(a) Is the system of ownership rights in respect of both land and other property reasonably stable and certain in this economy?

There is a large measure of certainty and stability of ownership rights in Hong Kong.

 

(b) In particular:

(i) is the system of land ownership and rights sufficiently developed to encourage lending on the security of land; and

Yes, the system of land ownership and land title registration is sufficiently developed to encourage lending on the security of land. However, there has been some confusion in recent years as to priority protection for unwritten equitable rights in land. See Section C2(c) below.

 

(ii) is the system of ownership and rights in relation to property other than land sufficiently developed to encourage lending on the security of such property?

In relation to personal (or movable) property, the system of ownership and rights is highly developed. In particular, a corporate borrower may grant a floating charge over all (or any class) of its present and future assets.

 

(a) What mechanisms for taking of security over assets of a corporate borrower are available to financiers in this economy (for example mortgages over land; fixed and/or floating charges over personal property; legal and/or equitable mortgages; debentures; pledges; liens, etc.)?

A wide variety of mechanisms for taking security exist. In addition to the legal mortgage over land, equitable mortgages may also be created. As one commentator noted, a legal mortgage over land is, in form, a charge with statutory powers equating to the traditional powers of a mortgagee under the common law.

A corporate borrower will typically grant a number of floating (or fixed and floating) charges to secure indebtedness to several lenders. The Companies Ordinance does not define the term 'floating charge.' In general, unlike a fixed charge which 'attaches' to 'ascertained and definite' property (eg, a company's premises or machinery), a floating charge 'hovers' over a changing class of assets. Illingworth v Houldsworth [1904] AC 355, 358. The noted commentator Professor Roy Goode describes the underlying notion of a floating charge as 'that of a class of revolving assets [eg, inventory] which the company is to be free to manage and deal with in the ordinary course of business until an event occurs which entitles the creditor to intervene and assert his security rights over the assets then held or subsequently acquired by the company.' Roy Goode, Commercial Law 732 (2d ed. 1995).

Various sorts of security mechanisms are common including liens, pledges or hypothecations, and securing deposit accounts in favour of a bank (see Section 15 of the Law Amendment and Reform (Consolidation) Ordinance 1991). Also used are title retention (which is discussed in Sections D(c) & (d) below), set-off, and guarantees (which are discussed in Section B10 above).

 

(b) In practice, which of these types of security are most commonly employed by financiers?

Mortgages over land and fixed and floating charges, together with guarantees, are often taken. Where a company has already granted several charges, a subsequent lender may well lend on an unsecured basis (but with guarantees).

 

(c) Is there a system of registration in this economy for any of these types of security taken by financiers?

Hong Kong, China has no uniform scheme whereby all types of security devices must or may be registered. The current registration system is something of a patchwork - although it appears to work satisfactorily in practice. Mortgages and other interests granted over land are registered pursuant to the land registration legislation. See the Land Registration Ordinance (cap 128). One commentator made several observations about the registration scheme provided in this ordinance. First of all, the available system of land registration is not mandatory and, therefore, legal mortgages (in the form of charges) over land are not required to be registered. However, in practice it is treated as if registration is compulsory because the system negates the doctrine of notice in respect of unregistered registrable interests. Yeung Shu v Alfred Lau & Co [1997] 2 HKC 153. Thus, failure to register a registrable mortgage can result in a loss of priority. Second, an equitable mortgage, or an equitable charge over land, and which is in writing, can also be registered under the registration system. And third, floating charges over land owned by a company may not be registered under the Land Registration Ordinance until the charge has crystallised and notice has been served on the chargor to that effect. Section 1A, Land Registration Ordinance. See Judith Sihombing, Completion of the Contract for the Sale of Land, Ch XIV, para [121], in 1(A) Judith Sihombing and Michael Wilkinson, Hong Kong Conveyancing: Law and Practice (1998).

Section 80(2) of the Companies Ordinance includes a list of charges that must be registered with the Registrar of Companies:

(a) a charge for the purpose of securing any issue of debentures;

(b) a charge on uncalled share capital of the company;

(c) a charge created or evidenced by an instrument which, if executed by an individual, would require registration as a bill of sale;

(d) a charge on land, wherever situate, or any interest therein, but not including a charge for any rent or other periodical sum issuing out of land;

(e) a charge on book debts of the company;

(f) a floating charge on the undertaking or property of the company;

(g) a charge on calls made but not paid;

(h) a charge on a ship or any share in a ship;

(i) a charge on goodwill, on a patent or a licence under a patent, on a trademark or on a copyright or a licence under a copyright.

For practical purposes, the list notably includes charges on land, floating charges on the undertaking or property of a company, charges on book debts or goodwill, and any charge securing the issue of debentures. (Security interests and charges not listed in Section 80 need not be registered.) The system for registration of company charges extends to charges on property in Hong Kong, China granted by foreign companies that have places of business in Hong Kong, China (Section 91), to charges granted by Hong Kong, China companies that were created in Hong Kong, China but comprise property outside Hong Kong, China Section 80(4), and to charges granted by Hong Kong, China companies that were created out of Hong Kong, China and comprise property outside Hong Kong, China (Section 80(3)).

 

(d) To what extent are priorities between competing securities regulated?

Detailed rules are provided in the case law and, to a lesser extent in legislation, as to questions of priority.

One commentator has noted that some confusion has resulted in recent years in respect of priority protection for unwritten equitable rights in land. In general, priority will be accorded on common law - thus, non-statutory - principles. Confusion is caused when a registrable and registered interest is in a priority contest with an unwritten equitable interest. Wong Chim-ying v Cheng Kam-wing [1991] 2 HKLR 253. See Sihombing, Ch XIV, supra, para [136].

 

(a) When a corporate borrower is in financial difficulties and a secured debt has become due, would it be usual or customary for a secured lender and/or the corporate borrower to attempt to negotiate a suitable arrangement for repayment and/or refinancing before the secured lender invokes legal enforcement methods?

A secured lender would not normally invoke legal enforcement methods before attempting to negotiate refinancing or other similar arrangements with a corporate debtor.

 

(b) What mechanisms are available to security holders to enforce their securities under the legal system of this economy (For example, power to take possession of the property, power to appoint a receiver, power to foreclose on a mortgage, power to sell the secured property, power to wind up the corporate borrower)?

A debenture securing a floating (or fixed and floating charge) would provide that a receiver may be appointed upon the occurrence of a specified event of default, such as the failure by a company to repay principal or make a scheduled interest payment. It is also possible for a debenture to provide for the automatic crystallisation of a charge without the appointment of a receiver. Debentures frequently provide banks with fixed charges over certain specified assets, including existing and future book debts and a floating charge over the company's 'undertaking.' The debentures are structured in this fashion to ensure that, if the fixed charge over the book debts is ineffective, the floating charge will protect the secured creditor's interest. The debenture will usually provide that the receiver is an agent of the company and empower the receiver to:

(1) take control of, and sell, the charged assets;

(2) carry on business in the name of the company;

(3) commence proceedings in the name of the company;

(4) enter into contracts on behalf of the company; and

(5) sell the company as a going concern.

Although the appointment of a receiver pursuant to a debenture does not displace management, it does enable the receiver to assume most of the powers of management. The appointment of a receiver does not automatically terminate contracts of employment, nor does it terminate pre-existing contracts entered into by the company. When appointed by the court, the receiver's powers would be determined by the order of the court making his appointment. However, a receiver appointed by the court would not be an agent of the company and the judicial appointment of the receiver would automatically terminate the contracts of employment.

One commentator pointed out that it is also possible to seek the appointment of a Mareva Receiver, whose functions are somewhat different from those of a court appointed receiver. Chinese United Establishment Ltd v Cheung Siu Ki [1997] 2 HKC 212; National Australia Bank v Bond Brewery [1991] VR 530.

Where a fixed charge or mortgage is taken over land, the enforcement of such security (eg, by appointing a receiver) is generally straightforward. Section 50 of the Conveyancing and Property Ordinance (cap 219) implies into legal and equitable mortgages (by deed) the power to appoint a receiver with the powers specified in the Fourth Schedule to the Conveyancing and Property Ordinance (the (including the power of sale). The advantage of appointing a receiver is that the mortgagee does not become liable for breaching any duty or responsibility owed to the mortgagor. See Judith Sihombing, Security Transactions over Land, Ch XIII, para [1452], in 1(A) Judith Sihombing & Michael Wilkinson, Hong Kong Conveyancing: Law and Practice (1998). Among the other remedies to be considered by a lender are judicial sale or sale by a private agent, delivery of possession, or foreclosure. However, foreclosure has not been common in Hong Kong, China as there is no real incentive for commercial banks to become owners of commercial realty.

A secured creditor may petition for the winding up of a company, but would usually only do so if it were undersecured.

 

(c) Do these methods include that a secured creditor may 'self-enforce' the security (ie, without the need for an order of a court or the consent of a regulatory authority)?

The most commonly used enforcement method by a lender holding a floating charge, ie the appointment of a receiver and manager, does not require court involvement. Where there are omissions in the debenture, or on other rare occasions, the secured creditor may instead decide to seek the judicial appointment of a receiver. See, eg, Section 21L, District Court Ordinance (cap 336).

Although a mortgage provides the secured creditor with some mechanisms for self-enforcement (eg, the appointment of a receiver), in practice a lender would almost always first seek the comfort of a court order under Order 88 of the Rules of the High Court (cap 4) before taking any steps to enforce its security. Order 88 provides a summary procedure for mortgage actions.

 

(d) In practice, which method(s) of enforcement are most commonly employed by security holders?

The most commonly employed method is the appointment of a receiver and manager pursuant to a floating or fixed and floating charge.

When enforcing a mortgage, the usual practice would be to seek possession through a receiver (who would take possession on behalf of the mortgagee, but as the agent of the mortgagor) and would exercise the power of sale. Sihombing, Ch XIII, supra, paras [1552, 1554].

 

(e) Briefly describe the process involved in these method(s).

The normal method of enforcing the floating charge is pursuant to the terms of the debenture by the appointment (out of court) of a receiver, which is usually defined to include a receiver and manager. The receiver will in practice be an accountant who specialises in insolvency work. The Registrar of Companies must be notified of his appointment within 7 days of the appointment. Where the need arises, a receiver appointed pursuant to a debenture may apply to the court for directions. (Section 298A).

As noted in Section C3(d) immediately above, in regards to real property, the lender usually wishes to rely on possession and sale. Judith Sihombing writes (Ch XIII, supra, para [1602]):

The usual procedure for the sale of the mortgaged property is for notice to be given, by registered mail or personally, demanding repayment and warning that the mortgagee will exercise his power of sale on continued default. The mortgagee will then take action under Order 88, Rules of the High Court for recovery of the land so that he can give vacant possession on the sale. If the property is subject to a valid tenancy, then he will not take action for recovery as the sale will be subject to the terms of that tenancy. However, if the mortgagor had granted the tenancy in breach of the terms of the mortgage, for example he did not obtain the necessary consent from the mortgagee, then that tenancy will not be enforceable against the mortgagee nor his successors-in-title.

When the sale occurs, it is often by private treaty through an agent (who has undertaken a thorough valuation of the property to ensure that the proper price is obtained) or by auction. However, it must be kept in mind that this procedure is often easier in theory than in practice. One commentator noted that recalcitrant mortgagors often try to delay or frustrate the mortgagee's actions through a variety of actions that might well include changing the locks or granting illegal tenancies. He noted that although the mortgagee has the law on its side, its remedies often prove illusory; and when successful, are time-consuming.

 

(a) How effective is the judicial or court system for the purpose of enforcing secured property rights?

Secured rights can be enforced satisfactorily by use of the judicial system. However, where documentation has been properly drafted - as in a floating charge - a secured lender should not normally need to resort to the judicial process in the ordinary course of events. However, as noted by one commentator, a secured creditor should be aware that the terms of a contract of security might now be subject to legislation that examines the unconscionability of those terms.

 

(a) What effect, if any, does the commencement of insolvency proceedings in respect of the corporate borrower (ie where an application has been filed for some type of insolvency procedure but has not yet been adjudicated) have on the process of security enforcement?

In a compulsory winding up, pursuant to Section 181 of the Companies Ordinance at any time after the presentation of a winding-up petition and before the making of a winding-up order, the court may (if so requested by the company or any creditor or contributory) stay any action or proceeding against the company on such terms as it thinks fit. However, Section 181 does not effect the ability of a secured creditor to enforce its security rights through out-of-court methods of enforcement (such as the appointment of a receiver and manager).

The commencement of a voluntary winding up or of a Section 166 scheme has no formal effect on the process of security enforcement.

Under the Law Reform Commission's proposed provisional supervision procedures, upon the commencement of provisional supervision, a moratorium will take effect that will prevent both unsecured and secured creditors (with the exception of 'major secured creditors') from taking actions to collect their debts. A major secured creditor is defined as a 'holder of any charge [whether fixed or floating or a combination of the two] over the whole or substantially the whole of a company's assets, whose level of exposure of lending would warrant such an extensive charge.' Report on Corporate Rescue and Insolvent Trading, supra, para 5.18(a) and (e) at pp 36-37.

The moratorium will last for an initial thirty-day period. If the provisional supervisor is unable to formulate a plan within this period, he may apply to the court for an extension or extensions of the moratorium for up to six months. Beyond that time, the moratorium may only be extended with the agreement of creditors.

(b) What effect, if any, does the formal pronouncement of an insolvency administration in respect of the corporate debtor have on the process of security enforcement?

Pursuant to Section 186 of the Companies Ordinance, once a winding-up order has been made by the court (or a provisional liquidator has been appointed), creditors may not proceed with or commence actions against the company unless leave to proceed is granted and on such terms as the court may impose. As with Section 181, enforcement by a secured creditor of security through out-of-court methods is unaffected by Section 186. Should a secured creditor require court intervention (eg, to foreclose on a mortgage), leave under Section 186 will readily be granted to enable the security to be realised.

This question is inapplicable to a voluntary winding up or a Section 166 Scheme because there is no formal pronouncement in such cases. The same will be true of provisional supervision; in provisional supervision, the moratorium will take effect from the date of commencement. See Section C5(a) immediately above.

It should be noted, however, that the ability of a secured party to realize its security would be adversely affected in those instances in which a liquidator successfully asserts the application of an avoidance power. See Section K2(a) below. In addition, upon the appointment of a liquidator, a receiver and manager appointed pursuant to a floating charge is no longer entitled to carry on business as agent of the company, although he is entitled to continue realizing the security subject to the bank's charge.