Hong Kong: Second Judicial Interpretation Of The PRC Enterprise Bankruptcy Law

Last Updated: 1 July 2014
Article by Terry Kan

The People's Supreme Court of the PRC promulgated the second judicial interpretation on various issues in relation to the application of the PRC Enterprise Bankruptcy Law (EBL) on 16 September 2013 (2nd Interpretation) . It consists of 48 articles with a key focus to ascertain assets of the debtor company which is subject to bankruptcy proceedings (Debtor). This article highlights the key provisions in this 2nd Interpretation and the distinction between this 2nd Interpretation and the relevant Hong Kong insolvency provisions.

Overview

The 1st Interpretation of the EBL, was published on 26 September 2011 (1st Interpretation), provides detailed explanations of the insolvency tests that the PRC Court would accept when submitting a bankruptcy application. Compared to the 9 Articles of the 1st Interpretation, the 48 Articles of the 2nd Interpretation cover extensive issues relating to assets (see Table 1).

Table 1

Distinction between Debtor's assets and assets with diverse interests in ownership

According to the 2nd Interpretation, in addition to cash on hand and tangible assets, assets of the Debtor may include debts, equity, intellectual property, charged assets, interests in property (Art. 1 of 2nd Interpretation). Where assets are in possession of the Debtor arising from warehousing, custody, consignment, leasing and state-owned assets, they should not be regarded as Debtor's assets (Art. 2 of 2nd Interpretation).

For secured assets which have already been discharged or realised with surplus sale proceeds, they become free assets of the Debtor which are applicable to satisfy the bankruptcy costs and expenses (Art. 3 of 2nd Interpretation). Debtor with a joint or specific ownership interest in properties, the PRC Court declares that bankruptcy proceedings are valid grounds for the legal division of asset(s) according to the respective ownership interests (Art. 4 of 2nd Interpretation). Effectively, assets which may be available to creditors have been broadly elaborated in the 2nd Interpretation.

By contrast, the Statement of Affairs of a Hong Kong company in liquidation is the key source of information for assets that may be available for realisation (S. 190 of Hong Kong Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap.32)). Court appointed provisional liquidator or liquidator should take custody of all assets that a company is or appeared to be entitled (S. 197 of Cap. 32). The liquidator may apply to court for the vesting of property of a company which is being wound- up (S. 198 of Cap. 32). Typically, secured creditor(s) would prove their residual claim if there is a deficiency after realisation of the charged assets. Assets with disputed ownership would usually be determined by court if a commercial negotiation is not achievable.

Avoidance of attachments and preservation of assets

Articles 5 to 8 of the 2nd Interpretation ascertain that asset under the enforcement action would form part of the bankruptcy estate. Essentially, upon acceptance of a bankruptcy application by the PRC Court (the Relevant Date), any enforcement of the Debtor's property by creditor or interested party shall cease (Art. 5 of 2nd Interpretation; Art. 19 of EBL) and the underlying asset shall become available to the general body of unsecured creditors. Where bankruptcy application is dismissed or the bankruptcy proceedings are completed, original suspended enforcement action shall be resumed (Art. 108 of EBL).

Additionally, the Administrator may take out a court application to actively preserve Debtor's property from any enforcement. Creditor or interested party who has already preserved the assets of the Debtor should promptly remove such preservation measures after the Relevant Date.

These provisions are equivalent to Sections 181 and 183 of the Cap. 32 that aim to preserve assets subject to enforcement or execution at any time after the presentation of a winding-up petition but before a winding-up order has been made.

Voidable disposition of property and early repayment of debts

According to Art. 31 and 32 of the EBL, disposition of Debtor's property at unreasonable price, without consideration or triggered by the abandon of equity interests, would be subject to challenge. Administrator may invoke a court application to challenge the transferee to return the property and the Debtor to repay the sale proceeds. Failure of the Debtor to return the sale proceeds would enable the transferee to claim the estate at a priority immediately after the first ranking bankruptcy costs and expenses (Art. 10 &11 of 2nd Interpretation, Art 113 of EBL). Administrator should also note that their potential personal liability for not invoking a court application to pursue any voidable disposition of assets (Art. 9 of 2nd Interpretation).

Early repayment of premature debts by Debtor may also be regarded as disposition if repayment was made within 6 months prior to the Relevant Date, during which the Debtor was insolvent (Art. 12 of 2nd Interpretation). This Article is equivalent to the unfair preference claim in Hong Kong against creditors for receiving preferred payments or assets of Debtor in priority to other creditors. However, it is silent as to whether or not the burden of proof of intention to prefer is required and if the claw back period would extend beyond 6 months if payment was made to associates (S.266 & 266B of Cap. 32; S.50 of the Bankruptcy Ordinance (Cap.6) (BO)). It appears that the equivalent concept of associates is not set out in the 2nd Interpretation.

Interestingly, the PRC Court would support certain repayments by the Debtor. For example, settlement or composition arrangements in relation to (1) assets charged to secured creditor or (2) specific property of the Debtor, being an enforcement action of the decision of litigation or arbitration, is supported by the PRC Court. The exception is that if the underlying assets included in settlement arrangement is valued below the admitted claim or the settlement is arranged by collusion.

Article 19 of the 2nd Interpretation specifically stated that the Debtor's rights to sue its debtors shall cease at the Relevant Date. If however the Debtor has never commenced any legal actions against its debtors resulting in the expiry of the limitation period, which falls within 12 months before the Relevant Date, the PRC court shall determine the limitation period to resume from the Relevant Date.

Claims against contributories and management

The 2nd Interpretation empowers the Administrator to demand contributories to make up shortfall on unpaid capital or reverse any unauthorised distribution of capital of the Debtor. Management, founder or party with ultimate control or interest over the Debtor may also be liable for their failure to oversee such malpractice (Art. 20 of 2nd Interpretation). In addition, creditor is entitled to demand Administrator to pursue repayment from contributories to return Debtor's assets, failing which the Administrator runs the risk of replacement at court by the aggrieved creditor (Art 21 of 2nd Interpretation).

Further, directors or senior management are required to return their performance bonuses or non- regular income received from the Debtor from the exercising of their authorities or powers in their capacities. Claims arising from management on these repayments are regarded as unsecured ordinary debts (Art. 24 of 2nd Interpretation). In addition, the legal representative and management may be liable for any wrongdoings because of their intentional or grossly negligence resulting in losses of the Debtor's assets. They may also be liable for seizure of debtor's assets relying on invalid, fictitious or untrue debts (Art. 18 of 2nd Interpretation).

Liquidators in Hong Kong are empowered by law to recover unpaid calls and may claim against directors / officers who have misappropriated company's funds and breached of their fiduciary duties (S.213, 226 & 276 of Cap. 32). However, the Hong Kong court may validate application for payments out of the Debtor's estate should payments made were beneficial to the company, for example, for payment of on-going trading expenses (S.182 of Cap. 32) after presentation for winding-up and before order for liquidation.

Third party assets

The 2nd Interpretation allows the owner to claim for the return of third party assets from the Debtor. True owner should raise their claim on assets to the Administrator, and if not, to the Court. The Administrator may refuse such demand should there are outstanding counter-claims such as processing fees, custodial fees, commissions, agency and other expenses (Art 28 of 2nd Interpretation).

The 2nd Interpretation stipulates that if third party assets were sold by the Debtor, claims from the true owner shall be treated as follows (Art. 31 & 32 of 2nd Interpretation):

  • Assets sold before the Relevant Date - ordinary unsecured claims.
  • Assets sold after the Relevant Date - claim is ranked immediate after the first ranking bankruptcy costs and expenses as per Art. 113 of EBL.
  • Insurance compensation received in relation to third party assets - for any compensation which has not been refunded to the Debtor or it can be separated and distinguished from the general pool of the Debtor's assets, the PRC Court would support third party's claim on the compensation. Otherwise, the same treatment as above should be followed.

Table 2

Administrators should note their personal liability if third party assets are sold as a result of gross negligence. Claims arising on this basis shall have a priority immediately after the first ranking bankruptcy costs and expenses (Art 113 of EBL); and before the ordinary unsecured creditors. Administrator may be liable for any shortfall of unrecoverable sum from the Debtor's estate (Art. 33 of 2nd Interpretation).

It appears that there is no apparent provision in Hong Kong specifically to deal with the return of third party assets. Quite often, insolvency practitioner would duly examine title of assets with the assistance of solicitors, having regard to any claims of ownership or beneficial interests on the assets. Any issue of retention of title on assets should ring the bell of the insolvency practitioner requesting him/her to deal with them carefully. Otherwise, the insolvency practitioner may be liable for trespass and conversion of another's property.

Outstanding contracts in bankruptcy proceedings

Where there are contracts outstanding at the Relevant Date, the Administrator, under Article 18 of the EBL, should determine either to fulfil or terminate the contract within two months thereof. The 2nd Interpretation has explained the treatments of unfinished contracts if either the vendor or purchaser is in bankruptcy proceedings, which can be summarised in Table 2 below (Art 35 to 38 of 2nd Interpretation).

Practically speaking, provisional liquidator / liquidator in Hong Kong, immediately after their appointment, would review all outstanding contracts of a debtor company and decide whether to continue or terminate them. This would facilitate decision to trade on and minimise any potential exposure to third party claims.

Insolvency set-off

Article 40 of the EBL states that creditor can assert its rights of set- off against the Debtor on mutual debts amongst each other (Art. 41 of 2nd Interpretation). Set-off shall become effective when the Administrator receives notice of set-off issued by the creditor. Administrator who disagrees with the claim of set-off should appeal to the PRC Court within 3 months. Set-off would not be allowed if:

  • Debt due to the creditor from the Debtor are premature and not yet fall due at the Relevant Date;
  • Debt due to the Debtor from the creditor are premature and not yet fall due at the Relevant Date; and
  • Nature and type of debts between Debtor and creditor are different.

Further, set-off within 6 months prior to the Relevant Date may be voidable by the Administrator at the application to Court if such netting was transacted to extinguish specific debt when the Debtor was insolvent. Similarly, set-off arrangements between the Debtor's entitlement on its book debts owing by others and the unsecured portion of debt owing to a secured creditor may be voidable unless where the claim is a deficiency after realisation of the security (Art 44 & 45 of 2nd Interpretation).

Specifically, set-off is prohibited for debts due to the Debtor against any unpaid capital contributions of shareholders, in particular where the interests of the company are prejudiced because of the abuse of shareholder's rights (Art. 46 of 2nd Interpretation).

In general, insolvency set-off provisions in Hong Kong is mandatory, which takes place automatically where the mutuality of debts and credits or other mutual dealings between the same debtor and creditor are in place. Mutual dealings do not necessary relate to the same transaction (S35 of BO) insofar as the debtor and creditor are the same. Unlike the EBL, there is no specific 6 month period prior to the Relevant Date where set-off may be subject to be challenged.

Jurisdiction

Subsequent to the Relevant Date, any civil litigation subsequently filed in relation to the Debtor shall be dealt with and administered by the same PRC Court, which has accepted the Debtor's bankruptcy proceedings. In general, any previous provisions relating to corporate bankruptcy that are inconsistent with the current judicial interpretations will no longer be applicable (Art 47 & 48 of 2nd Interpretation).

Conclusion

The 2nd Interpretation provides comprehensive and practical rules for an Administrator to pursue asset preservation and recovery exercises in bankruptcy proceedings. It clearly empowers the Administrator to look for recoverable assets, raise challenges against management for unusual payments of remunerations; and deal with asset claims from third parties. Likewise, Administrator shall examine all outstanding contracts and any claims on set-off from creditors. In the event of a sizeable PRC bankruptcy case, for example with numerous pending contracts and dispute on third party assets, it would pose a real challenge to the Administrator to address all these matters with due care and diligence. Hence, the risk of exposure to personal liability of Administrator should not be underestimated.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions