THE LAW REFORM COMMISSION
OF HONG KONG
REPORT ON
CORPORATE RESCUE
AND
INSOLVENT TRADING
OCTOBER 1996
The Law Reform Commission was established by His Excellency the Governor in Council in January 1980. The Commission considers such reforms of the laws of Hong Kong as may be referred to it by the Attorney General or the Chief Justice.
The members of the Commission at present are:
The Hon Mr J F Mathews, CMG, JP (Attorney General) (Chairman)
The Hon Sir Ti Liang Yang (Chief Justice)
Mr Tony Yen (Law Draftsman)
The Hon Mr Justice J Chan
Mr Eric Cheung
Professor Yash Ghai, CBE
Professor Kuan Hsin-chi
Mr Andrew Liao, QC
Mr Gage McAfee
Mr Alasdair G Morrison
Mr Robert Ribeiro, QC
Professor Derek Roebuck
Professor Peter Wesley-Smith
Mr Justein Wong Chun, JP
The
Secretary of the Commission is Mr Stuart M I Stoker and its offices
are at:
20/F Harcourt House,
39 Gloucester Road,
Wanchai,
Hong Kong.
Telephone: 2528 0472
Fax: 2865 2902
E-mail : agcitr@hkstar.com
Mr Jeremy Glen, Senior Crown Counsel, was principally responsible
for the writing of this report.
THE LAW REFORM COMMISSION OF HONG KONG
REPORT ON
CORPORATE RESCUE AND INSOLVENT TRADING
CONTENTS
Chapter Page
Introduction
Terms of reference
The need for an interim report on corporate rescue and insolvent trading
Submissions on the Consultation Paper on Corporate Rescue and Insolvent Trading
Confidentiality
Model Bill
Abbreviations
Acknowledgements
Report in English and Chinese
1. Provisional supervision
The present position
Other jurisdictions
Benefits of provisional supervision
The name of the procedure
Recognition of foreign procedures
Environment
Insolvent trading
2. Companies to whom provisional supervision would apply
Companies to whom the procedure would apply
Companies to whom the procedure would not apply
3. Purposes of provisional supervision
Provisional supervision whether solvent or insolvent
Other jurisdictions
4. Those who may initiate the procedure
Company or directors may initiate provisional supervision
Provisional liquidator may initiate provisional supervision except in respect
of a declaration under section 228A of the Companies Ordinance
Creditors
Receivers
Liquidators
Other arrangements under the Companies Ordinance
Shareholders
5. The moratorium (or stay of proceedings)
Court involvement
Length of the stay in other jurisdictions
The moratorium
Where the creditors’ meeting resolves to extend the moratorium
Significant financial hardship
Creditors excluded from the moratorium
Crown bound
Employees
End of the moratorium
6. Initiating the procedure
Documents to be filed and their effects
Affidavit of the directors setting out the reasons for initiating provisional
supervision
Appointment of the provisional supervisor
Gazetting and advertising
Meetings of creditors
7. Who may be the provisional supervisor
Independent person
Provisional liquidator as provisional supervisor
Joint appointment as provisional supervisor
8. Role of the provisional supervisor
Level of involvement
Functions of the provisional supervisor
Provisional supervisor as agent of the company
The relationship between the provisional supervisor and the directors
Directors’ actions during provisional supervision
Directors’ actions prior to provisional supervision
Delegation of his powers by the provisional supervisor
Power to remove and appoint directors
Other powers of the provisional supervisor
Provisional supervisor may apply to the court for directions
Persons dealing with the provisional supervisor
9. Duties, rights and liabilities of the provisional superviso
Liability of the provisional supervisor
Fresh debt incurred by the company during provisional supervision
Indemnity
Remuneration
Payments for property used by the company
10. Ascertaining the company’s affairs
Information and assistance
Specified persons
Statement of affairs
Costs of providing a statement of affairs
11. Removal and resignation of the provisional supervisor
Removal of and reporting on the provisional supervisor
Removal from the panel of provisional supervisors
Resignation of the provisional supervisor
Where a company goes from provisional supervision into liquidation
12. Super priority
13. Secured creditors
Right of election for major secured creditors
Other secured creditors
Provisional supervision should complement existing procedures
Timing of charges
14. Procedure the provisional supervisor follows in the
formulation of a proposal to present to creditors
Provisional supervisor to decide whether a voluntary arrangement could be
achieved
Consultation by the provisional supervisor
If a voluntary arrangement could be achieved
If a voluntary arrangement could not be achieved
No quorum
15. Requirements for meetings of creditors
Where the provisional supervisor decided that none of the purposes could be
achieved
Where the provisional supervisor was satisfied that he would complete the
formulation of an arrangement plan within 6 months
Where it appeared to the provisional supervisor that he would be able to
complete the formulation of an arrangement plan but not within 6 months
of the commencement of provisional supervision
16. Procedures for meetings of creditors
Classes of creditors
Chairman
Notices
Quorum
Proxies
Adjournments of meeting
Voting
Implementation of creditors’ resolutions
17. Consequences of the approval of a voluntary arrangement
Effects of a voluntary arrangement
18. The supervisor of a voluntary arrangement
Vacation of office
19. Insolvent trading
Introduction
Directors and senior management should be
liable as responsible persons
Responsible persons’ duties
Presumptions
Defences
Responsible persons may be liable to compensate the company
Director may be disqualified for insolvent trading
Person managing a company while disqualified may
become liable for company’s debts
Transitional
Holding companies
Fraudulent trading under section 275 of the Companies Ordinance
Annexure
I Organizations in Hong Kong which commented on the Consultation Paper
INTRODUCTION
1. The Law Reform Commission of Hong Kong was established by the Governor-in-Council in January 1980. The Commission reports on such matters as the Attorney General or the Chief Justice refers to it.
Terms of reference
2. On 14th September 1990, the Attorney General and the Chief Justice referred the following topic to the Commission:
“(1) To review the law and practice relating to the insolvency of both individuals and bodies corporate in Hong Kong, and in particular:
(a) the provisions of the Bankruptcy Ordinance, Chapter 6, in their application both to business and non-business debtors; and
(b) the winding-up provisions of the Companies Ordinance, Chapter 32
taking into account existing and proposed legislation in other jurisdictions, in particular the UK Insolvency Act 1986 and Chapter 11 of the US Bankruptcy Code, and to consider what reforms are necessary or desirable.
(2) To submit an early interim report on:
(a) such changes in the Bankruptcy Ordinance as are considered to be required for simplifying bankruptcy procedures, and
(b) any other aspects of insolvency law or practice which the Commission considers should be introduced in advance of the Commission’s final report.”
3. A sub-committee was appointed by the Attorney General to consider the reference and report to the Commission. The sub-committee on insolvency is chaired by Professor Edward L.G. Tyler, formerly a Judge of the District Court and Professor and Head of the Department of Professional Legal Education at the University of Hong Kong, and now Professor and Head of the Department of Legal Education at the City University of Hong Kong. Professor Tyler was a member of the Law Reform Commission from 4th July 1987 to 11th August 1993. The other members of the sub-committee are:
Mr Mark Bradley Solicitor,
Deacons
Mr Graham Cheng OBE JP Chairman,
Taching Petroleum Company Ltd
Mr S. K. Cheung Senior Executive,
(since 7.8.1995) Corporate & Institutional Banking,
Hongkong and Shanghai Banking Corporation Ltd
Mr Nicholas Etches Accountant,
KPMG Peat Marwick
Mr Stefan Gannon JP General Counsel to the
Hong Kong Monetary Authority
Mr David Hague Accountant,
Price Waterhouse
Mr Robin Hearder JP The Official Receiver
Mr Nic Johnston Solicitor,
(since 7.8.1995) Freshfields
Ms Barbara Martin Solicitor,
(until 21.8.1995) Carey & Lui
Mr Michael Page Senior Manager,
(until 30.3.1994) Hong Kong & Shanghai Banking
Corporation Ltd
Mr David Tam Wai-hung Senior Executive, Corporate and
(from 25.4.1994 to 19.7.1995) Institutional Banking,
Hong Kong & Shanghai Banking
Corporation Ltd
Mr Winston Poon QC Barrister
Mr Ian Robinson Accountant, formerly of Ernst &
Young, now a director of
Robinson Management Limited
Mr Jeremy Glen Senior Crown Counsel (Secretary)
4. The terms of reference provide that the Commission may make an interim report on such other aspects of insolvency law or practice which the Commission considers should be introduced in advance of the final report on insolvency. The sub-committee’s intention had been to make a single interim report on bankruptcy to the Commission followed by a final report on all other aspects of personal and corporate insolvency. The Commission’s Report on Bankruptcy was published in May 1995.
5. Following completion of its report to the Commission on bankruptcy the sub-committee considered that, as provided for under paragraph 2(b) of the terms of reference, it would be appropriate to make a second interim report to the Commission on the issue of making provision for a procedure to facilitate the rescue of ailing companies. The sub-committee’s report to the Commission on a procedure for corporate rescue and for a provision which could impose liability on directors and senior management of a company for insolvent trading has formed the basis of this report.
The need for an interim report on corporate rescue and insolvent trading
6. The sub-committee on insolvency considered that provisions of the Companies Ordinance relating to arrangements and reconstructions were inadequate as they were not capable of providing the legislative and procedural support required to propose and formulate a voluntary arrangement. The sub-committee considered that Hong Kong needed a comprehensive system to enable and encourage the reorganisation of companies in situations where liquidation was not the appropriate solution. The sub-committee noted that reorganisation or rescue provisions had been introduced in a number of jurisdictions in recent years and have generally been well received.
Submissions on the Consultation Paper on Corporate Rescue and Insolvent Trading
7. A Consultative Document on Corporate Rescue and Insolvent Trading setting out the sub-committee’s proposals was published by the sub-committee on insolvency in May 1995. Altogether there were 30 substantive submissions on the proposals and the general response was supportive. Points made in the submissions were considered by the sub-committee and, where appropriate, were referred to its report to the Commission. Some of the arguments for amendment of the proposals presented in the Consultation Paper were accepted by the sub-committee and these amendments are acknowledged in this report.
8. The Commission considered the sub-committee’s report in detail and this report substantially supports the sub-committee’s proposals. Where the Commission has departed from the sub-committee’s proposals the reasons are given and the sub-committee’s proposals are recorded.
Confidentiality
9. This report is in line with the Commission’s recent policy of naming those who make submissions unless confidentiality is requested, though only where it is considered appropriate. None of those who made submissions requested confidentiality. A list of those who made substantive submissions is annexed (Annexure I). The Commission would like to express its gratitude to all those who responded to the Consultation Paper.
Model Bill
10. The sub-committee on insolvency prepared a model Bill to assist them in their deliberations on corporate rescue and insolvent trading. The sub-committee found the model Bill useful in drawing the provisions together and ironing out contradictions. The model Bill was published in the Consultation Paper on Corporate Rescue and Insolvent Trading. While the model Bill was intended to assist those considering the Consultation Paper it was never intended that it should be adopted as draft legislation. In the circumstances the Commission prefers to publish this report without a model Bill attached.
11. While many aspects of procedure are addressed in the report, not all of the relevant supporting rules are referred to when recommendations are based on existing legislation in other jurisdictions. It is the general intention, however, that the relevant supporting rules would be adopted in respect of each proposal that draws on existing provisions.
Abbreviations
12. For the sake of brevity, references to “he” mean ”he or she” unless the context implies otherwise. Abbreviated forms of the following reports and legislation have been used:
“The Cork Report” : The Report of the United Kingdom Committee on Insolvency Law and Practice under the Chairmanship of Sir Kenneth Cork.1
“The Harmer Report” : General Insolvency Inquiry: a Report of the Law Reform Commission of Australia under the Chairmanship of Mr Ron Harmer.2
“The Insolvency Act” : This refers to the United Kingdom Insolvency Act 1986.
“The Insolvency Rules” : This refers to the United Kingdom Insolvency Rules 1986.
Acknowledgements
13. In the course of its considerations the sub-committee on insolvency had the benefit of meeting, on separate occasions, with Colin Bird, Head of Corporate Recovery at Price Waterhouse, United Kingdom and Chairman of the Technical Committee of the Society of Insolvency Practitioners, Professor Jacob Ziegel of the Faculty of Law, University of Toronto, Canada and with Dr W J Gough, a partner with Goughs, Solicitors, of Sydney, Australia, all of whom offered valuable insights into the procedures in place in their jurisdictions and their views on how corporate rescue might best be achieved. We wish to thank Mr Bird, Professor Ziegel and Dr Gough for giving so freely of their time.
14. Finally, we extend our thanks to the sub-committee on insolvency without whose considerable efforts this report would not have been possible.
Report in English and Chinese
15. This report is available in both Chinese and English.
CHAPTER 1
PROVISIONAL SUPERVISION
The present position
1.1 At present, Hong Kong companies that get into financial difficulties may try to come to an arrangement with their creditors by means of a non-statutory arrangement or by means of the arrangement and reconstruction provisions under section 166 of the Companies Ordinance, which provides that:
“(1) Where a compromise or arrangement is proposed between a company and its creditors or any class of them, or between the company and its members and any class of them, the court may, on the application in a summary way of the company or of any creditor or member of the company, or, in the case of a company being wound up, of the liquidator, order a meeting of the creditors or class of creditors, or of the members of the company or class of members, as the case may be, to be summoned in such manner as the court directs.
(2) If a majority in number representing three-fourths in value of the creditors or class of creditors, or members or class of members, as the case may be, present and voting either in person or by proxy at the meeting, agree to any compromise or arrangement, the compromise or arrangement shall, if sanctioned by the court, be binding on all creditors or the class of creditors, or on the members or the class of members, as the case may be, and also on the company or, in the case of a company on the course of being wound up, on the liquidator and contributories of the company.
(3) An order made under subsection (2) shall have no effect until an office copy of the order has been delivered to the Registrar for registration, and a copy of every such order shall be annexed to every copy of the memorandum of the company issued after the order has been made, or, in the case of a company not having a memorandum, of every copy so issued of the instrument constituting or defining the constitution of the company.
(4) If the company makes default in complying with subsection (3), the company and every officer of the company who is in default shall be liable to a fine for each copy in respect of which default is made.
(5) In this section and in section 166(A), the expression “company” means any company liable to be wound up under this Ordinance, and the expression “arrangement” includes a re-organisation of the share capital of the company by the consolidation of shares of different classes or by the division of shares into shares of different classes or by both these methods.”
1.2 The major deficiency with section 166 is the lack of a moratorium that can bind creditors while an arrangement plan is being formulated. There is nothing in section 166 to prevent a creditor presenting a petition to wind up the company, an event which could have the effect of ending the formulation of any proposal. There is no comparison to be made between section 166 and the sophisticated corporate rescue procedures operating in jurisdictions such as the United Kingdom, Australia, Canada and the United States of America. Section 166 is so clearly deficient in the elements required for a proposal to creditors to be made that it did not assist in any way in the formulation of our proposals. There are no figures available on the number of successful, near insolvency, arrangements under section 166 but, to the best of our knowledge, the number of arrangements involving companies of any size over the last ten years are relatively few.
1.3 It is not our intention, however, to replace section 166 with our recommendations. We see a place for section 166, as it might be considered suitable for use in some insolvency situations. The availability of more than one procedure is not unique, as evidenced for example by the company voluntary arrangement and administration procedures under the Insolvency Act 1986 and by the procedures available under the Canadian Companies’ Creditors Arrangement Act and the Bankruptcy and Insolvency Act. Indeed, proposals for a new company voluntary arrangement procedure in the United Kingdom would be in addition to the two existing procedures.3
1.4 The sub-committee on insolvency’s Consultation Paper on Corporate Rescue and Insolvent Trading proposed that it was worth considering amending section 166 to provide for a moratorium where a company was insolvent and added that section 166 might still be used in circumstances where the proposed procedure was terminated without a voluntary arrangement having been achieved, though this was unlikely to happen as there is extensive provision made for the procedure to be extended at the behest of creditors.4 The sub-committee reconsidered this statement following a submission which pointed out that if an attempt to secure a voluntary arrangement through a provisional supervision was unsuccessful, a further moratorium provision would be unnecessary because at this point the only viable solution would be liquidation and there should be no necessity for there to be any further attempt to rescue the company.5 The sub-committee agreed with the submission, stating that it was never its intention that moratoria under provisional supervision and section 166 should be cumulative or consecutive. The sub-committee also reconsidered the proposal that section 166 might be linked to a moratorium and recommended no such amendment, on the basis that section 166, combined with a moratorium, would create a debtor in possession type situation akin to Chapter 11, particularly in the case of a company which had not been wound up.6 In essence, the sub-committee saw no objection to a proposal under section 166 flowing into provisional supervision but did not countenance it happening the other way round.7 We agree with the sub-committee’s view.
1.5 It was submitted that section 166 may be used both before and after winding-up and that neither the presentation of a petition nor an order made upon it would, as a matter of law, finally end the possibility of a scheme. Given the procedural requirements for advertising, and the practical considerations for fixing dates, there would inevitably be a time lapse between presentation of the petition and a hearing on the merits, which, although not a true moratorium, is an effective period of time in which proposals can be finalised. In addition, once a petition is presented, the court has power to grant a stay of proceedings or execution where a scheme is being prepared. The submission concluded that if lack of a moratorium was considered to be a major defect, consideration could be given to extending section 181 of the Companies Ordinance to pre-presentation situations.8
1.6 The point is mentioned only in passing as it does not have a direct bearing on the recommendations for provisional supervision. We will consider the suggestion further in our final report on the winding-up provisions of the Companies Ordinance. It does, however, prompt us to address suggestions that the step by step procedure we recommend cannot be cheaper, quicker, simpler and more effective when compared to the seemingly simple alternative under section 166.
1.7 We are convinced that provisional supervision would be better than the existing procedures for the following reasons:
· First, provisional supervision would provide a solid basis on which to calculate the costs and time involved in putting a proposal to creditors. Section 166 is an open-ended procedure, which provides no assistance in planning the time it would take and the cost of putting a proposal to creditors.
· Second, provisional supervision would provide a flexible framework which would allow the provisional supervisor to take on his task in relative peace in that he would be guaranteed court protection from the outset. Section 166 provides no court protection.
· Third, provisional supervision would limit the costs of court appearances as the provisional supervisor would only have to approach the court, apart from exceptional matters, after 30 days, and after that only when an extension of provisional supervision is sought or the company is deemed to be wound up as a creditors’ voluntary winding up. Under section 166, the number of court applications and hearings have no limit.
· Fourth, provisional supervision sets out the role of the provisional supervisor, gives the provisional supervisor the power of management together with rights duties and liabilities, prevents rogue creditors from threatening proceedings as a form of leverage, permits super priority borrowing, allows creditors to vote on the proposal when formulated and provides a smooth transition into a company voluntary arrangement or winding-up as the case may be. Section 166 provides none of these things which, we consider, is a discouragement to companies ever starting the process in the first place.
· Fifth, provisional supervision would provide certainty. Even disaffected creditors could be sure that after usually not more than six months, they would have their say on a proposal. They would know this from the outset. Section 166 provides no certainty. A member of the sub-committee on insolvency spoke of his experience when, as a receiver of a company some years ago, he carried out a voluntary arrangement under section 166. He estimated that he could have completed the scheme in one month rather than the five months it took, he would have had one creditor’s meeting instead of the three it needed, on top of which there were many other procedures and pressures that had to be dealt with which could have been limited if provisional supervision had been available. Finally, the company concerned was in receivership for two years before the proposal for a company voluntary arrangement was put to creditors; a period of uncertainly that could have been avoided under provisional supervision.
Other jurisdictions
1.8 We have had the benefit of the experience of several reporting committees and of the operation of systems for corporate rescue in various jurisdictions. Most notably, the experience in the United Kingdom and its Law Commission’s report, under the Chairmanship of Sir Kenneth Cork, commonly referred to as “the Cork Report”9 and the experience of the company voluntary arrangement and administration procedures under the Insolvency Act 1986 have been drawn on.
1.9 The “Harmer Report”10, the result of the Australian Law Reform Commission’s General Insolvency Inquiry under the Chairmanship of Mr Ron Harmer was considered together with the recent Australian provisions on administration of a company's affairs with a view to executing a deed of company arrangement.11 The Canadian provisions for a general scheme for proposals were also considered.12 Both the Australian and Canadian provisions provide innovative solutions for problems that occur in corporate rescue culture and elements of both sets of legislation appear in our proposals.
1.10 Chapter 11 of the United States Bankruptcy Code was looked at and, while not adopting the Chapter 11 concept of debtor in possession, we believe that the directors of a company should, where possible, remain involved in the management of the company during the proposal period and, depending on the terms of the proposal, beyond. We did not believe, however, that the concept of the debtor in possession, in other words the existing management, would be acceptable to creditors in Hong Kong and our proposals reflected this in providing for an outside party, the provisional supervisor, to take effective control of the company during the proposal period, to be known as the provisional supervision period.
1.11 It is worth noting that several submissions expressed outright hostility towards the Chapter 11 concept of debtor in possession, perhaps best summed up by a submission which stated that it was a concern that provisional supervision should not become a simple way for a company to avoid or delay its obligations to creditors, adding that in this respect, the proposals seemed reasonably fair but expressing concern that representations from other parties might influence us to move towards the US model of Chapter 11.13
1.12 Neither the Canadian nor the Australian procedures have yet had time to build up a significant body of statistics to indicate whether they may be considered a success, though the early signs from both jurisdictions are encouraging.14
1.13 The provisions on judicial management in Singapore, which follows the Insolvency Act 1986 to a significant extent were considered together with the provisions on examinership in Ireland.15
1.14 Some of the procedures in other jurisdictions are being reviewed. In the United Kingdom, the Insolvency Service has issued Consultative Documents on the Insolvency Act's company voluntary arrangement and administration procedures.16 In the United States, Chapter 11 is being reconsidered and the comparatively recent Irish procedure is also being reconsidered.
Benefits of provisional supervision
1.15 We considered whether a crude, though effective, reorganisation process already operates in the demise of businesses or industries and their replacement by new businesses or new industries. We asked whether Hong Kong needed a formal procedure for restructuring as opposed to the existing situation which, it may be argued, allows businesses to decline and die and encourages the development and growth of new businesses.
1.16 This argument was taken up by the one submission which expressed serious reservations about the proposals.17 The submission questioned the need for “Government-mandated” intervention in corporate failure at all. No other submission took this view. The balance of opinion was strongly supportive of the introduction of measures such as those proposed in the Consultation Paper.
1.17 The process of decline and growth would continue in any event. We are in no doubt that there is a place for a corporate rescue procedure which would complement the existing procedures provided it was used in cases where a company or part of a company could be saved.
1.18 In our view, it is beyond dispute that it is better for a viable business to survive as a going concern, in whole or in part, than for it to be simply wound up and such assets as remain distributed. It benefits the company's shareholders, as if the company survives, their share holdings might become valuable, whereas if a company is insolvent and wound up they get nothing. It benefits the ordinary creditors of the company if they obtain more from a company reorganisation than from a dividend in a winding up, with the added benefit that they would keep a customer. It has become increasingly clear that secured creditors, usually banks, must look beyond the notion that being secured means that they are not affected by the winding up of a client company. Employment that would otherwise disappear would be preserved, at least to some extent. All of this has implications for Government both in revenue and social terms.
The company
1.19 The advantage for a company and its shareholders is plain. If it can achieve a voluntary arrangement under supervision, there are good prospects that it can return to profitability. This is attractive to the shareholders, who generally have the lowest priority when it comes to the distribution of the assets of a company that has gone into liquidation, and who would otherwise be unlikely to get anything from a winding up.18
Employees
1.20 For employees, the preservation of their jobs is of the utmost importance. For older workers, accumulated pension rights might be at risk, and it would probably be difficult to find new employment at the same remuneration, if at all. Younger workers have families to support, mortgages to service or rent to pay. The greatest numbers of jobs are lost in times of recession when a job lost is not easy to replace. Successful workouts in times of recession take on a greater significance than may be apparent in a booming economy. The Official Receiver's Office reports that in 1991/92 it took an average of 4.00 years to pay an average rate of 58.54% first and final dividend to preferential creditors; in 1992/93 the average time was 3.30 years to pay an average dividend of 71.97%. In 1993/94 the average time was 2.85 years to pay an average dividend of 63.37% and in 1994/95 the average was 2.88 years to pay an average dividend of 59.28%.
1.21 We are mindful that provisional supervision would have far reaching consequences for employees in terms of entitlements to severance payments. These concerns are addressed in detail elsewhere in the Report.19
1.22 We consider that employees would be placed in a better condition under provisional supervision than under liquidation. The best chance of a solution that would achieve the most benefit for all parties, whether employer, employee or creditor would come under a scheme of voluntary arrangement fostered by provisional supervision. Provided all parties approached provisional supervision in a reasonable manner the provision would be constructive rather than divisive.
Unsecured creditors
1.23 Unsecured creditors are often considered to have a raw deal in a liquidation. By the time preferential creditors have been paid and secured creditors have taken their entitlement out of a company, unsecured creditors often find that they receive no dividend and, even in cases where there is a dividend they have to wait several years, on average, for payment. Preferential creditors, including employees, are in a better position but even for them the statistics show that liquidation is not a cause for celebration. The Official Receiver’s Office reports that in 1991/92 it took an average time of 5.99 years to pay an average rate of 18.89% first and final dividend to ordinary creditors; in 1992/93 the average time was 5.36 years to pay a dividend of 32.45%; in 1993/94 the average time was 4.51 years to pay a dividend of 32.82%; and in 1994/95 the average time was 4.62 years to pay an average dividend of 26.98%.
Secured creditors
1.24 Why then should secured creditors have any interest in entering into a voluntary arrangement? On the face of it, they have security and the ability to realise it by appointing a receiver under the debenture. The reality, however, is that it is not unusual for there to be multiple secured creditors with varying securities and priorities over the assets of a company. Because of the nature of floating charges in particular, which permit a company to deal with the assets covered by the floating charge in the ordinary course of business, and also because of what critics would say is the lack of caution of some lenders, the value of a company’s assets can diminish, leaving some or all of the secured creditors under-secured. In such a situation, the secured creditors might conclude that a voluntary arrangement was an attractive proposition.
1.25 It goes further than that however. Lenders, usually banks, are in a competitive business and realise that if a client company goes into liquidation they lose any prospect of new business with that company. Even if the gap left by a wound up company is filled by another entity there is no guarantee that the lender will get the new business. If the lender can participate in a provisional supervision leading to a voluntary arrangement under supervision, the lender can retain a client which it understands much better and with which it can do business in the future.
1.26 In the greater scheme of business lending therefore, it is in the general interest of lenders to promote and participate in a rescue culture. This is evidenced by the development in the United Kingdom of what is known as the London (Bankers’) Approach. This is a non-statutory, informal arrangement whereby a lead bank of lenders seeks to support a company in financial difficulties while a decision on the company’s long term future is made. The lenders work together to reach a collective view on whether and on what terms a company should be given a financial lifeline. The Bank of England has a role in this as it is prepared to offer help in negotiations if called upon to do so and, in any event, it is kept advised of progress in major workouts using the approach. It appears that the London Approach is working well and that in recent years there have been comparatively few cases where an attempt to organise a workout has failed because the banks concerned could not agree terms themselves.20
1.27 The usefulness of a corporate rescue procedure was recently, graphically, demonstrated in the collapse of Barings Bank, which was an international operation. Barings Bank in the United Kingdom went into administration under the Insolvency Act and was sold off, with the approval of the court, within two weeks of going into administration. If Barings had not had the benefit of the moratorium imposed under the administration procedure, it would have proved more difficult to achieve the sell off as other parties could have taken proceedings and disrupted the negotiations.
The name of the procedure
1.28 The procedure we contemplate, while borrowing from other procedures, has its own characteristics and is quite distinct. To distinguish it further we settled on provisional supervision, as the procedure revolves around the person who is brought in to prepare a proposal and we considered that “provisional supervisor” was the best expression of his or her function. If a proposal was subsequently accepted by creditors, a supervisor, who in all probability would be the provisional supervisor, would oversee the voluntary arrangement.
1.29 When work started on this report there were no preconceived ideas as to the system that would be adopted. What has developed is basically a procedure for the preparation of a proposal for a voluntary arrangement. To achieve this there must be a moratorium and there must be clear statements as to the purposes of provisional supervision and the powers and functions of the provisional supervisor. This reasoning is developed in the following chapters, which detail the procedure.
1.30 The ideal procedure would be cheap, quick, simple and effective. To be effective, however, a proper procedure comes with a cost. The procedure already available under section 166 of the Companies Ordinance has proved to be very expensive to operate. The difficulties involved in a reorganisation are considerable and necessarily involve a certain amount of expense and time. In addition, the need to delineate responsibilities and protect the interests of the various parties means that procedures have to be adopted to provide checks and balances. The four criteria above were, however, given a high priority at all stages of the procedure and every effort has been made to reduce the chances of a long, involved and expensive process.
1.31 Attention has been given to keeping the procedure within strict time limits, as undue delay acts against the chances of success of a reorganisation, by imposing an initial stay of 30 days which may be extended by application to the court. In this, the new Australian and Canadian provisions were drawn on. Although initially it was intended that the moratorium should only last for a maximum of six months in the end it had to be accepted, reluctantly, that a strict six month limit, after which the proposal would lose the protection of the moratorium, was not viable in the case of larger companies, or indeed in smaller complex situations. We are nonetheless convinced that time is of the essence in putting a proposal to creditors and we have provided every encouragement in our recommendations for the provisional supervisor to put his proposal to creditors before the expiration of six months.
1.32 It is important to keep court involvement to a minimum to save costs and the time involved in waiting for a hearing. This procedure can be initiated without the involvement of the court, apart from the filing requirements and in a straightforward case, a workout could be achieved within 30 days without going to the court.
1.33 The key to provisional supervision is the provisional supervisor, who would be appointed to formulate a proposal to be put to the creditors. The procedure would flow through him and his powers and functions are clearly set out in the following chapters. The main point to note is that the provisional supervisor would take control of the company as soon as he is appointed and that the management of the company and such directors as he retains would be answerable to him.
1.34 Cost is a factor in any procedure, and is especially relevant when insolvency is looming. There has been criticism of both abuse of and unnecessary costs involved in the systems in some other jurisdictions. We would like to avoid unnecessary expense. We certainly want to avoid the procedure becoming a cash cow for provisional supervisors and for those who would seek to use it as a vehicle to make work for themselves and our recommendations introduce more stringent recommendations on who may be the provisional supervisor and how their fees would be regulated than those proposed by the sub-committee on insolvency.21 The cheaper that a procedure is to initiate and run, the more viable a proposition it becomes to a greater number of companies in difficulties.
1.35 One of the best ways of keeping costs down is to limit the involvement of the courts. There is therefore a corresponding need to have practitioners of the highest quality to supervise a proposal. High quality professionals are not cheap but, under the procedure, they would have multiple responsibilities and we anticipate that vesting of control of a company and the formulation of a proposal in the provisional supervisor combined with an extensive moratorium, should avoid the sort the problems associated with, for example, Chapter 11 proceedings in the United States.
1.36 We consider that only one procedure, in addition to the provisions under section 166, needs to be introduced, initially at least. We hope that the procedure would be sufficiently cheap and simple to be used by all sizes of business but we recognise that it might prove too expensive for many small businesses. This would be regrettable but may be unavoidable if a system capable of withstanding the pressures of a major reorganisation is to be introduced.22
1.37 This is the first attempt to put in place a comprehensive company rescue procedure in Hong Kong. We are fully aware that lessons will be learned from the experience as we cannot hope to put the perfect procedure in place at the first attempt. We recognise, and intend, that the system should be refined in time. In this context, we note that the Superintendent of Bankruptcy in Canada has undertaken an exhaustive and comprehensive survey of the new procedure under the Bankruptcy and Insolvency Act 1992 and we suggest that a similar monitoring exercise could usefully be carried out in Hong Kong.
1.38 Provisional supervision would not necessarily be used all that extensively and we would not calculate its success or failure in terms of how often it is used or as a percentage of windings up, but in terms of how successful it is as a process when it is used.
1.39 We are aware that Hong Kong has a large number of family run businesses, some of them very large and well known, and the point has been made that family businesses will not be prepared to allow a provisional supervisor take control of the business under any circumstances. This may prove to be a problem with such businesses but we believe that the relevant families will see the sense of trying to save their businesses. We hope that any distrust of the procedure would dissipate as it is appreciated that provisional supervision can be used to save businesses.
Recognition of foreign procedures
1.40 The issue of co-operation in international insolvencies and restructuring needs to be considered in the overall context of insolvency law. For that reason, we have not made any recommendations on recognition here but we will address the subject in our final report on insolvency law. We recognise, however, that co-operation between jurisdictions, particularly in the context of a restructuring of a company with interests in several jurisdictions, is desirable and we are in favour of provisions which encourage co-operation.
1.41 In this context, we note that section 426 of the Insolvency Act 1986 obliges courts in the United Kingdom as a matter of insolvency law, to co-operate with each other and that this co-operation is extended to other relevant countries, including Hong Kong. Hong Kong does not reciprocate. Section 304 of the United States Bankruptcy Code also permits co-operation with foreign courts by allowing a case ancillary to a foreign proceeding to be filed in the United States courts by a foreign representative. The Australian Corporations Law also makes provision for reciprocity with other jurisdictions.
1.42 We consider that it may be appropriate for Hong Kong to take the initiative, as the countries mentioned above have, and introduce a reciprocal arrangement. It may be limited, as under the Australian provisions, to provisional supervision or to an arrangement under section 166. In order to protect Hong Kong businesses and companies, it may be useful to take the approach of the United States Bankruptcy Code which provides that in determining whether to grant relief, the court shall be guided by what will best assure an economical and expeditious administration of the estate, consistent with just treatment of all holders of claims against or interests in such estate, protection of claim holders in the United States against prejudice and inconvenience in the processing of claims in the foreign proceeding, prevention of preferential or fraudulent dispositions property of such estate, distribution of proceeds of such estate substantially in accordance with the order prescribed in the Bankruptcy Code and comity.
1.43 The alternative to a co-operation provision would be participation in a treaty, but this is not likely to be an option for some time to come. It has been noted that:
“There is a highly noticeable unwillingness or lack of attention among governments toward implementing effective multinational treaties in the insolvency area and a comparable unwillingness or lack of attention toward enacting provisions in domestic legislation to deal with the cross-border impact of insolvencies and reorganisations.” 23
Environment
1.44 There is a growing awareness that insolvency practitioners need to consider their potential liability for damage to the environment caused by companies with which they become involved both in terms of damage caused before and after their appointment. This is a matter of particular concern to practitioners who take over the control and management of a company, such as receivers and, in the context of our proposals, provisional supervisors.
1.45 The Hong Kong Society of Accountants prepared, in 1991, a list of environmental laws in Hong Kong as they related to creditors and creditors’ representatives as part of an INSOL International project.24 The paper listed about twenty eight Ordinances and Regulations that made provision for noise, air and water pollution, waste disposal, spills at sea, transportation of dangerous goods, hazardous goods management, waste management and occupational health and safety. The paper commented on the statutory liabilities which may affect representatives during the conduct of their roles in the following terms:
“Statutory liability is imposed on persons committing an act or omission, owners and occupiers of premises. Therefore, representatives are covered if they are the ones who committed the prohibited acts, failed to comply with orders or are legal owners or occupiers of the offending premises.
The environmental statutes impose criminal liability on offenders. Normally a fine is levied on the first conviction and a more severe fine on the second conviction. A further fine may also be imposed for every day or hour during which the offence continues. Such liability is often imposed where the legislation provides that certain acts are prohibited or certain orders must be complied with. The liability is not retrospective.
Regulatory liability is imposed on the grant of licences and permits. Where a breach of licensing conditions is involved, the licence or permit may be forfeited.
Civil liability may also arise from breach of contract and tort. It is not provided for in the statutes.”
“Liability is normally strict in that once the act or omission is committed, an offence is constituted and there is no need to prove that the act or omission was accompanied by any intention, knowledge or negligence. Certain statutes, such as the Water Pollution Control Ordinance and Waste Disposal Ordinance25 have set this out expressly.”
1.46 The possible consequences of liability for environmental damage has been of concern in other jurisdictions that may be considered to be ahead of Hong Kong in terms of environmental awareness. The Canadian Bankruptcy and Insolvency Act 1992 provides that a trustee will not be personally liable, under federal and provincial legislation, in respect of any environmental damage that occurred before the trustee’s appointment as trustee or after that appointment, except where the condition arose or the damage occurred as a result of the trustee’s failure to exercise due diligence.26 It has been noted that there is hardly an insolvency in Canada today where environmental concerns are not an issue. It was also noted that trustees have become so concerned about the spectre of personal liability in respect of bankrupt estates with potential environmental problems that it has resulted in numerous situations where trustees have refused to act with respect to potential bankruptcies.27
1.47 Concerns have also been raised in the United Kingdom about receiver’s liability under the Environmental Protection Act 1990. Under the Act a receiver may be liable if he is held to be the owner or occupier of contaminated land, or in the course of carrying on the borrower’s business he causes or knowingly causes or knowingly permits the pollution of the environment. A receiver does, however, have a defence if he can show that he took all reasonable precautions and exercised due diligence to avoid the commission of the offence.28
1.48 It should come as no surprise to Hong Kong receivers to find dangerous goods for which premises are unlicensed and which they were unaware of when appointed. We are also aware of instances where difficulties in complying with environmental provisions have been influential in receivers deciding to wind up companies rather than trying to save them.
1.49 We consider that it would be worthwhile at this stage to attempt to establish the extent to which provisional supervisors, and by extension receivers, should be liable for environmental damage. We consider that there are two, and possibly three elements to this. The first concerns environmental damage that occurred before the appointment of the provisional supervisor. We consider that there is no reason whatsoever for liability to be imposed on a provisional supervisor in such circumstances. Any liability should remain firmly fixed on those whose responsibility it was to avoid the damage or who caused the damage, depending on the relevant provisions. Furthermore, provisional supervision should not be allowed to be used by responsible parties to try to extract themselves from responsibility.
1.50 The second situation concerns environmental damage that occurs after the provisional supervisor’s appointment. We recommend following the Canadian lead in this to the effect that the provisional supervisor should not be liable for environmental damage that arose after appointment except where the condition arose or the damage occurred as a result of the trustee’s failure to exercise due diligence.
1.51 The third situation is covered by our second proposal but for certainty we recommend that if environmental damage is occurring or continuing as the provisional supervisor “enters the premises” he should only be liable for failure to exercise due diligence.
1.52 We would caution practitioners who act at present as receivers and managers to acquaint themselves with the environmental legislation in Hong Kong and to consider environmental implications when appropriate.
Insolvent trading
1.53 In the context of the directors and senior management acting on insolvency earlier rather than later, we recommend in Chapter 19 that directors and senior management, who would be known under the collective title of “responsible persons”, could be made personally liable for the debts of a company which traded while insolvent. The respective duties of directors and senior management as regards trading while insolvent would be defined. The hope is that the introduction of an insolvent trading provision would assist in encouraging directors and senior management to consider going into provisional supervision early as the prospect of personal liability would give many directors and senior management pause for thought before they allowed a company to proceed into an insolvent trading position.
CHAPTER 2
COMPANIES TO WHOM PROVISIONAL
SUPERVISION WOULD APPLY
2.1 There were two issues involved in deciding which companies provisional supervision should apply to. The first issue was that we did not expect nor did we intend that supervision should become the panacea for all ailing corporations. We thought, from the experience of other jurisdictions, that provisional supervision would only be viable for relatively small numbers of companies. We have recently seen figures from Australia, however, that offer encouraging evidence of the enthusiasm with which the new voluntary administrations procedure under the Corporate Law Reform Act 1992 has been adopted in that country. In 1993 there were 349 voluntary administrations against 2,253 liquidations. In 1994, there were 1,326 voluntary administration against 1,299 liquidations and in the year to the end of August 1995 there were 2,258 voluntary administrations against 1,395 liquidations.29 It is difficult without greater analysis to know what can be drawn from these figures but they tend to lend credence to the argument that corporate rescue procedures have a place in the insolvency regime. It may be noted that Australia did not have a comprehensive corporate rescue procedure before the 1992 Act. The alternatives available were schemes of arrangements and official management. The figures for schemes of arrangement between 1991 and 1995 were consistent at between 22 and 40 annually while official management cases went from 13 in 1991 and nine in 1992 to none in 1994 and 1995.
2.2 What may have happened was that there was a crying need for a viable rescue procedure in Australian, a country which had gone through a traumatic recession over the last several years. Perhaps Australia was ripe for corporate rescue. We do not anticipate that Hong Kong would embrace the procedure with such alacrity but we are encouraged by the Australian experience.
2.3 The procedure aims to facilitate the rescue of those companies that have viable businesses which are worth saving in whole or in part. In Hong Kong, this could mean a small number of companies going into provisional supervision in any one year and we anticipate that it will take some time for a rescue culture to become part of business thinking. Nonetheless, we believe that the provisional supervision procedure would benefit businesses in Hong Kong and, consequently, benefit Hong Kong as a whole.
2.4 The second issue is that, while provisional supervision should be available to as many companies as possible, there are certain industries which may be exempted from the recommendations for the reasons stated later in this chapter.
Companies to whom the procedure would apply
2.5 The Consultation Paper proposed that the procedure should apply to companies formed and/or registered under Parts I and XI of the Companies Ordinance but excluding the regulated industries discussed later in this chapter. Submissions were received, however, from organisations involved in those industries which led to an industry by industry approach being taken. We endorse this approach.
2.6 For the avoidance of doubt, provisional supervision would apply to both listed and unlisted companies.
2.7 Companies registered under Part I of the Companies Ordinance account for most companies in Hong Kong, including both private and public companies. As at 31 May, 1995 there were 462,489 locally incorporated companies on the companies register. Of these 456,144 were private companies and 6,345 were public companies, 510 were companies limited by shares and 5,835 were companies limited by guarantee. A total of 4,127 oversea companies were registered under Part XI, representing a 10% increase over the corresponding figure of 3,778 in July 1994. In April 1994 the Hong Kong Stock Exchange had 275 Part XI companies listed and 201 locally incorporated public companies.30
2.8 Part XI of the Companies Ordinance relates to companies incorporated outside Hong Kong, which are referred to in Part XI as “oversea companies” and which are provided for as follows under section 332:
“This Part shall apply to all oversea companies, that is to say, companies incorporated outside Hong Kong which, after the commencement of this Ordinance, establish a place of business in Hong Kong, and companies incorporated outside Hong Kong which have, before the commencement of this Ordinance, established a place of business in Hong Kong and continue to have a place of business in Hong Kong at the commencement of this Ordinance.”
2.9 The inclusion of oversea companies is important as Hong Kong is a major international trading, manufacturing and financial centre and there are a considerable number of international companies operating in Hong Kong in one form or another. Oversea companies operating in Hong Kong have the choice of forming a Hong Kong subsidiary under Part I of the Companies Ordinance or registering as an oversea company under Part XI. As this choice is open to oversea companies, which would include multinationals, the procedure should be available to them whether they choose to incorporate under Part I or to register under Part XI.
2.10 It would be inadvisable for a provisional supervisor to be appointed over an oversea company which had most of its assets and share holding in another jurisdiction. In such a case, it would be appropriate to use the provisional supervision as an ancillary procedure to the procedures being taken in the company’s home jurisdiction.
2.11 The appointment of a provisional supervisor of an oversea company whose main business was carried out in another jurisdiction could result in local creditors only receiving the benefit of assets that were in Hong Kong, with local creditors losing out on the prospect of benefiting from a distribution from a larger pool of assets if an administrator was subsequently appointed overseas. Another consideration would be that the moratorium imposed by the procedure could not be enforced overseas, in the absence of a reciprocal agreement.
Companies to whom the procedure would not apply
2.12 The sub-committee on insolvency’s Consultation Paper proposed that the procedure should not apply to industries that were already regulated by statute and which had provision for the relevant authority to assume control of the business or oblige a business to act in a certain manner. The industries identified were (i) banking, (ii) insurance and (iii) securities and futures. It was noted that the regulatory powers of each industry differed substantially, according to their needs and that the Securities and Futures Commission Ordinance and the Securities Ordinance did not provide a detailed insolvency regime, whereas the Banking Ordinance did. While the Consultation