DLA Piper Article: The modernisation of Hong Kong corporate insolvency law
Here’s what they say…..
For at least 15 years, Hong Kong has sought to reform its outdated insolvency legislation. Now, the Official Receiver is confident that changes will be enacted before the end of the current legislative council term.
Some of the new proposals are about to be put out for public consultation, with other proposals having already been through this process. The law regulating corporate insolvency is currently contained in the Companies Ordinance (Cap 32) (CO). The new legislation will be contained in a separate Companies (Winding Up and Miscellaneous Provisions) Ordinance (CWUMPO). The main purpose of the legislation is to introduce a formal corporate rescue procedure and to update and streamline parts of the existing law. The main elements are as follows.
Under current law, Hong Kong has no formal rescue procedure. Insolvency practitioners have to apply for a provisional liquidation to create a protective moratorium, using Section 166 of the CO, which gives the company power to enter into a compromise with creditors. However, the procedure is cumbersome and expensive and requires separate consent from ‘different classes of creditors’, which has led to much litigation.
CWUMPO would introduce a procedure under which the company, its directors or liquidator would be able to initiate the provisional supervision process by filing a notice with the Companies Registry. It is not intended to involve the courts. Filing the notice creates a moratorium, for an initial 45-day period, to give the Provisional Supervisor (PS) time to prepare a voluntary arrangement. This period can be extended only by resolution of the creditors, to a maximum of six months. The PS would be chosen from a panel of approved practitioners operated by the Official Receiver.
Discussion is still going on about the extent to which employee claims might be exempt from the moratorium; certain entitlements may have be covered in order for it to continue.
A ‘major secured creditor’ (defined as one whose charge covers the whole or the substantial majority of the company?s property) must be served with notice of the process within three days and may object, in which case the provisional supervision and moratorium end.
An initial meeting of creditors is held to approve the PS remuneration and, if decided by resolution, to replace the PS.
A second meeting of creditors is then held to either approve the proposal or extend the time for preparation for up to six months. Approval (or modification) is currently proposed to be by:
A majority of creditors present in person or by proxy voting on the resolution (the
‘headcount test’) and
In excess of two-thirds in value of creditors attending and voting in person or by proxy and
No more than 50 percent in value of those voting who are not connected to the company
have voted against it
The headcount test was proposed to ensure that employees and small creditors are heard, but this test may not survive into the final draft bill. If the proposal is approved, then the moratorium and the provisional supervision ends and the voluntary arrangement begins. If not approved, the provisional supervision and moratorium ends and a creditors voluntary liquidation is deemed to commence.
These proposals have already been put to public consultation and will not form part of the current consultation.
Currently, Hong Kong has no wrongful trading provisions. This has been seen as a disincentive for directors, encouraging them to ignore company financial problems and even continue trading a troubled company into the ground. While directors do have common law
duties under which their duties transfer from their shareholders to their creditors when the company is insolvent, this issue is difficult to litigate. Section 275 of the CO has a fraudulent trading provision, but its enforcement requires establishing intent to defraud. Making wrongful trading a statutory liability is expected to encourage companies to take the provisional supervision route earlier.
The burden of proof is that ‘responsible persons’ be held liable if they “knew or ought to have known that the company was insolvent or knew or ought reasonably to have known that there was no reasonable prospect that the company would avoid becoming insolvent” and that they failed to take any steps to prevent the insolvent trading. ‘Responsible persons’ originally included senior management, but will now cover only directors or shadow directors. This measure has also already been through the public consultation procedure. Notably, however, because the Legislative Council includes many company directors, such provisions have always been regarded as unlikely to survive. Time will tell.
Transactions at an undervalue
It is proposed a provision on ‘transactions at an undervalue’ be introduced. There is currently legislative redress for assets transferred at an undervalue. It has been proposed that the recipient of assets belonging to the insolvent company received either as a gift or for no consideration, or if the consideration was significantly less than the value of the assets transferred, could be made to recompense the insolvent company. At present, such transactions are most likely to be covered by the misfeasance provisions in Section 276 of the CO, but this requires establishing dishonesty.
It is believed that the ?transactions at an undervalue? provision will be similar to that contained in Section 238 of the UK Insolvency Act 1986, and that the court will not issue an order if the company entered into the transaction in good faith and for the purpose of carrying on its business, and that at the time they did so there were reasonable grounds for believing the transaction would benefit the company.
This new provision is welcomed by insolvency practitioners as a weapon missing from their armoury for too long.
The CO does currently contain legislation under which a liquidator can attack unfair preferences, but this has been done by applying the bankruptcy provisions to company insolvencies.
The preferred person must be a creditor, guarantor or surety, and the company must not ?do anything? or ?suffer anything to be done? which puts the creditor in a better position than they would have been in under insolvency. The company must have been ‘influenced by a desire to prefer’. This has led to considerable confusion, especially over who can be considered to be an ‘associate’. The desire to prefer is presumed where the recipient is an associate, but the bankruptcy legislation refers to such people as ‘spouses’; however, in a corporate context, a company is an associate ‘if the debtor has control of it’. This had led to such strange anomalies as a subsidiary being an associate, but not a holding company, because the debtor does not ‘control’ its holding company, nor a fellow subsidiary of the same holding company, for the same reason.
The new legislation is expected to address these issues. All of these proposals are sensible and will bring Hong Kong more in line with other jurisdictions. Hong Kong still lacks a statutory provision for the recognition of foreign insolvency proceedings, an issue that we trust will be addressed in the future.
This article was first published in ‘Global Insight’, our e-newsletter which includes news, views and analysis from our Global Restructuring Group.