Hong Kong: Insolvency Provisions Under the Companies Law Applied to State Owned Enterprises

Last Updated: 26 September 1995
This article is intended to provide a general guide to the subject matter. Specific advice should be sought about individual circumstances. Further information or advice may be obtained from Linklaters & Paines, Hong Kong office, 14th Floor, Alexandra House, Chater Road, Hong Kong; telephone: (852) 2842 4888; fax: (852) 2810 8133; contact David Mullarkey or Jeremy Parr.

The Companies Law applies only to companies limited by shares and limited liability companies formed under the present Companies Law or previously existing companies laws.

The Companies Law would apply to state owned enterprises if they have been converted into companies limited by shares or limited liability companies. This will be the case when a state owned enterprise is restructured as a wholly state owned limited liability company, or as a company limited by shares owned partly by the state and partly by other investing entities.

It is unclear whether the Companies Law would apply to foreign investment enterprises ("FIEs"). Article 18 of the Companies Law states that in respect of limited liability companies with foreign investment, the Companies Law would apply unless over-ridden by laws with respect to FIEs. The PRC authorities have been known to apply laws by analogy, i.e. filling in areas of legislative vacuum with legislation from similar areas. Therefore it is probable that the insolvency provisions under the Companies Law may be taken to supplement the provisions with regard to FIEs, if the latter should be found lacking.

Insolvency under the Companies Law

Part 8 of the Companies Law contains provisions with regard to the insolvency, dissolution and liquidation of companies.

The Civil Procedure Law and the Civil Procedure Law Opinion would also be applicable to companies, in addition to the provisions under Part 8. It would seem that the Civil Procedure Law and the Civil Procedure Law Opinion would supplement the Companies Law in respect of the insolvency provisions, although in the event of conflict, it would seem that the Companies Law would have precedence, only because it is much more recent.

A. When can a company be liquidated

There are provisions here for mandatory liquidation and voluntary liquidation.

Article 189 of the Companies Law provides that a company may be declared bankrupt by the court because it is unable to pay its debts as they fall due ("mandatory liquidation by reason of bankruptcy"). The consequences here are governed by the Companies Law and Chapter 19 of the Civil Procedure Law.

Article 192 provides that a company may be ordered to close down because it has violated laws or administrative regulations. The consequences here are governed by the Companies Law primarily.

Article 190 provides for voluntary liquidation, where the company may be liquidated when:-

(a) a ground for dissolution as specified in the company's articles of association arises, for instance, where the duration of the company expires;

(b) the shareholders' meeting resolves to liquidate the company; or

(c) such liquidation is necessary as a result of the merger or division of the company.

The consequences here are governed primarily by the Companies Law.

B. Procedures for liquidation

1. Mandatory Liquidation

In respect of mandatory liquidation by reason of bankruptcy under Article 189 of the Companies Law, the creditors may apply to a court for the company to be declared bankrupt, or the company may itself apply to the court to be declared bankrupt.

In this case, the court will form a liquidation committee comprising the shareholders of the company, representatives from the authorities and professionals. This committee will implement the liquidation of the company.

Much of what is done by the liquidation committee is identical to that undertaken by the liquidation committee in the case of a voluntary liquidation, which will be discussed below in detail. Under the Civil Procedure Law, which applies only to a mandatory liquidation by reason of bankruptcy, provision is made for a creditors' meeting and a scheme of arrangement, whereas the Companies Law is silent on this.

Article 200 of the Civil Procedure Law provides that the creditors may organise a creditors' meeting and discuss disposal and distribution methods or a scheme of arrangement. Article 202 provides that if a company and the creditors agree on a scheme of arrangement, the court shall approve and announce the terms of the scheme of arrangement and suspend the liquidation. The scheme of arrangement will take legal effect from its date of announcement.

Thereafter, the assets will be distributed in the ranking order if the assets are insufficient to settle all claims in full, the assets will be distributed in proportion amongst the creditors.

The Civil Procedure Law does not say what would happen if the creditors and the liquidation committee of the company cannot agree on a scheme of arrangement.

In respect of mandatory liquidation under Article 192 of the Companies Law (where the company is ordered to close down because of its violation of applicable laws and regulations), the court will appoint a liquidation committee, and thereafter, the consequences are governed by the Companies Law, which will be discussed in detail below.

2. Voluntary Liquidation

A company may be liquidated voluntarily under three conditions set out in Article 190 of the Companies Law:-

(a) where a ground for dissolution arises under the company's articles of association;

(b) a shareholders' meeting resolves to dissolve the company; or

(c) the dissolution is necessary as a result of the merger or division of the company.

Once it is decided that the company is to be liquidated under these grounds, the company must establish a liquidation committee within 15 days. In the case of a company limited by shares, the liquidation committee will comprise such members as will be decided by the shareholders in general meeting. (If no liquidation committee is established within the time limit, the creditors may request the court to form a liquidation committee.)

The liquidation committee will exercise the functions of examining the property of the company, preparing a balance sheet and property list, notifying the creditors, disposing of the property and dealing with all claims.

The liquidation committee will notify the creditors within 10 days of its establishment of the company's liquidation, and within 60 days of its establishment, it must make at least three newspaper announcements of the liquidation. Creditors must declare their claims to the liquidation committee within 30 days of the receipt of any written notification by the liquidation committee or within 90 days from the date of the first announcement of the liquidation. The Companies Law is silent as to what would happen if the creditors fail to notify their claims within these time limits, although Article 200 of the Civil Procedure Law provides that such failure to notify claims within the time periods will be deemed as an abandonment of the claims.

After the liquidation committee has examined the company's property and prepared a balance sheet and property list, it must formulate a liquidation plan. This will be submitted later to the shareholders' meeting or authorities in charge for confirmation.

If the company's property is sufficient to pay its debts in full, the priority of payment shall be as follows:-

(a) payment of the liquidation expenses;

(b) payment of the wages and labour insurance premiums of the staff;

(c) payment of the outstanding taxes;

(d) payment of the debts of the company; and

(e) distribution of the balance of the property amongst the shareholders of the company pro rata to their shareholdings.

The Companies Law does not provide for the position of a secured creditor. Article 241 of the Civil Law Procedure Opinion states that in the case of a mandatory liquidation by reason of bankruptcy, secured creditors will have priority in front of the queue for repayment; holders of secured debts other than mortgagees must obtain the permission of the court for priority repayment.

If the company is unable to meet all its debts and creditors claims, the liquidation committee will apply to the court for a declaration of bankruptcy. Thereafter, the company's liquidation committee will turn over the liquidation matters to the court, who will in turn organise its liquidation committee. In this event, the consequences will be much the same as those relating to a mandatory liquidation of the company by reason of bankruptcy, see the section on Mandatory Liquidation above. It should be noted that the provisions in the Civil Procedure Law in respect of creditors' meetings and scheme of arrangement will then be applicable.

During the course of liquidation, the company may not engage in new business activities, and the company's property may not be distributed otherwise than in accordance with the ranking discussed above.

Article 198 provides that if members of a liquidation committee wilfully or through gross negligence cause the company or its creditors to suffer loss, they will be liable to compensate the company or the creditors.

Article 197 provides that after the completion of the liquidation, the liquidation committee will submit a liquidation report to the shareholders' meeting and the authorities for confirmation, and lodge the report with the company registry. In addition, the company will apply for the cancellation of its registration with the company registry and announce its termination.

For further details, see the article headed "General framework of insolvency in the PRC".

Further information or advice may be obtained from Linklaters & Paines, Hong Kong office, 14th Floor, Alexandra House, Chater Road, Hong Kong; telephone: (852) 2842 4888; fax: (852) 2810 8133; contact David Mullarkey or Jeremy Parr.

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