Consumer Protection: Corporate Rescue & Insolvent Trading

This letter is written in response to Davyd Wong’s article, While We Wait: Using Consumer Protection Provisions in Insolvency, published in the Hong Kong Lawyer’s August 2016 issue (the “Article”), in which he summarises how directors in Hong Kong can be held personally liable for wrongly accepting payment through a successful criminal prosecution brought under the Trade Descriptions Ordinance s. 13I(2)(c) (Cap. 362) (“TDO”). Although the courts have discretion to order compensation, consumers may seek redress only by way of a subsequent civil action (via s. 18A(2) of the TDO), which inevitably causes delays for consumers seeking compensation.

The Article supports and discusses the propositions in the Law Reform Commission’s October 1996 Report on Corporate Rescue and Insolvent Trading (the “Report”) which recommends the concept of provisional supervision in cases of companies in financial distress. Under this mechanism where a provisional supervisor fails in his attempt to save the business, a liquidator would step in. The liquidator would then have the right to bring an action against the directors or shadow directors (“responsible persons”), but not senior management, of the company to hold them personally liable for the company’s debts. The standard in establishing such liability has been modified to a lower threshold compared to the criminal standard under the TDO: that the director knew or ought to reasonably have known that the company was insolvent or knew or ought reasonably to have known that there was no reasonable prospect that the company could avoid becoming insolvent and that the responsible persons failed to prevent the insolvent trading.

The Article concludes by suggesting that the concept of provisional supervision would better protect consumers in that (a) directors would be prevented from taking excessive risks in a business which might harm consumers and creditors; and that (b) with the benefit of a limited statutory moratorium against creditor actions the provisional supervisor would have some breathing space to allow him or her to save the business from folding.

Provisional Supervision

The provisional supervision mechanism provides a solution to a consumer’s claim for compensation for money lost as a result of pre-paid purchases. Undoubtedly, the aim of the provisional supervision concept is to prevent companies from taking excessive risks at the expense of the consumers and creditors and to rescue the business from going into liquidation.

However, would the responsible persons of a financially distressed company choose the provisional supervision mechanism early enough to save their business and avoid being held personally liable for the company’s debts?

The following are factors which responsible persons of a company might consider a hindrance and deter them from appointing a provisional supervisor.

Family-Run Businesses

The Report acknowledges that a large number of businesses in Hong Kong are family-run businesses who “would be reluctant to allow a provisional supervisor to take control of their business under any circumstances”.

Family-run businesses in Hong Kong are typically concerned about their reputation and would avoid, at any cost, a potential stigma caused by taking such a step. However, based on hope, the Report anticipates that these family-run businesses would see the bigger picture and adopt this mechanism to save their business.

Time and Costs involved in Appointing a Provisional Supervisor

While time and costs would be minimised due to the absence of court involvement, the Report provides that only certified professional accountants or practising solicitors can act as provisional supervisors. This could lead to enormous fees for companies already in financial distress, as such professionals would necessarily be required to take control of and be involved in the day-to-day running of the business. While the Report provides that creditors would be given an opportunity to approve the appointing of a provisional supervisor based on the remuneration, the process of selecting an appropriate provisional supervisor could be long and drawn out. Therefore, fear surrounding the time and costs of appointment a provisional liquidator may deter businesses, particularly small businesses, from adopting this mechanism.

When to Appoint a Provisional Supervisor

The Article also suggests that there may be situations where the responsible persons of a business “may honestly believe that they can trade out of these difficulties or will be able to secure new lines of credit to tide them over so that they can deliver the promised goods and services.” In such circumstances the responsible person might find the provisional supervision mechanism a good solution thereby avoiding any potential personal liability being imposed on him if the company eventually goes into liquidation. However, many companies run on credit terms from the start of their business or rely on seasonal factors which may only temporarily affect the business. In the circumstances therefore it is unclear as to precisely when responsible persons should appoint a provisional supervisor.

Conclusion

In the light of the above, the Report may need to be further refined before the legislation is passed.

Perhaps an additional preventive measure could be considered in terms of consumer protection per se such as depositing a percentage of any advance payments or pre-payments for goods and/or services provided by companies into a separate account managed by a regulated body for distribution if and when the company faces insolvency. Further, a provisional supervisor may be allowed to have access to this account for the purposes of rescuing the company where its appointment has been made at a later stage rather than early on.

Consumers should not have to worry about businesses closing down the next day or soon after when it comes to making advance payment or pre-payment for goods or services to be rendered. Therefore the Report or the statutory corporate rescue regime might just be the dawn of a new beginning.

Jurisdictions: 

Barrister-at-Law, Admiralty Chambers

Doctor of Juridical Science Candidate, City University of Hong Kong