Restructuring and insolvency law in Hong Kong

1. What is the primary legislation governing amicable restructuring proceedings in your jurisdiction?

The primary legislation governing consensual restructuring is:

• the Companies Ordinance (Cap. 622 of the laws of Hong Kong) (the “CO”)
• the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32)

2. How are amicable restructuring proceedings initiated?

Informal workouts and schemes of arrangement are usually commenced by the debtor, but they may also be commenced by any creditor or member of the debtor company. 

3. Which different types of amicable restructuring proceedings exist and what are their characteristics?

There are no dedicated restructuring proceedings in Hong Kong. However, where the debtor intends to undergo a restructuring, there are two ways of achieving this: informal workouts and schemes of arrangement.

Informal workouts

An informal workout comprises contractual arrangements agreed between a debtor and its creditors. It is an out-of-court process and the parties involved are free to agree on a mutually acceptable arrangement. 

Schemes of arrangement (Part 13 of the CO)

A scheme of arrangement is a formal arrangement between the debtor and its creditors (and/or its members) or any class of them which, when approved by creditors and/or members (as relevant) and sanctioned by the court, becomes binding. Creditors are grouped into classes whose rights are similar enough to allow them to consult together meaningfully on their common interests. To be approved, each class must approve the scheme by a simple majority in number constituting at least 75% by value of the relevant class attending and voting on the scheme approval process.

There is no automatic moratorium from creditor actions (save as may be provided under the approved and sanctioned scheme itself), and the compromises which may be proposed under a scheme are wide-ranging. Sometimes, a provisional liquidation is sought simultaneously as a scheme is being attempted so that the debtor may take advantage of the statutory moratorium under a provisional liquidation. However, while the powers of a provisional liquidator may include exploring a restructuring of the debtor, a provisional liquidator cannot be appointed solely for this purpose (Re Legend International Resorts Ltd [2006]).

There are three stages to effecting a scheme:

• first, the court is asked to agree that a meeting of creditors (and/or members as the case may be) should be summoned to vote on the scheme (the convening hearing);
• secondly, the vote takes place; and
• finally, the court is asked (assuming the scheme is approved by creditors/members) to approve the scheme (the sanction hearing).  

At the convening hearing, the court considers whether it has jurisdiction and whether the class constitution is appropriate. At the sanction hearing, the court considers whether the statutory requirements have been met, whether the relevant majorities for approval have been obtained, whether the scheme is ‘fair’ and whether there are any other issues of relevance that might impact the decision to sanction the scheme. The scheme takes effect on the filing of the court order sanctioning the scheme with the Registrar of Companies of Hong Kong.

Legislative developments

Since 1996, there have been discussions regarding the introduction of a corporate rescue mechanism in Hong Kong. In 2020, a related bill was introduced, but it failed to gain momentum due to a lack of consensus. Therefore, as of the time of writing, there is still no statutory corporate rescue law in Hong Kong.

4. Are there different types of creditors and what is the significance of the differences between them?

Informal workouts

In an informal workout, unless a creditor has agreed to any arrangement with the debtor, it is not bound by the arrangement agreed between the debtor and the other creditors. Therefore, unanimous consent from the creditors will usually be necessary in order to avoid a dissenting creditor commencing winding-up proceedings against the debtor.

Schemes of arrangements

Generally, in schemes of arrangements, secured creditors can be compromised if the relevant class voting approves or the court exercises ‘cram down’ discretion where relevant. Equally, it is technically possible to compromise preferential creditors in schemes, but the court is not quick to exercise class cram down in a restructuring plan, not least given preferential claims are mostly dominated by taxation liabilities.  

5. Is there any obligation to initiate restructuring/insolvency proceedings? For whom does this obligation exist and under what conditions? What are the consequences if this obligation is violated?

There is no obligation to commence an insolvency process. However, there can be a risk of personal liability for directors who trade beyond the point of no return and worsen the creditor position. In Hong Kong, there is also potential criminal liability (including possible imprisonment) for directors who “wilfully and without reasonable excuse” fail to pay any employee wages within 7 days from the day on which they become due. Therefore, some directors of distressed companies will be advised to seek the protection of a liquidation process to avoid or mitigate such risks.   

6. What are the main duties of the representative bodies in connection with restructuring proceedings?

Generally, the members of a company have no duties in connection with restructuring proceedings. The main responsibilities (and risk) lie with the directors of the debtor company. Those responsibilities are mainly against the backdrop of the general duties of directors, both statutory and fiduciary, in promoting the best interests of the debtor company of which they are directors in an appropriate manner. Clearly where the debtor company seeks the implementation of an informal workout or a scheme of arrangement, it is primarily the responsibility of the directors collectively to undertake the process appropriately.

7. What are the main duties of shareholders in connection with restructuring proceedings?

Generally, there are no shareholder duties in connection with restructuring proceedings. 

1. What is the primary legislation governing insolvency proceedings in your jurisdiction?

The Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32 of the laws of Hong Kong) (the “CWUMPO”) as supplemented by the Companies (Winding-up) Rules (Cap. 32H of the laws of Hong Kong).

2. How are insolvency proceedings initiated?

Proceedings are initiated by the debtor itself, its members (in or out of court) or its directors; or alternatively, any creditor can commence an insolvency proceeding by application to the court.

Hong Kong law also has a private enforcement remedy for secured lenders whereby a secured lender can, on default, appoint a receiver over certain secured assets of the debtor. Such a receiver acts as agent of the debtor which alone is liable for his acts and defaults and the receiver displaces the powers of the directors to deal with the assets over which he is appointed. No court involvement of any kind is required. Such a receiver does not control the debtor entity as such but only the relevant secured assets.  

3. What are the legal reasons for insolvency in your jurisdiction?

Normally, insolvency is demonstrated by the inability to pay debts as they fall due or by a deficiency of assets to liabilities (the cash flow test and balance sheet test respectively). Under section 178 of the CWUMPO, there are certain circumstances upon the occurrence of which a debtor company would be deemed to be unable to pay its debts. 

There is no legal requirement to initiate an insolvency process even if both tests are satisfied. A failure to initiate insolvency proceedings may however involve a risk of personal liability for the directors of the debtor company.

4. Which different types of insolvency proceedings exist and what are their characteristics?

There are three main types of insolvency proceedings in Hong Kong:

• members voluntary liquidation
• creditors voluntary liquidation
• compulsory liquidation

Members voluntary liquidation (MVL)

MVL is not technically an insolvency process as it is only available to a solvent debtor company. The process begins with the directors of the debtor company signing a certificate of solvency certifying that the debtor company is able to pay its debts in full. Thereafter, the directors will call a meeting of the members whereupon a special resolution to voluntarily wind up the debtor company and to appoint a liquidator is passed. Liquidation of the debtor commences once the special resolution is passed. Liquidation is the process of realising assets for distribution to creditors. It is the precursor to dissolving the debtor company and so only involves short-term continued trading, if at all, for this purpose.

Creditors voluntary liquidation (CVL)

Despite the name of the process, a CVL is not commenced by creditors. Instead, the process begins with the directors of the debtor company forming the view that the debtor company is insolvent. Thereafter, the directors will call a meeting of the members whereupon a special resolution to wind up the debtor company and to nominate a liquidator is passed. Afterwards, the debtor company will call for a creditors’ meeting whereupon the creditors will decide whether to appoint the liquidator nominated by the members or whether to appoint another liquidator of their choice. The winding-up of the debtor company is deemed to commence at the time of the passing of the resolution by the debtor company (s.184, CWUMPO).

Compulsory liquidation

A compulsory liquidation is usually commenced by a creditor presenting a winding-up petition to the court. The winding-up of the debtor company is deemed to commence at the time of the presentation of the petition for the winding-up (s.184, CWUMPO). A compulsory winding-up may also be commenced by the members of the debtor company. Upon the court being satisfied that one of the grounds in section 177(1) of the CWUMPO is satisfied, a winding-up order may be made by the court. If such an order is made, the role of a liquidator will be carried out by the official receiver until another liquidator is appointed. During a compulsory winding-up, except with the leave of the court, all legal proceedings and creditors’ actions against the debtor company are automatically stayed (s.182, CWUMPO).

Section 228A of the CWUMPO

There is a fourth type of insolvency proceeding set out in section 228A of the CWUMPO.  If the directors of a debtor company are of the opinion that the debtor company cannot continue its business due to its liabilities, it may resolve to such effect in a directors’ meeting to deliver a winding-up statement to the Registrar of Companies of Hong Kong and commence voluntary winding-up of the debtor company. In practice, this proceeding is rarely used as it is only available in circumstances where it is not reasonably practicable for the debtor company to be wound up using the other methods under the CWUMPO (i.e. the proceedings described above).

5. Are there different types of creditors and what is the significance of the differences between them?

Generally, secured creditors are paid before unsecured creditors; however, a distinction is to be made between realisations from assets subject to a fixed charge security (commonly real estate and intellectual property) and realisations from assets subject to a floating charge security (commonly book debts/receivables and stock in trade).  

Fixed charge realisations are remitted to the security holder net of realisation costs. The order of payment out of floating charge receipts is: first, to the liabilities incurred in the estate operations; secondly, to the remuneration and general expenses of the administration or liquidation (which may include taxation liabilities); next to preferential creditors; and then to the floating charge holder (who is still paid ahead of other unsecured creditors).

Any remaining realisations after paying unsecured creditors go to shareholders. In practice, shareholders will only receive distributions if the debtor company was not balance sheet insolvent.

6. Is a solvent liquidation of the company an alternative to regular insolvency proceedings?

See MVL as discussed in Q4 above.

Besides MVL, in a solvent situation it is also possible to do a de-registration if certain conditions under section 750 of the CO are satisfied. A de-registration will usually be significantly cheaper than an MVL because a liquidator is not required to be appointed for de-registration. 

1. If a lender wants to monitor its borrower very closely (i.e. more closely than the usual information covenants in the credit agreement require), what options are there?

It is common for lenders, usually in return for providing covenant breach waivers, providing new money, or extending interest or capital payments, to require the borrower’s agreement to a variety of enhanced monitoring and information access options. At its most basic, this involves additional contractual information requirements and regular reporting in a variety of formats but may also include:

• independent business review (IBR): setting out the circumstances in which the lender may commission an independent business review of the borrower. This usually involves a third party accountant taking a high level or deeper dive into the borrower’s business with the customer’s cooperation, providing access to borrower personnel and financial information. An IBR usually focuses on cash flow and cash constraints suitably sensitised by the accountant. It is also often accompanied by enhanced contractual information requirements and may, depending on circumstances, also require an accelerated M&A with lender acceptable oversight. It is not unusual for the accountant undertaking the IBR to provide additional support to the borrower on an ongoing basis around the quality and frequency of its management and financial information
• appointment of a board observer: the lenders may require the appointment of a board observer or a chief restructuring officer (CRO). The latter will owe his duties in the same way as all other directors. So, while he may be appointed at the instance of the lenders, he is not the lender’s appointee. The appointment is often accompanied by a specific scope setting out the borrower’s commitment to the CRO’s ability to provide certain information to, and to consult with, the lender on behalf of the borrower, among other specific tasks (for example, preparing the borrower for disposal of part/all of its business or restructuring the existing business). A CRO requirement is most often used where there is potential value in a restructured business, but the existing board of directors does not have the appropriate skill sets and/or the desire to undertake the steps perceived as necessary by the lender
• appointment of M&A advisers: if it is clear that a disposal represents the optimum outcome for a lender, then the lender will usually require appointment of acceptable M&A advisers to the borrower (likely to be the same firm which has undertaken any prior IBR if relevant although not always). That appointment will also carry with it the obligation to provide information to the lender around the sales process and is usually managed closely by the appointed adviser

The backdrop to securing these types of enhanced monitoring and information obligations is usually that the lender has security capable of enforcement so that the alternative to the borrower refusing to cooperate may well be an enforcement or insolvency process. Even without security, a lender with the power to accelerate enjoys commercial leverage. Clearly, if an amicable restructuring is feasible, the enhanced information flow will be a necessary element in securing lender support which is almost certain to be needed.

2. What issues arise if a creditor extends credit facilities or offers support conditional on additional or extended guarantees to a company in financial difficulties and/or takes asset security?

Generally, extending credit facilities does not create difficulties for lenders beyond normal commercial risks. In isolation, additional funding is not considered to deplete the estate in subsequent insolvency proceedings.

Instead, in the period prior to a subsequent insolvency, the focus is on transactions where the value received by the debtor is significantly less than the value given by it to the lender and/or the lender is deliberately preferred over other creditors.

There are a number of specific insolvency antecedent clawback provisions which may impact lenders in such circumstances:

• floating charges given in the 12 months prior to a winding-up commencing (2 years if the lender and borrower are connected parties) are invalid, except to the extent of fresh consideration provided to the borrower at the time of the granting of the security (s.267, CWUMPO). So ‘old’ indebtedness may not be secured by the floating charge in such circumstances
• undervalue transactions in the 5-year period immediately before the commencement of winding-up may also be vulnerable, subject to certain statutory ingredients and defences (s.265E, CWUMPO). There is case law authority to suggest that the giving of security cannot amount to an undervalue because it is a reordering of priorities with respect to an asset rather than a disposition if it does not deplete the insolvency estate. The same may not necessarily follow for the giving of guarantees where the benefit to the borrower may not be easily assessed
• giving security or a guarantee may amount to a preference to the lender (look back period of 6 months immediately before the commencement of winding-up for unconnected parties or 2 years if connected) again subject to statutory requirements
• there is also a commercial benefit consideration in giving guarantees, and in any transaction with a lender where a borrower is giving something to the lender while it is in financial difficulties, and receiving insufficient in return; there may be implications for the directors personally in so doing even outside of the specific antecedent transaction provisions noted above. Each transaction must be considered on its merits in the context of the surrounding circumstances 

1. How does a lender sell a loan?

Unless a loan is expressed to be non-assignable or incapable of transfer, Hong Kong law generally recognises the free assignability of loans. In more sophisticated debt arrangements, and certainly with syndicated loans, there is usually a process set out in the debt documentation confirming whether there are any prohibited assignees to whom a loan may not be assigned and the documents required for valid assignment.  

While specific loans can and often are traded individually, it is not uncommon for lenders to group NPLs together and seek to dispose of them as a portfolio. Sometimes, these NPL portfolios are sold into a securitisation structure where the buyer is a special purpose vehicle which will issue securitisation bonds to capital market investors.  

Disposal of NPLs is usually completed by a process inviting expressions of interest and indicative terms, moving through subsequent rounds of bidding as diligence is undertaken, price and portfolio content firmed up and acceptable potential assignees identified. If securitisation is used, rating agencies may also be involved to diligence and analyse the NPL portfolio. There are sometimes related servicing agreements to be negotiated and various other ancillary documents depending on the circumstances.

Hong Kong law does not generally superimpose any additional obligations on loan sales, other than the potential need to register in public registers the transfer of security interests held for any of the sold loans (although that can take a considerable time and the buyer and seller often provide for the seller to hold registered security to the buyer’s order until actual transfer) and the terms of the contractual loan documentation.

2. If the underlying credit agreement prohibits transfer or assignment (i.e. a change in the lender of record), how else – if at all – can a lender transfer the economic risk and/or benefit in the loan? For instance, are sub-participation agreements allowed under the law of your jurisdiction?

If transfer or assignment is prohibited under the underlying agreement, and it is not possible to obtain consent from the other party, other possible options to transfer the economic risk/benefit in the loan are by way of:

• sub-participation
• declaration of trust
• a credit default swap.

Under these alternative options, the seller remains the lender of record but will pass the economic risk/benefit of the loan to the buyer through a contractual arrangement between the buyer and seller.

3. Regulatory issues: is any form of licence or prior authorisation from any regulatory authority required for the purchase, sale and/or transfer of loans? Does it fall within the definition of providing banking or financial services in the territory of the assignor or the borrower?

Generally, to sell and purchase loans involving Hong Kong entities, there are no regulatory approvals required. However, depending on the make-up of the loans being acquired, there may be a number of regulatory hurdles to be overcome when operating the acquired loans post-acquisition, such as:

• approval when dealing with regulated assets
• banking or regulatory approvals when the transaction involves the potential for making further advances where there are undrawn commitments or revolving credit facilities
• related issues over data protection requirements and securities laws generally