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Proposed Changes to Winding Up to Impact Directors’ Dealings
1 October 2016

The Hong Kong Companies (Winding Up and Miscellaneous Provisions) (Amendment) Ordinance 2016, which sets out proposed changes to the Companies (Winding Up and Miscellaneous Provisions) Ordinance and the Companies (Winding up) Rules, was gazetted on 3 June 2016.

The proposed change is a broad reform, with a number of more substantial amendments, as well as many minor changes aim inter alia to have better creditor protection. We consider two of the reforms in the proposed amendments below in an insolvency setting relating to making transactions at Undervalue and Unfair Preferences voidable on application to court by the liquidator.

Transactions at Undervalue

The proposed amendments will give the courts the power to set aside company transactions entered into within 5 years before the commencement of the winding up, that were made at undervalue.

This power will be new to Hong Kong, although similar provisions exist in other jurisdictions.

For a transaction to be undervalue, it may be a gift made by the company or a transaction where the company receives no consideration, or a transaction where the consideration received by the company is “significantly less” than the actual value of transaction.

For the section to apply, the company must be insolvent at the time of the transaction or become insolvent because of the transaction.

If the court determines that a transaction is made at undervalue, the transaction will be voidable by the liquidator and the court may make an order to restore the company to the position it would have been in, had the company not entered into that transaction. However such an order will not be made if the transaction was made in good faith and for the purpose of carrying on the company business, or there were reasonable grounds for believing that the transaction would benefit the company.

These safeguards in the amendments will give directors protection, however directors should take steps to ensure that there are documents to properly substantiate transactions if they could be seen to be at undervalue. The financial records should also confirm the solvency of the company at the time the transaction was made. The amendments will not have retrospective effect, but a director may find that after he or she leaves a company and the company later becomes insolvent, transactions that were made during the director’s tenure are reviewed from an entirely different perspective by a liquidator looking for ways to claw back a benefit for the creditors.

Unfair Preferences

There is currently an unfair preference regime in Hong Kong for Hong Kong corporate insolvencies which is connected to provisions in the Bankruptcy Ordinance. The proposed amendments introduce stand-alone provisions that remove anomalies arising from reliance on the Bankruptcy Ordinance. This provides clarity.

In an insolvency context, an unfair preference will arise where a company does an act that will place one (for example) creditor in a better position that it would have been, had that act that gives the preference not been done. For the provisions to apply, the company must be insolvent at the time or become insolvent because of the transaction.

A court may set aside the transaction if made within 6 months before the commencement of the winding up, and if the preference was given to a person “connected with the company” then the court may go back 2 years.

In essence, the proposed amendments should give effect to the Unfair Preference regime. All unfair preferences (as defined) will be caught, and the changes will expand the scope and operation of the provisions. It is likely that claims by a liquidator that a payment was an “unfair preference” will grow in prominence in Hong Kong once the amendments commence operation.

Commencement

The proposed sections that make transactions at undervalue and unfair preferences voidable will not apply to transactions made or unfair preferences given by a company before the commencement date.

Conclusion

These changes are designed to assist liquidators in recovering funds for creditors in the event of insolvency. Although there are no proposed penalty provisions to place specific liability on the directors, once the proposed amendments commence operation, directors will be well advised to ensure that there is sufficient documentation and evidence to rebut any liquidator’s concerns about a transaction being made at undervalue, or the making of an unfair preference.

For any queries regarding this e-news or other questions regarding corporate law or insolvency, experienced lawyers in our Corporate department or Litigation and Dispute Resolution department would be happy to assist you.

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