Corporate Insolvency & Restructuring Report 2020: Covid-19 Special Focus: Hong Kong SAR
James Warboys and Suzi Duncan, Linklaters
Hong Kong SAR does not have a statutory corporate rescue regime. Many restructurings take the form of workouts, implemented by consent or by way of a Hong Kong SAR law scheme of arrangement.
The court appointment of a provisional liquidator, which displaces the company's directors and includes a statutory stay on proceedings, may be used to facilitate a corporate rescue. However, this is a somewhat limited rescue device as a provisional liquidator can only be appointed where the company's assets are in jeopardy. It is often coupled with a scheme of arrangement, which contains no moratorium preventing creditor action.
There are no statutory provisions for the court to provide assistance on cross-border insolvencies and Hong Kong is not party to the UNCITRAL Model Law on Cross-Border Insolvency. The court has the power to recognise and grant assistance to foreign insolvency proceedings under the common law principle of modified universalism and generally takes pragmatic approach in this regard.
The Financial Services and Treasury Bureau has been preparing an amendment bill to introduce a new statutory corporate rescue procedure. It is expected to include provision for a "provisional supervision" regime and an "insolvent trading" law, similar to the wrongful trading regimes of other common law jurisdictions. This has been under consideration for a long period of time and it is currently unclear when the new law will be implemented.
There is only one formal collective insolvency procedure under the Companies Ordinance: liquidation.
Liquidation 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.
A compulsory liquidation is commenced by filing a winding-up petition at court and is usually presented on the grounds of insolvency.
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.
A scheme of arrangement may also be used to achieve a corporate rescue. In the absence of a scheme, any restructuring will need to be implemented consensually, using the contractual powers under finance documentation to implement the solution or otherwise.
Receivership is a secured creditor's enforcement remedy and is not a collective insolvency procedure.
Generally, a group of companies does not receive special treatment. Hong Kong SAR does not have legislation under which a pooling order may be made – companies need to implement restructuring and insolvency procedures on an entity-by-entity basis.
Generally, the duties of directors to act in the best interests of shareholders transition to a duty to act in the best interests of creditors as a whole when a company is insolvent or in the "zone of insolvency".
The court has power to declare that any persons who were knowingly parties to carrying on the company's business with an intent to defraud creditors are personally responsible for all or any part of the company's debts. Such liability only arises where the company has entered liquidation. Successful actions in this regard are rare, owing to the need to establish actual dishonesty or fraud.
In December 2019, the court extended recognition and assistance to an insolvency administrator from Mainland China for the first time
There are currently no wrongful or insolvent trading provisions similar to those in other common law jurisdictions.
Where a company enters into an insolvent liquidation within one year from the date on which payment out of capital was made to a shareholder or a former shareholder in connection with a redemption or buy-back of the company's shares, any director who made the required solvency statement will be jointly and severally liable with the recipient of the funds to contribute assets to the company up to an amount not exceeding the relevant payment out of capital.
Transactions at an undervalue and unfair preferences can be set aside in insolvent liquidation (see below).
There have been no amendments to the law in this regard as a result of the Covid-19 pandemic.
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) or (ii) in a voluntary winding up.
When a court makes a winding-up order or a provisional liquidator is appointed over the company, 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, this does not prevent a secured creditor enforcing its security through any out of court process, such as the appointment of a receiver. Where a secured creditor's security enforcement involves an action or proceeding, the court's leave must be sought and will usually be given.
The stay in Hong Kong SAR does not prevent counterparties from terminating contracts with the company.
Priority, dissenters and asset sales
Secured creditors' claims, in respect of the proceeds of realisation of assets secured in their favour, rank ahead of all other claims save for: costs of preserving and realising such assets; and 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). Preferential claims primarily comprise certain amounts owed to employees and domestic tax liabilities.
For proceeds of realisation of unsecured assets, the payment order in a liquidation or receivership is broadly as follows:
the receiver or liquidator's costs and expenses;
preferential claims; and
unsecured claims (which rank pari passu).
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 creditors' committee. 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 with super-priority (i.e. payable in priority to the liquidator's remuneration). There is no legislation permitting 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.
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 any other 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.
A scheme of arrangement can, in theory, impose a solution on both creditors and shareholders without their consent, subject to the requisite numbers of each class voting in favour of the scheme.
There is no specific legislation expressly permitting pre-packaged sales, though we note that (i) pre-packaged sales by receivers are possible (though somewhat uncommon) and (ii) pre-packaged sales by provisional liquidators have been allowed in exceptional circumstances.
There is no legislation which expressly permits credit-bidding or stalking-horse bids, but they are generally permissible.
The introduction of the National Security Law in June 2020 has caused some uncertainty as regards the future of business and finance
A liquidator may sell the whole or any part of the business or assets of the company without court approval and without sanction from the creditors' committee. However, a provisional liquidator must apply to the court for permission to sell the company's assets, if such power is not included in the appointing order.
A receiver appointed by the holder of the security will derive his powers from that security agreement, which 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.
It is worth noting that there are some sector-specific regimes. The Banking Ordinance and Insurance Ordinance contain special provisions in respect of authorised institutions and insurers respectively which supplement, modify or dis-apply general corporate insolvency laws. The Financial Institutions (Resolution) Ordinance provides a framework for the orderly resolution of financial institutions. The Insurance Authority, the Monetary Authority and the Securities and Futures Commission act as resolution authorities for the financial institutions under their respective purviews.
Employees, government or regulatory bodies (including, for example, the Hong Kong Stock Exchange in the case of listed companies) may have an impact on the outcome of a restructuring depending on the situation and what is proposed.
A transferee may, in certain circumstances, become liable for employment claims of the transferor under the Transfer of Businesses (Protection of Creditors) Ordinance.
Challenging debtor's transactions
The debtor's transaction s can be challenged on insolvency on the following grounds.
Transaction at an undervalue: a transaction at an undervalue entered into by the debtor within five years of the commencement of its winding up.
Unfair preference: a payment to a creditor which puts the recipient in a better position than it would otherwise be if the debtor went into insolvent liquidation and the court were satisfied that the debtor was "influenced by a desire" to create that preference. The clawback period is two years before the commencement of the winding up in the case of a person connected with the debtor and six months in all other cases.
Floating charge: a floating charge created within 12 months of commencement of the debtor's winding up will be invalid, except where the debtor has received valuable consideration in exchange for its creation. The clawback period is two years for floating charges created in favour of a person connected with the debtor and 12 months in all other cases.
The court will not make any order in respect of any such antecedent transaction (other than where a floating charge has been created in favour of a connected person) unless the debtor was (or became, as a result or the relevant transaction) unable to pay its debts.
The court can also set aside (i) extortionate credit transaction (i.e. transactions requiring grossly exorbitant payments to be made in respect of the provision of credit or otherwise grossly contravening ordinary principles of fair dealing); and (ii) fraudulent conveyances (i.e. dispositions of property with the intent to defraud creditors).
The court has discretionary jurisdiction to wind up a foreign debtor as an unregistered company if it is unable to pay its debts or if it is just and equitable to do so. As a matter of common law, the court must also be satisfied that: (i) there is a sufficient connection with Hong Kong SAR; (ii) there is a reasonable possibility that the winding up would benefit the applicants; and (iii) the court will be able to exercise jurisdiction over one or more persons in the distribution of assets.
The court has jurisdiction to sanction a scheme concerning a foreign company where there is a "sufficient connection" with Hong Kong SAR. A connection which is insufficient to satisfy the sufficient connection test for winding up may be sufficient connection to establish jurisdiction to sanction a scheme. A common connection is that the debt is governed by Hong Kong law.
There is no legislative power for the court to recognise and assist foreign insolvencies or restructurings. However, the court will generally recognise and assist foreign insolvency practitioners if: (i) the laws of the foreign insolvency proceedings are substantially similar to Hong Kong insolvency law; and (ii) the order sought is available under both the laws of the jurisdiction of appointment and Hong Kong.
There has long been uncertainty as to which countries' systems might satisfy the "substantially similar" test but in December 2019, the court extended recognition and assistance to an insolvency administrator from Mainland China for the first time.
Covid-19 and beyond
Levels of restructurings and insolvencies in Hong Kong SAR have steadily increased over the last few months following a period of political unrest and intervention from the Mainland government. However, levels of insolvencies remain lower than expected as at summer 2020. This is a result, in part, of government stimulus packages and regulatory and political pressure on financial institutions to grant accommodation / forbearance to defaulting borrowers and issuers. It is expected that a material increase in restructurings and insolvencies will occur towards the end of 2020.
The Hong Kong SAR government has provided various financial measures to help individuals and businesses cope, including government-guaranteed low-interest rate loans to SMEs, an employment support scheme which provides subsidies to enable continued payment of wages and subsidies for specific business sectors. Further, in April 2020, the Hong Kong Monetary Authority instructed all banks in Hong Kong to grant six-month loan repayment holidays to SMEs. The majority of measures were initially implemented for a limited period of six months but it is expected that a number will continue as necessary. To date, there has been no change made to insolvency laws similar to those implemented in other common law jurisdictions.
Elsewhere, an amendment bill to introduce a new statutory corporate rescue procedure was expected to be introduced into the Legislative Council in the 2020/21 session. However, the government has been considering proposals for a statutory corporate procedure since 1994 and, given the Covid-19 situation, further delays are expected.
The introduction of the National Security Law in June 2020 has caused some uncertainty as regards the future of business and finance in Hong Kong SAR. Businesses are affected by the measures as well as individuals and growing political pressures and concerns against the backdrop of the ongoing US-China trade war mean that there is potential for an uptick in restructuring and insolvency situations in Hong Kong SAR.
T: +852 2901 5260
James Warboys is restructuring & insolvency (R&I) and special situations partner at Linklaters. He represents companies, financial stakeholders, advisory firms and insolvency practitioners on transactions across the full spectrum of R&I in multiple jurisdictions and sectors, including distressed M&A, debt-for-equity swaps, liability management exercises, bond restructuring, alternative credit and other new money financings and distressed debt investments.
Managing associate, Linklaters
T: +852 2901 5167
Suzi Duncan is a managing associate in Linklaters' Hong Kong office advising a range of creditors, companies, other stakeholders and insolvency practitioners on all aspects of restructuring and insolvency transactions across multiple jurisdictions and sectors. She has advised on complex restructurings in Europe (from both London and Paris) and Asia (from Hong Kong) and also has experience with distressed debt trading and special situations in the European market.