A "magical incantation" - Hong Kong court warns it will carefully examine restructuring viability

The Hong Kong court has taken aim at Hong Kong-listed companies that are incorporated offshore, carry on business primarily in the mainland and that appear to want to engineer de facto moratoria on winding-up actions often to the detriment of the company's creditors. Insolvency proceedings launched from offshore "letterbox" jurisdictions – and where the powers of the provisional liquidators to properly supervise any restructuring appear light – are less likely in future to receive recognition and assistance in Hong Kong.

In four similar decisions, the Hong Kong companies court has taken aim at Hong Kong-listed companies that are incorporated offshore, carry on business primarily in the mainland and that appear to want to engineer de facto moratoria on winding-up actions often to the detriment of the company's creditors.

In Li Yiqing v. Lamtex Holdings Limited [2021] HKCFI 622, Re Ping An Securities Group (Holdings) Limited [2021] HKCFI 651, Re Joint Provisional Liquidators of China Bozza Development Holdings Ltd. [2021] HKCFI 1235, and Re Joint and Several Provisional Liquidators of Victory City International Holdings Limited [2021] HKCFI 1370, the Honorable Mr. Justice Harris criticized debtor companies for using "soft touch" provisional liquidation as a delaying tactic whilst remaining in control of the company under the supervision of provisional liquidators.

In a "soft touch" provisional liquidation, the company remains under the day to day control of the directors, but is placed under the general oversight of provisional liquidators. The approach, as it has evolved over time, is similar to debtor-in-possession under the United States Chapter 11 regime.

Over time, the powers granted to the provisional liquidators and the level of oversight exercised by officeholders appear to have dwindled in the cases being brought before the Hong Kong court, causing the court to rethink the merit of such applications.

Listed companies, similar issues

Lamtex Holdings Limited (Lamtex), Ping An Securities Group (Holdings) Limited (Ping An), and Victory City International Holdings Limited (Victory City) were incorporated in Bermuda while China Bozza Development Holdings Limited (China Bozza) was incorporated in the Cayman Islands. All four companies were listed in Hong Kong.

The companies were insolvent and were subject to winding-up petitions in Hong Kong. In each case, after the winding-up petition was presented in Hong Kong, the companies appointed soft-touch provisional liquidators in Bermuda and Cayman Islands and obtained letters of request from the respective courts seeking the recognition and assistance of the provisional liquidators for restructuring purposes.

Place of incorporation vs. centre of main interests (COMI)

As a general principle, the constitution and management of a foreign company is determined by the law of the place of its incorporation. Under common law and private international law, the Hong Kong court will cooperate with the courts in the country of the principal liquidation to ensure that the company's assets are distributed to creditors under a single legal system.

In Lamtex, Harris J. explored the question of whether primacy should be given to the proceedings in Bermuda, the place of incorporation, or Hong Kong, the company's COMI, for the purposes of winding-up of the company and distribution of its assets.

The current position in Hong Kong is that recognition and assistance of foreign liquidators is limited to providing assistance in respect of foreign insolvency proceedings commenced in the company's place of incorporation and where there is an equivalent provision in Hong Kong law to the type of assistance being sought.

However, Harris J. suggested that there was no particular rule that prevented the recognition and assistance of liquidators appointed in a company's COMI or a jurisdiction with which it has a strong connection. If a company's assets, management, and creditors had little connection with the place of incorporation, it would be more efficient and effective for an insolvency process to be managed out of the location of the COMI.

Harris J. commented that, "ultimately… this means that which insolvency process should be given primacy will depend on the circumstances of the case and involve giving appropriate weight to the location of a company's COMI."

Stalling tactics?

Lamtex, Ping An and China Bozza represent a continuation of themes first advanced in Re FDG Electric Vehicles Ltd [2020] HKCFI 2931(see Hogan Lovells client alert Managing misconceptions: Hong Kong court issues dual warnings over cross-border insolvency), in which the court held that an offshore provisional liquidation order would not lead to an automatic stay of the Hong Kong winding-up proceedings.

Harris J. granted a winding-up order in Lamtex and adjourned the petition in Ping An, the key difference being that the court felt that Lamtex had no prospect of a viable restructuring while Ping An had already demonstrated some progress with its restructuring plans.

In Lamtex, the company failed to demonstrate a good reason (i.e. a credible restructuring plan at the time of appointment of provisional liquidators) as to why the petition should be adjourned. Harris J. criticized the information provided about the restructuring as being "scanty in the extreme."

It seemed more likely to the court that the application in Bermuda was an attempt to engineer a de facto moratorium which could not be obtained under Hong Kong law, with a view to then search for a way out of the company's financial problems. Harris J. commented that this was a questionable use of soft-touch provisional liquidation and warned that the court would view future applications with care.

In Ping An, Harris J. applied Lamtex and reiterated that, when faced with a Hong Kong petition to wind up a foreign incorporated company whose COMI is located in Hong Kong, primacy was not automatically to be given to a soft-touch provisional liquidation in the place of incorporation, where the purpose of the application appeared to be to gain time to formulate a restructuring proposal.

The company would still be required to satisfy the criteria by reference to which the Hong Kong court assess applications on similar grounds by companies incorporated in Hong Kong. If the company were unable to do so, it would be wound up and an application for recognition of the soft-touch provisional liquidation denied. 

Harris J. cited his previous decision in Re China Huiyuan Juice Group Ltd. [2020] HKCFI 2940 regarding the test for determining whether the company has satisfied the requirements allowing for petitions to be adjourned (see Hogan Lovells client alert Show us the evidence – Hong Kong court sets out principles on the adjournment of winding-up petitions).

The court held that the restructuring plan was straightforward as it involved the subscription for new shares by the chief executive director of Ping An, which served as a loan to provide working capital for the company. The approval process and completion of subscription agreement would take about two months, which was the adjournment period that the provisional liquidators of Ping An were seeking.

Application refused

In China Bozza, although Harris J. recognized the appointment of the provisional liquidators under private international law grounds, he refused to grant an order granting them active assistance. He expressed his concern that the approach used to facilitate soft-touch restructuring, known as the Z-Obee technique (named after the case of Re Z-Obee Holdings Ltd [2018] 2 HKLRD 338, in which the technique was first used) was "being abused to obtain a de facto moratorium of enforcement action by creditors in Hong Kong."

Harris J. noted that the Cayman Islands courts' criteria for adjourning winding-up petitions appeared to be less onerous than the test used by the Hong Kong court and emphasized the need for evidence that describes a company's financial position and a possible solution. He commented that, "simply referring to a possible 'debt restructuring' and treating the expression as a kind of magical incantation, the recitation of which will conjure up an adjournment of the petition is as inadequate as it is facile."

The court went on to criticize both the board for focusing on their own interests rather than on those of the creditors, and the provisional liquidators for, "selling their ability to find an investor and work with it to avoid a liquidation and retain some shareholder value. The creditors were a group to be bought off; not the group whose financial interests took priority to other considerations."

In the most recent decision, Victory City, which concerned a company incorporated in Bermuda and with its principal place of business in Hong Kong, Harris J. granted the application by Hong Kong and Bermudan liquidators for recognition and assistance whilst making further comments on the misuse, as he saw it, of soft-touch provisional liquidation.

He suggested that often "the companies that use (provisional liquidations) are more concerned with the interests of the owners with whom the board is aligned than the creditors" and also, referring to the appointment of the initial provisional liquidators said to be for "restructuring purposes", cited the "involvement of professionals who are not ensuring that creditors' interests are being properly protected."

The importance of COMI

The concept of COMI is underlined in the new cross-border insolvency cooperation mechanism between mainland China and Hong Kong (see Hogan Lovells client alert Hong Kong and mainland China agree new co-operation mechanism for cross-border insolvency). 

For mainland China insolvency proceedings to be recognized in Hong Kong, it must be demonstrated that Hong Kong has been the debtor's COMI for a continuous period of at least six months at the time of making the application. The likely purpose of including the six-month track record requirement is to prevent forum shopping, which is consistent with the use of COMI in determining eligibility of recognition and assistance as discussed in Lamtex and Ping An.

In all four cases, the soft-touch provisional liquidators were appointed by a court in the offshore jurisdiction on application by the company. Lamtex, Ping An, and Victory City are now in liquidation.

Harris J. warned in Victory City that he will approach future applications for recognition and assistance which exhibit similar characteristics to these four cases with the "greatest circumspection." As the court is often guided by the views of creditors, it would be prudent for insolvent companies to seek creditors' support for the adjournment of petitions to avoid being wound-up and to be mindful of the directors' duties owed to creditors.

Taken together, the decisions show the way forward for cross-border insolvency recognition in Hong Kong, affirming that in the future, the Hong Kong court is likely to give primacy to insolvency proceedings in the company's COMI (i.e. Hong Kong) rather than its place of incorporation for the purposes of winding-up of company and distribution of the company's assets to creditors.

Insolvency proceedings launched from offshore "letterbox" jurisdictions – and where the powers of the provisional liquidators to properly supervise any restructuring appear light – are less likely in future to receive recognition and assistance in Hong Kong.



Authored by Jonathan Leitch, Yolanda Lau, and Nigel Sharman.







This website is operated by Hogan Lovells International LLP, whose registered office is at Atlantic House, Holborn Viaduct, London, EC1A 2FG. For further details of Hogan Lovells International LLP and the international legal practice that comprises Hogan Lovells International LLP, Hogan Lovells US LLP and their affiliated businesses ("Hogan Lovells"), please see our Legal Notices page. © 2024 Hogan Lovells.

Attorney advertising. Prior results do not guarantee a similar outcome.