Hong Kong's new Companies Ordinance will come into force on 3 March 2014. Much of its content is designed to modernise Hong Kong companies and make them easier to operate. Historically, certain aspects of the Hong Kong company law regime have encouraged the use of offshore vehicles, typically in Bermuda, the Cayman Islands and the British Virgin Islands. Will the modernisation exercise in the new legislation reduce demand for such vehicles?
Before dealing with the relative merits of the companies legislation in the various jurisdictions, one point worth noting is that stamp duty will remain payable on most transfers of shares in Hong Kong companies. There is no stamp duty in Bermuda, Cayman or the BVI on transfers of shares, and so the use of such companies will deliver a saving on any subsequent transfer of shares (unless the transfer of the shares in the offshore vehicle attracts stamp duty for some other reason, e.g. by virtue of a listing on the Hong Kong Stock Exchange). This alone may explain the popularity of offshore vehicles for many in the business community in Hong Kong. For others, however, the relative ease of use of a corporate vehicle may be a factor.
The new Ordinance retains the prohibition against financial assistance for both public and private companies, but adds further exceptions to those currently available and simplified the "whitewash" procedure. In the major offshore jurisdictions, including Bermuda, Cayman and the BVI, there is no prohibition against financial assistance, making even a simplified whitewash procedure (or the need to seek out an exception) relatively onerous. In addition, while Hong Kong-incorporated subsidiaries are unable to provide financial assistance for the acquisition of shares in their Hong Kong-incorporated parent company, offshore subsidiaries of the Hong Kong parent should continue to be able to provide such financial assistance following Arab Bank v Mercantile Holdings. This can be useful when selling a group to a buyer who needs to finance the acquisition.
While the new Ordinance will introduce numerous welcome measures such as simplified financial reporting for small and medium-sized enterprises that satisfy certain criteria, an audit requirement will remain. This can be contrasted with the various offshore jurisdictions, where audits are not required or, in the case of Bermuda, the requirement can be waived by the directors and members.
Removal of Requirement for Memorandum of Association/Authorised Capital
The new Companies Ordinance does away with the requirement for a memorandum of association: the constitution of a Hong Kong company will now consist solely of its articles of association (and, for existing companies, the provisions of their memoranda will be deemed to be part of their articles). The new Ordinance also provides that, unless the objects of the company are restricted in its articles, there will be no restrictions on its powers. While removing the requirement for a separate memorandum of association, the only consequence per se is a change to the drafting and presentation of a Hong Kong company's constitutive documents. It is interesting to note that, while the directors of a Hong Kong company who cause it to exceed its powers will be in breach of their duties (and liable to the company for the consequences), those acts will remain valid for a third party dealing with the company in good faith.
This mirrors the position in the BVI and Cayman, while Bermuda company law does not provide third parties with such protection. Interestingly, while conventional BVI business companies enjoy unfettered capacity (at least as far as a third party dealing with them in good faith is concerned), the BVI does offer the ability to incorporate a "restricted purpose company". This specialist vehicle veers away from the standard offshore company model, with its wide corporate powers, and instead provides a vehicle which can be legally restricted to only enter into specific transactions. If the restricted purpose company engages in an activity that is not listed in its constitutional documents, then those transactions are deemed void, whether or not the counterparty is dealing with the restricted purpose company in good faith. These vehicles can be useful in transactions where a company is required not to depart from a specific core purpose. The strict treatment should it do so is not available if a Hong Kong company is used.
Capital Increases and Share Issues
Another requirement that will no longer apply to companies formed after the new Ordinance becomes effective is the need for an authorised capital. This will mean that shares can be issued without the need to create additional capital "headroom". This is already the position in the BVI where a company can issue unlimited number of shares or a maximum number as specified in its memorandum of association, but the requirement for an increase in the authorised share capital of Cayman and Bermudian companies remains. However, the new Ordinance does require shareholder approval before directors may issue shares, which rather negates this advantage. There is no such requirement for Bermuda, Cayman and BVI companies, which makes private companies incorporated in these jurisdictions easier to administer (although such a requirement can be built into their constitutive documents if required).
The new Ordinance also does away with the par value of shares. Shares in BVI and Cayman companies may (but do not need to) have a par value: the choice remains with the promoters of the company.
Reductions of Capital
The new Ordinance allows companies to undertake capital reductions without the need for court approval, provided that the company has first obtained a special resolution from disinterested shareholders, published its intention in the Government Gazette and provided that it will, following the capital reduction, satisfy a new statutory solvency test. The solvency test is passed if the company will be able to pay its debts as they become due during the 12 months immediately following the reduction of capital, and immediately after the capital reduction there will be no ground on which the company could be found to be unable to pay its debts.
This echoes the position in Bermuda where the shareholders can approve a reduction of share capital provided that on the date the reduction is to be effected, there are no reasonable grounds for believing that the company is, or after the reduction would be, unable to pay its liabilities as they become due. In Cayman, a court order is still required, while a much more liberal regime operates in the BVI, where the maximum number of authorised shares of a company can simply be changed by amending the memorandum of association without the need to pass any solvency or asset test.
The new Ordinance removes the need for a company to pass a "headcount" test. As with many jurisdictions whose companies legislation is based on its English equivalent, Hong Kong has historically required schemes of arrangement to be approved by a majority in number representing three quarters by value of the members or creditors (as applicable) of a company. It will no longer be necessary to satisfy the headcount test where a scheme of arrangement involves a takeover offer or a general offer to buy back shares in a Hong Kong company: such a scheme may be approved by shareholders holding three quarters of the voting rights in a company, provided that the dissenting votes do not exceed 10 per cent of the voting rights attached to all disinterested shares in the company. This is a welcome development for Hong Kong companies.
While it remains to be seen whether the major offshore jurisdictions will follow suit, it is worth nothing that a BVI or Cayman target can be acquired by way of merger (including a merger with a foreign company in the case of a BVI target), with the approval of a simple majority of shareholders (in the BVI) or a two-thirds majority (in Cayman). In Bermuda, the approval threshold is a three-quarters majority, unless the bye-laws provide otherwise. In an acquisition context, therefore, a facility already exists in the offshore jurisdictions to allow a company to be acquired without applying a headcount test to its shareholders.
The new Companies Ordinance does provide for an amalgamation procedure for Hong Kong companies, provided that they are wholly owned entities within the same group.
In relation to the above matters, with the possible exception of the lack of a headcount test for schemes of arrangement, offshore vehicles incorporated in Bermuda, the BVI or Cayman are at no disadvantage to their Hong Kong counterparts. In addition, offshore companies also continue to enjoy numerous additional advantages over their onshore cousins, including the ability to redomicile, the ability to choose from a greater variety of corporate vehicles, and enhanced confidentiality.
A feature of companies incorporated in most offshore jurisdictions is the "continuation" or "redomiciliation" process. In essence, this means that a company can migrate from one jurisdiction to another, and the entity, on its arrival in the new jurisdiction of choice, is deemed to be the same entity that left the previous jurisdiction. This means that if an offshore jurisdiction is no longer favoured (for whatever reason), the owners can move it to any other offshore jurisdiction that has corresponding legislation (most offshore jurisdictions do). The only available alternative in Hong Kong would usually be a share swap with the newly formed company in the destination jurisdiction, or a more complex scheme of arrangement.
Availability of Different Corporate Vehicles
In addition to the numerous advantages discussed above, Hong Kong's companies legislation does not provide for certain entities that exist in the offshore world. In addition to the restricted purpose company referred to above, the offshore world offers segregated portfolio companies (SPCs) and protected cell companies (PCCs). These are single legal entities whose assets and liabilities can be allocated to different cells or portfolios within the company. The assets and liabilities of those portfolios and cells are ring-fenced from those of other portfolios or cells, making them useful for funds or captive insurance arrangements.
Certain offshore jurisdictions also offer incorporated cell companies, which are near-relations of SPCs and PCCs but where each cell constitutes a separate legal entity.
BVI and Cayman companies, in particular, offer a degree of confidentiality not found in Hong Kong companies. In both jurisdictions, the register of members and the register of directors are not required to be made available to the public.
In conclusion, many of the steps taken are positive, and result in a much-needed modernisation of Hong Kong's companies legislation. There remain, however, numerous advantages to the use of offshore companies: even when a parent company is incorporated in Hong Kong, the ability of offshore subsidiaries to provide financial assistance without prohibition is an incentive to continue with their use within a group structure. In addition to those advantages identified above, offshore companies enjoy greater flexibility (especially when privately held) than their Hong Kong counterparts.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.