Overview of Insolvency Law in Hong Kong

This paper sets out a brief overview of corporate insolvency law in Hong Kong and compares and contrasts the insolvency laws in Hong Kong with those of other jurisdictions. It was discussed at the Insolvency Session of the IATA Legal Symposium 2006.

Hong Kong Insolvency – Sources of Law

The principal legislation in Hong Kong relating to corporate insolvencies is the Companies Ordinance (Cap 32), which is supplemented by the Companies (Winding Up) Rules (Cap 32H). Some provisions of the Bankruptcy Ordinance (Cap 6) also apply to corporate insolvencies in Hong Kong.

Hong Kong also has a well-developed body of case law relating to insolvency as insolvency issues are often litigated in the Courts.

Compare/Contrast with Other Jurisdictions

• Terminology. Hong Kong’s legal system is based on the English law system and as such there are many similarities with the insolvency procedures available in the UK. Unlike the US, the term “bankruptcy” is only generally used to refer to individual debtors. When talking about corporate insolvency, the terms commonly used are “liquidation” or “winding up”.
• No implementation of UNCITRAL Model Law. Hong Kong has no statutory equivalent to the Chapter 15 procedures available in the US and has not yet adopted the UNCITRAL Model Law on Cross-Border Insolvency. Hong Kong Courts do, however, generally recognise foreign liquidators and take a pragmatic approach to cross-border insolvency issues.
• No Chapter 11 procedure. Hong Kong also has no statutory equivalent to the Chapter 11 process available in the US. The closest equivalent to this process in Hong Kong is where Schemes of Arrangement are negotiated and approved by the Courts after the Company has been placed into liquidation.
• No administration. Hong Kong also has no statutory equivalent of the administration process available for restructuring companies in the UK. However, statutory measures such as provisional liquidation and schemes of arrangement can be used to assist in restructuring a company either before or after it has been placed in liquidation.
• No airline insolvencies in Hong Kong. There have been no instances of airlines becoming insolvent in Hong Kong in recent history. It is not surprising, therefore, that there is no legislation in Hong Kong specifically dealing with airline insolvencies, unlike in the US and Brazil. Insolvency issues for airlines in Hong Kong typically relate to the consequences of default by travel agents, which is discussed later in this paper in relation to receivership. [The insolvency of Oasis Hong Kong Airlines took place in 2008, after this paper was written. This is explored in Flying too low – Oasis and the airline industry (PDF, 340KB), published in Asian Counsel, October 2008.]
• Broad jurisdiction to wind up. The Hong Kong Courts have a broad jurisdiction to wind up companies in Hong Kong. This extends not only to companies which are incorporated in Hong Kong but also to overseas companies registered in Hong Kong and unregistered companies providing certain requirements are met. The three core requirements are that the company has a sufficient connection to Hong Kong, there is a reasonable possibility that the winding-up order will be of some benefit to the petitioner and that the Hong Kong Courts will be able to exercise jurisdiction over one or more persons who have an interest in distribution of the assets. Given the number of carriers operating in Hong Kong, it is entirely possible that in the future a carrier may be wound up in Hong Kong whether or not Hong Kong is its place of incorporation.

Options for Creditors in event of Insolvency

If a company in Hong Kong appears to be in financial difficulty, creditors have a number of different options available to them, including:

1. Appointing a receiver over the company or some of its assets;
2. Negotiating a restructuring or workout arrangement with the company and its other creditors;
3. Applying for a provisional liquidator to be appointed before a winding-up order is made;
4. Having the Court sanction a scheme of arrangement agreed between the company and its creditors; or
5. Winding up the company.

A combination of these options may be used by the creditor depending on the circumstances in which the debt arose and the approach taken by other creditors to any restructuring proposals.

Receivership

The creditor may appoint a receiver over assets of the Company pursuant to a debenture or contract or may apply to the Court for a receiver to be appointed. The receiver’s job is to collect, protect and receive property and collect income from property. The scope of the receiver’s powers is limited to those set out in the Order or contract. Their appointment may be over the company’s whole business or specific assets only and they generally have no right to manage the company unless this is expressly provided for in the contract.

Receivers may be appointed by the Court for a variety of reasons including if the company is incapable of managing its own affairs, to protect and preserve assets for creditors or in relation to a shareholder dispute. The Court may appoint a receiver under s21L of the High Court Ordinance, s168A of the Companies Ordinance or under the inherent jurisdiction of the court. A receiver appointed by the Court is an officer of the Court and is not an agent or trustee of the party at whose instance the appointment was made. The receiver may pay the money received into Court or as the Court may direct.

In Hong Kong, receivership is a useful tool which we have employed on a number of occasions to recover ticket proceeds from travel agents who have defaulted or become insolvent. All IATA travel agents are party to the IATA Passenger Sales Agency Agreement (PSAA). The PSAA contains an express trust clause, which provides that all monies collected by the agent under the agreement are the property of the carrier and must be held by the agent in trust for the carrier. This express trust clause was upheld in Stevens Travel Service International Pty Limited v Qantas Airways Limited (1988) (12 NSWLR 331).

Under Hong Kong law, monies which are held on trust belong to the true owners, in this case the airlines, and do not form part of the assets of the company. If a travel agent defaults, IATA can rely on this clause to apply to the Court for a receiver to be appointed over bank accounts of the company to identify and recover any ticket sale proceeds which may still be held by the company. If a receiver is appointed immediately, they are often able to quickly identify ticket sales proceeds amongst the company assets and recover these for the airlines.

Restructuring and workouts

Although Hong Kong does not have an equivalent to the US Chapter 11, it is not uncommon for creditors of a large company in financial difficulty to attempt to negotiate an informal restructuring agreement with the Company. This generally requires the co-operation of all of the major creditors of the company as, if one of the creditors proceeds to wind up the Company, any agreement reached is likely to be set aside. Statutory procedures such as provisional liquidation and schemes of arrangement can also be used to help implement a restructuring proposal.

Provisional liquidation

Provisional liquidators may be appointed to preserve assets in the period between the date that the petition is filed and the date on which any order is likely to be made. It is also quite common for provisional liquidators to be appointed to facilitate a restructuring proposal which may be being negotiated between the creditors and the Company. The use of provisional liquidations in pursuance of restructurings is a good example of the flexibility of the Hong Kong Courts to develop insolvency law where legislation is sometimes slow to act.

An application to appoint a provisional liquidator may be made any time after a petition is issued although in some cases the application may be filed at the same time as the petition. The provisional liquidator’s powers are limited by the terms of the order.

To justify appointment of a provisional liquidator, the applicant must show that

• there is a reasonable prospect that the winding up petition will succeed, and
• there are sufficient circumstances justifying the appointment, for example if there is a risk that assets will be dissipated before a winding-up order is made. Factors taken into account by the Court include commercial realities, the degree of urgency, the need for the Order and the balance of convenience.

Schemes of Arrangement

Schemes of Arrangement are governed by Section 166 of the Companies Ordinance. They are a useful corporate restructuring tool as they enable a company to make a compromise arrangement with its creditors and members, which if approved by the Court is legally binding. Arrangements may include variations of contractual terms, for example freezing of payment of interest or capital; exchanges of debt for equity in related companies; or payment to unsecured creditors to compromise debts outstanding.

The Court has an ultimate discretion whether to sanction any scheme of arrangement and will consider whether the requirements of the Companies Ordinance have been complied with, whether the majority proposing the Scheme is acting bona fide and if the arrangement is fair to all creditors in the circumstances. If there are different classes of creditors, for example, contingent or unsecured, each class is required to hold separate meetings to discuss the proposals.

The advantage of a Scheme is that application can be made to the Court if the Scheme is approved by a majority of the creditors (50% of the creditors in number and 75% of the creditors in value attending the creditors meeting) and will be binding on all creditors if sanctioned.

It is not as effective as Chapter 11 as secured creditors retain veto power over the restructuring process because there is no mechanism to compel an unwilling secured creditor to agree to any modification of its contractual rights. The Scheme also doesn’t bind actions of future creditors who may commence action against the company.

Liquidation/Winding up

If all else fails, the creditor may choose to proceed to wind up the Company. Liquidation proceedings in Hong Kong are commenced by filing a winding-up petition. As in the US, the date of the winding up is the date of the petition, not the date the winding-up order is made. There is also an automatic stay of any Court proceedings against the Company once a winding-up order is made.

• Role of the Liquidator. The Official Receiver or appointed liquidator becomes trustee of the assets of the Company and is charged with investigating the affairs of the Company, winding up its business, realizing the assets and distributing dividends to interested parties.

The liquidators may investigate transactions or payments made by the Company within a certain period prior to the date of winding up to determine whether these transactions should be avoided or reimbursement of any payment claimed on the basis it was an unfair preference; an extortionate credit transaction; or constituted fraudulent trading.

The liquidator may also disclaim any contracts which the Company is no longer able to support or may help broker a scheme of arrangement if it appears to be in the interests of the creditors compared to the likely dividend on winding up.

• Debts and Distribution of Assets. The ability to recover debts owed by the Company differs depending on whether the debts are secured or unsecured or, as in the IATA travel agents case, if the monies are held on trust and do not form part of the assets of the Company. Secured creditors may choose to release their security and make a claim in the liquidation (known as a proof of debt) or can file a proof of debt for any amount still owing after the security has been realised. The proofs of debt filed will rank equally alongside those of the unsecured creditors.

Dividends will only be paid to unsecured creditors after payment has been made to preferential creditors and for the legitimate costs and expenses of the winding up.

Section 265 of the Companies Ordinance sets out a list of preferential payments and the priority in which those amounts will be paid from the company’s unsecured assets. Broadly, the ranking is:

1. Fees and expenses properly incurred in preserving, realizing or getting in the assets of the company;
2. Payment of certain amounts owing to or relating to employees including unpaid wages, salaries, termination payments, employees compensation etc (this will often not amount to the total sum due to employees as the legislation provides for certain caps in this regard); and
3. Statutory debts due from the company to the government, which become due and payable within 12 months next before the date of the winding-up order, e.g. taxes and duties.

Only once all preferential payments have been made are general unsecured creditors eligible to receive dividends from the remaining unsecured assets. If monies are also due from the creditor to the company being wound up, certain rules as to set-off may apply.

Cross-Border Insolvencies

Hong Kong law does not currently recognise the UNCITRAL Model Law on cross-border insolvency. However, the approach taken by the Courts to cross-border insolvency issues has been fairly pragmatic and the Courts will recognise foreign liquidations and have regard to foreign restructuring arrangements which have been approved overseas when considering what steps should be taken in Hong Kong. It is generally accepted that although the Court retains a discretion the Court will recognise a judicially sanctioned foreign corporate debt-restructuring scheme in order to prevent a creditor from gaining an unfair advantage over other creditors who observe such a scheme.

Where there are a number of liquidators in different countries, the Courts encourage them to agree a cross-border protocol for dealing with assets of the company and claims by creditors. The need for intervention by the Courts will also be considered if Hong Kong is not the main jurisdiction for winding up. If, for example, there are no assets in Hong Kong and the Order is unlikely to be of benefit to any creditors an Order may not be appropriate.

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

Ian De Witt Partner | E-mail

Robin Darton Partner | E-mail

Sunny Hathiramani Partner | E-mail

Troy Greig Partner | E-mail

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