Corporate Rescue in Hong Kong: What will it eventually look like?24Feb2015
Unlike many other common law jurisdictions, Hong Kong still lacks a statutory corporate rescue regime, despite a proposal for one first having been made by the Law Reform Commission in 1996 and a proposed bill containing a corporate rescue regime subsequently being introduced in 2001 (the “2001 Bill”). Therefore corporate restructurings in Hong Kong have historically been effected through more cumbersome procedures, such as schemes of arrangement or the creative use of provisional liquidators. However these alternative methods of corporate restructuring do not have the certainty provided by the statutory corporate rescue regimes which exist in countries such as Australia and the United States. For instance, schemes of arrangement notoriously lack the ability to impose a moratorium on creditor actions, while recent Hong Kong judicial authority has stressed the need to show danger to a company’s assets in order to appoint a provisional liquidator. (The “danger to the assets” test may not necessarily be satisfied in all cases where a corporate rescue is desirable.)
The financial crisis which swept the globe in 2008, and did not spare Hong Kong, appears to have jogged the law makers’ collective memory as to the continuing need for a statutory corporate rescue regime in this jurisdiction. The 2001 Bill was dusted off and Financial Services and the Treasury Bureau (“FSTB“) launched a public consultation with a view to introducing a new corporate rescue bill, updating the provisions of the 2001 Bill. The original intention was to introduce the new bill into the Legislative Council in late 2010 or early 2011. However the bill has not made it into the Legislative Council at the time of writing.
Nevertheless the conclusions of FSTB’s consultation published in July 2010 (the “Consultation Conclusions“) offer some valuable clues as to what the insolvency and restructuring community in Hong Kong may expect if a statutory corporate rescue mechanism is finally enacted in this jurisdiction. Despite the non-appearance of the new bill to date, this article therefore takes stock of some of the major proposals contained in the Consultation Conclusions and then concludes by offering suggestions for some changes in approach now that it appears there is more time available for tweaking the proposed regime.
Selected features of the proposed new corporate rescue bill
1. Initiation of provisional supervision
The corporate rescue regime is to be known as “provisional supervision” and may be initiated by a company or its directors or provisional liquidators or liquidators. However the company’s creditors will not have the right to initiate provisional supervision. Provisional supervision is intended to apply to both local and non-Hong Kong companies formed or registered under the Companies Ordinance, but would not apply to certain regulated financial institutions.
Procedural requirements proposed to apply to the initiation of provisional supervision include the following:
- The notice of appointment of provisional supervisor and relevant documents will be required to be filed with the Registrar of Companies, but not with the Court or the Official Receiver.
- The company should confirm that it has a valid insurance policy to cover its employee compensation liabilities prior to the commencement of the provisional supervision.
- The company’s directors should produce a statement of affairs of the company at the directors’ meeting that appoints the provisional supervisor.
- The notice of appointment of the provisional supervisor is to be published in the local newspapers on the working day following the day the last relevant document for the commencement of provisional supervision is filed with the Registrar of Companies.
One of the main attractions of the proposed provisional supervision regime is of course that it would offer a moratorium under which civil proceedings against the company would be stayed for a certain period commencing from the date that the provisional supervisor is appointed (the “Moratorium“).
It now appears that the Moratorium will in many respects be even more generous than that which was proposed in the 2001 Bill. It is now proposed that the initial Moratorium apply for 45 working days (as opposed to 30 calendar days in the 2001 Bill) and creditors may vote at a meeting of creditors to extend the Moratorium for up to 6 months. Extensions to the Moratorium could also be granted by the court at any time on application by the provisional supervisor, and in such cases the 6 months limit would not apply.
Furthermore it seems that there will be fewer exceptions to the Moratorium than the 2001 Bill initially provided for. The 2001 Bill was drafted to broadly allow post-commencement claims, but it is now proposed that in principle the only post-commencement claims to be exempted will be:
i. claims for arrears of wages under the Employment Ordinance (Cap 57); and
ii. claims for outstanding employers’ contributions to the MPF or other occupational retirement schemes.
On the other hand, in contrast to the 2001 Bill but following the example of many other Common Law jurisdictions, it is now proposed that creditors be allowed to exercise rights of set-off following the commencement of provisional supervision.
Finally, apparently to address concerns as to how the Moratorium might impact derivatives counterparties, the proposal that the corporate rescue regime include an “exemption list” of contracts and agreements to which the Moratorium will not apply has been retained. Unlike the 2001 Bill, it is intended that the “exemption list” be periodically updated to reflect market developments.
3. Employees’ Outstanding Entitlements
The issue of employees’ outstanding entitlements has been considered as one of the most controversial issues arising from the introduction of a statutory corporate rescue regime. The way that this issue was dealt with in the 2001 Bill was regarded by some as overly favourable to employees, in a way that would diminish the chances of rescuing the company’s business.
The consultation conclusions have therefore substantially changed the way employee entitlements are handled. The framework is now one of staggered payments, with various entitlements to be paid out in a staggered fashion at the following dates: (i) 30 calendar days from the commencement of provisional supervision, (ii) 45 calendar days after the date the voluntary arrangement for restructuring has come into effect (or if the Moratorium is extended, 45 calendar days from the date of extension) and (iii) 12 months after the voluntary arrangement for restructuring has come into effect.
This system of staggered payments is intended to give the company a greater chance of avoiding being sunk under the cumulative weight of employee entitlements, while still giving employees the right to take action outside the Moratorium if any of the payment dates is not met.
4. The provisional supervisor
All registered certified public accountants and practising solicitors will be allowed to perform the role of provisional supervisor, and creditors will be allowed to replace the provisional supervisor at the first meeting of creditors (to be held within 10 working days from the commencement of provisional supervision). Creditors will be able to fix the fees of the provisional supervisor by:
a. agreement between the provisional supervisor and the committee of creditors (if any);
b. resolution of the creditors; or
c. the court, if there is no such agreement or resolution.
One area in which there has perhaps been a step backwards since the 2001 Bill is that of the provisional supervisor’s liability for contracts. Unlike the 2001 Bill, the personal liability of the provisional supervisor will extend beyond contracts entered into by the provisional supervisor to also include pre-existing contracts adopted by the provisional supervisor in the performance or exercise of the provisional supervisor’s functions. The provisional supervisor will now also be liable for rent for properties which the company continues to use, possess or occupy after the commencement of provisional supervision (and in relation to which the Company does not renounce its rights during the 10 working day window period for doing so after the commencement of provisional supervision).
In relation to this expanded liability, provisional supervisors may perhaps still derive some measure of comfort from their right to be indemnified out of the assets of the company for any such personal liability. Nevertheless the expanded scope of liability may make some practitioners think twice before taking up the position of provisional supervisor, especially having regard to the various obligations to employees that a provisional supervisor would now be liable for if he adopts the relevant employment contracts.
5. Insolvent Trading
The proposed regime now provides that a ‘responsible person’ (either the director or the shadow director but excluding senior management), who knew or ought reasonably to have known the company was insolvent or knew or ought reasonably to have known that there was no reasonable prospect that the company could avoid becoming insolvent, will be personally liable for the debts of the company which traded while insolvent, if he/she fails to prevent insolvent trading. The bar for proving insolvent trading has been raised slightly higher than it was in the 2001 Bill, as simply having reasonable grounds for suspecting that the company was insolvent (or that there was no reasonable prospect that the company could avoid becoming insolvent) will no longer be enough to establish liability.
The introduction of insolvent trading provisions is to be welcomed as it brings Hong Kong into line with other common law jurisdictions which have established such provisions. However many members of the business community would no doubt also like to see Hong Kong simultaneously introduce some of the defenses to insolvent trading (revolving around steps taken to minimise damage to creditors or attempts to stop the debt from being incurred) that exist in other jurisdictions. Such defences do not seem to be on the agenda in the current proposals for a corporate rescue regime.
6. Secured Creditors
A key issue for any corporate rescue regime is of course how to deal with creditors holding security over the company’s assets. The 2001 Bill addressed this issue by effectively dividing secured creditors into the two categories of “major secured creditors” and all other secured creditors. In the 2001 Bill, a “major secured creditor” was defined as a creditor holding one or more charges (fixed or otherwise) over property of the company where the totality of the secured property constitutes “the whole or substantially the whole of the company’s property”. The major secured creditor has three working days to decide whether or not to participate in the provisional supervision and if the major secured creditor objects, the provisional supervision will cease. In contrast, those other secured creditors who are not a “major secured creditor” do not have the power to overturn the provisional supervision and the Moratorium, but may choose not to participate in the provisional supervision and attempt to enforce their own security once the Moratorium has ended.
The Consultation Conclusions state that the provisions of the 2001 Bill dealing with secured creditors’ rights will be retained. Among other proposals for change in this area, the FSTB noted the proposal that “major secured creditors” be defined by reference to a specific percentage of the company’s assets rather than by using the “whole or substantially the whole of” language. The FSTB rejected this proposal on the grounds that it would involve problems in valuing the relevant assets. Nevertheless it seems likely that, if the corporate rescue regime is introduced in the proposed form, the question of whether a creditor is secured over “substantially the whole of” the company’s property is likely to be a fertile area for dispute.
7. The potential for a “debtor-in-possession” approach
The corporate rescue regime currently being proposed is in marked contrast to the “Chapter 11″ regime available under United States federal law, which allows the debtor itself to continue to operate the business rather than appointing an external supervisor – the so-called “debtor-in- possession” approach. Proponents of the “debtor-in-possession” approach usually argue that this approach may be more likely to preserve the company as a going concern compared to an approach which gives greater power to creditors.
The Consultation Conclusions state that a “debtor-in-possession” approach will not currently be pursued as it is contrary to the creditor-centric manner in which the proposed Hong Kong corporate rescue regime has been developed to date. However, the consultation conclusions leave open the possibility that in the future a “hybrid” approach (allowing for the retention of existing company management while still giving creditors greater control than in a strict “debtor-in-possession” approach) might be developed in Hong Kong.
A bill containing the new proposed corporate rescue regime was not introduced into the Legislative Council by late 2010/early 2011 as planned. Nevertheless, recently there have been other important developments in relation to companies in Hong Kong. On 26 January 2011 a new companies bill, rewriting the Companies Ordinance in all areas except for company winding up, was read for the first time in the Legislative Council. This leaves the area of company winding up to be dealt with later in a proposed second phase of the project to rewrite the Companies Ordinance.
It is respectfully suggested that it would now be logical to deal with the proposed corporate rescue regime in one single bill together with the reforms to the company winding-up provisions. Rolling the corporate rescue proposals into the general company winding-up rewrite in this way would allow greater attention to be paid to the ways in which the corporate rescue regime may impact on the winding-up regime and vice versa.
Furthermore the greater time that now seems to be available for fine-tuning the corporate rescue proposals could now be used for considering some changes which may increase the chances of successful corporate rescues. It is suggested that attention could be paid to revisiting the question of the provisional supervisor’s liability in relation to employment contracts and to the possibility of adopting a Chapter 11 style debtor-in-possession approach for Hong Kong.