Avoidance rights in Hong Kong

Hong Kong is a common law jurisdiction, and its legal system is based on English law. Following Hong Kong’s handover to China on 1 July 1997, the Basic Law of Hong Kong is the constitutional document of the Hong Kong Special Administrative Region. Article 8 of the Basic Law provides that: “laws previously in force in Hong Kong, that is, the common law, rules of equity, ordinances, subordinate legislation and customary law shall be maintained, except for any that contravene [the Basic Law], and subject to any amendment by the legislature of the Hong Kong Special Administrative Region.”

General overview of Hong Kong’s avoidance rules

In relation to avoidance rights for Hong Kong companies, the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32) (CWUMPO) is the key legislation where avoidance rules can be found.

The major avoidance rules can be found in the following sections of CWUMPO:

• Unfair preference (section 266, 266A and 266B of CWUMPO);
• Transaction at an undervalue (sections 265D, 265E and 266B of CWUMPO);
• Fraudulent trading (section 275 of CWUMPO);
• Extortionate Credit Transactions (section 264B of CWUMPO);
• Floating Charges (sections 267 and 267A of CWUMPO).

Similar avoidance rights apply to bankruptcies for individuals, but this article is limited to companies only.

Unfair preference

Pursuant to section 266 of CWUMPO, if a company has at relevant time given unfair preference to a person, the liquidator may apply to the court to invalidate acts of unfair preference and restore the position to what it would have been had the company not been given this unfair preference. To establish unfair preference, the following must be evidenced:

• the person preferred must be one of the company’s creditors, or a guarantor or surety for any of the company’s debts or other liabilities;
• the company must have acted in a way that puts that creditor in a better position in the event of insolvent liquidation; and
• the company must be influenced by a desire to prefer.

Where the debtor company made payment as a result of the creditor placing the company under genuine commercial pressure to make payments, there will not be an unfair preference.

To successfully establish unfair preference, the company must be insolvent at the time of the preference or became insolvent as a result, and the alleged preference should have been given within six months of the commencement of the winding up (or two years where the parties are connected with the company other than by reason of being an employee).

Transactions at an undervalue

Sections 265D and 265E of CWUMPO provides that a company enters into a transaction with a person at an undervalue if the company:

• makes a gift to that person, or enters into a transaction with that person on terms that provide for the company to receive no consideration; or
• enters into a transaction with that person for consideration in which the value (in money or an asset equal to a certain amount of money) is significantly less than the value of the consideration provided by the company.

Liquidators have the power to apply to the court to invalidate and set aside transactions made to a person at a relevant time that are considered to be undervalue. The court has the power to set aside undervalue transactions entered into by a company within five years prior to the date of the winding up of the company, provided that at the time the transaction took place the company was unable to pay its debts or became unable to pay its debts as a consequence of the transaction.

Fraudulent trading

Under section 275 of CWUMPO, if it appears that the company carried out business with an intent to defraud creditors or for any fraudulent purpose in the course of winding up a company, the court may find such persons, who were knowingly parties to the fraud, personally liable for all or any of the company’s debt. Such person may also face criminal penalty, whether or not the company has been or is in the course of being wound up.

Extortionate credit transaction

Under section 264B(3) of CWUMPO, transactions are presumed to be extortionate if, considering the risk accepted by the credit provider, the terms of the agreement require the debtor company to make grossly exorbitant payments or otherwise grossly contravene ordinary principles of fair dealing.

The liquidator can make an application to a court to set aside whole or part of any obligation created by such a transaction or vary the terms of the transaction, etc. The time limit for the liquidator to make this application is three years from the date of the winding up of the company. There is no requirement that the company had to be insolvent at the date of the transaction.

Floating charges

Under section 267 of CWUMPO , if within 12 months prior to the winding up of the company (or two years for persons connected with the company), the company creates a floating charge on its undertaking or property, the floating charge is invalid except to the extent of the amount specified in section 267(3) of CWUMPO.

According to Section 267(3) of CWUMPO, the specified amount is the aggregate of:

• the money paid or property or services supplied to the company at, or after, the creation of the floating charge; and
• the amount of any interest that is payable on such amounts at the lesser of: the rate specified in the charge or consideration agreement; or the rate of 12% per annum.  

Avoidance of dispositions of property

In a compulsory winding up by the court, any disposition of the property of the company, including things in action, and any transfer of shares, or alteration in the status of the members of the company made after the commencement of the winding up will be considered void unless a court orders otherwise, pursuant to section 182 of CWUMPO. 

For more information on insolvency avoidance in Hong Kong, contact your client partner or one of these CMS experts:

Kingsley Ong, Partner, CMS Hong Kong (Email: [email protected])

Tony Lau, Associate, CMS Hong Kong (Email: [email protected])