The document summarizes the use of provisional liquidation as a tool for corporate rescue in Hong Kong. It discusses how provisional liquidators can safeguard a company's assets, continue operations, and potentially restructure the company through a scheme of arrangement. It also provides an example of how provisional liquidators marketed and sold a distressed company as a going concern, resulting in full payment to preferential creditors and a substantial distribution to unsecured creditors.

2. Webinar on Current Issues in Corporate Recovery and Insolvency Provisional Liquidation as a Tool for Corporate Rescue & Liquidators’ Investigations Presented by : Mr. Stephen Briscoe Date: 13 December 2011

3. Provisional Liquidation as a Tool For Corporate Rescue

4. Hong Kong has no formal corporate rescue procedure and hence no moratorium What is the significance of the absence of a moratorium Provisional Supervision was first proposed as far back as 1997 Based on our present understanding there is no prospect of it being enacted before 2014. The market has effected corporate rescue using a mixture of provisional liquidation and schemes of arrangement depending on the circumstances Background to Corporate Rescue in Hong Kong

5. Fundamentals of Provisional Liquidation PL is available when a winding-up petition has been presented and there is jeopardy to the Company’s assets Jeopardy needs to be established to the satisfaction of the Court PLs have limited powers – no power to dispose of assets PLs key role is to safeguard the assets until the hearing of the petition and the appointment of a liquidator PL is not a vehicle for restructuring (Legend International Resorts) PLs can seek additional powers from the Court

6. Appointment of Provisional Liquidators Application for appointment of PLs is either ex-parte or ex-parte on notice Often happens within days of the filing of the petition Usually heard by Companies Judge although it can be heard by the Duty Judge The application does not have to be by the party which filed the petition although it usually is In that case, the petitioner should be notified and given the opportunity to be heard Frequently, the application is made by the Company itself when it is under pressure from creditors

7. Role of Provisional Liquidators Key roles are to Secure and safeguard the Company’s assets Report to Court as appropriate Continue trading if appropriate in the circumstances Convene meetings of creditors and shareholders once the winding-up order has been made It is not the role of the PL to Sell or otherwise dispose of assets Deal with the claims of creditors Investigate the affairs of the Company (unless so ordered by the Court) Participate in a restructuring of the Company unless given such power by the Court

8. Outcome of Provisional Liquidation There are four potential outcomes A winding-up order is made, meetings of creditors and shareholders are held and a liquidator is appointed A winding-up order is made and liquidators are appointed by the Court pursuant to a Regulating Order For a variety of reasons the Court may make an order discharging the PLs and returning control of the Company to the existing shareholders and management The Company is restructured and exits from PL through a scheme of arrangement

9. X Ltd S was a company incorporated in Hong Kong It had a manufacturing operation in Guangzhou It had sales outlets in Europe and the USA It had invested heavily in new plant & machinery in 2006/7 It was badly affected by the financial crisis which started in 2008 There were disputes between management, directors, shareholders and loan creditors The Company was experiencing severe cash flow difficulties

10. Cash flow problems from the date of their appointment Sluggish sales in the Company’s major markets (2008/09) Arrears of rent to the landlord of the factory in PRC Overdue accounts payable to suppliers in PRC Cash flow forecasts showed the Company was running out of funds to continue its day-to-day operations The value of the business as a going-concern was significantly greater than its value on a break-up basis However, the PLs would run out of cash before they were likely to be appointed as liquidators. Problems Faced by the Provisional Liquidators

11. Visit the factory in PRC and warehouse in Europe Prepare cash flow forecast for the business as a whole Instruct valuers to provide going-concern and break-up valuations of the Company’s assets Consider the options available to dispose of the assets in the manner designed to maximise recoveries for the general body of creditors Devise and implement plan Provisional Liquidators’ Initial Actions

12. The PLs decided to proceed to market the business with a view to selling it as soon as possible before it ran out of cash Prepared a “sales pack” describing the business, its assets, customers etc Advertised the business extensively in the appropriate media Required potential purchasers to sign a non-disclosure agreement Sought offers by closing date of the tender, together with the full purchase price to be held by our solicitors Acceptance of best offer subject to approval of the sale by the Court Provisional Liquidators’ Plan (1)

13. Potential purchasers were made aware of the sale process Sales packs were distributed to interested parties after non-disclosure agreements had been signed. Interested parties made aware of the closing date for offers Offers were to be submitted to the PLs solicitors Highest offer “accepted” but subject to application to Court by PLs for approval. PLs application made on an ex-parte basis The sale was approved by the Court which said that it would not substitute its views for the commercial judgment of the PLs Provisional Liquidators’ Plan (2)

14. The outcome of the liquidation was:- Payment in full to all the preferential creditors Substantial distribution to unsecured creditors Much better outcome than would have been the case had PLs not been appointed Employment of most of the group employees was retained The ongoing business continued to trade and generate custom for its old trading partners Outcome of Liquidation

15. Liquidators’ Investigations

16. Statutory Disqualification reports Reports to Court Reports to others as appropriate Commercial To uncover undisclosed assets To find evidence to support claims against third parties or related parties To uncover and if possible take action to reverse antecedent transactions To find evidence to support possible misfeasance claims Reason for Investigations

17. Review all bank statements for last 6 months or 2 years if appropriate Identify material transactions both in and out Consider material transactions in conjunction with accounting records to ascertain identity of payees and source of payments in Obtain supporting information from the bank where the information is not available from the Company’s accounting records. Seek explanations as appropriate from the directors Bank Statements

18. This is a list of the Company’s assets and liabilities It must be prepared by the Directors of the Company In a compulsory liquidation it should be filed within 28 days of the making of the winding-up order In a voluntary liquidation it should be presented to the creditors at the meeting of creditors It is one of the starting points for the liquidator’s investigations He should compare the assets and liabilities in the SoA with those shown in the latest audited accounts and the latest management accounts Statement of Affairs (1)

19. Review discrepancies in respect of assets What is missing Where has it gone If it was sold, what was the consideration Was the consideration actually paid What happened to the consideration – how was it utilised Review discrepancies in respect of liabilities If liabilities have been repaid Who to and when Were the parties connected to the Company or its directors Does this raise possible unfair preference issues Statement of Affairs (2)

20. These should provide the base documents supporting the liquidators’ investigations The liquidators must secure them immediately following his appointment Also be aware of the fact that the records may be required for other purposes, for example by CCB in the event of criminal complaints Must be carefully sorted, catalogued and stored to facilitate easy access during the course of the liquidation Safeguarding electronic records Accounting Records

21. This issue is assuming greater importance than ever Copy or Forensic Copy Needs specific experience – not a D-I-Y option Key reasons:- Ability to access information to assist liquidators in their investigations, recovery of assets and agreement of liabilities To support any future investigations by the liquidators or by regulatory authorities To support any criminal proceedings that may be instituted Safeguarding/Securing Electronic Records

22. These would include:- Solicitors Auditors Insurance Brokers Stockbrokers Tax Advisors Travel Agents Property Agents Invoices of Professional Advisors

23. Directors should provide all information that the liquidator asks them to provide in relation to the affairs of the Company They have a statutory duty to provide this information Employees have no such statutory duty but the liquidator will often want to interview/meet with some or all of the:- Accounting staff Sales staff Personal assistants to directors Sales managers Former members of staff can be extremely helpful to liquidators in their investigations Interviews with Directors and Staff

24. This section allows the liquidator to compel anyone who has information about the Company to provide it to him The purpose behind this section is to make sure the liquidator has all the information that he needs to do his job properly If a person will not provide the information voluntarily they can be compelled to do so on oath and cannot refuse to answer questions on the grounds that he might incriminate himself It can be an expensive and time consuming process, but can result in real financial benefits for creditors Section 221 Private Examinations

25. What are Antecedent Transactions The key transactions that can be attacked are:- S.182 – void dispositions Any payment made after the presentation of a winding-up petition is void unless validated by the Court Relatively straightforward process to recover – application to the Court as part of the liquidation for an order that the payment be delivered up by the recipient S.266 – unfair preferences If a person is a creditor and receives a payment from the company when it is insolvent and the payment is made within 6 months of the presentation of the petition (for all creditors) or 2 years (for connected creditors) it can be recovered for the benefit of creditors Case law and the legislation make it difficult to enforce this section sometimes, but it is often used as a bargaining chip when reaching settlements with recipients of such payments Identify Antecedent Transactions

26. A relatively new tool in the armoury of liquidators Potentially allows a liquidator to go back much more than the two years for an unfair preference Also allows a liquidator to chase “gifts” of company assets to third parties Its purpose is to allow the “ clawback ” of transactions the effect of which has been to defraud creditors The principles were established in the case of Tradepower which was decided by the Court of Final Appeal in Hong Kong and so is of great persuasion S.60 Conveyancing and Property Ordinance

27. Breach of fiduciary duty by directors Also applies to shadow directors – “someone on whose instructions the company is accustomed to act” The breach has caused loss to the Company Little case law in Hong Kong although this may change with the advent of third party litigation funding for liquidators Proceedings are part of the liquidation so there’s no need to start separate proceedings Often used as a bargaining counter in settlement negotiations Misfeasance

28. These can comprise many different types of claims:- Overdrawn current accounts Monies drawn from the company that have not been properly authorised Company assets that have been effectively misappropriated by directors (misfeasance) Unauthorised loans/payments Floating charges created in favour of directors for little or no consideration Typical Claims Against Directors or Associated Persons

29. Liquidators prefer to resolve by way of settlement rather than through proceedings Commercial settlements are almost always better than full-blown legal actions because of the cost implications and the time delays. However, if the case is appropriate and funds are available the liquidator will seek the approval of the Committee of Inspection to employ solicitors and commence proceedings Liquidator almost always face the problem of an application for security for costs by the defendant Reach Compromises or Settlements or Commence Proceedings

30. Litigation Funding for Liquidators

31. Key Issues For The Liquidator To Consider Is it an action that can be funded Earlier the better – events are fresh Has CoI been consulted – are creditors prepared to fund Application to Court Role of liquidator going forward

32. Overview Litigation funding is the contribution to the cost and disbursements of litigation by the funder in exchange for a percentage of any settlement monies. The Courts have historically disapproved of litigation funding Long line of authorities in the UK and Australia Until recently, no authority in Hong Kong Ongoing concern regarding impact of the principle of maintenance and champerty in Hong Kong

33. Benefits of Litigation Funding Permits creditors to pursue wrongdoers or actions Reduces risk for the creditors and the liquidators Equal recovery for creditors Helps to resolve liquidation in an orderly and expeditious way Settlement

34. Maintenance and Champerty Maintenance: “ The giving of assistance or encouragement to one of the parties to litigation by a person who has neither an interest in the litigation nor any other motive recognised by law as justifying his interference ” Champerty: a species of maintenance where in return for his support, the maintainer is promised a share in the recoveries.

35. Maintenance and Champerty CFA decision in Unruh v Seeberger [2007] HKCU 246 “ Common law rules making maintenance and champerty criminal offences, torts and a ground for public policy for invalidating tainted contracts were part of Hong Kong law prior to 1997 and remain applicable by virtue of Article 7 of the Basic Law ” Various instances where conduct which would otherwise constitute maintenance and champerty has been excluded from liability: “ common interest ” category cases involving “ access to justice ” considerations a miscellaneous category of practices accepted as lawful such as the sale and assignment by a trustee in bankruptcy to a purchaser for value

36. New Hong Kong Authorities Re Cyberworks Audio Video Technology Ltd [2010] 2 HKLRD 1137 Application by the Liquidators for leave to enter into an option and investigation agreement with Remedy (the “Agreement”) The Agreement provided for Remedy to conduct investigations into various causes of action vested in the Company, in return for an option to take an assignment of the causes of action. Application made on the papers but the Court asked to be heard on the legal principles recognising there was no authority in HK addressing the issue

37. Cyberworks, cont. s.199(2)(a) CO gives a liquidator power to sell the property of the Company A cause of action is a “chose in action” (which is property of the company), therefore s.199(2)(a) enables a liquidator to sell a cause of action vested in the company. Adopting the UK position, a liquidator has the statutory power to sell a cause of action to a litigation funder, together with a right to commence or continue proceedings , the consideration for which is the funder agrees to pay over a share of any sum recovered. Such an assignment as part of the type of funding agreement in this case is an exception to the prohibition on maintenance and champerty and is lawful.

38. Cyberworks, cont. The statutory power of sale does not extend to causes of action vesting in the liquidators personally, such as unfair preferences A liquidator can also assign the fruits of a cause of action, however in such circumstances the liquidator is not permitted to assign the liquidator’s discretionary power to prosecute and conduct the proceedings.

39. Geoffrey L. Berman Geoffrey L. Berman (In His Capacity as Trustee of the Lender Trust) v. SPF CDO I, Ltd and Others [2011] 2 HKLRD 815 Application by a US Chapter XI Trustee of a Liquidation and Lender Trust seeking sanction to enter into a funding agreement with a litigation funder Although Berman was not a Hong Kong appointed liquidator who could seek directions from the Court under the Companies Ordinance, as a trustee of an overseas trust, Berman could seek directions from the Court The key question before the Court was whether or not executing the funding agreement would constitute a criminal offence and whether it may be found void and unenforceable under Hong Kong law by infringing the prohibition against maintenance and champerty

40. Berman, cont. The Court of First Instance held that the funding agreement was not caught by the prohibition against champerty because it has a legitimate commercial interest, namely the funding of a claim that might otherwise not be capable of prosecution. It is a type of transaction that ought not to be stifled by the prohibition against champerty. There is now a line of authority in Hong Kong showing that the Hong Kong Courts are willing to approve litigation funding agreements in the appropriate circumstances.

41. Contact Details Stephen Briscoe Managing Director Briscoe Wong Ferrier Limited Phone: (852) 2899 2105 Email: stephenbriscoe@briscoewongferrier.com

42. 602 The Chinese Bank Building, 61-65 Des Voeux Road, Central, Hong Kong t 852 2899 2178 f 852 2899 2948 [email_address]