09 July 2021

Pilot Mechanism in cross-border insolvency

Introduction

On 14 May 2021, representatives of the Government of the Hong Kong Special Administrative Region* (“HKSAR”) and the Supreme People’s Court (“SPC”) of the mainland of the PRC (“Mainland”) signed the Record of Meeting on Mutual Recognition of and Assistance to Bankruptcy (Insolvency) Proceedings between the Courts of the Mainland and of the HKSAR (“Record of Meeting”).  It sets out the long-awaited pilot mechanism for relevant courts in the two jurisdictions to mutually recognise certain types of bankruptcy proceedings and provide assistance to liquidators appointed in the other jurisdiction (“Pilot Mechanism”).  This development takes place after the Hong Kong courts issued a series of ground-breaking judgments in 2020[1] which recognised and assisted Mainland liquidators, and will be welcomed by insolvency practitioners across both jurisdictions.

The detailed arrangements for the Mainland courts’ implementation of the Pilot Mechanism is outlined in a separate Opinion (“SPC Opinion”). Similarly, the procedural requirements for Mainland bankruptcy administrators’ applications at the High Court of HKSAR is also provided in a separate Practical Guide (“Practical Guide”).

This Pilot Mechanism is only implemented with a limited scope at this stage.  Three designated Mainland courts in the relevant municipalities - Shanghai, Xiamen and Shenzhen will participate as “pilot courts” to implement this mechanism, and the SPC has prescribed multiple criteria which may trigger refusal by the designated Mainland courts to recognise and assist the Hong Kong insolvency proceedings.

In this alert, we provide an overview of the Pilot Mechanism by summarising its salient features, and identify the restrictions of the regime and their implications for insolvency practitioners in both jurisdictions.


Salient features of the Mainland Arrangements in the Pilot Mechanism

Under the Pilot Mechanism, a Mainland administrator may apply to the High Court of the HKSAR for recognition of bankruptcy liquidation, reorganisation and compromise proceedings under the Enterprise Bankruptcy Law of the People’s Republic of China (“Mainland Insolvency Proceedings”). The procedural requirements which the Mainland administrator will need to comply with are set out in the Practical Guide.  The Hong Kong court will grant a recognition order in the form set out in the Practical Guide, which will include a series of powers the Mainland administrator may exercise in the HKSAR.

As to the arrangements in respect of the Mainland courts pursuant to the Pilot Mechanism, we summarise its salient features below:

Scope of application of the Pilot Mechanism

Hong Kong liquidators must satisfy the following criteria before they can successfully apply for recognition and assistance from Mainland courts under the Pilot Mechanism:

  1. The “centre of main interest” of the debtor company must be HKSAR (Provision 4 of the SPC Opinion). Generally, if the place of incorporation of the debtor company is HKSAR, this criteria would be satisfied. However, the Mainland court will also consider the debtor company’s place of principal office, the principal place of business, the place of principal assets etc.

  2. The debtor company must have principal assets or a place of business / representative office in Shanghai, Xiamen or Shenzhen (collectively referred to as the “Pilot Areas”) (Provisions 1 and 5 of the SPC Opinion). As only the Mainland courts in the Pilot Areas received designation from the SPC to participate in the Pilot Mechanism, accordingly, the debtor company must either have substantial assets or a business presence in such Pilot Areas.

  3. The relevant insolvency proceeding in Hong Kong must be one of the following: compulsory winding up, creditors’ voluntary winding up or restructuring proceeding initiated by a liquidator or provisional liquidator and approved by the High Court of the HKSAR (Provision 2 of the SPC Opinion).

  4. None of the circumstances where the Mainland courts will refuse to grant recognition or assistance pursuant to Provision 18 of the SPC Opinion exists. Such circumstances include: where the centre of main interests of the debtor is not situated Hong Kong or it has been situated in the Hong Kong for less than six months continuously, where Article 2 of the Enterprise Bankruptcy Law of the People’s Republic of China is not satisfied, where the Mainland creditors are unfairly treated or where there is fraud.

Effect of Mainland court’s recognition of the Hong Kong insolvency proceedings

Recognition by the relevant Mainland Court on Hong Kong insolvency proceedings has the following effect:

  1. The debtor company’s payment made to individual creditors shall be invalid (Provision 11 of the SPC Opinion).

  2. Any ongoing civil action or arbitration involving the debtor company shall be suspended until the Hong Kong liquidator takes over the debtor company’s property (Provision 12 of the SPC Opinion).

  3. The measures for preserving the property of the debtor company shall be lifted and the procedure for execution shall be suspended (Provision 13 of the SPC Opinion).

  4. The Hong Kong liquidator may exercise a range of power in Mainland China, including investigation into the debtor company’s financial position, carrying out the internal management of the debtor company, dealing with the debtor company’s property, commencing legal proceedings on behalf of the debtor company, etc (Provision 14 of the SPC Opinion).

  5. In exercising their powers following recognition by the Mainland courts, the Hong Kong liquidators may need to familiarise themselves with the relevant PRC law in order to comply with some of the provisions in the SPC Opinion. For example, according to Provision 20 of the SPC Opinion, even if the Hong Kong insolvency proceeding in question is duly recognised in the relevant Mainland court, the property of the debtor company in Mainland must still first satisfy preferential claims under the law of the Mainland, before the remaining property could be distributed in accordance with the Hong Kong proceedings. 


Limitations of the Pilot Mechanism and potential difficulties facing Hong Kong liquidators

Despite the fact that the Pilot Mechanism is very much welcomed as a first step to streamline cross-border insolvency procedure as between Hong Kong and Mainland, there remain obvious limitations in its implementation:

Firstly, only Mainland courts in the three Pilot Areas will participate in the Pilot Mechanism.  Therefore, where the debtor company in question has assets in Mainland cities or regions other than the three Pilot Areas, difficulties remain for the Hong Kong liquidator to apply for recognition and assistance.

Secondly, separate approval is required for the Hong Kong liquidator to perform certain duties, e.g. transfer of property out of the Mainland and creation of security on the property (see Provision 14 of the SPC Opinion).  Due to this requirement, the Hong Kong liquidator may incur delay and extra costs as well as potential difficulties in their dealing with the debtor company’s assets in Mainland.

Thirdly, Provision 15 of the SPC Opinion allows for the designation of a Mainland administrator by the Mainland court upon application by either a Hong Kong administrator or a creditor after the Hong Kong Insolvency Proceedings is recognised in the Mainland.  However, the SPC Opinion does not specify whether and in what circumstances the Mainland court would grant a creditor’s application where a Hong Kong administrator is already appointed.  Assuming a creditor is allowed to make such an application under this provision despite a Hong Kong administrator being already appointed, a potential conflict may arise between the Hong Kong administrator and the Mainland administrator appointed by the creditor.   Provision 15 does not provide any clear guidance on how to address any potential conflict between administrators of the two jurisdictions.  It remains to be seen as to how the Mainland court would respond to a creditor’s application and whether the risk envisioned would materialise.


Conclusion

Following the launch of the Pilot Mechanism, Hong Kong has become the first jurisdiction to have an established mechanism of mutual recognition and assistance in insolvency proceedings with the PRC. As a result, insolvency practitioners in Hong Kong and PRC alike are now better equipped to carry out asset-recovery activities on companies with cross-border features.  With this crucial first step of the Pilot Mechanism in place, we look forward to further expansion of the Pilot Mechanism to more Mainland regions and increasing co-operation between the two jurisdictions.


 *Any reference to “Hong Kong” or “Hong Kong SAR” shall be construed as a reference to “Hong Kong Special Administrative Region of the People’s Republic of China”.

[1] See Re CEFC Shanghai International Group Limited [2020] HKCFI 167; Re Shenzhen Everich Supply Chain Co Ltd [2020] HKCFI 965; Re Ando Credit Limited [2020] HKCFI 2775.

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