28 May 2012

1. What is the test for corporate insolvency in Hong Kong?
As with certain other common law jurisdictions, Hong Kong law has no definition of "insolvency". Rather, Hong Kong law uses the expression, in relation to a company, of "unable to pay its debts". There are three broad ways under Hong Kong law in which to establish that a company is "unable to pay its debts": 
  • failure (for a period of three weeks) to pay, secure or compound for (to the reasonable satisfaction of the creditor) a debt of a sum equal to or exceeding HK$10,000 which is then due and which has been the subject of a statutory demand; 
  • failure to satisfy (in whole or in part) an execution or other processes issued on a judgment, decree or order of any Court in favour of a creditor of the company; or 
  • proving to the Court that a company is unable to pay its debts, taking into account the prospective and contingent liabilities of the company (note that, unlike England, the Hong Kong legislation does not refer to paying debts "as they fall due"). 
When considering whether a company is unable to pay its debts under (c) above, it appears that the Court may apply either the "cash flow test" (meaning the company cannot pay its debts as they fall due in the plain sense) or the "balance sheet test" (considering the company's assets against its liabilities, including both contingent and prospective liabilities) as the Court considers appropriate in all the circumstances.
2. What are the main types of formal procedures for companies in financial difficulties in Hong Kong?
2.1 A members’ voluntary liquidation
Strictly, this is not a procedure for a company in financial difficulties as a members' voluntary liquidation is only possible where the directors of the company sign a "certificate of solvency", to the effect that the directors have made a full inquiry into the affairs of the company, and that, having so done, they have formed the opinion that the company will be able to pay its debts in full within such period, not exceeding 12 months, from the commencement of the winding-up as may be specified in the certificate of solvency. To complete the initiation of the members’ voluntary liquidation, the shareholders of the company must then pass a special resolution for winding-up (if the company is being wound up pursuant to its Articles, only an ordinary resolution need be passed) and appoint a liquidator.
Procedural requirements which must be complied with in conducting a member’s voluntary liquidation in Hong Kong include, but are not limited to: (i) advertising (within specified time periods) the appointment of the liquidator and the passing of the resolution for winding-up, (ii) annual General Meetings of the company to be summoned by the liquidator during the course of the winding-up, at which the liquidator shall report on the progress of the winding-up and (iii) a final General Meeting of the company immediately following the affairs of the company being fully wound up, at which the liquidator will present an account of the winding-up.
Note that if the liquidator is of the opinion that the company will not be able to pay its debts in full during the relevant period, he must forthwith convene a meeting of creditors and present to the meeting a statement of the assets and liabilities of the company. At such a meeting the creditors have the statutory power to replace the liquidator and appoint a committee of inspection if they see fit. The Hong Kong Law Reform Commission has previously recommended the adoption of more detailed legislative provisions governing the conduct of equivalent meetings of creditors in England and Wales, but no such reforms have yet been enacted in Hong Kong.
2.2 A creditors’ voluntary liquidation 
A creditors' voluntary liquidation will occur where the company decides to put itself into voluntary liquidation but is not solvent. Therefore any voluntary liquidation in which there is no certificate of solvency will be a creditors' voluntary liquidation.  A special resolution of shareholders is required to commence a creditors’ voluntary liquidation and a meeting of creditors must be held on the same day as the meeting of shareholders which passed the special resolution (or the following day).  There are various formal requirements as to the notice of the relevant meetings of shareholders and creditors.  A statement of affairs of the company must be laid before the relevant meeting of creditors and any nomination of a liquidator by the meeting of creditors will prevail over any contrary nomination by the shareholders.
The procedural requirements in conducting a creditors' voluntary liquidation in Hong Kong are broadly the same as for a members’ voluntary liquidation.  However some pertinent differences include that creditors may appoint a committee of inspection (being a body to act as a sounding board for the liquidator and whose sanction is needed before the liquidator can take certain steps), which if appointed is required to meet once a month.
Hong Kong legislation also contains provisions which allow the directors of a company to commence a voluntary winding-up without a meeting of members. This type of winding-up is initiated by a director’s resolution that, amongst other things, the company cannot by reason of its liabilities continue its business and that it is not reasonably practicable to commence the winding-up in any other manner.  A statement signed by one of the directors and covering the matters in the resolution must be delivered to the Hong Kong Registrar of Companies within 7 days of being made. A director who makes the statement without having reasonable grounds for believing so shall be liable to a fine and imprisonment (for this reason, this procedure is not used as frequently as the procedure whereby meetings are called to commence the process).  Following the delivery of the statement to the Hong Kong Registrar of Companies a provisional liquidator must forthwith be appointed.  Subsequently, from the date of the first meeting of creditors onwards, a winding-up under this procedure progresses in the same manner as a creditors' voluntary winding-up commenced by a meeting of members (with the statutory provisions governing creditors' voluntary liquidations applying).
2.3 Compulsory liquidation
A compulsory liquidation is initiated with the presentation to the Court of a petition for the winding-up of the company.  The petition may be presented by various parties including creditors and the company itself. The party presenting the petition must satisfy certain notice, filing and advertising requirements. On hearing the petition the Court will make an order for the compulsory winding-up of the company if it is satisfied that one of the following grounds for the Court to wind-up a company exists:
  • the company has by special resolution resolved that the company be wound up by the Court; 
  • the company does not commence its business within a year from its incorporation or suspends its business for a whole year; 
  • the company has no members; 
  • the company is unable to pay its debts (see section 1 above); 
  • the event, if any, occurs on the occurrence of which the memorandum and articles provide that the company is to be dissolved; or 
  • the Court is of the opinion that it is just and equitable that the company should be wound up. 
Note however that the Court will not make a winding-up order if the company satisfies the Court that the debt upon which the petition is based is the subject of a bona fide dispute on substantial grounds. 
Following the presentation of the petition and prior to the hearing of the petition, the Court may appoint a provisional liquidator to safeguard the assets of the company. 
Following the making of the winding-up order, if no provisional liquidator has yet been appointed the Official Receiver of Hong Kong becomes the provisional liquidator until a liquidator is appointed (see below).  
Other important steps required following the making of the winding-up order include:
–  The delivery of a statement of affairs of the company within 28 days of the winding-up order (or within 28 days of the appointment of a provisional liquidator if the provisional liquidator was appointed prior to the making of the winding-up order).  
– The calling by the provisional liquidator of separate meetings of creditors and contributories of the company within 3 months of the date of the winding-up order. Matters to be decided at those meetings will include (i) whether to apply to the Court for the appointment of a liquidator in place of the provisional liquidator and (ii) whether to apply to the Court for the purpose of appointment of certain of the creditors and contributories to a committee of inspection (being a body to act as a sounding board for the liquidator and whose sanction is needed before the liquidator can take certain steps). If a committee of inspection is appointed following the first meetings of creditors and contributories, the committee of inspection must meet at least once a month.
The calling by the liquidator of such further meetings of creditors and/or contributories as are properly requested by creditors or contributories (as the case may be).
Presentation by the liquidator to the Court of a report on the causes of failure of the company (if applicable) and the affairs of the company.  As part of these investigations the liquidator will look into the actions of the directors of the company.  On this point it should be noted that unlike England and Wales, Hong Kong has no concept of "insolvent trading" or "wrongful trading".  There is a concept of “fraudulent trading” for which there are both civil and criminal penalties, but actions in connection with fraudulent trading are rare in Hong Kong – the main difficulty is meeting the requirement to show an intention to defraud.
– Satisfaction of various further consequential filing, notification and reporting duties of the liquidator in connection with his conduct of the liquidation, his investigations into the company and its directors and the termination of the liquidation.
Note however that where the Court is satisfied, or the Official Receiver of Hong Kong or provisional liquidator reports to the Court, that the assets of the company are unlikely to exceed HK$200,000, the Court may make an order that the company be wound up in a summary manner. In that case the Official Receiver of Hong Kong or other provisional liquidator (as applicable) shall become the liquidator and there will be no initial meetings of creditors or contributories and no committee of inspection. 
Furthermore, any of the Official Receiver of Hong Kong, the liquidator or any creditor may apply to the Court to make a "regulating order" by reason of the large number of creditor or contributories or for any other reason the interest of creditors so requires. A regulating order permits the winding-up to be regulated by the Court according to the terms of its order, which procedures will not necessarily be the same as for a normal winding-up (for example the regulating order will often dispense with the first meetings of creditors and contributories, though it should be noted that the specific application to dispense with these meetings under the regulating order can only be made by the Official Receiver of Hong Kong).
2.4 Appointment of Receivers
Receivers may be appointed: (i) by the Court; or (ii) out of Court, pursuant either to a statutory power or a contractual right contained in the relevant security document. 
Appointment of a receiver by the Court is at the discretion of the Court and the Court will have regard to a "just and convenient test" when deciding whether to appoint the receiver. The Court will sometimes also appoint a receiver by way of equitable execution against a judgment debtor. 
More commonly in respect of insolvency situations, receivers may be appointed under any security document whose terms expressly allow the secured party to appoint a receiver following the occurrence of particular events of default which have been contractually agreed between the securing party and the secured party. 
Receivers are appointed over specified property of a company (which may be specified to be the entire property of the company) with the power to manage and/or realise that property for the benefit of the creditor who appointed the receiver, although the receiver must first pay any creditor with security over relevant property who ranks ahead of the creditor who appointed the receiver.
It should be noted, however, that in Hong Kong the statutory power, which implies the right of a charge-holder to appoint a receiver, is narrower than in England & Wales. This is because the Hong Kong statutory power to appoint a receiver arises only in relation to land. Under the relevant legislation, there is implied into any legal charge of, or equitable mortgage by deed of, land a power to appoint a receiver or receivers of the mortgaged land and the income thereof when the mortgage money has become due. The equivalent legislation in England & Wales allows appointment of a receiver over "charged property" which extends beyond "land".
2.5 Scheme of Arrangement
The proposal of a scheme of arrangement is not limited to companies in financial difficulties or potential insolvency. The procedure can also be used, for example, for the reduction of share capital. A company, the shareholders of the company and/or the creditors of the company are free at any time to attempt to reach a binding agreement under Hong Kong's scheme of arrangement procedure. Further, even where a company is undergoing a winding-up procedure, the power to initiate a scheme of arrangement also resides with any liquidator of the company (and also any provisional liquidator, if the provisional liquidator's powers include the power to seek a corporate rescue – see section 5 below).
A successful application to court for the sanction of a scheme of arrangement will lead to a moratorium on creditor actions against the company. However, the procedure for obtaining court sanction in Hong Kong is complex and time-consuming. Prior to a petition for sanction of the proposed scheme being presented to the Court, the proposed scheme must be approved by meetings of each class of shareholders and/or creditors to be affected by the scheme. The necessary majority to approve the proposed scheme is both (i) a numerical majority of more than 50% and (ii) a majority of 75% in value.  Care must be taken in describing the classes of shareholders and/or creditors when applying for the Court’s approval to convene the meetings (an earlier stage in the process than when petitioning for sanction of the scheme itself), as incorrect constitution of classes will lead to failure when the Court ultimately considers the petition for sanction (factors to be taken into account by the Court when considering the application for sanction include whether those attending and voting at each meeting fairly represent the relevant class and that the relevant majority have in each case acted bona fide and not promoted interests adverse to the class they purport to represent ).
3. What is the position of creditors in a formal procedure?
3.1 Secured creditors
The most common types of security taken in Hong Kong are a fixed charge over specific assets of a company or a fixed and floating charge over all assets and undertaking of a company. Other types of security interest are also possible but are relatively less common.  There are various registration requirements to be complied with when taking security in Hong Kong, but further discussion of those would be beyond the scope of this article. 
Secured creditors stand outside of the ordinary order of priority in a liquidation (whether compulsory or voluntary) and are entitled to be paid out of the proceeds of their security. Any residual amount still owing can then be proved for as an unsecured creditor. Note, however, that one exception to this principle is where the security was created as a floating charge, any preferential debts of the company must be paid out of the proceeds of realisation of the charge before the charge-holder is paid.
During the appointment of a receiver, any secured creditors who did not appoint the receiver also remain free to enforce their own security, subject to the priorities applying between the securities (and the priorities of preferential creditors over floating charge holders).
With regards to a scheme of arrangement, secured creditors remain free to enforce their security against the company until the moment the scheme becomes binding on all creditors following sanction of the scheme by the court.
3.2 Unsecured creditors
The rights of unsecured creditors to take independent action are severely restricted in any liquidation. In a voluntary liquidation, there is no general stay of proceedings against the company but unsecured creditors will not be allowed to use any Court enforcement mechanisms to "jump the queue" and use any judgment obtained to stand in a better position than other unsecured creditors. In a compulsory liquidation, following presentation of the petition the company or any creditor or contributory may apply to the Court to stay any pending action or proceeding against the company. Following the winding-up order no action or proceeding shall be proceeded with or commenced against the company except by leave of the court. Note however that Hong Kong law includes a provision (based on Australian rather than English law) permitting the Court to make an order allowing a creditor to have an advantage over other creditors in certain circumstances where that creditor has funded, or given an indemnity, in respect of costs of steps taken to protect the company's assets or achieve recoveries. 
Particularly relevant to unsecured creditors will be certain principles of insolvency set-off which apply in all liquidations in Hong Kong.  For the set-off to apply there must have been mutual credits, mutual debts or other mutual dealings between the parties at or before the date the winding-up order was made but the set-off will not be available if the creditor was aware that a petition had been presented at the time he gave credit.
With regards to situations where a receiver is appointed over all or some of a company’s property, unsecured creditors remain free to exercise what rights they do have.  In practice unsecured creditors will often choose to petition to put the company into compulsory liquidation.
Prior to a scheme of arrangement being sanctioned by the Court, unsecured creditors remain free to exercise their rights.  In practice it is not unusual for unsecured creditors to petition to put a company into liquidation while a proposal for a scheme of arrangement is being worked out, although if such petition appears to be a “spoiling” tactic that does not benefit creditors as a whole, the Court will often stay the petition pending the Scheme meetings taking place.
3.3 Proving for debts by creditors in a liquidation
In a compulsory liquidation each creditor must submit a formal written proof of debt. In a Creditors' Voluntary Liquidation there is no strict legal requirement for a formal written proof, but in practice the liquidator will nevertheless usually invite creditors to submit their claims in writing. 
Broadly speaking, the relevant legislation provides that "all debts and liabilities, present or future, certain or contingent…shall be deemed to be debts provable". There are however certain specific exceptions, such as statute-barred debts, debts which could not be sued upon (e.g. foreign tax) and debts incurred after the winding-up petition was presented, if the debtor had notice of the petition. 
The liquidator must adjudicate the proofs of debt received and has the power to reject a proof of debt if he does not regard it as proved to his satisfaction. The liquidator's rejection of a proof of debt may be appealed to the Court by the relevant creditor within 21 days. Only creditors who have successfully proved for their debt may receive payment from the liquidator out of the realised assets of the company.
Broadly speaking, the order of payment in a liquidation is as follows: 
  • The costs and expenses of the liquidation (note that this will include costs orders made in favour of other parties where the liquidator has chosen to start or continue legal actions). 
  • Debts due to any preferential creditors of the company. Some categories of preferential creditor only apply in certain types of insolvency (such as banks or insurers), but generally speaking the main categories of preferential claim are debts owed to employees and debts owed to the Government (to the extent that an employee has received money from the Protection of Wages on Insolvency Fund (the “PWIF”) (see section 3.4 below), the PWIF will be a preferential creditor in place of the employee). 
  • Any preferential charges on goods distrained. 
  • The company's general creditors. 
  • The shareholders. 
3.4 The position of employees in a compulsory liquidation
As well as being preferential creditors, in a compulsory liquidation employees may also be entitled to an ex gratia payment out of the PWIF.  Under the relevant statute the PWIF scheme does not make payments in respect of a voluntary liquidation.
4 Challengeable transactions
In addition to any disposition of property or transfer of shares (etc.) made after the commencement of the compulsory liquidation being void, Hong Kong law has various categories of transactions that may be challenged or set aside by a liquidator or other party.  These include unfair preferences by the company, extortionate extensions of credit to the company, floating charges granted by the company and transactions made with the intent to defraud creditors. In most cases, for the relevant transaction to be challengeable or set aside it must have occurred within a certain time period prior to the commencement of the liquidation.
It should be noted that Hong Kong corporate insolvency law has no separate concept of transactions at an undervalue (although there is for personal bankruptcy). However, liquidators may consider using their power to institute proceedings against the directors of the company for misfeasance in order to pursue the directors for disposals of assets below market value, or alternatively consider bringing an action against the directors in the name of the company for breach of their fiduciary duties in executing such a transaction. The latter is more common.
5 Restructuring within and without formal procedures
Hong Kong currently lacks any formal procedure specifically aimed at rescuing companies such as can be found in some other common law jurisdictions (such as administration in England and Wales, Chapter 11 procedures in the United States or judicial management in Singapore).  A proposed corporate rescue law for Hong Kong has been mooted for over a decade, and extensive consultation procedures on the proposed law were undertaken only a few years ago, but at the time of writing the introduction of a corporate rescue bill into Hong Kong’s Legislative Council has once again fallen into limbo.
While a scheme of arrangement can be seen as intended to preserve a company as an ongoing concern, that procedure has a significant weakness in that there is no moratorium on actions by creditors until the scheme is finally sanctioned by the court, which, as discussed above, is a time consuming process. 
Insolvency practitioners in Hong Kong have also historically used the appointment of a provisional liquidator (which is not in itself a separate procedure, but forms part of the compulsory liquidation procedure) as a means of achieving corporate rescue. However, Hong Kong judicial authority has stressed that a provisional liquidator can only be given powers to attempt a corporate rescue where it can first be shown that his appointment is necessary to protect the assets of the company where the same are in jeopardy and would remain so without the immediate appointment of a provisional liquidator; and that a winding-up order will be sought if the corporate rescue fails. Nevertheless, instances of using provisional liquidators to try to achieve corporate rescue continue.
For completeness we note the Hong Kong Approach to Corporate Difficulties, produced in the late 1990s by the Hong Kong Association of Banks and the Hong Kong Monetary Authority. These are guidelines to how Hong Kong banks should approach dealing with corporate borrowers in financial difficulty and implementing corporate workouts. However these guidelines do not have any binding legal effect, and are not expressed to apply to any entities other than banks.
Furthermore, attempts to achieve a consensual restructuring outside of formal procedures and/or non-binding guidelines remain relatively common in Hong Kong. There are any number of ways of doing this, depending on the type of company, the assets and their locations etc. Common elements include a debt-for-equity swap, where lenders exchange some or all of their debt for equity in the company; the issue of convertible notes at a very low rate of interest which allow lenders the option of converting into shares; or through a "white knight" investor.


For further information, please contact:

Ian De Witt, Partner, Tanner De Witt 
Robin Darton, Partner, Tanner De Witt 


Leave a Reply

You must be logged in to post a comment.