Lending and taking security in Hong Kong: overview

A Q&A guide to Finance in Hong Kong. The Q&A gives a high level overview of the lending market, taking security over assets, special purpose vehicles in secured lending, quasi-security, guarantees, and loan agreements. It covers creation and registration requirements for security interests; problem assets over which security is difficult to grant; risk areas for lenders; structuring of debt agreements; enforcement of security interests and borrower insolvency; cross-border issues on loans; taxes; and proposals for reform.

To compare answers across multiple jurisdictions, visit the Finance Country Q&A tool. This article is part of the global guide to finance. For a full list of contents visit www.practicallaw.com/finance-guide.

Andrew Hutchins, Clifford Chance
Contents

Overview of the lending market

1. What have been the main trends and important developments in the lending market in your jurisdiction in the last 12 months?

The new Companies Ordinance (Cap 622) (CO) became effective in March 2014. Since its introduction, there has been some uncertainty as to the registrability of security over deposits and bank accounts (see Question 6).

The Contracts (Rights of Third Parties) Ordinance (Cap 623) was enacted in late 2014 and will come into force on 1 January 2016. It is expected that the market practice to this new Ordinance will follow that adopted in respect of its equivalent in the UK market, the Contract (Rights of Third Parties) Act 1999.

A new Hong Kong Competition Ordinance is expected to be enacted by the end of 2015. On 30 March 2015, the Hong Kong Competition Commission published revised guidelines (Guidelines) that assist in interpreting this Ordinance. This follows the publication of draft guidelines on 9 October 2014. The Commission is inviting another round of comments before the Guidelines will then be presented to the Legislative Council for consultation. The publication of the Guidelines is an important step towards the full implementation of the Ordinance, expected by the end of this year. In the lead up to the full implementation of the Ordinance, the Commission is expected to develop and release publications to assist businesses to comply with the new law. These include a statement of the Commission's enforcement policies and a leniency policy.

The Competition Ordinance (Cap 619) will come into effect on 14 December 2015.

The Ordinance prohibits and deters undertakings in all sectors from adopting anti-competitive conduct that has the object or effect of preventing, restricting or distorting competition in Hong Kong.

Multi-bank dealings are not exempt from the Ordinance and are treated in the same way as other business activities where the exchange of commercially sensitive information between competitors (or indirectly through a third party, such as facility agent) could amount to a breach of the law.

No express guidance has so far been issued by the Competition Commission that is tailored to the financing/lending sector. The Loan Market Association (based in the UK) released a "Notice on the application of competition law to syndicated loan arrangements" in May 2014. It recommends that any advice and procedures should address areas such as:

  • Taking general market soundings.

  • Dealing with the receipt of unsolicited commercially sensitive information.

  • Interaction between members of a syndicate related to the setting of terms.

  • Contact between banks in the context of refinancing or distressed arrangements.

It is expected that these recommendations will be followed in Hong Kong.

 

Forms of security over assets

Real estate

2. What is considered real estate in your jurisdiction? What are the most common forms of security granted over it? How are they created and perfected (that is, made valid and enforceable)?

Real estate

Real estate in Hong Kong is generally referred to as land and buildings. Land and buildings includes:

  • Land.

  • Buildings on the land.

  • Fixtures and fittings (movable assets that have been fixed to land and buildings, for example heavy structures or fittings, and some plant and machinery).

The majority of land in Hong Kong is held on a leasehold tenure under leases granted by the Hong Kong Government. Government leases can (but do not necessarily) restrict dealings relating to the land granted under those leases without the government's consent.

Common forms of security

Security over land is generally always taken by way of legal charge over the property, commonly labelled as a mortgage. A legal mortgage transfers legal title in the land to the mortgagee, subject to the mortgagor's equity of redemption (the right to redeem the mortgaged property on repayment of the loan).

The security allows the security provider to occupy the land and buildings and covers the land, fixtures, fittings and things permanently attached to the property.

Formalities

The following formalities apply:

  • Conveyance by deed. A conveyance of any interest in land (which would include the creation of a security interest) must be made by deed to pass legal title (section 44, Conveyancing and Property Ordinance (Cap 219)).

  • Companies Registry. Registration requirements for the creation of security over land and buildings apply to companies incorporated in Hong Kong, and companies incorporated outside Hong Kong but registered as a non-Hong Kong company under Part 16 of the Companies Ordinance. These companies must deliver a statement of particulars together with a certified copy of that security to the Hong Kong Companies Registry for registration within one month of the date the security is created, or the security is void against a liquidator and any creditor of the company.

  • Land Registry. The security must be registered at the Hong Kong Land Registry within one month of the security being created or the priority of the security may be affected.

 

Tangible movable property

3. What is considered tangible movable property in your jurisdiction? What are the most common forms of security granted over it? How are they created and perfected?

Tangible movable property

Generally, tangible movable property covers physical property that is not attached to land. Tangible movable property covers a broad range, including:

  • High value single items, such as ship and aircraft.

  • Low value large volume items, such as wheat and other commodities.

  • Physical property somewhere in between, such as office equipment and inventories in warehouses.

Common forms of security

The traditional form of security over tangible movable property is by way of pledge, where the pledgee will take possession of the physical property itself or documents of title to it. However, pledges are now less common as they impede the use or circulation of the pledged property and are generally not considered to be practicable or acceptable from a commercial perspective.

The more common forms of security over tangible movable property are:

  • Mortgage. Legal title to the property is transferred to the mortgagee but the mortgagor is allowed to have possession and use of the property (until enforcement). Depending on the nature of the movable property involved and its value, devices (such as metallic plaques or stickers) are sometimes attached to the secured movable property with messages notifying any third party using or dealing with the property that it is the subject of a security arrangement.

  • Charge. The legal title to the property remains with the chargor who grants a security interest (effectively an encumbrance over the beneficial interest) in favour of the chargee. Under a fixed charge, the chargee has control over the charged property. In practice, this poses similar commercial issues to a pledge (see above). If the chargee is prepared to allow the chargor to have freedom in using and dealing with the charged property, the charge will be a floating charge, which is probably the more common form of security over tangible movable property granted by a trading concern or an operating company. There will usually be a crystallisation provision in a floating charge instrument, which will enable the chargee to withdraw the right of the chargor to use the charged assets freely on the occurrence of certain pre-agreed events (normally events which are considered to be signs of financial deterioration of the relevant obligors).

Although it is not uncommon for a charge over tangible movable property (as well as intangibles) to be stated to be a fixed charge, this label is inconclusive. If the courts find that the chargee has failed to maintain the requisite degree of control over the charged property (and often any property derived from it), then the charge will be recharacterised as a floating charge.

Formalities

There is no registration requirement concerning any effective pledge of tangible movable property.

For any mortgage or charge over tangible movable property granted by a Hong Kong company, or a foreign company registered as a non-Hong Kong company under Part 16 of the CO, a statement of particulars together with a certified copy of the mortgage or charge must be filed with the Hong Kong Companies Registry within one month after the creation of the mortgage or charge.

If there is a dedicated register for the class of tangible movable property and/or security interest over it, then filing at this register will also be necessary. Ships registered in Hong Kong (Hong Kong flag) fall within this category. A mortgage over a Hong Kong registered vessel must be in the statutorily prescribed form and registered with the Marine Department. Hong Kong does not currently have a register of mortgages over aircraft registered in Hong Kong. The common practice is to notify the Director of Civil Aviation of any mortgage created over a Hong Kong registered aircraft.

 

Financial instruments

4. What are the most common types of financial instrument over which security is granted in your jurisdiction? What are the most common forms of security granted over those instruments? How are they created and perfected?

Financial instruments

The most common types of financial instrument over which security is granted are shares and debt securities.

Common forms of security

This depends on the type of financial instrument:

  • Shares of a Hong Kong company (public or private but not listed on the Hong Kong Stock Exchange). The usual method is to take a mortgage or a charge over the shares (see below, Formalities).

  • Shares listed on the Hong Kong Stock Exchange. Shares listed on the Hong Kong Stock Exchange can be held in certificated form (share certificate) or uncertificated form. For listed shares that are in certificated form, the method for taking security over them is the same as for unlisted shares (see above).

    If the shares are in uncertificated form, they will be held in the Central Clearing and Settlement System (CCASS), which is a central counterparty settlement and depository system for trades in stocks listed at the Hong Kong Stock Exchange. The legal title to all the shares held in CCASS will be registered in the name of a common nominee for CCASS. Therefore, all the "owners" of uncertificated shares will only have beneficial interests in the shares held by them. Security over shares held in CCASS will therefore take the form of a charge (see below, Formalities).

  • Debt securities. Some debt securities are held in the Central Moneymarkets Unit Service operated by the Hong Kong Monetary Authority (HKMA), in which event the debt securities are lodged with a sub-custodian appointed by the HKMA (currently HSBC). It is also possible for debt securities to be held in CCASS, and can be held by the depository, the Hong Kong Securities Clearing Company Limited (HKSCC), although this is very rare. The usual method to take security over debt securities in the CMU or CCASS is by way of a charge (see below).

Formalities

  • Shares of a Hong Kong company (public or private but not listed on the Hong Kong Stock Exchange). For a mortgage, the mortgagor must transfer legal title to the shares to the mortgagee and the name of the mortgagee will be recorded on the register of members of the company. For a charge, the legal title to the charged shares will remain with the chargor (or the chargor's nominee).

  • Shares listed on the Hong Kong Stock Exchange. For listed shares that are in certificated form, the formalities for taking security over them is the same as that for unlisted shares (see above). An "owner" of shares in CCASS will normally have those shares held through a securities account with his broker (it is possible for the "owner" to have a direct account with CCASS but that arrangement is not common). Security over shares held in CCASS will normally take one of two forms:

    • a charge over the shares held in the securities account as well the rights of the chargor under its accounts with the broker. Notice of the security will be given to the broker who will be required to acknowledge the notice (which will normally include undertakings to comply with instructions given to it by the chargee); or

    • the chargor arranging for the shares to be transferred from the securities account held with its broker to the securities account of the chargee or its nominee. The effect of this approach is akin to a (equitable) mortgage over the beneficial interest in the shares.

  • Debt securities. If the debt securities are held in CMU, it is advisable for them to be transferred to the account of the chargee with its own nominated CMU member. If the debt securities remain in the account of the security provider with its nominated CMU member, notice of the security should be given to the security provider's nominated CMU member and, preferably, an acknowledgement obtained.

To enforce security over debt and share securities, the secured creditor can either:

  • Transfer ownership of the shares to a third party (through sale) and use the proceeds to satisfy the debt.

  • Appoint a receiver to sell the shares and use the proceeds to satisfy the debt.

 

Claims and receivables

5. What are the most common types of claims and receivables over which security is granted in your jurisdiction? What are the most common forms of security granted over claims and receivables? How are they created and perfected?

Claims and receivables

Common types of claims and receivables include:

  • Cash deposits.

  • Rights to receive a debt.

  • Trade receivables.

  • Rights to payment under a specific contract.

  • Rights to insurance proceeds.

Special rules apply to certain receivables, such as insurance proceeds.

Common forms of security

Generally, security over claims and receivables is taken by way of fixed charge or assignment. In a bilateral loan involving cash deposits at a bank that is also the lender, security should not be taken by way of an assignment (see Question 6).

Formalities

Assignment. Notice should be provided to the relevant receivables payer or contractual counterparty. Where it is not practical to serve notice or specifically identify all contracts a charge is usually taken (see below). If notice is given, the assignment qualifies as a statutory assignment under section 9 of the Law Amendment and (Consolidation) Ordinance (Cap 23). One of the advantages of an assignment that qualifies as a statutory assignment is that the assignee can take action against the debtor (of the assigned debt or receivable) in his own name without the necessity of joining the assignor as a party to the action. In the case of security over trade receivables, there can be commercial considerations affecting the giving of notices.

Charge. While there is no strict necessity for notice to be given in the case of a charge (unlike an assignment), the preferred approach is for notice to be given because of the rule under Dearle v Hall concerning priority of assignments of equitable interests and choses in action. There may be commercial considerations affecting the giving of notices concerning security over trade receivables (see above).

If a fixed charge is taken, it is essential that the lender is able to control the proceeds of the debt. If a security provider is able to collect and deal with the proceeds of such debts without the consent or control of the lender, the fixed charge can be recharacterised as a floating charge. To enforce a fixed charge, the secured creditor must (if it has not already done so at the time of the creation of the charge) give notice to the debtor to pay monies into a particular account. In some cases set-off can be used for enforcement once the monies have been paid into a bank account with the secured creditor. The secured creditor can appoint a receiver to collect the monies and satisfy the debt.

For other rules relating to fixed and floating charges, see Question 3, Common forms of security.

Registration. Registration requirements apply to any charge granted over or any assignment of a claim or receivable granted by a Hong Kong company, or a foreign company registered as a non-Hong Kong company under Part 16 of the CO (see Question 2, Formalities).

 

Cash deposits

6. What are the most common forms of security over cash deposits? How are they created and perfected?

Common forms of security

The form of security over cash deposits depends on whether the arrangement is bilateral or multilateral:

  • Bilateral. This is where the loan is a bilateral arrangement between a single lender and a borrower, and the cash collateral for the loan is in an account in the borrower's name, with the lender as the account bank. In this case, the security should take the form of a charge by the borrower in favour of the lender.

  • Multilateral. This can apply in a number of different ways, including where:

    • the borrower and the account holder are different persons (third party security scenario);

    • the lender and the account bank are not the same; or

    • the beneficiary of the security and the account bank, although the same entity, are acting in different capacities (for example, the security over an account maintained with an account bank is granted to that account bank as security trustee for a group of lenders).

    In a multilateral scenario, the preferred approach is for the security provider to assign his rights, title and benefit in the account to the lender or security agent.

Formalities

A charge over a bank account is not registrable with the Companies Registry (see Question 2, Formalities). This is because where a company maintains a deposit of money with another person, a charge on the company's right to repayment of the money is not regarded as a charge on book debts of the company and is therefore not registrable as a charge under the Companies Ordinance (Cap 622) (CO) (section 334(3)(b), CO). The apparent justification for this exclusion is that, in such a charge back scenario, the account bank beneficiary can always rely on its right of set off against the account holder/borrower. However, set off is a rather complex subject and the availability of set off may depend on the specific factual circumstances of the transaction. During the initial period after the CO came into effect, the Companies Registry refused to register security over cash deposits/accounts on the ground of the exclusion set out in section 334(3)(b). This has resulted in banks and their legal advisers taking certain actions to achieve a registrable security document such as, for example, including a floating charge provision in what would otherwise have been a standard charge or assignment over a bank account/cash deposit. As a floating charge is a registrable charge under the CO, the Companies Registry will register an account/cash deposit charge that includes such floating charge language.

 

Intellectual property

7. What are the most common types of intellectual property over which security is granted in your jurisdiction? What are the most common forms of security granted over intellectual property? How are they created and perfected?

Intellectual property

Intellectual property includes trade marks, copyrights, patents, designs, database rights, other similar rights (registered or unregistered) and licences relating to any such rights.

Common forms of security

Generally security over intellectual property can be taken by a:

  • Fixed or floating charge.

  • Mortgage.

Formalities

It may be necessary to register the security at the Companies Registry (see Question 2, Formalities).

The security should also be registered at the relevant registry for the type of intellectual property:

  • Trade marks: Trade Marks Registry.

  • Patents: Patents Registry.

  • Designs: Designs Registry.

Failure to register with the relevant intellectual property registries within six months can limit the remedies available to the secured creditor if the intellectual property right is infringed.

 

Problem assets

8. Are there types of assets over which security cannot be granted or can only be granted with difficulty? Which assets are difficult or problematic when security is granted over them?

Future assets

A security provider cannot grant a legal mortgage over future assets as the security provider does not possess a proprietary interest in those assets. It is, however, possibly to take equitable security (usually by way of a charge) over future assets, provided that those future assets are clearly identified in the credit document.

Fungible assets

Fungible assets can be secured in Hong Kong. Given their interchangeable nature, it is important to clearly identify the class of assets over which security is to be given and it is common to appropriate or segregate the secured assets to properly attach the security interest created by the chargor.

Other assets

It may be necessary to obtain third party consent or a waiver before security can be granted over contractual rights and leases. It is important to perfect security over those assets, as a bona fide purchaser for value without notice can defeat priority, particularly where equitable charges or mortgages have been granted at the time of creation of the security interest.

Generally, when dealing with all assets subject to a fixed charge, it is necessary to consider that the key characteristic of a fixed charge is that the chargor is unable to deal freely with the charged asset in the ordinary course of its business. If the chargor is able to do so, it is very likely that such a charge would be recharacterised by a court as a floating charge. Whether sufficient control is exercised by the lender during the life of a charge depends on the facts.

The issue of control may not necessarily be tied to whether the secured asset is present or future. If a lender purports to take a fixed charge over an existing asset, for example, a trade debt which is in existence at the time when the charge is created, but the chargor is allowed (either expressly or through lack of proper monitoring) to sell the trade debt or collect it and use the proceeds freely, then that will still fail the required control test (under Re Spectrum) and the fixed charge will be recharacterised as a floating charge.

 

Release of security over assets

9. How are common forms of security released? Are any formalities required?

Release of security is usually documented by way of deed.

For security registered at the Companies Registry, the chargor or mortgagor (that is, the company itself) or the chargee or mortgagee should submit to the Registrar of Companies:

  • A certified copy of the instrument evidencing the payment, satisfaction, release or cessation (for example a deed of release).

  • The specified form (Form NM2).

Specialist registries (for example, the Land Registry, Trade Marks Registry or Hong Kong Register of Civil Aircraft) should also be informed of the release of security by the appropriate specified form or appropriate correspondence.

 

Special purpose vehicles (SPVs) in secured lending

10. Is it common in your jurisdiction to take security over the shares of an SPV set up to hold certain of the borrower's assets, rather than to take direct security over those assets?

It is common practice to take security over the shares of an SPV and the assets and undertaking of that SPV. In situations where the SPV is thinly capitalised, it may also be necessary to consider whether the intra-group loans advanced by a parent must be subordinated to loans advanced, or security taken, by a lender (see Question 15).

 

Quasi-security

11. What types of quasi-security structures are common in your jurisdiction? Is there a risk of such structures being recharacterised as a security interest?

A quasi-security transaction is at risk of being recharacterised as the granting of a security interest. If that happens, a company incorporated in Hong Kong or registered as a non-Hong Kong company under Part 16 of the Companies Ordinance (Cap 622) must register the (recharacterised) security interest at the Companies Registry, and all other issues regarding the granting, maintenance, perfection, preservation and enforcement of security apply (see Question 2, Formalities).

Sale and leaseback

Sale and leaseback arrangements involve the sale of an asset to a third party who then leases that asset back to the seller for a specified amount of time. Any default by the lessee of the terms of the lease can give rise to the right of the lessor to repossess the asset.

Factoring

Factoring arrangements involve an assignment of book debts and/or future receivables owing to an assignor in favour of a factor in return for an upfront cash payment, usually at a discount of the face value of each debt assigned. The amount of the discount usually depends on the type of factoring:

  • Recourse factoring: the risk of the debtor's default is borne by the assignor.

  • Non-recourse factoring: the factor bears the risk of the debtor's default.

Depending on whether legal or equitable assignment is used, notification may be required to be given to debtors on the assignment of book debts and each future assignment of receivables. Equitable assignments take effect without notification to the debtor and therefore the factor is at risk of subsequently notified assignments by a third party, which would take priority over a non-notified assignment (see Question 5). Additionally, if an assignor's book debts are subject to a negative pledge restriction, it will generally be unable to enter into a factoring arrangement.

Hire purchase

Hire purchase arrangements are commonly used to finance the acquisition of tangible assets (such as motor vehicles). The lease agreement will usually involve the lessor:

  • Leasing a nominated (by the lessee) asset to a lessee.

  • Granting an option to the lessee exercisable at the end of the lease period, to:

    • purchase the asset on payment of a pre-agreed sum; or

    • terminate the hire and return the asset to the lessor.

During the lease period, the lessor retains title to the leased asset and the lessee is prohibited from incorporating or modifying the leased asset into any other product, so as to ensure that, on any default, the lessor can immediately repossess the asset if desired.

Retention of title

Retention of title is often used where tangible assets are sold on credit. While possession of the asset is transferred to the buyer, a condition of the sale is that the buyer will not acquire title to the asset until the price has been settled in full.

Any attempt to retain title to the original asset once it has lost its physical identity (and therefore ceased to exist) is ineffective. However, if an asset sold subject to retention of title provisions has been mixed with other goods without resulting in a loss of physical identity, the seller should be able to claim co-ownership of the mixture.

Other structures

Negative pledge provisions are commonly employed in Hong Kong. They constitute undertakings in favour of a lender not to create or permit to subsist any security over any of all or part of a company's assets. A negative pledge serves an important function in secured and unsecured lending transactions:

  • Secured lending. Involves protecting floating charge holders by attempting to prevent a chargor from subsequently granting a fixed charge over the same asset(s), which would otherwise have priority over an earlier floating charge.

  • Unsecured lending. Involves ensuring there are unencumbered assets for distribution on liquidation on a pari passu basis among unsecured creditors (see Question 24).

 

Guarantees

12. Are guarantees commonly used in your jurisdiction? How are they created?

Guarantees are commonly used in Hong Kong. A guarantee need not be in writing to be enforceable, but is usually in written form, and standalone guarantees are usually executed as deeds to avoid any dispute as to consideration.

The scope of the guaranteed obligation(s) must be set out clearly, that is, whether it is a guarantee in respect of a third party's payment and/or performance obligations. Guarantees are secondary obligations as they are:

  • Granted to support a primary obligation of that third party (for example, a loan advanced to a borrower).

  • Often granted in conjunction with an indemnity which, as a primary obligation, is not vulnerable to failure if the obligations of that third party are set aside.

The granting of guarantees also gives rise to potential corporate benefit and financial assistance issues (see Question 13).

 

Risk areas for lenders

13. Do any laws affect the validity of a loan, security or guarantee (or the terms on which they are made or agreed)?

Financial assistance

Where a person has acquired, is acquiring or is proposing to acquire shares in a company (it is generally accepted that the financial assistance restrictions apply only where the company whose shares are being acquired is formed and registered in Hong Kong), it is not lawful for the company or any of its subsidiaries to give financial assistance directly or indirectly for the purpose of that acquisition. The following do not constitute financial assistance:

  • Dividend distributions.

  • Loans to employees to acquire shares.

  • Loans in the ordinary course of business.

Under the Companies Ordinance (Cap 622) (CO), any company (private or public) can now provide financial assistance so long as its directors approving the assistance have considered certain specified matters and are able to make a solvency statement. The amount of assistance provided will depend on whether shareholders' approval is obtained. Providing financial assistance by a Hong Kong incorporated company (or its subsidiaries) for the purposes of acquiring shares in the holding company of that Hong Kong company or for the purpose of reducing or discharging a liability incurred for that acquisition is not prohibited under the CO if that holding company is incorporated outside of Hong Kong.

Corporate benefit is also relevant in the context of financial assistance (see below).

Corporate benefit

Every director of a company has a fiduciary duty to act in the interests of the company. Every act of the directors should provide a "benefit" (whether direct or indirect) for the company.

In particular, corporate benefit should be considered in relation to the granting of upstream or cross-stream guarantees or security in respect of the obligations of other parties, where the benefit is usually indirect and can be more difficult to demonstrate. If directors are in breach of their fiduciary duties, the actions of the company, the guarantee or security may be unenforceable.

If there is doubt about whether there is corporate benefit, shareholders' approval for the act can be obtained (so shareholders cannot subsequently challenge the act on the basis of lack of corporate benefit). However, the actions could still be challenged by other parties, for example, creditors.

Loans to directors

A company is generally prohibited from making loans or quasi-loans to, or entering into credit transactions for, directors or their connected persons (individual or corporate).

The most relevant exemptions in the CO to the prohibition against a company entering into loan, quasi-loan or credit transactions with its directors are where:

  • Prior shareholders' approval is obtained in accordance with a prescribed procedure (in cases involving public companies, the approval of disinterested shareholders is needed).

  • The aggregate of the value of the transaction in question and any other relevant transaction or arrangement does not exceed 5% of the value of the company's net assets as determined by reference to:

    • its relevant financial statements; or

    • in the absence of financial statements, the company's called-up share capital.

  • The transaction is to provide funds to:

    • meet expenditure (for the purposes of the company or to enable the director to perform his duties as a director) incurred or to be incurred by a director (of the company or its holding company), a body corporate controlled by such a director or an entity connected with such a director; or

    • avoid incurring such expenditure.

  • The company's ordinary business includes the making of loans or quasi-loans or providing guarantees or other security, and the transaction in question is provided in the ordinary course of its business without any preferential terms for the director.

  • The transaction is an intra-group transaction.

Usury

The Money Lenders Ordinance (Cap 163) (MLO) regulates the business of money lenders. Authorized institutions (as defined in the Banking Ordinance (Cap 155)) are not subject to the MLO. Any lender that is not an authorized institution must consider any potential implications under the MLO when its proposed lending has a Hong Kong connection, including whether it qualifies as an exempted lender and/or its loan qualifies as an exempted loan under the MLO. Even if the relevant exemptions are applicable and the lender does not have to be licensed under the MLO, its loan will still be subject to certain provisions of the MLO regarding extortionate credit. Generally, an effective annual interest rate of 60% is illegal and an effective annual interest rate between 48% and 60% is presumed to be extortionate.

Others

If the rate of default interest on a loan is too high, it can be held by the courts of Hong Kong to be unenforceable on the grounds that it is a penalty.

The common law also offers certain protections to guarantors (for example, any variation in the primary obligation being guaranteed may discharge a guarantor's obligations). However, such protections can be (and are often) contractually excluded.

In relation to the potential for avoidance of transactions if the borrower, guarantor or security provider becomes insolvent, see Question 23.

 
14. Can a lender be liable under environmental laws for the actions of a borrower, security provider or guarantor?

Environmental law is principally focused on controlling, preventing and/or remediating:

  • Noise.

  • Air, water and marine pollution.

  • Waste disposal.

  • Contaminated land.

Liability incurred under environmental laws principally falls on an individual or entity that fails to comply with, or breaches, the relevant legislation. In general, as long as a lender does not participate in the operations or management of the borrower or security provider/guarantor, a lender will not be subject to secondary liability in connection with that obligor's breach or failure to comply with the relevant legislation. However, the exercise of "step-in" rights on a security provider default may give rise to primary liability.

 

Structuring the priority of debts

15. What methods of subordination are there?

Contractual subordination

Contractual subordination is common in Hong Kong. The senior and junior creditors will agree that the junior creditor will not exercise its rights in respect of the relevant debt until the senior creditor has been paid in full. Alternatively, contractual subordination can also be achieved by limiting the terms of a junior creditor's debt to a looser set of covenants compared to senior debt, which means that senior debt will default first and the holders of that debt will have the opportunity to negotiate with the debtor at first instance.

Structural subordination

Structural subordination is common in acquisition finance transactions, under which a loan is granted to a company which is a holding company of another asset-owning company. In this scenario, a creditor of the holding company will only be able to recover from the assets of the holding company and not of the subsidiary. In Hong Kong, company's assets are treated individually rather than as a group. Therefore any creditor of an asset-owning subsidiary (which holds security over that subsidiary's assets) will, as a practical matter, "rank" higher than a creditor of the holding company (which holds security over the assets of the holding company (which will be shares in the asset owning subsidiary)). The asset-owning subsidiary will need to be liquidated and its own creditors satisfied before assets can be distributed to the holding company's creditors.

Inter-creditor arrangements

Inter-creditor arrangements are commonly found in situations where a borrower has multiple layers of lending, amplifying the risk of competing creditors. Inter-creditor agreements generally regulate the relationship between senior and junior creditors, and include provisions for the junior creditors to agree:

  • The priority of debt and of rights of repayment, prepayment and cancellation of that debt before a default has occurred and/or after acceleration.

  • To regulate the commercial behaviour of the parties (for example, standstills on enforcement of security, declarations of default and pre-agreed voting arrangements for matters such as amendment and waiver requests).

  • To the extent that any distribution is received by any junior creditor(s) in priority to a senior creditor(s) on the debtor's insolvency, the junior creditor(s) will pay over any such distribution to the senior creditor(s).

 

Debt trading and transfer mechanisms

16. Is debt traded in your jurisdiction and what transfer mechanisms are used? How do buyers ensure that they obtain the benefit of the security and guarantees associated with the transferred debt?

Loans and credit support can be readily transferred if well-established principles are followed. In general, as long as the agreement evidencing the loan or credit support (for example, security and guarantees) does not prohibit an assignment and provides for a transfer of that loan or credit support, it can be transferred.

The following forms of transfer are used:

  • Assignment. An assignment takes effect as an agreement between the assignor and assignee to assign to the assignee some or all of the assignor's rights under the credit documents. A lender cannot transfer its obligations under a credit agreement (for example, an undrawn commitment or a revolving credit) without the consent of the borrower. Therefore, an assignment will only be effective in dealing with the rights and benefits of a lender under a credit agreement.

  • Novation. A lender can transfer its rights and obligations under a credit agreement to a third party by novation. Consent of the borrower will be required. In a syndicated loan agreement, it is fairly standard to have transfer provisions under which all the parties (including the borrower) agree on day one a mechanism for novation, which would normally be the execution of a transfer certificate by the outgoing lender (transferor), incoming lender (transferee) and the agent bank. If this mechanism is complied with, an existing lender's rights and obligations under the original loan documentation can be cancelled and discharged, in consideration of a third party (the transferee/buyer) assuming identical rights and obligations.

  • Sub-participation. Sub-participations can be categorised into two types:

    • a "funded" sub-participation, where the buyer funds or places a deposit with the seller at inception of the transaction on terms that its deposit will only be serviced and repaid when the borrower services and repays the loan to the seller. The buyer has no recourse to the seller; and

    • a "risk" participation, where the buyer agrees to deposit funds with the seller on the occurrence of certain risk events (for example, on default of the borrower).

    In a sub-participation, the transaction does not involve any transfer of rights or obligations and the seller's contractual relationship with the borrower is unaffected. A seller may therefore usually sub-participate without the consent of the borrower via a private, undisclosed arrangement between the buyer and the seller. The buyer, as sub-participant, will generally not have any direct recourse or other rights against the borrower. Any security provided by the borrower will remain with the seller.

 

Agent and trust concepts

17. Is the agent concept (such as a facility agent under a syndicated loan) recognised in your jurisdiction?

The agent concept is recognised in Hong Kong. The appointment and authority of the agent are subject to common law principles of agency and its role is often solely mechanical and administrative in nature.

 
18. Is the trust concept recognised in your jurisdiction?

The trust concept is recognised under Hong Kong law, and it is common to find security trust structures, that is, security granted by a security provider in favour of the security trustee appointed under the financing documents for a syndicated loan transaction.

 

Enforcement of security interests and borrower insolvency

19. What are the circumstances in which a lender can enforce its loan, guarantee or security interest? What requirements must the lender comply with?

The circumstances in which a lender can enforce its loan, guarantee or security interest will be set out in the relevant agreement and/or security instrument granting or creating (as the case may be) that loan, guarantee or security interest. Generally, acceleration of a loan and enforcement of a guarantee and/or security interest will occur on or after an "event of default", as specified in the relevant agreement and/or security instrument, for example:

  • Default in payment.

  • Insolvency or the onset of insolvency proceedings (see Question 22).

  • Breach of undertakings and covenants.

The holder of a legal charge or mortgage created under a deed in accordance with section 44 of the Conveyancing and Property Ordinance (Cap 219) (CPO) will, subject to the mandatory provisions of the CPO, also have the benefit of certain implied powers to enforce that legal charge or mortgage. The implied powers granted by the CPO to a receiver can be extended under the relevant security instrument (see Question 20).

A mortgagee or chargee entering into possession of the mortgaged/charged property of a Hong Kong company or foreign company registered as a non-Hong Kong company under Party 16 of the CO or appointing a receiver or manager in respect of that property must file the relevant statutory form (Form NM3 or NM5) with the Companies Registry.

 

Methods of enforcement

20. How are the main types of security interest usually enforced? What requirements must a lender comply with?

Subject to the terms of the credit document, a lender is generally able to enforce its security interest on an event of default and it is generally unnecessary to obtain a court order or conduct a public auction.

Real estate

Ideally a lender will recover a debt from a defaulting chargor/mortgagor from a voluntary sale of the property by the chargor/mortgagor. A voluntary sale saves enforcement costs that can reduce the net return to a mortgagee and protects the lender from potential liabilities that may arise out of a contract of sale.

Mortgagee. A legal charge over land executed as a deed in accordance with section 44 of the Conveyancing and Property Ordinance (Cap 219) (CPO) will, on the occurrence of an event of default, confer on the lender certain powers, including the power to:

  • Take possession of the property and, for that purpose, commence any legal proceedings to recover possession (for example, eviction proceedings).

  • Sell the property, subject to any prior interests, but free from the mortgage and all other interests to which the mortgage has priority.

  • Lease and accept the surrender of leases.

  • Do all things necessary or desirable for realising the property.

Exercising the power of possession should be notified to the Companies Registry if it is in respect of real estate charged/mortgaged by a Hong Kong company or a foreign company registered as a non-Hong Kong company under Part 16 of the CO.

Receivership. A lender can appoint a receiver, who acts as the agent of the chargor/mortgagor, who will be solely responsible for the receiver's acts and defaults. A receiver's powers are similar to those of a mortgagee (for example, the power to take possession of property and sell the property), subject to their regulation and (commonly) extension in the credit documents. The appointment of a receiver in respect of land must be registered in writing with the Land Registry and, where the chargor/mortgagor is a Hong Kong company or a foreign company registered as a non-Hong Kong company under Part 16 of the CO, notified to the Companies Registry.

Foreclosure. Foreclosure results in the lender becoming the absolute owner of the charged/mortgaged property. It extinguishes the chargor/mortgagor's equity of redemption and must be sanctioned by a court order.

Shares

Enforcement of security over shares will depend on whether the lender takes security in the form of:

  • A legal mortgage (in which case legal title is transferred to the lender at the time the mortgage is entered into).

  • An equitable charge (which gives a right to the lender to transfer the shares into its name on the terms of the charge).

On the security of the shares becoming enforceable, there is usually no requirement for the involvement of a court. The secured creditor will typically have the right to:

  • Sell the shares.

  • Exercise all of the voting rights attached to the shares, and all the consequential rights flowing from them, including the right to replace the board of directors.

Alternatively, the lender can appoint a receiver rather than take action in its own name, whose powers will include, among other matters, the power to sell the shares (see above, Real estate: Receivership).

Movable assets

Movable assets are often secured by way of fixed and/or floating charges. Both fixed and floating charges usually provide the lender with a right to appoint a receiver whose powers will include, among other matters, the power to take physical possession of and sell such assets (see above, Real estate: Receivership).

For the purposes of floating charges, an event of default will usually cause the floating charge to "crystallise", on which the floating charge will automatically convert to a fixed charge over all assets expressed to be subject to the floating charge.

 

Rescue, reorganisation and insolvency

21. Are company rescue or reorganisation procedures (outside of insolvency proceedings) available in your jurisdiction? How do they affect a lender's rights to enforce its loan, guarantee or security?

A scheme of arrangement is available. It is an arrangement or compromise by a company with either or both of its creditors or members (or class of creditors or members) under which some creditors or members can be lawfully deprived of their rights. It will be binding on the company and all of its creditors and/or members if:

  • In the case of:

    • a creditors' scheme, a majority in number representing at least 75% in value of the creditors present and voting at a meeting called to approve the scheme, approves the arrangement; or

    • a members' scheme, (in a rescue context), a majority in number (unless the court orders otherwise) of members representing at least 75% of the voting rights of the members present and voting at a meeting called to approve the scheme, approve the arrangement.

  • The proposed scheme is sanctioned by order of the court.

  • The sanction order is registered by the Registrar of Companies.

 
22. How does the start of insolvency procedures affect a lender's rights to enforce its loan, guarantee or security?

The start of insolvency proceedings will not affect a lender's rights to enforce, unless the loan, guarantee or security is invalid or liable to be set aside or the lender's enforcement action does not comply with the terms of the loan, guarantee or security. A liquidator can prevent the enforcement of security where an application is made to set aside the transaction because it falls within one of a number of categories (see Question 23).

 
23. What transactions involving loans, guarantees, or security interests can be made void if the borrower, guarantor or security provider becomes insolvent?

Generally, security which has been properly structured and created should be recognised in insolvency, subject to risk periods known as "hardening periods". Security is granted subject to the risk of the security being invalid or being attacked by a liquidator appointed to the security provider and rendered unenforceable if it is granted in risk periods on or before insolvency or winding-up. The length of the risk period varies according to the circumstances.

Unfair preferences

An unfair preference is usually an act (for example, granting security or a guarantee) that has the effect of putting a creditor or a guarantor in a better position than it would otherwise have been in on an insolvency of the company (sections 266 and 266B, Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32)) (CWUMPO). In this case, the risk period is six months ending on the onset of insolvency. The period is increased to two years if granted to an "associate" (including, for example, a company in which the insolvent company holds one-third or more of the votes capable of being cast at a general meeting).

Extortionate credit transactions

A credit transaction is extortionate if (taking into consideration the credit risks) credit is provided for grossly exorbitant payments (either actual or contingent, for example on default) or the transaction grossly contravenes principles of fair dealing (section 264B( 3), CWUMPO). The risk period for such transactions is three years prior to the winding-up of the company. An extortionate credit transaction entered into in a risk period will be valid unless successfully challenged in court by the liquidator.

Floating charges

For floating charges, the risk period is 12 months prior to commencement of winding-up (section 267, Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32)) (CWUMPO). A floating charge granted in the risk period will automatically be invalid except:

  • Where it can be proved that the company was solvent immediately after creation of the floating charge.

  • To the extent of cash received by the company for granting the floating charge and interest for it.

Director's breach of fiduciary duties

A liquidator applies to court for a transaction to be set aside because a director has entered into a transaction where no commercial benefit accrues to the borrower and therefore the director in question is in breach of his or her fiduciary duties.

Dispositions with intent to defraud creditors

For dispositions with intent to defraud creditors there is no time limit (section 60, Conveyancing and Property Ordinance (Cap 219)). Any such disposition can be challenged by any person prejudiced by such disposition. If successfully challenged, the disposition will be void and unenforceable. This is not dependent on the company making the disposition being wound up or insolvent.

Onerous property

The liquidator of a company may, with the leave of the court, disclaim onerous property of the company being wound up (including unprofitable contracts) at any time within 12 months after commencement of winding-up (or such longer period as may be allowed by the court). The disclaimer only operates from the time when the disclaimer is made and does not affect accrued rights and obligations.

 
24. In what order are creditors paid on the borrower's insolvency?

Assuming that security is properly perfected, creditors' claims will generally rank in the following order:

  • Fixed charge holders and creditors with a proprietary interest in assets are entitled either to the proceeds of the sale, or return, of a charged asset. These assets fall outside of the borrower's or security provider's estate.

  • Receivers' or liquidators' expenses and other expenses concerning the insolvency.

  • Creditors preferred by statute (for example, tax liabilities and employee salaries).

  • Floating charge holders.

  • Unsecured creditors.

  • Shareholders.

Except for fixed charge holders and creditors with a proprietary interest in assets, each class of creditors share distributions in proportion to the debts due to each creditor.

Priority among creditors within each class over certain assets will generally be determined by date of creation. Where security is created on the same date:

  • Holders of legal mortgages or charges rank above holders of equitable charges or mortgages.

  • The holder of the floating charge to crystallise first ranks above other holders whose floating charges crystallise at a later point in time.

  • Concerning assets which have been assigned, the order in which written notice is served on the third party.

However, creditors of a company can contractually agree through an inter-creditor agreement how claims should be ranked prior to and on insolvency of the company (see Question 15). The court will normally recognise security on insolvency but the extent to which an inter-creditor agreement will be enforceable in insolvency is unclear.

 

Cross-border issues on loans

25. Are there restrictions on the making of loans by foreign lenders or granting security (over all forms of property) or guarantees to foreign lenders?

See Question 13, Usury. Generally, there are no restrictions on the granting of security or guarantees in favour of foreign lenders.

 
26. Are there exchange controls that restrict payments to a foreign lender under a security document, guarantee or loan agreement?

There are no exchange controls in Hong Kong.

 

Taxes and fees on loans, guarantees and security interests

27. Are taxes or fees paid on the granting and enforcement of a loan, guarantee or security interest?

Documentary taxes

Stamp duty is generally not payable on the taking of security over shares. Where the security takes the form of a legal mortgage where title to the shares is transferred from the mortgagor to the mortgagee, a nominal fixed stamp duty is payable on the transfer.

No stamp duty is payable on the taking of security over land.

Debt securities. No stamp duty is payable in respect of transfer of bearer securities. No stamp duty is payable in respect of a transfer of registered debt securities if the debt securities either:

  • Are denominated in a currency other than HK$ and are not repayable in any circumstances in HK$.

  • Constitute loan capital (as defined in relevant legislation).

If the registered debt securities do not fall within the exemption, stamp duty is payable at the rate of 0.1% by both the transferor and the transferee.

Registered securities that do not fall within the exemption and are issued either in Hong Kong, or on behalf of a person in Hong Kong, will be subject to stamp duty at 3% of their market value on issue. The stamp duty is payable by the issuer.

Registration fees

A fee of HK$340 is payable for any security instrument which is presented to the Hong Kong Companies Registry for registration.

For assets with specific registers, the following filing fees are payable:

  • Land and buildings. Where the property is mortgaged or charged to secure obligations not exceeding HK$750,000, the registration fee payable to the Land Registry on the mortgage or charge is HK$230. Otherwise, it is HK$450. There is a registration fee where any charge or mortgage on property or on any share or interest in property is assigned or transferred.

  • Intellectual property. The following are payable:

    • Trade Marks Registry: a fee of HK$800 per transaction;

    • Patents Registry: a fee of HK$325 per transaction;

    • Designs Registry: a fee of HK$590 per transaction.

Notaries' fees

Not applicable.

 
28. Are there strategies to minimise the costs of taxes and fees on the granting and enforcement of a loan, guarantee or security interest?

Not applicable.

 

Reform

29. Are there any proposals for reform?

Reform of the corporate insolvency regime is expected. This may include the introduction of an insolvency procedure similar to administration in England and Wales.

The Companies (Winding Up and Miscellaneous Provisions) (Amendment) Bill 2015 was published in the Gazette on 2 October 2015. It is not clear at the moment whether the requisite legislative steps for the passing of the Bill can be completed before the end of the 2015/2016 legislative session.

The key proposals in the Bill that will increase protection of creditors in the course of a winding-up include:

  • Providing the court with the power to set aside transactions at an undervalue entered into by a company within five years before the commencement of its winding-up.

  • Introducing standalone provisions on the setting aside of transactions which are unfair preferences.

  • Making directors and members concerned to be liable to contribute to the assets of the company in connection with a redemption or buy-back of the company's own shares out of capital in cases where the company is wound up within one year of the relevant payment out of capital.

The government is in the process of developing detailed proposals to introduce a new statutory corporate rescue procedure and insolvent trading provisions. In view of the scale of the exercise and the complexity of the issues involved, the current target is to introduce the relevant legislation into the Legislative Council in 2017/18.

 

Online resources

Hong Kong Companies Ordinance

W www.cr.gov.hk/en/companies_ordinance and

Description. Non-binding translation of the Companies Ordinance.

Department of Justice Bilingual Laws Information System (BLIS)

W www.legislation.gov.hk

Description. This is the Hong Kong Special Administrative Region Government Department of Justice Bilingual Laws Information System (BLIS). It is the official website for obtaining Hong Kong legislation in both English and Chinese.



Contributor profiles

Andrew Hutchins, Partner

Clifford Chance

T +852 2826 2484
F +852 2825 8800
E Andrew.Hutchins@cliffordchance.com
W www.cliffordchance.com

Professional qualifications. England and Wales, Solicitor, 1994; Hong Kong, Solicitor, 1997

Areas of practice. Syndicated lending; acquisition/leveraged finance.


{ "siteName" : "PLC", "objType" : "PLC_Doc_C", "objID" : "1247323671961", "objName" : "Lending and taking security in Hong Kong overview", "userID" : "2", "objUrl" : "http://us.practicallaw.com/cs/Satellite/us/resource/0-501-3182?null", "pageType" : "Resource", "academicUserID" : "", "contentAccessed" : "true", "analyticsPermCookie" : "223c8752:15b19f99f9c:-31b3", "analyticsSessionCookie" : "223c8752:15b19f99f9c:-31b2", "statisticSensorPath" : "http://analytics.practicallaw.com/sensor/statistic" }