Hong Kong’s Provisional Supervision Plans, in Plain English

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By Stephen Briscoe

Hong Kong’s proposed new legislation on Provisional Supervision and Insolvent Trading has been in the pipeline for the last 20 years or so but before groaning “Oh no, not again,” this time there seems to be a genuine will on the part of the Administration to press ahead with bringing it back to LegCo in a workable form and maybe even passing it before the end of the 2016 session.

This series of posts will explain in plain English how the process is intended to work but will be interspersed with thoughts and observations on some of the issues that still don’t appear to have been fully thought through. Some of these issues may be addressed when the bill is drafted but experience tells us that there will be many issues that will require clarification by the courts in due course.

In 1986 the UK introduced the Administration process as part of the Insolvency Act. As late as 2002 the UK courts were still being asked to interpret aspects of the legislation. I’m sure that Hong Kong will be no different. I fully expect that my many friends in the legal profession will certainly benefit from the new legislation when it’s eventually introduced.

The Scope

These posts will deal with:

  • the appointment of a provisional supervisor, including who is appointed;
  • the duties and powers of the provisional supervisor;
  • how is it envisaged the process will work from the time of the appointment to the final meeting of creditors;
  • the still thorny (although slightly less so now) issue of how employees will be treated;
  • the construction and contents of the voluntary arrangement proposals;
  • and finally, the meaning of the insolvent trading provisions, which if passed, should, for the first time in Hong Kong, give real power to the courts to impose personal liability on directors of insolvent companies in circumstances where they have failed to address those problems on a timely basis.

However, before saying more it is important to emphasise that this legislation is not, repeat not, Hong Kong’s answer to the US Chapter 11 process. Unfortunately, whenever the question of provisional supervision is discussed in the local media there is always someone, and quite often it’s someone who should know better, who will liken the process to Chapter 11. Agreed, the hoped-for outcome, that is the rescue of a company; the saving of its business; the retention of employment etc, all of which benefit the stakeholders, is the same in either process.

The fundamental difference is that under the Chapter 11 process, existing management, that is management that has often been responsible for the company getting into its current difficulties, remains in control of the business (at least certainly at the start of the process), whereas in the provisional supervision process, control and management of the company is handed over to a professional, experienced in these matters, whose role is to ensure that the it operates in a transparent manner and that the interests of the creditors of the company are properly protected.

An Overview of Provisional Supervision

The intention behind the provisional supervision process is to provide a distressed company with a viable option for turning itself around and rescuing its business as opposed to going into liquidation. It is envisaged that the process will be supervised by an independent third party, (the provisional supervisor), whose initial role will be to safeguard the business and assets of the company, consider options for its rescue and put proposals to its creditors in the form of a voluntary arrangement. All this will be driven by a tight timeframe, set out in the legislation, and designed to ensure that the process proceeds in a timely manner.

Once the provisional supervisor has been appointed, a moratorium will come into force which will, in effect, prevent creditors from taking action against the company, unless there are exceptional circumstances, whilst the provisional supervisor formulates a rescue plan.

To protect the interests of the employees of the company, there are built-in safeguards to ensure that they are no worse off than they would be if the company went into liquidation. The intention is that this procedure, which will predominantly take place out-of-court, will be more cost-effective and faster than the current forms of corporate rescue available in Hong Kong at the moment.

Appointment and Formalities

For a company to avail itself of the protection afforded by the appointment of a provisional supervisor it will need to show that it is insolvent or is likely to become insolvent. The insolvency test can be satisfied by using a mixture of the cash flow test and balance sheet test as set out in section 178 of the Companies (Winding Up and Miscellaneous Provisions) Ordinance.

The appointment of a provisional supervisor can be either by the company (likely to be the most frequent manner of appointment), or by a liquidator or provisional liquidator if one has already been appointed. If the appointment is by a liquidator or provisional liquidator it must be with the consent of the court and then, the appointment must take place within ten business days of the court order.

In either case, however, it will be necessary to have the prior written consent of the major secured creditor before an appointment can take place. The proposed wording is not dissimilar to that used in England and Wales in respect of the appointment of Administrators under the original provisions of the 1986 Insolvency Act.

The definition of major secured creditor is “the holder of a charge, whether 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 on the company’s property where the property subject to those charges constitutes the whole or substantially the whole of the company’s property”.

In previous incarnations of this bill, major secured creditors were given a short period following the appointment of the provisional supervisor in which to object to the appointment. This would have raised the possibility of a provisional supervisor being appointed and then having to vacate office if the major secured creditor objected either to their appointment or to the appointment of anyone as a provisional supervisor.

This amendment resolves that potential dilemma, but still leaves one outstanding issue which, subject of course to the eventual wording of the bill is likely to require clarification by the courts at some later date. This potential difficulty relates to a creditor who has a charge, but where the charge has no economic value. It is often the case that the assets of the company which are subject to the first charge are of insufficient value to meet the amount outstanding to the charge holder. Even if a second charge holder comes within the above definition, would he still have the ability to prevent the appointment of a provisional supervisor even though his security has no economic value?

The next article in this series will deal with the appointment of the provisional supervisor, his powers, duties and responsibilities and, most worrying from a potential provisional supervisor’s point of view, the personal liabilities to which he may be subject, simply by carrying out the task of trying to rescue the company!