GENERAL BACKGROUND INFORMATION: HONG KONG, CHINA CORPORATE INSOLVENCY AND REORGANIZATION

Introduction

On July 1, 1997, the British colony of Hong Kong became a Special Administrative Region (an 'SAR') of the People's Republic of China. The 'one country, two systems' approach as embedded in the Basic Law (Hong Kong, China's new constitution) provides that the laws previously in force in Hong Kong - ordinances, subordinate legislation, the common law, rules of equity, and customary law - shall continue to apply in Hong Kong, China after the transition, except to the extent that they contravene the Basic Law or are amended by the legislature of the Hong Kong, China. (See The Basic Law of the Hong Kong, China, art 8.)

Although Hong Kong, China's insolvency laws have not been directly affected by the transfer of Hong Kong, China's sovereignty, they nevertheless are in a period of great change - new laws have recently been, and will continue to be, enacted to modernize and improve upon much of the nineteenth and early twentieth century Hong Kong, China insolvency legislation regarding bankruptcy, winding up, and corporate rescue. Bankruptcy law applies primarily to the insolvency of individuals and is contained in the Bankruptcy Ordinance (cap 6). Winding up (or liquidation) law applies primarily to companies and is contained in the Companies Ordinance (cap 32). Corporate rescue may be possible under the Companies Ordinance primarily through a formal scheme under Section 166 of the Companies Ordinance (either within or without winding up) or outside the legislation through receivership or an informal workout. In practice, the majority of rescues are by way of an informal workout. This will continue to be the case now that the Hong Kong Association of Banks has issued its Guidelines on Corporate Difficulties for banks to follow in multi-bank workouts.

Insolvency Statistics

Historically, Hong Kong, China has had a low rate of insolvency, both in absolute terms and as compared to the rates in other jurisdictions. Over the last ten years the number of compulsory winding up orders has been as follows: 151 in 1988/89; 187 in 1989/90; 306 in 1990/91; 355 in 1991/92; 327 in 1992/93; 433 in 1993/94; 429 in 1994/95; 514 in 1995/96; 557 in 1996/97; and 459 in 1997/98. Official Receiver's Office, Annual Departmental Report 1997-1998, Annex 6 (1998). However, with the Asian economic crisis, it should come as no surprise that the most recent monthly figures show that filings are increasing dramatically: for the first eight months of the 1998/99 year, 532 winding-up orders have already been made and an all-time high will certainly be reached. It must also be kept in mind that the number of winding-up orders does not fully capture the magnitude of the existing economic downturn. In the current deflationary environment in which real property prices have fallen more than 50% and corporate asset values have fallen generally, there is little incentive to commence winding-up proceedings except as a last resort. Thus, the banks in Hong Kong, China are trying very hard to resolve corporate financial problems through workouts, rather than liquidations. If these workouts were to collapse the number of winding ups would most likely increase by more than 100. This bleak situation is likely to continue well into 1999. The Hong Kong, China economy continues to contract, unemployment remains high, and non-performing and doubtful loans at banks are increasing.

For the 1997/98 year, the industries with the greatest number of companies being compulsorily wound up were the following: restaurants and canteens (68); garment, knitting, and textile manufacturing and trading (58); importers and exporters (50); construction and engineering (40); electrical and electronic products manufacturing and trading (32); and land/property development and investment (30). Id, Annex 9. The trades or businesses showing the largest increase in the number of filings over 1996/97 were transportation and godowns (+55.6%) and construction and engineering (+41.7%). Id, Annex 10. The major causes of corporate failure were a decline in business and cash flow problems. Id, Annex 13.

There are many more voluntary winding ups than compulsory winding ups, often by a factor of 4-5 times (eg, in 1995 there were 2,992 voluntary winding ups commenced, in 1996, 3,250: Roman Tomasic & ELG Tyler, Hong Kong Company Law, Legislation and Commentary, para [8929] (1997) (citing Companies Registry Statistics)). However, most of these liquidations were members' voluntary winding ups, which involve the liquidation of solvent companies. The number of creditor's voluntary winding ups is more telling - eg, of the 2,992 voluntary winding ups in 1995, only 182 were creditors' winding ups, and of the 3,250 in 1996, only 174. These are significant figures, although much lower than the comparable numbers for compulsory winding ups.

In contrast to liquidations, there are very, very few Section 166 schemes of arrangement or composition, either within or outside winding up (often only one or two per year, if that). By the time formal winding up proceedings are commenced, it is almost always too late to benefit from a Section 166 scheme; and although there are incentives for commencing a Section 166 scheme at an earlier stage, as will be seen in the discussion in Part I3 below, the inadequacies of the process lead to the process being seldom used.

Insolvency Law Reform

In September 1990 the Law Reform Commission of Hong Kong (the 'Law Reform Commission') began a review of both bankruptcy and liquidation law and practice in Hong Kong, China. The Law Reform Commission appointed the Sub-Committee on Insolvency, which commenced work on 12 November 1990, has just about completed its review.

The first area of review - bankruptcy law - has been completed. The Sub-Committee's Consultative Document on Bankruptcy was issued in August 1993 and was followed by the Law Reform Commission's Report on Bankruptcy in May 1995. The Bankruptcy (Amendment) Ordinance 1996 (Ord No 76 of 1996) (the 'BAO') was enacted in December 1996 and came into effect on 1 April 1998. A consequential amendment in the BAO amended one of the avoidance powers applicable in corporate insolvencies.

The second area of review - corporate rescue and insolvent trading - led to the publication of the Sub-Committee's Consultation Paper on Corporate Rescue and Insolvent Trading in June 1995 and to the Law Reform Commission's Report on Corporate Rescue and Insolvent Trading in October 1996, both of which proposed that a provisional supervision procedure be enacted in Hong Kong, China. A bill is currently being drafted, but is being held up by the issue of how to deal with the rights of workers. A short consultation document on this topic, entitled the Consultation Paper on Corporate Rescue and the Protection of Wages on Insolvency Fund (Treatment of Employees in "Provisional Supervision"), was recently issued by the Financial Services Bureau on 21 December 1998, and the consultation period will continue until 28 February 1999. Once this issue is resolved, a gazetted bill should appear, most likely by mid-1999 at the earliest, and enactment will follow shortly thereafter. Although some changes will quite likely emerge in the gazetted bill, it is anticipated that the Law Reform Commission's recommendations will form the basis for most of the proposed new legislation.

The third area of review - winding up - led to the publication of the Sub-Committee's Consultation Paper on the Winding-Up Provisions of the Companies Ordinance in April 1998, which has recently been open for comment. A Report by the Law Reform Commission will follow in March to April of 1999. The new legislation should be gazetted and enacted sometime in 2000. Section Q sets out the primary recommendations of the Sub-Committee, some of which are also incorporated into the relevant sections of this Report.

This Report

In the many sections requesting detailed discussion of the insolvency procedures, the primary focus is on compulsory liquidation, creditors' voluntary liquidation, and the proposed provisional supervision procedures (since they are quite likely to be enacted in the near future). Section 166 is also covered in some detail, with the focus on schemes outside insolvency. Although corporate rescue is possible through receivership (and thus will be noted in Section I3), receivership is better conceptualized as a debt collection strategy for a secured creditor and will therefore be discussed primarily in Part C. Members' voluntary liquidations involve solvent companies, and thus although they will be noted in Section I3, they will not be discussed in great detail. Informal workouts are of prime importance in Hong Kong, China, especially in the light of the recently issued Guidelines on Corporate Difficulties. But given their lack of formal structure, detailed discussion in Section I et seq did not seem appropriate. Therefore, although a general description is included in Section I3, informal workouts are primarily discussed in Section H.

Except where otherwise noted, legislative section references are to the Companies Ordinance.

I would like to express my gratitude to the many individuals who have assisted with this project. At the outset, I would like to thank my colleague Philip Smart for contributing to Sections A, C, F, L, M, and N of this Report, for commenting generally an earlier draft, and for sharing his views on corporate insolvency during our many conversations on the topic. I would also like to thank my other colleagues, Judith Sihombing and Professor Chris Sherrin, for commenting on issues involving security and security over land, respectively. I would also like to express my gratitude to Robin Hearder, the former Official Receiver, for taking the time to meet with me and share his views on those sections of the Report that involve winding-up matters and issues of relevance to the Official Receiver's Office, as well as for commenting on an earlier draft of this Report.

Much of the discussion throughout the Report (especially in Sections B, C, D, E, G, H, T, and U) is based on individual meetings that I held with individuals with expertise in banking and financial matters in Hong Kong, China and on presentations made by participants at the RMA - INSOL Lenders Group Roundtable Discussion for Senior Bankers on 23 October 1998. Given the time constraints involved in this project, it has not been possible to compile answers from a majority of the banks operating in Hong Kong, China. Instead, I have gathered answers from a group of bankers and their attorneys that were chosen as a representative sample, to the extent that that is possible. This group included Mr Simon Harris of Hongkong Bank, Mr Ian Chapman of Johnson Stokes & Master; Mr Christian Walsh of The Chase Manhattan Bank, Mr. Ernest Mak of DahSing Bank Limited, and Mr David McPherson of National Australia Bank Asia Ltd. I would alike to thank each of them for taking the time to meet with me and sharing their opinions. The survey results in Section S are based on responses from bankers, lawyers, and academics.

The answers to the questions draw generalizations where appropriate, but also try to distinguish between the different banking practices that are evident in Hong Kong, China. Further, more detailed, sampling would possibly demonstrate that some of these generalizations belie further important differences in practices - eg, between foreign and local banks, large and small banks, and lendings to upper- and lower-tier companies. To address these concerns, I intend to hold individual meetings with an expanded group of individuals before completing the final version of this Report.