THE LAW SOCIETY OF HONG KONG COMMENTS BY THE COMPANY AND FINANCE LAW COMMITTEE ("COMPANY COMMITTEE") AND THE INSOLVENCY LAW COMMITTEE ("INSOLVENCY COMMITTEE") ON THE COMPANIES (AMENDMENT) BILL 2000
1. Provisional Supervision and Voluntary Arrangements
The purpose of the Bill is not stated in its text. However, broadly
speaking, the main thrust of the Bill is to create a statutory
regime for corporate rescue, comparable to those which have been
adopted (with limited success) in other common law jurisdictions.
In summary, the Bill provides for a statutory freeze on individual
creditor enforcement and a power to bind dissenting creditors
into a rescue proposal. The Bill would give the directors and
shareholders of a company the power to initiate the new proceedings
without any supervision from the court. A "provisional supervisor"
is immediately appointed to take control of the company and a
statutory moratorium on creditors' claims (including security
enforcement) is imposed.
In general, the Company Committee is supportive of the proposal
to introduce an appropriate rescue procedure into Hong Kong law,
so as to bring Hong Kong into line with other jurisdictions. However,
the Company Committee does not consider that the Bill, in its
current form and without further amendment, would introduce an
appropriate, fair and workable procedure into Hong Kong law. There
are also serious doubts that its introduction would enable more
financially troubled companies to survive. The reasons are set
out below:
(a) Absence of court involvement
A striking feature of the Bill, in comparison to its cousins
overseas, is that it provides for very little court involvement
or other independent supervision as regards (a) entry into the
procedure, (b) conduct of the procedure and development of rescue
proposals, and (c) voting and binding minorities contrary to their
wishes and previous legal rights.
It is fundamental to the protection of the innocent that new
laws which, if implemented by certain members of the public (i.e.
directors or shareholders), would seriously affect the legal rights
of others, should contain appropriate safeguards to prevent abuse
and to ensure competing interests are fairly balanced. Such protections
would usually include the involvement of, or rights of appeal
to, the court or some other appropriate authority in various circumstances.
(b) he "Wild West"
The Companies Committee is concerned that, in practice, reputable
and experienced insolvency practitioners may be unwilling to accept
an appointment as provisional supervisor in many cases. This is
because the Bill imposes various personal liabilities automatically
upon the provisional supervisor, which would be payable by him
personally, regardless of whether there exists available funds
in the company. These liabilities include the wages of those employees
"kept on" by him during the rescue process and certain trade liabilities
incurred whilst keeping the company alive and its goodwill intact.
If experienced and reputable persons are not willing to take over
the running of a financially troubled company, the role would
likely be assumed, on a risk/reward basis, by less reputable characters
or, alternatively, fall upon the public sector.
(c) Usefulness
The Bill would not have any extra-territorial effect, so as to
afford protection to companies with assets in other jurisdictions
(e.g. Mainland China) or to groups of companies where various
companies in the group are incorporated or located overseas. Whilst
this would no doubt reduce the possibility of Hong Kong's laws
conflicting with those of other jurisdictions, particularly Mainland
China, it may nevertheless render the rescue procedure of limited
assistance to most companies or groups of companies currently
carrying on business in Hong Kong.
As business globalises, the Companies Committee wonders whether
it is "too late in the day" for the legislature to be seeking
to fill an age-old legislative gap by the introduction of a rescue
procedure which may only be of assistance to small, "old economy"
Hong Kong corporates.
(d) Fixed charge security
It is curious that the (unquantifiable) costs and expenses of
the provisional supervisor would rank ahead of fixed charge security,
whereas the costs and expenses of liquidation would normally rank
behind fixed charge security. This anomaly may be difficult for
lawyers to explain to their clients, since there appears no logical
justification for it. No doubt the financial community will make
separate representations on this point and as to the difficulties
they may face in the future when lending to Hong Kong companies
on a so-called secured basis.
Similarly, the invalidation of fixed charge security created
within 12 months of the commencement of the rescue procedure,
except to the extent of "new monies" provided, can be contrasted
with the position in liquidation where only floating charges can
be invalidated on such ground. Again, there appears no logical
justification for the distinction. Perhaps secured creditors may
even be prompted to seek an early liquidation of the company,
so as to preempt an invalidation of their security by the directors
or shareholders seeking to use the new rescue procedure.
(e) Drafting
Finally, the Bill is not particularly user-friendly and its drafting
contains numerous inconsistencies, ambiguities, and inadequacies.
These factors could exacerbate the costs of utilising the statutory
rescue procedure and may well provoke litigation. If possible,
these unnecessary features should be minimised by further work
on, and clarity in, the drafting of the Bill, with the assistance
of experienced and specialised external advisers if necessary.
2. Insolvent Trading
Generally, the Society welcomes the introduction of legislation
rendering directors and senior management accountable in respect
of their management decisions to a company's liquidator and/or
the court in the event of its insolvent liquidation.
In circumstances of potential insolvency, a well-advised director
would, of course, keep detailed records, minutes etc. so as to
ensure that he can justify his decisions and actions at a later
date if required. However, it must be recognised that during the
weeks or months prior to an insolvent liquidation, there will
usually be many pressures on the time and emotions of directors
and senior management. It should also be recognised that not all
directors or senior managers will have access to legal advice
on how best to protect themselves. There may be cases where directors
have insufficient time or forget to keep evidence of their personal
actions, whilst nevertheless acting responsibly and with creditors'
interests in mind. An unscrupulous liquidator, or a liquidator
supported by an unscrupulous creditor, could bring proceedings
against such individual and succeed.
Accordingly, the Company Committee's view is that the liquidator
should be obliged to prove more than merely "insolvent trading"
(i.e. that the company traded on having developed a cash-flow
problem), but actually that (a) there has in fact been a loss
suffered by creditors as a result of the insolvent trading, and
(b) the individual in question was in a position to influence
the direction of the company in a manner that may have avoided
such loss.
3. Specific Sections
(a) Section 168ZK Liability for certain contracts of employment
This section renders the provisional supervisor of a company
personally liable for "wages, salaries and other emoluments" under
contracts of employment. In the case of existing contracts, this
applies if they are accepted by the provisional supervisor within
14 days of the "relevant date" (i.e. date of commencing the provisional
supervision process).
If the existing contract is not accepted or is terminated within
the 14-day period, it is deemed terminated by the company on expiration
of that period. "Wages salaries and other emoluments" are then
deemed to be liabilities of the company that were incurred on
or after the relevant date. They are charged to be paid out of
the property of the company as a priority payment.
One of the arguments originally raised against this provision
was that many companies that seek the benefit of the moratorium
that applies in provisional supervision are likely to be at the
point where they are, in effect, insolvent and have little in
the way of funds or assets. The liability for these amounts therefore
means that in order to use the provisional supervision/voluntary
arrangement procedure, it would be necessary for a funding creditor
to advance funds to pay these amounts. This was considered likely
to limit the use of the new procedure.
The experience of members of the Insolvency Committee is that
creditors such as banks are not generally inclined to advance
further funds in these circumstances. If they do, they require
detailed information of the amounts that might ultimately be involved.
They also nearly always wish to assess the future prospects of
the company as a prerequisite to any funding decision. 14 days
is a very short period in which to gather information and make
these assessments. Troubled companies tend to have poor records
and it often takes weeks or even months to assess their true position.
For example, experience shows that most companies in difficulty
tend to retain their staff while in difficulty and keep salaries
up to date in order to avoid adverse publicity. But items such
as the payment of MPF (which is presumably an "emolument") where
there is unlikely to be any obvious evidence of default, are very
likely to have fallen into arrears. Often the amounts involved
are not readily ascertainable but they could be very substantial.
Unpaid VAT or national insurance in UK liquidations are examples
of this.
The effect of this provision is that unless the amount necessary
and the prospects can be ascertained within 14 days there will
be even fewer creditors willing to offer funding.
Provisional supervisors are therefore unlikely to be able to
make a decision on whether to retain employees within 14 days
of appointment and are likely to take the view that the only prudent
decision is to terminate if there is any doubt on this subject.\
The members of the Insolvency Committee consider that the general
use of provisional supervision as a way of preserving viable businesses
will be limited as a result of this provision. Neither is it likely
to preserve employment.
(b) Section 295
Under Section 295C the Court has the power to declare a "responsible
person" to be liable for insolvent trading.
Section 295C defines "responsible persons" as "directors and
shadow directors as in the equivalent UK legislation. However,
it also refers to "a manager of a company who is involved to a
substantial or material degree in directing the company's business
or affairs".
There is an exemption for managers in Section 295C(2)(a)(i) and
(ii) if they can satisfy the Court that before the relevant debts
were incurred, they issued a notice in the form specified in Part
2 of the Nineteenth Schedule to the Board of Directors of a company
stating that the company was engaged in insolvent trading and
attaching a copy of Section 295B or alternatively that they took
every step to minimise the potential losses to the company's creditors.
This provision was originally discussed in the Report of the
Committee at page 108 paragraph 19.32. It was thought that senior
management may know the financial position of the company as well
as directors and therefore there should be an obligation to warn
directors as soon as possible.
The members of the Insolvency Law Committee agree with these
general sentiments however they also consider that the addition
of managers who are "involved to a substantial or material degree
in directing the company's business or affairs" was imprecise.
Potentially, it exposes a range of persons with varying management
responsibilities within a company to a possible liability for
insolvent trading when they may not necessarily have a full or
complete picture of the company's true financial situation.
If managers are to be included as a category of person potentially
liable, it should be limited to the most senior management levels
where they have direct reporting responsibilities to the board.
Those managers' responsibilities should also include knowing the
company's overall financial position as part of their day to day
management duties.
It was also considered that in the case of typical smaller Hong
Kong companies an obligation of this type is unlikely to be particularly
effective. Even if it was most managers of small companies were
aware of their obligation and what it involves most would find
it difficult to serve notices on their directors. It would be
likely to create difficult personal situations and managers would
be inclined to desist for that reason.
While the Insolvency Committee agrees with the general objectives
of this provision they consider that it may not be workable in
Hong Kong at this time other than in the case of larger companies
and senior managers at the highest level where they report directly
to the directors and have responsibilities to know the company's
overall financial position.
(c) Section 228A
This is the section dealing with the commencement of creditors
voluntary liquidation by way of a resolution by directors which
is subsequently confirmed by a meeting of creditors. It has been
suggested that this is subject to abuse and this section has been
repealed in the Companies Bill 2000.
Abuse has always been offered as a reason to repeal this provision
however, relatively few specific examples have been cited.
The members of the Insolvency Law Committee take the view that
all liquidation procedures can potentially be the subject of abuse.
In the case of Section 228A there is always the safeguard of a
full creditors meeting where there is an opportunity to have a
voice on the question of appointment of liquidators. Also, in
view of the new insolvent trading provisions, the onus is on directors
to act responsibly and cease trading quickly in the event that
creditors' interests are at risk. The relative ease and speed
with which a company can be placed into liquidation using the
228A procedure is a reason to consider its retention.
(d) Section 295E (1)(b)
This involves the power to restrict compensation to creditors
who knew the company was trading while insolvent. If applied objectively
this provision could affect banks who agree to advance funds in
good faith to assist companies to carry out a workout where the
financial position of the company cannot be established when the
decision to advance funds is made. There should be scope for the
Court to consider the reason for advancing funds in exercising
this power.
4. General
By way of more general comments:
(a) The Secretary of Financial Services is invested with the
power to amend schedules and provisions to a much greater extent
than is normally the case in primary legislation. Whilst it is
common for this to occur in relation to subsidiary legislation
it is undesirable that this power should exist in relation to
substantive provisions.
(b) If and when the Bill is passed it is strongly recommend that
any regulations or rules be introduced simultaneously.
5. Miscellaneous
(a) The Committee supports the introduction of clauses 3, 7,
8, 9(b), 10(a) and (b)(ii), 11, 15, 46, 47, 48 and 49 which make
technical amendments to section 21, 57B, 64A, 107, 109, 110, 157D,
333, 333A and 336 respectively to reduce the documents required
to be filed by local and overseas companies and their directors.
(b) The Committee supports the introduction of clause 9(a) which
amends section 107 to simplify the annual return filing requirements.
(c) The Committee questions whether there is presently doubt
that the existing section 116B may not enable a company to pass
a resolution without holding a meeting if all the shareholders
agree and thus questions whether Clause 14 and the consequential
amendments contained in clauses 4, 5, 6, 12 and 51 of Bill are
necessary. Although clause 12 which amends section 111 and specifies
the process by which a company may hold a paper AGM is helpful.
(d) The Committee supports the introduction of clause 15 as it
clarifies the resignation process for a director or secretary.
(e) The Committee does not object to clause 20 of the Bill but
questions its usefulness in practice.
(f) The Committee does not object to clause 39 which repeals
section 228A and seeks clarification on why this amendment is
considered appropriate.
The Law Society of Hong Kong
Company & Financial Law Committee
Insolvency Law Committee
27 March 2000
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