As has been widely reported in the media, there has been a period of considerable stress in the real estate sector in Mainland China with a number of high-profile property developers having reportedly either already defaulted on onshore and offshore bond repayments or are on the verge of a payment default. The current credit crunch in this sector is largely a result of China’s three red lines policy which was introduced in August 2020 to improve the financial health of the real estate sector by controlling excessive leverage and a slowing ‘Covid’ economy, which is crushing domestic home sales.
The cash-strapped developers include China Evergrande Group, Kaisa Group Holdings, China Fortune Land Development, Yuzhou Group Holdings, Modern Land (China), Sunac China Holdings, Fantasia Holdings, Sunshine 100 China Holdings, Shimao Group Holdings, and China Aoyuan Group. A number of these companies have already had trading in their shares suspended on the Hong Kong Stock Exchange mostly due to failure to produce timely audited financial results.
Evergrande is perhaps receiving the most global attention as the world’s most indebted property developer. According to the BBC, Evergrande, with more than US$300 billion in liabilities, has already defaulted on interest payments to international investors, and which prompted Fitch Ratings, a top credit rating agency, to downgrade its credit rating to a substantial credit risk rating.
In the event that a financial restructuring is not possible and creditors form the view or anticipate that there will be a payment default, they will need to be ready to implement a suitable debt recovery or enforcement strategy to maximise their prospects of getting repaid.
For the many Mainland property developers listed in Hong Kong, the corporate structure often involves an ultimate holding company incorporated offshore in a jurisdiction such as Cayman or BVI (usually to minimise tax liability and with less stringent regulatory requirements) which, in turn, has multiple indirect wholly owned operating subsidiaries in the Mainland, where ultimately the true value of the business in terms of asset value is held. This complicated and cross jurisdictional legal structure can be challenging for creditors when it comes to taking enforcement action against the defaulting property developer or its related group companies. There will usually be multiple creditors both onshore (Mainland banks, bondholders, suppliers) and offshore (international banks and international bondholders).
In order to maximise recovery prospects and develop an effective litigation strategy, it is necessary to review and understand the specific corporate structure and contractual and financing arrangements and identify the potential causes of action, the proper legal ‘target’, the proper jurisdiction to commence legal action, and to consider the physical location of assets to enforce against. This analysis is critical. As an aside, creditors should also bear in mind that senior management of Mainland companies usually prefer to try and reach an amicable solution or settlement of disputes through negotiation rather than launching into legal proceedings.
In Hong Kong, creditors can deploy a number of enforcement options, including liquidation or ‘winding-up’ proceedings against the debtor company, a debt restructuring or ‘work-out’, commencing litigation through the Courts and potentially arbitration proceedings if the relevant contracts/agreements contain a valid arbitration clause. Each process has its own unique procedural requirements, advantages and limitations.
Depending on the particular circumstances, there are also various ‘interim relief’ measures available to creditors in Hong Kong to immediately identify and protect assets and/or ‘preserve the status quo’ until there has been a final determination by the Court or arbitration Tribunal.
- Winding-up/ liquidation
Under Hong Kong law, a winding-up of a company can be categorised into three types: (1) members’ voluntary liquidation, (2) creditors’ voluntary liquidation and (3) compulsory winding-up by the Court.
1 – To commence a members’ voluntary liquidation, the members of the company have to pass a special resolution (i.e. representing at least 75% of shareholdings) for the winding-up of the company and for the appointment of the liquidator. The directors also have to sign a certificate of solvency, declaring that the company will be able to fully pay is debts within 12 months from the commencement of the winding-up.
2 – To commence a creditors’ voluntary liquidation, the members of the company have to pass a special resolution to wind-up the insolvent company, or a majority of the directors have to certify that the company is insolvent and unable to carry on trading. The company will also call a meeting of creditors, held within 14 days after the members’ meeting, at which the creditors may nominate a liquidator and vote to establish a committee of inspection to oversee the conduct of liquidation.
3 – winding-up by the Court:
a) Key stages
Before presenting a winding-up petition, the creditor will issue a statutory demand for payment of the debt in a prescribed form. If there is no response to the statutory demand within 21 days, the creditors can file a winding-up petition at the High Court of First Instance in Hong Kong, and advertise the petition in Chinese and English language newspapers and the Government Gazette.
After obtaining a winding-up order, liquidators will be appointed at the first meetings of creditors and contributories, which must take place within 3 months after the date of winding-up order. Liquidators will investigate the company’s affairs, obtain possession of company property or books and records, and seek to recover assets for the benefit of creditors. They will conduct a ‘proof of debt’ process and adjudicate (i.e., admit or reject) creditors’ claims against the company. They also will make a distribution or pay a dividend (usually not substantial) to unsecured creditors from any surplus assets. This process could take several years.
It puts the debtor company under commercial pressure and the act of serving a statutory demand may in itself be sufficient to procure repayment of the debt or settlement discussions to avoid a winding-up. For example, the presentation of a winding-up petition may constitute an ‘event of default’ under other commercial contracts and finance documents; the petition also has to be advertised, which will likely alert banks and other creditors, counterparties, or stakeholders.
Time and cost-efficient
Winding-up proceedings can be considerably time-and-cost-efficient if they are unopposed. The costs of the winding-up are normally paid out of the assets of the company.
Winding-up also helps creditors secure assets: after commencement of the winding up, any disposition of property of the company and attachment or execution against the company is void; and banks will freeze the company’s account as soon as they become aware of the winding-up proceedings.
Winding-up on just and equitable grounds
On just and equitable grounds, a creditor may seek to wind up a company on grounds such as where there has been a fraud or misconduct by management or where the conduct of management calls for an investigation.
Liquidators’ power to investigate
Liquidators have extensive investigation powers including (i) to review transactions of the company prior to the commencement of winding-up and potentially to avoid ‘undervalue’ transactions or any ‘unfair preference’ to a creditor; (ii) to investigate the company’s affairs generally and to understand the cause of insolvency; (iii) to recover assets belonging to the company for the benefit of creditors; (iv) to investigate the conduct of the company’s directors and management prior to the commencement of winding-up and (v) to take legal action against directors or third parties who have engaged in fraud or misconduct.
However, winding up may not be the best option for some creditors. First, creditors who wish to keep the proceedings and information confidential should not seek a winding-up petition because of the advertising requirement, and the Court hearings are usually open to the public. For creditors holding debts that may potentially be disputed, there is a risk the winding-up petition will be dismissed by the Court if the debt is disputed bona fide on substantial grounds (for example, on the ground of reasonable doubt as to the existence of the debt) or where the debtor company has a valid set-off or cross-claim which exceeds the debt. Further, unsecured creditors usually do not receive full repayment of their debts because they rank pari passu with each other (i.e. they rank equally and share equally any available assets in proportion to the debts due to each creditor) and they rank behind secured creditors and preferential creditors, such as the debtor’s employees claims for unpaid wages.
For any creditor who plans to present a winding-up petition, it is important to appreciate that the petition may bring other creditors ‘out of the woodwork’. For example, it may be an ‘event of default,’ which triggers cross-default provisions in other commercial contracts and loan or finance documents, potentially leading to other creditors taking enforcement action.
d) Specific questions to be considered for winding-up action
- Does the debtor company have a defence to the claim or a basis to dispute the debt?
- Are there any other secured or unsecured creditors? What is the priority of their debts?
- Does the debtor company have sufficient assets to pay the creditors’ debt?
- Do creditors need an investigation into the debtor company’s affairs or conduct of management?
- Do creditors want to keep the disputes confidential?
2 – Restructuring without winding-up
Hong Kong does not have any formal or statutory corporate rescue procedure like other common law jurisdictions. A company in financial distress can seek to restructure its debts by means of (1) an informal workout agreement with its creditors, or (2) by a Court-sanctioned Scheme of Arrangement.
A Scheme of Arrangement is an arrangement or compromise between a company and its creditors (or class(es) of its creditors) in respect of the company’s debts. A distressed company will collaborate with its legal and financial advisors to formulate a proposal for a compromise of the company’s debts for the creditors’ approval and the court’s sanction. It is an effective tool to implement a financial restructuring, which binds all creditors to such arrangement or compromise. It will be necessary to prepare a ‘liquidation analysis’ to compare the rights that the creditors would have under the scheme against the company with their rights against the company in an insolvent liquidation.
The Companies Ordinance (Cap. 622) sets out the statutory requirements and procedures for implementing a Scheme of Arrangement, which includes:
- obtaining the approval of the court to convene meetings of each class of shareholders and/or creditors to be affected by the Scheme;
- convening the shareholders’ and creditors’ meetings in accordance with the court’s directions;
- obtaining the requisite shareholders’ and creditors’ approval at the respective meetings, i.e. a numerical majority of more than 50% and a majority of at least 75% in value; and
- seeking the court’s final sanction of the Scheme.
3 – Litigation/ Writ action
a) Key stages
A writ action starts with a creditor as Plaintiff issuing a Writ of Summons and serving the proceedings on the debtor as the defendant personally, which could be a time-consuming process if the defendant is located outside Hong Kong. Following valid service, the parties will then file pleadings (i.e. Statement of Claim, Defence and Reply) and go through the ‘discovery’ process whereby each party is required to disclose all relevant documents to the other party. The parties usually then exchange factual witness statements and experts’ reports (if required). There will then by a trial to hopefully obtain a judgment which can then be enforced against the assets of the Defendant and subject to any appeal and possible stay of execution of the judgment.
Enforcement against assets of judgment debtor
A judgment creditor (i.e. the winning party in a litigation, who is entitled to enforce execution under the judgment) can seek to enforce the judgment against the assets of the judgment debtor before other creditors. However, under section 186 of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32 of the Laws of Hong Kong) (“CWUMPO”), when a winding-up order has been made, or a provisional liquidator has been appointed, no action or proceeding shall be proceeded with or commenced against the liquidating company (except with leave of the Court). The Court has inherent jurisdiction to stay proceedings (e.g. Garnishee proceedings) or stay execution against a company in liquidation, if the judgment creditor gains an unfair advantage over other creditors by enforcing the judgment.
If a creditor does not have the relevant documents in its possession, the creditor can potentially benefit from the mandatory discovery process in Court proceedings: in a writ action, parties must disclose to the other side all relevant documents in their possession, custody or power, whether or not harmful to their case.
Impartiality, Certainty and Finality
Other advantages of a writ action include (i) impartiality of judges who are assigned by the court independently without reference to either party; (ii) certainty of procedures and timetables which are governed by court rules and practice directors; and (iii) finality of the highest court’s decisions – by virtue of the doctrine of res judicata, a party cannot re-litigate any issue, claim and defence that have already been litigated and determined by the Court.
Lack of procedural flexibility and less autonomy
There is less procedural flexibility: parties must comply with the prescribed court procedures and timetables, divergence from which requires parties’ consent and/or court’s permission. These prescribed court rules also lead to less autonomy of parties over the conduct of the proceedings.
Lack of confidentiality
A creditor will be unable to keep the existence of the dispute confidential: court hearings are generally open to the public and writs are accessible to members of the public.
Potentially a long process
The litigation can be a long process. There may be Court deadline time extensions and related interlocutory applications, which can l delay the proceedings going to trial. Depending on the court diary, it is not unrealistic for a case to take approximately 24 months or potentially longer for more complex cases to get to the stage of a trial.
At the conclusion of the proceedings, the ‘losing’ party usually is ordered to pay the ‘winning’ party’s legal costs. There is a ‘taxation’ process by the Court to assess the costs. Generally, a successful litigant can expect to recover around 60% to 80% of its actual legal costs from the losing side.
a) Key stages
The arbitration process commences when a party issues and serves a notice of arbitration to the other party. The parties will then appoint the arbitrator(s), who will then preside over the arbitral proceedings and give an arbitral award, which is enforceable in the same manner as a Court judgment.
Interjurisdictional scope of availability of interim relief and enforcement of awards
Arbitration may be appealing to some creditors because interim and final arbitral awards are more widely and readily enforceable in cross-border disputes. First, parties to arbitral proceedings in Hong Kong can seek interim relief from PRC courts and vice versa, parties to arbitral proceedings administrated in the PRC may apply to the Hong Kong courts for interim measures in aid of the proceedings, for example, injunctions and asset or evidence preservation orders. Besides, Hong Kong arbitral awards are automatically enforceable in all 163 signatory states to the ‘New York Convention’ and the PRC (pursuant to the Arrangement Concerning Mutual Enforcement of Arbitral Awards between the Mainland and Hong Kong).
Choice of representative, professional-based tribunals and appointment of arbitrators
Parties may appoint Hong Kong or foreign lawyers from other jurisdictions to represent them in arbitral proceedings in Hong Kong. Also, they may appoint arbitrators or tribunals with professional backgrounds or expertise relevant to the nature of the dispute. An arbitrator can only be challenged if there are justifiable doubts about his impartiality, or if he does not possess the qualifications agreed to by the parties.
Confidentiality, less formality, flexibility and finality of awards
Other advantages of arbitration include (i) confidentiality of arbitral proceedings; (ii) less procedural formality and generally more flexibility than court proceedings, for example, parties have more autonomy to decide as to how arbitral proceedings should be conducted within the arbitral rules governing the arbitration; (iii) finality of arbitral awards which cannot be appealed to the court on merits, except on the grounds of serious irregularity or on questions of law in limited circumstances.
Reliance on arbitration agreement
The existence of an arbitration agreement in writing is a prerequisite for proceeding with arbitration proceedings. This will depend on the relevant financing and legal documents.
Creditors generally only benefit from limited disclosure of documents. Often, the parties to the arbitration will agree to limit the scope of discovery to reduce costs and discovery may be confined to only disclosing documents upon which a party intends to rely on, which may allow them to withhold documents which are harmful to their own case. However, despite the downside, limited scope of discovery can reduce costs significantly and save time.
The general rule in respect of legal costs applicable to a writ action also applies to arbitration i.e. typically, the losing party will have to bear the costs reasonably incurred by the winning party in the arbitration. Parties are also often required to pay the fees of the arbitrator or tribunals and the administration fees charged by the arbitration institution in advance before the commencement of arbitral proceedings or the release of the arbitral award. These can be substantial.
d) Specific questions to be considered for arbitration
- Do creditors or the company have sufficient resources to fund legal costs?
- Do creditors want a final binding determination or the option of an appeal?
- Is there any arbitration clause in the contract between the parties?
- Do creditors want to keep the disputes confidential?
5 – Interim remedies
Each interim remedy has its own procedural and legal requirements and effectiveness. Creditors should consider their unique features and consider whether it is appropriate to seek such remedies in the course of a winding-up, writ action or arbitration.
a) Appointment of receivers
Receivers are often appointed by a secured creditor over charged assets pursuant to a security document or by the Court if it is ‘just and convenient to do so in order to protect and preserve the assets when, for example, there is a risk of dissipation or an event of default has occurred under a security document. Receivers will take possession of, protect and receive income from property for the benefit of the persons who are ultimately entitled to it.
b) Appointment of provisional liquidators/liquidators
Provisional liquidators can only be appointed after a winding-up petition has been presented to maintain the status quo of the company. They are usually appointed if (i) there is a good prima facie case for a winding-up order; and (ii) the assets of the company are in danger or there is a risk of dissipation of assets and/or there are concerns that those in control are misappropriating or wasting assets or any other good cause exists. Once appointed, provisional liquidators will take control of the company and their main function is to preserve the company’s assets until the making of a winding-up order and the appointment of liquidators.
An injunction is a court order compelling a person to do something or to refrain from doing something. It may be applied on an ex parte basis (without notice to the other party) in case of urgency. Common types of injunction include anti-suit injunctions and asset freezing injunctions, which usually also have an ancillary disclosure order requesting a defendant to disclose the existence and location of assets up to the value of the injunction.
d) Disclosure Order
Disclosure orders may be used against a party who refuses to disclose relevant information in its possession. These orders may also be made against a third party to obtain documents to determine whether there is a viable claim. Breach of a disclosure order may constitute contempt of court, which may ultimately lead to imprisonment. However, for disclosure orders granted on an ‘interlocutory basis,’ they should not be used as ‘fishing expedition’ and will be no wider than necessary.
e) Security for Costs Order
Security for costs orders may be made against a plaintiff/claimant to order them to provide security for the defendant’s costs of the action (costs already incurred and future costs) before a final judgment or award. An order for security may be granted where (i) the plaintiff/claimant is based overseas; or (ii) if the plaintiff/claimant’s financial position is weak and they may not be able to meet an cost order against them.
f) Anton Piller Orders
Anton Piller Orders compel a party to permit the other party to enter premises, to search for and seize documents or other things which are relevant to the case. The orders will only be granted if the party can demonstrate, amongst others, that there is a strong prima facie case and a high risk of destruction or removal of evidence.
Insolvency co-operation between Hong Kong and the Mainland
On May 14, 2021, the Supreme People’s Court of the People’s Republic of China (“SPC”) entered into the Record of Meeting of the Supreme People’s Court and the Government of the Hong Kong Special Administrative Region on Mutual Recognition and Assistance to Bankruptcy (Insolvency) Proceedings between the Courts of the Mainland and of the Hong Kong Special Administration Region (“Record of Meeting”) with the Government of Hong Kong SAR and promogulated The Supreme People’s Court’s Opinion on Taking Forward a Pilot Measure in relation to the Recognition of and Assistance to Insolvency Proceedings in the Hong Kong Special Administrative Region (“SPC’s Opinion”). The Record of Meeting and the SPC’s Opinion now offer a formal channel for both insolvency practitioners in Mainland China and Hong Kong to seek recognition and assistance from courts of both sides. Prior to the Record of Meeting, the Hong Kong court had already recognised and assisted administrators appointed under the bankruptcy/ liquidation proceedings of the Mainland Enterprise Bankruptcy Law 2006 by way of common law. Hence, the Record of Meeting specified that the common law route would also extend to reorganisation and compromise proceedings under the Mainland Enterprise Bankruptcy Law 2006.
As shown above, there are a number of enforcement options and interim remedies available to creditors who may seek to recover their debts in Hong Kong. In the context of the Mainland’s real estate debt crisis, it is essential for creditors to carefully review the legal, practical and jurisdictional aspects of each distressed situation to devise an enforcement strategy which will maximise commercial pressure and ultimately be effective in terms of actually obtaining a financial recovery. This should also include close monitoring of the continuing development of cross-border insolvency cooperation arrangements between Hong Kong and the Mainland. Our well-recognised insolvency disputes team have recently provided informative updates on these evolving and important legal developments.