22 Jul 2021

Increasing Scrutiny on the Z-Obee Technique

In the past two decades, the Hong Kong court has gradually increased its scrutiny on the appointment of provisional liquidators for the purpose of corporate rescue and as a means to resist winding-up petitions.

In the 2003 Court of First Instance decision of Re Seapower[1], the court granted the provisional liquidators powers to facilitate a restructuring as a part of a scheme of arrangement and dismissed the winding-up petition subject to conditions.

Then in 2006, the Court of Appeal commented in Re Legend[2] that, “……the power of the court……is to appoint a liquidator or liquidators for the purposes of the winding-up, not for the purposes of avoiding the winding-up…… Restructuring is an alternative to a winding-up”.

Re Legend and subsequent cases adopting it[3] clarified 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. Rather, provisional liquidators may be allowed additional powers to restructure the subject companies if they are insolvent and their assets are in jeopardy, but the purpose of the appointment should not depart from the objective of winding-up.

An arrangement was eventually developed in response to the above clarification. Considered in detail in Re Z-Obee Holdings Limited[4], this arrangement was coined the Z-Obee technique:

In gist, a foreign company facing a winding-up petition in Hong Kong would procure the appointment of soft-touch provisional liquidators in its place of incorporation (commonly the British Virgin Islands or the Cayman Islands) to facilitate a restructuring, whereupon it would
(1)  seek the Hong Kong court’s recognition of the appointment; and/or
(2)  request the Hong Kong court to provide assistance to the provisional liquidators with the force of a letter of request issued by a court of its place of incorporation.

Cases leading up to Re China Bozza

In Re Lamtex[5] and Re Ping An[6], the Hong Kong court was asked to recognize foreign appointments of soft-touch provisional liquidators and provide assistance to them.

In Re Lamtex, the court refused to recognize an appointment as there was insufficient evidence of a credible restructuring plan. The subject company was wound up.

In Re Ping An, the court granted an order of recognition and assistance upon being satisfied that there was tangible prospect of restructuring. The winding-up petition was adjourned for two months. The court commented that, “the power of assistance which the court normally grants foreign soft-touch provisional liquidators is simply a consequence of recognition[7].

One can sense a heightening caution where the Z-Obee technique was used, as the court observed in these decisions that the subject companies “were to engineer a de facto moratorium”, that it was “a questionable use of soft-touch provisional liquidation”[8], and that it had “the intention of frustrating a winding up petition issued in the company’s centre of main interest (COMI)”.

The court further commented that insolvency processes in a company’s COMI could be more efficient and effective than that in its place of incorporation where it has no connection with[9], and a more stringent approach may be adopted in similar applications for recognition and assistance in the future.[10]

The Re China Bozza decision

In the recent decision of Re China Bozza[11], the court recognized the appointment of offshore provisional liquidators “as a matter of private international law”, but in respect of the liquidators’ request for assistance, the court merely gave a general direction of “liberty to apply””: The court would not provide assistance as a matter of course. A separate application should be made with justifications.[12]

Further, the court’s recognition of an appointment of offshore provisional liquidators does not automatically entail the adjournment of the winding up petition[13].

The court will adjourn the petition only upon being satisfied that the prospect of a successful restructuring during the adjournment is justifiably strong,

“If the reality is, for example, that a company is (a) hopelessly insolvent, (b) there is no prospect of realising value from sale of its indirectly owned assets in the Mainland as they will be seized by Mainland creditors and (c) the only hope of achieving other than a de minimis return to off-shore creditors is the sale of the company to an investor, who may wish to acquire it to use as a listed vehicle for a different type of business; this should be explained and justified.  Simply referring to a possible “debt restructuring” and treating the expression as a kind of magical incantation, the recitation of which will conjure up an adjournment of the petition is as inadequate as it is facile.”[14]

The court also highlighted that, to restructure a company’s debt,

(1)  the appointment of a soft-touch provisional liquidator was not necessarily required;
(2)  insolvency practitioners can be engaged to advise the company on restructuring and persuade the petitioning and supporting creditors and the court to adjourn the winding up petition.[15]

Creditors’ Interest is Paramount

In Re China Bozza, the court emphasized that once a company became insolvent, it had a paramount duty to consider the creditors’ interests, and the company’s directors fiduciary duties would be owed to the general body of creditors instead.[16]

Soft-touch provisional liquidators may be appointed with an intention to salvage the current shareholders’ investments in the company, often by procuring “white knight” to acquire the company’s assets[17]. In so doing, if the provisional liquidators do not appear to prioritise creditors’ interests, this may contribute to the Court’s refusal to provide assistance.[18]

The court was wary that no proper regard had been given to creditors’ interest in some recent cases. Typically, the companies would have issued low interest corporate bonds to Mainland residents. These bonds may be unattractive in terms of return, but the subscribers’ real objective would be to circumvent PRC’s exchange restrictions[19] or to apply for residency status in Hong Kong. The subscribers may not fully understood their rights and may have limited means to seek recovery.[20] In these circumstances, a soft-touch restructuring may not provide sufficient protection to the subscribers.

As such, the court will closely supervise whether the Z-Obee technique is used with sufficient regard to creditors’ interests.

Conclusion

Companies and those advising them should take heed of the court’s clear preference for the commercial approach of negotiation to the Z-Obee technique.

Procedurally, it is important to note that the court’s recognition of an appointment of offshore provisional liquidators does not automatically entail an adjournment of a winding-up petition. Instead, a strong prospect of success of restructuring needs to be demonstrated to the court to persuade it to adjourn a winding-up petition.

Please contact our Partners Mr. Osbert Hui or Mr. Dominic Lau for any enquiries or further information.

This newsletter is for information purposes only. Its content does not constitute legal advice and should not be treated as such. Stevenson, Wong & Co. will not be liable to you in respect of any special, indirect or consequential loss or damage arising from or in connection with any decision made, action or inaction taken in reliance on the information set out herein.

References:
Re China Bozza Development Holdings Limited (HCMP 172/2021, Hearing Date: 15 April 2021; Date of Decision: 11 May 2021)
Re China Greenfresh Group Co Ltd (HCCW 187/2020, Hearing Date: 29 April 2021; Date of Decision: 29 April 2021)
Re China Solar Energy Holdings Ltd  (HCCW 108/2015, Hearing Date: 18 August 2017; Date of Handing Down of Decision: 20 March 2018)
Re Lamtex Holdings Limited (HCCW 263/2020, Hearing Date: 28 January 2021; Date of Decision: 11 March 2021)
Re Legend International Resorts Ltd (CACV 207/2005, Hearing Date: 7-9 February 2006; Date of Handing Down Judgement: 1 March 2006)
Re Ping An Securities Group (Holdings) Limited (HCCW 217/2020 & HCMP 1810/2020, Hearing Date: 5 March 2021; Date of Decision: 12 March 2021)
Re Plus Holdings Ltd (HCCW 612/2006, Hearing Date: 17 May 2007; Date of Decision 17 May 2007)
Re Seapower Resources International Ltd (HCMP 2977/2003, Hearing Date: 14 November 2003; Date of Judgment: 14 November 2003)
Re Z-Obee Holdings Limited (HCMP 1563/2017, Date of Hearing: 31 October 2017; Date of Decision: 31 October 2017)


[1] Re Seapower Resources International Ltd [2003] HKCFI 462
[2] Re Legend International Resorts Ltd [2006] HKCA 74
[3] Subsequent cases that provided interpretations of Re Legend include: Re Plus Holdings Ltd [2007] 2 HKLRD 725 and Re China Solar Energy Holdings Ltd [2018] HKCFI 555
[4] Re Z-Obee Holdings Limited [2018] 1 HKLRD 165
[5] Re Lamtex Holdings Limited [2021] HKCFI 622
[6] Re Ping An Securities Group (Holdings) Limited [2021] HKCFI 651
[7] ibid 6, para 13
[8] n 5, para 42
[9] n 5, paras 14-34, or particularly, para 27; n 6, para 20
[10] n 8
[11] Re China Bozza Development Holdings Limited [2021] HKCFI 1235
[12] ibid, para 23
[13] n 11, para 24
[14] n 11, para 25
[15] n 11, para 10
[16] n 11, paras 13-16
[17] n 11, paras 12 and 21
[18] Justice Harris stated in Re China Bozza, paragraph 23: “I am not currently satisfied that I should make an order granting the type of general assistance which I have on previous occasions, because of concerns that I have about the way in which the JPLs are approaching this and other cases.”
[19] Re China Greenfresh Group Co Ltd [2021] HKCFI 1182
[20] n 11, para 18