What is Insolvency?
Annual income twenty pounds, annual expenditure nineteen pounds, nineteen shillings and six pence, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six pence, result misery.
Charles Dickens – Mr Micawber in David Copperfield 1849.
Insolvency in Hong Kong, as anywhere, is when an individual or organisation can no longer meet its financial obligations to its creditors – in other words cannot pay their debts when they become due. Insolvency can arise from poor cash management, a reduction in forecasted cash inflow, an increase in cash expenses, trading losses, the loss of a major customer – there is usually no one cause, it’s often a multiplicity of reasons.
Hong Kong Insolvency Law for companies is primarily governed by the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32) and the Companies (Winding Up) Rules (Cap 32H), previously part of the Companies’ Ordinance.
Personal bankruptcy is regulated by the Bankruptcy Act (Cap 6).
Under Hong Kong Law the term ” liquidation” refers to companies, while “bankruptcy” refers to individuals. Hong Kong has no law similar to “Chapter 11” in the United States. Nor does Hong Kong have any modern legislation governing the restructuring of companies as in the UK or the the US. However, Schemes of Arrangement together with Provisional Liquidation can help restructure an insolvent company before it falls into liquidation.
Definitions of Insolvency in Hong Kong
There are two tests for insolvency: the cash flow and the balance sheet test.
Cash flow insolvency is the inability to pay debts as they fall due. For example, a person may own a large house and a valuable car, but may not have enough liquid assets to pay a debt when it falls due. Cash-flow insolvency can often be resolved by negotiation. For example, the bill collector may wait until the car is sold and the debtor agrees to pay a penalty.
Balance sheet insolvency is when a person or company does not have enough assets to pay all of their debts. The person or company might go into bankruptcy or liquidation, but not necessarily. Once a loss is accepted by all parties, negotiation is often able to resolve the situation without formal insolvency proceedings.
Insolvency can lead to formal insolvency proceedings, in which legal action will be taken against the insolvent entity and the assets are liquidated to pay off outstanding debts. It may even occur when the value of an entity’s total assets exceed its total liabilities (technical insolvency).
Mere insolvency does not provide sufficient grounds for creditors to petition for the bankruptcy of the borrower or force a liquidation of the entity’s or individual’s assets. But you need to know if you are getting close to insolvency and how to avoid it.
Before an insolvent company or person gets involved in formal insolvency proceedings, it is likely to be involved in informal discussions with creditors such as making alternative payment proposals as a way of avoiding formal insolvency.
Debtors as well as creditors may file a Bankruptcy petition with the Court in Hong Kong. For the individual an alternative to bankruptcy would be an Individual Voluntary Arrangement (IVA) The IVA helps avoid the stigma of bankruptcy, helps free the individual from the legal restrictions of bankruptcy and should allow the debtor to keep his or her job. (more on that here?)
Briscoe Wong Advisory has published a series of handy guides that will help you through the various procedures and requirements in an insolvency, bankruptcy or liquidation. You can find them here.