The Hong Kong Court of Final Appeal (CFA) recently delivered its judgment in a long-running dispute concerning a breach of "keepwell deeds" by Peking University Founder Group Company Limited (PUFG)¹. This article discusses the essential rulings of the CFA and proposes some key takeaways.

Background

The dispute arose out of the failure of US$1.7 billion worth of bonds issued by PUFG's two offshore subsidiaries, Nuoxi Capital Limited (Nuoxi) and Kunzhi Limited (Kunzhi, together with Nuoxi, the Issuers), in 2017 and 2018. These bonds were guaranteed by two other subsidiaries of PUFG, namely, Hongkong JHC Co Limited (HKJHC) and Founder Information (Hong Kong) Limited (FIHK, together with HKJHC, the Guarantors). They were further backed by four keepwell deeds executed by PUFG (the Keepwell Deeds), which served to give confidence to the bondholders in the financial viability of the Issuers and Guarantors and of the bond issues, in lieu of a parent guarantee ². These deeds obliged PUFG to maintain at all times a positive consolidated net worth of at least US$1 of the four subsidiaries, and to provide for their liquidity, by way of a lending facility ³, to meet payment obligations in respect of the bonds.

In early 2020, PUFG's financial condition deteriorated. The liquidity pressures which the company faced at the time eventually led to its court-ordered reorganisation in Beijing on 19 February 2020. Subsequently, the Issuers defaulted on the bonds and the Guarantors failed to honour their guarantees. One after another, they were placed into liquidation.

The Issuers and the Guarantors later brought proceedings against PUFG before the Hong Kong High Court, claiming loss and damage for PUFG's breach of the Keepwell Deeds. Originally, the Court of First Instance only allowed FIHK's claims, dismissing the rest brought by Nuoxi, Kunzhi and HKJHC (the latter three subsidiaries, hereafter referred to as the Respondents in the CFA decision). That decision was overturned by the Court of Appeal, which declared ⁴ that PUFG breached provisions of the Keepwell Deeds in failing to provide funds for the liquidity of the three subsidiaries in meeting specific payment obligations to bondholders they could have discharged had liquidity been made available to them.

The CFA's rulings

The dispute later found its way to the CFA. The CFA was tasked with determining a specific question of whether PUFG's breach of its obligation under the Keepwell Deeds to provide liquidity to the Respondents caused actionable loss measured by the amount of pre-existing debt they could have discharged with the liquidity they received, despite the fact that by receiving the liquidity they would have incurred a corresponding obligation to repay another creditor (such as PUFG) in the same amount, such that their balance sheet position would have remained unchanged.

The CFA answered the question in the negative. The core aspects of the CFA's reasoning, as delivered by Justice Allsop NPJ (with the remaining Justices concurring), are as follows.

1. The measure of damages and the "no net loss rule"

   
   

   The CFA first noted that the central proposition contended by PUFG was that, in measuring the consequences of the breach of the Keepwell Deeds, one must recognise that had PUFG complied with its obligation thereunder by lending the necessary funds to satisfy the claims raised on behalf of the bondholders for payment of principal and interest, the Respondent's liability (to the bondholders) would have been replaced by an equal debt (to PUFG, or other lender). PUFG accordingly relied on the so-called "net loss" or "no net loss" rule as recently expressed by the UK Supreme Court in Stanford International Bank Ltd (in liquidation) v. HSBC Bank Plc ⁵ in arguing that the three subsidiaries had suffered no actionable loss. The net loss rule provides that in awarding damages for breach of contract or in tort, losses and gains arising from the breach must be netted off against each other and only any net loss awarded as damages ⁶.

   
   

   The CFA accepted PUFG's submissions that the net loss rule shall apply, and that no net loss had been suffered by the Respondents. The CFA specifically rejected the Respondents' contention of loss and damage by reference to a lack of liquidity and the insolvency of the three Respondents caused by PUFG's breaches of the Keepwell Deeds. The CFA pointed out that such a status of lack of liquidity and of insolvency alone did not involve financial loss. Whilst the CFA noted that loss may flow from the lack of liquidity or from the entry into winding-up (for instance, by causing a reduction in the value of assets or an increase in the amount of liabilities), such loss had not been pleaded by the Respondents. Before the CFA, the loss claimed (and the subject of the Declarations of the Court of Appeal) was only the pre-existing indebtedness to bondholders. Therefore, if a loan had been made, such indebtedness would have been replaced by an equal debt to PUFG or another lender ⁷.

   
   
   

2. No diminishment of wealth suffered by Respondents as "creatures or vehicles" of PUFG

   
   

   The Respondents also sought to characterise the facts of the case as special and as going beyond the character of an agreement to lend or to provide funds by way of lending such as would attract the "net loss" rule, pointing out (among other things) that the Respondents were the "vehicles" and affiliates of PUFG and they "bargained for" the discharge of their debts through the provision of liquidity.

   
   

   The argument did not advance the Respondents' case. The CFA, adopting the Respondents' metaphor, observed that the subsidiary Issuers and Guarantors were "creatures or vehicles" to give comfort to the parties who did eventually lose something: the bondholders. On this basis, the CFA held that there is no commercial utility in granting substantial damages (in the amount of the debt to the bondholders) to the "creature or vehicle" of the borrowing company, when the true loss caused by the company is to the bondholders for which they can sue the company or prove in its re-organisation administration. Giving the Respondents the right to obtain substantial damages in the amount that the bondholders have suffered, in the CFA's view, would either set up a double claim (or double proof in the liquidation context), or lead to the Respondents holding the benefit of their proofs on account for the bondholders ⁸.

   
   
   

3. Lending as an acceptable form of compliance with the Keepwell Deeds

   
   

   The Respondents also challenged PUFG's entitlement to perform its obligation to provide liquidity by way of a lending facility. This point had been disputed by the Respondents on several grounds. One argument raised by the Respondent was that the lending of funds by PUFG to the Respondents would have brought about a breach of another provision in the Keepwell Deeds, in altering the consolidated net worth of the Respondents. The Respondents' argument went as follows: the trustees' notice calling for repayment of all principal and interest on the bonds would have resulted in those sums "coming onto the balance" of the Respondents and a loan which paid them off would not affect this position. The CFA disposed of this argument briefly, stating that it ignored the fact that the bonds were already "on the balance sheet", that is part of the consolidated net liabilities of the Issuers or Guarantors ⁹.

   
   

   The CFA also rejected the Respondent's argument that PUFG was not entitled to choose the "most favourable alternative" (i.e. lending) as a means to comply with its obligations to ensure liquidity, on the purported basis that the clause did not provide for alternative performance, but for a single obligation where there was a discretion or a choice as to how to perform (such as by making a gift to the Issuer or the Guarantor). The CFA considered that the Respondents were mistaken in presenting these two positions as conflicting rules or principles. In the CFA's view, they are broadly all illustrations, in particular circumstances, as to how contractually compliant performance will be assessed. In simple terms, given the Keepwell Deeds provided that discharge of the obligation to provide liquidity encompassed a lending facility, it could not be said in those circumstances a loan by PUFG would not have been compliant with performance of its obligations under the Keepwell Deeds ¹⁰.

   
   
   

4. The doctrine of transferred loss could not be relied on by the Respondents

   
   

   The final argument advanced by the Respondents was that, even if the "net loss" rule applied, they could rely on the "doctrine of transferred loss" and sue for the loss suffered by the bondholders as a result of PUFG's breach. The CFA rejected this argument. The CFA noted that the application of the doctrine of transferred loss hinged on at least two considerations: first, that there was a contractual intention to benefit the third party; and, secondly, that without the right to recover the loss of another, there would be no one able to sue for the contractual breach. The CFA concluded that neither consideration had been fulfilled in this instance. Firstly, the Keepwell Deeds evidenced no contractual intention to benefit a third party. Secondly, the third-party bondholders held contractual rights under the Keepwell Deed to sue PUFG for their loss through the trustee under the bonds. Therefore, the doctrine of transferred loss could not be relied on by the Respondents ¹¹.

   
   

   In the end, the CFA allowed the appeals and made an order that the Declarations made by the Court of Appeal be varied to state that PUFG's breaches of the Keepwell Deeds "sound in nominal damages only"¹².

Commentary and takeaways

Although the relevant PRC regulations giving rise to their commercial use ceased to have effect in 2017, the use of keepwell deeds remains common practice. Litigation concerning alleged breaches of these deeds has persisted in recent years.

In the judgment, the CFA was emphatic in its observation that the commercial reality of what had happened in the PUFG saga is that it was the bondholders who had suffered the ultimate financial loss, consisting of the principal and accrued interest due under the bonds. It follows that, in the words of the CFA, "there is no doubt that the Trustee can sue the contract-breaker for breach of contract and recover not only any loss that it has suffered personally (such as here, its own costs), but also the losses of third parties not party to the contract, if the Trustee holds the contractual rights, the choses in action, on trust for those third parties. Here, those third parties were and are the bondholders, and the Trustee holds rights under clause 4.1 on trust for the bondholders. Clause 11 of the Keepwell Deed makes this plain, in express terms."

The judgment therefore leaves open the possibility that creditors in any future litigation concerning keepwell deeds might yet be successful in recovering losses caused by the failure of a parent company to ensure the liquidity of its subsidiaries.

The CFA decision also highlights the material impact that the drafting of keepwell deeds could have on subsequent litigation. Particular attention must be given, when drafting keepwell deeds, to how the deeds specify the actions the keepwell provider must take to maintain the net worth and/or support the liquidity of its subsidiaries, and in particular what forms of lending and/or security are an acceptable form of compliance with these obligations.

1. Nuoxi Capital Limited (in Liquidation in the British Virgin Islands) and Others v. Peking University Founder Group Company Limited [2025] HKCFA 6
2. The practice of executing keepwell deeds emerged as a commercial workaround of a PRC regulation that existed from June 2014 until January 2017, requiring PRC business enterprises to apply to register and gain approval from the State Administration of Foreign Exchange for the entry into guarantees for off-shore debts, including by capital raisings by the issue of bonds. Since keepwell deeds, by nature, are expressly not guarantees and contain only obligations to maintain the financial well-being of any off-shore subsidiaries which were involved as issuer or guarantor, they would not be caught by the PRC regulation.
3. Clause 6 in the Keepwell Deeds provided for a mechanism of satisfying the liquidity obligation to the Issuer. That arrangement contemplated PUFG's use of a commercial banking arrangement, opened in an account with a PRC commercial bank for the purpose of transferring and remitting the required amount, for remittance to an account of the Issuer in Hong Kong, for the specified use of meeting the Issuer's bond obligations. The arrangement also contemplated a commercial obligation on the Issuer to repay the funds provided by the use of the facility, though one for which security could not be sought.
4. The declarations made by the Court of Appeal were to the effect that PUFG had breached the Keepwell Deeds by failing to make funds available to the Nuoxi, Kunzhi and HKJHC, and that the respective totals of the sums they had failed to make available represented loss and damage suffered by the three subsidiaries. The three subsidiaries explained to the Hong Kong Court at an interlocutory application that they did not seek money judgments for loss and damage caused by the breaches, but rather declarations as to breaches of the Keepwell Deeds resulting in loss and damage, upon which they could rely in support of proofs of debt in PUFG's re-organisation in Beijing.
5. [2022] UKSC 34.
6. As per paragraph 50 of Lord Legatt JSC's judgment in Stanford International Bank Ltd (in liquidation) v. HSBC Bank Plc [2022] UKSC 34, cited by PUFG in their submissions as summarised at para. 66 of the CFA's judgment.
7. n1 above paras. 64, 83.
8. Ibid paras 103-104.
9. n1 above para. 82.
10. Ibid para. 105-108.
11. Ibid para. 115-116.
12. Ibid para. 119.