise of the guarantor’s liability. After all, in this case, noteholders could release Empire from its liability as guarantor without needing to release the issuers.

 

The Court of Appeal, however, found that – at least when applying for leave to convene scheme meetings – all that needs to be shown for a third-party release to be valid is that there is a sufficient nexus between the release and the relationship between the creditor and the debtor. [1] Here, such a nexus existed because the debts all arose out of the same note issuances. The reasonableness of the releases would be considered at sanction stage.

 

Abuse
In order to establish that Berau’s conduct amounted to an abuse of court, noteholders essentially needed to demonstrate that Empire’s proceedings had been commenced for an improper purpose, or in a way which was significantly different from the ordinary and proper use of the court process. In the Court’s view, the inherently dynamic nature of the restructuring process meant that there was a high threshold for establishing such an abuse. Here, there was insufficient evidence to warrant such a finding, notwithstanding that the opposing noteholders could question Berau’s motives for the proceedings by pointing to:

  1. Berau having commenced four sets of proceedings, each of which had been withdrawn or dismissed due to lack of creditor support, but which had allowed the coal mining group to benefit from nearly two years of protection from its creditors;
     
  2. scheme terms which could only be viewed as favourable to Berau and which raised concerns that the only noteholders who could possibly support such terms must be acting in concert with Berau. Those terms:
    1. involved the discharge of all liabilities under the notes in exchange for the issuance of new notes on a dollar-for-dollar basis which: (i) had a maturity date 10 years from the date of issuance; (ii) had an interest rate of only Libor plus 1%; (iii) were to be guaranteed by BCE, but otherwise left unsecured; and (iv) could be redeemed at the discretion of the group at any time without penalty or premium;
       
    2. required noteholders to give up their rights to all sums in the CAMA accounts (in an amount of not less than USD 47m);
       
    3. provided releases to all third parties; and
       
    4. had noticeably deteriorated from the initial offer to noteholders, despite significant improvements in global coal prices, which should have translated into a stronger financial position;
       
  3. financial disclosure which the Court itself found to be woefully inadequate; and
     
  4. tactical foreign litigation, allegedly aimed at delaying creditor enforcement and preventing an investigation of the debtor’s true financial position, including:
    1. forcing noteholders to incur the cost of proving their holdings through a jury trial in the United States, unsuccessfully arguing that because the noteholders had acquired their interests through the secondary market, there was no proof they held the notes; and
       
    2. commencing proceedings against the solicitors acting for noteholders, alleging that by writing to Berau’s customers asking for the details of payments made to the Berau group, Kirkland & Ellis had endangered Berau’s bond-restructuring efforts and customer relations to the tune of USD 2.27bn. Of course, this was after noteholders had discovered that the main CAMA account bank had resigned and had not received into the accounts any Berau revenue for some time.

 

When you add to that list the core concern of the opposing noteholders – that the entire structure of the scheme had been devised to prevent the opposing noteholders from vetoing it – you might think noteholders had reasonably strong grounds to question Berau’s motives. Yet the Court of Appeal disagreed. In fact, the Court seemed reluctant to delve into Berau’s motives in any detail at all, preferring to leave it to creditors to take a commercial view on the coal mining group’s motives and the merits of the scheme at the scheme meetings. If Berau’s conduct was insufficient to amount to abuse, it must be difficult to envisage circumstances where creditors might successfully raise such a claim.

 

Woefully inadequate financial disclosure – a trend
Adding to the concerns of the opposing noteholders was the Group’s refusal to disclose any material financial information post-31 December 2014.

 

Empire first attempted to justify such a limited scope of disclosure on the basis that its management could not verify the accuracy of the information prepared by Berau’s former owners. When the Court refused to accept that argument, Empire raised confidentiality as an issue. First, it argued that as a contractor to the Indonesian government, it could not disclose financial information to foreign, third parties without approval from the government. Second, it argued that any further disclosure would result in highly sensitive trade secrets such as the average selling price of coal being brought to the attention of its competitors given the relationships held by certain noteholders. (Argentem Creek, a large Bumi Resources noteholder, has a representative of the Bakrie-family company’s board.) Empire also argued that the information requested by noteholders went beyond what a debtor was required to disclose at the leave stage of the proceedings, instead going to the merits of the proposed scheme.

 

If those arguments sound familiar, there is good reason. Hyflux Group made similar arguments to justify its limited disclosure prior to scheme meetings being called, both on the basis of confidentiality and on the basis that creditors did not need detailed financial information at an early stage of the proceedings. Ditto for Miclyn Express Offshore.

 

For their part, the opposing noteholders argued that Empire had failed to provide any information whatsoever in respect of the group entities whose debts were actually being compromised (apart from Berau Coal), any audited accounts post-2014, any information as to the debts of related parties or any operational data. Noteholders argued that the prices recently achieved for certain undisclosed sales of BCE and Berau Coal shares indicated that the financial position of the group might be better than claimed – hence the reluctance on the part of the group to disclose information.

 

A less than onerous obligation of disclosure
From a creditor’s perspective, the Court of Appeal’s decision on the scope of a debtor’s obligation to disclose financial information when seeking to convene creditors’ meetings was both encouraging and concerning. On the positive side, the Court noted that sufficient financial disclosure is pivotal to the integrity of the scheme regime. It also adopted the view expressed by Justice Snowden in the Indah Kiat scheme proceedings that the scheme jurisdiction can only work properly and command respect internationally if parties invoking the jurisdiction exhibit the utmost candour with the court. [2] To that end, the Singapore Court of Appeals found that a debtor must: (i) present a restructuring proposal which is not necessarily ready for creditors to vote on, but which contains sufficient particulars for the court to assess its feasibility; [3] and (ii) disclose sufficient information to ensure that the creditors are able to exercise their voting rights meaningfully.

 

Yet having announced these pro-disclosure sentiments, the Court of Appeal then proceeded to significantly water them down.

 

To start with, the Court noted that a less onerous standard of disclosure is required of a debtor at the time it seeks leave to convene scheme meetings than at the sanction stage of scheme proceedings. This is because matters are often in a state of flux at an early stage of the restructuring process – or in Berau’s case, two years into that process – and the sufficiency of financial disclosure should, within limits, be a matter of commercial risk for the creditors to weigh at scheme meetings. The Court made similar comments at the hearing itself, noting that a lack of financial information might not necessarily mean that a scheme meeting could not be held; other creditors might not be as concerned by the lack of financial disclosure as dissenting creditors are.

 

Next, the Court noted that the minimum financial disclosure which a debtor must provide is that which is reasonably necessary for the court to be satisfied that fair conduct of the creditors' meetings is possible. But in the Court’s view, even that requirement should not be applied in a particularly onerous or exacting manner. Only where financial disclosure is woefully inadequate and it appears that nothing further will be forthcoming, should the Court refuse leave to convene scheme meetings.

 

Finally, for good measure, the Court noted that oppressive disclosure obligations may fetter genuine attempts at restructuring, especially by smaller companies lacking resources and bargaining power. Accordingly, a Court will look to factors such as the size and resources of the debtor, the size of the debts to be restructured, the urgency of the application and the reasons for the debtor's inability to provide further disclosure when determining whether further disclosure should be required.

 

After all, why should a debtor, which already has the benefit of court protection from creditor enforcement and which is seeking the cooperation, patience and support of its creditors to pursue a restructuring, be duty bound to make full and frank disclosure of its financial position?

 

But Empire still failed this less-than-onerous hurdle
Of course, Empire’s inadequate disclosure in this case was so woeful that it could not even pass the less-than-onerous test proposed by the Court of Appeal.

 

The Court was particularly unimpressed with two facets of Empire’s disclosure. The first was the complete lack of updated financial information concerning the companies whose debts were to be compromised under the proposed scheme. The second was the fact that Berau had made no meaningful attempt to respond to the concerns of the opposing noteholders with respect to the alleged diversion of at least USD 150m from the Berau’s CAMA accounts.

 

For those reasons, the Court of Appeal found that Empire had failed to provide noteholders with the minimal level of financial disclosure reasonably necessary to satisfy the court that fair conduct of a creditors' meeting was possible. The financial disclosure was so insufficient that: (i) the court could not properly assess the classification of creditors, as there was insufficient information to determine the most realistic alternative to a successful scheme, and (ii) it would be an exercise in futility to grant leave since the court would not sanction the proposed scheme in any event. Accordingly, it refused to grant leave to convene the meetings.

 

Concluding thoughts
Ultimately, Court of Appeal’s decision might prove a stalemate for the parties.

 

While noteholders won this round by preventing Empire from convening scheme meetings as a result of its woefully inadequate disclosure, Berau might also take some solace from the decision. In theory, the decision means that it would be open to Berau to commence yet another round of restructuring proceedings – perhaps, in due course under section 211B of the Act, provided it is willing to provide further financial disclosure. The fact that the Court concluded that the holders of the 2015 and 2017 notes will likely form a single class of creditor for voting purposes removed the ability of the opposing noteholders to veto a scheme. The Court also confirmed that, at least from a jurisdictional perspective, there was nothing inherently wrong with Empire promoting a scheme which releases BCE and BCR from their primary obligations under the notes.

 

The biggest question might therefore be whether the Berau Group is actually willing to audit its accounts – or whether there might be some truth to the allegations of the opposing noteholders that Berau’s financial position is much better than disclosed. Of course, the Court also left it open for the issues of the fairness and reasonableness of the scheme to be considered at a subsequent sanction stage. If another scheme is proposed, that is likely to be the key battleground. Then there is also the question of whether the opposing noteholders, emboldened by their recent victory in the United States, are minded to attempt to enforce their judgment in Singapore, Indonesia or elsewhere. Quite how a Singaporean court would react to such a request after two years of failed restructuring proposals is unclear.

 

More broadly, however, the Court of Appeal’s decision highlights two worrying trends from a creditor’s perspective. The first is the continued watering-down of a debtor’s disclosure obligations. In this case, as well as in cases such as Hyflux, Miclyn and even Pacific Andes, the Singaporean Courts have made it clear that they will not impose rigorous obligations on debtors to disclose detailed restructuring plans or financial information at an early stage of Singaporean DIP proceedings. This is so even in circumstances involving regulatory investigations, allegations of accounting irregularities or where creditors complain of bad faith or abuse on the part of a debtor. In such circumstances, creditors might fairly ask why a debtor, which is seeking the indulgence of both its creditors and the court to pursue a restructuring while remaining in control of its business, should be given such latitude?

 

The second trend flows from the first – a reluctance on the part of the courts to give any detailed consideration to the concerns raised by dissenting creditors early in DIP proceedings. The courts have made it clear that they are reluctant to investigate or dwell on allegations of bad faith, ulterior or improper motives on the part of a debtor or other questions pertaining to a mistrust of management early in the proceedings. Rather, the Court would prefer to deal with applications for scheme moratoriums or applications to convene scheme meetings expeditiously, leaving it to creditors to determine whether such issues cause them sufficient angst to vote against the scheme in due course. In that respect, the Court of Appeal has made it clear that creditor dissent early in the process will not necessarily be fatal to a scheme – after all, creditors might later change their minds. Whether they do so where there are allegations of inadequate financial disclosure, ulterior motives and financial irregularities is of course another question.

 

Perhaps it is time to hold debtors more accountable for their actions, early in any DIP proceedings, at a time when the interests of creditors should be paramount.

 

by Ashley Bell

 

Prior to joining Debtwire, Ashley was a Partner at DLA Piper in Hong Kong with a practice focused on contentious cross-border restructuring and insolvency matters. Ashley regularly advised financial institutions, investors, debtors and insolvency practitioners in connection with a range of high-profile restructuring matters in Asia involving schemes of arrangement, contested winding-up proceedings, light-touch offshore proceedings, debtor-in-possession matters and cross-border recognition applications.
Any opinion, analysis or information provided in this article is not intended, nor should be construed, as legal advice, including, but not limited to, investment advice as defined by the Investment Company Act of 1940. Debtwire does not provide any legal advice and subscribers should consult with their own legal counsel for matters requiring legal advice.

 

[1] Re Opes Prime Stockbroking Ltd [2009] FCA 813.
[2] Re Indah Kiat International Finance Company BV [2016] EWHC 246 (Ch) at [38].
[3] Re Kuala Lumpur Industries Bhd [1990] 2 MLJ 180 at [182].