Resurrection of the Corporate Rescue Bill in Hong Kong

On 29 October 2009, the Hong Kong government formally announced a three-month public consultation on the review of legislative proposals on corporate rescue procedure. This consultation is the culmination of discussions following recommendations of the Task Force on Economic Challenges late last year that Hong Kong should reintroduce a corporate rescue procedure to assist companies facing financial difficulties.

The proposed rescue procedure will not be a US-style Chapter 11. Some reports have dubbed this “Hong Kong’s Chapter 11” but a debtor-inpossession is not envisaged by the proposals. Instead, a regime of “provisional supervision” by an appointed third party – similar to voluntary administration in the UK or Australia – is proposed.

Currently, the statutory rescue mechanism available to a financially distressed company is limited to the scheme of arrangement pursuant to section 166 of the Companies Ordinance (“CO”). Schemes of arrangement are generally quite complex and face the disadvantage of lacking a moratorium against creditors’ actions during the rescue period. In Hong Kong, a moratorium is imposed only when a winding up order is made or when a provisional liquidator is appointed. In recent years, the moratorium available to a company in provisional liquidation has proved useful for troubled companies seeking to restructure. Nevertheless, the criteria that the company has to be insolvent and the assets in jeopardy still have to be satisfied. Provisional liquidation may not be appropriate where a company is merely facing a short-term crisis, is not yet insolvent and there is no danger to its assets. Alternatively, troubled companies may try to come to an arrangement with their creditors by way of voluntary workouts, however, the risk is that there is no moratorium freezing creditors’ actions.

To address the deficiencies in the present regime, the government is revisiting previous reform proposals. The Companies (Corporate Rescue) Bill of 2001 (“the Bill”) will be used as the basis for the current review with some adjustments to address the concerns which stymied the Bill. The key features are described below.

 

Provisional Supervision

The proposed regime is to be called “provisional supervision”. This can be initiated by the company, its directors, provisional liquidators or liquidators by the appointment of a provisional supervisor. The regime applies to both local and non-Hong Kong companies formed or registered under the CO except for certain banking, insurance and securities institutions regulated by statutes which allow for the relevant authority to assume control when the entity is in financial difficulty. The provisional supervisor, who is an independent third party, has wide powers including the ability to manage and control the company, retain or dismiss directors and exclude creditors from the moratorium. To balance this, creditors are proposed to have more involvement in the rescue process and will have the ability to replace the provisional supervisor.

 

Moratorium

Similar to corporate voluntary administration in Australia, provisional supervision will have the advantage of a moratorium of up to 6 months. The moratorium begins upon the appointment of the provisional supervisor. During the moratorium, no application for winding up can be commenced or continued, receivers cannot be appointed and no proceedings or other process may be commenced or continued. Certain actions or transactions are exempted such as proceedings arising from regulatory actions under the Securities and Futures Commission Ordinance.

 

Employee Entitlements

A controversial issue under the Bill was that of employees’ entitlements. Proposals included according priority to these entitlements before the commencement of the provisional supervision, setting up a dedicated trust account to cover the entitlements and capping the amount in the trust account. The current options put forward for consultation include exempting employees who are owed wages or entitlements from the moratorium, according priority to employees’ debts and the setting up of a trust account for employee protected debts.

 

Insolvent Trading

An important feature that the Bill sought to introduce was the concept of insolvent trading, which was intended to be applicable to companies in general and not only in the context of provisional supervision. Insolvent trading occurs when a company incurs a debt at a time when it is unable to pay its debts as they fall due. Responsible persons such as directors, shadow directors or a member of senior management could be liable for insolvent trading if they 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, and that person failed to take any steps to prevent the insolvent trading. The Bill proposed that the knowledge to be held by the person should include a reasonable ground for suspicion. These provisions raised considerable debate as there would be serious implications for executives involved in the management of companies – they would risk exposure to personal liability when incurring credit at a time when the company is facing financial difficulties.

The government proposes to retain the concept of insolvent trading and to allow its application to directors and shadow directors but not senior management. Further, the government considers that in order to establish liability, a higher standard of requiring actual knowledge or reasonable knowledge should be adopted and that reasonable suspicion should not suffice. Secured Creditors The proposed rescue procedure is intended to minimise court involvement and provides for greater involvement of creditors including a right of veto by the major secured creditor who will have the ability to end a rescue arrangement. The Bill has proposed that a “major secured creditor” be the holder of a charge, fixed or otherwise, over the whole or substantially the whole of the company’s property or the holder of two or more charges, whether fixed or otherwise, where the property is the whole or substantially the whole of the company’s property.

 

Comment

The resurrection of the corporate rescue reform is an important development for Hong Kong. While the proposal continues to receive opposition and criticism, particularly from trade unions who consider that employees are still not adequate protected, it could be that as early as late 2010, Hong Kong may possess its own statutory rescue regime which will bridge the gap for viable companies facing short-term financial difficulties.