Real and discernible benefit – Hong Kong court sets out principles for winding up offshore holding companies
Jonathan Leitch, Partner, and Nigel Sharman, Senior Knowledge Lawyer, Hogan Lovells, Hong Kong, explain some recent court judgments and clarify the key issues that need to be addressed in applications for the winding-up of companies with offshore-incorporated subsidiaries controlling operating subsidiaries in the Mainland.
In two recent judgments, the Hong Kong companies court has set out the principles applicable to winding up companies holding operating subsidiaries in the Mainland through intermediate subsidiaries incorporated offshore, most commonly in the British Virgin Islands (BVI).
In doing so, the Honourable Mr Justice Harris highlighted the need for the petitioner to demonstrate a ‘real and discernible benefit’ to creditors, something which will be challenging to prove if the company’s centre of main interests is not in Hong Kong.
In Re Grand Peace Group Holdings Ltd  HKCFI 2361 (Grand Peace), Harris J considered an application to substitute a petitioner in respect of a Bermuda-incorporated, Hong Kong listed company that was having difficulty restructuring its debts. The petitioner also wanted to persuade the court to make an immediate winding-up order.
The question before the court concerned the court’s jurisdiction to make the order requested. The company said it would not seek an immediate dismissal of the petition should the application prove unsuccessful, as it accepted the reality was that if the restructuring eventually failed, liquidation would be inevitable.
Three core requirements
The main issue that arose was the Hong Kong court’s jurisdiction to make a winding-up order for this foreign incorporated company.
Section 327 of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32) sets out three core requirements that must be met before the court will exercise its discretion to wind up a foreign incorporated company.
- There has to be a sufficient connection with Hong Kong, but this does not necessarily have to consist of assets present within the jurisdiction.
- There must be a reasonable possibility that the winding-up order would benefit those applying for it.
- The court must be able to exercise jurisdiction over one or more persons in the distribution of the company’s assets.
There was no dispute that the first and third core requirements were met. The only dispute concerned the second core requirement.
Harris J said it was ‘futile’ for the Hong Kong court to appoint liquidators over a Bermuda-incorporated company in order to take control of the BVI subsidiaries (with the aim, in turn, of taking control of their Mainland subsidiaries), since the BVI courts would not recognise the liquidators. Harris J said the correct approach would be to seek to wind up the holding company in its place of incorporation.
The court carefully considered – but ultimately rejected – the petitioner’s suggestion that since the majority of directors were in Hong Kong, and thereby subject to the in personam jurisdiction of the Hong Kong court, the liquidators could apply to the court for an order that the directors execute the documents necessary for the liquidators to take control of the BVI subsidiaries.
As Harris J had explained in his earlier decision in Re China Huiyuan Juice Group Ltd  1 HKLRD 679, it is a principle of BVI private international law that only a liquidator appointed by the court of the place of incorporation will be recognised and given assistance. This principle is echoed in Hong Kong law, which holds that matters concerning the constitution and management of the affairs of a foreign company are determined by the laws of the place of incorporation.
Even if the Hong Kong court were to take the view that the principle did not prevent the making of an order in respect of assets within its jurisdiction (as in this case, the shares of a Hong Kong company), ‘it would seem to me highly questionable whether it should do so in respect of an asset in another jurisdiction, particularly if that jurisdiction’s own substantive law would not recognise the Hong Kong winding-up.’
Harris J concluded that it seemed wrong to proceed on the basis that if he were to make a winding-up order, the liquidators would be able to obtain control of the BVI subsidiaries by seeking orders against the company’s directors, unless there were some other overriding principles which justified treating the Hong Kong liquidators as the agents of the company.
Powers of directors lapse
In determining whether the second core requirement is satisfied (that is, whether there was a reasonable possibility it would benefit those applying for it), the petitioner ‘must be able to point to a discernible and real benefit’ to creditors.
It was ‘not necessary for the petitioner to identify with great precision what the benefit will be or quantify with exactness the benefit’s alleged value. However, the court must be satisfied that the benefit is tangible and justifies putting in motion the entire Hong Kong insolvency regime…’
The requirement could be satisfied if it could be demonstrated that the centre of main interests (COMI) of the BVI subsidiaries was in Hong Kong and that what was sought was the making of applications pursuant to the new Hong Kong–Mainland insolvency arrangement.
The court said it was trite in English law – and there appeared no reason to suggest that the law in Hong Kong was any different from the English position – that in the case of compulsory liquidation, once a company has been ordered to be wound up and a liquidator appointed, the powers of directors cease and the liquidators are the only agents of the company in liquidation with power to act on its behalf.
Harris J said he assumed that the same situation applies in Bermuda and BVI. So even if a winding-up order were made, the liquidators would not be able to obtain control of the BVI subsidiaries unless other factors were present.
The court noted that these objections could be overridden under the insolvency arrangement if it could be demonstrated that:
- the centre of main interests of the BVI subsidiaries was in Hong Kong for six months or more prior to the application for recognition being commenced in the Mainland, and
- an application is made to the Mainland’s Intermediate People’s Courts concerning the appointment of liquidators in Hong Kong.
If the conditions are satisfied, then the insolvency arrangement would apply to the winding-up, regardless of where the company is incorporated and, in these circumstances, the court would be able to make in personam orders against the company’s directors.
Harris J said he was not satisfied that the second core requirement had been met in this case, particularly as most of the assets were owned through BVI incorporated entities, which could only be accessed by liquidators appointed in Bermuda. Whilst the evidence suggested that most of the BVI subsidiaries did have their COMI in Hong Kong, one did not. In addition, since the company’s shares were now delisted, the company’s listed status had lost its value.
Harris J held that the petitioner was unable to point to a discernible and real benefit, and so failed to satisfy the second core requirement. The court dismissed the substitution application with costs paid to the company and listed the petition for hearing.
Two in a row
Similar factors applied in Yao Weitang v China Creative Global Holdings Ltd  HKCFI 2814, with Harris J again considering whether the second core requirement had been met.
The court said that the company, which was listed in Hong Kong and incorporated in the Cayman Islands, had not engaged in a responsible way with its creditors to address the repayment of its debts and appeared to be under the control of directors who had misappropriated nearly all of its assets.
Harris J said it was clear the company should be wound up and would have been wound up if the petitioner had issued a petition in the Cayman Islands.
The petitioner advanced two matters, which it claimed constituted a real and discernible benefit. The first was bank and cash balances, but the court noted there was insufficient cash in the company’s Hong Kong bank accounts to justify making a winding-up order. The second again concerned obtaining control of BVI intermediate subsidiaries controlling subsidiaries in the Mainland.
The petitioner did not have access to the company’s financial records and neither was there evidence that the subsidiary’s COMI was located in Hong Kong. Harris J found the second core requirement had not been met and declined to make the winding-up order.
Grand Peace swiftly reconsidered
Harris J was asked to consider whether he might have been wrong on the issue of the court’s discretion to make in personam orders against directors in a case he heard subsequently.
In Re Evergreen International Holdings Ltd  HKCFI 2694, a creditor asked him to consider whether certain observations of Ma CJ and Lord Millett NPJ in the Court of Final Appeal case Kam Leung Sui Kwan v Kam Kwan Lai (2015) 18 HKCFAR 501 (the Yung Kee case), meant that the court did have discretion to make in personam orders against directors.
Harris J said that whilst he did not have to decide the point straight away, it was important for any future consideration to understand whether the comments would be relevant to consideration of the second core requirement and also whether it would apply to the kinds of situations seen in Grand Peace, since the Yung Kee case concerned a solvent company and a dispute between ultimate beneficial owners, all of whom were resident in Hong Kong.
The three decisions considered together underline several key issues that will be important for future petitioners to ensure are properly addressed in future applications for the winding-up of offshore-incorporated holding companies:
- The clear preference of the Hong Kong court is for petitioners to commence winding-up proceedings in the debtor’s jurisdiction of incorporation.
- If this is not possible (or desirable), it may be permissible to approach the Hong Kong court if the provisions of the new cross-border insolvency arrangement apply. This means the company’s COMI must have been in Hong Kong for a period of at least six months and an application must be made to the Intermediate People’s Courts following the procedure set out in the new cross-border insolvency arrangement.
- Careful consideration should always be given as to whether the second core requirement can be satisfied. If the petitioner is not able to demonstrate a discernible and real benefit, the application is unlikely to be successful.
Jonathan Leitch, Partner, and Nigel Sharman, Senior Knowledge Lawyer
Hogan Lovells, Hong Kong
Copyright © Hogan Lovells October 2021