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04 August 2006
There are no corporate rescue provisions in Hong Kong's winding-up legislation, except those which allow for a scheme of arrangement under Section 166 of the Companies Ordinance. However, it had been thought that the courts could and would appoint provisional liquidators for the purpose of allowing a defaulting company and its creditors to work out the feasibility of corporate rescue and restructuring. A recent Court of Appeal case, Re Legend International Resorts Ltd, has firmly rejected such thinking.
A provisional liquidator can be appointed only after a winding-up petition has been presented, but Section 193 gives no guidance as to the circumstances in which an appointment can or should be made; such guidance is given by case law. In Yick Fung the court held that it is an "unusual and drastic" step to appoint a provisional liquidator in respect of a solvent company. However, it has traditionally been recognized that a provisional liquidator may be appointed if the assets of a company are in jeopardy or those in control of them are misappropriating or wasting them - an unusual and drastic step for a solvent company, perhaps, but not impossible. It might be argued that corporate rescue could constitute a sufficiently unusual and drastic position, whether or not the company is insolvent or its assets are in jeopardy, as such a step would be in the interests of its creditors; a company can be wound up not only if it is insolvent, but also if it is just and equitable to do so.
Once a provisional liquidator has been appointed, Hong Kong legislation states that "no action or proceeding shall be proceeded with or commenced against the company except by leave of the court and subject to such terms as the court may impose".
There is no similar provision to 'hold the ring' while a company explores the possibility of a scheme of arrangement and seeks court approval for it. It had been understood that case law had effectively filled this gap - and the gap in providing for corporate rescue - and that the court would allow an appointment, whether or not the assets of the company were in jeopardy, in order to allow a corporate rescue to take place, whether or not approval was ultimately required for a proposed scheme under Section 166.
However, in Re Legend the court rejected that proposition, stating that "it is not the function of the court to legislate". Nevertheless, a provisional liquidator may be appointed for the purpose of winding up a company. The court found that:
The court did not refer to the decision in Yick Fung.
In the present case a company faced with a winding-up petition and a request that provisional liquidators be appointed in order to explore a restructuring of the company argued that such a move would take control of the company away from its existing management and amounted to an abuse of process. It was also argued that the petition had been presented not to achieve a winding-up, but simply in order to appoint provisional liquidators, which could then propose a scheme of arrangement. Nevertheless, this course has the advantage of placing a moratorium on the company's debts while the scheme of arrangement is considered and taken before the court, although such an advantage was not spelled out in the judgment.
Legend International Resorts Ltd was incorporated in Hong Kong and was involved in running a casino in Subic Bay in the Philippines. In July 1995 Legend entered into a facility agreement in which Société Générale Asia (Singapore) Ltd was the coordinating arranger and agent. The facility consisted of a revolving credit facility of up to US$33 million. The agreement was effectively a syndicated loan in which a number of financial institutions were the lenders. They included a bank called Keppel Bank. Keppel Bank assigned its share of the facility to Morgan Stanley Emerging Markets Inc. It was argued that an assignment could be made only to an 'eligible transferee' as defined in the agreement, and that Morgan Stanley was not a 'bank, deposit-taking company or financial institution' as defined in the General Corporations Law of Delaware under which it was incorporated.
In July 1998 Legend defaulted on repayment under the agreement. Accordingly, Société Générale Asia served a written demand for repayment of the total outstanding balance of the loan (over US$26 million) within 10 days.
On November 3 2004 Morgan Stanley presented a winding-up petition against Legend in Hong Kong for its failure to repay under the agreement. Two days later Legend filed its own petition in court in the Philippines for corporate rehabilitation.
Morgan Stanley applied to the court of first instance in Hong Kong seeking the appointment of provisional liquidators and asking that they be empowered to explore a corporate rescue or restructuring. Legend asked the court to strike out Morgan Stanley's petition on the grounds that it disclosed no reasonable cause of action and was scandalous, frivolous, vexatious or an abuse of process. Legend contended that Morgan Stanley had no right to act as a creditor, as it was not an eligible transferee under the agreement, and/or that Morgan Stanley's action was based on the collateral purpose of trying to take control of Legend and its assets. Morgan Stanley contended that it was a financial institution engaged in the business of investment banking.
The first instance judge dismissed the application to strike out the petition, refused to appoint provisional liquidators and wound up Legend. Both parties appealed to the Court of Appeal.
The court upheld the decision and dismissed the parties' appeals. It referred to Sections 192, 193 and 199 of the Companies Ordinance. Section 192 provides that Section 193 relates to the appointment and power of provisional liquidators and Section 199 specifies the powers of liquidators:
The court noted the traditional basis for the appointment of provisional liquidators and the development in England that provisional liquidators may be appointed in respect of insurance companies, even if the company's assets are not in jeopardy.
The court further reviewed other previous judgments made by the court of first instance in Re Keview Technology (BVI) Ltd(1) and the Court of Appeal in Re Luen Cheong Tai International Holdings Ltd(2) and SFC v Mandarin Resources Corp Ltd,(3) citing the finding in Re Luen Cheong Tai International Holdings Ltd:
Expanding on this, the court concluded as follows:
As the first instance judge had concluded that the company's assets were not in jeopardy, the Court of Appeal did not consider that there were grounds for disturbing the judge's decision to dismiss the application to appoint provisional liquidators.
The court also dismissed Legend's application to strike out the petition. It gave the words 'financial institution' their ordinary meaning and held that Morgan Stanley's business included lending money as a financial institution; it therefore fell within the definition of an eligible transferee and had the right to lodge the petition. Finally, the court concluded that the petition disclosed reasonable cause of action and was not scandalous, frivolous, vexatious or an abuse of process.
Although Legend subsequently applied for leave to appeal to the Court of Final Appeal, the Court of Appeal dismissed its application.
On June 8 2006 the court of first instance dealt with the winding-up petition and ordered Legend to be wound up on the basis of its inability to pay its debts. The court held that Legend had failed to demonstrate that a bona fide dispute existed on substantial grounds in respect of Morgan Stanley's right to act as a creditor (ie, whether Morgan Stanley was an eligible transferee). It further held that the order to stay under the rehabilitation proceedings was confined to proceedings in the Philippines and did not bind the Hong Kong court. The judge therefore granted the winding-up order.
The appointment of provisional liquidators is restricted to cases where the company is insolvent and its assets are in jeopardy. An appointment cannot be made "solely for the purpose of enabling a corporate rescue to take place".
Given that the Hong Kong court declined to allow the appointment of provisional liquidators as an alternative to a Section 166 scheme of arrangement or an informal work-out through corporate rescue and restructuring, insolvency practitioners in Hong Kong must ensure that they advise their clients accordingly. If they advise their clients to consider appointing provisional liquidators with a view to exploring the possibility of corporate rescue or restructuring, they must be able to demonstrate that the insolvent company's assets are in jeopardy and that the appointment of provisional liquidators is necessary in the circumstances before making the application for the appointment of provisional liquidators.
It would be beneficial if amendments were made to the winding-up legislation to facilitate corporate rescue.
For further information on this topic please contact Andrew Kinnison or Jacky Yeung at Holman Fenwick & Willan by telephone (+852 2522 3006) or by fax (+852 2877 8110) or by email (firstname.lastname@example.org or email@example.com).
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