In two remarkably similar cases, Re Peking University Founder Group Company Limited  HKCFI 1350 (the “Peking University Case”) and Re Tsinghua Unigroup Co., Ltd  HKCFI 1572 (the “Tsinghua Case”), the Hong Kong Court affirmed the enforceability of keepwell deeds entered into by PRC companies as credit enhancement for bonds issued by their respective offshore subsidiaries. The Court recognised that although keepwell deeds are not guarantees, they are still enforceable contractual obligations that provide additional security to bondholders. However, both cases illustrate that keepwell deeds are sensitive to supervening events and subject to approval from relevant PRC authorities, particularly where the keepwell provider enters into reorganisation proceedings in the PRC.
The function of keepwell deeds
Keepwell deeds are typically made between the onshore PRC parent company, its offshore subsidiary and a creditor (usually a bond trustee) to provide financial and solvency backing to the offshore subsidiary for its offshore debts. Over the years, they have been used to facilitate offshore bonds issued by subsidiary companies in raising funds in the international debt capital markets. The parent company will usually undertake to ensure its offshore subsidiary issuers (and guarantors, if applicable) remain solvent and have sufficient liquidity to pay interest and principal on such bonds.
However, their legal status and enforceability under Hong Kong law was unclear until the Court confirmed its enforceability in these two cases.
The Peking University Case
Peking University Founder Group Company Limited (“PUFG”), a state-owned enterprise, issued and guaranteed separate bonds through its offshore subsidiaries in 2017 and 2018. All subsidiaries were incorporated in either Hong Kong or the BVI and were in liquidation at the time of the claim.
In connection with the bond issue exercise, PUFG entered into keepwell deeds with its subsidiaries and a bond trustee in 2017 and 2018 in materially identical terms: (i) they were governed by English law and subject to the Hong Kong Court’s exclusive jurisdiction; (ii) each deed expressly stated they were not guarantees and that the performance of the undertakings by PUFG was subject to the PRC authorities’ approval; and (iii) PUFG undertook to use its best efforts to obtain necessary regulatory approvals to perform its obligations.
In December 2021, PUFG entered into reorganisation proceedings under PRC law. Meanwhile, its offshore subsidiaries defaulted on the bonds they had, respectively, issued and guaranteed. The liquidators of the subsidiaries claimed that PUFG breached its obligation under the keepwell deeds to ensure the subsidiaries could discharge their obligations regarding bond payments.
Keepwell deeds are enforceable contractual agreements
In recognising the enforceability of keepwell deeds overall, the Court held that it is reasonable for parties to assume that keepwell deeds are intended to have significant value and to create substantive rights as these documents are often used to offer financial backing to sophisticated and carefully documented transactions that involve significant sums of moneys so to attract investors. Further, there is no inherent public policy objection against the enforcement of keepwell deeds.
Therefore, the Court has expressly recognised keepwell deeds as an enforceable contractual obligation and it is now clear that creditors can take enforcement action against keepwell providers for breach of undertakings under the same.
Inherent material limitation of keepwell deeds when the keepwell provider enters reorganization proceedings
Having decided that keepwell deeds are enforceable agreements, the Court then turned to consider whether PUFG satisfied the “best efforts” obligation under the keepwell deeds to obtain necessary regulatory approvals in the PRC. In doing so, the Court applied the test laid down in Tam King Hang v Yuen Lei Gwun (HCA 490/2011, 16 April 2014), applying the leading English authority IBM United Kingdom v Rockware Glass Ltd  FSR 335, to interpret what “best efforts” entailed, i.e. the undertaking party is required “to take all reasonable steps which a prudent and determined man acting in his own interests and anxious would have taken“. Therefore, the “best efforts” undertaking requires the keepwell provider to demonstrate with cogent evidence of “what it would have had to do to comply with its obligations and further show why it would have been prevented from doing so“.
Nevertheless, having considered expert evidence on PRC law, the Court held that where the keepwell provider enters into reorganisation proceedings, as PUFG did in the present case, it was not necessary to consider whether the “best efforts” requirement was satisfied at all. This is because where a keepwell provider enters into reorganisation proceedings, the PRC authorities would restrict any money outflow out of the PRC such that there would be no realistic likelihood that the keepwell provider could obtain necessary approval to transfer funds out of the PRC and any “best efforts” would be redundant. As such, in these situations, a keepwell provider can effectively rely on the “subject to approval” caveat to its undertakings under the keepwell deed to discharge its obligations without having to make “best efforts”.
In the present case, although PUFG could not adduce any evidence of using “best efforts”, since it had already entered reorganisation proceedings under PRC law by the time the claim was made, PUFG was able to successfully rely on the “subject to approval” qualification to discharge its duty under the keepwell deeds for the period after reorganisation proceedings were commenced. This is in contrast to the Court’s finding of breach in respect of one of PUFG’s offshore subsidiaries which did not meet the specified net worth prior to the reorganisation proceedings.
In the circumstances, the Court only declared breach of the keepwell deed in respect of one of the offshore subsidiaries whose net asset worth fell below the specified value prior to PUFG entering into reorganisation proceedings, and for which PUFG failed to demonstrate it took any steps to fulfil its “best efforts” undertaking. In contrast, however, claims made post-reorganisation were dismissed because once PUFG was in reorganisation there was no realistic likelihood of approvals being given to transfers out of the Mainland.
The Tsinghua Case
Tsinghua Unigroup Co.Ltd (“Tsinghua”), ultimately owned by a state-owned enterprise, provided keepwell deed support for offshore bonds issued and guaranteed by its Hong Kong subsidiaries in 2015 and 2016 (the “Offshore Bonds“). The keepwell deed, which Tsinghua entered into with its Hong Kong subsidiaries and the bond trustee (the “Trustee”), contained similar clauses to that in the Peking University Case. Separately, Tsinghua issued onshore bonds in the PRC in its own right (the “PRC bonds“). Following the bond issues, Tsinghua and its subsidiaries fell into financial difficulties:
- In November 2020, Tsinghua failed to repay the PRC bonds upon their maturity. Tsinghua obtained a loan from the guarantor of the Offshore Bonds (acting as lender here) (the “Guarantor/Lender“) for US$523,000,000 to settle its obligations under the PRC bonds.
- In December 2020, the offshore subsidiaries defaulted on the Offshore Bonds, and the Trustee subsequently declared the bonds immediately due and payable.
- In July 2021, Tsinghua began reorganisation proceedings in the PRC and the Trustee’s claims in relation to the Offshore Bonds was left “pending”.
- In July 2022, the reorganisation proceedings were terminated and Tsinghua resumed usual operations. The Trustee commenced its claim against Tsinghua for breach of the keepwell deed in relation to the Offshore Bonds.
Timing of the PRC reorganisation proceedings matters
Applying the ruling in Peking University, the Court reaffirmed the enforceability of keepwell deeds. The Court therefore turned to consider whether Tsinghua had to show that despite its best efforts it could not obtain the necessary PRC regulatory approvals.
Paying close attention to the timing of events, Harris J found that well before the reorganisation, Tsinghua must have known it was experiencing financial difficulties and would need to implement measures to facilitate bond repayments. The loan obtained from the Guarantor/Lender in November 2020 showed that Tsinghua had access to US dollar funding that could have been used to comply with its obligations under the keepwell deed. Instead, Tsinghua used all of the proceeds in the ordinary course of its own business. The onerous obligation of a “best efforts” undertaking required Tsinghua to use part, if not all, of the US dollars at its disposal to satisfy its obligations under the keepwell deed. Hence, by using all the funds for itself, Tsinghua failed to discharge the “best efforts” requirement under the keepwell deed.
Consistent with the Peking University Case, Harris J accepted that any effort to obtain regulatory approval would have been futile after Tsinghua entered reorganisation proceedings in the PRC. Tsinghua would thus be freed of its obligations. However, before the reorganisation commenced, Tsinghua had to demonstrate it took steps to comply with the “best efforts” obligation and explain why they were unsuccessful. Since Tsinghua failed to do so, Harris J ordered Tsinghua to pay damages for breaching the keepwell deed, assessed to be the principal amount of the offshore bonds and accrued interest.
The decisions should be welcome news to offshores bondholders – they confirm that keepwell deeds are binding and enforceable contractual obligations despite not being guarantees. However, these decisions also illustrate that (i) the enforceability of keepwell deeds are highly susceptible to PRC regulatory approval and supervening events such as reorganisation proceedings in the PRC; and (ii) since they are not guarantees, breaches of a keepwell deed are subject to the usual rules of assessing damages.
Therefore, having a keepwell deed in place does not mean the keepwell provider will always be obliged to perform its undertakings and these court decisions make clear that reorganisation proceedings in the PRC will essentially automatically defeat any subsequent enforcement claim. Creditors should closely monitor the keepwell provider’s financial position, and file claims timely once they become aware of any relevant breaches of keepwell deeds or the underlying debt. The Court will pay close attention to the timing of events as illustrated above and a late claim may be defeated once the keepwell provider enters into reorganisation proceedings in the PRC.
For more information, please contact Jojo Fan, Partner, William Ku, Partner, Peter Ng, Senior Associate, Sarah Shen, Senior Associate, Marcus Wong, Senior Associate, Grace Lee, Associate, or your usual Herbert Smith Freehills contact.