Latest Developments in Hong Kong Restructuring Law

In summary

This article introduces the possible features of the new corporate rescue bill and the courts’ rulings in respect of interactions between winding-up petitions and arbitration agreements, and the general principles in recognising and assisting foreign insolvency proceedings in Hong Kong.

Discussion points

• Development of the corporate rescue legal framework in Hong Kong
• Interactions between winding-up petitions and arbitration agreements
• Recognition of foreign insolvency proceedings
• No approval for an examination that constitutes a fishing expedition
• Recognition of foreign provisional liquidators appointed on a soft-touch basis
• Recent developments on sanctioning schemes of arrangement

Referenced in this article

• Legislative Council Panel on Financial Affairs, Consultation Conclusions on Corporate Insolvency Law Improvement Exercise and Detailed proposals on a new Statutory Corporate Rescue Procedure, 7 July 2014
• Re Southwest Pacific Bauxite (HK) Ltd
• But Ka Chon v Interactive Brokers LLC
• Dayang (HK) Marine Shipping Co, Ltd v Asia Master Logistics Ltd
• Re CEFC Shanghai International Group Ltd
• Re Joint Liquidators of Supreme Tycoon Ltd
• Re A Civil Matter Now Pending in United States District Court for the Western District of Washington
• Re Joint Provisional Liquidators of Moody Technology Holdings Ltd
• Re the Joint and Several Provisional Liquidators of China Oil Gangran Energy Group Holdings Limited
• Re China Singyes Solar Technologies Holdings Ltd

Introduction

As a special administrative region of the People’s Republic of China under the ‘one country, two systems’ principle, Hong Kong retains a common law legal system that is different from the system of law in mainland China.

As one of the world’s leading international financial centres, Hong Kong is a prime location for financial services and home to many financial institutions. With minimal government intervention, Hong Kong’s financial markets operate under effective and transparent regulations that are in line with international standards and have attracted foreign investments from investors around the world.

In the meantime, Hong Kong also plays a vital role in offshore fundraising for Chinese enterprises. As at the end of 2019, a total of 1,231 mainland companies were listed in Hong Kong, comprising H-share, red-chip and private companies, with total market capitalisation of around US$3.4 trillion, or 73 per cent of the market total.^[1]

The promulgation of the Outline Development Plan for the Guangdong-Hong Kong-Macao Greater Bay Area on 18 February 2019 further signified Hong Kong’s role as the ‘super connector’ in the development of the Greater Bay Area. It is expected that Hong Kong, with the full support of the central government, will proactively integrate itself into the overall national development, thereby generating new impetus for growth to bring new development opportunities to different sectors of the community.^[2]

Development of the corporate rescue legal framework in Hong Kong

In Hong Kong, corporate insolvency is primarily governed by the remaining provisions of the old Companies Ordinance, renamed as the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32), as amended by the Companies (Winding Up and Miscellaneous Provisions) Amendment Ordinance, which came into effect on 13 February 2017 (the Amendment Ordinance). At present, there is no statutory restructuring procedure available under Hong Kong law, but it is possible for creditors of a Hong Kong company to negotiate an informal contractual restructuring agreement with the company, which will in general require the cooperation of all creditors of the company as any one creditor may still exercise its right to wind up the company. It is only possible to achieve a corporate rescue of a financially distressed company in Hong Kong through an out-of-court workout, a scheme of arrangement or following the appointment of provisional liquidators, which leaves the company’s creditors with limited options to rescue the company in times of financial difficulty.

With the impact brought about by the covid-19 pandemic, the number of corporate failures is expected to increase. In March 2020, the Hong Kong government announced that the drafting of the new corporate rescue bill has reached an advanced stage, and it intends to hold a fresh round of consultations on specific areas in the draft bill, with the aim of finalising the bill for introduction to the Legislative Council in the first half of the 2020/2021 legislative session.^[3] In light of this, it is worth revisiting past developments of the corporate rescue legal framework in Hong Kong.

In October 1996, the Law Reform Commission of Hong Kong published the Report on Corporate Rescue and Insolvent Trading, and the Companies (Corporate Rescue) Bill (the Bill) was proposed as a new part of the then Companies Ordinance in 2001. However, owing to the complexity of the legislative proposals and non-consensus among various stakeholders, the Bill was not enacted and lapsed in 2004.

In 2009, after the global financial crisis, the Hong Kong government decided to take action to reform the corporate rescue law. In October 2009, the Financial Services and Treasury Bureau issued a new consultation paper on the conceptual framework and key issues relating to the introduction of provisional supervision as a corporate rescue procedure in Hong Kong. Despite the general support from a majority of responses submitted during the consultation, there were a few proposals that drew disparate views from stakeholder groups.

In July 2014, the Hong Kong government published detailed legislative proposals on the introduction of a new statutory corporate rescue procedure and insolvent trading provisions (the 2014 Proposal).^[4]

In February 2017, the Amendment Ordinance came into effect, which provided greater protection for creditors in the course of a winding-up by, among other things, introducing stand-alone provisions on setting aside transactions at an undervalue or unfair preference and extending the relevant period for invalidating a floating charge created in favour of a connected person.

In regard to the Hong Kong government’s announcement on the proposed introduction of a new corporate rescue bill, the details are yet to be released. It is possible that the new bill may resemble the 2014 Proposal. As such, it may be useful to recap the key features of the 2014 Proposal.

Initiation of process

The 2014 Proposal suggested that the corporate rescue process may be initiated by the company (either by resolution of its members or directors) or by the provisional liquidator where the company has already entered the winding-up process through the appointment of a provisional supervisor if it is of the opinion that the company is insolvent or likely to become insolvent. It also proposed that if a company seeks to commence the process by appointment of a provisional supervisor, it must obtain the prior written consent of its major secured creditors, or if it does not have any major secured creditors, consent from all its secured creditors.

Moratorium

Under the 2014 Proposal, the moratorium on legal actions and proceedings against the company lasts for 45 days, starting from the date that the provisional supervisor is appointed, thereby allowing the provisional supervisor to formulate a voluntary arrangement proposal to creditors and to restructure the company’s finances. The creditors may vote to extend the moratorium for up to six months. The exemptions from the restrictions against a new claim or winding-up petition include those for employees’ outstanding entitlements and unfairly prejudicial claims by minority shareholders. The moratorium does not prohibit set-off against the company and allows the enforcement of contractual terms that provide for the termination of contract upon specific events.

Employees’ outstanding entitlements

The 2014 Proposal suggested a phased payment schedule for outstanding employees’ entitlements to ensure that employees would be no worse off than in the situation where the company goes into immediate insolvent winding-up. However, there were concerns that those provisions would overly favour the employees and would diminish the chances of rescuing the company’s business, or that the corporate rescue process would delay repayment to employees when compared to payments under the Protection of Wages on Insolvency Fund^[5] in the event of winding up.

Appointment, duties and powers of the provisional supervisor

It was proposed that certified public accountants and solicitors with practising certificates would be qualified to be appointed as provisional supervisors, and any complaint against the provisional supervisor’s conduct in the corporate rescue process would be addressed to the Hong Kong Institute of Certified Public Accountants or the Law Society of Hong Kong as appropriate. The provisional supervisor would be required to provide a declaration of relevant relationship and a declaration of indemnity to enable the creditors to make an informed decision on whether his or her appointment is appropriate.

During the period of provisional supervision, the provisional supervisor would become an agent of the company and assume control of its business affairs and property. He or she would also be empowered to, among other things, appoint and remove directors of the company, request for a statement of affairs of the company, execute documents, bring or defend proceedings and seek directions from the court in the company’s name and on its behalf. As a check-and-balance measure, the 2014 Proposal also suggested that the court may, on application by an eligible party, examine the conduct of the provisional supervisor for misfeasance or breach of duty and, where appropriate, make an order against him or her as it sees fit.

Treatment of secured creditors

Under the 2014 Proposal, secured creditors were divided into ‘major secured creditors’ and ‘other secured creditors’. The prior written consent from a major secured creditor, which was defined as the holder of one or more charges, whether fixed or otherwise, over the whole or substantially the whole of the company’s property, is required for the commencement of the corporate rescue procedure. In the absence of a major secured creditor, a company would have to obtain consent from all its secured creditors to initiate the process.

Insolvent trading provisions

Another legislative addition under the 2014 Proposal was the introduction of insolvent trading provisions, under which a director or shadow director may be held personally liable to certain debts of the company in liquidation that continued to trade and further incurred debts while insolvent if the director knew or reasonably ought to have known that the company would not be able to repay those debts.

In determining whether the director concerned had knowledge on whether the company was insolvent at the time, the director will be judged based on the general knowledge, skills and experience that can reasonably be expected of a person carrying out the same functions as are carried out by that director in relation to the company and that the director actually has. A possible defence would be that the director had taken all reasonable steps to prevent the company from incurring the debt, or that the incurring of the debt is part and parcel of the steps taken by the director concerned to initiate the corporate rescue procedure.

It remains to be seen the extent to which the above-mentioned key features of the 2014 Proposal would be included in the upcoming new bill, and how the government would address the concerns by various stakeholders in the previous legislative exercise. If the legislation is enacted as envisaged under the 2014 Proposal, a financially distressed company would be given the option to initiate the corporate rescue procedure with a view to turning around its business as much as possible instead of pursuing winding-up immediately. The directors of those companies would also have to consider the financial position of those companies carefully before allowing them to continue to trade.

Recent developments on the interaction between winding-up petitions and arbitration agreements

As an international arbitration hub, and with growing policy emphasis on the use of arbitration, the Hong Kong Court has seen a growing number of winding-up cases where the parties’ underlying agreement contains an arbitration agreement. The impact of such an arbitration agreement on the Court’s discretion to grant a winding-up order has been reviewed by the Court.

Traditional approach

Traditionally, the courts will only dismiss a winding-up petition in favour of arbitration if the opposing debtor is able to prove that it has a bona fide defence on substantial grounds to the underlying debt. This is because winding-up petitions are considered as a class remedy available to all creditors and do not involve the enforcement of a creditor’s rights against the debtor. In practice, the courts will grant the creditor’s application to wind up the debtor if the debtor has failed to pay a debt without a credible defence, without requiring the parties to commence arbitration (the traditional approach).

Re Southwest Pacific Bauxite (HK) Ltd

In 2018, Mr Justice Jonathan Harris, being the judge in charge of the Companies Court, in Re Southwest Pacific Bauxite (HK) Ltd,^[6] broadly followed the English Court of Appeal’s approach in Salford Estates (No 2) Ltd v Altomart Ltd (No 2),^[7] giving substantial weight to the policy consideration underlying the Arbitration Ordinance (Cap 609), which encourages and supports party autonomy in determining the means by which a dispute arising between them should be resolved. Citing the related authorities, Harris J held that the courts should generally dismiss an insolvency petition in favour of arbitration when the following three requirements are met:

• the opposing debtor disputes the petitioning debt (it is sufficient for the debtor to show that the debt is not admitted);
• the contract under which the petitioning debt is alleged to arise contains an arbitration clause that covers any dispute relating to the debt; and
• the opposing debtor takes steps required under the arbitration clause to commence the contractually mandated dispute resolution process (the Lasmos approach).

Under the Lasmos approach, the debtor is able to stay insolvency proceedings in Hong Kong simply by not admitting the underlying debt, and force the creditor to arbitrate, even though there is no ‘real’ dispute about the debt. The ruling in the Lasmos case establishes a substantial obstacle to winding-up petitioners where the underlying agreements contain an arbitration clause.

But Ka Chon v Interactive Brokers LLC

In mid-2019, the Lasmos approach was further considered in But Ka Chon v Interactive Brokers LLC ^[8] by the Court of Appeal on an obiter basis. In light of the statutory right conferred on creditors to petition for the winding up or bankruptcy of an insolvent debtor, the Court of Appeal took the view that such right is part of Hong Kong law, and absent any evidence of the legislative intent of the Arbitration Ordinance to change the insolvency legislation, the Lasmos approach represents ‘a substantial curtailment’ of creditors’ statutory rights by requiring the courts to exercise the discretion only in favour of arbitration except in wholly exceptional circumstances if the three requirements are met. Although it remains to be seen how the Court of Appeal will rule in the future, and each case would be decided based on its facts, these obiter remarks indicate that there is a possibility that it may not follow the Lasmos approach.

Dayang (HK) Marine Shipping Co, Ltd v Asia Master Logistics Ltd

Recent developments in respect of the issue of winding-up petitions with the existence of an arbitration agreement in the underlying contract have shown that the court has shifted from the traditional approach to the Lasmos approach and then back to a more moderate approach in the But Ka Chon case. In a recent judgment in Dayang (HK) Marine Shipping Co, Ltd v Asia Master Logistics Ltd ^[9] on 12 March 2020, Deputy High Court Judge William Wong SC deviated from the Lasmos approach and held that to dispute the existence of a debt, a debtor must show there is a bona fide dispute on substantial grounds, and a bare denial or non-admission of the debt is not enough regardless of whether the debt has arisen from a contract incorporating an arbitration clause. Further, the court must exercise discretion irrespective of whether there is an arbitration agreement, and commencing arbitration proceedings itself is not sufficient proof of the existence of a bona fide dispute on substantial grounds, but may constitute relevant evidence of such a dispute.

The court in the Dayang case relied primarily on the traditional approach in deciding in favour of the creditor. The court spent over three-quarters of the judgment reviewing the recent developments in this area. Although it did not come to a conclusion on the matter in the judgment, in spending much time analysing it, the court demonstrated a clear intention to resolve this issue. Therefore, we envisage that further developments in this area will be forthcoming.

Recognition of foreign insolvency proceedings

In recent years, the Hong Kong Court has extensively granted recognition and assistance orders, most commonly to facilitate debt restructuring of Hong Kong listed companies incorporated in an offshore jurisdiction.^[10]

However, in Re CEFC Shanghai International Group Ltd,^[11] it was for the first time that the Court granted an order for recognition and assistance to mainland liquidators of a mainland China-incorporated company.

It was held that two criteria must be satisfied before recognition and assistance is granted to insolvency proceedings opened in a civil law jurisdiction. First, the foreign insolvency proceedings are collective insolvency proceedings. Second, the foreign insolvency proceedings are opened in the company’s country of incorporation.^[12]

Further, the Court noted that there are principles that circumscribe the common law power of assistance that could be exercised:

1. The power of assistance exists for the purpose of enabling foreign courts to surmount the problems posed for a world-wide winding up of the company’s affairs by the territorial limits of each court’s powers. Therefore, the power of assistance is not available to enable foreign office holders to do something which they could not do even under the law by which they were appointed.
2. The power of assistance is available only when it is necessary for the performance of the foreign officeholder’s functions.
3. An order granting assistance must be consistent with the substantive law and public policy of the assisting court.^[13]

The Court refused to follow the decision in Galbraith v Grimshaw,^[14] where the House of Lords chose not to stay a garnishee order application despite there being an appointment of trustee in bankruptcy. Had this case been followed, the effect would have been that no assistance would have been granted to the liquidators. It was explained by the Court that the decision in Galbraith is inconsistent with contemporary cross-border insolvency law, given that it was made well before the development on common law cross-border insolvency assistance.

Recognition of foreign voluntary liquidation

Contrary to the Privy Council’s obiter objection to recognising foreign voluntary winding up in Singularis Holdings Ltd v PricewaterhouseCoopers,^[15] the court in Re Joint Liquidators of Supreme Tycoon Ltd ^[16] held that the mere fact of a foreign liquidation being a voluntary liquidation does not prevent the court from recognising and assisting that liquidation under the principle of modified universalism.

In considering whether a foreign insolvent liquidation commenced by a shareholders’ resolution is eligible for common law recognition and assistance, the key issue for cross-border insolvency assistance is not whether the foreign insolvency office holder is or is not an officer of the foreign court. Rather what matters is whether the foreign insolvency proceeding is collective in nature in the sense that it is ‘a process of collective enforcement of debts for the benefit of the general body of creditors’.^[17]

Even though the company’s liquidation was commenced by a shareholders’ resolution, it was observed by the court that the company’s liquidation was a collective insolvent proceeding. Therefore, the court granted the recognition order sought to allow the liquidators appointed to investigate the affairs of the company.

However, where the foreign liquidation is a solvent liquidation that is more akin to a ‘private arrangement’ as referred to by the Privy Council in Singularis Holdings Ltd, it would not fall within the principle of modified universalism and, hence, would not be recognised or assisted by the court.

A similar approach was adopted in the recent English case of Re Sturgeon Central Asia Balanced Fund Ltd (No 2),^[18] where the court terminated the recognition order concerning a Bermuda solvent liquidation because the solvency liquidation falls outside the scope of the UNCITRAL Model Law on Cross-Border Insolvency in Great Britain.

No approval for an examination that constitutes a fishing expedition

In Re A Civil Matter Now Pending in United States District Court for the Western District of Washington,^[19] the court rejected two letters of request issued by the United States District Court, Western District of Washington at Seattle (the Washington Federal Court) seeking to compel two distressed debt investors in Hong Kong to appear and provide oral testimony regarding certain alleged receivables owing to a foreign company.

In arriving at the decision, the court pinpointed that the requirements under section 75 of the Evidence Ordinance (Cap 8) (EO) must be met before an order for the taking of evidence in Hong Kong is to be granted. The court must be satisfied:^[20]

1. that the application is made in pursuance of a request issued by or on behalf of a court or tribunal (the requesting court) exercising jurisdiction in a country or territory outside Hong Kong; and
2. that the evidence to which the application relates is to be obtained for the purposes of civil proceedings which either have been instituted before the requesting court or whose institution before that court is contemplated.

Considering the above, the court stressed that the discovery was sought against persons who were not party to the judgments made by the Washington Federal Court and was for the purpose of ‘plotting the course’ of unspecified, possible future proceedings. Hence, the proposed examination was found to be a pretrial discovery, which was essentially a fishing expedition that ought to be prohibited under section 76(3) of the EO.

The significance of this case in the context of insolvency and restructuring is that if liquidators wish to seek an order from the Hong Kong Court for the taking of evidence pursuant to a foreign court’s request, they should be careful in respect of whether the Court will construe their application as a fishing expedition that may jeopardise the chance of success of their application.

Recognition of foreign provisional liquidator appointed on soft-touch basis

In recent cases, the Hong Kong courts have held that their lack of power to appoint provisional liquidators only for facilitating restructuring and corporate rescue (ie, on a soft-touch basis) does not prevent the courts from recognising and assisting foreign liquidators appointed for this purpose.

Re Joint Provisional Liquidators of Moody Technology Holdings Ltd

In Re Joint Provisional Liquidators of Moody Technology Holdings Ltd,^[21] the Hong Kong Court of First Instance granted a recognition order to foreign provisional liquidators, who were appointed on a soft-touch basis, to explore and facilitate the restructuring of a company. This order was made despite soft-touch provisional liquidation being impermissible in Hong Kong.

The joint and several liquidators (JPLs) of Moody Technology Holdings Limited (Moody), a company incorporated in Bermuda, were appointed by an order made by the Supreme Court of Bermuda (Bermuda Court). Moody’s JPLs applied to the Hong Kong court for recognising their appointment and powers as set out in the letter of request issued by the Bermuda Court.

Moody’s JPLs were appointed on a soft-touch basis to restructure Moody and its debts in Bermuda. The key question before the Hong Kong court is whether it should give recognition to Moody’s JPLs while under current Hong Kong law, according to the Court of Appeal decision in Re Legend International Resorts Ltd,^[22] soft-touch provisional liquidation is impermissible.

In this case, the court held that where circumstances warrant appointment of provisional liquidators, the provisional liquidators may be granted powers to explore and facilitate a restructuring of the company. The court discussed the rationale of granting those powers as follows.

First, it held that the purpose of recognising foreign proceedings is to enable the foreign office holders or the creditors to avoid starting parallel insolvency proceedings and to give them the remedies to which they would have been entitled if the equivalent proceedings had taken place in the domestic forum. It also emphasised that despite obtaining recognition and assistance from the Hong Kong court, the foreign office holders will not be acting as or acting in the capacity of, or have the status of, office holders appointed by the Hong Kong court. The fact that the Hong Kong court may not appoint domestic soft-touch provisional liquidators cannot constitute a bar to recognising and assisting foreign soft-touch provisional liquidators.

Second, the court held that cross-border recognition premised on universalism does not require foreign insolvency law and local insolvency law to be identical. In this case, failing to recognise foreign soft-touch provisional liquidation just because Hong Kong domestic law contains no such regime would be to fail to appreciate and apply the universalism rationale.

Lastly, the court held that recognising and assisting foreign soft-touch provisional liquidators is fully consistent with Hong Kong private international law principles and cross-border insolvency policy. Failing to do so would create a discriminatory environment that would be unjust, unprincipled and unsupported by authorities. Therefore, it held that regardless of whether a technical recognition order in Hong Kong is obtained, foreign provisional liquidators may promulgate a restructuring scheme of arrangement in Hong Kong.

Consequently, the court granted the recognition order.

Re the Joint and Several Provisional Liquidators of China Oil Gangran Energy Group Holdings Limited

In Re the Joint and Several Provisional Liquidators of China Oil Gangran Energy Group Holdings Limited,^[23] the Hong Kong court continued a trend of recognising foreign soft-touch provisional liquidators.

Joint and several provisional liquidators were appointed over China Oil Gangran Energy Group Holdings Limited (China Oil’s JPLs) by the Cayman court, with a view to pursuing a debt restructuring. China Oil’s JPLs applied to the Hong Kong court for recognition of their appointment.

The court considered the general principles of recognising foreign insolvency proceedings in Re CEFC Shanghai International Group Ltd, and its past practice of recognising foreign soft-touch provisional liquidation,^[24] and accordingly granted the recognition order.

These two recent decisions reflect the Hong Kong courts’ commitment to universalism and its position to facilitate cross-border restructurings. Although the Hong Kong courts may not appoint domestic soft-touch provisional liquidators, the same cannot constitute a bar to recognising and assisting foreign soft-touch provisional liquidators.

Scheme of arrangement

A scheme of arrangement in Hong Kong is an effective tool to compromise debts, even those governed by non-Hong Kong law despite the old common law Gibbs rule.^[25]

In Re China Singyes Solar Technologies Holdings Ltd,^[26] the Hong Kong court considered an exception to the Gibbs Rule and more generally the principles of sanctioning a scheme.

China Singyes Solar Technologies Holdings Limited (Singyes) is incorporated in Bermuda and listed in Hong Kong. In 2018, as Singyes and its subsidiaries’ financial condition seriously deteriorated, Singyes defaulted in its mainland China and offshore obligations, comprising convertible bonds and notes.

Singyes proposed a Hong Kong scheme, compromising convertible bonds governed by English law and notes governed by New York law (the Scheme). In considering whether to sanction the Scheme, the court considered whether the Scheme would be effective in the relevant jurisdictions.

The court concluded that the Scheme would be substantially effective in these jurisdictions even though there was no application to the English and US courts for recognition of the Hong Kong scheme. The court reasoned that the Scheme was effective in its place of incorporation because there was a parallel scheme in Bermuda. It also reasoned that although the convertible bonds were governed by English law, there was no need to seek recognition of the Scheme in England. This is because 100 per cent of the holders of the convertible bonds voted in favour of the Scheme, which constituted an exception to the Gibbs rule. In reaching this decision, the court considered the observation in Re OJSC International Bank of Azerbaijan:^[27]

[T]here is an exception to the rule if the relevant creditor submits to the foreign insolvency preceding. In that situation, the creditor is taken to have accepted that his contractual rights will be governed by the law of the foreign insolvency proceeding.

Therefore, the Scheme would be effective in England.

The court also accepted that there was no need to seek recognition of the Scheme under US law as more than 99 per cent of the noteholders had acceded to the restructuring support agreement and voted in favour of the Scheme. The remaining creditors had not come forward, and there was no reason to believe that any of them would try to enforce their pre-scheme claims in the United States. The court accepted that the risk of adverse enforcement by a dissenting scheme creditor in the United States was de minimis.

Ultimately, the court held that the guiding principle is that the court should not act in vain or make an order that has no substantive effect or will not achieve its purpose. The principle does not require worldwide effectiveness nor worldwide certainty. The court will sanction a scheme provided it is satisfied that the scheme would achieve a substantial effect. Although the Gibbs rule will continue to be valid in Hong Kong, this recent case shows that the rule is not a bar for parties to the success of cross-border restructuring.

Notes