Twenty years ago, the PRC resumed its sovereignty over Hong Kong with the establishment of the Hong Kong Special Administrative Region of the PRC on 1 July 1997.
Hong Kong operates a free trade economic system with minimal government intervention. A primary attraction remains Hong Kong's legal system, based on English common law and rules of equity, involving strict adherence to the principles of the rule of law and judicial independence.
Given its proximity to and relationship with the PRC, Hong Kong is often regarded as the primary intermediary platform for trade between mainland China and the rest of the world, and therefore serves a dual role as both conduit for access to the mainland Chinese market and a springboard for Chinese businesses to gain exposure to international markets.
Hong Kong has also pioneered offshore yuan business, having been the first offshore market to launch, in 2004. As China's economy integrates more and more with the rest of the world's markets, the yuan will be used increasingly as a payment currency. During April 2017, 5.442 trillion yuan was converted into Hong Kong dollars and other currencies, and an equivalent of 5.437 trillion yuan of Hong Kong dollars and other currencies was converted into renminbi through authorised institutions engaged in renminbi business. There were 40,672 renminbi remittance transactions from Hong Kong to mainland China, amounting to 1.101 trillion yuan.1
The restructuring and insolvency legal framework
Provisions covering the winding up of Hong Kong companies and foreign corporations registered in Hong Kong and the insolvency-related regime are found in the Companies (Winding Up and Miscellaneous Provisions) Ordinance (the Winding Up Ordinance) and subsidiary legislation. The Winding Up Ordinance was recently amended by the Companies (Winding Up and Miscellaneous Provisions) (Amendment) Ordinance 2016 (the Amendment Ordinance) and the new changes came into effect on 13 February 2017.
In addition to voluntary or compulsory liquidation, restructuring methods include workouts and schemes of arrangement.
Hong Kong operates on the generally creditor-friendly English law approach to distressed enterprises but without the benefit of any statutory corporate rescue procedures (such as administration). However, statistics from the Official Receiver's Office2 show that the number of compulsory winding-up petitions presented and orders made has broadly continued to decline. For example, the annual total of petitions presented during 2003 was 1,451, of which 1,248 received orders to be wound up, whereas in 2016, the annual total was 456, of which 325 were ordered into liquidation.
Despite a mechanism referred to as ‘provisional supervision' being put forward by the government more than 15 years ago, Hong Kong continues to operate without a formal procedure by which a distressed company can reorganise its debt obligations and trade out of difficulties, such as administration in the UK or Chapter 11 in the United States.
The primary restructuring tool available, therefore, remains the scheme of arrangement, which can be used for both insolvent and solvent companies. Schemes may be used to supplement informal contractual workouts implemented by multi-bank creditor groups or other creditor constituencies. As a number of entities listed on the Hong Kong Stock Exchange and otherwise are incorporated offshore, parallel schemes running in Hong Kong and the relevant offshore jurisdictions have become more common.
As schemes of arrangement do not provide a statutory moratorium, there remains a risk of a creditor taking enforcement action, including winding-up proceedings, after a scheme of arrangement has been initiated. For this reason, schemes of arrangement in the insolvency context are frequently undertaken in conjunction with provisional liquidation (where appropriate) or liquidation, to create the necessary moratorium. As a result of the Legend case,3 it is currently clear that restructuring alone is not sufficient to found the appointment of provisional liquidators so that an applicant will still have to show concern as to, for example, potential jeopardy to the company's assets and that it may reasonably be expected that liquidation will ultimately ensue.
Currently, there is no statutory provision empowering a Hong Kong court to render assistance to a foreign court in an insolvency matter, as Hong Kong has not adopted the Model Law in its domestic legislation, or any other legislation to similar effect (except with regard to certain aspects of arbitration).
The approach taken by the Hong Kong courts to cross-border insolvencies has been pragmatic. There is increasing acknowledgement of the need for courts from different jurisdictions to assist one another where possible and to address the common law recognition of foreign liquidators.
The Hong Kong courts have a broad jurisdiction to wind up companies in Hong Kong. This extends not only to companies that are incorporated in Hong Kong, but also to overseas companies registered in Hong Kong and unregistered companies, providing certain requirements are met.
Notably absent from the Amendment Ordinance is any provision for some form of statutory corporate rescue procedure. Recently, the Hong Kong Financial Services and the Treasury Bureau indicated that their target is to table a bill to the Legislative Council in 2018 for the introduction of a statutory corporate rescue procedure and insolvent trading provisions.4
Recent legal developments - legislation
The Amendment Ordinance has updated Hong Kong's antecedent breach legislation, including the introduction of undervalue transactions for corporate insolvency (the concept is well known but previously only applicable in personal bankruptcy).
An undervalue transaction occurs when a company makes a gift to, or enters into a transaction with, a person on terms that provide for the company to receive no consideration; or enters into a transaction with a person for a consideration (to be assessed in terms of money or money's worth), the value of which is significantly less than the value of the consideration provided by the company (new section 265E, the Winding Up Ordinance). The ‘relevant time' for a transaction at an undervalue to be caught is any time within five years ending on the commencement of the winding up, but only if at that time the company was unable to pay its debts, or became unable to pay its debts as a result of the transaction (new section 266B, the Winding Up Ordinance).
However, the court will not order the company back to the position it would have been in had it not entered into the transaction, if it is satisfied that the company entered into the transaction in good faith for the purpose of carrying on its business and, at the time the company did so, there were reasonable grounds for believing that the transaction would benefit the company (new section 265D, the Winding Up Ordinance).
Until recently, the unfair preference concept in corporate insolvency was founded in bankruptcy legislation applicable to individuals under the Bankruptcy Ordinance. The attempts at analogous incorporation by reference were unsatisfactory and the Amendment Ordinance addresses the issue by introducing a stand-alone power for the court to set aside transactions entered into by a company prior to its winding up that unfairly puts one particular creditor in a better position over other creditors (new section 266, the Winding Up Ordinance).
Further, the definition of ‘associate' for the provisions on transactions at an undervalue and unfair preferences is now broadened and includes categories of persons that are formulated with specific regard to the usual manner in which corporations operate. This is in contrast to the old definition under the Bankruptcy Ordinance, which was formulated on the basis of the bankrupt being an individual.
The Amendment Ordinance also changes the law in respect of floating charges and when they may be set aside. The aim of the existing legislation was to prevent a company's controllers creating last-minute floating charges in their favour, with liquidators able to treat floating charges made within a prescribed period of the commencement of the winding up as invalid security unless the company was solvent immediately after the creation of the charge. New section 267 of the Winding Up Ordinance extends the ‘relevant time' for a floating charge created in favour of a connected person to two years prior to the commencement of the winding up. It also allows liquidators to take into account the provision of property and services, as well as cash, by way of consideration for the amount of the charge.
If a company is compulsorily wound up within one year of a payment out of capital under statutory procedures for redemption or buy-back of any of its own shares, the Amendment Ordinance now provides that directors who signed the solvency statement in relation to the payment out of capital and former shareholders will be jointly and severally liable to contribute to the assets of that company. It is a defence for a director to show that he or she had reasonable grounds for believing the opinion expressed in the solvency statement. The change is intended to protect the interests of creditors by ensuring that the company's paid-up capital is preserved and not returned to its members immediately before the insolvent winding up of the company at the expense of the company's creditors.
Bank resolution regime
In the wake of the recent global financial crisis, the G20 tasked the Financial Stability Board with developing a robust approach to allow systemically important financial institutions to fail safely. The Board concluded that each of its member jurisdictions needs to establish a resolution regime providing relevant authorities with certain powers to implement an orderly resolution of a failing institution, stabilising and securing continuity for key parts of the business.
Given Hong Kong's status as an international financial centre and a Financial Stability Board member jurisdiction, the Financial Institutions (Resolution) Ordinance was enacted by the Legislative Council on 22 June 2016 and its commencement date was designated as 7 July 2017 (with the exception of certain provisions, which require finalisation of additional rules).
The Ordinance is intended to establish a cross-financial sector resolution regime that is designed to strengthen the resilience of the Hong Kong financial system and operates in the banking, insurance, and securities and futures sectors.
The Hong Kong Monetary Authority, the Insurance Authority and the Securities and Futures Commission are given powers as resolution authorities, including to:
- impose a write-off or conversion of capital instruments issued by authorised institutions;
- resolve a holding company or group company of a within-scope entity; and
- give effect to a resolution action taken by an overseas counterpart.
Where a failing financial institution operates in more than one sector, one of the authorities will coordinate the resolution as lead resolution authority.
The Ordinance provides for various stabilisation options, which the relevant resolution authority can apply individually or in combination - broadly:
- transfer of the failing financial institution, or some or all of its business, to a commercial purchaser, a bridge institution or an asset management vehicle;
- statutory bail-in; and
- as a last resort, taking the institution into temporary public ownership (involving the use of public funds).
Given the intention of enabling an orderly resolution, the Ordinance provides that a person intending to wind up a financial institution or its holding company within the scope of the regime, must notify the resolution authorities in writing of the intention to do so before presenting the petition, and the resolution authority has a period in which to decide whether to initiate resolution.
A critical element for regimes around the world will be, when a resolution is cross-border in nature, whether foreign jurisdictions will recognise each other's resolutions. The Ordinance provides for recognition to give effect to measures adopted by the foreign authority and measures by the Hong Kong authorities to support the resolution action being taken by the foreign authority.
Recent legal developments - case law
Hong Kong is a gateway to business around Asia and investors continue to appreciate the certainty of its legal system and application of the rule of law. For a variety of reasons, including legal and tax considerations, enterprises running businesses through Hong Kong will often do so using corporate structures involving several jurisdictions. In addition, the assets underpinning those businesses are frequently situated outside Hong Kong.
Winding up foreign companies
Hong Kong courts have power under the legislation to wind up a foreign company, including one that is not registered in Hong Kong. The courts will not exercise the power lightly, determining the position case by case and recognising that it is generally more appropriate to wind up a foreign company in its country of incorporation. Three core requirements have been formulated for exercising the courts' power to wind up a foreign company:
(i) there has to be a sufficient connection with Hong Kong, although this does not necessarily have to consist of the presence of assets within the jurisdiction;
(ii)there must be 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 in the distribution of the company's assets.5
The fact that the court considers itself to have jurisdiction does not mean that it will make a winding-up order and will maintain discretion whether or not to do so.
In the high-profile Yung Kee case,6 the Court of Final Appeal (CFA) reversed the lower courts' decisions and decided Yung Kee Holdings Limited (Yung Kee), incorporated in the BVI and indirectly holding the well-known Yung Kee restaurant in Hong Kong, has sufficient connection with Hong Kong to trigger the Hong Kong court's winding-up jurisdiction, and to do so on just and equitable grounds.
Considering jurisdiction from a winding-up perspective, the CFA focused on the first core requirement, namely a ‘sufficient connection with Hong Kong', holding that the test is whether the petitioner will derive significant benefit from a winding-up order in Hong Kong, even though the company is incorporated elsewhere.
In a recent case,7 a dispute arose between a PRC Hong Kong/Shenzhen-listed entity and its Hong Kong joint venture party, with subsequent arbitration resulting in a substantial award in favour of the Hong Kong company. Following receipt of a statutory demand for payment in advance of a winding-up petition against it, the PRC company suggested that the Hong Kong courts lacked jurisdiction to wind it up and that the ‘benefit' test (see core requirement (ii), above) would not be satisfied in the absence of assets of the PRC company in Hong Kong being available for distribution to creditors and the difficulties of investigation by a liquidator.
The court of first instance concluded that the pressure brought about by a winding up was sufficient to constitute a benefit to the Hong Kong company in its efforts to enforce the award. In any event, as a matter of public policy, a winding-up order could be justified on the basis that the PRC entity's behaviour should be discouraged: having chosen to list its shares in Hong Kong, a company should not then be able to refuse to honour an award required under Hong Kong law.
Recognition of foreign proceedings
In Singularis Holdings Ltd v PwC,8 the Privy Council Board considered the doctrine of modified universalism (whereby, broadly speaking, a court will give such assistance as it can to foreign insolvency proceedings, consistent with local law and local public policy, to ensure that a company's assets are distributed under a single system) and held by a majority that there was a common law power to assist a foreign insolvency, although the power could not be used to enable foreign liquidators to do something that they could not do under the law of the liquidation under which they were appointed.
The Companies Court in Hong Kong has relied on and developed common law increasingly since 2014, in recognising in Hong Kong the appointment of foreign liquidators without the need for expensive and time-consuming winding-up proceedings in Hong Kong and including the grant of certain investigative powers.
Where a UK administrator sought assistance from the Hong Kong court in recognising the moratorium created by the administration order in the UK to prevent disposal of the company's assets, the court concluded that it could not provide that assistance because to do so would be an impermissible extension of common law principles: Hong Kong currently has no procedure analogous to administration in the UK and thus the order was not one that would be available to a Hong Kong office holder.9
In the recent matter of BJB Career Educational Co Ltd (in provisional liquidation) v Xu Zhendong,10 the court noted that:
in the exercise of its common law powers the Hong Kong Companies Court can order the oral examination of a director of a Cayman Island company in liquidation in the Cayman Islands if satisfied that it is necessary and that it would not infringe the established limitations on the exercise of the power conferred by section 221 [of the Winding Up Ordinance].11
That common law power did not contravene article 96 of the Basic Law, which provides as follows:
With the assistance or authorisation of the Central People's Government, the Government of the Hong Kong Special Administrative Region may make appropriate arrangements with foreign states for reciprocal juridical assistance.
In Bay Capital Asia,12 the Companies Court repeated that banks should give assistance to foreign liquidators seeking information on receipt of a letter of request, having satisfied themselves that the liquidators have been appointed by the court of the place of the company's incorporation, without the need for a Hong Kong court order. The recent line of decisions shows that, to the extent established common law principles require Hong Kong courts to recognise foreign liquidators, they are both prepared and willing to provide assistance to them.
Significant transactions, developments and active industries
Recent examples of schemes of arrangement are becoming increasingly cross-border in nature, given the mix of creditor constituencies involving bank debt as well as bonds subject to, for example, New York law. The result increasingly requires parallel schemes in Hong Kong, the relevant offshore jurisdiction (such as Bermuda, the Cayman Islands or the British Virgin Islands, where companies listed in Hong Kong are frequently incorporated) together with Chapter 15 recognition in the United States, with a view to ensuring that claims in all relevant jurisdictions are extinguished.
Kaisa Group Holdings Limited
Kaisa Group is one of the leading PRC real estate property developers listed on the Hong Kong Stock Exchange, with interest-bearing borrowings amounting to billions of dollars, and has borrowings in the PRC and offshore through a mixture of bank and bond debt. Its default is the first time that a major property company operating exclusively in the PRC has defaulted on its offshore debt. Schemes of arrangement were sanctioned in both Hong Kong, where Kaisa was listed, and the Cayman Islands, where it was incorporated; and the United States Bankruptcy Court for the Southern District of New York provided recognition of the scheme of arrangement proceedings, then pending before the High Court of Hong Kong under Chapter 15 of Title 11 of the United States Code.
In the Lehman Brothers liquidations in Hong Kong, schemes of arrangement13 have been used recently to help accelerate the liquidation process.
One scheme was proposed with the objective of reducing the company's creditor constituency and thereby simplifying its liquidation and reducing costs, providing for the full and final discharge of the scheme claims by the scheme creditors in return for them receiving a payment that, with the interim dividends in the past, will give them the anticipated total recovery (calculated on a best-case basis) much earlier than if the liquidation were to continue without the scheme.
At the sanction hearing, the key legal issue was whether (moving on from Garuda14) it is permissible to have a scheme of arrangement between an insolvent company and only some (ie, not all) of its unsecured creditors, having regard to the principle of pari passu distribution in insolvency law. The liquidators relied on English and Hong Kong authorities to the effect that a scheme of arrangement can be used to achieve a departure from the pari passu principle in a liquidation and, although all creditors in a class must have similar rights, not all creditors with similar rights have to be joined in a class, notwithstanding the insolvency of the debtor.
Another addressed the uncertainties and litigation risk in connection with questions of payment priority with regard to
post-liquidation interest, matters forming the basis for many months of court time in the English Waterfall cases.15
Both schemes operated to impose a cut-off date by which creditors must submit claims in the relevant company's liquidation (if not already admitted), failing which they will be barred from participating in the scheme or the liquidation.
The forum shopping of the debtor group in the ongoing restructuring of Pacific Andes and China Fishery has been the subject of much debate in each of the primary jurisdictions of Hong Kong, New York and Singapore. The debtors filed selectively for Chapter 11 protection in respect of certain of their subsidiaries, while at the same time instituting Singapore proceedings seeking to take the benefit of the scheme moratorium available there. Involuntary winding-up proceedings were also initiated in Peru.
Transactions under review also rest at certain Bermuda and BVI entities within the group. When creditors filed a petition to wind up one of the key holding companies in Bermuda, following an overturning of the Singapore moratorium, it filed a voluntary petition for relief in New York under Chapter 11 of the US Bankruptcy Code. As a consequence of the new Chapter 11 filing, creditors were prohibited from proceeding with the petition. The matter involves complex arguments of international insolvency law and practice as to the territorial reach of relevant legislation and the sovereignty of jurisdictions of incorporation to become seized of winding-up proceedings.
Addressing the Legend decision16
Since Legend, the general view has been that Hong Kong law does not strictly allow ‘soft touch' provisional liquidation to restructure a company. Rogers VP pithily noted that:
[t]he power of the court ... is to appoint a [provisional] liquidator ... for the purposes of the winding up, not for the purposes of avoiding the winding up ... Restructuring a company is an alternative to a winding up.17
In an ongoing restructuring case, the initial appointment of Hong Kong provisional liquidators (PLs) to Z-Obee, a Bermuda-incorporated company listed in Hong Kong, satisfied the ‘jeopardy to assets' test of Legend but that state of affairs disappeared following their appointment.
The company's lengthy status in provisional liquidation for the, now sole, purpose of restructuring through a white knight investment and a battle to convince the Hong Kong Stock Exchange to allow a resumption of trading, which is inconsistent with Legend, were increasingly untenable before the court.
The Hong Kong judge was asked to adjourn the winding-up hearing further, whereafter the appointment of soft touch provisional liquidations was sought in Bermuda, with a subsequent discharge of the Hong Kong PLs and their appointment in Bermuda recognised in Hong Kong, allowing them to continue with the proposed restructuring and mitigating the impact of Legend.
The Companies Judge also directed the parties to consider how the recent Guidelines for Communication and Cooperation between Courts in Cross-Border Insolvency Matters formulated by the Judicial Insolvency Network could potentially be applied in this case. The guidelines aim to enhance efficiency in the administration of parallel insolvency proceedings by establishing a framework for close cooperation between courts of different jurisdictions.
- Table 3.3: Customer deposits by type, Monetary Statistics for March 2017, The Hong Kong Monetary Authority.
- See www.oro.gov.hk/cgi-bin/oro/stat.cgihttp://www.oro.gov.hk/cgi-bin/oro/stat.cgi.
- Re Legend International Resorts Ltd  2 HKLRD 192.
- See www.hkreform.gov.hk/en/implementation/.
- As summarised by Kwan J (as she then was) in Re Beauty China Holdings Ltd  6 HKC 351.
- Kam Leung Sui Kwan, personal representative of the estate of Kam Kwan Sing, the deceased v Kam Kwan Lai & Ors (FACV 4/2015, on appeal from CACV 266/2012, HCCW 154/2010).
- Shandong Chenming Paper Holdings Limited v Arjowiggins HKK 2 Limited (HCMP 3060/2016).
-  UKPC 36.
- The Joint Administrators of African Minerals Ltd (in administration) v Madison Pacific Trust Ltd and Shandong Steel Hong Kong Zengli Limited  HKEC 608.
-  HKEC 2516.
- Ibid. at paragraph 7.
- Bay Capital Asia LP v DBS Bank (Hong Kong) Ltd  HKEC 2377.
- For example: HCMP 2762/2015; and  HKCFI 203.
- Sea Assets Ltd v Penerbangan Garuda Indonesia  EWCA Civ 1696.
- For example:  UKSC 38.
-  2 HKLRD 192.
- Ibid. at paragraph 36.