Soft touch provisional liquidation: Restructuring under the protection of a debt moratorium
In a soft touch provisional liquidation in Hong Kong, a provisional liquidator is appointed to pursue a corporate restructuring. When permitted, a soft interim liquidation places a debtor business under a legal moratorium on creditor enforcement action, thereby protecting the debtor business from lawsuits by creditors against it while it explores options for restructuring. A soft interim liquidation fills a legislative gap in Hong Kong, as Hong Kong’s corporate bankruptcy laws provide no moratorium on creditor enforcement proceedings during the period a company attempts restructuring. However, the courts are limited in their ability to appoint provisional liquidators only to pursue a restructuring. Instead, such an appointment can only be made if certain conditions are met. In this article, we explore the circumstances in which a court may appoint provisional liquidators in a soft touch provisional liquidation.
Unlike many jurisdictions, Hong Kong does not have a legal regime designed to facilitate a restructuring of a company’s debt, thereby allowing the company to effect a rescue, avoid liquidation and continue in business. . While the Companies Ordinance (“CO”) provides schemes of arrangement to bind creditors to a restructuring and companies and their creditors can negotiate their own restructuringthere is no legal moratorium to prevent creditors from thwarting the restructuring effort by placing the company in liquidation before the restructuring can be agreed or approved.
The courts have stepped in to fill the legislative gap and recent developments in case law suggest that there is more room than many practitioners previously thought possible to take advantage of the winding-up provisions of the Companies Ordinance. (winding-up and miscellaneous provisions) (“CWUMPO”) to facilitate a corporate rescue.
Debt moratorium on the appointment of the provisional liquidator
CWUMPO provides that where a winding up order is made against a company or where a provisional liquidator is appointed with respect to a company, no action or proceeding shall be continued or commenced against the company except with leave of the court. For just over 15 years, Hong Kong courts have grappled with the circumstances in which this statutory debt moratorium can be used to effect a corporate bailout.
The starting point for this discussion is Re Keview Technology, where the Hong Kong Magistrate’s Court observed that CWUMPO does not circumscribe the circumstances in which a court may appoint a provisional liquidator or restrict the powers the court may grant to a provisional liquidator. Accordingly, while the appointment of a provisional liquidator has traditionally been made to preserve and protect assets in an emergency, the court held that there was no jurisprudential objection to empowering provisional liquidators to explore a salvage. of business.
Re Keview Technology appeared to open the door to soft provisional liquidations, i.e. the appointment of a provisional liquidator as a means of effecting a corporate rescue, taking advantage of the statutory debt moratorium available under CWUMPO on the appointment of a provisional liquidator and the fact that the provisional liquidation was inherently taking place before a liquidation order had been issued. Indeed, at first it was thought that so long as it was anticipated that it was likely that a liquidation order would be issued if a bailout did not materialize, it was permissible to appoint a provisional liquidator for the express purpose of such a rescue.
However, in International Legend, the Hong Kong Court of Appeal clarified that it was prohibited to appoint a provisional liquidator for the express purpose of pursuing a rescue and that a provisional liquidator could only be appointed for the purpose of a liquidation. The court said:
“…it is clear from the wording of these articles that the appointment of a provisional liquidator must be for the purposes of a liquidation. Provided that these purposes exist, there is nothing to prevent additional powers from being conferred on the provisional liquidator(s), for example those which would make it possible to submit a request [for a scheme of arrangement]…
The power of the court under section 192 is to appoint one or more liquidators for the purpose of liquidation and not for the purpose of avoiding liquidation.
Compatibility of company rescue and liquidation
Following the decision of International Legend, many practitioners considered that, strictly speaking, soft touch provisional liquidations whose express purpose was to pursue the rescue of the company were incompatible with the object of a liquidation, namely to ensure the liquidation of the company. However, as one court noted:
“the reality is that on occasion, the court, despite the decision of Re Legend International Resorts Ltd…continued to be used as a mechanism by which debt, particularly of listed companies, is restructured”.
The decision of the Hong Kong Magistrate’s Court in Re China Solar confirms that the decision of International Legend is not as hostile to soft interim liquidations to pursue corporate bailouts as some practitioners had thought. In particular, the court held that while it is true that a provisional liquidator must be appointed for the purposes of a liquidation, the purposes of a liquidation are not limited to the liquidation of the company but include the preservation of the assets of the company in the event of liquidation. As the court stated:
“The law has never said that the provisional liquidation should lead to a judicial liquidation. The law has always been that a provisional liquidation is intended to ensure that the liquidation operation would not be hindered, if there is liquidation…” [emphasis added]
Conditions for Soft Touch Provisional Liquidations for Restructuring
The court in Re China Solar declared:
“a restructuring is in many circumstances in line with the obligation to preserve the assets of the provisional liquidator”, emphasizing in this respect that “a reduction in the company’s liabilities is the correlative of the protection of its assets”.
In saying this, the court observed that International Legend “only affirmed the conventional criteria for the opening of the provisional liquidation”suggesting that a debt restructuring was consistent with the objective of protecting the assets of a provisional liquidator, since the appointment of a provisional liquidator was duly justified on the grounds of the preservation of the threatened assets.
In many cases, justification may lie in form rather than substance. Citing International Legend the court in Re China Solar asserted:
“However, there is a significant difference between the appointment of provisional liquidators on the grounds that the Company is insolvent and the assets are at risk and the appointment of provisional liquidators solely for the purpose of enabling a business rescue. The difference may, in most cases, be just a matter of emphasis, but in the final analysis the difference is there.” [emphasis added]
In this regard, the court of Re China Solar explained that the view taken by the court in International Legend was only an insistence that:
“[W]here, the elements related to a liquidation are absent, in particular when the assets of the company are not in danger, it would not be advisable to order a provisional liquidation, in spite of the general need for restructuring of the company.
As to whether there are assets in danger which could justify the appointment of a provisional liquidator, the court of Re China Solar pointed out that:
“[It] It has never been the law that a potential loss of assets solely following a liquidation means that the assets are in danger and this danger may justify the appointment of provisional liquidators.
Accordingly, it remains important to identify the risky assets in each case for provisional liquidation purposes.
Taking the two decisions together, it appears that a soft interim liquidation may nevertheless be possible to pursue a corporate rescue o as long as the grounds for interim liquidation are formulated on the basis of debt restructuring to protect assets in danger rather than on the basis of a debt restructuring to avoid total liquidation.
Soft Touch Interim Liquidations of HKSE Listed Companies
The court in Re China Solar determined that while a listed company’s listing is not a type of distributable asset in a liquidation, it is nonetheless an asset and a provisional liquidator may be appointed to protect that asset. This does not mean that a mere risk of delisting by the Hong Kong Stock Exchange (“SEHK”) may be the basis for the appointment of a provisional liquidator. The court noted that a provisional liquidator may be appointed to investigate the affairs of the company and that where the circumstances in which the company is at risk of debarment are worth considering, the need for such investigation may form the basis of a preliminary investigation. liquidation. In this case, it involved accounting and management irregularities that had not been satisfactorily explained to SEHK.
Summary of the law
As a result of Re China Solarit seems that while a soft touch interim liquidation is not always available to effect a business rescue, there will be many circumstances in which it will be a viable alternative.
- A threshold issue with appointing a provisional liquidator to effect a business rescue is that a winding-up order is likely to be issued. Normally this means that the company is unable to pay its debts.
- If this threshold is reached, the provisional liquidation must have a legitimate aim, namely to guard against the risk of dissipation of the assets of the company or the need for an independent investigation into the affairs of the company, including in the event of embezzlement. leaders. In the first case, it is abusive to pursue a soft touch provisional liquidation for the sole purpose of a restructuring whose objective is to avoid a liquidation. However, it may be appropriate to pursue a soft touch provisional liquidation to effect a restructuring where there are risky assets that require preservation by a provisional liquidator.