2015 Insolvency and Corporate Reorganisation Report: Hong Kong

Author: | Published: 1 Jun 2015
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1.1 What reorganisation and bankruptcy processes are available for financially troubled debtors?

Only one formal collective insolvency procedure exists under the Companies (Winding Up and Miscellaneous Provisions) Ordinance (the Act): liquidation.

Liquidation is a terminal procedure typically resulting in the piecemeal sale of assets (rather than the business), distribution of the proceeds to creditors and dissolution of the company. It may be compulsory or voluntary. Voluntary liquidations can be either a members' voluntary liquidation (MVL) or a creditors' voluntary liquidation (CVL). In any form of liquidation, a court supervised liquidator is appointed and the directors lose control.

There is no formal rescue procedure available, although there are proposals to introduce legislation in the consultation and drafting phrase. In the absence of a formal rescue procedure, the court appointment of a provisional liquidator, which displaces the company's directors and brings about a statutory stay on proceedings, has been used in the past as a means to facilitate a corporate rescue. It is often coupled with a scheme of arrangement. However this is a somewhat limited rescue device as the court has made it clear that a provisional liquidator can only be appointed where the company's assets are in jeopardy.

A compulsory liquidation is commenced by filing a winding-up petition at court. A creditor generally presents the petition. A petition is usually presented on the grounds of insolvency (which is tested on a current or near future inability to pay debts as they fall due or, on a longer-term basis, where the company's liabilities exceed its assets).

MVLs and (subject to one limited exception) CVLs are commenced by shareholder resolution. MVLs are a solvent liquidation process - all creditors are to be paid in full and any surplus distributed to shareholders. CVLs are (generally) insolvent liquidations.

The Banking Ordinance and Insurance Ordinance contain special provisions in respect of authorised institutions and insurers respectively which supplement, modify or disapply general corporate insolvency laws.

A statutory scheme of arrangement may also be used to achieve a corporate rescue. The scheme is a creature of general company law rather than insolvency law (a state of insolvency is unnecessary to support a filing for a scheme), but it provides an important tool where there are minority dissenting creditors.

In the absence of a scheme, any restructuring will need to be achieved consensually, whether using the contractual powers under an intercreditor agreement to implement the solution or otherwise.

Receivership is a secured creditor's enforcement remedy; it is not a collective insolvency procedure. A receiver is typically appointed out of court by the holder of the security under the contractual powers contained in the relevant security agreement. The receiver's principal role is typically to sell the secured asset and account to the secured creditor for the proceeds.

1.2 Is a stay on creditor enforcement action available?

When a court makes a winding-up order or a provisional liquidator is appointed over the company, section 186 of the Act provides that no action or proceeding may be commenced or continued against the company, except by leave of the court. Leave will generally be refused if the issues in the action or proceeding can be dealt with more conveniently and with less expense and delay in the winding-up proceedings.

However, section 186 will not prevent a secured creditor enforcing its security through any out of court process. For example, by appointing a receiver under contractual powers within the relevant security agreement. Where a secured creditor's security enforcement involves an action or proceeding, and is caught within section 186 of the Act, leave will usually be given.

No automatic procedural stay applies: (i) in the period between the presentation of a winding-up petition and the court making a winding-up order (except where a provisional liquidator has been appointed). The company, any creditor or contributory can however apply to the court to stay or restrain pending proceedings (but not the commencement of new proceedings) against the company; or (ii) in a voluntary winding up. However a liquidator, contributory or creditor may apply to the court for a stay on any action or proceeding.

In either case, a stay will not usually be granted where a secured creditor is seeking to enforce its security.

While a scheme of arrangement contains no moratorium preventing creditor action, the appointment of provisional liquidators allows the company to benefit from the automatic procedural stay on proceedings described above. The court may, in any event, be prepared to grant a temporary stay of creditor action where a scheme is being implemented and appears to have a reasonable chance of success with majority creditor support.

In an informal restructuring where provisional liquidators have not been appointed, there are no procedures applicable in respect of stays. However, for large financial restructurings, financial creditors tend to refrain voluntarily from bringing disruptive action or may agree to a temporary stay contractually to assist stability during the negotiation of a consensual deal.

The proposed provisional supervision rescue procedure is expected to include a moratorium on creditor action for a finite period during which the company and its creditors would need to negotiate and implement a proposal for restructuring.

1.3 What are the key features of a reorganisation plan and how is it approved?

A scheme of arrangement may be proposed by the company or any of its creditors with the company's consent.

For the most part, the terms of a scheme are not restricted by legislation and offer a lot of flexibility. For example, debt write-offs, debt for equity conversions and asset disposals are all possible. Further, a scheme may bind secured creditors without their individual consent.

In a scheme, creditors are divided into classes. For each class, approval of the scheme requires a majority in number representing 75% in value of the creditors in that class present and voting at the relevant creditors' meeting, either in person or by proxy, to vote in favour. The scheme will also need to be sanctioned by the court and a copy delivered to the registrar of companies before it becomes binding. The rules regarding identification of classes have evolved in the course of recent English court decisions and are likely to be highly persuasive in Hong Kong.

1.4 Can a creditor or a class of creditor be 'crammed-down'?

A scheme of arrangement can bind dissenting or non-voting unsecured and secured creditors. While creditors within a class may be crammed-down in a scheme, it is not possible to cram-down an entire class, since each class must vote in favour of the scheme for the court to sanction it and for it to take effect against that class.

If the relevant creditors' meetings vote in favour of the scheme, the court will then need to decide whether to sanction it. In particular, the court needs to be satisfied that the relevant statutory requirements have been complied with, the classes of creditors were properly identified, each class was fairly represented by those attending the creditors' meeting, the statutory majority was acting bona fide in the interests of the class and the approval of the scheme is reasonable.

1.5 Is there a process for facilitating the sale of a distressed debtor's assets or business?

There is no specific legislation permitting pre-packaged sales. Pre-packaged sales by provisional liquidators have only been allowed in exceptional circumstances and there is no way in which the scheme timetable can be truncated.

While there is no legislation which expressly permits credit-bidding or stalking-horse bids, they are generally permissible. The liquidators, provisional liquidators, receivers or directors as applicable have discretion to determine the way in which a sales process is conducted.

In a liquidation, a liquidator may sell, by auction, tender or private treaty, the whole or any part of the business or assets of the company without court approval and without sanction from the creditors' committee of inspection. However the liquidator may seek court approval to ensure that their actions in dealing with the assets are not vulnerable to a subsequent claim that the transaction was invalid.

A provisional liquidator will need to apply to the court for permission to sell the company's asset, if such power is not included in the appointing order.

A receiver appointed out of court by the holder of the security under the contractual powers contained in the relevant security agreement will derive his powers from that security agreement, and will typically include the power to sell the secured asset without court approval.

There is no legislation which permits liquidators, provisional liquidators or receivers to sell the company's assets free and clear of existing claims.

1.6 What are the duties of directors of a company in financial difficulty?

Directors of a solvent company have a duty to act in the interests of the company and its shareholders. When the company nears insolvency, creditors' interests intrude on this duty; the duties of the directors shift from advancing the interests of the shareholders as a whole towards protecting the interests of creditors as a class.

In addition, section 275(1) of the Act provides that the court has the power on the application of the liquidator or any creditor or contributory of the company to declare that any persons who were knowingly parties to carrying on the company's business with an intent to defraud creditors will be personally responsible for all or any part of the company's debts. Such civil liability only arises where the company has entered liquidation. There is a similar criminal offence under section 275(3) of the Act that applies whether or not the company has been, or is in the course of being, wound up.

Successful actions under section 275 and their equivalents elsewhere are rare, due to the need to establish actual dishonesty or fraud.

This issue has been addressed in respect of directors in England following the introduction of a wrongful trading provision under section 214 of the Insolvency Act 1986 that imposes personal liability on directors without the need to prove fraud. Directors (including shadow directors) can be personally liable to contribute to an insolvent company's assets if, before the commencement of the winding up, the director knew or ought to have concluded that there was no reasonable prospect that it would avoid going into insolvent liquidation, and, once aware (or deemed aware), the director failed to take every step with a view to minimising the potential loss to the company's creditors which they ought to have taken. The government is looking at introducing similar legislation.

1.7 What priority claims are there and is protection available for post-petition credit?

(a) Liquidation

Where a company has entered liquidation, a secured creditor may elect to enforce their security, rather than leaving the liquidator to realise the secured asset. Regardless, secured creditors' claims, in respect of the proceeds of realisation of assets secured in their favour, rank ahead of all other claims, save for: (i) costs of preserving and realising such assets; and (ii) preferential claims, when the proceeds of realisation of assets are subject to floating security (if the free assets are insufficient to pay those preferential claims). Any balance owed to secured creditors are unsecured claims and will be subject to the priority claims described below.

Preferential claims primarily comprise certain amounts owed to employees and the government. There are additional categories of preferential claims in the winding up of banks and insurance companies.

For proceeds of realisation of unsecured assets, the payment order in a liquidation is as follows: (1) the liquidation's costs and expenses; (2) preferential claims; and (3) unsecured claims (which rank pari passu).

All sums owed as a result of mutual dealings between each creditor and the company must be set-off; the creditor pays to or claims from the company only the net sum. Such set-off is wide-ranging, automatic, self-executing as at the commencement of the liquidation and cannot be excluded by contract.

For post-petition credit, a liquidator can raise money on the security of the company's assets without court approval and without sanction from the committee of inspection. A provisional liquidator can raise funds on the security of the company's assets if granted this power by the court. Such funds rank as an expense of the liquidation (unless raised by the provisional liquidator and his appointment is not followed by a liquidation; such funds would need to be repaid as a condition of his discharge from liability). Within the category of expense claims, such new funding will be a super-priority expense claim, payable in priority to the liquidator's remuneration. Unlike the US Bankruptcy Code, there is no legislation permitting the security granted in respect of such new money to have priority over existing security; any such priority would require the agreement of the relevant secured creditors.

(b) Receivership

Whether or not the company is in liquidation, where a receiver is appointed over assets secured by a floating charge, the proceeds of realisation of those assets will be used to satisfy the claims of the secured creditor in whose favour that asset is secured, which will rank ahead of all other claims, save for those described in 1.7(a) (i) and (ii). Any surplus is paid to the company.

1.8 Is there a different regime for banks and other financial institutions?

The Banking Ordinance gives the Hong Kong Monetary Authority (HKMA) the authority to exercise certain powers in relation to an authorised institution (AI) that is likely to be unable to meet its obligations, is insolvent or is about to suspend payments.

These powers include, following consultation with the Financial Secretary, the right to: (i) impose restrictions on such AI; (ii) appoint an adviser from whom the relevant AI will be required to seek advice on management of its affairs, business and property; and (iii) appoint a manager who will manage the affairs, business and property of the AI. Where the courts have granted an order for the winding-up of an AI, the right to appoint an adviser or manager cannot be exercised by the HKMA.

There have been consultations on establishing an effective resolution regime for financial institutions (FIs), including financial market infrastructures (FMIs). The proposed resolution regime seeks to bring Hong Kong in line with the Financial Stability Board's Key Attributes of Effective Resolution Regimes for Financial Institutions, which put in place reforms so that future banking failures can be safely managed without recourse to public funds. The first consultation was released on 7 January 2014 by HKMA, the Securities and Futures Commission (SFC) and the Insurance Authority (IA). The second consultation was launched on 21 January 2015 and one more consultation is expected this year with the aim to introduce legislative proposals into the Legislative Council by the year-end.

The scope of the resolution regime should cover: (i) all AIs; (ii) licensed corporations designated as non-bank non-insurer global systemically important FIs; (iii) licensed corporations that are subsidiaries or branches of groups which are identified as being or containing global systemically important FIs; (iv) FMIs designated under the Clearing and Settlement Systems Ordinance or recognised as clearing houses under the Securities and Futures Ordinance; and (v) certain insurers.

A single resolution framework would be established for FIs in different sectors, with the HKMA, SFC and IA designated as the resolution authority for FIs operating under their respective purviews.


2.1 Can bankruptcy or reorganisation proceedings be opened in respect of a foreign debtor?

The court has jurisdiction to wind up a foreign debtor as an unregistered company, based principally on a sufficient connection test.

Exercise of the winding-up jurisdiction remains discretionary. The same approach applies in respect of the court's jurisdiction to appoint provisional liquidators to unregistered companies.

For a foreign debtor, the most common ground on which a petition is usually presented is insolvency.

There is no ability for an unregistered company to be wound up voluntarily under the Act.

The court has jurisdiction to sanction a scheme for any company liable to be wound up under the Act. While the Act specifies three grounds, including insolvency, on which a foreign company may be wound up, it seems unlikely based on the English position and obiter comments from Judge Lam in Re LDK Solar [2015] that the court would require these to be met. Nevertheless, it appears that the court will generally only exercise its discretion to take jurisdiction where there is a sufficient connection. While the court accepted that the sufficient connection test was met on the basis of a Hong Kong governing law provision in the relevant agreement, it remains to be seen whether it will follow the English court's approach to the sufficient connection test, which has gradually weakened over time.

2.2 Can recognition and assistance be given to foreign bankruptcy or reorganisation proceedings?

There are no statutory provisions for the courts to provide assistance on cross-border insolvencies and Hong Kong is not party to the Uncitral Model Law on Cross-Border Insolvency.

The courts have an inherent power to recognise and grant assistance to foreign insolvency proceedings under the common law principle of modified universalism. In Joint Official Liquidators of A Co and B (2014), it was held that the courts have the power under common law to recognise and grant assistance to foreign insolvency proceedings, but only if a number of conditions are met, including that: (i) the law of the foreign insolvency proceedings is substantially similar to Hong Kong insolvency law; and (ii) the order sought is available under Hong Kong insolvency law. However, recent judicial authority has shown the common law power of assistance to be limited and any assistance provided must be available in the jurisdiction of the foreign insolvency proceedings. In a recent case, the court declined to act on a letter of request from the English court for assistance available under English law to be provided to English office holders where such assistance would not be available to office holders under Hong Kong law.

Hong Kong has entered into reciprocal enforcement treaties with a number of foreign jurisdictions and applications can be made to the court to register certain foreign judgments under the Foreign Judgments (Reciprocal Enforcement) Ordinance. Hong Kong has also entered into an arrangement with China regarding recognition and enforcement of judgments in civil and commercial matters.


3.1 What other major stakeholders (such as governmental or regulatory institutions) could have a material impact on the outcome of the reorganisation?

Employees, the government or regulatory bodies may have an impact on the outcome of a restructuring depending on the particular situation. For example, on a transfer of a business, the transferee may in certain circumstances become liable for employment claims of the transferor under the Transfer of Businesses (Protection of Creditors) Ordinance (TOBO).

TOBO is a piece of legislation that is perhaps unique to Hong Kong; its effect is, subject to certain exceptions and requirements, to make the transferee of a business liable for the debts of (including employment claims against) the transferor. TOBO will not apply where the business is sold by a court-appointed liquidator or by a receiver who is selling under a charge which has been registered for at least one year. However, no such exemptions apply for the sale of a business by a liquidator in a CVL or MVL.

Restructuring a listed company dependent on the listed status being retained will often depend on persuading the SFC that the company should be allowed to resume trading on the restructuring's completion.

There could also be sector-specific or political issues to consider.


4.1 Outline any bankruptcy and reorganisation trends specific to your jurisdiction.

The Law Reform Commission first recommended that corporate rescue laws were needed back in 1996. The latest attempt to translate that recommendation into reality seems to be gathering momentum. In May 2014, the Financial Services and Treasury Bureau and the official receiver's office jointly released a framework of proposals and quickly set up meetings with market participants to discuss outstanding issues. In its 2015 policy address, the Legislative Council Panel on Financial Affairs said that it hopes to introduce an amendment bill in this legislative session.

Under the proposals, companies in financial difficulty will be able to appoint provisional supervisors out of court. A mandatory stay on proceedings and other legal processes will immediately result, providing a window to facilitate the preparation of a voluntary arrangement (VA). The process is conditional on written consent from any major secured creditor. Employee rights are protected by the requirement that all pre-appointment employee claims should be paid in instalments within set periods after the process begins and a VA is approved.

Another impending legislative addition is the introduction of an insolvent trading law under which a director or shadow director may be ordered to pay compensation to a company in liquidation where the company incurred debt while insolvent (or which caused insolvency) and the director knew or ought reasonably to have known of the insolvent state or potential insolvent state. A defence will be that the director took all reasonable steps to prevent the company from incurring the relevant debt.

This law is intended to encourage directors to act on insolvency earlier and take steps to protect creditors' interests. Both the provisional supervision and insolvent trading laws will be welcome tools with which to rescue distressed companies where possible and hold directors accountable. This aims to incentivise better behaviour in a market where companies have often been allowed to trade long past the point at which remedial action should have been taken.

About the author

David Kidd
Partner, Linklaters

Hong Kong
T: +852 2901 5558
E: david.kidd@linklaters.com
W: www.linklaters.com

David Kidd is a partner at Linklaters and leads the Asia-Pacific restructuring and insolvency practice. He has been recognised as one of the leading restructuring and insolvency practitioners in the region for the past 17 years. His clients have included private equity investors, creditors and debtors, banks and funds, directors and shareholders, receivers and liquidators.

Kidd has acted on some of the world's largest restructurings and insolvencies including GDE, Evergrande and Lehman in Asia and Dubai World/Nakheel in the Middle East. He has worked in all the significant Asian jurisdictions including China, Korea, Thailand, Philippines, Indonesia, Vietnam and India. His more recent restructuring work includes acting for the bondholders and provisional liquidators of China Sun, the payment-in-kind noteholders of Asia Aluminium, the trustee and receivers of the Lehman minibonds, Suzlon on the restructuring of its foreign currency convertible bonds (the largest Indian bond restructuring to date) and Shandong Iron and Steel Group (China) on the protection of its $1.5 billion investment in a Sierra Leone iron ore project.


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