First Annual ABI International Matter of the Year Award
The committee selected In re LATAM Airlines Group S.A., et al., as the winner of the First Annual ABI International Matter of the Year Award. The award is given to a matter that (1) involved the U.S. and one or more other jurisdictions; (2) resulted in the completion of a unique, strategic or challenging international transaction or litigation; and (3) was of international legal significance and impact in relation to the distressed/insolvency industry. Additionally, the committee selected In re Luckin Coffee Inc. for an Honorable Mention. Both awards were presented at the Cross-Border Insolvency Program on Nov. 14, 2022, at the New York offices of Blank Rome LLP. Check out the summary below!
Luckin Coffee Inc.: A Cross-Border Restructuring Success Story
Luckin Coffee Inc. was founded in 2017 by a Chinese entrepreneur, Charles Lu, who had the goal of building China’s largest coffee chain. At the time of its initial public offering (IPO) in 2019, Luckin had already opened 2,370 stores. Coffee consumption in China was estimated to increase exponentially, and Luckin formulated aggressive expansion plans to open a further 2,500 stores during 2019. The company’s 2019 IPO, secondary public offering (SPO) and bond issuance raised approximately $2.2 billion. Was this rapid growth and expansion too good to be true?
In February 2020, Muddy Waters published a report alleging that Luckin had been inflating its sales. Following an extensive internal investigation, Luckin announced that it had suspended Mr. Lu after finding that he had exaggerated the company’s 2019 sales by more than $300 million. This resulted in the company’s share price collapsing and the company being delisted by NASDAQ. Litigation followed, with various direct and class action claims being asserted in the U.S., a class action claim in Canada, and injunctive proceedings in both the Cayman Islands and Hong Kong. Luckin’s issues also became political ammunition for U.S. senators, given that they arose at a time where there was geopolitical tension between the U.S. and China, which sparked interest in Luckin’s operations between the U.S. Securities and Exchange Commission (SEC) and the U.S. Department of Justice (DOJ).
In order to protect Luckin from creditor enforcement actions while restructuring proposals were being considered, a winding-up petition (WUP) was filed by a former director, followed by an application for the appointment of joint provisional liquidators (JPLs) in the Cayman Islands. Alexander Lawson and Tiffany Wong, both of Alvarez & Marsal (A&M), were appointed as the joint provisional liquidators.
In light of the events that precipitated the restructuring, the company had not formulated a restructuring plan prior to the commencement of the provisional liquidation. As such, all of the restructuring milestones were achieved from a “standing start.” Ultimately, a collaborative effort among the company, its team of advisors and the JPLs’ team was required to address the complex practical, operational and legal issues, and to formulate a strategy to implement a restructuring that would allow the company to remain a going concern. The case was an excellent example of the exemplary outcomes that can be achieved when courts in multiple jurisdictions are willing to cooperate and assist other jurisdictions in cross-border insolvency proceedings.
In the Cayman Islands, the powers conferred upon provisional liquidators are defined in the order by which they are appointed. Following the appointment of the JPLs, the board was empowered to continue managing Luckin’s day-to-day operations. However, the JPLs were required to supervise those operations.
As a result, the JPLs worked closely with Luckin’s management teams in China, which included a wholesale review and analysis of the company’s business plan. The review and recommendations in respect of the business plan allowed for some key changes regarding operations and products to be implemented during the restructuring period, which subsequently contributed to an increase in profitability.
The JPLs also oversaw the completion of the 2019 and 2020 financial statement audit (PCAOB). This was required for the comfort of stakeholders, but it is also required as part of listing requirements should Luckin decide to relist in the future. Interestingly, and possibly as a result of this case, the listing rules had changed; they now require listed Chinese-based entities to submit PCAOB audits as a mandatory listing requirement.
The operational involvement of the JPLs allowed for them to obtain a deep understanding of the overall business and become comfortable that a plan, if agreed upon by the stakeholders, could be recommended based on the ongoing viability of the business.
Scheme of Arrangement
The company owed approximately $460 million of U.S. governed debt to its convertible bondholders. Following the JPLs’ appointment, significant negotiations between the company and its bondholders took place, all of which culminated in the Restructuring Support Agreement (RSA) being entered into among the company, the JPLs and a large majority of bondholders. The RSA provided an agreed-upon set of high-level terms that the scheme of arrangement was to contain, as well as a timeframe for the completion of the scheme.
The Cayman Islands scheme of arrangement regime is analogous to the U.S. chapter 11 plan of reorganization process. A Cayman Islands scheme is a court-supervised process provided for in Section 86 of the Companies Act. It allows for a class of creditor claims to be compromised. Where a compromise or arrangement is proposed, the provisional liquidator(s) can ask the court to order a meeting of the creditors whose debt the scheme intends to compromise. If, at that meeting, a majority in number representing 75% in value of the creditors to be schemed who are present and voting at the meeting agree to the compromise, the court can be asked to sanction the scheme.
Any stakeholder that could be affected by the scheme is entitled to be heard at the sanction hearing. The Companies Act does not prescribe a test that the court must consider. The court usually considers that the stakeholders are the best judges of their own commercial interests, so they will typically sanction a scheme that has the requisite support, unless the court considers that the terms of the scheme are not fair such that an intelligent and honest creditor, being a member of the class concerned and acting in its own interests, would not reasonably vote in favour of the scheme. If the court sanctions the scheme, it will be binding on all creditors in the relevant class, including those who voted against the scheme.
Ultimately, the agreed-upon scheme terms were comprised of cash, equity and a convertible debt/equity election, which collectively represented an exceptional return in excess of 91% for the company’s convertible bondholders. The scheme received overwhelming support from 97.7 percent of the convertible bondholders (being 100 percent of the convertible bondholders present and voting at the scheme meeting). There were no objections during the court process to sanction the scheme.
Following the announcement of the financial misrepresentations made by the company, a class action was launched in the U.S. and in Canada to address losses to shareholders caused by the fraudulent activity and subsequent announcement. While a scheme of arrangement is a flexible tool in a restructuring context, there were perceived limitations for its ability to effect an enforceable compromise of class action claims through a scheme. However, the provisional liquidation created an environment whereby the JPLs were able to engage with the company and the class action claimants. The JPLs engaged experts to analyze the value and types of claims under the class actions. Following extensive work and discussions, it was determined that the claimants may have been entitled to more than $1 billion. Given the significant potential value of these claims, there was significant benefit to the company to resolve these claims during the provisional liquidation, given the high legal costs associated with a class action, as well as the usual timeframe to resolve the same.
The JPLs worked with the company to provide support and assist them in agreeing to a settlement in the amount of $175 million with the Federal Class, which was then approved by the Cayman court and the U.S. bankruptcy court. It proved an excellent result under the circumstances: The company was able to resolve its two largest stakeholder groups prior to the end of the provisional liquidation period, giving it a stable platform to move forward.
Recognition and Enforcement
Given the international profile of Luckin’s operations, supply chain and creditors, it was necessary to seek recognition of the JPLs’ appointment in both the U.S. and Hong Kong. Despite having no significant assets in the U.S., the U.S.-law governed notes, the various class action and other litigation claims, the interests of the SEC and DOJ, and the present and future need to access U.S. money markets were all factors the JPLs considered when determining that recognition in the U.S. was necessary.
The Cayman Islands proceedings were recognized by the U.S. bankruptcy court as a foreign main proceeding under chapter 15 of the U.S. Bankruptcy Code, and a stay of proceedings against the company was invoked. Recognition of the JPLs’ appointment was also sought and obtained from the High Court in Hong Kong, although no moratorium on claims was sought, as it was considered unnecessary. The recognition allowed for the scheme (as set out above) to be recognized and enforced in the U.S. once approved, and also allowed for an open and constructive dialogue with the SEC and the equity litigants.
The JPLs and the company came to an agreement with the SEC (as set out in the judgment dated Feb. 4, 2021) whereby the company, without admitting or denying the allegations of the SEC, consented to the entry of an order requiring the company to pay a civil penalty in the amount of $180 million (believed to be the largest-ever SEC settlement against a listed Chinese-based operating entity).
It was also negotiated that the penalty would be offset by the dollar value of any cash payments made by the company to the stakeholders in any scheme of arrangement to be sanctioned by the Cayman court (and to be enforced in the relevant jurisdictions). This novel approach allowed the company to address the SEC’s concerns in such a way that would not result in any monetary loss, should the stakeholders agree to compromise their debts under a scheme including at least the same value of cash distribution. It also creates useful precedent and knowledge that the SEC is willing to engage constructively (i.e., offering an offset) where there is clear benefit to victims of fraud and stakeholders in a restructuring context.
The JPLs, with the assistance of their advisors, and the company and its advisors, planned and implemented a successful restructuring, notwithstanding the operational challenges presented by the COVID-19 pandemic. Luckin has since emerged from its restructuring in a position of strength, seeing its revenues more than double during the period of the restructuring.
Luckin's restructuring, using a provisional liquidation, scheme of arrangement and foreign recognition, exemplify the efficiency, strength and adaptable nature of the Cayman Islands restructuring regime in combination with U.S.’s bankruptcy courts and chapter 15 regime. The company has continued its success after emerging from the restructuring process, having now grown to more than 7,000 stores and increasing its revenues along with its share price. It now calls itself China’s largest coffee chain.