The Hong Kong Government has released its major proposals for introducing a new statutory corporate rescue procedure. At the same time, it has published the consultation conclusions for improving the corporate insolvency and winding up provisions in the Companies (Winding Up and Miscellaneous Provisions Ordinance) (Chapter 32) (“C(WUMP)O”). The Government plans to introduce an amendment bill into the Legislative Council in 2015.
Implications for companies
The latest developments have important implications for Hong Kong. The proposed corporate rescue procedure (“CR”) provides troubled companies with greater flexibility and rescue options. The proposed corporate insolvency and winding up revisions aim to facilitate a more efficient administration of the winding-up process and increase creditor protection.
A key reform relates to the proposed introduction of insolvent trading. This will require an elevated level of responsibility for company executives. Directors of financially distressed companies will need to carefully consider the company’s solvency before continuing to trade and incur debts.
What is the current status of the CR reform?
Hong Kong’s statutory rescue mechanism available to a financially distressed company is currently limited to the schemes of arrangement which are quite complex and often a lengthy process. Schemes have the disadvantage of lacking a moratorium against creditors’ actions during the rescue period which can easily stymie a restructuring effort. In Hong Kong, a moratorium is imposed only when a winding up order is made or when a provisional liquidator is appointed. This has proved useful for companies in provisional liquidation seeking to restructure. However, the criteria for appointing a provisional liquidator are that (i) the company has to be insolvent and (ii) its assets are in jeopardy.
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In 2010, the Government conducted a public consultation on the framework and issues relating to the statutory CR and insolvent trading provisions. Based on the consultation conclusions, the Government has worked out further details of the proposals. The main points of the proposed CR are detailed below.
Commencing the CR and the moratorium
The Government has confirmed that the CR can be initiated by the company (by members’ or directors’ resolution), or by the provisional liquidator or liquidator. The CR will provide for a moratorium under which civil proceedings and other legal process will be stayed during the CR.
In 2010, the Government proposed a moratorium period set at 45 working days from the commencement of the provisional supervision, followed by a potential extension of up to a maximum period of 6 months with creditor approval. The moratorium begins upon the appointment of the provisional supervisor. After taking on board the views of practitioners and others, the Government considered it appropriate to allow the court to extend the moratorium period as it thinks fit. This may be necessary in cases of large and complex corporate restructuring exercises involving numerous entities and parallel proceedings in foreign countries. During the moratorium, no application for winding up can be commenced or continued, receivers cannot be appointed and no proceedings or other process may be commenced or continued.
The CR will be commenced by the appointment of a provisional supervisor (“PS”). The PS will take temporary control of the company, consider options for rescuing the company and prepare proposals for a voluntary arrangement within a specified period for creditors’ approval.
The latest proposal confirms that certified public accountants and solicitors with practising certificates will be eligible to be appointed as a PS. Checks and balances include the court’s ability to make orders against a PS for misfeasance or breach of duty.
The proposed reform is intended to minimise court involvement and provide for greater involvement of creditors including a right of veto by the major secured creditor who will have the ability to end a rescue arrangement. The latest proposal has confirmed the role of the company’s major secured creditor whose prior written consent will be necessary for commencing a CR.
The Government previously proposed that a “major secured creditor” is the holder of a charge, whether fixed or otherwise, over the whole or substantially the whole of the company’s property; or the holder of two or more charges, whether fixed or otherwise, on
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the company’s property where the property subject to those charges constitutes the whole or substantially the whole of the company’s property.
The latest proposal confirms there will be a phased payment schedule for outstanding employees’ entitlements as at the commencement of the CR.
After the consultation conclusions in 2010, the Government recommended that the phased payment schedule provides that outstanding wages up to HK$36,000 (per employee) be paid within the first month after the commencement of the provisional supervision. Wages in lieu of notice and severance payments owed to former employees whose employment contracts were terminated before the commencement of provisional supervision should be paid up to the relevant caps of the Protection of Wages on Insolvency Fund. If the company does not meet its obligations pursuant to the phased payment schedule, the employees concerned will no longer be bound by the moratorium and may petition the court to wind up the company.
An important aspect of the reform is the introduction of insolvent trading. This is intended to be applicable to companies in general and not only in the context of the CR, and will bring Hong Kong in line with other common law jurisdictions. Insolvent trading occurs when a company incurs a debt at a time when it is unable to pay its debts as they fall due. This has significant implications for the corporate governance of companies and provides a disincentive for directors of financially distressed companies to continue to trade while a company is insolvent.
The Government’s latest proposal has confirmed that the liquidator will be empowered to seek a court declaration that the director is civilly liable for insolvent trading and an order for the director to pay compensation to the company. The proposal states that a director may be held liable if (i) the company incurs a debt; (ii) the company is insolvent at that time or becomes insolvent by incurring that debt; and (iii) the director concerned knew or ought to have known about the insolvency of the company. It will be a statutory defence if (i) the director has taken all reasonable steps to prevent the company from incurring the debt, or (ii) the incurring of the debt is part and parcel of the steps to initiate the CR process.
What are the relevant corporate insolvency and winding up developments?
The last major review of Hong Kong’s insolvency legislation was conducted almost 30 years ago. The present legislative review aims to improve Hong Kong’s corporate insolvency and winding up provisions, facilitate more
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efficient administration of the winding-up process, and increase protection of creditors through streamlining and rationalising the company winding-up procedures having regard to international experience.
Amongst other things, the consultation document proposes to improve the quality of notifications provided at the outset of a liquidation and clarify the procedures applicable at the commencement of the winding-up. Improvements are also proposed to clarify the powers and liabilities of provisional liquidators and liquidators. To provide greater protection for corporate creditors, the proposals extend the avoidance provisions by including transactions at an undervalue and expanding the definition of “associate”. After receiving the submissions of various stakeholders in 2013, the Government made some modifications and published its consultation conclusions. Some of the key features appear below:
Revisions to avoidance provisions
There is currently no avoidance provision for transactions at an undervalue for companies, which is available only in bankruptcy cases. For better protection of creditors, the modifications include new provisions to empower the court to make orders (for example, to invalidate the transaction) in relation to a company which has entered into a transaction at an undervalue before its winding-up. The “relevant time” for a transaction at an undervalue to be caught would be any time within the period of five years ending with the commencement of the winding-up, but only if at that time the company was unable to pay its debts or became unable to pay its debts as a result of the transaction.
The current regime is also lacking in a self-contained provision on unfair preferences. The Government’s latest conclusions have been modified to expand the definition of “associate” for the proposed provisions on voidable transactions to the effect that a person is to be considered as having control of a company if he is entitled to exercise, or control the exercise of, more than 30% of the voting power (instead of one third or more as originally proposed) at any general meeting of the company or of another company which has control of it.
Liability of past directors and members for redemption or buy-back of shares out of capital
Past directors and members will be potentially liable for improperly returning share capital to members prior to the insolvent winding-up of a company. This can occur where a company has redeemed or bought back its own shares by payment out of its capital and the company was wound up insolvent within one year of the redemption or buy-back. The proposal provides that the recipient (of the payment of the redeemed or bought-back shares) and the directors (who made the relevant solvency statement without having reasonable grounds for the opinion expressed in the statement) should be jointly and severally liable to contribute to the assets of
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the company an amount not exceeding the payment in respect of the shares.
Clarifying the nature of “provisional liquidators” in a court winding up
The proposal that all “provisional liquidators” who take office upon and after the making of a winding-up order under the different sub-sections of section 194 of C(WUMP)O will be designated as “liquidators” and subject to provisions which apply to liquidators (such as those relating to powers, duties and remuneration) has been clarified. Concern arose that creditors’ interests might be undermined if a provisional liquidator who has not yet received the approval of the creditors and contributories for his appointment, is given full and unrestricted powers to carry out all the duties in the same way as liquidators. Specific provisions will be introduced to clarify the powers, duties and remuneration of the different types of provisional liquidators appointed under section 194. Amongst other things, the provisional liquidator’s powers will be restricted to taking into his custody or control property which the company is or appears to be entitled; and to sell or dispose of certain perishable goods or assets.
Improving efficiency and enhancing creditor protection in a creditors’ voluntary winding up
The Government’s proposals in relation to creditors’ meetings (modelled on the relevant legislation in the UK) have received support from majority of the respondents. This will ensure that sufficient notice is given to creditors to prepare for the first creditors’ meeting while reducing the time for a company to commence a creditors’ voluntary winding up. The Government proposes to:
replace the existing requirement of holding the first creditors’ meeting on the same or the following day of the members’ meeting for commencing a creditors’ voluntary winding-up case with the requirement of holding the first creditors’ meeting on a day not later than the fourteenth day after the day on which there is to be held the members’ meeting;
prescribe a minimum notice period of seven days for calling the aforesaid first creditors’ meeting;
limit the powers of the liquidator appointed by the members during the period before the holding of the first creditors’ meeting; and
provide that the powers of the directors would be restricted before the appointment of a liquidator.
Priority of preferential payments in a winding-up
In response to submissions that employees should be accorded a higher priority than secured creditors and liquidators, the
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Government considered that under the existing legislation, employees are already accorded the highest priority amongst all unsecured creditors in relation to certain debts ahead of other preferential debts such as deposits in a bank winding-up and Government’s statutory debts.
Actions to consider
Directors risk exposure when incurring credit at a time when the company is facing financial difficulties. They will need to ensure they adopt clear processes and governance to ensure the company does not incur a debt while insolvent.
The latest developments are significant for Hong Kong as a leading business hub and financial centre. The proposed legislative reforms and corporate rescue procedures bring the regime closer to international standards. Creditors and business investors can take greater comfort with the proposals to increase their rights and improve protection against depletion of company assets whilst directors will need to be more vigilant.
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