Directors opposed to winding up the company with little more than a glimmer of hope that a restructuring proposal might bear fruit may have to carefully weigh their actions going forward, following a recent ruling by Hong Kong’s Companies Court. In Carnival Group International Holdings Limited [2022] HKCFI 2668, the Honorable Madam Justice Linda Chan ordered the directors of the Chinese property development company, who had opposed a winding-up citing an unrealistic restructuring proposal, to be joined as defendants in the proceedings for the possible purposes of awarding costs against their due to behavior.
Completed request
Carnival Group (the company, which is not related in any way to Carnival Corporation & plc) was an investment and property development holding company incorporated in Bermuda with shares listed in Hong Kong (HK:996). It had subsidiaries in Hong Kong, the mainland and the BVI (group). The group developed and operated theme-based restaurants and leisure complexes on the continent.
The company ran into financial difficulties and a winding-up order was obtained on 10 March 2020. In all the affidavits submitted by the company, the company did not dispute that the three essential requirements for the court to exercise its discretionary jurisdiction to wind up the company were satisfied.
The court rejected the company’s subsequent attempts to argue that the second essential requirement (that there was no reasonable possibility that a winding-up order would benefit those applying for it) had not been met. If the company had really believed this, it would have been expected that the company would have asked the court to dismiss the claim on jurisdictional grounds at a much earlier stage.
In this regard, the court noted that the company was principally registered in Hong Kong and maintained a principal office in Hong Kong where the directors managed the affairs of the group. The evidence showed that the company had substantial assets which could be realized for the benefit of unsecured creditors.
The company’s claims that there would be “cross-border insolvency barriers” were, in the court’s view, equally unfounded. There was no evidence that the directors of the mainland subsidiaries would refuse to co-operate with the Hong Kong-appointed liquidators and in any event, once the liquidators took control of the Hong Kong subsidiaries, they would be able to access the mainland subsidiaries.
A fruitless restructuring
The only reason put forward by the company in opposition to the petition was that there had been an ongoing restructuring effort related to the company’s debt, which it said would result in a higher return for unsecured creditors.
Linda Chan J observed that the so-called restructuring effort had failed. The case history showed that the company had used this pretext “to obtain numerous adjournments of the Petition” and had failed to comply with court orders requiring the company to submit sworn evidence to address the progress of the alleged restructuring. There was no evidence before the court to show that in the last two and a half years, the company had made any real effort to follow through on the restructuring proposals.
The court noted that in the absence of a workable restructuring proposal which had the requisite support of the requisite majority of creditors, “it would be the duty of the directors to take steps to put the company into liquidation in order to come into operation the statutory scheme for the closure of its affairs and assets”.
Linda Chan J said that despite knowing that the restructuring was unworkable, the directors “saw fit to cause the Company to continue to oppose the Petition” and “had even instructed senior counsel to raise the case”.
cheer of creditors
The directors involved in causing the Company to oppose the petition are now required to file and provide evidence as to why they should not be liable to pay the costs. The decision is potentially good news for creditors. In the absence of any wrongful commercial legislation in Hong Kong, the court appears to be going out of its way to emphasize that directors have a duty to consider whether there is any reasonable prospect of the company avoiding going into insolvency liquidation.
The court explained the nature of the duty, which it said was:
“Provided in the avoidance provisions under [Companies (Winding Up and Miscellaneous Provisions) Ordinance] such as s.266, which makes voidable preferences made when the company is unable to pay its debts, and s.275 which imposes liability on directors for fraudulent trading.
It also conforms to the principle that when a company is insolvent or of doubtful solvency, the interests of the company are in reality the interests of the creditors since it is the creditors’ money that is at stake. Directors, while performing their duty to the company, must prioritize the interests of creditors and take them into account when exercising their discretion.
The court has previously targeted Hong Kong-listed companies that are incorporated offshore, conduct business primarily on the mainland and appear to want to create de facto moratoriums on winding-up actions often to the detriment of the company’s creditors.
In a series of rulings, the court had previously warned that insolvency proceedings initiated by offshore “box of letters” jurisdictions – and where the powers of provisional liquidators to properly oversee any restructuring – would have more unlikely in the future to obtain recognition and assistance in Hong Kong (see Hogan Lovells alert “A magic spell” – Hong Kong court warns that it will carefully consider the viability of the restructuring).
This line of reasoning was given additional strength by Linda Chan J in her judgment in New Up Energy Development Group Limited [2022] HKCFI 1329, that where the three essential requirements for the winding up of a foreign company under section 327(1) of the CWUMPO are met, a Hong Kong court will be ready to take winding up jurisdiction (see Hogan Lovells alert Deja vu – Hong Kong Court Kongut orders closure of Bermuda-based listco despite objections from PLs).
Add to this, the decision of the honorable Mr. Justice Harris that, following this, it should be the Company’s Center of Principal Interests that should take precedence over the place of incorporation when it comes to recognition and assistance (see Hogan Lovells alert Hong Kong court emphasizes COMI over the place of incorporation when recognizing processes bankruptcy foreign), and you have the signs of a particular course correction when it comes to the operation of the so-called “soft touch” corporate bankruptcy.
New warning for directors in Carnival it seems to strengthen the tools of the courts when it comes to protecting the interests of creditors. It is a timely reminder that directors must always be aware of the risks of personal liability as they continue to keep their company trading while they are insolvent.
