(a) Are there civil or penal/criminal sanctions in the legal system of this economy in relation to the incurring and non-payment of debts by corporate debtors (for example, some type of sanction - such as the concept of 'insolvent trading' - to which the directors of the corporate debtor may be subject)?

(b) What are these sanctions?

(c) Do any of these sanctions have the effect of encouraging the directors of a corporate debtor to seek protection for the corporate borrower under the insolvency law regime?

(d) Does the presence of the possible application of any of these sanctions create a problem if a corporate debtor which is in financial difficulty or insolvent seeks to negotiate an informal work out with creditors?

Currently there is little in the way of sanctions imposed upon directors in relation to the incurring and non-payment of debts by a corporate debtor. The most obvious sanction is contained in Section 275 of the Companies Ordinance, which deals with fraudulent trading. If a company's affairs have been conducted by any party (including directors) with intent to defraud creditors, then the court may impose civil and criminal sanctions. The criminal sanctions are a fine and imprisonment; the civil sanction is that a guilty party may be ordered to be personally liable for all or any of the company's debts (as the court directs). Fraudulent trading is rarely invoked and notoriously difficult to establish. For this reason the Law Reform Commission proposed in Chapter 19 of its Report on Corporate Rescue and Insolvent Trading the introduction of an additional sanction to be called 'insolvent trading': civil liability (but not criminal liability) for insolvent trading could be incurred by directors if a company traded while insolvent or when there was no reasonable prospect of avoiding insolvency.

Potential liability for fraudulent trading does not encourage directors to seek early protection for a corporate borrower - since liability depends solely upon fraud. The notion of insolvent trading is clearly designed to encourage directors to take appropriate steps. To a limited extent, the provisions in the Companies Ordinance on the disqualification of directors (Part IVA, which was brought into operation in 1994) should encourage directors to seek protection. The director of an insolvent company can be subject to a disqualification order on the ground, inter alia, of unfitness. The court is instructed in the legislation (Schedule 15, Part II) to consider, inter alia, any failure by the company to supply any goods or services that have been paid for in whole or part. However, it is unlikely that directors' disqualification has any major practical impact in this area, since relatively few disqualification applications on the ground of unfitness are currently made to the court.

The introduction of civil liability for insolvent trading should have a significant impact on this area of the law. Another reform recently proposed by the Sub-Committee on Insolvency (based on Section 76 of the United Kingdom Insolvency Act 1986 (the 'UK Insolvency Act')) that could assist in this area would be the enactment of a provision imposing liability on directors and shareholders for payments made out of the capital of a private company within a year of the winding up of a company for the redemption or re-purchase of a company's shares. Consultation Paper on the Winding Up Provisions of the Companies Ordinance, supra, paras 3.2-.3 at 11.

Directors can also be disqualified under Section 168H for, among other things, entering into a transaction or giving a preference that would lead to the transaction being set aside under Section 182 or Section 266. Since this provision was introduced in 1994, only one director was disqualified for such conduct under Section 266. Id, para 16.4 at 120.

In addition, pursuant to Section 60 of the Conveyancing and Property Ordinance directors can be made liable for disposing of property with the intent to defraud creditors. This avoidance power (which is discussed in greater detail in Section K2(a) below) is applicable both during and outside insolvency proceedings. However, as noted in the later discussion, recovery often proves difficult.

When it comes to an informal workout with creditors, the impact of the above sanctions is more theoretical than real. A bank, for example, playing a lead role in a workout could in theory be liable for fraudulent trading. But, in reality there will be little likelihood of liability, since no party is trying to defraud the company's creditors. It is also possible that a bank closely supervising a corporate rescue could be regarded as a shadow director for the purposes of Part IVA (directors' disqualification), but it seems unlikely that any such potential difficulty has much, if any, practical impact in Hong Kong, China at present.