International Corporate Rescue

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Hong Kong’s Insolvency Regime: A Time of Change

Jeremy Leifer, Partner, and David Chu, Partner, Proskauer Rose, Hong Kong

Earlier this year, Hong Kong’s insolvency regime turned ground on some of some of the changes to the winding a corner with the coming into effect of much needed up regime. It will then look very briefly at the proposed amendments to its corporate insolvency statute, the second phase amendments, where the detail has yet to Companies (Winding Up and Miscellaneous Provi- be published. sions) Ordinance. These amendments represent the first of two phases of regime changes. This first set of changes has gone some way to strengthening creditor Phase 1 Amendments – Anti-Avoidance protection particularly for avoidance transactions prior Transaction Provisions to winding up which breach the pari passu principle, as well as to streamline the winding up process. The Liability of directors and shareholders involved in share second phase, which should start its legislative journey redemption or buy-back out prior to winding up later this year, will however be the ‘game changer’, and if this phase makes it into law in the shape that the This is a new provision which can require a share- Government is proposing, after a very long wait, Hong holder or a director to contribute to the assets of an Kong will finally have a much needed statutory corpo- insolvent company. It provides that if a winding up rate rescue procedure.1 of the company commences within one year after the Hong Kong sits at a pivot point in North-East Asia payment out of capital2 was made by the company for where it serves as a major centre for financial ser- a redemption or buy-back of its own shares, and the vices for the region, attracting very significant levels company is insolvent, the shareholder involved can be of corporate activity, driven by its unique geopolitical made liable to pay back the amount of the capital pay- position and its cross border treaty arrangements with ment received from the company. This provision works Mainland China. These and other factors have helped in parallel to the requirement that a majority of the di- to make Hong Kong a natural focal point for both rectors must sign a solvency statement3 as a condition inbound transactions into Mainland China as well as to the effectiveness of the redemption or buy-back. Di- outbound. Hong Kong is also recognised as having rectors who have signed this solvency statement can be one of the most mature and trusted legal systems in held liable (jointly and severally with the shareholder) Asia, which accounts for the presence of much of this to contribute the amount for which the shareholder is activity. Given these factors, the process of modernis- liable, subject to a defence that the director had reason- ing some of the key aspects of Hong Kong’s corporate able grounds for forming the opinion expressed in the insolvency regime as a component in the corporate life solvency statement. Prior to the introduction of this cycle, is long overdue. provision, it was (and still is) a criminal offence for a This article will give an overview of the first phase director to make a solvency statement without having amendments now in force, focusing on the new reasonable grounds for the opinion expressed in it. creditor protection provisions, as well as covering the Following a director’s conviction for this offence, the

Notes

1 The corporate winding-up regime, which follows a creditor (rather than debtor) oriented approach, was last subject to major overhaul in 1984. The Government had sought to enact a statutory corporate rescue procedure involving a process of provisional supervision through the Companies (Corporate Rescue) Bill 2001, but owing to a range of concerns raised by members of the Legislative Council which included the question of addressing outstanding entitlements of employees, it was not passed into law. 2 A payment out of distributable profits or the proceeds of a fresh issue of shares for the purpose of the redemption or buy-back, falls outside of this provision. 3 This contains a statement to be made by directors that having inquired into the company’s state of affairs and prospects and taken into account all the liabilities of the company (including contingent and prospective liabilities), the director has formed the opinion that (a) immediately after the transaction in question, there will be no ground on which the company could be found to be unable to pay its debts; and (b) (i) if it is intended to commence the winding up of the company within 12 months after the transaction date, the company will be able to pay its debts in full within 12 months after the commencement of the winding up; or (ii) in any other case, the company will be able to pay its debts as they become due during the period of 12 months immediately following the transaction date.

319 Jeremy Leifer and David Chu company (and its creditors) would receive no benefit an employee), conditions (a) and (b) are presumed to be from any monetary fine imposed by the court. This new satisfied, unless the contrary is shown. provision corrects that anomaly.

Unfair preferences voidable in certain circumstances6 Transactions at an undervalue voidable in certain circumstances This provision which already existed in the corporate regime legislation is concerned with payments that pre- This is a new statutory provision in the context of a fer one creditor unfairly over another during the period corporate insolvency.4 Until its introduction, it existed before the commencement of winding up. However, only in the Hong Kong Bankruptcy Ordinance in the unhelpfully, it operated by reference to the equivalent context of individual bankruptcy5 but without a cor- provision for unfair preferences in the Bankruptcy Or- porate equivalent. It provides that if the company goes dinance. It has now been made a standalone provision into liquidation and during the five year period before for corporate insolvency. the winding up commences it has entered into a trans- In the context of this provision and the new corpo- action with a person at an undervalue, the liquidator rate provisions for transactions at an undervalue (see may apply to the court for an order to set aside the above), the amending legislation has also clarified some transaction. The court has wide ranging powers to definitional issues under the prior regime; specifically in make an order to restore the position to what it would relation to the meaning of who is a person ‘connected’ have been if the company had not entered into the with, and an ‘associate’ of, a company for the purposes transaction. of the length of the look back period prior to the com- A transaction entered into by a company with a per- mencement of the winding up when examining prior son is a ‘transaction at an undervalue’ if: transactions.7 A company gives an unfair preference to a person if (a) the company makes a gift to that person, or other- (a) that person is (i) one of the company’s creditors, or wise enters into a transaction with that person on (ii) a surety or guarantor for any of the company’s debts terms that provide for the company to receive no or other liabilities, and (b) the company does anything consideration; or or permits anything to be done which has the effect of (b) the company enters into a transaction with that putting that person into a position which, in the event person for a consideration the value of which, in of the company going into insolvent liquidation, will be money or money’s worth, is significantly less than better than the position that person would have been in the value, in money or money’s worth, of the con- if that thing had not been done. sideration provided by the company. The liquidator will have the right to apply to the court for an order to set aside the preferential payment: The court must not make an order if it is satisfied that (i) the company entered into the transaction in good (a) if it is given to a person who is ‘connected’ with the faith and for the purpose of carrying on its business, company (excluding an employee) at a time in the and (ii) at the time the company did so, there were 2 year period before the winding up commences;8 reasonable grounds for believing that the transaction or would benefit the company. (b) in any other case of an unfair preference (which is Notably, the transaction under scrutiny will only be not a transaction at an undervalue), at a time in the regarded as a ‘transaction at an undervalue’ if either 6 month period before the winding up commences. (a) at the time of the transaction the company was unable to pay its debts as they fell due, or (b) the company Again, the court has a range of orders at its disposal became unable to pay its debts as a result of the transac- which are generally intended to enable it to restore the tion. Where the company entered into the transaction entity to the original position as if the transaction had with a person ‘connected’ with the company (excluding not taken place.

Notes

4 Formerly, a liquidator could only challenge a transaction at an undervalue on the basis of, inter alia, fraud, breach of fiduciary duty etc. by a director, and seek restitutionary relief to unwind the transaction. 5 This provision was also drafted with reference to the UK Insolvency Act 1986. 6 Previously referred to as a ‘fraudulent preference’. 7 The concept of ‘control’ of a company has been introduced and is satisfied if (i) any or all of the directors of the company, or of another company which has control of it, are accustomed to act in accordance with that person’s directions or instructions; or (ii) that person is entitled to exercise, or control the exercise of, more than 30% of the voting power at any general meeting of the company or of another company which has control of it. 8 This assumes that the unfair preference is not also a transaction at an undervalue. If it were such a transaction, then it would be dealt with as such, rather than as an unfair preference, resulting instead in a five year look back period.

A continuing issue in practice with this provision is Voluntary winding up of company by the directors the requirement that the liquidator must demonstrate to the court that in deciding to give a creditor an Under a special procedure the directors of a company unfair preference, the company was influenced by a have the power under the corporate insolvency re- desire to prefer that creditor over another. In circum- gime to place the company into insolvent liquidation stances in which a company is financially stressed, it (a creditors’ winding up). The intended purpose of can be very difficult for a liquidator to demonstrate this procedure is to give to the directors the power to this ‘desire’ e.g. where a payment is made to a firm of wind up the company and to appoint a provisional accountants to retain their services during a time of liquidator with effect from the commencement of the financial stress. winding up, thereby accelerating the appointment process in an emergency case. Meetings of creditors and shareholders must then be convened within 28 days of Floating charge – potential invalidity the commencement of the winding up. A majority of the directors’ may pass a resolution to commence the This provision already existed in the corporate regime winding-up of the company, if they have formed an legislation and addressed the validity of a floating opinion that the company cannot by reason of its li- charge granted close to the time of the commence- abilities continue its business. A winding-up statement ment of winding up. It has been strengthened and must then be filed with the Registrar of Companies, at clarified by expanding the types of consideration that which time the winding up will commence. Safeguards a company may receive for giving the floating charge, to address concerns that this ‘fast tracking’ process to to prevent invalidity, and by introducing a longer claw appoint a liquidator might be subject to abuse were back period prior to the commencement of the winding introduced by restricting the powers of the provi- up for a person ‘connected’ with the company. sional liquidator appointed by the directors. Whilst the It provides that if a company creates a floating charge provisional liquidator will have the same powers as a on its undertaking or property in favour of any of the liquidator in a creditors’ voluntary winding up, aside following persons, the charge will be invalid except to from certain powers stated in the legislation,9 the pro- the extent of the value of consideration received by the visional liquidator will now be required to obtain the chargor company for its creation if: sanction of the court to exercise his powers. (a) in the case of a person connected with the company, the charge was created within the 2 year period before the winding up commenced; or Liquidator not absolved from liabilities arising from the liquidator’s misfeasance or breach of duty or trust (b) in any other case, the charge was created within the 12 months period before the winding up com- Provisions similar to those in the UK insolvency regime menced, and the company was unable to pay its concerning the liabilities of a liquidator have been debts at that time, or became unable to pay its adopted to enhance the regulation of instances of debts as a result of the transaction under which misfeasance or breach of duty or trust by a liquidator the charge was created. notwithstanding his/her release by the court. Whilst a liquidator may have obtained a court order releas- The consideration referred to will be the value of any ing him/her from office once the winding-up has been money paid to or at the direction of the company, or completed, interested parties including a creditor or property or services supplied to the company, at the contributory will now be entitled to apply to the court same time as or after the creation of the charge. for leave to take legal action against the liquidator after the liquidator’s release. This provision is intended to address possible delinquency of a liquidator during the Other Phase 1 Amendments performance of his/her duties.

Streamlining the winding up process Streamlining the committee of inspection (COI) The amending legislation introduced a wide range of other provisions aimed at streamlining the winding up The COI may be appointed by the court in a compulsory process. The following are some of the highlights. liquidation following the determination of meetings of the creditors and contributories of the company. The

Notes

9 These are (a) to take into the provisional liquidator’s custody, or under the provisional liquidator’s control, all the property and things in action to which the company is or appears to be entitled, (b) dispose of perishable goods and other goods that are likely to diminish in value if not immediately disposed of, and (c) do anything that may be necessary to protect the company’s assets.

321 International Corporate Rescue, Volume 14, Issue 5 © 2017 Chase Cambria Publishing Jeremy Leifer and David Chu purpose of the COI is that of supervising and giving major pieces intended to be dealt with in Phase 2 are directions to the liquidator during the course of the these: winding-up. Various changes have been made to the procedures surrounding the COI to improve their work- ings, and these include: Provisional supervision (a) setting the COI’s minimum and maximum num- This would create a formal turnaround and rescue bers of members at three and seven. This is subject regime. Currently, Hong Kong has only a liquidation to variation by a court order on the application of regime (with rescue being provided through the pro- the liquidator; visional liquidation route – which was not designed (b) dispensing with the requirement that the COI for this purpose – at times combined with schemes of should meet at least monthly if the COI failed to arrangement). The likely framework for provisional su- set a time for a meeting, and instead providing pervision (when it appears) is that it could be initiated that it should meet as and when determined by the by a company or its directors or provisional liquidators liquidator; or liquidators, but not the company’s creditors. It would give to the debtor company a moratorium period dur- (c) altering the provisions for filling vacancies on the ing which civil proceedings against the company would COI, such that a vacancy need not be filled if the be stayed, thus giving valuable time to the provisional liquidator and a majority of the continuing mem- supervisor to work towards a possible turnaround of bers agree that, having regard to the position in the business whilst freed up from the threat of credi- the winding-up, it is unnecessary for the vacancy tor action. Provisional supervision could be used in the to be filled, and the total number of the continuing case of both a locally incorporated company and a non- members does not fall below three (or the mini- Hong Kong company registered under the Companies mum number ordered by the court); and Ordinance. (d) providing for COIs to conduct their meetings remotely (e.g. by video conference) and to make Insolvent trading decisions through written resolutions. Hong Kong’s insolvency regime has no provision for insolvent or wrongful trading.10 This would make di- Regulatory measures for liquidators and provisional rectors and senior management personally liable for liquidators the debts of a company which traded while insolvent. The goal of this provision would be to encourage the di- The Phase 1 amendments also strengthen regulation rectors and senior management to initiate provisional under the winding-up regime by setting out more supervision much earlier in time, to raise the chances clearly the powers, duties, the basis for determining re- of salvaging the business before a liquidation. The liq- muneration, tenure of office of a provisional liquidator uidator would be empowered to apply to the court to in a court winding-up, the termination and resignation seek a declaration that a ‘responsible person’ was liable of a provisional liquidator. to the company for insolvent trading at the time it went into liquidation.

Phase 2 Amendments It is very much hoped that both of these proposals will arrive on the statute book in the form proposed by the Given the scale of the changes overall and some political Government. Both would represent a great leap for- contentiousness connected with some of the amend- ward, and a significant catching up of the insolvency ments, the Government divided the process of making regime with other legal regimes in Hong Kong. The time these amendments into two distinct phases. The two for implementing these changes is now long overdue.

Notes

10 The offence of fraudulent trading exists in the current regime, but the courts have consistently been reluctant to make a declaration for civil liability in the absence of dishonesty.

International Corporate Rescue addresses the most relevant issues in the topical area of insolvency and corporate rescue law and practice. The journal encompasses within its scope banking and financial services, company and insolvency law from an international perspective. It is broad enough to cover industry perspectives, yet specialized enough to provide in-depth analysis to practitioners facing these issues on a day-to-day basis. The coverage and analysis published in the journal is truly international and reaches the key jurisdictions where there is corporate rescue activity within core regions of North and South America, UK, Europe Austral Asia and Asia. Alongside its regular features – Editorial, US Corner, Economists’ Outlook and Case Review Section – each issue of International Corporate Rescue brings superbly authoritative articles on the most pertinent international business issues written by the leading experts in the field. International Corporate Rescue has been relied on by practitioners and lawyers throughout the world and is designed to help: • Better understanding of the practical implications of insolvency and business failure – and the risk of operating in certain markets. • Keeping the reader up to date with relevant developments in international business and trade, legislation, regulation and litigation. • Identify and assess potential problems and avoid costly mistakes.

Editor-in-Chief: Mark Fennessy, Proskauer Rose LLP, London Emanuella Agostinelli, Curtis, Mallet-Prevost, Colt & Mosle LLP, Milan; Scott Atkins, Henry Davis York, Sydney; Samantha Bewick, KPMG, London; Geoff Carton-Kelly, FRP Advisory, London; Gillian Carty, Shepherd and Wedderburn, Edinburgh; Charlotte Cooke, South Square, London; Sandie Corbett, Walkers, British Virgin Islands; Ronald DeKoven, DeKoven Chambers, London; Hon. Robert D. Drain, United States Bankruptcy Court, Southern District of New York; Matthew Kersey, Russell McVeagh, Auckland; Prof. Ioannis Kokkoris, Queen Mary, University of London; Professor John Lowry, University College London, London; Neil Lupton, Walkers, Cayman Islands; Lee Manning, Deloitte, London; Ian McDonald, Mayer Brown International LLP, London; Professor Riz Mokal, UCL, London; Mathew Newman, Ogier, Guernsey; Karen O’Flynn, Clayton Utz, Sydney; Professor Rodrigo Olivares-Caminal, Queen Mary, University of London; Christian Pilkington, White & Case LLP, London; Susan Prevezer Q.C., Quinn Emanuel Urquhart Oliver & Hedges LLP, London; Sandy Purcell, Houlihan Lokey Howard & Zukin, Chicago; Professor Professor Arad Reisberg, Brunel University, London; Daniel Schwarzmann, PricewaterhouseCoopers, London; The Hon Mr Justice Richard Snowden, Royal Courts of Justice, London; Anker Sørensen, De Gaulle Fleurance & Associés, Paris; Kathleen Stephansen, Huawei Technologies U.S.A., New York; Angela Swarbrick, Ernst & Young, London; Dr Artur Swierczok, Clifford Chance, Frankfurt; Dr Shinjiro Takagi, Morgan Lewis & Bockius LLP, Tokyo ; Lloyd Tamlyn, South Square, London; Stephen Taylor, Isonomy Limited, London; Richard Tett, Freshfields, London; William Trower Q.C., South Square, London; Professor Edward Tyler, The University of Hong Kong; Mahesh Uttamchandani, The World Bank, Washington, DC; Robert van Galen, NautaDutilh, Amsterdam; Miguel Virgós, Uría & Menéndez, Madrid; Maja Zerjal, Proskauer Rose, New York; Dr Haizheng Zhang, Beijing Foreign Studies University, Beijing. For more information about International Corporate Rescue, please visit www.chasecambria.com