Brief guide to solvent and insolvent liquidation in Hong Kong

Directors’ duties

• Key duties in this context:

• To act bona fide for the benefit of the company
  
  
• To exercise powers for their proper purpose
  
  
• Not to allow any conflict between duties as directors and personal interests

• A director’s duty is to the individual company, not the group
  
  
• If a company is insolvent or nearly insolvent, directors’ duty to the company includes an obligation to ensure creditors’ interests are protected. The duty is not owed to the creditors directly, so creditors do not have standing to bring an action against directors for breach of duty
  
  
• Because directors owe duties to the company, in the event of breach of duty, it is the company which should sue the directors
  
  
• Director may be liable for damages / account of profits / disqualification
  
  
• Any provision in the articles or other agreement is void if it purports to exempt, or provide an indemnity in favour of, a director from any liability for negligence, default, breach of duty or breach of trust towards the company. The company can purchase insurance for a director for liabilities to the company except where liability arises from the director’s fraud. A company can however indemnify a director for a director’s liabilities to third parties, subject to certain exceptions (eg. criminal and regulatory fines)

Transactions subject to potential challenge and key offences

Unfair preference (formerly called fraudulent preference)

• Company should treat creditors fairly before a winding-up
  
  
• Company gives an unfair preference if it does anything which puts a creditor into a position which, in the event of an insolvent liquidation, will be better than the position creditor would have been in if that thing had not been done
  
  
• There must be a desire to produce the effect in question (ie, subjective test). Such desire is presumed where the preferred person is an “associate” of the company
  
  
• Look back period of 6 months (2 years in the case of a preference to an associate) before commencement of liquidation. Company must have been insolvent at the time of the transaction or become insolvent as a consequence
  
  
• Court may make such order as it sees fit to restore position to pre-unfair preference position. This will often involve setting aside the transaction

Transactions at an undervalue

• Court may set aside a transaction at an undervalue (eg. a gift or where there is disproportionately low consideration) entered into within 5 years of commencement of winding-up if company was insolvent at the time of the transaction or became insolvent as a consequence
  
  
• Court may make such order as it sees fit to restore the position to what it would have been had the transaction not been entered into - eg. unwinding the transaction and returning the property / money to the company, although a third party bona fide purchaser will not be requested to retransfer the property
  
  
• Directors may be personally liable for breach of duty to protect creditors’ interests and to pay compensation for loss caused
  
  
• It is a defence if the company entered into the transaction in good faith, believing the transaction would benefit the company, but better to ensure the company is not insolvent and that the consideration is adequate rather than seek to rely on this

Floating charges

• If a floating charge is created within 12 months (24 months where the floating charge is given in favour of someone connected to the company) of the commencement of winding-up, it is invalid except (i) if the company was solvent immediately after its creation, or (ii) to the extent cash is paid to the company at the time of, or subsequent to, the creation of the charge and in consideration of the charge
  
  
• Aim is to prevent an insolvent company from creating floating charges to secure past debts and thus prefer certain creditors

Other offences

Fraudulent Trading

• If in the course of a winding-up, it appears the business has been carried on with an intent to defraud its creditors, any person who knows the business has been carried on in this manner may be personally liable without limit for the debts or other liabilities of the company. Note in particular:

• Fraudulent trading occurs when there is “no reasonable prospect of the creditors receiving payment of their debts”
  
  
• Actual dishonesty / recklessness are essential

• Paying one creditor knowing the company is unable to pay all creditors is not fraudulent if directors generally believe that the company will be able to satisfy all creditors in the future

Failure to keep proper books of account

• Failure to keep proper books of account through 2 years prior to winding-up may result in every defaulting officer being liable for a fine or imprisonment unless they can show they acted honestly and the default was excusable

Attempting to put assets beyond reach of creditors

• If an officer, with intent to defraud creditors, made a gift or transfer of, or charged, the property of the company or conceded or removed any part of the property of the company within 2 months of any judgement or order for payment against the company, and if the company is subsequently wound up, he / she is liable to a fine and imprisonment

Misfeasance

• Any past or present officer who has misapplied money or property of the company, may be compelled to repay / restore the money or property, or otherwise contribute to the assets of the company

Practical stuff

• When a company is being wound up, every business communication (including invoices, orders and business letters) issued by or on behalf of the company must contain a statement that the company is being wound up. Any officer who knowingly or willfully authorises a default will be fined

Winding-up processes

Members’ voluntary liquidation

• Directors, having prepared recent financial statements, issue a certificate of solvency that, after full inquiry, they believe the company to be solvent and able to pay its debts in full within 12 months
  
  
• Certificate must be issued within 5 weeks preceding special resolution to wind-up the company and appoint a liquidator (although often it is on the same day)
  
  
• From passing of the special resolution, liquidation commences and company will cease to carry on business except so far as necessary for winding-up. Powers of directors cease immediately upon appointment of liquidator
  
  
• Solvency certificate must be filed with Companies Registry no later than when the resolution is filed (ie within 15 days of resolution)
  
  
• Publish notice of resolution approving liquidation in the Gazette within 14 days
  
  
• Liquidator must notify the Companies Registry of appointment and publish appointment in the Gazette within 21 days
  
  
• The main cause of any delay in concluding an MVL is seeking tax clearance from the IRD. For straightforward matters, this typically takes 3-4 months
  
  
• Liquidator settles company’s debts, collects in funds, liquidates assets and settles list of contributories etc. as per the prescribed order (see below), then makes up an account for how things have been wound up and lays it before a general meeting, notice of which has been advertised in the Gazette at least one month before the meeting
  
  
• Once approved by the general meeting, the liquidator files the account with the Companies Registry within 1 week of the meeting, and 3 months after registration the company is dissolved

Creditors’ voluntary liquidation

• Directors prepare financial statements to form the opinion that the company is not solvent (both on the balance sheet test and because the company cannot pay debts as they fall due)
  
  
• Company must arrange meeting of creditors on the same day or day after the general meeting approving the liquidation and appointing liquidator
  
  
• Notice of the creditors meeting should be sent out at the same time as the notice of general meeting and be published in the Gazette and in both an English language and Chinese language newspaper
  
  
• Directors must compile a statement of the company’s affairs and a list of creditors and the estimated amount of their claims ahead of the creditors’ meeting
  
  
• Shareholders and creditors may nominate a liquidator. In case of conflict, the creditors’ choice prevails
  
  
• Publish notice of resolution approving liquidation in the Gazette within 14 days
  
  
• From passing of the special resolution, liquidation commences and company will cease to carry on business except so far as necessary for winding-up. Powers of directors cease immediately upon appointment of liquidator
  
  
• Liquidator must notify the Companies Registry of appointment and publish appointment in the Gazette within 21 days
  
  
• Creditors may appoint a committee of inspection to act with the liquidator for the purpose of acting in the best interests of creditors as a whole
  
  
• Liquidator settles company’s debts, collects in funds, liquidates assets and settles list of contributories etc. as per the prescribed order (see below), then makes up an account for how things have been wound up and lays it before a general meeting and a creditors’ meeting, notice of which has been advertised in the Gazette at least one month before the meetings
  
  
• Once approved by the general meeting and creditors’ meeting, the liquidator files the account with the Companies Registry within 1 week of the meetings, and 3 months after registration the company is dissolved

Special procedure under s228A Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32)

• Often used – quicker and simpler than alternatives and, due to earlier commencement of liquidation, safeguards company’s assets earlier in the process than under other routes
  
  
• Used where, in the directors’ opinion, a company should be wound up with immediate effect
  
  
• Directors resolve (and deliver to the Companies Registry a written winding-up statement to this effect within 7 days), that:

• The Company cannot, by reason of its liabilities, continue its business
  
  
• It is necessary for the company to be wound up, and it is not practicable to do so under other routes

• Directors immediately upon registration appoint a solicitor or certified public accountant as provisional liquidator, and appointment must be notified to the Companies Registry and be published in the Gazette within 14 days
  
  
• Liquidation commences as soon as the winding-up statement is delivered to the Companies Registry
  
  
• Meetings of shareholders and creditors will be held within 28 days of filing the statement
  
  
• Directors must compile a statement of the company’s affairs and a list of creditors and the estimated amount of their claims ahead of the creditors’ meeting
  
  
• Process then proceeds as per a creditors’ voluntary liquidation

Deregistration

• Applicable to private companies only. Can be a simple, inexpensive and relatively quick solution
  
  
• Involves an application in the specified form to the Companies Registry by a company, director or member confirming that:

• All members agree to the deregistration
  
  
• The company has no outstanding liabilities
  
  
• Either the company has ceased operations for at least 3 months prior to the application or the company has never commenced business

• Application must be accompanied by a written statement from the IRD confirming it has no objection to deregistration (ie. that no tax remains outstanding)
  
  
• If satisfied, the Companies Registry advertises the deregistration in the Gazette
  
  
• Unless an objection is raised within 3 months of publication, the company is deregistered and dissolved and the Companies Registry publishes a notice in the Gazette to this effect
  
  
• Despite deregistration and dissolution, the liabilities of officers and members survive
  
  
• Reinstatement may be effected by the Companies Registry or by court order (on application) in limited circumstances

Compulsory liquidation by the court

• Compulsory winding–up commences when a petition for winding-up is presented to the court
  
  
• Petition may be presented by the company, any of its creditors, its contributories, the Financial Secretary, the Companies Registry, the Official Receiver, and in some cases the SFC, Insurance Authority and the HKMA
  
  
• Company may be wound up by the court where, for example:

• Members pass a special resolution to be wound up by the court
  
  
• The company is unable to pay its debts, including where a creditor’s written demand of HK$10,000 or more remains unpaid for at least 3 weeks
  
  
• The court thinks it is just and equitable to do so (eg. reason for existence no longer exists)

• Following presentation of a petition, where the court is satisfied that the property of the company is unlikely to exceed HK$200,000, the court may order the company to be wound up summarily on an expedited basis
  
  
• Court may appoint a provisional liquidator to take charge of the company’s affairs between the date of the petition and the date of the winding-up order if the court fears wastage or dissipation of the company’s assets. Otherwise the provisional liquidator (Official Receiver is the default option) is appointed on the making of the winding-up order. Upon appointment of the liquidator, the directors cease to have power to manage the company
  
  
• Winding-up hearing is a summary procedure. Evidence is generally confined to affidavits
  
  
• A copy of the winding-up order must be filed with the Companies Registry and Official Receiver and a notice of winding-up must be advertised in the Gazette
  
  
• Within 28 days of appointment of the provisional liquidator, a statement of the affairs of the company (including details of its assets and liabilities), verified by the company’s directors, must be prepared in the prescribed form and submitted to the provisional liquidator
  
  
• Separate meetings of creditors and contributories are held
  
  
• Court has a wide range of powers in relation to the management of the winding-up. For example, a committee of inspection may be appointed by creditors and contributories with approval of the court to work with the liquidator for the purpose of acting in the best interests of creditors as a whole
  
  
• Following distribution of the final dividend and the making of the final return to the contributories, the liquidator applies to the court for release. Typically, the company is dissolved 2 years later

Order of application of assets on a liquidation

• In each winding-up scenario, the assets of the company are applied in the following order:

1. Expenses relating to the winding-up
2. Preferential creditors
   
   

– In particular:

Category A - Employee-related payments (subject to limits)

Category B - Government debts

Category A takes precedence over Category B (and so on) and debts within each category rank equally (and, if assets are insufficient to pay everything, abate equally) among themselves

– Preferential creditors rank ahead of floating charge holders where the assets of the company are insufficient to satisfy all preferential creditors

3. Ordinary (unsecured) creditors
4. Members
   
   

– Share pari passu, subject to rights attaching to different classes of share in the constitution

– If proceeds are insufficient, they all receive the same percentage of what they would otherwise be entitled to

• Secured creditors are generally entitled to pay themselves out of their security. If there is a surplus, they must pay this to the company. If there is a shortfall, they rank as unsecured creditors for the balance