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Hong Kong – Court Clarifies The Legal Principles In Respect Of Winding Up An Unregistered Overseas Company.
1 May, 2014 

Legal News & Analysis – Asia Pacific – Hong Kong – Dispute Resolution

 

The exercise of the court’s discretionary jurisdiction to wind up an unregistered overseas company has again come under judicial spotlight in the recent case of Re China Medical Technologies Inc. (HCCW 435/2012). In this case, the Hong Kong High Court further clarified the legal principles it will follow when determining whether to exercise its discretionary jurisdiction to wind up an unregistered overseas company, which normally would be subject to the insolvency regime of the country in which it was incorporated.  

 

China Medical Technologies Inc. (the “Company”), incorporated in the Cayman Islands, was the ultimate holding company of a group of companies which included some indirectly wholly-owned Hong Kong subsidiaries (which were subsidiaries of companies incorporated in the British Virgin Islands). The Company did not carry on business in Hong Kong or the Cayman Islands.  Its principal business, carried out through its operating subsidiaries, was to develop, manufacture and market advanced medical equipment in mainland China. The Company raised funds in the USA by way of share and unsecured senior convertible notes offerings.

 

In 2011, the Company failed to make interest payments on its outstanding notes, which constituted events of default. The trustee filed a petition to wind up the Company in the Cayman Islands and provisional liquidators were appointed. Action was also taken to liquidate the Company in New York. The Company then sought a winding up order in Hong Kong, in order to enable the provisional liquidators to use the tools provided by the Hong Kong insolvency regime (in particular section 221 of the then Companies Ordinance (Cap 32), now section 221 of the Companies (Winding Up and Miscellaneous Provisions) Ordinance) (Cap 32)) to examine directors based in Hong Kong, to identify and realise assets and identify possible causes of action in Hong Kong and elsewhere which could lead to the recovery of assets for the benefit of the Company’s creditors. Harris J in the Hong Kong High Court dismissed the petition.

 

The principles and issues considered

 

On 6 March 2013, the Court in Re Pioneer Iron and Steel Group Company Limited [2013] HKEC 317, in applying Re Yung Kee Holdings Ltd [2012] 6 HKC 246, confirmed the three core requirements that a petitioner seeking to wind up an unregistered company under section 327 of the old Companies Ordinance (Cap 32)  (now section 327 of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 622)) must establish in order for the Hong Kong Courts to have jurisdiction.  They are: (i) there must be a sufficient connection with Hong Kong, which in an insolvency context is commonly the presence of assets in the jurisdiction; (ii) there is a “reasonable possibility that the winding-up order would benefit those applying for it“; and (iii) the Court must be able to exercise jurisdiction over one or more persons interested in the distribution of the company’s assets.  For further details on these requirements and how they are applied.

 

In the present case of Re China Medical Technologies Inc., Harris J applied these principles and considered three key issues:

 

  1. Whether the core requirements go to jurisdiction or discretion (i.e., are they pre-conditions that must be met before the court’s jurisdiction to wind up an unregistered company is invoked?);
  2. Whether the third requirement must be also satisfied; and, if yes,
  3. Whether there are circumstances in which the Court will consider winding up if the third requirement is not satisfied.

 

First issue – Jurisdiction or discretion

 

Different courts have taken different views on whether the core requirements go to jurisdiction or discretion, and the issue  has not been material in any previous Hong Kong cases.  In clarifying the position for the first time, Harris J held, in applying Re Drax Holdings Ltd [2004] 1 WLR 903, that the three core requirements go to discretion, rather than jurisdiction.  As such, they do not act as a pre-condition to the existence of the Court’s statutory jurisdiction, but instead are principles to be observed in exercising that jurisdiction. If the jurisdiction is engaged, the Court then has to consider whether or not to exercise its discretion to wind up an unregistered company.  The core requirements are then relevant to that determination.

 

In most cases, however, the distinction will not matter as a Court will not wind up a foreign company where it has no legitimate interest, as to do so would be to exercise an exorbitant jurisdiction contrary to international comity.

 

Second issue – Whether the third core requirement must be satisfied

 

Up until now, it has generally been accepted since In Re Real Estate Development Company [1991] BCLC 210 that the three core requirements have to be satisfied before the Court will exercise its jurisdiction to wind up an unregistered company.  In the present case, the Court was asked to consider whether it is actually necessary to satisfy the third core requirement (i.e: whether the Court must be able to exercise jurisdiction over one or more persons interested in the distribution of the company’s assets) and to depart from the accepted view.

 

In his reasons for decision, Harris J confirmed the necessity to satisfy the third core requirement and that no departure should be made from the accepted view. In doing so, he further clarified the third core requirement as being that “There are persons with sufficient connection with the jurisdiction (other than by being the petitioner or a creditor who would become subject to the court’s jurisdiction if a winding up order were to be made and he submitted a proof of debt) and sufficient economic interest in the winding up of the company to justify the making of an order which will engage the Hong Kong winding up regime.”  The Court considered that generally this requirement will be satisfied by the presence of a creditor or a number of creditors holding a material portion of the debt (the materiality of which depends on a combination of the amount of the total debt of the company and the amount of the debt held by local creditors).

 

The Court’s view was based upon the following key considerations, that:

 

  1. If a winding up order is made, it engages the entire domestic insolvency regime, so there ought to be someone within the jurisdiction who benefits from it.
  2. A creditor cannot satisfy the third core requirement by simply presenting a petition.  The creditor must be subject to the court’s jurisdiction by doing ‘something more’. Examples include being resident, employed, having the benefit of a judgment debt in Hong Kong, being registered under Part XI of the Companies Ordinance or having a place of business in Hong Kong.
  3. A person with a mere general commercial interest in the outcome of the liquidation cannot satisfy the third core requirement, although there may be rare cases where the third core requirement is satisfied by the presence of a person in Hong Kong who has an indirect but substantial economic interest in the liquidation, for example, the owner of a foreign company who is also a major creditor of the subject company. 

 

Third issue – Where the third core requirement is not satisfied

 

In cases where the third core requirement cannot be satisfied, Harris J considered whether the Court can still exercise its jurisdiction to wind up an unregistered overseas company.  Consistent with his judgment in Pioneer Iron and Steel Group Company Limited, he held that “the core requirements constitute guidance as to the circumstances in which the discretion should be exercised and their application can be moderated if the circumstances clearly call for it.”

 

As such, whether or not the Court considers it proper to exercise its jurisdiction, despite the third core requirement not being met, depends upon two key practical considerations:

 

  1. Whether the connection that the particular company’s activities has with Hong Kong is sufficiently strong; and
  2. Whether the benefits of a winding up order are sufficiently substantial.

 

As to the first consideration, the Court considered the position of an unregistered company whose operations are carried out substantially in Hong Kong and involve exclusively exporting products sourced in the Mainland to overseas customers, where management is based in Hong Kong, its assets and records are in Hong Kong, even though it may be part of a group which operates in such a way that the company does not have trade or utility creditors in Hong Kong at the time a petition is presented against it.  Harris J was of the view that in such an example, it would be a proper exercise of the Court’s discretion to wind up the unregistered company because it would have most of the features of a normal Hong Kong liquidation, other than for the calling of proofs from overseas based creditors, and therefore proper to make an order that engaged the Hong Kong insolvency regime.  By way of guidance, he concluded that “the further removed are the facts from those of the type of case described above, the less likely it is that it can properly be said that the connection with Hong Kong is sufficiently strong to justify making a winding up order when there is no creditor on Hong Kong with a material debt, who will benefit from it.

 

As to the second consideration, the Court held that whether the connection is sufficiently strong will then depend on both the nature of the individual matters relied on, and also the significance of the company’s Hong Kong connection to its activities viewed as a whole.  Harris J considered it relevant that “Matters constituting the Hong Kong connection may represent a significant part of one company’s activities, but similar matters may form a small part of those of a larger, multinational company with offices or factories in many different jurisdictions.”

 

In applying these principles to the facts of the present case, Harris J held that, although the Company (i) used Hong Kong banking services for certain significant banking transactions; (ii) instructed certain professional service providers in Hong Kong; (iii) conducted some board meetings in Hong Kong; (iv) had a small office in Hong Kong (although owned through a subsidiary); (v) occasionally gave Hong Kong contact details to investors; and (vi) had two Hong Kong resident directors, none of the activities concerned the Company’s principal business which, in this case, was to develop, manufacture and market advanced medical equipment.  Accordingly, the Court set aside the petition, primarily on the basis that the third core requirement applied but was not satisfied.

 

Other findings of practical importance

 

  1. In considering the substance of the connection with Hong Kong and whether or not it is sufficient to justify making a winding up order, it is important to have regard to what is being sought and its consequences.  The Hong Kong winding up regime, designed for the liquidation of Hong Kong companies with assets and creditors largely located here, is extended to unregistered company where there is justification for subjecting it to the regime, and the formulation of the three core requirements reflects this.
  2. The Court should not make a winding up order simply to allow foreign liquidators to avail themselves of the process available under section 221 of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32). The Court should only exercise its jurisdiction to grant a winding up order “where the reasons for liquidating an unregistered company in Hong Kong are more extensive.” Section 221 gives the Court the power (usually exercised as a result of an application by a liquidator) to examine persons, including directors and shareholders of a company, and investigate their affairs under oath.
  3. Further, while there are matters which liquidators quite properly wish to investigate, the use of section 221 forms part of such investigations, and those matters are capable of constituting a benefit at some stage, they are not of themselves a reason for the Court to exercise its discretion to grant a winding up order in applying the second core requirement.
  4. Proceeds deposited into Hong Kong bank accounts from the running of a company’s business and any payments made in connection with the business may not necessarily establish a sufficient connection with Hong Kong (i.e., the first core requirement).  Liquid assets can be moved easily and therefore the significance of their domicile in determining the degree of a company’s connection to a country is less important than in the past when there was a greater personal and physical element to the banking process.

 

Key take away points

 

  1. The Court confirmed that there are three core requirements which must be established in order for the Hong Kong Court to exercise its jurisdiction to wind up an unregistered overseas company.
  2. The Court clarified that third core requirement as there being persons with sufficient connection to the jurisdiction, other than being a petitioner or creditor, and sufficient economic interest in the winding up of the company, in order to constitute a person interested in the distribution of the company’s assets over which the Court is able to exercise jurisdiction.
  3. These core requirements are not pre-conditions for the existence of the Court’s jurisdiction, but instead are principles to be observed by the Court in exercising its jurisdiction to wind up an unregistered overseas company. If the jurisdiction is engaged, the Court then has to consider whether or not to exercise its discretion to wind up an unregistered company.  The core requirements are then relevant to that determination.
  4. The Court may choose to dispense with the third requirement, where the connection that the particular company’s activities has with Hong Kong is sufficiently strong,  and where the benefits of a winding up order are sufficiently substantial. The Court will examine whether Hong Kong is clearly central to the company’s principal activities.

 

 

For further information, please contact:

 

Mark Johnson, Partner, Herbert Smith Freehills
mark.johnson@hsf.com

 

Gareth Thomas, Partner, Herbert Smith Freehills
gareth.thomas@hsf.com

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