Hong Kong Law Reform Commission

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Chapter 1 - Overview

1.1 The function of the insolvency provisions of the Companies Ordinance is to provide a means by which companies which fail can be disposed of effectively or restructured. At its crudest, the insolvency provisions may be considered to be the waste disposal system for companies which have failed and while this is undoubtedly the case with the majority of companies which become involved in insolvency processes, it is not the full story.

1.2 There is a need for the insolvency provisions because, although the vast majority of companies do not become insolvent, those that do leave behind a trail that needs to be tidied up, a point that we address further in the chapter on the funding of the Official Receiver's Office.[3] This is an important function, as it oversees the fair distribution of the remaining assets of the insolvent company among its creditors. This is not to say that the administration of an insolvent company is simple matter. It can be difficult to recover assets, particularly in situations where companies do not have the cash to fund recovery actions, and there are often difficulties in getting the former owners to co-operate with each other and with the liquidator.

1.3 The insolvency provisions are only necessary because the nature of doing business requires that companies operate on credit: companies borrow money in order to trade and develop. This process is not limited to companies; private individuals and countries also go into debt. The types of debt that are now being developed in the financial markets are tending to increase the complexity of some insolvencies, usually those where the insolvent company is a finance company or bank or where a company is dealing in complex debt market contracts. The more usual forms of debt used by companies involve the obtaining of loans from financial institutions or the obtaining of credit terms from companies with which a company is doing business.

1.4 The impact of the failure of a company that has been carrying on a genuine business is difficult to understand at first glance. The obvious victims are the employees and the shareholders of the company but the failure also affects unpaid creditors and the holders of loans that might have been made to the company. When, as happens periodically, significant numbers of companies fail at about the same time, the impact on an economy becomes plain and can be seen in the form of increased unemployment, falling prices, poorer results from companies which are still in business and increasing social discontent.

1.5 The law of insolvency cannot prevent economic downturns but it can assist in ameliorating the effect of the downturn. The aim of this report is to examine the existing company winding-up provisions and to see how they can be improved or developed to facilitate the more efficient winding-up of companies. The Australian Law Reform Commission’s General Insolvency Inquiry, better known as the Harmer Report, identified certain principles that should guide the development of a modern insolvency law.[4] We cannot express those principles in any better way and therefore set them out below. These principles apply equally well to this report as it did to the Harmer Report. We would note that the Harmer Report addressed both individual and corporate insolvency. The Commission’s Reports on Bankruptcy and Corporate Rescue and Insolvent Trading, when read with this report, would cover all the principles identified in the Harmer Report, which are that:

“(a) the fundamental purpose of an insolvency law is to provide a fair and orderly process for dealing with the financial affairs of insolvent individuals and companies;

(b) insolvency law should provide mechanisms that enable both debtor and creditor to participate with the least possible delay and expense;

(c) an insolvency administration should be impartial, efficient and expeditious;

(d) the law should provide a convenient means of collecting or recovering property that should be applied toward payment of the debts and liabilities of the insolvent person;

(e) the principle of equal sharing between creditors should be retained and in some areas reinforced;

(f) the end result of an insolvency administration, particularly as it affects individuals, should, with very limited exceptions, be the effective release or relief from the financial liabilities and obligations of the insolvent;

(g) insolvency law should, so far as it is convenient and practical, support the commercial and economic processes of the community;

(h) as far as is possible and practical, insolvency law should harmonise with the general law; and

(i) an insolvency law should enable ancillary assistance in the administration of an insolvency originating in a foreign country.”

1.6 It is when companies, individuals and countries do not manage their debt properly or take on unsustainable amounts of debt, either because of indiscipline, incompetence or dishonesty, or they are struck by situations that could not have reasonably been predicted, that the insolvency provisions are called upon to tidy up the resulting mess.

1.7 The last two years have produced some graphic examples of companies, individuals and countries moving from positions that were perceived as being solvent, secure and solid, to positions of penury. This happened so suddenly that it took nearly everybody, including those whom might have been expected to have known better, by surprise. Bad management and dishonesty have undoubtedly had their place in the current crisis. The bad luck can be found in the cases of companies and individuals who took positions that at the time seemed to be appropriate but falling currencies and failing markets have driven to the wall those who would otherwise still be doing good business.

1.8 While the imposition of good business practice is more the function of the main companies provisions, the insolvency provisions hold scope for creativity in dealing with companies which are heading towards insolvency but which still have potential. In the Report on Corporate Rescue and Insolvent Trading, we have recommended the adoption of a corporate rescue procedure based on procedures that are already operating successfully in other jurisdictions and the recently[5] amended bankruptcy provisions have introduced a scheme which would assist individuals with debt problems to reorganise them under the protection of the court.

1.9 Outside of the bare insolvency provisions, the nature of insolvency is undergoing changes in that there are now many more significant insolvencies that cannot be dealt with simply on a local basis. These international insolvencies can take on a complexity that is virtually unfathomable, particularly where those who control the insolvent entity are not acting in the best interests of company or its creditors. There is no need to name names but over the last several years there have been many jurisdictions that have suffered from well known business people being found to have gone on a frolic of their own with company assets.

1.10 The recommendations we made in this report extend from, frankly, recommendations for dull technical amendments, to recommendations that would constitute a significant shift in the way the insolvency provisions are administered. The purpose, therefore, of this report, is to reposition the insolvency provisions so that they will be better able to deal with changes in the business, legal and social environment.

Review of the Hong Kong Companies Ordinance

1.11 In addition to this report on the winding-up provisions of the Companies Ordinance, a Consultancy Report on the Review of the Hong Kong Companies Ordinance, on the other provisions of the Companies Ordinance, was published in 1997.

1.12 The Review of the Hong Kong Companies Ordinance recommended that the insolvency provisions of the Companies Ordinance should be separated from what it describes as the “core” provisions of the Companies Ordinance, which the Review recommends should not have extraterritorial effect.[6] The recommendations under Part X of the Companies Ordinance on cross-border insolvency would give the insolvency provisions extraterritorial effect.

Recommendations / Format of the report

1.13 The opening chapters of the report address a number of issues relevant to the law of insolvency in general. These issues, that is, recommendations for a separate Insolvency Ordinance[7], the licensing of insolvency practitioners, the remuneration of office-holders, and the funding of the Official Receiver's Office, are contained in Chapters 2 to 6. These issues are best addressed first as the comments and recommendations made under these chapters have a bearing on other recommendations made in relation to the provisions of the Companies Ordinance that follow.

Language of the new Insolvency Ordinance

1.14 Assuming that these recommendations are ultimately adopted, we note that the language of many of the provisions recommended (for instance, those from the Insolvency Act) would be expressed in a language different from many of the current provisions of the Companies Ordinance and Bankruptcy Ordinance (Cap. 6).

1.15 It would be desirable for the provisions of any new Insolvency Ordinance to be expressed in the same terms throughout and we recommend that, in drafting a new Insolvency Ordinance, the opportunity should be taken to review those provisions on which we make no comment with a view to expressing the new Ordinance in modern language.

1.16 We recommend that a new Ordinance should be set out in such a way as to avoid the long sub-sections that proliferate in the current provisions. We have noticed that identical provisions in the Insolvency Act have been broken down into smaller sub-sections that are more readily understandable.

1.17 We recommend that sub-sections should be titled, as is the practice in the Insolvency Act. We realise that this is not the convention in the Ordinances of Hong Kong but the practice is an aid to understanding and finding provisions and should be adopted.

[3] See paragraphs 5.8 to 5.21.

[4] General Insolvency Inquiry: a Report of the Law Reform Commission of Australia under the Chairmanship of Mr Ron Harmer, paragraph 33.

[5] Bankruptcy (Amendment) Ordinance 1996, which came into effect on 1 April 1998.

[6] Review of the Hong Kong Companies Ordinance, paragraphs 1.01 and 1.05, and see also Chapter 26 of this report.

[7] Note that the reference to “Insolvency Ordinance” is made for convenience only and is not intended as a recommendation for the title to any new Ordinance. A more comprehensive title might be more appropriate.