COVID-19: Time for Hong Kong to update its insolvency law and statutory corporate rescue regime

The tragically unforeseen current novel coronavirus (COVID-19) global pandemic has brought unprecedented challenges to all aspects of Hong Kong society including the health of its citizens, the economy and the business community.

Economic activities across most sectors globally are being devastated. In Hong Kong, the unemployment rate has surged in the first quarter hitting 3.7%, the highest in more than nine years and expected to continue to rise to record levels. This will result in a huge financial burden on the hardworking people of Hong Kong and the economy as a whole. Market predictions are that the economic impact of COVID-19 will be more severe than SARS (severe acute respiratory syndrome) which hit Hong Kong hard back in 2003. In these unparalleled circumstances, it is unfortunately inevitable that many businesses in Hong Kong will not survive. Urgent corporate rescue measures are needed to enable many of these businesses to navigate safely and quickly through the pandemic to hopefully more stable and prosperous times ahead.

In this article, we look at certain new insolvency law measures introduced recently in other common law jurisdictions to help businesses cope with the serious financial consequences of the COVID-19 pandemic as well as reviewing the company rescue procedures currently available in Hong Kong.

Insolvency law relief offered in various common law jurisdictions

Many countries have promptly introduced various insolvency law measures to help individuals and businesses to weather the COVID-19 global storm. Some praiseworthy recent examples are set out below.

Australia

On 23 March 2020, the Australian government passed the ‘Coronavirus Economic Response Package Omnibus Bill 2020’ to provide temporary reliefs for financially distressed businesses. The key elements of the package include:

• a temporary increase in the threshold at which creditors can issue a statutory demand on a company (from A$2000 to A$20,000) and the time limit for companies to respond to statutory demands (from 21 days to 6 months)
• a temporary increase in the threshold for creditors to initiate bankruptcy proceedings against an individual (from A$5,000 to A$20,000) and the time limit for debtors to respond to bankruptcy notice (from 21 days to 6 months)
• a temporary extension of the moratorium period (from 21 days to 6 months) during which unsecured creditors are prohibited from taking further action to recover debts when a debtor declares an intention to enter into voluntary bankruptcy by making a declaration of intention to present a debtor’s petition
• a six-month suspension of the statutory insolvent trading provisions to relieve directors from personal liability for debts incurred by an insolvent company in the ordinary course of business of the company

New Zealand

On 3 April 2020, the New Zealand government announced that it would be introducing legislation to make changes to the Companies Act to help businesses facing insolvency due to COVID-19 to remain viable.  The temporary changes include:

• A six-month ‘safe harbour’ for directors of companies from insolvency duties under the Companies Act. Directors’ decisions to keep on trading and to take on new obligations over the next six months will not result in breach of duties if:
  • the company is, in the good faith opinion of the directors, facing or is likely to face significant liquidity problems in the next six months as a result of the impact of COVID-19 pandemic on them or their creditors
  • the company was able to pay its debts as they fell due on 31 December 2019
  • the directors consider in good faith that it is more likely than not that the company will be able to pay its debts as they fall due within 18 months
• A COVID-19 business ‘debt hibernation’ regime to encourage directors of companies to negotiate with their creditors with a view to putting together a simple proposal for putting the business into hibernation and allow directors to retain control of the company. The key features of the proposed regime are that:
  • creditors will have a month from the date of notification of the business hibernation proposal to vote on it, with the proposal going ahead if 50% (by number and value) agree
  • there will be a one-month moratorium on the enforcement of debts from the date the business hibernation proposal is notified, and a further six-month moratorium if the proposal is passed

Singapore

On 7 April 2020, the Singapore parliament passed the COVID-19 (Temporary Measures) Act (the ‘Singapore Act’), which has also come into effect on the same day. The Singapore Act offers temporary and targeted reliefs to individuals and businesses that are unable to fulfil certain contractual obligations of specified contracts because of COVID-19. It also introduces temporary adjustments to the monetary thresholds and time limits for bankruptcy and insolvency.

The Singapore Act applies to the following contracts entered into before 24 March 2020:

• Leases or licences for non-residential immovable property
• Construction contract or supply contract
• Contracts for the provision of goods and services for events
• Contracts for goods or services for visitors to Singapore, or promotion of tourism
• Certain loan facilities granted by a bank or a finance company to small and medium enterprises

The Singapore Act prohibits a contracting party from taking the following legal actions against a non-performing party:

• Court and insolvency proceedings
• Enforcement of security over property that is used for business or trade purposes
• Call on a performance bond given pursuant to a construction contract
• Termination of leases of non-residential premises

The temporary measures relating to bankruptcy and insolvency under the Singapore Act are:

• Increasing the monetary threshold for bankruptcy (individuals) from S$15,000 to S$60,000
• Increasing the monetary threshold for insolvency (companies / partnerships) from S$10,000 to S$100,000
• Extending the statutory period to respond to demands from creditors from 21 days to 6 months
• Directors will be temporarily relieved from their obligations to prevent their companies trading while insolvent if the debts are incurred in the company’s ordinary course of business

The measures prescribed under the Singapore Act will be in place for six months and the government may extend them for a further six months in due course, if necessary.

United Kingdom

On 28 March 2020, the UK government announced new insolvency measures in response to COVID-19, which include:

• A temporary suspension of wrongful trading rules to allow directors to continue trading through the COVID-19 crisis period without the threat of personal liability should the company ultimately fall into insolvency. The suspension is to be applied retrospectively from 1 March 2020 for an initial period of three months
• An introduction of a short moratorium for companies in financial distress (preventing creditor action, including the issue of winding-up petitions) to help facilitate business rescue
• A protection of essential supplies (such as raw materials, component parts and energy etc) during the moratorium period to enable companies to continue trading while they formulate a rescue plan
• An introduction of a ‘new restructuring plan’, which includes a ‘cross-class-cram-down’ feature such that the restructuring plan can be binding on dissenting creditors

There is currently little technical details on these insolvency measures. The UK government has indicated that it will introduce legislation in the UK parliament at the earliest opportunity. However, the UK parliament is currently in recess until 21 April 2020.

The situation in Hong Kong

The Hong Kong government has announced various significant financial measures to help individuals and businesses cope with the COVID-19 crisis (such as cash pay-outs to Hong Kong permanent residents aged 18 or above, government-guaranteed concessionary low interest rate loans to small and medium enterprises and the establishment of an anti-epidemic fund). Further, on 17 April 2020, the Hong Kong Monetary Authority instructed all banks in Hong Kong to grant a six-month loan repayment holiday to SMEs aimed at helping them survive the worst business slump in decades. Most recently, on 18 April 2020, the Legislative Council passed the Hong Kong government’s second round of the anti-epidemic fund and other relief measures worth HKD137.5 billion (USD17.6 billion). The latest round of relief measures includes, among others, an HKD81 billion employment support scheme providing wage subsidies to eligible employers to retain their employees, subsidies to hard-hit business sectors and an enhanced SME Financing Guarantee Scheme. So far, the Hong Kong government has not introduced any new insolvency law relief measures similar to those identified above introduced in other common law jurisdictions.

It is unfortunate that Hong Kong does not at this very uncertain time have any formal or statutory corporate rescue procedure such as can be found in other common law jurisdictions (for example, the administration process in England and Wales, the Chapter 11 process in the United States or the judicial management debt restructuring process in Singapore). At present, it is only possible to achieve a corporate rescue of a financially distressed company in Hong Kong through a scheme of arrangement or following the appointment of provisional liquidators.

Scheme of Arrangement

A scheme of arrangement is an arrangement or compromise between a company and its creditors (or class(es) of its creditors) in respect of the company’s debts. A distressed company will collaborate with its legal and financial advisors to formulate a proposal for a compromise of the company’s debts for the creditors’ approval and the court’s sanction. It is an effective tool to implement a financial restructuring, which binds all creditors to such arrangement or compromise. It will be necessary to prepare a ‘liquidation analysis’ to compare the rights that the creditors would have under the scheme against the company with their rights against the company in an insolvent liquidation.

The Companies Ordinance (Cap. 622) (CO) sets out the statutory requirements and procedures for implementing a scheme of arrangement, which includes:

• obtaining the approval of the court to convene meetings of each class of shareholders and/or creditors to be affected by the scheme
• convening the shareholders’ and creditors’ meetings in accordance with the court’s directions
• obtaining the requisite shareholders’ and creditors’ approval at the respective meetings, i.e. a numerical majority of more than 50% and a majority of at least 75% in value
• seeking the court’s final sanction of the scheme

Provisional liquidation

After a winding-up petition has been presented against a company, the court may, upon application, appoint a provisional liquidator if there is a prima facie case for a winding-up order and on the basis of cogent evidence that the assets of the company are in real danger and the appointment is necessary to protect those assets. Provisional liquidation aims to preserve the ‘status quo’ of the value of the company during the interim period between the presentation of a winding-up petition and the making of a winding-up order. The court usually gives a provisional liquidator extensive powers, including the power to negotiate restructuring proposals with creditors and to deal with the subsidiaries of the company. As such, a provisional liquidator can assist the company to achieve a corporate rescue but the dominant purpose for appointing provisional liquidators should not be for effecting a restructuring. The petitioning creditor will have to inform the court that if a corporate rescue is not possible that it will proceed to seek a winding-up order from the court.

However, these corporate rescue options in Hong Kong are far from ideal in the current COVID-19 pandemic for the following reasons:

• As may be evident from the above, a scheme of arrangement is a time-consuming and costly court-driven process, which requires strict compliance with the statutory procedural requirements under the CO before the scheme can become legally binding and effective. Importantly, there is no statutory moratorium on creditor actions prior to a scheme becoming effective, which practically means that any creditor can take legal action against the company including presenting a petition to seek to wind-up the company, thereby potentially thwarting the company’s bona fide restructuring efforts.
• The court will only appoint a provisional liquidator after the presentation of a petition to wind-up the company. Putting a company into a compulsory liquidation process is a draconian step to take since it will ultimately kill the business. It can also have immediate drastic financial consequences for the company. For example, banks will usually freeze company bank accounts as soon as they become aware that a creditor has presented a petition to wind-up the company. Further, the commencement of winding-up proceedings in itself will often be an ‘insolvency event of default’ in critical finance documents and other commercial contracts. This can result in further creditor enforcement action, which might jeopardise the prospects of a successful restructuring.

Hong Kong’s proposed statutory corporate rescue regime has undergone an unfortunate long legislative development process, which is still ongoing. In summary:

• In October 1996, the Law Reform Commission issued the Report on Corporate Rescue and Insolvent Trading, which recommended the introduction of a corporate rescue procedure known as ‘provisional supervision’, whereby a moratorium on legal action would be provided to a company in financial difficulty
• In 2000 and 2001, there were attempts by the Hong Kong government to legislate a statutory corporate rescue regime and insolvency trading provisions. These attempts were not successful due to, among other things, non-consensus among the accountants, lawyers and business community as regards certain aspects of the proposals including in particular the requirement for companies to pay all employees their unpaid wages and entitlements in full before the commencement of corporate rescue procedure
• In 2009 to 2010, there was another round of public consultation, which did not lead to any finalisation of the proposed corporate rescue law
• In July 2014, the Hong Kong government published detailed legislative proposals on the introduction of a statutory corporate rescue regime and insolvency trading provisions, taking into account stakeholders’ views on, among others, issues concerning the personal liability of provisional supervisor, employees’ outstanding entitlements and statutory defences to insolvent trading offences
• Since then, there has not been any concrete developments, despite the Hong Kong government’s repeated indications to introduce a corporate rescue bill

However, as recently as March 2020, there has been a welcome announcement from the Hong Kong government that it intends to hold a new round of consultation in the coming months and finalise the corporate rescue bill for the introduction in the first half of the 2020 / 2021 legislative session.

Going forward

The Hong Kong government’s recent announcement as regards the statutory corporate rescue regime is a welcome development in the current climate of significant social and economic uncertainty. Completion of the legislative process will inevitably take further time and is unlikely to provide timely relief to distressed businesses in Hong Kong. We can only hope that all relevant stakeholders can reach consensus in the upcoming round of further public consultations and a statutory corporate rescue regime can be enacted in Hong Kong sooner rather than later so that Hong Kong will be on a level playing field with other common law jurisdictions. We shall provide a further update on any material developments in this regard in due course.

The Hong Kong government should also consider urgently implementing temporary much-needed insolvency law relief measures to give businesses and individuals more ‘breathing space’ to cushion the severe economic impact of COVID-19. This could include increasing the financial threshold and extending the time to respond to statutory demands and granting a short moratorium for companies in financial distress to prevent aggressive creditor enforcement action, including the issue of winding-up petitions, to help create a commercial environment and mind-set conducive to business continuity rather than business destruction.

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