Initiation of provisional supervision
Employees' outstanding entitlements
Potential for debtor-in-possession approach
Unlike many other common law jurisdictions, Hong Kong still lacks a statutory corporate rescue regime, despite the fact that a proposal was first made by the Law Reform Commission in 1996 and a proposed bill containing a corporate rescue regime was introduced in 2001. Corporate restructurings in Hong Kong have been effected through more cumbersome procedures, such as schemes of arrangement or the creative use of provisional liquidators. However, these methods do not offer the certainty provided by the statutory corporate rescue regimes that exist in countries such as Australia and the United States. For instance, schemes of arrangement notoriously lack the ability to impose a moratorium on creditor actions and recent Hong Kong judicial authority has stressed the need to demonstrate danger to a company's assets in order to appoint a provisional liquidator. The 'danger to the assets' test may not necessarily be satisfied in all cases where a corporate rescue is desirable.
The financial crisis which swept the world in 2008 did not spare Hong Kong, and it appears to have reminded the legislature of the need for a statutory corporate rescue regime. The Financial Services and the Treasury Bureau (FSTB) launched a public consultation with a view to introducing a new corporate rescue bill, updating the provisions of the 2001 bill. The original intention was to introduce the new bill into the Legislative Council in late 2010 or early 2011, but this has not happened.
Nevertheless, the conclusions of the FSTB's consultation, which were published in July 2010, offer valuable clues as to what insolvency and restructuring practitioners in Hong Kong may expect if a statutory corporate rescue mechanism is finally enacted. This update considers some of the main proposals in the consultation conclusions and suggests possible changes in approach, now that there appears to be more time in which to modify the proposed regime.
Initiation of provisional supervision
The corporate rescue regime is to be known by the term 'provisional supervision' and may be initiated by a company or its directors, or by provisional liquidators or liquidators. However, the company's creditors will not have the right to initiate provisional supervision. Provisional supervision is intended to apply to both local and non-Hong Kong companies formed or registered under the Companies Ordinance, but not to certain regulated financial institutions.
The procedural requirements that are proposed to apply to the initiation of provisional supervision include the following points:
- The notice of appointment of a provisional supervisor and relevant documents must be filed with the registrar of companies, but not with the court or the official receiver.
- The company must confirm that it has a valid insurance policy to cover its employee compensation liabilities before the commencement of provisional supervision.
- The company's directors must produce a statement of affairs of the company at the directors' meeting that appoints the provisional supervisor.
- The notice of appointment of the provisional supervisor must be published in the local newspapers on the working day following the day on which the last relevant document for the commencement of provisional supervision is filed with the registrar of companies.
One of the main attractions of the proposed regime is that it would offer a moratorium that would stay civil proceedings against the company for a certain period, beginning on the date on which the provisional supervisor is appointed.
It appears that in many respects the moratorium will be more generous than that proposed in the 2001 bill. It is now proposed that the initial moratorium apply for 45 working days (as opposed to 30 calendar days in the 2001 bill), and a creditors' meeting would be able to vote to extend the moratorium for up to six months. Extensions to the moratorium could also be granted by the court at any time on the provisional supervisor's application and the six-month limit would not apply in such cases.
Furthermore, it seems that the new proposal will make fewer exceptions to the moratorium than the 2001 bill. The latter was drafted so as generally to allow post-commencement claims, but it is now proposed that, in principle, the only post-commencement claims to be exempt will be for:
- arrears of wages under the Employment Ordinance (Cap 57); and
- outstanding employer contributions to the Mandatory Provident Fund or other occupational retirement schemes.
However, the proposal diverges from the 2001 bill - but follows the example of many other common law jurisdictions - in allowing creditors to exercise rights of set-off following the commencement of provisional supervision.
Apparently to address concerns as to how the moratorium might affect derivatives counterparties, the proposal retains a recommendation that the corporate rescue regime include an exemption list of contracts and agreements to which the moratorium will not apply. Unlike the 2001 bill, the proposal intends that the list be periodically updated to reflect market developments.
Employees' outstanding entitlements
The issue of employees' outstanding entitlements has been considered one of the most controversial issues arising from the introduction of a statutory corporate rescue regime. Some commentators regarded the 2001 bill's approach to the issue as overly favourable to employees and likely to diminish the chances of rescuing a company's business.
The consultation conclusions propose a substantial change to the way in which employee entitlements are handled. A framework of staggered payments provides for various entitlements to be paid:
- 30 calendar days from the commencement of provisional supervision;
- 45 calendar days after the entry into effect of the voluntary arrangement for restructuring (or, if the moratorium is extended, 45 calendar days from the date of extension); and
- 12 months after the entry into effect of the voluntary arrangement for restructuring.
This system of staggered payments is intended to reduce the risk of a company sinking under the cumulative weight of employee entitlements, while giving employees the right to take action outside the moratorium if a payment date is not met.
All registered certified public accountants and practising solicitors will be allowed to perform the role of provisional supervisor. Creditors will be allowed to replace the provisional supervisor at the first meeting of creditors (to be held within 10 working days of the commencement of provisional supervision). Creditors will be able to fix the provisional supervisor's fees:
- by agreement between the provisional supervisor and the committee of creditors (if any);
- by creditors' resolution; or
- through the court, in the absence of agreement or resolution.
However, there has arguably been a step backwards in the approach to the provisional supervisor's liability for contracts. Unlike the 2001 bill, the new regime would provide for the provisional supervisor's provisional liability to extend beyond contracts entered into by the provisional supervisor and to include pre-existing contracts adopted by the provisional supervisor in the performance or exercise of the latter's functions. It would also make the provisional supervisor liable for rent for properties that the company continues to use, possess or occupy after the commencement of provisional supervision (and in relation to which the company has not renounced its rights during the 10 working days after the commencement of provisional supervision, as it is entitled to do).
Provisional supervisors may derive comfort from their right to be indemnified out of the company's assets for any such personal liability. Nevertheless, the expanded scope of liability may make some practitioners think twice before assuming the position of provisional supervisor, especially in view of the various obligations to employees that a provisional supervisor will now assume if he or she adopts the relevant employment contracts.
The proposed regime now provides that a 'responsible person' (ie, either the director or the shadow director, but not a member of senior management) who knew or ought reasonably 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 could avoid insolvency, will be personally liable for the debts of the company which traded while insolvent if he or she fails to prevent insolvent trading. The bar for proving insolvent trading has been raised slightly since the drafting of the 2001 bill, as simply having reasonable grounds to suspect that the company was insolvent (or that there was no reasonable prospect that the company could avoid insolvency) will no longer be enough to establish liability.
The introduction of insolvent trading provisions would be a welcome change, bringing Hong Kong into line with many other common law jurisdictions. However, most senior corporate professionals would no doubt wish to see the simultaneous introduction of some of the defences to insolvent trading that exist in other jurisdictions, which are typically based on steps taken to minimise damage to creditors or attempts to prevent a debt from being incurred. Such defences are apparently not part of the current proposals.
A key issue for any corporate rescue regime is how to deal with creditors that hold security over the company's assets. The 2001 bill addressed the issue by effectively dividing secured creditors into two categories: major secured creditors and all other secured creditors. A 'major secured creditor' was defined as a creditor which holds one or more charges (fixed or otherwise) over company property where the totality of the secured property constitutes "the whole or substantially the whole of the company's property". The major secured creditor has three working days in which to decide whether to participate in the provisional supervision; if the major secured creditor objects, the provisional supervision will cease. In contrast, other secured creditors have no power to overturn the provisional supervision and the moratorium, but may choose not to participate in the provisional supervision and attempt to enforce their own security once the moratorium has ended.
The consultation conclusions state that the provisions of the 2001 bill on secured creditors' rights will be retained. Among other proposals for change in this area, the FSTB noted the suggestion that major secured creditors be defined by reference to a specific percentage of the company's assets, rather than by the phrase "the whole or substantially the whole". The FSTB rejected the proposal on the grounds that it would involve problems of valuation of the relevant assets. Nonetheless, if the corporate rescue regime is introduced in its proposed form, the question of whether a creditor is secured over substantially the whole of the company's property is likely to be a frequent area of dispute.
Potential for debtor-in-possession approach
The proposed corporate rescue regime contrasts with the Chapter 11 regime available under US federal law, which allows the debtor to continue to operate the business, rather than appointing an external supervisor. Proponents of this debtor-in-possession approach usually argue that it is more likely to preserve the company as a going concern, compared with an approach which gives greater power to creditors.
The consultation conclusions state that a debtor-in-possession approach will not be pursued, as it is contrary to the creditor-centred manner in which the proposed Hong Kong corporate rescue regime has been developed to date. However, the conclusions leave open the future possibility of a hybrid approach, which would allow for the retention of existing company management while giving creditors greater control than under a strict debtor-in-possession regime.
A bill containing the new proposed corporate rescue regime was not introduced into the Legislative Council by early 2011 as planned. Nevertheless, there have been other significant developments in relation to companies. On January 26 2011 a new companies bill, rewriting the Companies Ordinance in all areas except for company winding-up, was read for the first time in the Legislative Council. This leaves the area of company winding-up to be dealt with in a proposed second phase of the project to rewrite the Companies Ordinance.
It might be argued that it would now be logical to deal with the proposed corporate rescue regime in a single bill, together with the reforms to the company winding-up provisions. This would allow greater attention to be paid to the ways in which the corporate rescue regime may affect the winding-up regime, and vice versa.
Furthermore, the greater time that now seems to be available for refining the corporate rescue proposals could be used to consider changes that might increase the chances of successful corporate rescues. For example, attention could be paid to revisiting the question of the provisional supervisor's liability in relation to employment contracts and to the possibility of adopting a Chapter 11-style debtor-in-possession approach in Hong Kong.
For further information on this topic please contact Ian De Witt or Robin Darton at Tanner De Witt by telephone (+852 2573 5000), fax (+852 2802 3553) or email ([email protected] or [email protected]).