Corporate rescue in Hong Kong: time for change
Andrew Kinnison, a solicitor and partner with Howse Williams Bowers, argues that it is time to enact legislation in Hong Kong to support a corporate rescue culture.
Corporate rescue is a means by which the directors of an ailing company can seek to nurse it out of its financial difficulties, back to financial health. The management do so with the assistance of appropriately qualified professionals – usually licensed insolvency practitioners.
A cornerstone in any legislation facilitating corporate rescue procedures is invariably a moratorium (or stay of proceedings). This protects the company from creditor claims or winding up petitions and preserves the company's assets for a given period. The moratorium gives a breathing space to formulate rescue proposals. Without it, any 'rogue' creditor could present a winding-up petition and frustrate the potential rescue.
Hong Kong does not facilitate corporate rescue through legislation despite recommendations first having been made that it do so as long ago as 1996 – nearly 20 years ago.
Other jurisdictions have corporate rescue cultures – examples include Singapore, Australia, Canada, England and Wales, and the US. On 12 March 2014, the European Commission issued a recommendation to ensure that viable enterprises in financial difficulty within the European Union 'have access to national insolvency frameworks which enable them to restructure at an early stage with a view to preventing their insolvency'.
It is now time for Hong Kong to introduce legislation to facilitate corporate rescue. This is important, not least to ensure that Hong Kong remains competitive with other jurisdictions that have corporate rescue legislation.
Why bother with corporate rescue?
In October 1996, the Law Reform Commission of Hong Kong recognised the need for corporate rescue in its Corporate Rescue and Insolvent Trading report. It said that it is better for a viable business to survive than for it to 'decline and die'.
It therefore recommended a form of provisional supervision, similar to the 'administration' mechanism used in England and Wales. It said that 'the ideal procedure would be cheap, quick, simple and effective'. It recommended provisional supervision with a view to keeping court involvement to a minimum and ideally achieving a rescue in 30 days. Subject to exceptions in relation to the banking, insurance and securities and futures industries, it said that provisional supervision should apply to both listed and unlisted companies.
There can be no serious dispute with such an approach. If a viable business is able to survive, that will encourage and develop investment. It will save the company, jobs and other businesses that might otherwise decline and die as part of a 'domino effect' as the liquidation of one company has a knock-on effect in causing difficulties for its suppliers and the like. It ensures that enterprises in financial difficulties would have recourse to a restructuring regime, limiting the risk of a formal and expensive insolvency becoming inevitable.
If a company is instead allowed to 'die' through the process of liquidation its assets will effectively be sold for scrap when they might otherwise have been used more profitably for the rehabilitated business. In its Corporate Rescue and Insolvent Trading report, the Law Reform Commission cites the collapse of Barings Bank as a graphic example of how corporate rescue can be particularly useful for large companies with international operations. Barings Bank in the UK went into administration under the Insolvency Act and was sold off, with the approval of the court, within two weeks of going into administration.
'If Barings had not had the benefit of the moratorium imposed under the administration procedure, it would have proved more difficult to achieve the sell off as other parties could have taken proceedings and disrupted the negotiations,' the Law Reform Commission report stated.
Corporate rescue is therefore good for:
unsecured creditors who may be able to maximise their recoveries and get a better level of payment on their bills, and keep a customer, rather than a small (and otherwise possibly negligible) dividend following a liquidation
employees who keep their jobs
shareholders whose shareholdings may become more valuable rather than being lost in a liquidation, and
directors and management who can thereby ensure that they act in the best interests of creditors, employees and shareholders.
As the Law Reform Commission states in its Corporate Rescue and Insolvent Trading report: 'This has implications for government both in revenue and social terms'. To put it another way, it is good social governance (people have jobs and pay tax), as well as good corporate governance (directors and management ensure that they act in the best interests of creditors, shareholders and employees).
So why has no statutory corporate rescue procedure been introduced in Hong Kong? A cynic might infer that the political will to introduce corporate rescue, at least in order to save jobs, is lukewarm at best, given that the unemployment rate in Hong Kong is currently around 3%. But even if that is the case, times change and one should be prepared for the future.
Singapore, England and the US
In Singapore corporate rescue can be facilitated through a process of judicial management. That is similar to the process of 'administration' in England & Wales, enshrined in the Insolvency Act 1986 (as amended, particularly, by the Enterprise Act 2002) which has the benefit of a moratorium on claims. There, an administrator can be appointed without necessarily involving the court, with the stated aim of 'rescuing the company as a going concern', or achieving a better result for creditors than they might get in a liquidation, or realising property to make a distribution to one or more secured or preferential creditors.
In the US, a company in financial difficulty can have recourse to the 'debtor in possession' protection of Chapter 11 of the Bankruptcy Code – with the benefit of an automatic stay on claims.
On 12 March 2014, a European Commission recommendation 'On a New Approach to Business Failure and Insolvency' sought to ensure that viable enterprises in financial difficulty, wherever they are located in the Union, have access to national insolvency frameworks which enable them to restructure at an early stage with a view to preventing their insolvency, and therefore maximise the total value to creditors, employees, owners and the economy as a whole. The recommendation also aims at giving honest bankrupt entrepreneurs a second chance.
The European Commission said that 'national insolvency rules vary greatly in respect of the range of the procedures available to debtors facing financial difficulties in order to restructure their business'. It noted that 'Some member states have a limited range of procedures meaning that businesses are only able to restructure at a relatively late stage, in the context of formal insolvency proceedings. In other member states, restructuring is possible at an earlier stage but the procedures available are not as effective as they could be'.
The Law Reform Commission also recommended back in 1996 that 'a solvent company which recognised that it was trading into difficulties should [also] be able to avail itself of supervision. It would stand a better chance of a successful reorganisation than a company that continued trading until it was insolvent'. That is to say, sooner rather than later.
Insolvency procedures in Hong Kong
Sadly, Hong Kong does not have a statutory regime for corporate rescue and the limited range of formal insolvency procedures means that businesses are only able to restructure at a relatively late stage.
Hong Kong's Financial Services and the Treasury Bureau pointed out in its consultation (Improvement of Corporate Insolvency Law Legislative Proposals) in April 2013, that the corporate insolvency and winding-up provisions in Hong Kong are broadly based on the UK Companies Acts of 1929 and 1948. That is to say, our corporate insolvency procedures are based on legislation dating back nearly 85 years from a jurisdiction which itself introduced new legislation to facilitate corporate rescue nearly 30 years ago, and then amended and improved it over a decade ago.
Attempts have nevertheless been made to develop the law in Hong Kong by appointing provisional liquidators under section 193 of the Companies (Winding Up and Miscellaneous Provisions) Ordinance with power to explore the possibility of a corporate rescue. These attempts have been motivated by a desire to maximise creditor recoveries, by showing that there is a valuable asset, such as the listing status of a company, which might be realised in the event that the company is not wound up. These attempts can best be understood in the context of the relevant legal framework.
Absent a voluntary, non-statutory agreement between the company and all of its creditors, a company in Hong Kong can only have recourse to two alternatives.
1. Schemes of Arrangement. This requires the court to sanction the holding of initial meetings and
thereafter to approve the proposed Scheme. The procedure is time consuming and has proved to be very expensive to operate. Perhaps most importantly, it does not provide for any moratorium on claims against the company during the process.
2. Provisional Liquidation. This can only be used if the company is insolvent, where its assets are in jeopardy and a winding-up petition has been presented at court – as the appointment of provisional liquidators must be for the purposes of the winding up:
Providing that provisional liquidators can be appointed in these circumstances, there is no objection to them having extra powers to enable them to consider a corporate rescue.
The presentation of a winding- up petition secures the benefit of its own statutory moratorium, while the provisional liquidators explore (amongst other things) the possibility of a corporate rescue, which might then be implemented through a Scheme of Arrangement.
There is, nevertheless, a significant difference between such an appointment and one which might otherwise be made solely for the purpose of enabling a corporate rescue to take place.
he difficulties are demonstrated in Re Plus Holdings Ltd (2 HKLRD 726/2007). The company was insolvent. A creditor's winding-up petition had been presented and an application was made to appoint provisional liquidators. The most valuable asset of the company was its listing status. That was in serious jeopardy because the company had been put into the third stage of the delisting procedures and the management had not submitted a viable resumption proposal. To protect that asset, the petitioning creditor wanted to appoint provisional liquidators who could submit a viable resumption proposal to the stock exchange – accepting that, if there was no realistic prospect of rescuing the company in a specified period, the petitioner would apply to wind up the company.
The court appointed provisional liquidators with powers to enable them to consider a corporate rescue. In so doing, the court made it clear that 'the statutory power to appoint provisional liquidators … must be for the purposes of the winding up … there is a significant difference between appointing provisional liquidators on the basis that the company is insolvent and assets are in jeopardy, which is permissible, and appointing provisional liquidators solely to facilitate a corporate rescue, which is not permissible'.
While recognising that 'the sale of listing status … would now appear to be a thing of the past, with the SFC and the HKEx adopting a very stringent approach after 2004', the court was 'not prepared to say that it would be futile for independent professionals to explore viable methods of restructuring'.
Ultimately an investor was found, and a rescue was effected through a Scheme
of Arrangement, and the winding-up petition was dismissed. This was, however, in relation to a petition presented in 2006 and was only dismissed nearly two years later in 2008.
Provisional liquidation is time consuming and expensive. While it works in some cases, the rescue of smaller, otherwise viable but insolvent, companies in Hong Kong may be being frustrated by the time and expense involved in such a procedure.
Equally, there can be no serious argument that it must be better to be able to effect a sell-off, at a sensible price, within a couple of weeks of administration (as with Barings, and consistent with the 30-day period envisaged by the Law Reform Commission), rather than face the prospect of a potentially futile sale of assets, that are already in jeopardy, and which might ultimately only be effected two years after issuing a winding-up petition (as with Plus Holdings).
The Law Reform Commission recognised the need for corporate rescue in Hong Kong back in 1996. While it saw a role for a reformed Scheme of Arrangement procedure (incorporating a moratorium), the Commission said that the current statutory framework for Schemes of Arrangement 'is so clearly deficient in the elements required for a proposal to creditors to be made that it did not assist in any way in the formulation of our proposals'.
It was in no doubt that there is a place for a corporate rescue procedure that could be used in cases where a company or part of a company could be saved. In trenchant terms, it said that 'it is beyond dispute that it is better for a viable business to survive as a going concern, in whole or in part, than for it to be simply wound up and such assets as remain distributed.' This 'distribution' in a liquidation is effectively a fire sale.
The Commission clearly stated that 'Hong Kong [needs] a comprehensive system to enable and encourage
the reorganisation of companies in situations where liquidation was not the appropriate solution'. It therefore recommended introducing provisional supervision. It was 'convinced' that this 'would be better than the existing procedures', not least because it would provide a flexible framework and limit the costs of court appearances.
Despite the Commission's recommendations, and despite numerous rounds of consultations and formal provisional supervision proposals – such as the Companies (Corporate Rescue) Bill in 2001; further public consultation in 2009; the publication of the conclusions from that consultation in 2010; and another consultation in 2013 – there is still no statutory corporate rescue procedure in Hong Kong.
In its Consultation Conclusions of May 2014, the Financial Services and the Treasury Bureau stated that the government is now actively developing a proposal to introduce a new statutory corporate rescue procedure for Hong Kong. 'Since the last public consultation on the introduction of a corporate rescue procedure, the government has been studying the various other key issues of the proposals. We are further consulting stakeholders on the detailed proposals in 2014.'
Those Consultation Conclusions, together with the government's detailed proposals on a new statutory corporate rescue procedure, were placed before a meeting of the Panel on Financial Affairs on 7 July 2014. In an Updated Background Brief that was prepared for the meeting, dated 4 July 2014, the LegCo secretariat referred to the 1996 Law Reform Commission recommendation for 'provisional supervision' to provide a moratorium on legal action to a company in financial difficulty, and to the need to encourage directors to act on insolvency earlier.
At the time of writing, no minutes are available for that meeting. It is, however, understood from a webcast of the meeting that it is proposed to have a draft bill in the next two years – so, presumably, around 2016. This begs the question: how much further consultation is needed? What is meant by 'actively developing' proposals to introduce a new statutory corporate rescue procedure? After all, detailed proposals for corporate rescue have been available for nearly 20 years. It is time to enact legislation in Hong Kong to facilitate a corporate rescue culture. Now is the time for change!
Andrew Kinnison
Howse Williams Bowers Solicitor and Partner
The author can be contacted by email at: andrew.kinnison@hwbhk. com; or by phone at: +(852) 2803 3695.