Booth,Charles D.

Briscoe, Stephen

Smart,Philip

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INVESTIGATION OF INSOLVENT COMPANIESIN HONG KONG:A CORPORATE GOVERNANCE CRISIS*0Philip Smart," Charles D. Booth* & Stephen Briscoe*The authors discuss a corporate governance crisis in Hong Kong involving theinvestigation of insolvent companies. Over the last decade the rates paid toinsolvency practitioners to handle "summary cases" in liquidation has beensteeply declining. At the current rate of HK$2,558 per case, it is not possibleto undertake a proper investigation of the insolvent company. To address thisproblem, the authors propose that the government consider establishing a specialinvestigations unit.IntroductionGovernment officials are frequently heard extolling the virtues of good cor-porate governance, whilst stressing Hong Kong's credentials in this regard.Therefore, it may come as a surprise to learn that the government has for anumber of years been presiding over an increasingly obvious corporate gov-ernance debacle. This undermining of Hong Kong's corporate governancecredentials concerns the proper investigation of businesses that go into in-solvent liquidation.For the government apparently believes that in a typical case a subsidyof HK$2,558 per case is sufficient to ensure that a full investigation of aninsolvent company's affairs and, in particular, the conduct of its directors,will be conducted. Yes, HK$2,558 is the going rate for private insolvencypractitioners to agree to undertake an in-depth statutory investigation - ina jurisdiction that has some of the highest professional fees in the world! NoAt the time of Philip Smart's death, Philip, Stephen Briscoe and I were working on this article,which was intended for publication in Hong Kong. This article updates data presented in our ear-lier publication: Insolvent Liquidations in Hong Kong: A Crisis of Confidence, 2007 4(5) InternationalCorporate Rescue 263-275.Harold Hsiao-Wo Lee Professor in Corporate Law, Faculty of Law, University of Hong Kong.Professor of Law and Director, Institute of Asian-Pacific Business Law (IAPBL), William S. Rich-ardson School of Law, University of Hawaii at Manoa.Managing Director, Briscoe & Wong Limited - Licensed Insolvency Practitioner.60 Philip Smart, Charles D. Booth & Stephen Briscoewonder there is a growing body of opinion that government policies are help-ing dodgy directors get away with (corporate) murder.Investigation of Insolvent CompaniesLimited liability, as any lawyer, accountant or business student can tell you,is a pillar of the modem commercial environment. The distinct advantageof limited liability is, of course, that it enables controlling directors / share-holders to run all aspects of a company's business without thereby exposingthemselves to liability for the debts of the company should it go bust. Theprice to be paid for this benefit has always been a level of public disclosureand scrutiny.Where a company goes under and is liquidated, it follows that there hasto be an appropriate level of investigation to ensure that any directors whohave cheated creditors, or otherwise breached the law, will be brought tobook. Because Hong Kong inherited UK company law, so too Hong Kongused to follow the UK model for investigations. Namely, that the OfficialReceiver (a government official) would in most cases be appointed to con-duct the administration of a company in compulsory liquidation.Liquidation involves collecting in all the company's assets, settling a listof creditors to whom any dividend might eventually be paid and, of great-est importance, investigating the causes of failure and the conduct of thedirectors. A proper investigation takes time and resources - it is expen-sive. The figures given in the Audit Commission Report on the OfficialReceiver's Office (March 2000) indicate that roughly HK$80,000 was theaverage cost to government of each liquidation when these were conductedin-house. Not surprisingly, therefore, the government has sought to con-tract out liquidation work in an effort to save costs.Contracting Out Summary CasesContracting out liquidation work is relatively straightforward in the biginsolvency cases. Because the company has substantial assets, the liquida-tor knows that his fees (charged on a time cost basis) and expenses willbe paid out of those assets (in particular before any money is paid out tocreditors). But in small cases, where there are no or virtually no assetsleft by the time a liquidator steps in, the difficult question is how will aliquidator drawn from the private sector get remunerated? This is a par-ticularly pressing question because over 90% of all liquidations in HongKong are small asset cases - these are referred to under the CompaniesOrdinance as "summary cases". Moreover, in 85% of all summary casesthere will in effect be zero assets.(2009) HKLJVol 39 Part 1 Investiption of Insolvent Comaies in Hong Kong: A Corporate Govmwance Crisis 61When the Government first started contracting out summary cases, in1997, it paid a maximum fee of HK$60,000 to a private sector liquidator:which was a significant saving on the government's previous in-house costs.The fee was reduced in 1999 to $40,000. Thereafter a tender system -now known as Panel T - was introduced. Under Panel T, firms of (usually)accountants or solicitors submit "bids" specifying the extent of the subsidythey will require to handle batches of for example 20 or 100 summaryliquidations. The bid sets out, in effect, what the firm will charge the gov-ernment to handle each case assuming that there are no realisations fromwhich to meet their fees. The government, as one would expect, acceptsthe lowest bids.The following Table sets of the average tender price for the exercisesduring the period 2001-2008:*Year Average Price in HK$2001 16,5852002 11,2002003 9,2002004/5 5,5002006/7 3,1002008/9 2,558From 2004, the tender has been conducted every two years.The lowest successful bid in the March 2008 exercise was HK$41,850 for anestimated batch of 93 cases - amounting to an average amount of a mereHK$450 per case; whilst the highest successful bid was HK$288,300 - anaverage amount of HK$3,100. Thus, the highest bid in 2008 amounted tothe average levels overall in 2006/7, and the average figure in 2008, takingall successful bids into account, fell to an all-time low of HK$2,558. Thegovernment might look at these figures and see them as evidence of a greatsuccess - in terms of cutting its costs from HK$80,000 to HK$2,558 percase. But a liquidation, even in a summary case, ought to require many tensof hours of work from the liquidator and his team. How else can a properinvestigation, as required by the Companies Ordinance, be carried out?Government Policies Create Moral HazardIn the language of corporate governance, there is a significant "moral haz-ard" presented to a private liquidator in a Panel T case. Take the all too62 Philip Smart, Charles D. Booth & Stephen Briscoefamiliar scenario where there is some evidence that the directors, with theassistance of a number of friends and relatives, have ripped off the companyand its creditors. However, let us assume that some of the directors havealready disappeared and the chances of actually recovering assets (out ofwhich the liquidator might be able to recover some of his time costs) are atbest very slim.A proper investigation ought to be conducted to discover: (i) whichdirectors were involved; (ii) what actually happened to the company's as-sets; and (iii) the role of the implicated friends and relatives. But let us saythat such an investigation would require an estimated minimum of 80 bill-able hours of work, as well as the incurring of considerable out-of-pocketexpenses by the liquidator. However, there is no prospect of recoveringthose expenses, let alone being paid for any of the billable hours. Surely,it is laughable to suggest that a private liquidator can be expected to giveaway so much of his own time and money in such a scenario. A HK$2,558subsidy is patently absurd.Unscrupulous DirectorsIn addition, there is anecdotal evidence to suggest that unscrupulousdirectors are aware of the realities in relation to the investigation of sum-mary cases. Such directors are being encouraged, in effect, to make surethat they spend, take or otherwise run down their company's assets tothe lowest possible level before the company goes into liquidation. Whyleave the company with HK$500,000, which can later be used to fund athorough investigation by the liquidator, when if that money has alreadybeen dissipated, the company will fall into the "bargain basement" inves-tigation category?Many Insolvency Practitioners have stories of being consulted by direc-tors of insolvent companies that have little or no prospect of recovery. Inmany of these situations, an immediate liquidation would result in a divi-dend for creditors. However, the directors frequently ignore the advice ofthe Insolvency Practitioner and continue trading at a loss - with the com-pany eventually being wound up with no assets and therefore no funds withwhich to fund an investigation.Government InactivityConcerns as to low levels of investigations in insolvency cases were an is-sue even as long ago as 2002, when the government appointed a consultant(2009) HKLJVol 39 Part 1 Investigaion of Insolvent Comaies in Hong Kong: A Corporate Govmwance Crisis 63to review the role of the Official Receiver's Office. The consultant high-lighted the general perception that insufficient resources were devoted toinsolvency investigations. The consultant recommended that a specialistinvestigations unit should be established by the government to ensure thatthe more complex Panel T cases were thoroughly investigated. This recom-mendation received broad public support in the consultation exercise thatfollowed publication of the consultant's report.Not only has the government not set up a specialist investigations unit,it has in fact allowed the situation to deteriorate drastically by presidingover the current tender arrangements, which have resulted in a systemwhere $2,558 is supposed to be sufficient to fund a proper investigation.The Way ForwardThe manner in which no asset cases are now contracted out in HongKong is unique, as far as the authors are aware. No precedent is to befound in England, Australia or the United States. The Panel T arrange-ments were initially put in place at a time of severe economic recessionin Hong Kong. Whilst everyone is in favour of reducing unnecessarygovernment expenditure, the Panel T system threatens to undermine thecredibility of the whole insolvency process. The faults of the current sys-tem are glaring - any system that encourages directors to dissipate assetsin the run up to the commencement of formal insolvency proceedings isfatally flawed.No new laws are required. It is simply a question of proper enforcementof the existing laws via appropriate administrative arrangements. There isno need to go back to the pre-1997 position, when all no asset cases werehandled in-house by the Official Receiver's Office. But, if some sort oftender process is to be retained, the Consultant's recommendation for theestablishment of a specialist investigations unit will have to be given themost serious consideration. We already know, from the work of the inter-departmental task force set up to combat insolvency abuse in the cateringsector, that proper enforcement may lead to widespread changes of behav-iour by directors. There is every reason to think that a similar commitmentfrom the government can rescue the Hong Kong insolvency regime from itscurrent crisis.

Investigation of Insolvent Companies in Hong Kong: A Corporate Governance Crisis

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Investigation of Insolvent Companies in Hong Kong: A Corporate Governance Crisis

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