Seven things directors should keep in mind as the company circles insolvency: the view from Hong Kong

The impact upon the economy as a result of COVID-19 sees no signs of abatement in the near-term and not a single sector of industry has been spared.  Economic data shows that GDP declines in real terms, along with private expenditure.

Perhaps some of the rounds of stimulus distributed by the HKSAR Government will help cushion the local economy, but in any event any recovery will be patchy at best with some sectors facing a much longer period of uncertainty than others.

For the foreseeable future directors will continue to face the difficult task of balancing their core legal duties to the company (e.g. to act in the company’s best interests) with the ever-present interests of its creditors.

Directors[1] should keep the following in mind:

1. You may be held personally liable for fraudulent trading

At times of financial distress the temptation is for a director to allow the company to incur one or more liabilities in order to ‘keep the company afloat’.  Whilst there is no statutory prohibition against trading while insolvent, a director must consider and act in the interests of creditors as a whole rather than shareholders when causing the company to incur liabilities.

The bottom-line is that creditors have an interest in the assets of a company approaching or in insolvent liquidation.  The failure to take into account creditors’ collective interests near or during insolvency may have serious legal ramifications for a director.

A director has a statutory obligation to not carry on the business of a company with the intent to defraud its creditors, creditors of any other person or for any fraudulent purpose.

Put another way, a director who causes a company to incur a liability must honestly believe that the company would be able to satisfy it.  Otherwise the inference is that the director intended to use the company as an instrument of fraud, and it is open to a court to declare the director as being personally liable to pay any or all of the debts or other liabilities of the company.  There is no limit to a director’s personal liability.   

A breach of this obligation may involve a director or anyone who knowingly assisted, conspired or otherwise participated in, or deliberately or recklessly turned a blind eye to the intent to defraud.  Directors serving on boards should be particularly attentive to potential accessorial liability; you can be held liable for the acts of other directors if you were ‘put on notice’ of another director’s intent to defraud yet you took no action to intervene.   

2. You may be held criminally liable if you try to reduce the amount of assets available to pay the company’s creditors

A director or officer may be held criminally liable if he intends to commit fraud by taking steps to put the company’s assets out-of-reach of its creditors, or otherwise impairing the value of such assets in the event the company is wound up.

Such conduct includes transferring, gifting or charging the company’s assets, or concealing or removing any part of its assets before or any time after the date of an unsatisfied judgment or order for the payment of money by the company.

3. You may be ordered to compensate the company because of certain conduct even if you are no longer a director  

A current or past director or officer who is guilty of any misfeasance, breach of duty or breach of trust with respect to the company, or has misappropriated or retained or become accountable for any of the company’s money or property can be ordered to:

• repay or restore the money or property to the company with interest;
• otherwise compensate the company as the court thinks just.

Misfeasance or breach of duty may include the failure to take into account creditors’ collective interests near or during insolvency, or to exercise care, skill and diligence in the management of the company.

Not all decisions by a director or officer will be of benefit to the company.  The law recognises the balance between risk and reward, and gives latitude to the proper exercise of business acumen.

You are more likely to be found liable if you make a decision that no ordinary business person in the same situation would make, or you fail to pay attention to surrounding circumstances (including seeking professional advice where appropriate).  In broad terms, the greater the risk the more appropriate it will be to seek professional advice.

4. You may be held criminally liable for failing to ensure the company kept proper records

A current or past director or officer who fails to ensure that the company has kept proper accounting records for a period of up to 2 years prior to winding-up is guilty of a criminal offence punishable by imprisonment and a fine.

Here proper accounting records are those set out in statute, but essentially includes those records which provide clear information about the company’s transactions and the financial position and performance generally.       

5. It is an offence to falsify, destroy and/or withhold information from liquidators, or otherwise improperly deal with the company’s property   

A current or past director or officer which is being wound up must not, among other things:

• fail to disclose information regarding the assets of the company to the liquidator, save for any assets sold in the ordinary course of business;
  
• fail to deliver up the company’s assets in his custody or control to the liquidator when asked or required by law to do so;
  
• conceal any part of an asset of the company valued at HK$100 or more within 12 months prior to or any time after the winding up of the company;
  
• conceal, destroy, mutilate or falsify (or is privy to such conduct) within 12 months prior to or any time after the winding up of the company;
  
• make a material omission in any statement of affairs of the company.
  
  Any person found guilty of such an act is liable to be punished by imprisonment and a fine. 

6. You may be disqualified from acting as a director for a substantial period of time

A person may be disqualified from acting as a director or be prevented from acting in that capacity for up to 15 years.  This extends to the creation, management or promotion of a company, and entities incorporated within or outside of Hong Kong.

In the context of a winding up, you will be at risk if you are a past or present director or officer and:

• you are found liable for fraudulent trading;
• you are found liable for fraud or breach of duty;
• you are deemed “unfit” to be concerned with the management of a company (there is no statutory definition, but the court will adjudge the accused’s conduct against standard norms of conduct for directors).

7. Employees

Wages must be paid not later than 7 days after the last day of a wage period.

Failure to comply with this obligation without a reasonable excuse is a criminal offence punishable by imprisonment and fine.

A company being in financial difficulty is not a reasonable excuse.

Ian De Witt and Troy Greig

If you would like to discuss any of the matters raised in this article, please contact:

Disclaimer: This publication is general in nature and is not intended to constitute legal advice. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.

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[1] in this article includes shadow and de facto directors, as well as officeholders who participate in the wrongful conduct.