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HK investors need to know insolvency laws

Published on Friday, 11 Dec 2009
Anita So is senior manager, restructuring, investigation and insolvency, at Grant Thornton

Many small and medium-sized foreign-invested enterprises (FIE) on the mainland suffered losses during the past year as a result of the financial crisis. In some cases, this caused Hong Kong investors to shut down operations with a view to possibly restarting when markets pick up and opportunities improve.

If taking this course, it is important to understand and observe the correct procedures regarding bankruptcy and liquidation.

The central government enacted unified legislation and promulgated an enterprise bankruptcy law, which took effect in June 2007. All persons acting for a legal enterprise are subject to the law, although those working for financial institutions must also adhere to additional rules and regulations imposed by the State Council.

Under the enterprise law, an FIE may file its own bankruptcy petition with the people's court in the city where it is situated. One main criterion is to show "insolvency". The law introduced the concept of a "balance-sheet" test to determine if the company's liabilities exceed its assets and if it is unable to pay outstanding debts. Decisions on whether or not to accept registration of a bankruptcy petition are at the full discretion of the people's courts.

The FIE should submit a written application together with a statement of affairs, financial report, and lists of assets and liabilities. There should also be a status report on staff salaries and social insurance, and a settlement plan for employee entitlements. Usually the court will decide whether to accept registration of the bankruptcy petition within 15 days of application.

Experience shows that there can be inconsistencies in the way the law is applied or interpreted in different cities. In practice, it seems that courts with less experience in this area tend to reject petitions if the bankruptcy procedure was expected to be complex.

If the petition is accepted, the court will then appoint an administrator whose principal duty is to preserve the assets and operations of the FIE. The administrator may explore the possibilities of reorganisation or reconciliation and, if the court does allow an order for bankruptcy, will take possession and manage the remaining assets and liabilities. A committee of no more than nine representatives of creditors may be appointed to supervise the work of the administrator in handling and distributing assets.

The enterprise bankruptcy law also addresses the issues of attempted debt evasion. So, If the intentional or reckless behaviour of the directors, managers or other officers of the FIE caused bankruptcy, these individuals may be subject to personal liability and criminal prosecution. Other offences, which the law identifies, include non co-operation with the court and administrator, refusal to surrender the FIE's property, forgery or destruction of records and concealment of assets.

If Hong Kong investors do not duly complete the winding-up of an FIE on the mainland, the shareholders and de facto controlling parties may be held personally liable for the company's debts. Where significant debts and sums of tax payable are involved, criminal prosecution may follow. In addition, investors, legal representatives and senior managers may be prevented from making new investments in, or even visiting, the mainland. Alternatively, article 181 of the mainland's company law, in effect since January 2006, empowers shareholders to dissolve an FIE. The requisite condition for this type of non-bankruptcy liquidation is that the FIE must have sufficient assets to pay all debts.

A liquidation committee, formed within 15 days of the shareholders' resolution, will assume control of the FIE's assets and liabilities and formulate a plan. After settling payment of expenses, salaries, social insurance and severance entitlements, taxes and all debts, the remaining assets will be distributed to the shareholders. Compliance with the relevant laws will allow Hong Kong investors to reorganise their business activities on the mainland and make a fresh start in an organised and systematic way.

Anita So is senior manager, restructuring, investigation and insolvency, at Grant Thornton

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