Provisional Supervision And (More Importantly) Insolvent Trading

Provisional Supervision legislation has been talked about for many years and at long last it appears to be on its way. Government has issued its latest take on the issue and has indicated its intention to introduce a bill to Legco. As part of the bill there will also be the equally long awaited insolvent trading provisions, designed to allow personal liability to be imposed on directors of insolvent companies.

What follows is a brief summary of some of the major aspects of the legislation and the Government’s view on them as a result of the last 12 months or so of consultation. We also make a few of our own considered comments. If you would like to see the whole of the Government’s response it can be seen here.

Moratorium

The initial moratorium is to be extended to 45 days. It is expected that this will give the Provisional Supervisor (PS) sufficient time to put together a proposal for consideration by creditors. Creditors can approve an extension of the moratorium for up to 6 months, but any further extension will be subject to the approval of the Court on an application by the PS. If the PS’s proposals are not accepted, the company will go straight into liquidation.

Who Can Be a Provisional Supervisor

Only registered CPA’s and practising solicitors will be eligible to take up appointments as a PS – a rule that excludes some very experienced corporate rescue professionals – but which allows people who may know very little about the process to be appointed as a PS. This must be a cause for concern in view of the number of liquidators, many of whom are CPAs or solicitors, who have been removed as liquidators by the Court in recent years.

Employee’s Outstanding Entitlements

Historically, this has been the most difficult issue to deal with given the competing demands to protect the position of employees and at the same time create a workable corporate rescue process. The chosen option is inevitably a compromise and only time will tell if it will allow the provisional supervision procedure to successfully facilitate corporate rescue in Hong Kong. The final proposals look like this:

  1. Arrears of wages up to the commencement of provisional supervision should be paid up to the PWIF limit (i.e. $36,000 per employee) by the 30th calendar day after the commencement of provisional supervision;
  2. For employees whose employment had been terminated before the commencement of provisional supervision, any outstanding pay-in-lieu of notice and any severance payments should be paid up to the PWIF limits within: a) 45 calendar days after the voluntary arrangement has been approved; or b) if the initial moratorium period is extended, within 45 calendar days from the date of extension;
  3. Any remaining pre-commencement entitlements, (which we assume includes holiday pay) including outstanding employers’ contributions under either MPF or ORSO Schemes, must be paid in full within 12 months after the voluntary arrangement has come into effect;
  4. If the company fails to pay according to this timetable, the employees concerned will not be bound by the moratorium and may petition the court to wind-up the company; and
  5. To facilitate employees taking legal action against the company in case it fails to pay as set out above, the PS will be required to verify the details of debts owed to employees at the start of the provisional supervision with the employees concerned within 30 days after its commencement.

This appears to remain the key issue that is likely to limit the effectiveness of the bill. The problem continues to be, how can a company that is hopelessly insolvent come up with sufficient cash to meet employee liabilities, particularly those which have to be paid under (1) and (2) above, within such a tight timeframe. This is likely to limit the use of the legislation, as many companies will not have the funds available to satisfy these requirements. In those cases, the outcome is likely to be liquidation and the loss of jobs rather than the company being rescued.

Personal Liability for Provisional Supervisors

The PS will be personally liable for any pre appointment contracts that he adopts. He will also be liable for any rent due on property that he continues to occupy or have possession of after his appointment, unless he gives notice within 10 days of his appointment that he is not going to continue to occupy the property. He will not be liable for the first 10 days rent.

The potential liability for ongoing rent, in a city with such high rentals, is likely to act as a serious disincentive to accept any provisional supervision appointment where leased premises are involved, except in circumstances where the proposed PS is absolutely certain that he is not exposed to any personal liability.

Insolvent Trading

Insolvent trading provisions will be introduced which are crucial to the “carrot and stick” approach of the legislation. It will allow the imposition of personal liability for the debts of the company (or at least some of them) on directors who know their company is likely to go into liquidation but who at the same time allow it to continue trading. In the eyes of many, this aspect of the legislation is crucial to improving the quality of corporate governance in Hong Kong, by making directors more aware that they have a duty to take into account the interests of all stakeholders, creditors included, when their company is facing financial difficulties.

The Headcount Rule

There will be no headcount rule for voting at meetings at creditors. This is a positive move and could be a precursor to a similar change in the rules relating to Schemes of Arrangement, which still has the headcount rule as well as the requirement for a 75% majority in value. As a protection mechanism, it is proposed to refine the definition of “connected persons” to avoid proposals being pushed through by parties connected with the Company and/or its directors.

Conclusion

The Government has indicated that it will now incorporate the outcome of the consultation process into a draft bill, but as yet there does not appear to be a timetable for this.

The lack of a corporate rescue process in Hong Kong continues to be a major impediment to rescuing companies in distress. The stated intention to produce a draft bill for submission to Legco is progress indeed. However, some of the proposed solutions in relation to employees’ entitlements and the personal liability of the PS are such that the long-term success of provisional supervision, if the bill is enacted as written, is far from certain.

On a positive note, the insolvent trading provisions represent a definite move forward and should eventually result in greater returns to creditors of insolvent companies by persuading directors to address a company’s difficulties in a more timely manner than many do at the moment.

For more information contact:

Stephen Briscoe, Managing Director t: (852) 2899 2178
Wong Teck Meng, Executive Director t: (852) 2899 2125
Nichole Chan, Director t: (852) 2899 2067
Rosenna Mak, Manager t: (852) 2899 2734