Insolvency and directors' duties in Hong Kong: overview

Q&A guide to insolvency and directors' duties in Hong Kong.

The Q&A global guide provides an overview of insolvency from the perspective of companies that are operating within a domestic and/or international group of companies, and considers the various complexities that this can introduce into insolvency procedures. It also has a significant concentration on duties, liabilities, insurance, litigation, and subsequent restrictions imposed on directors of an insolvent company.

To compare answers across multiple jurisdictions, visit the Insolvency and Directors’ Duties Country Q&A tool.

This Q&A is part of the Insolvency and Directors’ Duties Global Guide. For a full list of contents, please visit www.practicallaw.com/internationalinsolvency-guide.

John Robert Lees, JLA Asia Limited
Contents

Corporate insolvency proceedings

1. What are the main out-of-court and court-sanctioned insolvency proceedings involving a liquidation of the company's assets?

In Hong Kong there are several out-of-court and court-sanctioned proceedings available to creditors and shareholders.

Out-of-court proceedings

The following out-of-court proceedings are available:

  • Members' voluntary liquidation (only applicable to solvent liquidation).

  • Creditors' voluntary liquidation.

  • Receivership.

  • Corporate restructuring.

Court-sanctioned proceedings

The following court-sanctioned proceedings are available:

  • Compulsory liquidation.

  • Scheme of arrangement.

  • Provisional supervision (proposed legislation).

The following proceedings are available for a liquidation of assets:

  • Compulsory liquidation.

  • Members' voluntary liquidation (for solvent liquidation only).

  • Creditors' voluntary liquidation.

 
2. Are there statutory proceedings allowing for a rescue/restructuring of the debtor company's operations and debts?

The statutory proceedings available for a restructuring of the debtor's operations and debts are limited at present (see Question 3).

 
3. What are the general requirements for commencing insolvency proceedings?

Out-of-court proceedings

Members' voluntary liquidation (MVL) . The intention behind an MVL is to wind up the company without court involvement when the shareholders no longer wish to continue the business. An MVL is commenced by the directors of a company by convening an extraordinary general meeting of shareholders in which a special resolution to wind up the company must be passed by at least 75% of the votes cast. To carry out an MVL, the company must be solvent and a majority of the directors (within five weeks prior to commencement of the liquidation) must prepare and file a certificate of solvency with the Companies Registry in Hong Kong. The certificate of solvency states that the company is able to pay all of its creditors in full within 12 months from the commencement of the liquidation.

Creditors' voluntary liquidation (CVL) . A CVL is also commenced without court involvement. There are two ways to commence a CVL:

  • The first method is for the directors of a company to convene an extraordinary general meeting of shareholders in which a special resolution to wind up the company must be passed by at least 75% of the votes cast. A creditors' meeting is convened to confirm the appointment of the liquidator proposed by the shareholders or to propose their own nominee for liquidator, within a day of the shareholders' resolution. If there is a disagreement in the choice of liquidator between shareholders and creditors, the creditors' choice will normally prevail. The meetings are held pursuant to section 241 of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32) (CWUMPO). A committee of inspection (COI) consisting of no more than five persons (as per the CWUMPO) can be formed by the creditors of the company to assist the liquidator and provide advice during the liquidation. The Companies (Winding Up and Miscellaneous Provisions) (Amendment) Ordinance (Amendment Ordinance) which was gazetted on 3 June 2016, will come into effect on 13 February 2017. The Amendment Ordinance, among other things, aims to increase creditor protection and streamline the winding-up process. In respect of the establishment, operation and functions of the COI, the Amendment Ordinance:

    • specifies that the minimum and maximum numbers of members to be three and seven respectively;

    • allows body corporates to act as a member of the COI;

    • allows communication with the COI to be by electronic means;

    • allows committee meetings to be held remotely and for decisions to be made by way of written resolutions.

  • The second method is for the majority of directors to pass a board resolution under section 228A of the CWUMPO. A statutory declaration must be filed with the Companies Registry, verifying written statements of the directors within seven days of the resolution. The statements will explain that the company cannot continue its business because it is unable to meet its liabilities and it is not reasonably possible for the company to be wound up by any other means. The directors must then appoint a provisional liquidator and give notice in the Government Gazette regarding the commencement of the winding-up of the company within 14 days. Within 28 days of the statutory declaration, creditors' and shareholders' meetings must be held within 28 days of the statutory declaration and pursuant to section 241 of the CWUMPO.

Section 228A of the Amendment Ordinance will introduce certain safeguards. In particular, directors will be required to appoint a provisional liquidator with effect from the date of commencement of winding-up, prior to the filing of the statutory declaration. The powers and obligations of the provisional liquidator will be the same as those of a liquidator in a CVL while the powers of the directors will cease from the date of commencement of the winding-up except in certain limited circumstances as specified in section 228A(15) of the CWUMPO. Also, the statutory declaration must be in a specified format and certify that:

  • A resolution to wind up the company has been passed.

  • Meetings of the company's creditors and shareholders have been summoned with the time and date specified in the statutory declaration.

  • A specific person has been appointed as provisional liquidator.

Receivership. Under a charge over a specific asset, a creditor can appoint a receiver to take possession of that asset to safeguard it, receive income from it and/or dispose of it. The intention of a receivership is for the creditor to realise sufficient value of the specific asset in order to pay off the debt due to the specific creditor. If there is any surplus realisation of the asset, the funds must be returned to the company. The receiver's duty is to the appointing creditor and their powers and obligations are limited to the powers contained in the receivership charge document.

Court-sanctioned proceedings

Compulsory liquidation. Compulsory liquidation is also known as court liquidation. It is an insolvency proceeding which is commenced by the presentation of a winding-up petition to the court. Under a compulsory liquidation, the intention is to realise the company's assets and distribute the proceeds to creditors. The petition can be presented by the company, a creditor, a director or relevant government officials (if authorised to do so by law). Once the petition is accepted by the court, it can appoint a provisional liquidator to protect the assets of the company until the petition is dealt with by the court or until a rescue plan can be formulated. Any company (subject to jurisdiction) can be placed into compulsory liquidation irrespective of where it has been incorporated.

Scheme of arrangement. A scheme of arrangement is a statutory mechanism governed by sections 668 to 677 of the Companies Ordinance (Cap 622) (Companies Ordinance). It enables a company to make a compromise or arrangement binding on all of its creditors/shareholders or various classes of either or both. It is very similar to corporate restructuring except that a scheme of arrangement (scheme) need only be approved by a substantial majority (75% in value and 50% in numbers) rather than the 100% agreement required under corporate restructuring. The scheme must also be approved by the court, once approved, it becomes binding on all parties. Negotiations for the scheme are voluntary and can be commenced at any time by the company, its creditors or shareholders. A scheme is available to any company registered in Hong Kong, including overseas companies registered under section 776 of the Companies Ordinance.

Corporate restructuring. There is no statutory restructuring process presently available in Hong Kong. However, voluntary corporate restructuring is available to any company. Corporate restructuring refers to any compromise or contractual agreement between a company and its creditors where the general intention is to avoid liquidation. This can be achieved through various strategies, including allowing the company to restructure debt, re-organise assets and/or improve its business.

In voluntary corporate restructuring, there is no court involvement and there are no obligations on the company or its creditors to enter into negotiations. The success of the process is determined by the ability of the parties to reach an agreement. The company can negotiate with its creditors any time before liquidation proceedings. However 100% agreement is required from all of the class or classes of creditors affected for the agreement to be implemented.

Provisional supervision. Hong Kong does not have a statutory corporate rescue regime (unlike other common law jurisdictions such as Australia). This is despite the fact that proposals have been put forward since 1996 to enact legislation to this effect. As a result, corporate rescue has often been carried out through the use of provisional liquidation to provide a moratorium until a scheme of arrangement can be implemented. This is a costly procedure and in recent years, courts have ruled that this is an improper use of the provisional liquidation provisions. The main reason for the delay in implementing the statutory corporate rescue regime has been a disagreement between employee representatives and creditor representatives as to the extent of employee protection.

The Financial Services Branch of the Financial Services and Treasury Bureau of the Hong Kong Government is in the process of drafting an amendment bill which is expected to incorporate a statutory corporate rescue procedure and insolvent trading provisions. It is anticipated that the bill will be passed into law in 2018. The proposed corporate rescue regime will be referred to as "provisional supervision" which can be initiated by the company, its directors, provisional liquidators or liquidators, but not creditors. It will be applicable to local and foreign companies incorporated or registered under the Companies Ordinance (with the exception of certain regulated financial institutions). The procedure for initiating provisional supervision is expected to include:

  • The filing of the appointment and other relevant documents with the Companies Registry but not the Official Receiver or court.

  • Confirmation by the company that it has sufficient provision to meet its employee compensation liabilities prior to the commencement of the provisional supervision.

  • Preparation of a statement of affairs of the company to be presented by the directors at the directors' meeting that appoints the provisional supervisor.

  • Publishing the notice of appointment of the provisional supervisor in the local newspapers.

Provisional supervision is expected to require the company to be able to pay all arrears of wages and other employee entitlements (up to the caps set by the Protection of Wages on Insolvency Fund) within a specified period of time after the date the restructuring plan is approved. Any remaining employee entitlements must be paid within 12 months from the date the restructuring plan is approved. If not, employees can petition for the winding-up of the company.

Provisional supervision is also expected to have a moratorium under which civil proceedings against the company would be stayed for a certain period (extendable by up to six months by way of a vote at a creditors' meeting) commencing from the date of appointment of the provisional supervisor. An expected feature of provisional supervision relates to insolvent trading. Directors or officers of the company who continued to trade, despite knowing that there was no reasonable prospect of the company avoiding insolvency, will be personally liable for the debts arising from the insolvent trading.

 

Insolvency of corporate groups

4. Are there joint insolvency proceedings available that can apply to a whole group of companies? Do all members of a corporate group have to proceed under the same type of insolvency proceeding?

Separate proceedings need to be conducted for each company in a group of companies as the nature and manner of assets and liabilities are unique to each company. The aim of insolvency proceedings is to maximise the return to creditors for each individual company.

Different members of a group can submit to different insolvency proceedings (depending on the circumstances that gave rise to the proceedings and the assets to be realised). For example, some subsidiaries can submit to court liquidation, while others can submit to corporate restructuring or provisional supervision. This can help preserve the corporate group's sustainability because the redundant business lines will be liquidated and the viable business lines will be maintained.

Where members of the group are organised under, or operate in different locations, such cross-border insolvency can be dealt with by taking two different approaches:

  • The first is for Hong Kong liquidators to apply to the court to determine any questions on the administration of the Hong Kong insolvency proceedings. The court will handle the questions by identifying the principal and secondary jurisdictions, and adopting the principle of comity. However, the process tends to be time-consuming and usually cannot address all the issues that arise in restructuring under a modern insolvency regime. 

  • The second approach is for foreign and Hong Kong liquidators to agree on an insolvency protocol. An insolvency protocol refers to the private agreement between liquidators on how to resolve any issues that arise as a result of an overlap and/or conflict in relation to litigation, information, administration and costs, of concurrent insolvency proceedings in different jurisdictions. Global assets can be maximised for the benefit of creditors across jurisdictions by agreeing on an insolvency protocol. In Hong Kong, there is no legislation that deals with cross-border liquidation in Hong Kong. However in recent years, courts have adopted the approach of approving cross-border insolvency protocols between liquidators to deal with such situations. In order to obtain the Hong Kong court's approval of insolvency protocols, the protocols must have been voluntarily adopted by the Hong Kong and foreign liquidators and should:

    • not contravene or be inconsistent with the relevant provisions of Hong Kong and the foreign jurisdictions' laws and rules;

    • aim to administer concurrent insolvency proceedings in an economical manner to reduce conflicts and complications for the benefit of creditors;

    • observe the principle of equal treatment for all creditors without displacing the Hong Kong and foreign jurisdiction's statutory schemes of distribution. 

The enforceability of an insolvency protocol justifies a liquidator's decision to enter into and act on an insolvency protocol and ensures commitment of each liquidator to co-ordinate concurrent insolvency proceedings. An insolvency protocol is not legally binding or legally enforceable, but liquidators can apply to a court in Hong Kong for approval and authority to enter into and implement the protocol (section 200(3), Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32) (CWUMPO)). The court approval protects liquidators from a creditors' challenge for his entering into and acting on the protocol. In the event that a party is aggrieved by the Hong Kong liquidator not abiding by the protocol, they can apply to the court for directions under section 200(5) of the CWUMPO. 

 
5. Can the same insolvency office holder(s) administer the assets and the liabilities of the entire corporate group? Is a court hearing required to determine whether administration by the same individual(s) is appropriate and, if yes, does notice have to be given to creditors?

A single insolvency practitioner can administer the assets and the liabilities of the entire corporate group (subject to any conflict of interest between the appointed practitioner and individual members of the corporate group). The Amendment Ordinance will require that prospective liquidators and provisional liquidators to complete a disclosure statement in relation to any specified relationships between them (and their immediate group members) and the relevant debtor company.

A court hearing is not required to determine whether insolvency proceedings can be administered by a single party. However, in cases of dispute or disagreement, secured and unsecured creditors or other parties with an interest are allowed to object and can apply to the court for relief.

 
6. If the law does not permit a single insolvency office holder, are there provisions allowing different office holders to co-ordinate with each other so that the value of the group's assets can be maximised?

In Hong Kong, a single insolvency practitioner is permitted.

If more than one insolvency practitioner is appointed, there are no legal provisions in Hong Kong that enforce co-operation to maximise the return to creditors.

 
7. Can professional advisers work for the entire corporate group?

Provided there is no conflict of interest, professional advisers can work for the entire corporate group.

Once an insolvency practitioner is appointed to administer the insolvency proceedings for the corporate group, it is up to the practitioner (based on the circumstances of the case and available funds) to determine whether the assistance of other professionals is required. Legal professionals are commonly appointed by the insolvency practitioner, (who is usually a trained accountant) to assist in various legal aspects of the proceedings. Other professionals, for example, valuers can be appointed to provide independent advice.

The insolvency practitioner should decide whether any conflict of interest exists before assigning professionals to assist them under the proceedings.

 
8. Are the rules regarding members of a corporate group transferring assets to one another different when one or more members are insolvent?

Any transaction that is made to secure a debt owed by the debtor company to a creditor that puts one or more creditors in a better position than if the payments had not been made, will be treated as fraudulent preference, if the transaction is carried out within a six month period before the date of commencement of winding-up of the company (section 266 and 266B, Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32) (CWUMPO)). In the case of related parties or associates which include members of a corporate group, the period is extended to two years before the date of commencement of the company's winding-up.

The existing unfair preference provisions and meaning of the term "associate" under the CWUMPO are confusing as they refer to definitions contained in the Bankruptcy Ordinance (Cap 6) which in Hong Kong, applies only to individuals. The Amendment Ordinance will introduce a standalone provision and detailed definition for what is an "unfair preference". It will also contain a standalone definition for "associate" which includes:

  • A director, shadow director or officer of the company.

  • Another company in control of that director, shadow director or officer.

  • An employee or employer of the director or shadow director of the company.

  • A spouse (or former spouse), cohabitant or relative of a director, shadow director or officer of the company.

  • A relative of a spouse or cohabitant of a director, shadow director or officer of the company.

Any disposition of the company's assets or shares or changes to the status of shareholders following the commencement of insolvency proceedings is void unless otherwise ordered by the courts (section 182, CWUMPO).

Section 60 of the Conveyancing and Property Ordinance can also be applied to corporate group transactions. Section 60 provides that any disposal of property with the intent to defraud creditors is voidable at the request of the person prejudiced by the disposal.

The CWUMPO does not provide for the concept of undervalued transactions, so liquidators have used their powers to institute legal proceedings against the directors of the company for disposal of assets below market value (a situation that can sometimes arise in corporate group transactions). However, the Amendment Ordinance will correct this by introducing specific provisions for undervalued transactions. On the application of a liquidator, the court will have the power to set aside an undervalued transaction entered into by the company within five years from the date of commencement of its winding-up. A company will have been deemed to have entered into an undervalued transaction if:

  • It makes a gift or enters into a transaction for which the company will receive no consideration.

  • It enters into a transaction for which the consideration is significantly less than the consideration paid by the company.

In addition, the transaction should have resulted in the company being unable to pay its debts or at the time of making such undervalued transaction, the company was unable to pay its debts.

 
9. How are claims of one member of a corporate group against other members of the group treated in a formal insolvency processes for those members?

The insolvency practitioner will review the nature, purpose and circumstances under which the claim arose by analysing any available financial statements and supporting documents and making enquiries with directors/ former directors/company staff. The claim can be rejected or accepted in full or in part (depending on the results of the insolvency practitioner's adjudication). Claims that are accepted are enforceable in the same manner as ordinary third party creditors, unless they are found to be subordinated to the claims of other ordinary creditors.

Substantive consolidation

10. Is pooling of assets and liabilities of some or all members of a corporate group allowed, so that a creditor of one member becomes, in essence, a creditor of all members?

There is no law that provides for the pooling of assets. The pooling of assets and liabilities in Hong Kong is based on judicial discretion. Pooling is only allowed when it appears that it is the best or only method of distributing assets back to creditors. However, court sanction is required and the reasons for pooling assets must be clearly stated. For example, pooling may be recommended when there are insufficient records between group companies in respect of inter-company claims.

 
11. What proceedings are required for the court to order the pooling of assets and liabilities?

The pooling of assets in insolvency proceedings is based on judicial discretion. The insolvency practitioner must make an application to court stating the facts of the case and the reasons why this method is required. A court hearing will then be scheduled to determine the merits of the application. Creditors must be given notice of the hearing and the proposal. The court will either grant an order allowing the pooling of assets and setting out the terms for distribution, or request further steps to be undertaken, based on the arguments presented at the court hearing.

 
12. Is the partial pooling of assets and liabilities allowed? What conditions apply?

There are no laws in Hong Kong that relate to the pooling of assets. It is therefore up to the court to decide (based on the merits and demerits of the application put forward by the insolvency professional) whether or not partial pooling should be allowed.

 
13. If the pooling of assets and liabilities is permitted, are there any protections for certain types of creditors?

Creditors secured by a lien or mortgage, are normally settled through the realisation of the secured assets and other priority creditors are normally protected by specific provisions of the Companies (Winding Up and Miscellaneous Provisions) Ordinance and other laws including the Protection of Wages on Insolvency Ordinance or the Inland Revenue Ordinance. Therefore, if the pooling of assets is allowed by the court, it will generally be in respect of unsecured creditors. In any event, the manner in which different classes of creditors are treated would be subject to the terms of order sanctioned by the court.

Secured creditors

14. How are secured creditors treated in relation to a group of companies?

If a secured creditor has more than one claim in a group of companies, the claims are treated separately (as individual companies in the group are treated as separate entities). The secured creditor must accurately estimate the extent of claims against the various group companies and has four options in dealing with their claim(s):

  • Estimate the value of the security and claim for the balance on the debt.

  • Realise the security and claim the balance on the debt.

  • Surrender the security and claim for the whole debt.

  • Rely on the security and not claim at all.

If the creditor has security over assets of one group company and a guarantee from another group company for the same debt, that creditor cannot recover more than the amount of the debt.

Under section 267 of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32), any floating charge created in favour of a person who is connected to the company within 12 months from the date of commencement of the company's winding-up will be invalid unless the company was solvent immediately after creating the said floating charge. Under the Amendment Ordinance, the clawback period for the floating charge favouring a connected person will be increased to two years.

 

Insolvency proceedings for international corporate groups

15. What extra considerations are necessary if one or more members of the corporate group is incorporated under or governed by the laws of another jurisdiction?

The Hong Kong courts have the power to wind up a foreign company (that is, one not registered in Hong Kong) but that can be shown to have a connection with the territory (section 327, Companies (Winding Up and Miscellaneous Provisions) Ordinance (CWUMPO)). Under this section, it must be shown to the satisfaction of the court that:

  • The company has sufficient connection with Hong Kong.

  • There is a reasonable possibility that the winding-up of the company will benefit those applying for the company's winding-up.

  • The court is able to exercise jurisdiction over one or more persons interested in the distribution of the company's assets.

The court does not exercise this power lightly, and petitioners are required to submit a strong case. Once allowed, the same statutory regime for winding-up that applies to a Hong Kong incorporated company will be applicable to the foreign company and there is no qualification or limitation to the application of Hong Kong laws to that company.

The potential does exist for the winding-up of a non-Hong Kong company to be made by a court in its place of incorporation at the same time as by a court in Hong Kong. Hong Kong has not adopted the UNCITRAL Model Law on Cross-Border insolvency 1997 (UNCITRAL Model Insolvency Law), so this can lead to conflict between the two insolvency regimes in the respective two countries. Therefore, the general rule is that a liquidator appointed under the CWUMPO to wind up an insolvent non-Hong Kong company is required to collect the foreign company's assets in Hong Kong and settle those creditors worldwide who have submitted proof of debt in accordance with Hong Kong law. However, most foreign jurisdictions do not recognise the Hong Kong winding-up of the foreign company and will not allow collection of assets in the foreign jurisdiction. If a foreign company is already in liquidation in its place of incorporation, the insolvency proceedings in Hong Kong will be treated as ancillary to the foreign proceedings and the functions of the Hong Kong liquidator will be framed accordingly in the court order. In such cases, the Hong Kong liquidator will collect the Hong Kong assets, prepare a list of Hong Kong creditors and transmit the assets to the principal liquidators in the company's place of incorporation together with the creditor list to enable dividend to be declared and paid.

 
16. If insolvency/restructuring proceedings are started for corporate group members in different countries, do international treaties or EU legislation apply?

Hong Kong's corporate insolvency laws do not expressly provide for the recognition of an overseas insolvency, or those administering an overseas insolvency. Hong Kong has also not enacted the UNCITRAL Model Insolvency Law (and is unlikely to adopt it in the near future). However, existing case law indicates that Hong Kong courts will generally recognise the status of an insolvency representative appointed by an overseas court. As a result, it may not always be necessary for a creditor to commence liquidation in Hong Kong to protect and realise the Hong Kong assets of the foreign company. It may be sufficient to obtain a winding-up order in the company's place of incorporation and for the insolvency practitioner appointed in the company's place of incorporation to obtain possession of the foreign company's assets in Hong Kong. If necessary, the foreign insolvency practitioner can also seek orders from the Hong Kong court to secure and realise the assets. Sometimes it can be easier and more efficient to appoint liquidators in Hong Kong for the-winding up of a foreign company in order to avoid the uncertainty that may arise due to Hong Kong's lack of a formal cross-border insolvency laws. This is particularly in cases where there is the potential for the company or other parties to dispute the insolvency representative's claim for recognition.

 
17. Do domestic courts typically attempt to exercise jurisdiction over all the assets of a company filing locally (regardless of where the assets are located) or do they limit their jurisdiction to local assets?

Hong Kong law provides for the liquidator to have control over all the assets of the Hong Kong company irrespective of location.

 
18. Do local courts enforce court orders from foreign jurisdictions that attempt to exercise jurisdiction over assets located in your jurisdiction that are owned by a company subject to foreign insolvency proceedings?

Hong Kong's corporate insolvency laws do not expressly provide for the recognition of an overseas insolvency, or those administering an overseas insolvency. Hong Kong also has not enacted the UNCITRAL Model Insolvency Law. However, Hong Kong courts have adopted a fairly pragmatic approach on cross-border insolvency issues. The Hong Kong courts recognise most foreign liquidations and have regard to foreign restructuring arrangements which have been approved overseas (provided that the rights of the Hong Kong creditors are protected). Where there are a number of liquidators in different countries, the courts encourage them to agree on a cross-border insolvency protocol for dealing with assets of the company and claims by creditors.

 
19. Can the courts co-operate with foreign courts to co-ordinate the administration of group assets?

Hong Kong has not enacted or adopted any formal framework for dealing with cross-border insolvency proceedings, and there are no specific conditions which require communication and co-ordination between Hong Kong and foreign courts. However, Hong Kong courts have adopted a fairly pragmatic approach on cross-border insolvency issues. Hong Kong courts will recognise foreign liquidations and have regard to foreign restructuring arrangements which have been approved overseas, as is the case with foreign-owned Hong Kong assets (see Question 18). Therefore, the communication between courts is decided on a case-by-case basis.

 

Directors' duties

20. Does your jurisdiction encourage or discourage overlapping boards or management teams for separate members of a corporate group?

Hong Kong courts neither encourage nor discourage overlapping boards or management teams for separate members of a corporate group.

 
21. What legal consequences are there for the directors of a parent company where they are not directors of the subsidiary but do manage the subsidiary's affairs?

If a director of the parent company manages the affairs of the subsidiary (but is not a director of that subsidiary), he/she should consider the following questions, when determining whether the director is actually a "de facto" or "shadow" director:

  • Did the individual assume the status and function of a director in a manner that makes them responsible as if they were acting in the capacity of a director?

  • Did the company consider that individual to be a director and held them out to be a director on a regular basis?

  • Did third parties consider that individual as if they were a director of the company?

  • In what capacity was the director acting?

In summary, directors will be recognised based on their functions and the authority and power that they actually exercise.

If the director is found to be a "de facto" or "shadow" director of the subsidiary, they will treated as if they were a normal director of the subsidiary in the event of a breach of duties. The director could also be subject to criminal prosecution under the Companies (Winding Up and Miscellaneous Provisions) Ordinance and the Companies Ordinance.

 
22. What are the main duties and responsibilities of directors and officers to the company, shareholders and third parties? Do they change when the company becomes insolvent?

Directors' duties can be generally classified into three broad categories:

  • Direct duties. This is where a director is required to act for the benefit of the company or a third party.

  • Indirect duties. This is where the company is required to act for the benefit of third parties or in the general public interest. There is an obligation for the directors to ensure the company complies with this requirement.

  • Incidental duties. This is where other people are required to discharge a duty (in addition to the directors), but where the nature of the directors' role means that it is likely that the directors will need to discharge the duty.

Directors owe duties to various stakeholders, including shareholders, creditors, government authorities and employees.

Directors' duties to shareholders include:

  • Acting honestly and in good faith.

  • Exercising reasonable care, skill and diligence.

  • Exercising their powers for the benefit of the company and for a proper purpose.

  • Not delegating powers (except with proper authorisation and exercising independent judgement).

  • Avoiding any conflict arising between their personal interests and their duties.

  • Not entering into any transactions where the directors have an interest (except where it complies with the requirements of the law).

  • Not gaining advantage from their position as director or accepting personal benefits from third parties because of their position as director.

  • Not making unauthorised use of the company's property or information.

  • Maintaining confidentiality.

Directors owe both direct and indirect duties to creditors.

The majority of the duties that directors owe to government authorities relate to compliance and reporting for example:

  • Maintaining proper books and records.

  • Preparing company accounts.

  • Filing the requisite documents with the Companies Registry in a timely manner.

  • Adhering to the company's articles of association.

  • Adhering to the provisions of the Companies Ordinance and other relevant legislation (including the Securities and Futures Ordinance (Cap 571) (SFO) and the Listing Rules of the Hong Kong Stock Exchange in the case of listed companies or companies registered under the SFO).

Directors are expected to safeguard the interests of the company's employees and not delegate powers except with proper authorisation. Directors also owe a duty to make any payments of employee entitlements in a timely manner.

Most duties or responsibilities of the officers or directors apply regardless of whether the company is solvent or insolvent.

The directors cease to act as directors on the commencement of insolvency proceedings. The former directors will owe a duty to the insolvency practitioner administering the proceedings to co-operate and provide documents and information on the affairs of the company as and when requested.

The proposed corporate rescue regime (see Question 3) which has yet to be enacted contains a special provision which imposes an additional duty on directors in respect of insolvent trading. Under the provision, any director or officer of the company (including shadow directors but excluding senior management) who knew or should have known that the company would not be able to avoid insolvency but failed to prevent insolvent trading by the company, will be held personally liable for any debts of the company incurred during the insolvent trading.

 
23. How are competing duties addressed where directors and officers of different group company members overlap and there are conflicts of interest between the group members?

Directors typically owe their duties to the company they represent, and the duties are not superseded by the commercial interests of the broader corporate group. However, in cases where the same officers and directors are involved in different group companies and their duties overlap and conflict between group members, subsidiary companies are permitted to consider the broader interests of the group when considering the interests of the company for which they are acting. This is provided that appropriate weight is given to the interests of minority shareholders of the company and, where a transaction is likely to prejudice creditors, the interests of creditors of the company. In cases where there are irreconcilable conflicts of interest, the directors may have no option, other than to resign.

 
24. What specific types of conduct are in breach of the duties and responsibilities of directors and officers?

The officers and directors of a company have a statutory duty to observe the provisions of various Hong Kong legislations that regulate the conduct of operations and management of the company. Breaches can be broadly classified as follows:

  • Failure to keep and maintain statutory books and registers of the company, including:

    • registers of charges, members, directors and company secretaries;

    • minutes book;

    • books of accounts.

  • Breach of director's statutory duties in the Companies Ordinance which include:

    • filing of annual returns;

    • an undischarged bankrupt acting as a director;

    • loans to directors;

    • disclosure of material interests in contracts;

    • disclosure of payment for loss of office.

  • Breach of the provisions of the Inland Revenue Ordinance, including:

    • the failure or late filing of tax returns;

    • withholding related information;

    • breaches in record-keeping.

  • Breach of the provisions of the Conveyancing & Property Ordinance which mainly relates to disposition of property with the intent to defraud creditors.

  • Breach of the provisions of the Securities and Futures Ordinance (applicable to directors of listed companies) in relation to the issue of and dealings in their company's securities and in providing related information. In particular, directors can be called out for:

    • market misconduct;

    • failure to disclose inside information;

    • providing false or misleading information to regulators;

    • issuing false or misleading communications to the public;

    • failure to disclose a director's interests in shares or debentures of the company.

  • Failure to pay employees entitlements in a timely manner (Employment Ordinance).

  • Breaches of fiduciary and common law duties by directors, including:

    • failure to act for the benefit of the company;

    • exercising powers for improper purposes;

    • conflict between directors' personal interest and their duties as directors.

 
25. What civil and criminal liability exists for directors and officers if they breach their duties and responsibilities?

Liabilities to directors can include the following (depending on the type of breach incurred):

  • Fines.

  • Imprisonment.

  • Disqualification from acting as a director of any company for a specified number of years.

  • Personal liability for damages incurred by the company arising from a breach.

In general, the punishment remains the same regardless of whether the company is a going concern or has commenced insolvency proceedings. The principle remedy is compensation in the form of damages. However, many breaches that relate to insolvency proceedings carry damages, a fine and/or imprisonment, including:

  • Fraudulent trading, including where a person knowingly carries on a business with the intent to defraud creditors of the company.

  • Falsification of records, including the destruction, alteration, mutilation or falsification of books and records of the company.

  • Failure of the director to deliver all real and personal property and all books and records of the company to the liquidator.

Where there is capital paid to a shareholder or former shareholder in relation to a redemption or buy-back of the company's shares, the Amendment Ordinance will contain a new provision (section 170A) which provides that directors who signed the solvency statement to be jointly and severally liable to contribute to the assets of the company in cases where the company entered into an insolvent liquidation within one year from the date on which the payment was made.

 
26. Is potential personal civil or criminal liability a factor in officers and directors deciding if and when to put the company into a formal insolvency/reorganisation procedure?

Potential personal liability will depend on the impact of the civil or criminal liability on the company. Directors must take prompt action to reduce exposure to potential claims.

 
27. Is insurance available to protect directors and officers from claims arising while operating a financially distressed company?

Directors & Officers (D&O) Insurance is only available to financially viable companies to cover directors' civil liabilities. D&O Insurance can cover a director's liability for:

  • Damages in negligence, default, breach of duty or breach of trust in relation to the company or associated company (except for fraud).

  • Defence costs incurred by the director in defending any proceedings (whether civil or criminal) taken against the director for any negligence, default, breach of duty or breach of trust in relation to the company (or associated company, provided it is included in the policy).

Compensation will not be payable under a D&O Insurance policy if the director is criminally liable.

 
28. Can directors and officers resign from their positions if the company becomes financially distressed and what difference will this make to their potential liability?

A director of the company can resign from his position, despite the existence of any personal civil or criminal liability against him. However, resignation does not mean that the director is freed from the legal proceedings. In addition, the liquidator can call on any former director to provide information during the course of their investigations and potentially be the subject of future legal proceedings.

 
29. How common is litigation against directors and officers for violation of their duties after commencement of insolvency/reorganisation proceedings? Is the litigation typically successful?

Litigation against directors and officers for violation of their duties is more common in larger insolvencies where the insolvency practitioner has more resources to pursue legal action. The Official Receiver's Office normally pursues litigation against directors in smaller insolvency proceedings. In the case of listed companies and registered financial institutions, the Securities and Futures Commission can commence litigation under the provisions of the Securities and Futures Ordinance.

The success of litigation against officers and directors is largely mixed and depends on a number of factors, including the strength of the facts and the funds available.

 
30. What defences against civil and/or criminal sanctions are available to directors and officers?

The general defences that can be adopted by directors and officers include:

  • Acting in good faith.

  • Exercising due diligence (for example, by obtaining independent valuation of assets).

  • Relying on outside consultants or professionals (for example, accountants, legal advice, financial advisers).

  • Exercising reasonable judgement with the intent to preserve the "on-going value" of the company.

 
31. If it appears that "going concern values" will result in a higher return to creditors than a liquidation of the assets, can directors and officers be protected if they decide to continue operations to protect the values for the benefit of all creditors?

Under the current regime, it is difficult for directors and officers to be protected if they continue to operate the company in order to protect the values for the benefit of the creditors. However, when the proposed provisional supervision regime is enacted (see Question 3) the provisional supervisor should be able to continue operations to maximise returns to creditors.

 
32. If a company becomes insolvent, is a director or officer of the insolvent company legally restricted from acting as a director or officer in another company, or from obtaining credit as a promoter of another company?

An officer or director of an insolvent company is generally not restricted from acting as an officer or director of another company. This is unless there has been a judgment against the director that disqualifies him/her from acting as a director of any company in Hong Kong for a specific number of years. Sections 168E to 168G of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32) (CWUMPO) provide that disqualification can arise when the director:

  • Is convicted of an indictable offence.

  • Persistently breaches specified provisions of the Companies Ordinance or the CWUMPO.

  • Is guilty of committing fraud or any other breach of duty in the winding-up of a company.

 
33. If a director or officer becomes personally insolvent, is he legally restricted from continuing to act as a director or officer of his current company or another company?

Current company

An individual who is an undischarged bankrupt must not (except with the leave of the court by which the individual was adjudged bankrupt):

  • Act as director of a company.

  • Directly or indirectly take part or be concerned in the management of a company.

Another company

See above, Current company.

 

Online resources

Bilingual Laws Information System (BLIS)

W www.legislation.gov.hk/blis/eng/index.html

Description. BLIS is an electronic database of the legislation of Hong Kong, including the Companies (Winding Up and Miscellaneous Provisions) Ordinance and the Companies Ordinance. It is established and updated by the Department of Justice. The text of the legislation in BLIS is up to date, except individual provisions that have been specially marked before their headings. Amendments that came into effect on or after 1 March 2015 have yet to be incorporated in the provisions. BLIS provides:

  • Bilingual texts of ordinances and subsidiary legislation in force on or after 30 June 1997 (including the current version and past versions dating back to 30 June 1997).
  • Full text search functions and customised search functions.
  • Viewing of legislation either on a provision-by-provision basis, or whole enactment basis.

Official Receiver's Office

W www.oro.gov.hk/eng/home/home.htm

Description. The official website of the Official Receiver of Hong Kong administers court insolvencies for both bankruptcies and the compulsory liquidation of companies. It contains the latest updates and information on insolvency matters.

Companies Registry

W www.cr.gov.hk/en/home/index.htm

Description. The Companies Registry is responsible for providing services to incorporate local companies with or without limited liability and register non-Hong Kong companies. The website provides up-to-date information on the Registry's major services, compliance with the relevant ordinances and development plans.



Contributor profiles

John Robert Lees, Executive Chairman

JLA Asia Limited

T +852 2842 5010
F +852 2526 0771
E jrlees@jla-asia.com
W www.jla-asia.com

Professional qualifications. Certified Public Accountant, Hong Kong; Chartered Accountant, New Zealand

Areas of practice. Insolvency management; forensic accounting; corporate restructuring and transactional services.

Non-professional qualifications. Bachelor of Commerce, Victoria University of Wellington

Recent transactions

  • Assisted in the turnaround of numerous listed public and private companies in Hong Kong, and has conducted insolvency assignments in various jurisdictions in the Asia Pacific region.
  • Handled a number of complex personal bankruptcies and individual voluntary arrangements.
  • Appointed as Administrator of Deceased Estates.
  • Appointed as Administrator of Hedge Funds and Brokerages in Hong Kong on the application of the Securities and Futures Commission.
  • Other engagements have involved asset fund tracing and recovery, partnership and shareholder disputes, valuation of companies, insider dealing, share valuations, share price manipulation, money laundering, intellectual property, licensing disputes and misappropriation of company assets.

Professional associations/memberships

  • Director and Past President of the Turnaround Management Association Hong Kong Limited.
  • Fellow of the American College of Bankruptcy.
  • Member and Past President, INSOL International.
  • Member of the Restructuring and Insolvency Faculty of the Hong Kong Institute of Certified Public Accountants.
  • Member of the American Bankruptcy Institute.
  • Treasurer and Member of the International Insolvency Institute.

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