This article was written by Edmund Wan, Natalie Ng and Kristy Wong.
The recent case of Re China Bozza Development Holdings Ltd [2021] HKLRD 977 demonstrated the attitude and increased scrutiny of the Hong Kong Companies' Court towards offshore soft-touch provisional liquidation.
The leading authority on the meaning of soft-touch is the British Virgin Islands case of Re Constellation Overseas Ltd BVIHC (Com) 2018/0206,0207,0208, 0210 and 0212 . (§3) :
"The essence of a "soft-touch" provisional liquidation is that a company remains under the day to day control of the directors but is protected against actions by individual creditors. The purpose is to give the group the opportunity to restructure its debts, or otherwise achieve a better outcome for creditors than would be achieved by liquidation."
Re China Bozza Development Holdings Ltd
China Bozza Development Holdings Ltd ("China Bozza") was incorporated in Cayman Islands and listed on the Hong Kong Stock Exchange. A petition was first presented in Hong Kong Court for the winding up of China Bozza on the ground of insolvency.
Within a span of few months, a director of China Bozza presented a petition in Cayman Islands for the winding up of China Bozza, and subsequently, applied for the appointment of soft-touch provisional liquidators in Cayman Islands to facilitate a restructuring of the debts of China Bozza.
The Cayman Court approved the application and appointed joint provisional liquidators over China Bozza. Thereafter, the soft-touch provisional liquidators of China Bozza applied to the Hong Kong Court for recognition of and assistance to the insolvency proceedings in Hong Kong.
The Court granted an order for recognition of the insolvency proceedings in Cayman Islands, but refused to grant an order for assistance to the provisional liquidators at this stage. In his Decision, Harris J expressed his concerns over the increasing use of the commonly called "Z-Obee" technique in debt restructuring. Particularly, his Lordship was concerned that the Z-Obee technique is being abused to obtain a de facto moratorium of enforcement action by creditors in Hong Kong.
What is the Z-Obee technique?
This technique is named after the case of Re Z-Obee Ltd [2018] 1 HKLRD 165. It was developed as a result of the Court's clarification that section 193 of the Companies (Winding Up and Miscellaneous Provisions) Ordinance does not allow provisional liquidators to be appointed solely for the purpose of corporate restructuring or rescue.
To get around this statutory limitation, a foreign company faced with a winding-up petition in Hong Kong may procure the appointment of soft-touch provisional liquidators in its place of incorporation in order to facilitate restructuring of the company. Upon their appointment, the soft-touch provisional liquidators would then petition the Hong Kong Court to recognise their appointment and to provide assistance to the soft-touch provisional liquidators pursuant to the terms of a letter of request issued by a court of its place of incorporation.
Harris J emphasized that the interests of creditors should take precedence over the proprietary interests of the shareholders once it appears likely that the company is insolvent. Various other authorities include dicta to the effect that once a company becomes insolvent, the directors' fiduciary duties are owed to the general body of creditors, instead of the shareholders. As such, creditors are expected to have a central role in the development of any plan to restructure a company's debts in the circumstances. His Lordship was wary about giving blessing to soft-touch provisional liquidations when creditors' interests may be unheard due to their non-involvement in the restructuring process.
In the case of China Bozza, the circumstances leading to the present application set alarm bells ringing:
- China Bozza did not have any restructuring plan at the time of the application. Rather, it was seeking to appoint soft-touch provisional liquidators, who would then make efforts to formulate such a plan;
- the Hong Kong Court was told nothing about the business of China Bozza, such as how it became profitable, why any investor might be interested in injecting funds into China Bozza, or how the Board thought the business of China Bozza might be rehabilitated;
- the Board did not seek legal or other professional advice on the consequences and implications of the dire financial position of China Bozza, the statutory demand nor of the petition issued against it; and
- China Bozza did not have any banking debts in Hong Kong. The creditors were members of the public who had little understanding of their rights or the methods available for securing maximum return on the loans that they had made.
Harris J came to a view that no consideration appeared to have been given by China Bozza or its advisers as to whether or not it might be in the interests of its creditors for China Bozza to be wound up. Whilst he recognised that a liquidator, including a provisional liquidator, appointed by the courts of the place of incorporation of a company ought to be recognised as a matter of private international law, Harris J refused to grant an order providing assistance to the provisional liquidators at this stage due to concerns about the way China Bozza approached the case.
Insights
While certainly Re China Bozza is not a blanket denial to soft-touch provisional liquidations, it clearly shows the Companies Court's desire to scrutinise deployment of the Z-Obee technique in the future. This comes as no surprise as we continue to see an upward surge of companies relying on offshore soft-touch provisional liquidation as a means to obtain a de facto moratorium of enforcement action by creditors in Hong Kong.
The Companies Court made it clear that the grant of recognition of foreign insolvency proceedings does not automatically entail adjournment of any winding up petition presented in Hong Kong. The Hong Kong court will only adjourn the petition upon satisfactory evidence that the prospect of a successful restructuring during the adjournment is justifiably strong.
In view of the various comments made by Harris J regarding soft-touch provisional liquidations, any company wishing to deploy the Z-Obee technique should be prepared to address the Hong Kong court on the following issues:
- details of the restructuring plan that the company wishes to implement out of provisional liquidation;
- whether creditors' input has been sought in the process of formulation of the restructuring plan;
- details of the business of the company;
- the reasons for the Board to have taken a view that the business of the company might be rehabilitated through the restructuring plan;
- details of legal and other professional advice on the company's financial position and restructuring plan.
In addition, for companies which are likely insolvent, their directors must be advised that their fiduciary duties are owed to the general body of creditors rather than the shareholders.
