The Companies (Winding Up and Miscellaneous Provisions) (Amendment) Ordinance (Cap. 32) (the “Amendment Ordinance”) recently came into operation on 13 February 2017. The Amendment Ordinance brings Hong Kong’s winding-up procedures and insolvency law in line with international developments. As identified in the reform exercise, the underlying objectives are to have a more efficient administration of the winding-up process and enhanced creditor protection.
New and Improved Avoidance Provisions
An important aspect of the reform is the increased protection offered to creditors against asset depletion in an insolvent company. This includes a new provision on transactions at an undervalue (which was previously only applicable to individuals) and a self-contained provision on unfair preferences applicable to companies. Notably, there is greater clarity to the definition of associates and connected persons. The floating charge provision has also been improved to distinguish those charges created in favour of persons connected with the insolvent company and those created in favour of persons not so connected.
Transactions at an Undervalue and Unfair Preferences
The previous legislation did not include any avoidance provision for transactions at an undervalue for companies (although a provision existed in respect of individuals under the Bankruptcy Ordinance (Cap. 6)). A transaction at an undervalue takes place when the company makes a gift or enters into a transaction on terms providing for no consideration to the company, or enters into a transaction for a consideration the value of which is significantly less than the value of the consideration provided by the company. The provision empowers the court to make orders (for example, to require the property transferred to be vested in the company) in relation to a company which has entered into a transaction at an undervalue before its winding-up.
Furthermore, under the previous regime, the provisions on unfair preferences in relation to companies were incorporated by reference to the Bankruptcy Ordinance which concerns individuals only. There is now a self-contained provision on unfair preference applicable to companies, largely mirroring that of the Bankruptcy Ordinance.
Both transactions at an undervalue and unfair preferences can only arise during the “relevant time”:
- the relevant time for a transaction at an undervalue to be caught is any time within the period of five years ending with the commencement of the winding-up;
- the relevant time in relation to unfair preferences given to a person who is connected with the company is at a time in the period of two years ending with the commencement of the winding up. In other cases of unfair preference, the relevant time is at a time in the period of six months ending with the commencement of winding up.
In addition to the above, the company must have been unable to pay its debts at the time of the transaction or unfair preference, or became unable to pay its debts as a result of the transaction or unfair preference.
Separately, the previous legislation also had anomalies in the definition of “associate” under the Bankruptcy Ordinance when applied in the context of companies. The definition of “associate” has now been specifically tailored for companies and a concept of “person connected with the company” has been added. A “person connected with the company” means:
- an associate of the company; or
- an associate of the company’s director or shadow director.
The definition of “associate” includes:
- in respect of individuals (eg, directors), a person is an associate of another person if that person is a spouse or cohabitant of that other person;
- in respect of companies, a company is an associate of another company if the same person has control of both companies; and
- a person can be considered as having control of a company if he is entitled to exercise, or control the exercise of, more than 30 percent of the voting power at any general meeting of the company or of another company which has control of it.
The previous regime provided that floating charges created on an undertaking or property of a company within 12 months of commencement of its winding up were invalid, unless it was proved that the company was solvent immediately after the charge was created. This was designed to prevent companies from creating, at a time when liquidation was imminent, floating charges which give no new value to the company and which resulted in converting unsecured creditors into secured creditors in preference to other unsecured creditors. However, the provision did not distinguish between floating charges created in favour of persons connected with the insolvent company (eg, a director) and floating charges created in favour of persons not so connected. This has now been addressed.
The Amended Ordinance has increased the clawback period for floating charges created in favour of a person who is connected with the company to a period of two years ending with the commencement of winding up. For floating charges created in favour of persons who are not connected with the company, the relevant time remains as 12 months. The company must also have been unable to pay its debts at the time or became unable to pay its debts as a result of the transaction creating the charge. As with the previous regime, however, if new money was paid to the company in consideration for the charge at the same time or after the charge was created, the charge will only be invalidated to the amount not covered by the new money. The Amended Ordinance further provides that the consideration for the charge can either be new money paid at the direction of the company, or property or services supplied to the company.
New Liability of Past Shareholders and Directors for Share Redemption or Buy-Back Out of Capital
Under the Amendment Ordinance, past directors and members can be potentially liable for improperly returning share capital to members prior to the insolvent winding-up of a company. This can occur where a company has redeemed or bought back its own shares by payment out of its capital and the company became insolvent and was wound up within one year of the redemption or buy-back. Past shareholders and the directors (who made the relevant solvency statement for the payment out of capital without having reasonable grounds for the opinion expressed in the statement) will be jointly and severally liable to contribute to the assets of the company an amount not exceeding the payment in respect of the shares.
This is a new provision that protects the company against any divestment of capital prior to its insolvent liquidation and members getting a preference in circumstances where they ought not do so. To manage any risk of exposure, shareholders and directors should ensure that they are properly acquainted with the company’s financial state and that the company has sufficient assets prior to any redemption or buy-back of capital.
Enhanced Creditor Protection in a Creditors’ Voluntary Winding-Up
Under the previous regime, the first creditors’ meeting had to be held on the same or the following day of the members’ meeting for commencing a creditors’ voluntary winding-up case. There was no minimum notice period for calling the first creditors’ meeting which meant that creditors were often not given sufficient time to prepare for the first meeting.
The Amendment Ordinance requires the first creditors’ meeting in a creditors voluntary winding-up to be held on a day not later than 14 days after the members’ meeting. There will then be a minimum notice period of seven days for calling the first creditors’ meeting. In addition to improving the efficiency of a creditors’ voluntary winding-up, this will protect the company’s assets and provide creditors with sufficient time for considering their position and making the appropriate decisions.
Meanwhile, additional safeguards are in place to limit the powers of the liquidator appointed by the members during the period before the holding of the first creditors’ meeting. The powers of the directors will also be restricted (before the appointment of a liquidator) so that they cease to have full management powers and can hand over the administration of the company’s affairs to a duly appointed liquidator as soon as possible.
New Provisions on Provisional Liquidators and Liquidators
New provisions have also been added in relation to a provisional liquidator or liquidator’s appointment, disqualification, disclosure and liability. These improve the transparency and integrity of the winding-up process, and include:
- The list of persons disqualified from acting as a provisional liquidator or liquidator has been expanded to include certain persons with a conflict of interest and those subject to a disqualification order.
- A provisional liquidator or liquidator (excluding those appointed for a members’ voluntary winding-up) must file a disclosure statement disclosing specified relationships (eg, the creditor, debtor or auditor, etc. of the company).
- The prohibition on touting has been expanded to any person who offers an inducement to anyone to secure or prevent an appointment or nomination as a provisional liquidator or liquidator.
- An order for release of a liquidator will not absolve the liquidator from liabilities arising from his misfeasance or breach of duty or trust.
Practical Tips for Companies and Creditors
Businesses need to be continually vigilant and seek advice when negotiating transactions, especially in volatile times, to ensure that transactions are not eventually found to be at an undervalue. This may require conducting professional valuations of the assets.
Similarly, any creditors receiving payments or security from companies that may be under financial distress should be wary of the risk of the payment or security being an unfair preference. Advice should be sought early on as to the surrounding circumstances of the payment or granting of the security (eg, reasons for providing the credit or security and how demands were made). This can have a substantial impact on whether a court finds that there has been an unfair preference.