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Liquidators & Committees of Inspection

Posted on by morgan Posted in Companies (Winding-up and Miscellaneous Provisions) Ordinance (Cap 32), Companies Ordinance, Liquidators

By Stephen Briscoe

Conduct of the Winding Up

Committee Of Inspection

As part of the proposed changes, the Administration has made a number of sensible suggestions that are likely to improve the interaction between liquidators and Committees Of Inspection.

For the sake of clarity, the new proposals will provide for the minimum and maximum number of members to be set at three and seven respectively, for both voluntary and compulsory liquidations, with the power for the court to vary these numbers.

The draft legislation will also allow meetings of the CoI to be held in two or more places at the same time through the use of technology. Written notice of meetings of the CoI can be given by the liquidator by electronic means and the proposals will also allow for written resolutions to be passed by a majority of the members of the CoI.

Whilst seemingly obvious, these changes simply reflect the reality of the way in which much of the business of a CoI is presently conducted.

At the moment, although a CoI can approve the remuneration of the liquidator, it is not in a position to approve the remuneration of the liquidators’ agents – usually solicitors employed to assist the liquidator. Instead, it is necessary for these fees to be sent to the Court for taxation. This is both a time consuming and potentially costly process which also delays the administration of the estate.

It is proposed that in future it will only be necessary to send the agents fees for taxation if they cannot be determined by agreement between the liquidator and the CoI. It seems however that it will still be necessary for them to be subject to taxation when they are working for a provisional liquidator appointed pursuant to s.193.

Electronic Communications

The present insolvency provisions of the Ordinance stem from a time in the dim and distant past when computers did not even exist. As said previously, they are based on the 1948 Companies Act from the UK. All communication with creditors was mandated to be in writing as in reality there was no alternative. However, the Administration has recognised that it is appropriate to bring the legislation into the 21st-century by, among other things, allowing liquidators to communicate with stakeholders by electronic means. The Administration says that it intends these proposals to be flexible, but they will also give stakeholdes the opportunity to opt to continue to receive information by “snail mail”.

The difficulty faced by the Administration is how to craft flexible procedures which are commensurate with ensuring all stakeholders are kept advised of progress, but which at the same time are able to accommodate future methods of communication, some of which probably do not exist at the moment. It will be a difficult task and as they say, “the devil is in the detail”.

Voidable Transactions

Transactions At An Undervalue

The concept of a “transaction at undervalue” has been part of Hong Kong personal insolvency legislation since 1998. At long last, the Administration proposes introducing the same concept to corporate insolvency. The provisions will allow a liquidator to go back as far as five years to review what a liquidator considers to be suspicious transactions whereby “the consideration received by the company is ‘significantly’ less than the value of the consideration provided by the company“. In other words, if an asset is sold for a figure materially less than its true value the transaction will be susceptible to challenge and may be overturned.  Quite rightly, the Administration does not seek to put numbers on “significant” or “material” as every case will have to be treated on its merits. However, from a practical and commercial point of view, a starting figure of 15% -20% less than an asset’s true value may not be too far off the mark.

To establish that it is a transaction at an undervalue, it will be necessary for the liquidator to establish that at the time it took place the company was insolvent or became insolvent as a result. If the transaction took place with an associated party, there will be a presumption that the company was insolvent at the time of the transaction.

We understand that the new ordinance will contain definitions of what constitutes connected or associated parties, separate from those presently contained in the Bankruptcy Ordinance, thus avoiding the problems that this currently creates in the area of unfair preferences.

It is important to be clear that the proposals are not intended to attack transactions that have been entered into by the company in good faith and for fair value. Rather, the intention is to attack those transactions which are clearly not in the interests of creditors generally.

Unfair Preferences

As indicated previously, the current provisions regarding unfair preferences are flawed, primarily because of the cross-references to the Bankruptcy Ordnance when defining connected persons. At long last, the Administration has decided to introduce a “stand-alone” definition of connected persons which will apply to liquidations that will not make any cross reference to the Bankruptcy Ordinance, and which hopefully will remove the limits placed on the effectiveness of the current unfair preference provisions caused by previous poor drafting.

As part of this, the Administration has produced a definition of “persons who are connected with a company” and “associates” which largely follow the current provisions of s.50B of the Bankruptcy Ordinance. However, instead of adopting the requirement of “one third or more of the voting power” for determining control of a company when defining an associate, the Administration has decided to adopt the requirement of “more than 30%” thus aligning the new provisions with those of the new Companies Ordinance and the Stock Exchange listing rules.

The next post will deal with a variety of issues including invalid floating charges, public and private examinations and possible claims arising from a buy-back of shares out of capital. The final post will then deal with what we think is missing from the current round of proposals.

When is a Liquidator Not a Liquidator?

Posted on by morgan Posted in Liquidators, Receivers

By Stephen Briscoe

Inducements

Together with the changes mentioned in our previous post, the proposals will also “beef-up” the existing prohibition on inducements being offered in relation to the appointment of provisional liquidators, liquidators and receivers. These amendments are to be welcomed, but in truth there is little evidence that the existing provisions do not already contain sufficient powers to deal with any such inducements. In fact, there is no indication that it has ever been necessary to invoke the existing provisions.

What Is The Definition Of A Liquidator

One issue that has come to the fore in recent years relates to the definition of who is a liquidator. In practice, this has come into question as a result of two cases where provisional liquidators were appointed pursuant to s.193, and where for a variety of reasons they realised significant assets before the winding-up order was made, and where the compulsory liquidations were then converted to creditors’ voluntary liquidations pursuant to s.209A .  In simple terms, the argument was whether a provisional liquidator appointed under s.193 of the Ordinance automatically became its liquidator on the making of the winding-up order.

The need for clarification arose  because if he remained the provisional liquidator, and the liquidation was subsequently converted into a creditors’ voluntary liquidation, there was a strong argument that the Ad Val fee, payable as a percentage of realisations, was not payable on the realisations made by the provisional liquidator.

Continue reading “When is a Liquidator Not a Liquidator?” »

Potentially Voidable Transactions in Hong Kong Liquidations

Posted on by morgan Posted in Liquidation

By Wong Teck Meng

In recent months we have come across several situations where directors of companies have got themselves into difficulties – simply because they were trying to help the company get out of its difficulties. In this post we will explain how those difficulties arose and offer some practical advice as to how directors and other potential lenders can avoid getting themselves into these situations.

It is not uncommon for directors of a company, when it is in financial difficulties, to advance funds to the company in the hope that it can avoid going into liquidation. This is all well and good and directors should be encouraged to support an ailing company in the hope that its fortunes can be turned around. The problem arises when directors fail to seek professional advice prior to advancing money to an insolvent company, but then at the first opportunity are repaid, often in priority to the general body of creditors.

Continue reading “Potentially Voidable Transactions in Hong Kong Liquidations” »

More Disclosure by Liquidators of Hong Kong Companies Ordinance

Posted on by morgan Posted in Companies (Winding-up and Miscellaneous Provisions) Ordinance (Cap 32), HKICPA, Liquidators, Receivers

More Disclosure for Liquidators; Should Insolvency Practitioners be Licensed? – (The Correct Answer is Yes!)

By Stephen Briscoe

Who Can Act As A Liquidator

This section of the Administration’s proposals focuses on the appointment and control of provisional liquidators and liquidators. There are a number of sensible suggestions about establishing those categories of people who should not be able to act in either capacity. The stated intention is to disqualify from acting, people who might have a conflict of interest in taking up such appointments. In practice, these categories are not significantly different to those already established by the HKICPA in its guidelines dealing with professional ethics in liquidation and insolvency.

The proposals are more equivocal when it comes to who might be appointed as a receiver and unfortunately leave open the possibility that with the approval of the Court, someone who had acted as receiver of a company could subsequently be appointed as its liquidator. Whilst acknowledging the checks and balances that automatically come with an appointment by the Court, there remain strong arguments for simply prohibiting such appointments. It is just impossible to see how a liquidator can properly investigate the actions of a receiver when he is one and the same.  As Homer Simpson would say – DOH!!!!

Disclosure Requirements For Prospective Liquidators

The proposals will also require future liquidators to positively confirm to all the stakeholders that they do not have a conflict of interest when it comes to acting as liquidators. This is a welcome development as the necessity of making that written statement, which must be presented to the meeting of creditors, should serve to ensure that before accepting an appointment, proper consideration has been given to the issue of any potential conflict of interest. Putting something in writing confers much more responsibility than simply going through the thought process.

As with all these proposals, it will be necessary to look carefully at the wording of the draft legislation. The current proposals appear to focus on situations where a proposed liquidator may have a conflict of interest because of work that he or his firm have previously done for the company i.e as auditors or financial advisors; or situations where the proposed liquidator may have a personal or family relationship with the company or someone at the company. However, another potential issue which arises is whether or not such a conflict would be perceived to have arisen as a result of a creditor putting a liquidator in funds to investigate the affairs of a company. On the face of it, this does not create a conflict, but the question that may arise is whether or not the proposed liquidator should disclose any funding arrangement, particularly in light of the proposed criminal sanctions associated with non-disclosure.

Should These Amendments Be Part Of Primary Legislation

Two issues come immediately to mind in respect of the proposals that relate to who may be appointed as a liquidator and their fitness to be appointed.

Much of what is suggested is to be included in amendments to the primary legislation. The problem with this approach is that Hong Kong’s record of amending primary legislation with any degree of urgency, is not good. Witness for example the current unfair preference provisions, first implemented in 1998. Soon after their implementation it became very clear that there was a lacuna in particular insofar as a subsidiary company was not deemed to be “associated” with its parent company. This was a problem because even if a parent company (which of course controls its subsidiary) caused the subsidiary to enter into transactions that in other circumstances would be considered to be unfair preferences, it would not be possible (where the transactions took place more than six months before the start of the liquidation), for a liquidator to unwind those transactions because the parent company was not considered to be an associate – clearly not what was envisaged when the legislation was enacted. It could and should have been easy for emergency legislation to be introduced to remedy this defect. This happens in other countries. However, nothing was done in Hong Kong and the defects in the legislation remain to this day. Updating legislation relating to corporate insolvency is not a sexy subject, and the chances of amendments to primary legislation being pushed through, even if the legislation is flawed, seem to be somewhat slim.

The suggestion has been that detail of this nature should be included in the subsidiary legislation, which in theory is easier to amend. Unfortunately, the Administration remains of the view that these detailed provisions should be part of the primary legislation.

Licensing Of Insolvency Practitioners

In many other common law jurisdictions, the issue of the control of insolvency practitioners is dealt with through a licensing regime. Whilst a number of suggestions were made in support of a licensing regime being introduced in Hong Kong, the Administration has made it clear that this is not an option. From the perspective of an insolvency practitioner this is, to say the very least, unfortunate. The HKICPA has in place a rigorous insolvency diploma course and it is difficult to see why this could not be used as the basis for some form of regulation of insolvency practitioners. Rather than consider this option, the Administration summarily dismisses the possibility of a licensing regime in one short paragraph claiming, with no supporting evidence, that Hong Kong’s population of insolvency practitioners is too small and therefore it would not be cost-effective to have a licensing regime.

In the next post we will look at the definition of a liquidator – yes, in the past it has been an issue; and the welcome changes to the operation of Committees of Inspection.

Bankruptcy Discharge – Thorny Issues

Posted on by morgan Posted in Bankruptcy, Hong Kong

By Stephen Briscoe

Prior to 1998 it was relatively rare for a person who was made bankrupt in Hong Kong ever to get their discharge from bankruptcy. This was because they had to satisfy a number of strict criteria, which for most bankrupts were impossible to achieve.

With the introduction of the automatic discharge provision in 1998 most bankrupts became eligible to get their discharge four years after the bankruptcy order was made. However, in recent years the Court has, on a number of occasions, had to consider various issues relating to the discharge provisions.

First were the provisions relating to the travel restrictions placed on bankrupts insofar as they impacted on the timing of a bankrupt’s discharge. The Court of Final Appeal ruled these to be unconstitutional and are dealt with in more detail here.

Next came the question of the discharge of bankrupts who were out of Hong Kong at the time the bankruptcy order was made and who never returned, and those who left Hong Kong after the bankruptcy order was made. As we set out in this post, the Court of Appeal also considered these provisions to be unconstitutional, although this issue is likely to go the Court of Final Appeal for a definitive decision.

In the light of other recent decisions it is therefore worth considering another thorny issue regarding discharge – when someone, usually the trustee, objects to the automatic discharge.

Continue reading “Bankruptcy Discharge – Thorny Issues” »

Constitutionality of Bankruptcy Discharge Provisions Challenged (update)

Posted on by morgan Posted in Bankruptcy, Bankruptcy Amendment Ordinance, Companies Ordinance, Hong Kong

By Rosenna Mak

Just a brief update on our article entitled “Constitutionality of Bankruptcy Discharge Provisions Challenged” published last month reporting that section 30A(10)(a) of the Bankruptcy Ordinance had been ruled to be unconstitutional by the Court of Appeal.  Due the significance of that ruling, a stay of the execution of the judgement was granted, pending the determination of the Official Receiver’s application for leave to appeal to the Court of Final Appeal.

We understand that the Official Receiver has now filed an application for leave to appeal to the Court of Final Appeal.  Due to the importance of the issue at hand, we anticipate that leave will be granted and the case should be heard by the CFA – probably towards the end of this year.  We will update you on further developments as and when they happen.

 

 

Winding Up – Moving Colonial Legislation into the New Century

Posted on by morgan Posted in Companies Ordinance, Insolvency, Provisional Liquidators, Winding Up

By Stephen Briscoe 

The existing provisions dealing with the winding-up of companies in Hong Kong are still largely based on the 1948 Companies Act from the UK. Of course, there have been changes over the years, but generally these haven’t been material and so we continue to use the legislation first enacted almost 70 years ago and probably written 20 years before that!

Whilst the legislation itself is relatively robust, it was of course never designed to deal with many of the types of companies trading in the early part of the 21st-century, particularly those in industries which could never have been dreamed of 70 years ago. Moreover, the legislation could never have envisaged the types of communications we have available to us in this day and age. Accordingly we remain tied to ’snail mail” for most, if not all of our communications.

In 1998, the Law Reform Commission Report on the winding-up provisions of the then Companies Ordinance was published with a number of very sensible suggestions as to how the legislation could be modernised. Unfortunately, that report was consigned to the cupboard to gather dust and was effectively ignored with the result that the legislation continues unchanged to this day.

As part of the Administration’s review of the Companies Ordinance generally, there has been a further review of the winding-up provisions and in April 2013 it published a consultation document entitled “Improvement of Corporate Insolvency Law – Legislative Proposals”. The purpose of this review was to suggest ways in which the legislation could be updated to resolve certain lacunas which had come to light and to modernise the legislation to make it more “fit for purpose” for the 21st-century. Whether the new proposals which have been put forward and which will form the basis of a bill scheduled to go before Legco in 2015, achieve that is for you the reader to decide. In order for you to consider the question, over the next few weeks, we will publish a plain English summary of the Administration’s proposals, together with our comments and in particular with reference to areas where we believe more could have been done or where we just plain disagree!

The Administration’s review has come up with key areas where it believes change is needed. These are:

  • Commencement of the Winding-up;
  • Appointment, Powers, Vacation of Office And Release of Provisional Liquidators and Liquidators;
  • Conduct of the Winding-up; and
  • Voidable Transactions, Investigations and Offences during the Winding-up.

We will take a look at each of these areas with specific reference to the Administration’s proposals, key comments which came to the fore during the consultation process, the government’s response to those comments and, where appropriate, where we believe the changes go too far, do not go far enough or are simply misconceived.

We will also comment on some of the most glaring omissions from the proposals of which ufortunately there is a number.

We will start this week with the commencement of the winding-up. The Administration’s proposals deal with three key areas.

Continue reading “Winding Up – Moving Colonial Legislation into the New Century” »

Small Practitioners – Stealing a Marketing March

Posted on by morgan Posted in Insolvency, Marketing

By Stephen Briscoe

This article is reprinted with permission from INSOL World magazine

This is the first of  two articles written from the perspective of a small firm practitioner working in a close-knit, but highly competitive market.

It is a fact of life that smaller firms do not have the financial “clout” to challenge their larger competitors, particularly when it comes to marketing their skills and services. The advantages they do have are flexibility and nimbleness. My own experience of working for a “big four” firm, albeit a number of years ago, was that trying to convert marketing ideas into actions could be extremely time consuming and not a little frustrating. Innovative marketing ideas tended to suffer “death by a 1000 cuts” when submitted to the committee system that seemed in those days to be how the larger firms operated. (Maybe they still do!!)

A smaller firm has the ability to take an idea, develop it and implement it within a relatively short time frame. It is necessarily the case that some of  these initiatives do not come to fruition because sometimes our ideas, however clever, are not capable of implementation and so they fall away. At the same time our ability to develop and implement new technological solutions to our workflows, to our administrative processes and to developing more efficient working methods remains unhindered by the bureaucracy which unfortunately is prevalent in many larger firms.

This article will explore some of  the non-technological ways in which small firms can differentiate themselves from their larger competitors, whilst the second will look at how technology and the internet (no, not just social media!) can be used by specialist boutique firms to give them a competitive advantage in the market.

I would hasten to add that none of this is rocket science! Some readers will already do all this and more and if  they do I hope that they will be willing to share their experiences with us. I hope that for others this will be a reminder of the fact that however small we are, we are still capable of  leveling the playing field with our larger brethren.

In many jurisdictions, professionals, be they bankers, solicitors or accountants often have a requirement to undertake continuing professional development courses with the aim of accumulating a particular number of CPD hours every year. For insolvency practitioners, the opportunity to present on these courses is a very cost effective piece of marketing. Not simply do you only have to prepare for one presentation but the chances are that you will be in front of 20, 30, 40 or more potential work providers – all in one go. I would be the first to admit that not everyone who comes to these courses is particularly interested in the subject matter (I’ve known one person sit at the back working on his laptop throughout), although insolvency and corporate recovery related courses are usually perceived as being more interesting than the general run-of-the-mill courses offered by CPD providers.

Nonetheless, this is a golden opportunity to impress groups of fellow professionals, not only with your presentation skills but, more importantly with your technical knowledge. On occasions, members of the audience are willing to participate in quite wide-ranging and interesting discussions based on their personal experience and this generally gives the insolvency practitioner the opportunity to display his breadth of knowledge, rather than simply speaking to a set of slides. These interactive passages also garner more interest on the part of the general audience who consequently are more likely to remember the presenter i.e. you!! I have lost track of  the number of  occasions on which, at the end of the presentation, a member of the audience has come up to me and asked a very specific question, clearly based on a matter they are currently dealing with. The standard response is to have an outline discussion on a no-names basis, but to indicate that for more specific advice, bearing in mind that pretty much everything we advise on is fact specific, it would be best to sit down with the client for an initial meeting. When this offer is taken up, it creates a further opportunity to differentiate the firm from its competitors by showing technical expertise and commercial acumen in terms of seeking solutions to the problems they are presenting.

Many law firms conduct their own internal CPD courses. In my experience these firms welcome external presenters going to their offices to present on a specific insolvency or corporate recovery related subjects. This gives them free CPD hours for a number of their staff. However, it gives the insolvency practitioner the opportunity to develop deeper and wider relationships with that firm. Moreover, it is quite easy to re-purpose the material used for external CPD providers for internal training purposes. To extend this even further, it is a small step to providing the same, or a similar presentation, to numerous different firms over a period of several months.

Thus it is possible to utilise one presentation on multiple occasions to broaden your range of contacts. The one downside to this process is that by the time you have started doing the presentation for the 12th or 13th time it’s easy to get bored with the sound of your own voice! But it’s a small price to pay.

Another extremely cost-effective and useful form of marketing for smaller firm insolvency practitioners is writing articles for professional publications that are likely to be seen by work providers in your jurisdiction. Generally these articles will be on a specific issue; quite possibly on a topical issue relating to new legislation or a recent decision which has important repercussions for the industry. Again, as a small firm practitioner it is much easier for you to sit down and pen a meaningful article and arrange for its publication, than it is for one of your competitors in a larger firm who will have to have the article checked and double-checked before it can be released into the wild. Being in the public eye so to speak, and communicating to potential work providers your technical, commercial and personal skills, which can be used to solve their client’s problems, has become known as “thought leadership”.

Whilst this is little more than a badge to describe what to many people are standard marketing activities, these are certainly effective and inexpensive ways of establishing our credentials and encouraging work providers to come knocking on our door rather than on the door of one of our larger competitors.

See original article published March IW Q4 2014

Constitutionality of Bankruptcy Discharge Provisions Challenged

Posted on by morgan Posted in Bankruptcy, Bankruptcy Amendment Ordinance, Hong Kong

S.30A(10)(a) of the Bankruptcy Ordinance is Challenged – Unconstitutional

 By Stephen Briscoe  and Rosenna Mak

A few months ago, we published an article entitled “Discharge from Bankruptcy or Trustee Forever” where we discussed the position of the release of a trustee when the debtor was not in the jurisdiction at the time of the bankruptcy order and who does not return. We concluded that it was unlikely that a trustee would be released in those circumstances. Following the recent Court of Appeal decision in Re Chang Hyun Chi, that s.30A(10)(a) of the Bankruptcy Ordinance (“BO”) is unconstitutional, it appears that position has changed, although it is possible the decision may be subject to a further appeal to the Court of Final Appeal.

First a reminder of the core issue. Pursuant to s.30A(10)(a) of the BO, the bankruptcy period does not start running if a bankrupt has left Hong Kong before the commencement of the bankruptcy and has not returned to Hong Kong. The period only starts to run when the bankrupt returns to Hong Kong and notifies the trustee. In Re Chang Hyun Chi [2013], the Court of First Instance confirmed this point. The Honourable Mr Justice Chung was of the view that s.30A(10)(a) of the BO was not unconstitutional and so the bankrupt would not be discharged. The Court of Appeal has now ruled to the contrary and declared that s.30A(10)(a) of the BO is unconstitutional in light of the “right to travel” provisions of the Basic Law and the Bill of Rights.

The main reason behind the unanimous decision of the Court of Appeal relates to the “proportionality of the restriction” and it follows the same rationale as the Court of Final Appeal decision in Official Receiver & Trustee in Bankruptcy of Chan Wing Hing and Anor v Chan Wing Hing and Anor & Secretary for Justice (2006) where s.30A(10)(b)(i) of the BO was declared unconstitutional because the restriction on the bankrupt’s right to travel was considered more than necessary.

In this case, it was agreed that the same reasoning is equally applicable to s.30A(10)(a) of the BO because the trustees and creditors do have the right to object to the automatic discharge of a bankrupt should the bankrupt not cooperate. Accordingly, the bankrupt was confirmed as having been discharged on the expiration of the four-year period from the date of the bankruptcy order.

The decision, if it stands, does however raise an interesting moral question:  does it mean that a bankrupt can escape from his/her duties and liabilities by leaving Hong Kong prior to the making of a bankruptcy order and then returning to Hong Kong after four years from the date of the bankruptcy order (assuming a first-time bankruptcy)? Our initial view is yes and no. Yes because ultimately the bankrupt will be discharged – and No because objections by the trustee can mean that the period of discharge may be extended up to eight years.

Nevertheless, it seems that the decision may give some clarity to the release of trustees in bankruptcy where the bankrupt falls within the provisions of s.30A(10)(a) of the BO. Given that a bankrupt can be discharged after the four year period (assuming a first-time bankruptcy) even if he/she is not in Hong Kong during the whole of the four year period, there would now seem to be no reason not to allow a trustee to get his/her discharge.

In view of the significance of this ruling, a stay of the execution of the judgement of the Court of Appeal was granted pending the determination of the Official Receiver’s application for leave to appeal to the Court of Final Appeal.

We will update you when there are further developments regarding the anticipated appeal.

Insolvent Trading – The Last Piece of HK’s Corporate Rescue Puzzle

Posted on by morgan Posted in Companies (Winding-up and Miscellaneous Provisions) Ordinance (Cap 32), Insolvent Trading, Provisional Supervision

By Stephen Briscoe

In the eyes of many people in Hong Kong, the most important part of the new corporate rescue legislation is that relating to Insolvent Trading.

Very similar to Wrongful Trading in the UK, the purpose of this legislation is to encourage directors of distressed companies to act sooner rather than later, and by doing so to protect the interests of creditors. If they don’t, it gives the power to a liquidator to apply to the court for a declaration that the director can be personally liable for some or all of the company’s debts that have been incurred because the company continued to trade whilst it was insolvent.

What Is Insolvency

It seems that the proposed legislation will adopt the current insolvency test from the Companies (Winding-up and Miscellaneous Provisions) Ordinance, being a mixture of the cash flow test (the inability to pay its debts as and when they are due);  and the balance sheet test (not having sufficient assets to pay its debts in full). In other words, if a company fails either of the two tests, it can be deemed to be insolvent.

Who Could Be Liable

These new provisions would apply to both directors and “shadow directors” as currently defined by s.2 of the Companies Ordinance. A shadow director is generally viewed as being someone “upon whose instructions the company is accustomed to act.”

What Is Insolvent Trading

Insolvent trading takes place where:

  • a company is insolvent (using either of the two tests);
  • it continues to trade and incur further debts; and
  • the director knew or ought to have known that the company would not be able repay those debts.

In other words, if the director:

  • allows the company to continue trading;
  • it incurs further debts which it is unable to pay; and
  • it then goes into insolvent liquidation;

there is a possibility that the director(s), (or shadow director(s) as the case may be) could be made personal liable for some or all of the debts incurred.

In determining the knowledge of the director as to whether or not the company was insolvent at the time, the director will be judged on the basis of:

  • the general knowledge skill and experience that can reasonably be expected of a person carrying out the same functions as carried out by that director in relation to the company; and
  • the general knowledge skills and experience that the direct actually has.

If the legislation is enacted as envisaged it will inevitably put greater pressure on directors who “should know better” than to allow a distressed company to continue trading without considering the position very carefully. At the same time, given recent case law, particularly that in particular the disqualification of directors, it appears unlikely that a director will be able to hide behind the excuse that he did not have sufficient information to be aware of the company’s position; (he should have made himself aware of the Company’s financial position); nor will he be able to hide behind the excuse that he did not have the necessary skills and experience; (in that case, he should not have been acting as a director in the first place).

Possible Defences

As with the legislation in the UK, it seems that the key defence that a director will be able to put forward is that he took all reasonable steps to prevent the company from incurring the debts referred to. It is also envisaged that if the director has taken steps to seek to rescue the company, possibly through the new provisional supervision process, that this will similarly constitute a defence to an insolvent trading case.

It is also likely that a good defence to an insolvent trading claim would be that the director, whilst allowing the company to continue to trade, took all the necessary steps to improve the company’s position; to return it to profitability; to reduce costs and to take such steps as were appropriate to improve as far as possible the position of the unsecured creditors.

Compensation

It is important to appreciate that an insolvent trading application can only be made by the liquidator of the company. The legislation only “kicks in” once the company has gone into insolvent liquidation. Importantly, the proposed legislation specifies that any compensation would not be subject to any pre-exising legal charge over the assets of the company, whether that be either a fixed or a floating charge, and would thus be available for the benefit of the unsecured creditors of the company.

Conclusion

When these provisions were first suggested, it was envisaged that “senior management” would also be subject to possible insolvent trading claims. For a variety of reasons, which make sense, that provision has now been removed from the draft legislation.

However it is imperative that the current version of the legislation is not watered down when it comes before LegCo.

Provisional supervision and insolvent trading go hand-in-hand. They form a “carrot and stick” approach.

The carrot for directors is that if the company is in difficulties they now have a formal corporate rescue process, that is provisional supervision, which can be utilised to create a moratorium to give the company or part of its business an opportunity to be rescued in one form or another.

The stick is that if the directors do not act in a responsible manner, i.e. when faced with an insolvent company, among other things they:

  • allow it to continue to trade;
  • to incur further credit which they know or must reasonably believe is not going to be paid;
  • where they cannot reasonably believe that it can avoid insolvent liquidation;
  • where they themselves benefit from the continuation of trading, particularly through the continued payment of their remuneration when creditors remain unpaid;

then they face the prospect of having personal liability imposed on them by the courts in respect to the debts of the company.

The hope is that the enactment of a robust Insolvent Trading regime will contribute materially towards the improvement of corporate governance in Hong Kong.