Booth,Charles D.

Smart, Philip

ScholarSpace at University of Hawai'i at Manoa

CORPORATE RESCUE: HONG KONG DEVELOPMENTS*PHILIP SMART" AND CHARLES D. BOOTH***The terms "rescue culture" and "corporate rescue" have been commonly used inthe commercial world for many years. In the 1970s, the Americans introduced theircelebrated (or notorious) chapter 11 procedure. In the 1980s, the United Kingdomput in place its administration and company voluntary arrangement regimes. And inthe early 1990s, Australia enacted its own corporate voluntary administrationprocedure. In the mid-1990s, the Law Reform Commission ("LRC") in Hong Kongbegan considering corporate rescue and, in due course, recommended a regime - tobe called "provisional supervision" - with marked similarities to the corporatevoluntary administration in Australia.With the onset of the Asian financial crisis, and seemingly ever-rising levels ofinsolvency in Hong Kong, corporate rescue has remained a high-profile topic. Untilnow, re-structurings in Hong Kong have been conducted wholly outside of amodem statutory rescue framework. But, finally, it seems Hong Kong is close toputting its own corporate rescue regime on the statute books, following thegazetting in May 2001 of the Companies (Corporate Rescue) Bill 2001. Yet, evennow in early 2002, some doubts remain as to the future of the Bill.INTRODUCTIONAt present, the only statutory mechanism that is available in Hong Kong underwhich a financially distressed company can re-structure is a scheme of arrangementpursuant to section 166 of the Companies Ordinance (a replica of the UK scheme ofarrangement procedure). There have always been complaints about the section 166scheme of arrangement when used in relation to a corporate rescue (for which it wasnot specifically designed), including that schemes of arrangement tend to becomplex, are highly technical, require too many court hearings and, unlessconducted when a company is in provisional liquidation, do not benefit from amoratorium.When, in 1996, the LRC put forward its plans for the new provisionalsupervision regime, it was intended that provisional supervision would be astreamlined procedure, with minimal court involvement but with the crucialadvantage of a moratorium. A company, without going to court, could appoint asuitably qualified professional - normally an accountant with extensive insolvencyexperience - who would take over the management of the company and whose task. This is an updated and slightly amended version of an article, Corporate Rescue: Hong Kong's NewLegislation, that appeared in Hong Kong in I BANKING TODAY at 32-33 (Sept./Oct. 2001).Associate Professor, Faculty of Law, University of Hong Kong.Associate Professor and Director, Asian Institute of International Financial Law (AIIFL), Faculty ofLaw, University of Hong Kong.ABILA WREVIEWit would be to ascertain whether a rescue plan was feasible. If so, the rescueproposal would in due course be put to the creditors for approval. Approval wouldbe obtained by a vote of two-thirds in value of the creditors present and voting inone single class. (It may be noted that three-quarters approval is required toapprove a scheme of arrangement and creditors will often be divided into severalclasses.) To facilitate a provisional supervisor's attempts to rescue a company, theLRC also recommended the introduction of super-priority funding: so that wherefunds were provided as working capital by a lender after the commencement of theprovisional supervision, such debt would be given priority over all other debts(except a fixed charge).I. THE OLD BILLThe recommendations of the LRC were first put forward in Bill form (the "oldBill") in January 2000, as part of the Companies (Amendment) Bill 2000. The oldBill, however, came under heavy criticism for a number of its proposals. The oneissue that attracted the most public debate was the way in which the old Bill dealtwith wage and other claims owed to a company's workers. It proposed that acompany would either have to pay, in full, all wages and other entitlements owingto the workers, or set up a trust account with sufficient funds at a bank, before thecompany could go into provisional supervision. This was not, however, what theLRC had initially proposed. The LRC had hoped that the Protection of Wages onInsolvency Fund - a very rough equivalent of the UK's National Insurance Fund -would be extended to cover provisional supervision (currently it only applies wherea company goes into insolvent liquidation). The obvious question in relation to theold Bill was how a financially distressed company might raise the cash necessary topay (in advance and in full) all outstanding wages, severance payments, long-service payments etc. Not surprisingly, many commentators saw the requirement ofhaving to pay the workers in full as an enormous limitation upon the utility ofprovisional supervision. Unfortunately, however, the new Bill (discussed below)did not improve upon this position.Another criticism of the old Bill, of particular concern to secured lenders, wasthat the old Bill did not prevent the meeting of creditors from approving a proposalthat cut down the rights of a secured creditor. In other words, it was contemplatedthat a secured creditor (even though fully secured) could be forced to take a haircutalong with the rest of the (unsecured) creditors.[Vol. 10:41CORPORATE RESCUEII. THE NEW BILLThe Companies (Corporate Rescue) Bill 2001 ("the new Bill") has cured thislast-mentioned defect. Under the new Bill (see section 23(1)) the rights of asecured creditor cannot be cut down without the consent in writing of the creditorconcerned.1Unfortunately, however, the approach to workers' wages was not improvedunder the new Bill. Under section 8, and the Second Schedule, no provisionalsupervision may commence until the company has paid off in full (or set up a trustaccount with a licensed bank containing sufficient funds to pay off in full): (a) allwage claims owed to its employees; and (b) all entitlements arising under theEmployment Ordinance (e.g. severance payments) owed to its "former employees."Moreover, "former employees" is widely defined. It includes not just workers whohave already been laid off, but also workers whose employment will be terminatedon or after the commencement of the provisional supervision. For example, if acompany intends to go into provisional supervision and then lay off half its workersas part of a restructuring, the company will have to calculate and pay, in advance,not only the wages it owes to all its employees but also any severance payments thatwill become due once the lay-offs are put into effect. There can be no doubt butthat the treatment of workers' entitlements under the new Bill would act as a majorobstacle to many companies that might otherwise seek to go into provisionalsupervision. This fact has been repeatedly pointed out to the Government.Finally, it appears that a possible compromise is in the offing. The BillsCommittee of the Legislative Council has (as of December 2001) suspended itsdeliberations on the new Bill pending further consultations. It is now beingproposed that instead of a company having to pay off its workers in full in advance(or to set up a trust account), a limit or cap will be put on the amount that will haveto be set aside by the company before it can go into provisional supervision. Thislimit would be calculated by reference to the amounts currently payable by theProtection of Wages on Insolvency Fund where a company goes into insolventliquidation.2III. PROVISIONAL SUPERVISION AND THE SECURED LENDERLeaving to one side the question of the treatment of workers' wages, the numberof companies that will make use of provisional supervision in the future dependsgreatly upon the attitude of the banks. Where a bank has security, typically a1 See "The Companies (Corporate Rescue) Bill 2001, available at http://law.hku.hk/staff/psm (givingfurther details about new Bill, which also seeks to introduce concept of insolvent or wrongful trading intoHong Kong law).2 See Legislative Council, available at http://legco.gov.hk/yr00-0I/english/bc/bc 12/minutes/bc 121205.pdf(setting forth further details).20021ABILAWREVIEWfloating charge, over substantially all the company's assets, the new Bill gives aveto power to the bank over the continuation of the provisional supervision. Underthe new Bill a major secured creditor will have only 4-7 working days (see section19(1) for precise details) in which to inform the provisional supervisor whether theveto power is exercised. Exercise of the veto power will at once terminate theprovisional supervision. In practice, however, the proposed provisional supervisorwill inevitably consult with secured creditors in advance and provisionalsupervision will not be commenced if a secured creditor makes it clear that the vetopower will be exercised. (The recent reforms in UK with reference to floatingcharges have not influenced the Hong Kong debate in the slightest.)3Where a secured creditor allows a provisional supervision to go ahead, themoratorium will apply to the secured creditor and prevent, for example, theappointment of a receiver or other steps to realize charged assets. Thus the securedcreditor will be delayed from being able to enforce his rights, although under thenew Bill the actual substance of those rights cannot be cut down without the securedcreditor's consent. Except to the extent that he is under-secured, a secured creditorhas no vote at the creditors' meeting.4Lenders who are under-secured - which is not uncommon in the light of recentHong Kong property and stock prices - may have greater willingness to forgo theexercise of the veto than a fully secured creditor. Nevertheless, it may well be inthe interests of even a fully secured lender to allow a company to gq intoprovisional supervision. Few banks will wish to see a customer go into liquidation,particularly if the exercise of a veto power will generate bad publicity. Moreover,principles of reciprocity will always be borne in mind: Bank A may well be fullysecured in relation to Company X and would not be harmed if Company X were togo into liquidation rather than provisional supervision; but that may not hold truewith reference to Company Y, in relation to which Bank A is under-secured andBank B is fully secured. (Companies in Hong Kong tend to use several banks,rather than stick to one or two.) The same factors that operate in relation to thecurrent non-statutory "Hong Kong Approach to Corporate Difficulties"(promulgated by the HKAB and the HKMA and modeled on the "LondonApproach 5) will influence the decision to exercise or not to exercise the statutoryveto under the new Bill.In theory the new Bill should have several advantages over the HKAB/HKMAguidelines. The new Bill applies to all creditors, not just banks, and has statutoryforce - a holdout creditor will have no option but to fall in line with everyone elsein a provisional supervision (unless, as a secured creditor, it has a veto). In practice,3 The recent White Paper, INSOLVENCY: A SECOND CHANCE (Cm. 5234, July 2001) proposed to abolishthe veto of holders of floating charges in relation to administration. These recommendations have now beenincorporated into the Enterprise Bill, introduced to the House of Commons on Mar. 26, 2002.4 See The Companies (Corporate Rescue) Bill 2001, Seventh Schedule, 14, available athtT .://legco.gov.hk/yr00-01/english/bills/c025-e.pdf.HKMA, QUARTERLY BULLETIN (November 13, 1999) available athttp://www.info.gov.hk/hkma/eng/public/qb9911/toc.htm.[Vol. 10:41CORPORATE RESCUEhowever, it is likely that lenders, as well as companies themselves, will continue tofavour an informal workout wherever possible. The appointment of a provisionalsupervisor - an independent third party supposedly looking after the interest of allthe creditors - may be a bitter pill for the directors of a financially troubledcompany to swallow and, at the same time, may lessen the direct influence of alender on any re-structuring plan. Nor should it be overlooked that most HongKong corporations (even those listed on the stock market) are family controlled andthe perceived wisdom is that the family may be particularly unwilling to hand overcontrol to an outside restructuring specialist. It remains to be seen whether the costsinvolved in appointing a professional insolvency expert as the provisionalsupervisor will be significantly less than costs incurred in an informal workout.CONCLUSIONWhilst these commentators favour the introduction of legislation as early aspossible - the phrase "better than nothing" being applicable - it would be mostwelcome if the Government were to drop the requirement that workers' wages mustbe paid up front in full. It is hoped that, after the current round of consultations, theproposed cap on payments will be adopted.In any event, even after the legislation is (hopefully) put in place, it wouldperhaps be unrealistic to expect provisional supervision to have a major orimmediate impact upon the number of successful corporate rescues and re-structurings in Hong Kong. Large companies, which already have their ownprofessional advisers, will continue to favour informal workouts (and so will theirlenders). Small businesses will not be able to bear the costs of a provisionalsupervisor and are unlikely, in any event, to act quickly enough to get a provisionalsupervisor in place before things are already too late. These last-mentionedconsiderations are also relevant to medium-sized enterprises, particularly as itwould be foolish to underestimate the level of professional fees that are likely to becharged by insolvency practitioners (and their legal advisers) in Hong Kong. Inaddition, particularly for some medium-sized enterprises, the cost of paying off itsworkers' claims in advance - albeit with a cap - may yet prove to be a significantobstacle in the path of commencing a rescue attempt.2002]

Corporate Rescue: Hong Kong Developments

Smart, P

Booth, CD

HKU Scholars Hub