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Litigation funding and financial provision payments for children of unmarried parents

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This is the second in a series of articles where we examine recent trends in Family Law issues which have a broad impact on the community. The initial article discussed recent developments in divorce law and procedure in England and Wales regarding “no fault” divorce. This article relates to litigation funding and maintenance payments for children of unmarried parents.  

The Family Law Department of OLN headed by Partner and Head of Department Stephen Peaker has been closely involved for several years in a long-running series of court hearings regarding various cutting edge issues in an evolving area of law: (1) the rights of a child to certain financial provision irrespective of its parents’ marital status, (2) the breadth of discretion of the court to award such payments, and (3) the availability of litigation funding to finance a party’s legal costs in securing such payments.   

Background

The hearings all relate to the same case, a dispute between two unmarried parents. The parties to the dispute were in a four year relationship and had a daughter. They never married, but cohabited for a period of time. A year after their daughter was born, the relationship broke down and the mother moved out with their daughter. The father made regular payments to the mother for rent and her and their daughter’s expenses. The mother subsequently applied for custody and related financial provision and included in the application an order that either the father buy or transfer to her a property outright for their child to live in, or he pay a lump sum to purchase a property to accommodate her and their child which would be held in trust for her child until she reached 18 or completed full time education, and then revert to the father. 

Rights of children of unmarried couples

The application was brought under the Guardianship of Minors Ordinance Cap 13 (“GMO”) as opposed to the Matrimonial Property and Proceedings Ordinance Cap 192 (“MPPO”) as the MPPO currently is limited to children born to married parents.     

The mother argued that either the property should be purchased outright pursuant to s10(2)(a) GMO as there was an “immediate and non-recurring need”, failing which it should be purchased on trust with a reversionary interest pursuant to s10(2)(e) GMO (on the basis that the language “property to which such parent or either of such parents is so entitled” means money to purchase property, i.e. a property which could be purchased in the future). The father’s argument was that accommodation was not an immediate and non-recurring need but an ongoing, everyday need and consequently the mother’s application was based on an incorrect interpretation of the GMO. HHJ Bruno Chan (in IDC v SSA [2013] HKFLR @ 61) agreed with the father and consequently held that the court had no power to make an award, dismissing this limb of the mother’s claim for financial provision.

The mother appealed at the Court of Appeal (“CA”) (IDC v SSA CACV [2014] HKFLR @ 267) arguing that the lower court had erred in not accepting that s10(2) was broad enough to allow the court to grant an order, and that the relevant legislation discriminated between children of cohabitants in favour of a married couple because such an order would have been available under the MPPO. The CA, in reviewing the relevant legislation, determined that the language in the relevant provisions of the GMO was not intended to, and did not in fact, discriminate between the two classes of children. It also found that the lower court erred in its reading of s10(2)(e) GMO and that it could in fact have made such an order as the language was indeed broad enough to encapsulate money to purchase a property. It is now clear that the court has power under the GMO to order a financial provision including a lump sum to purchase a property upon trust, with a reversionary interest to the parent providing the funds.    

However, on the particular facts of the case the CA held that the original decision not to make the order was correct notwithstanding the judge did not consider making such an order at the time of the trial in 2013 as he proceeded on the basis that he had no jurisdiction to do so. This was an important point to note as the CA has not only confirmed the current statutory interpretation but it also affirmed that the lower court has discretion on the facts of the case to order a lump sum in the future.  

The mother then applied to the Court of Final Appeal (“CFA”) (IDC v SSA  [2015] HKFLR @158 ) for leave to appeal on grounds that there were issues of great general or public importance at stake. She argued that the CA erred in not using the principle of the fairness approach when considering the quantum of financial provision in cases involving a child of unmarried parents as opposed to married parents. Ma CJ dismissed the application. He found that there were no issues of great general or public importance at stake and that at best this was a complaint that the CA had incorrectly exercised its discretion. He added that the court had looked at the correct cases and referred to the principles set out in the cases. In this case, the answer was dependent on the underlying facts of the case at the date of the trial in 2013.

In a related and subsequent hearing to this case, HHJ Bruno Chan J (in IDC v SSA (Relocation of a Child) [2015] HKFLR @ 404) in granting the mother’s application to relocate to London, commented on  the issues raised in the  related financial provision litigation between the mother and father, saying the issues were “in my view [issues which] desperately require to be addressed by legislation and serious soul-searching by society”. Highlighting that a dependent cohabitant of a deceased person had the right under statute to make a claim for financial provision from the estate, he found it illogical that current law would offer a dependent legal remedies on the death of a cohabitant but no such remedy whilst the cohabitant was still alive. He added that “it is time that some workable scheme or system should be put in place through legislation to help individual cohabitants and their children for financial provision and adjustment of property right between cohabiting couples on separation…”. 

Litigation Funding

In April 2018, the father applied to vary downwards and/or discharge the earlier 2013 maintenance order. Around the same time the mother applied to vary the same 2013 order, seeking a variation which would provide inter alia a lump sum payment and property transfer order in the name of the child and/or the mother. These applications are currently progressing through the Family Court system. 

However, in a more recent reported judgment (In the matter of Z [2019] HKFC255) between the same parties on an interlocutory matter, the court was asked to determine whether the mother could apply for litigation funding to cover her legal costs in continuing litigation with the father. HHJ C.K. Chan first considered whether disputed legal costs should be dealt with under s10(2) GMO (final orders) or s13(3) GMO (interim orders). He confirmed that where costs are not agreed by the parties they cannot be dealt with under s10(2) which presumes a cost or expense is final and therefore agreed, so must therefore come under s13(3). 

He subsequently confirmed the principle that “…in considering whether such a litigation funding order should be made, the principles as set out in Currey v Currey [2006] EWCA Civ 1338 are applicable, despite the fact that these are not matrimonial proceedings”.        

In brief, the Currey principles are: (1) that the applicant spouse has no assets, or none that can be reasonably deployed; (2) that she can provide no security for borrowing, or none which can reasonably be offered; (3) that she cannot reasonably obtain legal services by offering a charge on the outcome of the litigation; (4) that she cannot secure publicly funded legal help “at a level of expertise apt to the proceedings”. 

On the facts of the dispute, the court decided that the mother did satisfy the Currey test, and would need further funding to have “some equality of arms before the court”. HHJ C.K. Chan then set out his rationale calculating the quantum of the award.  

This is an important confirmation of the current law and is consistent with the other recent judgments in this area involving litigation funding for financial provision cases involving an unmarried party.

OLN is proud to have been able to play a role in the development of an important area of the law regarding financial provision for a child of unmarried parents. In the 2015 case cited above, HHJ Bruno Chan’s concluding words were “…it is time that some workable scheme or system should be put in place through legislation to help individual cohabitants and their children for financial provision and adjustment of property right between cohabiting couples on separation….”. Commenting on his team’s work on these long-running cases, Stephen Peaker remarked “it is very satisfying to see such positive decisions from the courts on these types of issues and I hope that we will see progress in the legislation in due course. My team and I have been working hard to fight for many clients who currently face significant disadvantages as the law currently stands, and we would welcome further positive developments in this area of law”.  

June 2020

Stephen Peaker, Partner and Head of Family Law
Michael Openshaw, Consultant
Family Law Department
Oldham, Li & Nie

This article is for information purposes only. Its contents do not constitute legal advice and readers should not regard this article as a substitute for detailed advice in individual instances.

As the UK moves closer to allowing no fault divorce where does Hong Kong stand?

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This is the first in a series of articles where we examine recent trends in Family Law issues which have a broad impact on the community. This article discusses developments in divorce procedure and the impact of upcoming changes in the UK for Hong Kong 

One of the most frequent questions we are asked is whether Hong Kong allows “no fault” divorces as is the case in many other countries with sizeable expat communities in Hong Kong such as UK, USA, Australia, China and Canada. Recent developments in England and Wales indicate that the era of no fault based divorces may soon come in to force.

The leading case in this area and which precipitated the upcoming legislative changes in England and Wales is Owens v Owens [2018] AC 899. Mrs Owens filed a petition for divorce in 2015 on the grounds that the marriage had broken down irretrievably. The petition was based on Mr Owen’s unreasonable behaviour, being such that Mrs Owens could not reasonably be expected to live with him (which is the statutory test under English law). At this stage, the couple had been married over 25 years and had adult children, but had not separated. Under English law, an unhappy spouse may only petition for divorce against a non-consenting spouse citing separation as the fact for the irretrievable breakdown of the marriage if the separation is for a period of two years with consent or, absent consent, five years or more. The petition included 27 separate allegations of unreasonable behaviour on the husband’s part. Notwithstanding this, he defended the petition, arguing his behaviour was not so unreasonable that Mrs Owens could not be reasonably expected to live with him. At the trial, the Judge found in favour of the husband. The wife appealed and in 2017 the Court of Appeal upheld the Judge’s decision, finding that the Judge had applied the law correctly, and on the facts reached a defendable conclusion. The wife appealed to the Supreme Court in 2018, which dismissed her appeal but invited the UK Parliament to consider changing the law, recognizing that under current law “it is not a ground for divorce that you find yourself in a wretchedly unhappy marriage…”.

Post Owens v Owens, the following key changes are now very likely to be implemented following the introduction of the Divorce, Dissolution and Separation Bill:

  • There will no longer be any requirement to evidence conduct; a spouse need only state that the marriage has broken down irretrievably 
  • Parties will be able to make a joint application for divorce where the decision is mutual
  • It will no longer be possible for a spouse to contest the basis of the divorce

It will take some time for the courts in Hong Kong to decide whether to review the changes locally, but it is likely that a review will happen. In 1996, the existing statue (the Matrimonial Causes Ordinance) was amended to allow (i) “no fault” divorces based on one (with consent) or two (without consent) years’ separation and (ii) mutually consenting parties to make a joint application, more closely aligning the law with modern society’s values than the position in England and Wales.   

Today, as in England and Wales, the Hong Kong divorce framework requires one of five “facts” to satisfy the court that a marriage has irretrievably broken down. Three facts relate to conduct: adultery, unreasonable behaviour, and desertion for a period of at least one year prior to filing of the petition. The remaining two facts are: one year’s separation (with consent), and two years’ separation (without consent).  

Consequently, if there is no agreement to divorce, a party can bring an unhappy marriage to an end without the consent of the other only after a two year separation. If a party cannot wait for two years, then he or she would typically cite the respondent’s unreasonable behaviour as the “fact” for the irretrievable breakdown of the marriage (as was the case with the unhappy Mrs Owens). This can cause further conflict as the spouse must “particularise” (i.e. list out) the other party’s unreasonable behaviour. Family lawyers in Hong Kong have adopted for the  majority of petitions relying on unreasonable behaviour a “mild particulars” involving standard generic particulars. Typically the petitioner will state that he or she cannot reasonably be expected to live with the respondent, alleging certain reasons setting out their differences in an objective way without focusing on specific details.

It is submitted that there would be a significant advantage in Hong Kong Family Law jurisprudence if (i) an unhappy spouse could simply commence divorce proceedings without proving conduct,  and (ii) the respondent was no longer able to contest the basis for the divorce save where it may cause financial hardship by loss of pension or loss of beneficial rights under a trust for the respondent or where no proper financial arrangements have been made for the children. The parties would then start the divorce process in a kinder, less adversarial and more objective fashion which would likely lead to more settlement minded outcomes. The alternative is to maintain the status quo, and in certain situations it is not possible to just rely on separation from a non-consenting spouse as a two year delay may not always be realistic where an unhappy spouse does not have the luxury of finding a separate home (eg in cases involving low income families, or where there is domestic abuse). 

June 2020
Stephen Peaker, Partner and Head of Family Law
Michael Openshaw, Consultant
Family Law Department
Oldham, Li & Nie

This article is for information purposes only. Its contents do not constitute legal advice and readers should not regard this article as a substitute for detailed advice in individual instances.

Hong Kong – Updates on Trade Marks Law and Practice in June 2020

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The Trade Marks (Amendment) Ordinance 2020 (“2020 Amendment Ordinance”) has come into effect on 19 June 2020, which provides for the implementation of the international trade mark registration system under Madrid Protocol, the enhancement of mechanism for trade mark registration, enforcement powers as well as technical amendments of the existing Trade Marks Ordinance.

In respect of International trade mark registration system, there is an entire new Part XA detailing the international registration under Madrid Protocol in Hong Kong. However, the international registration system in Hong Kong will only be implemented in 2022-2023 the latest.    

Regarding updates of the technical amendments under different stage of trade mark matter, please see below for your reference.

1.    Pre-filing

The revised Form T1 has included nature and scope of preliminary advice as to whether a trade mark is likely to be refused registration on absolute ground in section 11 (preliminary advice on registrability) and/or relative ground in section 12(1) to (3) (search of records) of the Trade Marks Ordinance.

2.    Filing

i.    The Applicant must indicate its “Applicant Type”, “Country/territory/area of incorporation” and/or “State of Incorporation” (for US corporation only)
ii.    However, the Registrar will not verify the information provided by an applicant regarding applicant type or place of incorporation
iii.    The Registrar will not allot the filing date for a trade mark application until the application fee is paid in full. Failure to pay the application fee within two months after the date of the Registry’s notice, the application shall be deemed never to have been made
iv.    If an applicant wishes to made an amendment to a trade mark application by adding thereto the representation of the applicant’s own registered trade mark, the applicant has to set out that the specification of goods and/or services of the registered trade mark which representation is to be added so that the Registrar could examine if the registered goods and/or services are  identical to or wide enough to cover the specification of goods and/or services of the trade mark being applied for.  
v.    In addition, certain registered particulars of the registered trade mark have also required to be added to the amended application.
vi.    In case of an assignment of the applicant to new owner, the new applicant is required to specify its “Owner Type”, “Country/territory/area of incorporation” and/or “State of Incorporation” (for US corporation only)

3.    Post registration

i.    For assignment of a trade mark registration, the above 2(i) and 2(vi) is also applicable
ii.    Amendments concerning correction of an error or omission in the register of trade marks that is attributable to an error or omission on the part of the Registrar of Trade Marks only seek to codify the existing practice, so no substantial change

4.    Trade Marks Registry Work Manual (“Work Manual”)

i.    The chapter on “Absolute grounds for refusal” of Work Manual has been updated, namely the addition of a new absolute ground for refusal of registration into the Trade Marks Ordinance concerning use of the national anthem in applied-for trade marks is prohibited pursuant to the National Anthem Ordinance (Instrument A405) with effect from 12 June 2020.   
ii.    In addition, there are certain technical amendments in many of the chapters in the Work Manual.

5.    Revised Trade Mark forms

With the 2020 Amendment Ordinance, the Trade Marks Registry has also revised various Trade Mark forms.  The revised forms have taken effect on 19 June 2020.   The current version is still acceptable in a 6-month transitional period from 19 June 2020 to 19 December 2020.  Thereafter, the revised forms must be used.

Please see the following link for details: https://www.ipd.gov.hk/en/trade-marks/current-topics/trade-marks-amendment-ordinance-2020/index.html

Should you have any questions related to this article, please contact evelyne.yeung@oln-law.com and we will be pleased to answer and assist.

Disclaimer: This article is for reference only. Nothing herein shall be construed as Hong Kong legal advice or any legal advice for that matter to any person. Oldham, Li & Nie shall not be held liable for any loss and/or damage incurred by any person acting as a result of the materials contained in this article.

Legal Update: Hong Kong Court Recognizes Application by Shanghai Liquidators

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By Xiaosu Zhu (Watson & Band) and Anna Chan (OLN) 

In a landmark decision by the Hong Kong Court of First Instance in Re Joint and Several Liquidators of CEFC Shanghai International Group Ltd (the “CEFC Case”), the Hong Kong Courts extended recognition and assistance to liquidators in Mainland China, which is a huge step towards Hong Kong-PRC coordination in cross-border liquidations. 

Previously, there has also been precedents whereby Hong Kong Court urged for multi-jurisdictional cooperation in cross-border liquidation cases. In Re Da Yu Financial Holdings Limited, the Court sanctioned a scheme of arrangement proposed by a Cayman-incorporated company listed in Hong Kong and commented that the full blown parallel schemes, instead of a simple recognition of foreign scheme, are an outmoded way of conducting cross-border restructuring. The CEFC Case now marks the first time that Hong Kong Courts has recognized and provided assistance to liquidators from the Mainland China, a non-common law jurisdiction. 

Background 

CEFC Shanghai International Group Limited (“CEFC”) is a PRC-incorporated company undergoing insolvent liquidation in the Mainland China. CEFC’s assets included a claim against its Hong Kong subsidiary, Shanghai Huaxin Group (Hong Kong) Limited, amounting to around HK$7.2 billion (the “Receivable”). Given the Subsidiary was in liquidation in Hong Kong, CEFC had submitted a proof of debt in respect of the Receivable. 

Subsequently, CEFC’s liquidators (known as “administrators” in PRC) discovered that, before the liquidation, a creditor of CEFC had obtained default judgment against CEFC in Hong Kong for a sum of around EUR 29 million, and a Garnishee Order nisi in respect of the Receivable. 

If CEFC was only asserting itself as the creditor of the Hong Kong subsidiary, it would only rank pari passu with the judgment creditor, therefore running the risk that it would be too late to enforce upon the Receivable if the judgment creditor obtained Garnishee Order absolute.   

To mitigate such risk, the PRC liquidators sought recognition of the PRC insolvency proceedings, and assistance for a stay of the Garnishee proceedings. The Hong Kong Court granted such recognition and assistance, and allowed the stay of the creditor’s Garnishee proceedings.  

Criteria for application to the Hong Kong Court 

Mr. Justice Harris summarized the now well-established principles and procedures governing applications to the Courts of Hong Kong for recognition and assistance. Provided that:- 

  1. the foreign insolvency proceedings are collective insolvency proceedings; and
  2. the foreign insolvency proceedings are opened in the company’s country of incorporation,

the Court may recognize insolvency proceedings in a civil law jurisdiction. Upon recognition, the Court will then grant assistance to the foreign liquidators by applying Hong Kong insolvency law. The above 2 criteria were ruled to be satisfied in the present case. 

However, in the judgment the Court said that it will not grant the foreign liquidators all powers as are available to a liquidator appointed pursuant to the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32 of the Laws of Hong Kong)(“CWUMPO”). Powers of assistance granted to foreign liquidators are limited to:- 

  1. enabling the foreign liquidators to do something which they could do under the law by which  they are appointed;
  2. only when it is necessary for the performance for the foreign liquidators’ function; and
  3. where it is consistent with the substantive law and public policy of the assisting court.

Mr. Justice Harris opined that the case satisfied all of the above requirements, and observed that there were considerable similarities in the insolvency laws of Hong Kong and the PRC, such as the powers and duties of liquidators and pari passu distribution of debtor’s assets. 

His Lordship also held that, if a creditor commences Garnishee proceedings in Hong Kong after liquidation has commenced, the Garnishee proceedings should be terminated. Even if an order nisi has been obtained before the foreign insolvency proceedings, the Court has discretion to make the order absolute. In coming to the conclusion, the English case Galbraith v Grimshaw was held to be incompatible with modern insolvency laws (and indeed the case has been subject to much judicial and academic criticism) and therefore no longer applicable. 

Significance 

This case is the first ever in time that Mainland Chinese liquidators have applied for and been granted recognition from the Hong Kong Court. Although the Court cautioned that assistance granted to PRC liquidators should be on a case by case basis, this case certainly lends support to future PRC liquidators in seeking Hong Kong Court’s recognition and assistance (provided that they pass the thresholds). Immediately following this case, on 4th June 2020 in Re Shenzhen Everich Supply Chain Co Ltd, Mr. Justice Harris made another ruling recognizing the Shenzhen bankruptcy proceedings and the appointment of the liquidator by Shenzhen intermediate Court, empowering the liquidator to exercise its powers in Hong Kong. 

In light of the growing trend for PRC-incorporated companies to hold assets in Hong Kong, it is expected that where such companies enter liquidation, liquidators will seek Hong Kong Court’s recognition relying on this landmark judgment. If the mainland Chinese authorities are agreeable to promoting a unitary approach to trans-national insolvencies like Hong Kong, it is likely that this case will become highly persuasive in favour of Hong Kong Courts granting recognition and assistance to mainland liquidators.  

This result can also be contrasted with past cases where the Hong Kong Courts refused assistance to trustees of a foreign-incorporated company governed by foreign jurisdictions, such as in the case of China Fishery Group Ltd where it was held that the companies involved did not have a connection with the US. In that case, the companies involved were found to have been acting in bad faith by filing the Chapter 11 proceedings in the US and appointing the trustee thereunder, in an attempt to defeat the creditor’s enforcement action under the Hong Kong jurisdiction. As such, the Courts declined to allow the companies to reap from their egregious conduct. 

It appears to suggest that, provided that companies have acted in good faith in the proceedings, Hong Kong Courts are prepared to offer recognition and assistance to liquidators. This would be in the interest of expediting cross-border insolvency and restructuring in future. 

The position by the PRC Courts remains to be tested. According to the PRC Enterprise Bankruptcy Law, if a legally effective foreign ruling on a bankruptcy case involves the property of a debtor within the territory of Mainland China, and an application for the recognition and execution thereof is filed with the Mainland Court, the Mainland Court shall, according to international treaties or the principle of reciprocity, review the ruling, and decide whether to recognize or execute such ruling having regard to factors such as whether such recognition or execution would violate the fundamental principles of the law of Mainland China, impair state sovereignty, security and social public interests, or impair the legitimate rights and interests of the debtors within Mainland China. However, in practice, so far there is no precedent in which Mainland Courts recognize the effectiveness of foreign bankruptcy proceedings. 

Now that Hong Kong Courts have made this breakthrough, it is expected to lead to positive influence on Mainland Courts. Whether Mainland and Hong Kong will further recognize and cooperate in cross-border insolvency and restructuring in the future will largely depend on whether Mainland Courts, like the Hong Kong Courts, will adopt a unified approach. In fact, mutual recognition by the Mainland and Hong Kong Courts is believed to be a two-way street and the Supreme People’s Court in China has begun to explore and establish institutional arrangements for judicial assistance in insolvency cases with relevant parties in Hong Kong. This case definitely provides reference and practical experience in this area and will have a great impact on foreign application for recognition in the Mainland in the future. 

Other points to note in cross-border insolvency

  1. Application of pari passu principle

It is commonly the case that in cross-border insolvency, a company in one jurisdiction holds assets situated in a foreign jurisdiction. It has been held in Re Guangdong International Trust & Investment Corporation Hong Kong (Holdings) Ltd that it is possible to apply the principle of pari passu distribution to distribute the insolvent estate’s assets both in Hong Kong and abroad.In that instance, the liquidators of the company were tasked with distributing the company’s cash in a PRC bank account, and its Hong Kong assets, to the creditors. Given the mainland regulations on currency transfer, the cash in the PRC bank account could only be transferred to other PRC bank accounts. The Court allowed the proposed mechanism of distribution of the PRC account balance to creditors who had a PRC account, and distribution of Hong Kong assets to those who did not receive the PRC account balance, both on a pari passu basis. Despite this mechanism not involving a pooling of all assets of the company before pari passu distribution, it was held that the principle was concerned with achieving a substantive result but not the procedural mechanisms. This is a welcoming flexibility that would no doubt assist future liquidators in proposing methods of distribution of assets, where there might be procedural difficulty in adhering to the traditional understanding of pari passu principle.

  1. Bankruptcy proceedings vs. garnishee proceedings

Notably, if the parent company undergoing liquidation were a Hong Kong company instead of a Shanghai entity, it would still result in the way as in the CEFC Case (that the Garnishee proceedings could not continue against the company’s receivables). This is by virtue of section 186, CWUMPO, which provides that when a winding-up order has been made, or a provisional liquidator has been appointed, no proceeding shall be proceeded with or commenced against the liquidating company (except by leave of the Court). It is a well-settled principle that the Court has inherent jurisdiction to stay proceedings (e.g. Garnishee proceedings) or stay execution against a company in liquidation, with good policy reasons behind. It would be “unfair or more likely an abuse” if, in liquidation where pari passu distribution of a judgment debtor’s asset is in place or imminent, the judgment creditor gains an unfair advantage over other creditors by enforcing the judgment. In the CEFC Case, the stay of Garnishee proceedings was precisely because the Court wished to achieve the same result as it would in local winding-ups under section 186 CWUMPO, so that it may oversee creditor action to promote an orderly liquidation. 

Comparison of the insolvency regimes in Hong Kong and Shanghai/PRC 

Extrapolating on the Court’s ending remark on unitary approach by the two jurisdictions, this part sets out differences in winding-up proceedings in Hong Kong and Shanghai in order to explore the possibility of future similar treatment of Hong Kong liquidators by the PRC authorities.   

 Hong KongShanghai/ PRC
Primary legislationCWUMPO; andCompanies Ordinance (Cap. 622).Enterprise Bankruptcy Law; andthe relevant Judicial Interpretations on Enterprise Bankruptcy Law by the Supreme People’s Court
Corporate rescue/ restructuring regimeNo rescue regimes, but restructuring by scheme of arrangement is possible.There are special chapters under the Enterprise Bankruptcy Law about corporate rescue and restricting, namely Chapter 8 about reorganization and Chapter 9 about reconciliation.
Insolvency testCompany is unable to pay its debts and if:-
A creditor serves on the company at its registered office a Statutory Demand and the company neglects to pay the sum within 3 weeks of service;
Execution or other process issued on a judgment or court order in favor of the creditor is returned unsatisfied; or
After considering the contingent and prospective liabilities of the company, it is proved to the court that the company cannot pay its debts. The usual test relied upon is the cash flow test but the balance sheet test is also applicable, and is applied as the Court considers appropriate. 		An enterprise is unable to pay its debts due and if:
Its assets are not sufficient to pay all its debts (namely, the balance sheet test); or
Such enterprise obviously lacks solvency (to some extent like the cash flow test).
If the assets of a debtor exceed the liabilities on the balance sheet, the Court will hold that it obviously lacks solvency if:
it is unable to pay its debts due to such reasons as the serious insufficiency of funds or the failure to realize property; or
it is unable to pay its debts because the whereabouts of its legal representative is unknown and there is no other person responsible for managing its property; or
it is unable to pay its debts upon enforcement of the Court; orit is unable to pay its debts because it has made a loss for a long time and it is difficult for it to turn losses into profits; or
in any other circumstances which result in the loss of solvency of the debtor.
As for reorganization, the threshold could be even lower; as long as the enterprise has apparently forfeited the ability to pay its debts, it may undergo reorganization according to the provisions of the Law.
Applicants  Winding up proceedings:
Creditors, directors, shareholders
Scheme of arrangement:
Creditors, liquidators, shareholders		Bankruptcy Liquidation (winding ups):
Creditors,  debtor
Reorganization:  
Creditors, debtor, shareholders who hold more than one-tenth of the debtor’s registered capital 
Reconciliation:  
Debtor
Secured creditors’ positionSecured creditors can enforce its security.Secured creditors can enforce its security.
Transactions subject to challengeUnfair preferences:
If the company previously entered into any transaction influenced by the desire to prefer a particular creditor over creditors, the liquidator may apply to the Court to have the transaction set aside. Such transaction must have occurred:In the 6 months before liquidation has commenced; orIn the 2 years before liquidation has commenced if transaction is with an associate of the company, its director or shadow director.
Dispositions in compulsory liquidation:
All dispositions of property, transfer of shares, or alteration of shareholders’ status after commencement of winding up will be void.
Extortionate credit transactions:
A liquidator may apply to the Court for various orders regarding a transaction, which requires grossly exorbitant payments or is otherwise grossly against fair dealing principles, entered into within 3 years before commencement of the winding up. 
Transaction at undervalue:
Transactions at undervalue entered into within 5 years before liquidation has commenced may be voidable. This refers to transactions by the company where the company receives consideration significantly less than that provided by the company, or receives no consideration.
Floating charges:
A floating charge may be invalid if it was created:Within 2 years before the liquidation has commenced, if created in favor of an associate of the company, its director or shadow director; orWithin 1 year before the liquidation has commenced, if created in favor of other persons.		Within 6 months before the Court accepts the application for bankruptcy, if the debtor meets the bankruptcy test but still pays debts to specific creditors, the liquidator is entitled to request the Court to rescind the payoff unless the debtor’s property benefits from such payoff.After the Court accepts the application for bankruptcy, it shall be invalid for the debtor to pay off debts to a particular creditor.The following activities concerning the property of the debtor shall be invalid and the liquidator is entitled to recover the property:Hiding or transferring property for avoidance of debts;Fabricating debts or recognizing unreal debts.Within 1 year before the Court accepts the application for bankruptcy, the liquidator is entitled to request the Court to rescind the following activities concerning the debtor’s property:Transferring property free of charge; orTransferring property at obviously unreasonable low prices; orProviding property security for the debts that originally have no property security; orPaying in advance the debt undue; orWaiving creditsThe liquidator is entitled to recover the unusual income that the directors, supervisors and senior executives of the debtor have obtained by taking advantages of their authority of office and recover the enterprise property that they appropriate in the same manner.

 If you have any question regarding the topic discussed above, please contact our partners for further assistance. 

Anna Chan
Partner of Oldham, Li & Nie

anna.chan@oln-law.com

Xiaosu Zhu
Partner of Watson & Band

xiaosu.zhu@watsonband.com 

Oldham, Li & Nie Solicitors and Watson & Band have entered into formal association in 2020. The new Association will strengthen OLN’s China Legal Service Network and Watson & Band’s international practice, allowing the Association strategic and direct access to lawyers in different jurisdictions. With a deeper understanding of clients’ needs and behaviour, it will complement the ambitious growth of OLN and Watson & Band to provide high-quality legal services on a global scale. 

Disclaimer: This article is for reference only. Nothing herein shall be construed as Hong Kong or PRC legal advice or any legal advice for that matter to any person. Neither Oldham, Li & Nie nor Watson & Band shall be held liable for any loss and/or damage incurred by any person acting as a result of the materials contained in this article. Shall you be interested to download this article as a brochure, please click on the following link:  Legal Update: Hong Kong Court Recognizes Application by Shanghai Liquidators

Issues in Loan Agreements Facing Borrowers in Covid-19

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Covid-19 has caused significant financial difficulties to business, some of which may have entered into loan agreements or are looking to sign up for loan schemes. This article explores various issues arising from key terms in loan agreements, their implications in light of Covid-19, and potential resolutions.   

What Key Terms may Affect Borrowers?

  1. Material Adverse Effect

In financial transactions it is common for the agreement to include a “material adverse effect” (“MAE”) clause as a representation by the borrower i.e. it would be a conditional precedent that there is no MAE on a borrower or its business, operations, property, condition (financial or otherwise), prospects and/or ability to perform, before funds can be drawn down under a credit facility. One example of MAE is where there is a large negative variation in successive financial statements of the borrower. 

Depending on the specific wording of the MAE clause in a loan agreement, such as whether it targets only the payment obligation of the borrower (which is narrower) or applies to the borrower’s entire business (wider by comparison), the implications vary. If the latter, a business suffering loss of clients and income from the pandemic might be caught under the clause. 

Even though MAE clauses are not commonly used by lenders to default borrowers, they are always heavily negotiated. Once an MAE occurs, it creates leverage for the lender to renegotiate terms. Graver consequences might present in the case of an existing revolving loan, however. Borrowers have to meet the conditional precedent before drawdowns, but if they fail to do so they might face cash flow issues. Businesses will then have to turn to alternative lenders (and be prepared to accept harsher terms), or alternative ways of preserving liquidity. 

  1. Financial Covenants

Loan agreements are crafted to ensure lenders are aware of any financial stress on the borrower as early as possible. In this regard, financial covenants impose obligations on borrowers such as not to cease business, to seek consent of the lender before business change or asset disposal, and to maintain a specific financial metric on an ongoing basis (e.g. cash flow cover ratio, interest cover ratio and leverage ratio).

Borrowers are likely to face challenges by the covenants in the face of Covid-19 and its adverse effect on business. They might breach such covenants if, for example, revenue falls so that they are unable to maintain a certain level of financial metric required under the covenants. This could trigger an event of default (discussed in Paragraph 3 below), resulting in lenders accelerating the loan to enforce security thereunder.

Fate might not necessarily be sealed though, even when a breach occurs. In this situation, the breaching borrower should find out if any cure rights can be used as remedy. An equity cure provision usually allows a borrower’s shareholders to inject additional equity into the borrower. This will then bring the borrower’s financial conditions up to the threshold required under the covenants.  If cures are not provided for, as will be seen below, there might still be a way out.     

  1. Events of default

Common events of default are non-payment, insolvency and insolvency proceedings. Businesses struggling to repay a sum due will be at risk of default. As for insolvency, it should be noted that the threshold/ insolvency test varies from jurisdiction to jurisdiction. In Hong Kong, companies may be wound up by the court if it is unable to pay debts in the sum of HK$10,000 or more, taking into account its contingent and prospective liabilities (on either cash flow or balance sheet basis).

In comparison, the insolvency test in Singapore is that a company is unable to meet its due payment obligations, or where its total liabilities exceed the value of its assets.

A related issue, “cross-default”, arises when there is a provision in the loan agreement that considers it an event of default if the borrower breaches another loan agreement with another creditor. This means one default by a borrower may lead to defaults under more than one loan agreement under a domino effect (provided that all these agreements have a cross-default clause).

Borrowers are advised to comply with any notification requirements under the agreements, and update the lenders in a timely manner if it will potentially default/has actually defaulted. It is unclear how lenient lenders are prepared to be but practically, there is always room for borrowers to negotiate for a waiver of its default, especially if it is only the first time of default. Typically, lenders will waive the default in consideration of a waiver fee.  

What Ongoing Obligations should Borrowers Note?

  1. Reporting obligations

Borrowers should check their loan agreements for undertakings to provide information to the lender, such as the borrowers’ financial statements and audit reports. In light of alternative workplace arrangements, companies should arrange with their accounting/audit companies well before any deadline to ensure relevant reports can be prepared and delivered for lenders’ perusal.

In addition, borrowers may be under a duty to notify the lender if an event of default may potentially occur or has already occurred. Other matters which can be subject to notification include potential breaches of any of the borrower’s material contracts (which therefore affects its business and financial condition), key management members failing to perform work duties due to Covid-19, and change in business activities to adjust to post-Covid market conditions etc. If a borrower does not comply with these obligations, it might trigger a breach of undertakings or event of default.

  1. Maintaining financial metrics

As mentioned above, a borrower will be required to stay above a certain level in terms of its financial conditions as a conditional precedent or representation to the loan agreement. Keeping in mind that loan agreements are bespoke and crafted to address the specific circumstances of parties, it may be helpful to check the provisions as to the calculation period used to test the borrower’s financial metrics. As an illustration, a long calculation period will help to alleviate short term stress, and the borrower’s revenue before Covid might be applied in the calculations to help it stay above the required thresholds.  

Conclusion

There is no doubt that Covid-19 has slowed down deal flow in the debt capital market. For existing loan agreements, apart from borrowers taking action to negotiate with creditors to restructure loans (but taking care that this does not trigger a technical default under existing loan agreements), it would be of even more help if lenders, particularly institutional ones, take the initiative to offer relief packages to companies, especially SMEs.

Indeed, in the note from the Hong Kong Monetary Authority (“HKMA”) to authorized institutions (including banks) on 6th February 2020[1], HKMA observed that some institutions had plans to offer temporary relief measures to borrowers and encouraged others to do the same. The HKMA further said that “a proactive response by the banking industry will help mitigate the financial consequences” of Covid.

It remains to be seen how many lenders will be rolling out similar relief measures, but consistent, collective effort from both sides of a loan deal will undoubtedly ease financial pressure faced by local businesses in these unprecedented times.

If you have any question regarding the topic discussed above, please contact our partner Tracy Yip at tracy.yip@oln-law.com for further assistance.

Disclaimer: This article is for reference only. Nothing herein shall be construed as Hong Kong legal advice or any legal advice for that matter to any person. Oldham, Li & Nie shall not be held liable for any loss and/or damage incurred by any person acting as a result of the materials contained in this article.

[1] “Measures to relieve impact of the novel coronavirus”, HKMA (https://www.hkma.gov.hk/media/eng/doc/key-information/guidelines-and-circular/2020/20200206e1.pdf), 06 February 2020.

General Restructuring and Insolvency Regime in Hong Kong

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With the epidemic levelling off locally, some restrictive measures have been relaxed but businesses continue to feel the pressure posed by Covid-19. Many companies will need to manage solvency risks in the coming months, and some may need to consider taking the inevitable route of closure. This article explains the different ways of closing down a company in Hong Kong.

In Hong Kong, company closures are usually effected by either “deregistration” or “winding-up”. Despite leading to the same result, the procedures involved are different. Closure of a defunct solvent private company by way of deregistration is relatively straightforward, cost-effective and fast. In contrast, winding-up involves the process of settling the accounts and liquidating the assets of a company for the purpose of repaying debts and making residual distribution to members. As could be imagined, winding up requires relatively higher costs and time.

Deregistration

Only a private company formed and registered under the Companies Ordinance (Cap. 622 of the Laws of Hong Kong)(“CO”) may apply for deregistration. The company must be a defunct solvent company. In addition, it must meet the following conditions before making an application for deregistration:

a.    all the members of the company agree to the deregistration;
b.    the company has not commenced operation or business, or has not been in operation or carried on business during the 3 months immediately before the application;
c.    the company has no outstanding liabilities;
d.    the company is not a party to any legal proceedings;
e.    the company’s assets do not consist of any immovable property situate in Hong Kong; and
f.    the company has obtained a “Notice of No Objection to a Company being Deregistered” (“Notice of No Objection”) from the Commissioner of Inland Revenue.

What steps are involved in deregistration?

An application for deregistration should be delivered to the Registrar of Companies (the “Registrar”), within 3 months from the date of issue of the Notice of No Objection.

If all documents are in order, a letter acknowledging receipt of the application will be issued in 5 working days. The Registrar will publish a notice of the proposed deregistration in the Gazette. If no objection to the deregistration is received within 3 months after the date of publication of the notice, the Registrar will deregister the company by publishing another notice in the Gazette declaring it to be deregistered on the date of publication of that other notice. The company is then dissolved on deregistration. The whole process takes approximately 5 months.

Voluntary Winding Up

If a company does not satisfy the pre-requisites for deregistration (e.g. if the company has operating business in recent months), it can instead be dissolved by members’ voluntary liquidation (“MVL”) or creditors’ winding up. In rare cases, a Compulsory Winding up Petition by the High Court of Hong Kong may also lead to a winding up. MVL and creditors’ winding up will be discussed below.

How does voluntary winding up work?

MVL requires the company to be solvent i.e. having the ability to settle all of its debts in full. Before a company commences MVL, it should settle all outstanding liabilities and dispose of assets held in order to expedite the process. To kick off the process, the company would have to resolve issue a certificate of solvency and the shareholders would have to resolve the winding up decision.   

In the certificate of solvency, directors have to certify that a full inquiry into the company’s affairs was made, and having so done, they have formed the opinion that the company will be able to pay its debts in full within 12 months from the winding-up. If the Certificate is not filed, or if the company subsequently becomes insolvent after commencement of MVL, the winding up will be conducted as a creditors’ winding up[1].

The company has to convene an EGM to pass a special resolution for the dissolution of the company, and an ordinary resolution for the appointment of a liquidator. A notice of the resolution has to be advertised in the Government Gazette and liquidator must deliver a notice of his appointment to the Hong Kong Registrar of Companies within 14 days of the appointment.

The liquidator, who is usually a solicitor or a professional accountant, will deal with the affairs of the company, liquidating its assets and paying creditors of the company. Once tax clearance has been obtained from the Inland Revenue Department, the liquidator will proceed to distribute any surplus and return the capital back to shareholders. If the company has the simplest structure of huge assets or liabilities, the process may take around 8-9 months, depending significantly on the tax clearance process mentioned (which may take up to 3-6 months).

What should a company be aware of after MVL has commenced?

After the commencement of winding up, it should be noted that:-

1. From the day of commencement of winding-up (i.e. the day when the company is dissolved by special resolution), the company must cease business operation, except for those required for winding-up[2].

2. The powers of the board of directors will cease unless the liquidator has decided that the board shall continue to have such powers.

3. Unless with the sanction of the liquidator, any transfer of shares or alteration of members’ status shall be void.

What if overseas winding-up proceedings are commenced against Hong Kong assets/business?

It is common for MNCs to have presence one way or the other in HK (such as by way of holding assets or having business in HK). If a foreign parent undergoes foreign insolvency proceedings and there are liquidators appointed by foreign Court, foreign liquidators might encounter difficulties during its enforcement action in HK. To address this, foreign liquidators might resort to the Hong Kong Companies Court to obtain a recognition order of the foreign insolvency proceeding in order to lay their hands on the company’s Hong Kong properties.

The HK Court has been open to providing such assistance to liquidators, provided that certain conditions are satisfied. Indeed, liquidators from a common law jurisdiction will likely be granted recognition and assistance, and recent cases show that the Court will even recognize insolvency proceedings in the PRC, a civil law jurisdiction (for details, please see our article on “Legal Update – HK Court Recognizes Application by PRC Liquidators”).

Good news to foreign liquidators but bad news to businesses which might want to protect the Hong Kong assets in case of liquidation — there are claw back mechanisms under CWUMPO whereby certain transactions preceding winding up could be void by liquidators. In particular, transactions or dispositions which are undervalue or unfairly preferential to one creditor over the others are subject to claw back if they happen within specified timeframes before liquidation.

What can a Hong Kong subsidiary do if its foreign parent is being wound up overseas?

A subsidiary is a legal entity with its own stock, and is separate and distinct from its parent company. When a parent company goes bankrupt, legally it should have no impact in the subsidiary.

Practically however, the foreign parent’s ownership interest in the Hong Kong subsidiary is an asset. The liquidators of the parent company have a duty to manage and liquidate assets of the parent company in order to pay debts. What the liquidators will do is to arrange for the liquidation of the Hong Kong subsidiary in order to distribute assets to creditors of the foreign parent company. Essentially, with an insolvent parent, the Hong Kong subsidiary will be at risk of a complete upheaval.

 To expedite the liquidation process, it is advisable for the Hong Kong subsidiary to engage legal advisors so as to better understand each step of the proceedings. Our firm is experienced in handling cross border insolvency, and has frequently collaborated with foreign counterparts in similar matters. If such needs arise, our firm will be happy to provide assistance.  

Scheme of arrangement

Hong Kong lacks procedure akin to Chapter 11 procedures in the United States which aims at rescuing companies on the verge of insolvency. The closest alternative in Hong Kong is the scheme of arrangement, which is frequently used by companies to give effect to a debt restructuring. Importantly, a scheme is neither an insolvency nor a bankruptcy process, and are relatively low profile in terms of publicity as no Gazetting is required.

A company in fiscal difficulty would usually compile a proposal for its creditors, proposing terms for a compromise of the company’s debts so that creditors may accept a lesser amount in full settlement of the debt. It should be noted that even where a company is undergoing a winding-up procedure, the liquidator has power to initiate a scheme of arrangement.

What are the procedures effecting a scheme of arrangement?

Once the proposal has been finalized, the application is made to the Court for its approval to convene meeting of each class of affected creditors. In each of the meetings, the scheme must be approved by both a majority of at least 50% in number, and a majority in number presenting at least 75% in value of the voting creditors. Upon the Court’s approval, an order sanctioning the scheme will be made.  Such order will bind all creditors of the company, even if they did not vote.

What kind of company can invoke a scheme?

Apart from companies incorporated under the CO in Hong Kong, the Courts of Hong Kong may also approve schemes of arrangement having a “sufficient connection” with Hong Kong, as evidenced by factors such as listing on the Hong Kong Stock Exchange, creditors and/or management located in Hong Kong etc. In other words, foreign-incorporated companies, such as those from offshore jurisdictions, can also apply for approval of the scheme (as long as they can establish a sufficient connection with Hong Kong). It is therefore common for a foreign company with debts and liabilities in Hong Kong to seek the Court’s sanction for a scheme of arrangement in Hong Kong.

Our firm has extensive experience in assisting businesses in their closing down exercise in HK including the devising of a restructuring strategy, advice on each step of the restructure, negotiations with creditors if necessary, as well as preparation of proposed terms of the scheme. We will also be able to offer bespoke advice on the suitability of implementing a scheme and whether other alternatives are available to the company, so as to tailor to the specific needs of each company. 

If you have any question regarding the topic discussed above, please contact our partner Anna Chan at anna.chan@oln-law.com for further assistance.

Disclaimer: This article is for reference only. Nothing herein shall be construed as Hong Kong legal advice or any legal advice for that matter to any person. Oldham, Li & Nie shall not be held liable for any loss and/or damage incurred by any person acting as a result of the materials contained in this article.

[1] Sections 237A & 237B, Companies (Winding up and Miscellaneous Provisions) Ordinance (Cap. 32 of the Laws of Hong Kong)(“CWUMPO”).

[2] Section 231, CWUMPO.