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Surviving the Current Economy Series Part 1: What Options are Open to Corporate Debtors

OLN Marketing

Surviving the Current Economy Series Part 1: What Options are Open to Corporate Debtors

mai 8, 2020 by OLN Marketing

At the start of the COVID-19 pandemic, we saw many small to medium sized businesses (SMEs) going into panic mode.  They sought legal advice on how to deal with issues arising from immediate or near immediate cash flow problems and creditors, and at the same time, limit their potential liabilities and protect their assets.

We are now more than 3 months into this new way of life.  In the business world though, for the first quarter of 2020, there are reports of most businesses suffering large percentages of revenue loss.  There are employee lay-offs, salary reductions and in some instances, companies simply closed shop for good. 

Would our legal advice be any different now compared with 3 months ago?  Yes and no.  The laws have not changed but the global spreading of the virus has created further limitations on businesses, e.g. travel limitations have resulted in the cut-off of supply chains.  Such changed or changing circumstances may require a revisit of commercial and therefore legal strategy.  

In Part 2 of this series, we will explore options available to businesses/companies operating in specific sectors of the economy at this juncture.  For now, let’s discuss the basics of insolvency law as many clients appear most concerned about outstanding debts and cashflow problems.

Commercial Considerations 

Directors and shareholders should first and foremost consider whether the business is worth keeping, taking into consideration the current economic climate, business projections and personal preferences.  An all-round risk assessment of the business and its commercial value, along with an analysis of whether short term obligations can be met should be conducted.

Negotiations with creditors

The short-term analysis is highly based on whether creditors (e.g. financial institutions, landlords, suppliers and employees) are willing to give the business a break.  

When entering into negotiations with a creditor, be straightforward and ready to offer a concrete plan of repayment.  Often times, creditors are equally interested in allowing the company to continue, with a view to the company arriving in a better position to settle the debt in the future.  A concrete repayment/fund raising plan will instil confidence in the creditor.
Where the creditor is a bank and the debt arises from a loan, the loan is usually secured against certain assets of the company (e.g. equipment, revenue), assets of the majority shareholders (e.g. landed properties) and personal guarantees of the directors and shareholders.  On the strength of the personal guarantees, bankruptcy could be a real risk faced by directors and shareholders. Successfully working out a deal with the bank is pertinent but it requires skill, especially if the business is an SME with far less bargaining power.

Negotiations with landlords can prove to be fruitful in the current HK economy, in particular where the lease is about to expire.  Extractions of rental reductions are common-place whilst negotiating for a break clause (the right to terminate the lease early), rent abatement clause (the suspension of rental payments upon the happening of certain events), force majeure clause (essentially the termination of the contract upon the happening of certain events beyond the control of the parties), and rent-free periods should be explored.  

Force majeure clauses and how they operate have been discussed by our firm here: https://oln-law.com/are-you-frustrated-by-your-force-majeure-clause.  For what the law allows when dealing with employees, our firm has published an article on this: https://oln-law.com/employment-matters-to-consider-in-economic-downturn. 

Scheme of Arrangement as an alternative to being wound up/liquidated

If negotiations fail and the company otherwise cannot find a way to pay its debts as they fall due, the company should consider entering into a scheme of arrangement which is essentially the company’s proposal on how to compromise with creditors on their respective debts, generally resulting in creditors accepting less than the amount that they are fully owed.  It is an alternative to being wound up.

Once the proposal is completed, the company must apply to the Court to convene a meeting of shareholders and/or creditors to seek their agreement to the scheme of arrangement.  Agreement under section 674 of the Companies Ordinance (Cap. 32) means 75% of creditors’ votes (in person or by proxy) in favour of the scheme.  Upon obtaining such agreement, the scheme must sanctioned by the Court.  In deciding whether to sanction the scheme, the Court will consider the following factors (Re China Singyes Solar Technologies Holdings Ltd [2020] HKCFI 467): 

(1)    whether the scheme is for a permissible purpose;
(2)    whether creditors who were called on to vote as a single class had sufficiently similar legal rights such that they could consult together with a view to their common interest at a single meeting;
(3)    whether the meeting was duly convened in accordance with the Court’s directions;
(4)    whether creditors have been given sufficient information about the scheme to enable them to make an informed decision whether or not to support it;
(5)    whether the necessary statutory majorities have been obtained;
(6)    whether the Court is satisfied in the exercise of its discretion that an intelligent and honest man acting in accordance with his interests as a member of the class within which he voted might reasonably approve the scheme; and
(7)    in an international case, whether there is sufficient connection between the scheme and Hong Kong, and whether the scheme is effective in other relevant jurisdictions.

The implementation of a scheme of arrangement in HK is time-consuming and costly, particularly as it involves separate Court applications and meetings.  Even when a meeting can be conducted, it may be difficult to obtain 75% support, for example, if creditors consider that they may have a better chance of recovery in separate legal proceedings.  Moreover, until the scheme is fully sanctioned by the Court, there is nothing that stops creditors from commencing legal proceedings in the Courts against the company. 

Winding Up

Of all options open to creditors, winding up a company is the most severe.  The process involves a liquidator stepping into the shoes of the company to collect and realize on the company’s assets and settle outstanding liabilities of the company.  The process will almost always involve directors who will be required to assist the liquidator in giving all sorts of information about the company including its financial information and flow of money, sometimes via affidavits and testimonies in Court.

An order for winding up will be made in the following 3 scenarios:

1.    The debtor fails to pay or fails to provide sufficient security for a sum of more than HK$10,000 within 21 days after being served with a statutory demand.
2.    The debtor fails to satisfy wholly or partially a judgment or order of the Court granted in favour of a creditor.
3.    When the creditor proves that the debtor is unable to pay its debts as they fall due (cash flow test) or the assets of the company are not sufficient to meet its liabilities (the balance sheet test).

One of the defences often used to resist an order for winding up is that the debt is the subject of a genuine dispute.  

Commercial transactions to avoid when the company is undergoing difficult times

The liquidator has wide powers to investigate the affairs of the company and the acts of its directors and officers.  

In particular, the liquidator may call into question the following types of transactions:
    
1.    Transactions at an undervalue, defined as where (i) the company makes a gift without receiving any consideration; or (ii) the company enters into a transaction for a consideration that is significantly less than the value of the consideration provided by the company, e.g. selling the company’s shares to a relative at a fraction of the value.  The relevant time frame under scrutiny is 5 years before the date on which the winding up of the company commences (i.e. the time that the winding-up petition is presented).

2.    Unfair preferences, defined as acts of the company that place certain creditors in a better position than they normally would have been, e.g. paying creditors with lower priority before those with higher priority.  For an unfair preference given to a person who is connected with the company (i.e. an associate which includes a spouse of the director or the director’s blood relations), the relevant time frame under scrutiny is 2 years before the date on which the winding up commences.  For an unfair preference given to an unconnected person, the relevant time frame under scrutiny is 6 months.

If a transaction is found to be a transaction at an undervalue or an unfair preference, the liquidator will commence legal proceedings to recover the assets from the current owner.  Once a transaction is found to be a transaction at an undervalue or an unfair preference, the directors of the company may face civil or criminal sanctions for approving/allowing the transaction to take place.  

For the above reasons, directors need to be extremely careful when handling the transactions of a company undergoing difficult times or that is otherwise already trading insolvent.

If you wish to learn more about what options are available to corporate debtors facing the possibility of being wound up, please feel free to speak to our litigation partner, Eunice Chiu.

Eunice Chiu
+852 2186 1885
Partner, Dispute Resolution
Oldham, Li & Nie

Filed Under: Résolution des Litiges

CHINA – Strengthening Intellectual Property Protection from 2020 – 2021

avril 29, 2020 by OLN Marketing

The China National Intellectual Property Administration has issued a Plan for “Implementation of the Opinions on Strengthening Intellectual Property Protection from 2020 to 2021” (“Plan”) on 20 April 2020, which detailing the roadmap to strengthen Intellectual Property Right (“IPR”) Protection in China covering patents, trade secrets, trademarks, copyrights, pharmaceutical products, e-commence as well as plan to deal with piracy, counterfeiting, and enforcement.

We summarize parts of the Plan concerning trade mark (Including infringement and counterfeiting) as follows:

1.    Trade Mark Laws and Regulations
  
•    Reviewing and revising Trademark Law as appropriate to strengthen trademark protection and enforcement

•    Stipulating punitive compensation for intellectual property infringement 

•    Refining criminal procedures and penalties, destroy infringing and counterfeit goods, and regulate government disclosures

•    Viewing legislative research on the protection of geographical indications (Completed before end of December 2021)

•    Revising the measures for the registration and management of collective marks and certification marks (Continue to advance)

•    Introducing judicial interpretations to combat online infringement and counterfeiting (Completed before end of August 2020)

•    Formulating interpretations of the Supreme People’s Court, Supreme People’s Procuratorate on the specific application of laws in handling criminal cases of intellectual property infringement (3) (Completed before end of August 2020)

•    Amending certain provisions on the Anti unfair competition of counterfeiting (Continue to advance)

•    Studying and compiling management standards for intellectual property protection of e-commerce platforms and formulating policy documents to control piracy, infringement and counterfeiting on e-commerce platforms (Completed before end of October 2020)

•    Formulating policy documents for the destruction of infringing and counterfeit goods (Completed before end of July 2020)

2.    Strengthen the administrative enforcement and judicial protection of intellectual property rights

•    Formulating and issuing standards for trademark infringement judgment (Completed before end of June 2020)

•    Publishing annual report on typical cases for patents, trademarks, copyrights, new varieties of agricultural plants and other types, as well as administrative enforcement and judicial protection in the fields of customs and cultural markets (Completed before end of December 2021 and continue to advance)

•    Cracking down on counterfeit goods with health and safety risks, increasing the frequency of handling cases, and establishing a system to publicly release the above-mentioned law enforcement action data and information on a quarterly basis (Completed before end of May 2020)

•    Promoting pilot inspection and identification of trademark infringement disputes, improving the inspection and identification system for intellectual property infringement disputes, and studying and establishing an infringement damage assessment system (Continue to advance)

•    Organizing special actions for intellectual property law enforcement protection, destruction of infringing and counterfeit commodities, and crack down on intellectual property infringement (Continue to advance)


3.    Improve the construction of a large-scale intellectual property protection mechanism

•    Studying and establishing a connection and information sharing mechanism for trademark administrative confirmation and major infringement administrative law enforcement cases and carrying out pilot projects (Continue to advance)

•    Carrying out pilot projects of hierarchical classification supervision based on credit in the field of intellectual property and regulating bad faith trademark registration (Completed before end of December 2021 and continue to advance)

4.    Optimizing key links for fast protection of intellectual property

•    Improving trademark examinations capabilities by shortening the examination period to less than 4 months (Completed before end of December 2021)

•    Exploring a rapid review mechanism for trademark registration, modification, renewal and other applications (Continue to advance)

•    Intensifying the itinerant trademark review cases and establishing an open review mechanism for major cases (Continue to advance)

•    Formulating the management, training and quality control related regulations of the Intellectual Property Protection Center and enhancing the ability of rapid collaborative protection (Completed before end of December 2020)

5.    Expand foreign exchange and cooperation in intellectual property protection

•    Improving overseas intellectual property information service, early warning and other platforms, strengthen the dynamic tracking and research mechanism construction of major trade countries (regions) intellectual property laws and policies revisions and major dispute cases, and building overseas trademark dispute case databases (Continue to advance)

6.    Strengthen the protection of intellectual property protection resources
 
•    Strengthening the construction of infringement and counterfeiting administrative law enforcement and criminal justice information sharing platforms (Continue to advance)

•    Promoting the establishment of an information system platform to combat IPR infringement cases (Continue to advance)
 
   
7.    Promote intellectual property protection publicity and cultural construction

•    Continuing to run large-scale publicity activities such as the National Intellectual Property Publicity Week, China Intellectual Property Annual Conference, China International Trademark and Brand Festival, etc (Continue to advance)
 
8.    Strengthen the protection of intellectual property protection organizations

•    Carrying out performance appraisal of cracking down on the infringement of IPR and the manufacture and sale of counterfeit and shoddy goods (Continue to advance)

•    Improving piracy report reward mechanism for IPR infringement (Continue to advance)

You will see that the CNIPA is actively pursuing changes / implementations in respect of IPR protection within two years, so we may need to wait and see on the updates of CNIPA in the coming years for the outcome of the Plan.  

Full version of the Implementation Plan can be found from the following link: https://www.cnipa.gov.cn/art/2020/4/20/art_53_118147.html (in Chinese only)

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.

Filed Under: Droit de la Propriété Intellectuelle

New Trend of Japanese Corporates Retreating from China

avril 28, 2020 by OLN Marketing

In early April 2020, the Japanese Government announced its plan to earmark about USD$2.2 billion as part of its economic stimulus package to help manufacturers to shift their production out of China.  This effort has surfaced following the outbreak of coronavirus in China and its devastating disruptions to supply chains after temporary suspension of production bases in various parts of the country. 

According to latest statistics, there are over 30,000 Japanese entities having establishments and presence in the PRC.  Not surprisingly, most of them structure their investment in China via Hong Kong intermediaries for tax efficiency reasons.  With the rolling out of the stimulus measures, will we be witnessing a new trend of Japanese companies moving out from China?  What are the factors the enterprises should consider on their decision to “exit” China? What is the most tax efficient way to structure the investment post-exit? Should the Japanese enterprises maintain their regional head office in Hong Kong post-exit?

To leave or not to leave?

Targeting at Japanese manufacturers whose production is highly dependent on China (including pharmaceutical products, automobile, electronic components and other computer components), this new funding aims to encourage these manufacturers to build a stronger supply chain by shifting more high-value added productions back to Japan (Total: JPY 220 billion) and diversifying other manufacturing activities to neighbouring ASEAN countries (Total: JPY23.5 billion yen).  Depending on the company size, these subsidies will cover from at least one half (for large corporations) to two-third (for SMEs) and even 75% (for SME groups) of their relocation expenses, including building and equipment acquisition and installation.

Though the proposed domestic return may gain support from export-oriented companies due to the rising labour costs in China and the US-China Trade War while some others may consider strengthening their procurement chain from outside China, there might be hesitation for enterprises with strong domestic market demand in China (notably the automobile industry).  In addition, it is expected that the Mainland authorities, with a very strong desire to attract foreign enterprises to develop its high-technology (e.g. AI and 5G), will continue to provide more incentives to convince them to stay in China.  At present, the tax incentives to such sector include a 15% preferential Corporate Income Tax (“CIT”) rate designated to foreign enterprises which are qualified as new/high technology enterprises, key software enterprises, technology-advanced service providers and those operating in Qianhai Shenzhen-HK Modern Services Industry Cooperation Zone and Zhuhai Hengqin New Area.  Besides, tax reductions and exemptions also apply to specific industries and projects.  For instance, qualified new/high-tech enterprises (established in certain parts of PRC) and software enterprises are entitled to enjoy a “2+3” tax holiday, meaning that they could enjoy first two years of exemption from CIT followed by three years of 50% CIT reduction.

Costs of exiting China – How to shut down a WFOE?

However attractive the stimulus measures might be, if the costs outweigh the benefit one could potentially receive, Japanese enterprises might still have hesitation to exit China. Currently, there are a number of ways to shut down a wholly foreign-invested enterprise (or commonly called “WFOE”) in China, with the most common being a formal dissolution.  After paying up all the salaries and social insurances, taxes and debts, the WFOE must submit dissolution applications with various Chinese authorities one by one (including Commerce Bureau, Industrial and Commercial Administration Bureau, Statistic Bureau, Finance Bureau, Tax Bureau, State Administration of Foreign Exchange, etc.).  The entire process, though complicated and time-consuming (often take around one year), remains the prudent way for management and shareholders as non-compliance by simply walking away and abandoning the WFOE may result in severe repercussions (including penalty, criminal and personal liability and failure to establish a new business in China again).  The likely costs involved shall include administrative and other dissolution expenses, publication of notice and tax clearance prior to dissolution.  Investors should therefore be mindful and seek independent advice for the best course of action before terminating their operation in China.

Whether to Keep Hong Kong Regional Head Office

Historically, Hong Kong is preferred over Singapore as a better option for Japanese enterprises to expand their business, likely because of the vibrant capital market, the more volatile stock market, an independent judiciary and a simple and competitive tax system.  More importantly, Hong Kong’s strategic location in the post-CEPA regime allows Japanese investors to have access to the opportunities in Mainland market. 

As alternative to the manufacturing bases in China, Japanese enterprises have found vigour by establishing more than 10,000 bases (2019) in other Southeast Asian countries, such as Thailand (3,925 bases, representing 5.2%), Indonesia (1,911, 2.5%), Vietnam (1,816, 2.4%), the Philippines (1,502, 2.0%) and Malaysia (1,295, 1.7%).  Despite the similarity between the tax system in Hong Kong and Singapore, in determining whether Hong Kong or Singapore is more appropriate to set up their regional head office, enterprises should also consider the following factors:-

  1. The relevant Double Taxation Agreements (“DTAs”) that HK and Singapore have each signed with these ASEAN countries —  While business profits are not generally at issue because they are taxed in the country where they are derived (and not in Hong Kong or Singapore on the basis of territorial source concept), attention should be paid to the reduction of withholding tax levied on incomes (e.g., dividends, interest and royalty) to be received by the Hong Kong or Singaporean head office.  The relevant applicable withholding tax rates under the DTAs with the eight ASEAN countries are summarised in the table below.

Financing Needs and Future Investors’ Pitching — Hong Kong remains the market leader in equity and debt capital raisings in Asia possessing US$2.4 trillion worth of bank assets (triple of its keen competitor Singapore).  With strong physical and technological infrastructure, Hong Kong has edge over Singapore to meet corporate financing needs with a domestic market capitalisation of US$4 trillion (as compared to US$0.8 trillion in Singapore) and its corporate bond issuance stands at US$33 million (more than double of Singapore).  Coupled with Hong Kong’s proximity to their underlying businesses in Japan, better access to strong equity and debt capital raising markets in Hong Kong will continue to attract Japanese corporations seeking a stronger presence or expansion in the region.

  1. While two cities appear to be on par in terms of various tax incentives, regard must be made to other non-tax factors, e.g. availability of talent pool, corporate structure, etc.

If you have any question regarding the topic discussed above, please contact our partner Ms. 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.

Filed Under: Japanese Practice

Holiday Notice from Intellectual Property Team

avril 24, 2020 by OLN Marketing

Holiday Notice

Our PRC and Hong Kong offices will close on the following dates due to the public holidays. Please note that Sunday, 26 April 2020 and Saturday, 9 May 2020 are working days in China; deadlines in respect of PRC trademark matters fall on 26 April & 9 May 2020 cannot be postponed.

OfficeOffice closedResume to workSpecial working days
From-To
PRC Office1 May 2020 – 5 May 20206 May 2020Sunday, 26 April 2020
Saturday, 9 May 2020
Hong Kong Office30 April 2020 – 3 May 20204 May 2020N/A

OLN IP Team wishes you a Happy Labour Day !

Filed Under: Droit de la Propriété Intellectuelle

Constructive dismissal in a nutshell in the time of COVID-19 pandemic

avril 24, 2020 by OLN Marketing

Prelude
With the worldwide economy being hit hard with the COVID-19 pandemic, employers, irrespective of the scale of the business, have been forced to reduce costs to survive this economic ice age. With the diminished demand for labour force due to the stagnant economy, it is always tempting for employers to start cutting costs by downsizing the labour force or making alternative working arrangements with their employees (including requesting the employees to take no pay leave or to have a pay cut). Employers should, however, beware of constructive dismissal in the course of implementing such downsizing plan or alternative working arrangements; otherwise the additional costs incurred thereof might outweigh the costs saved by these costs-cutting measures. 

Constructive dismissal – General legal position
Subject to the factual matrix of each particular case, common circumstances which give rise to a claim for constructive dismissal include but not limited to unilateral variation of the contract of employment (for example, reduction in wages or substantial reduction in working hours), failure to pay wages, failure to provide reasonable amount of work, failure to pay statutory entitlements and discriminatory conduct at workplace etc.
In the event of constructive dismissal, an employee may terminate his employment contract without notice or payment in lieu of notice. In such case, although the employee is the party who terminates the employment contract, such dismissal is referred to as a “constructive dismissal” because the laws construe the employee’s termination of employment as a de facto dismissal by his employer. That being said, such finding might be rebutted by acts of the employee pointing to the otherwise.

Unilateral variation of the terms of employment
The relevant general legal position in Hong Kong is that an employer may not unilaterally vary the terms of employment (including imposing a substantial reduction in working hours (thus a reduction in pay) and requesting its employees to take on no pay leave), unless the relevant employment contract contains an express provision allowing the employer to do so. In the absence of any express provision to that effect, any unilateral variation of the terms of employment can therefore amount to constructive dismissal. This allows the employee to terminate their employment contracts without the need to give notice or payment in lieu of notice to the employer, and to bring common law claims for damages against the employer for any loss suffered by them as a result of the constructive dismissal. Damages which can be recovered by the employees might include:- (a) the amount which the employees would have earned has their employment been terminated with proper notice (including any outstanding wages, payment in lieu of notice, end of year payment, annual leave pay, holiday pay, bonus payment and other benefits and other payments due under the employment contract); (b) damages for breach of implied term of trust and confidence which the Court may assess the same by considering the potential loss of salary and contractual benefits on the employees’ part caused by the constructive dismissal; and (c) the legal costs of the claims.

In addition, section 32A(1)(b) of the Employment Ordinance (Cap. 57 of the laws of Hong Kong) (“EO”) confers upon an employee who has been employed under a continuous contract the right to claim remedies for “unreasonable dismissal” in the circumstances where his employer unilaterally varies the terms of his employment contract by the reason that his employer intends to extinguish or reduce any statutory right or benefit conferred upon such employee by the EO. 

Section 32A(3) of the EO further presumes that “the variation of the terms of the contract of employment by the employer as referred to in that subsection [i.e. section 32A(1)(b) of the EO] shall, unless a valid reason is shown for that variation within the meaning of section 32K, be taken to be a variation of the terms of the contract of employment by the employer by reason that the employer intends to extinguish or reduce any right, benefit or protection conferred or to be conferred upon the employee by this Ordinance [i.e. the EO]”.

Given that section 32K(c) of the EO specifically sets out that a dismissal, or the variation of an  employment contract, may be regarded as valid in the circumstances where the same is resulting from the redundancy of the employee or other genuine operational requirements of the business of the employer, it is therefore arguable that the COVID-19 pandemic triggers the application of section 32K and protects the employer from the statutory claim of “unreasonable dismissal”.

Notwithstanding the foregoing, the provisions under section 32K of the EO may only protect employers from the statutory claim of “unreasonable dismissal”. The general legal position remains that employers may not unilaterally vary the terms of employment on their employees in Hong Kong, unless the relevant employment contracts contain an express provision to allow the employers to do so. 

Requesting for voluntary resignation by the employees
It is commonly seen that an employer would ask an employee to resign “voluntarily” for face saving or in return for a favourable reference letter; otherwise the employment would still be terminated by the employer by way of dismissal.

 If an employer gives notice to an employee requiring him to resign, or giving him the option to resign or be dismissed, and subsequently the employee tenders his resignation, the Court is likely to characterize such termination as constructive dismissal rather than a resignation. That being said, the situation could be quite different in circumstances where an employer wishes to give an employee the genuine option of being able to resign rather than being dismissed by way of summary dismissal. 

Discriminatory conduct at workplace
Under the anti-discrimination laws in Hong Kong, an employer is prohibited from treating an employee less favourably in relation to employment on the grounds of an employee’s sex, disability, family status, or race. An employee may treat himself as constructively dismissed if he is subjected to discrimination or victimization conduct by his employer under the Sex Discrimination Ordinance (Cap. 480 of the laws of Hong Kong), the Disability Discrimination Ordinance (Cap. 487 of the laws of Hong Kong), the Race Discrimination Ordinance (Cap. 602 of the laws of Hong Kong), or the Family Status Discrimination Ordinance (Cap. 527 of the laws of Hong Kong), if it can be shown that the conduct complained about is initiated, encouraged or tolerated by the employer.

It is not unusual for an employer to consider (subject to the employee’s consent, if the circumstances may require):- (a) requesting some or all employees to take no pay leave; (b) requesting some or all employees to lower their working hours thus the salary on a pro-rata basis; or (c) implementing lay-off, in order to manage its costs in the time of COVID-19 pandemic. However, when implementing any of these costs-cutting measures, an employer is prohibited from selecting the employees pertaining on the employees’ sex, disability, family status, or race; otherwise, that could amount to constructive dismissal. 

How can OLN helps?
As can be seen, the downsizing of labour force by an employer in the time of the COVID-19 pandemic could easily give rise to constructive dismissal. We have practical experience in helping an employer with the implementation of temporary employment measures during the time of the COVID-19 pandemic and the review relevant documentation to ensure the same complies with the employment law regime in Hong Kong and to protect the employer from any potential claims. 

On the other hand, we also assist, from time to time, an employee on the review of the employment measures implemented by employers and advise the employee to take appropriate legal actions against the employer if any of the employment measures are in contravention of the employment laws.

If you have any question regarding the topic discussed or other employment issues, please contact our senior associate Mr. Victor Ng at victor.ng@oln-law.com or our associate Ms. Barbara Kwong at barbara.kwong@oln-law.com for further assistance.

Shall you be interested to download this article as a brochure, please click on the following link: Constructive dismissal in a nutshell in the time of COVID-19 pandemic


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.

Filed Under: Droit du Travail et de l’immigration Appliqué aux Entreprises

Coping with frustration: does Coronavirus pandemic (Covid-19) provide a legal justification for a commercial tenant to not pay rent?

avril 22, 2020 by OLN Marketing

Like the rest of the world, Hong Kong is struggling with the impact caused by the Coronavirus in different facets.  The pandemic is not only taking away lives, but also ravaging the economy without mercy.  For business owners, did you rent premises you thought you would be able to afford until the Coronavirus changed everything?  Are you planning to get out of the tenancy agreement by reason of the Coronavirus?  In this article, we will list out some frequently asked questions and provide you with our answers, so that you might have a grasp of what impact a public health emergency (like the Coronavirus) may have on the rights and obligations of landlords and tenants. 

Click to jump to answer

Question 1: Has anyone ever brought a case to Court to terminate the tenancy agreement / get out of his/her rental obligations by reason of a virus outbreak? ↓
Question 2: Does the judgment in Li Chun Wing debar future tenants from claiming frustration by reason of the Covid-19 pandemic? ↓
Question 3: So, how can tenants seek immediate termination of tenancy and request for refund of prepaid rental / deposit? ↓
Question 4: In light of the above, what actions should landlords take? ↓
Question 5: What should I pay attention to if I am contemplating to enter into a new tenancy agreement? ↓

 

Question 1: Has anyone ever brought a case to Court to terminate the tenancy agreement / get out of his/her rental obligations by reason of a virus outbreak?

Answer:
Yes, but in the context of a domestic tenancy.

In 2003, Hong Kong was devastated by the outbreak of severe acute respiratory syndrome (SARS), which infected 8,096 worldwide and killed 744.  Block E of Amoy Gardens (淘大花園), a private housing multi-storey estate in Hong Kong, was unfortunately hard hit in the epidemic as there were 107 people infected there.  In view of the severe situation, the Government imposed a 10-day isolation order on Block E and all the residents therein had to be evacuated.  Subsequently, scientific investigations suggested that the U-traps in the sewage systems had been left dry which allowed the virus to pass from the building sewage system back to the apartments.  

The unfortunate tenants of Block E of Amoy Gardens were faced with a dilemma: given the situation, was there a legal justification for them to terminate the tenancy agreements?  Or should they continue to stay in the premises which seemed to be unsafe for many after the expiry of the isolation order?

This question went before the District Court of Hong Kong in the case of Li Chun Wing v Xuan Yi Xiong [2004] 1 HKLRD 754.  In this case, a tenant of Block E (“T”) terminated the 2-year rental agreement after the isolation order lapsed, and the landlord (“L”) applied for summary judgment against T for the accrued rent and damages arising from the alleged repudiation of the tenancy agreement.  The question for the Court was therefore whether T was entitled to terminate the tenancy agreement. 

The main argument that T relied on was the doctrine of frustration.  The general doctrine of frustration would kick in when there is an supervening event (without default of either party and for which the contract makes no sufficient provision) which so significantly changes the outstanding contractual rights and/or obligations from which the parties could reasonably have contemplated at the time of its execution such that it would be unjust for the parties to further perform the contract.  The supervening event, however, must not merely increase the burden of the contracting parties but must be so substantial to discharge the parties from the contract entirely.   In considering the argument of frustration, the Court in Li Chun Wing commented that the 10-day isolation order in the case was “quite insignificant in terms of the overall use of the Premises”, as the term of the tenancy agreement in question was 2 years.  Therefore, the Court rejected the argument of frustration and held that the lease was not frustrated by the isolation order.

Another argument by T was that there should be an implied covenant for the premises to be fit for human habitation. The Court rejected such argument also because it was unusual for the Court to imply such a term in tenancy, and in any event there was just no evidence to suggest Block E continued to be unsafe for human habitation after the expiry of the isolation order.

Question 2: Does the judgment in Li Chun Wing debar future tenants from claiming frustration by reason of the Covid-19 pandemic?

Answer:
Not necessarily.  

In Li Chun Wing, the Court stressed that “an event which causes an interruption in the expected use of the premises by the lessee will not frustrate the lease, unless the interruption is expected to last for the unexpired term of the lease, or at least, for a long period of that unexpired term.”  

That means, the duration of the epidemic, or more precisely the relative duration of the epidemic comparing to the length of the tenancy, is an important factor for deciding whether a tenancy has been frustrated. As experts of infectious diseases have pointed out, Covid-19 may not go away swiftly and we might have to fight a prolonged war against it.  This may be contrasted with the case of SARS epidemic which hit Hong Kong very hard at first but was swiftly alleviated within weeks. 

For tenants who have short leases, it may therefore be easier for them to claim frustration. However, this does not necessarily mean that long leases could never be frustrated at all as Li Chun Wing is only a decision by the District Court, being a court at a lower level in Hong Kong. On the other hand, in the recent English High Court case of Canary Wharf (BP4) T1 Limited & ors v European Medicines Agency [2019] EWHC 335 (Ch), it was suggested that it is not simply a question about the length of the tenancy. Instead, the Court should adopt a multi-factorial approach by looking at all the circumstances to decide whether the “common purpose” of the contract has been frustrated. This would require us to look beyond the four corners of the tenancy to consider also:-

–    The matrix or context when the tenancy was entered into
–    The parties’ knowledge, expectations, assumptions and contemplations, in particular as to risk, at the time of the contract
–    The nature of the supervening event; and
–    The parties’ reasonable and objectively ascertainable calculations as to the possibilities of future performance in the new circumstances

Question 3: So, how can tenants seek immediate termination of tenancy and request for refund of prepaid rental / deposit?

Answer:
Unless otherwise provided by the contract, generally landlord and tenant do not have the right to terminate the tenancy anytime before the period contemplated in the contract lapses. In most cases, even if force majeure clauses apply, they would only allow rent suspension or abatement but not termination of the tenancy. However, besides the situation that may give rise to frustration as discussed above, under certain circumstances, where a “repudiatory breach” of the contract has arisen, the non-breaching party may have the right to terminate the tenancy.

Generally, a repudiatory breach would only arise if the breach of the contract is sufficiently significant so as to deprive the non-breaching party of “substantially the whole benefit” of the contract.  In the context of tenancy, where the landlord shut down the premises, it may be argued that the landlord has breached the implied covenant of quiet enjoyment where the shutdown is unilaterally decided by the landlord and not authorised by the tenancy.  But where the shutdown is mandated by the government, it is difficult to attribute fault to the landlord and claim there is a breach of the tenancy on the part of the landlord.

Insofar as the issue of prepaid rental or deposit that is advanced by the tenant (e.g. two months’ rent) is concerned, first of all, one must turn to the actual tenancy agreement and check if parties have agreed on how the deposit would be dealt with.  Where the contract is ambiguous or silent on the issue, it requires a case-by-case analysis of the tenancy agreements and the circumstances.  If it is a straight-forward case that the landlord has breached the tenancy agreement so as to give rise to a “repudiatory breach”, the tenant can almost certainly terminate the tenancy and request for refund of the deposit.  In contrast, if the tenant is the defaulting party, the landlord may just apply the deposit to cover the tenant’s default.

However, as discussed above, very often the answer is less than clear and the tenant may not be certain whether he/she is entitled to rescind or terminate the contract on other ground such as frustration (Please refer to the answer in Question 2 hereinabove).  This is where the tenants must be extra cautious because if it was later adjudicated that the breach is not a “repudiatory” one, they may be liable to compensate the landlord, amongst others, the outstanding rents, consequential losses and legal costs.

Question 4: In light of the above, what actions should landlords take?

Answer:
As for landlords, it is important to consider whether your right to collect rental payment has been impacted by Covid-19 before commencing any legal action to collect rent.  As discussed below, there may be contractual provisions (e.g. a force majeure clauses and “material adverse change” clauses) in your tenancy agreement that have contemplated the situation of an epidemic/pandemic and relieve the parties from the performance of the contract.  Of course, the answer would very much depend on the intention of the parties and other circumstantial factors. 

Question 5: What should I pay attention to if I am contemplating to enter into a new tenancy agreement?

Answer:
Besides express contractual provisions regarding termination of contract, parties have to pay attention to force majeure clauses and “material adverse change” (MAC) clauses. 

For a discussion of force majeure clause, please refer to the article written by our Senior Partner, Mr. Gordon Oldham: https://oln-law.com/are-you-frustrated-by-your-force-majeure-clause.  Parties may consider to provide a clear and unambiguous force majeure clause to contemplate the event of epidemic/pandemic.

In addition, very often the contracts would contain a MAC clause which expressly stipulates that certain events that materially change the business, operations, assets, liabilities, condition (e.g. financial condition) of a party may give rise to a right to terminate the agreement. Again, like a force majeure clause, the MAC clause must clearly contemplate the event of epidemic/pandemic if parties wish to rely on it.  If MAC clauses are drafted in a generic way, the Court will tend to construe the clause narrowly by excluding Covid-19 as a MAC event.  In determining whether a MAC clause is triggered, a case-specific analysis of the following circumstances will also have to be conducted:-

–    Intention of the parties
–    What the parties have discussed on the treatment of Covid-19;
–    What the market comparable is for the party’s business; and
–    How the party’s business performance is compared with that of the market comparable.

Concluding thoughts

With the uncertain development of the Covid-19 situation, we believe that there might be upcoming cases testing whether the doctrine of frustration could discharge tenants from tenancy agreements and if so under what circumstances it will happen.  Before a clear guidance is laid down, we suggest both landlords and tenants to keep track of the situation and review key tenancy agreements in order to assess what impact had Covid-19 caused to them specifically.  Similar to most other disputes, the best way of resolution is always to attempt amicable negotiation and discussion by taking into account various commercial reality and practicality. If the tenant finds it inevitable to renege on rental payments, we suggest that he/she approaches the landlord to initiate a discussion and try to sort out whether rental reduction / deferment would be feasible before taking any legal action. 

If you wish to obtain legal advice to assess your current situation, please don’t hesitate to contact any of us (at anna.chan@oln-law.com or martin.tse@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.

Filed Under: Résolution des Litiges

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