New legislation came into force in Hong Kong in eary February which gives the court power to set aside transactions performed at an undervalue. This briefing explains the scope of this new law and the key considerations for directors when approving corporate transactions in order to avoid the risk of incurring personal liability. It is available in English and Chinese.

Earlier this month new legislation came into force in Hong Kong which gives the court power to set aside transactions performed at an undervalue. This briefing explains the scope of this new law and the key considerations for directors when approving corporate transactions in order to avoid the risk of incurring personal liability.

The Companies (Winding Up and Miscellaneous Provisions) (Amendment) Ordinance 2016 (‘Amendment Ordinance’) came into force on 13 February 2017. The Amendment Ordinance introduces a new category of vulnerable transaction under HK corporate insolvency law, namely transaction at an undervalue, which the court may set aside if it was entered into by a company within five years of its winding-up.

Scope of transaction at an undervalue

The Amendment Ordinance 2016 seeks to improve and modernise Hong Kong’s corporate liquidation regime by providing measures to increase protection for creditors. One aspect of this is the introduction of the “transaction at an undervalue” regime, which is modelled on the English regime.

Broadly speaking, the Hong Kong courts may set aside a transaction at an undervalue entered into by a company within five years of the commencement of its winding-up, provided the company was insolvent at the time of the transaction or became insolvent as a consequence of the transaction.

Transactions at an undervalue include gifts or transactions where the company receives no consideration or receives consideration of a value (in money’s or money’s worth) which is significantly less than the consideration provided by the company.

Where the court sets aside a transaction at an undervalue, the court may make such order as it thinks fit for restoring the position to what it would have been if the company had not entered into that transaction. This can include requiring any person (including the company’s directors) holding the property transferred (or the traceable proceeds) to transfer the property or proceeds back to the company.

However, the court may not require a third-party bona fide purchaser of the property to re-transfer the property to the company.

In terms of defences, there is an ‘ordinary course of business’ defence. This defences provides that if the company entered into the transaction in good faith for the purpose of carrying on its business, and there were reasonable grounds for believing that the transaction would benefit the company, then the Court will not set aside the transaction.

Application to foreign companies

It is worth noting that this new regime can apply to both Hong Kong companies and foreign companies provided they can be subject to liquidation in Hong Kong.

The Hong Kong courts have the power to wind up foreign companies, however, subject to limited exceptions, the courts will do so only if the following criteria are met:

1. there is a substantial connection between the company and Hong Kong; 2. there is a reasonable possibility of the winding-up benefiting those applying for it;

3. there is a person in Hong Kong with sufficient economic interest in the liquidation.

Where a foreign company is wound up in Hong Kong, the whole of the Hong Kong insolvency regime applies to it. Therefore directors of foreign companies with a substantial connection to Hong Kong need to have regard to the new rules around transaction at an undervalue and the recommendations made below.

Directors’ personal liability in relation to transactions at an undervalue

A director is under a duty to act bona fide in the best interests of the company. When the company is in financial distress, the duty requires the director to take into account the interests of creditors. The duty extends to not prejudicing the interests of creditors and preserving the assets of the company so that those assets may be dealt with in accordance with ordinary principles of insolvency law.

Where directors of a distressed company authorise a transaction at an undervalue, they might be acting in breach of their duty to protect creditors’ interests and might therefore be made personally liable to pay compensation for the loss caused.

In order to mitigate the risk of personal liability, wherever possible, the directors when approving corporate transactions (including making distributions to shareholders) ought to be satisfied that:

1. the company is not insolvent (on a balance-sheet or cashflow basis) at the time of the transaction and will not become insolvent as a result of the transaction; and 2. from the company’s perspective, the incoming consideration is not significantly less than the outgoing consideration.

The defence of ‘ordinary course of business’ should be relied on only as a last resort.

Therefore, in practice, a lot will depend on the valuation of company’s assets, liabilities and the transactions involved. The directors must ensure that they seek the appropriate advice on valuation and have reasonable grounds for adopting it.

Summary

1. Hong Kong insolvency law has to some extent caught up with the insolvency laws of other jurisdictions; and 2. from a company director’s perspective, there is a sharpened focus on creditor protection and the need for accurate valuation when reviewing and approving corporate transactions.