A Q&A guide to Finance in Hong Kong. The Q&A gives a high level overview of the lending market, taking security over assets, special purpose vehicles in secured lending, quasi-security, guarantees, and loan agreements. It covers creation and registration requirements for security interests; problem assets over which security is difficult to grant; risk areas for lenders; structuring of debt agreements; enforcement of security interests and borrower insolvency; cross-border issues on loans; taxes; and proposals for reform.
To compare answers across multiple jurisdictions, visit the Finance Country Q&A tool. This article is part of the PLC multi-jurisdictional guide to finance. For a full list of contents visit www.practicallaw.com/finance-mjg.
The beginning of 2012 saw both the loan and bond markets adversely affected by the Eurozone crisis, with companies decreasing their borrowing and analysing the market before committing to new loans or refinancing their debts at higher rates in the first half of the year.
In the second half of 2012, there has been greater optimism and a surge in loan volume. Acquisition finance has gained momentum as Asian companies in good financial shape make plans to expand overseas. Additionally, many mainland Chinese companies are tapping the Hong Kong loan market, due to tighter liquidity in mainland China and relatively strict lending quota (albeit more relaxed when compared to 2011).
In addition, in July 2012 the Legislative Council in Hong Kong passed the New Companies Ordinance (New CO), which is expected to take effect in 2014. The New CO is a complete overhaul of the existing Companies Ordinance and some of the changes will have an impact on financing related transactions. There are new requirements relating to the registration of charges, relaxation of the existing financial assistance regime, and so on (see Question 35).
Real estate comprises land, which is defined as:
Land covered by water.
Any estate, right, interest or easement in or over any land.
The whole or part of an undivided share in land and any estate, right, interest or easement in or over the whole or part of an undivided share in land.
Things attached to land (fixtures) or permanently fastened to anything attached to land (Conveyancing and Property Ordinance (Cap 219, Laws of Hong Kong)) (CPO). Whether an object constitutes a fixture depends on the degree and purpose of fixing.
The most common forms of security are as follows:
Legal mortgage. A mortgage involves a transfer of the legal title to the mortgaged assets to the creditor (mortgagee), subject to the debtor's (mortgagor's) equity of redemption (that is, the mortgagor's right to require the mortgagee to transfer the mortgaged assets back to it on discharge of the underlying obligations). A legal mortgage over real estate is created by way of a legal charge, in writing and executed as a deed under the CPO. It gives the protection, powers and remedies traditionally given to a mortgagee, including foreclosure and the equity of redemption. However, the mortgagee cannot take possession before default.
Equitable mortgage. An equitable mortgage does not transfer the legal title to the mortgagee. An equitable mortgage can be created by depositing title deeds or other similar documents of title with the mortgagee. Where an equitable mortgage is executed as a deed, the equitable mortgagee enjoys the same powers and remedies as a legal mortgagee on the mortgagor's default, except that the mortgagee has no power to sell the real estate because an equitable mortgagee cannot execute an assignment (see Question 23, Security over real estate).
The following registration requirements apply:
Land Registry. Documents such as deeds and conveyances (including a mortgage over real estate) must be registered with the Land Registry to protect their priority (Land Registration Ordinance (Cap 128, Laws of Hong Kong)) (LRO). If the document is registered within one month of its execution, it takes priority from the date of execution. When registration takes place after one month of execution, it only takes priority from the date of registration. For example, a mortgage that was registered within one month from its execution will rank behind a mortgage that had been executed earlier and registered within one month after its execution.
Companies Registry. If the mortgagor is incorporated in Hong Kong as a company, or registered in Hong Kong as a non-Hong Kong company, the mortgage must also be registered with the Hong Kong Companies Registry (CR) within five weeks after its date of creation (Companies Ordinance (Cap 32, Laws of Hong Kong)) (CO) (see Question 3, Formalities)).
Tangible property is any property that has a physical existence (as opposed to intangible property, which is any property non-physical in nature). Tangible movable property is any tangible property except immovable property (for example, land (Interpretation and General Clauses Ordinance (Cap 1, Laws of Hong Kong)) (see Question 2, Real estate)). Tangible movable property includes among others:
Machinery.
Physical inventory.
Aircraft and ships.
The most common forms of security over tangible movable property are as follows:
Mortgage. A mortgage can be applied to tangible movable assets in the form of a legal or equitable mortgage (see Question 2, Common forms of security).
Charge. A charge does not affect ownership or possession of the charged property. It is an equitable concept and merely gives a chargee (secured creditor) a right to the proceeds from the charged assets on the borrower's default. A charge over movable property can be fixed or floating:
a fixed charge is usually created over a particular property (which can also be a future property). The chargor can only dispose of that property, free of encumbrance, with the chargee's consent. A fixed charge ranks in priority above a floating charge (in the event of the chargor's insolvency) (see Question 27);
a floating charge is usually created over a class of assets, present and future. These assets may change from time to time in the ordinary course of the chargor's business. Unlike a fixed charge, until the chargee takes steps to enforce the floating charge, the chargor can carry on its business as usual. A chargee's interest is in a changing fund of assets until a certain event occurs that causes the floating charge to crystallise. It is then converted into a fixed charge that attaches to the charged assets.
The courts may treat a fixed charge as a floating charge if the chargee allows the chargor to deal with the charged assets in a way inconsistent with a fixed security. Therefore, whether a charge is fixed or floating is a matter of substance and not merely the form or construction of the relevant agreement.
Pledge. A pledge involves the transfer of possession of the pledged assets, actual or constructive, to the pledgee. The pledgee may sell the assets if the pledgor defaults on the underlying loan. However, subject to few exceptions, a pledge can only be granted over physical assets and not pure intangible property. A pledge is created by delivery of the pledged asset to the pledgee (or its agent), coupled with the intention to create a pledge over it, as evidenced by the parties' conduct.
Lien. A lien is a right to retain possession of the property of another until the underlying obligations are discharged. It can arise in a number of different circumstances (for example, when the goods have been delivered to the creditor for some purpose other than security, such as storage or repair). The main difference between a pledge and a lien is that a lien holder cannot sell the relevant assets.
Perfection requirements depend on the type of assets and security and may involve registration (which depends on the place of incorporation and registration of the security provider and the type of collateral (see below)) or giving of notice or possession:
A registrable charge (including a mortgage) created by a Hong Kong-incorporated company or a foreign company registered in Hong Kong as a non-Hong Kong company, is required by the CO to be registered at the CR within five weeks after the date of the charge's creation. Failure to register within the prescribed time limit will render the charge void against the liquidator and every creditor of the company.
Certain assets (for example, ships (see below) and certain intellectual property rights (such as trade marks and patents) (see Question 7)) have their own registries and it is necessary to record the creation of any security interest over those assets in the relevant registry.
Both pledges and liens are perfected by delivery of the underlying assets to the creditor.
The following assets are subject to special rules:
Machinery. In most cases, security over machinery will be in the form of a mortgage or a fixed charge. The mortgagor/chargor can only dispose of that property, free from encumbrance, with the mortgagee's/chargee's consent. Apart from the requirement to register a mortgage/charge with the CR (see above), it is also common practice to fix a nameplate on the machinery, to notify a third party of the security interest.
Inventory. A security over inventory, given its nature, usually takes the form of a floating charge. A charge is usually created by the chargor executing a debenture charging its present and future inventory in favour of the chargee. It is necessary to perfect a floating charge by registration at the CR (see above).
Aircraft. Aircraft can be secured with a mortgage or charge. There is no register of aircraft mortgages in Hong Kong, and the only required registration is with the CR (see above). However, it is market practice to notify the Civil Aviation Department in Hong Kong of the security interest and the mortgagee's/chargee's details will also be put on the nameplate on the aircraft.
Ships. A ship mortgage over a Hong Kong-registered ship must be in a prescribed form and registered with the Hong Kong Shipping Registry. It takes priority from the time of registration and not from the date of the instrument. Since the prescribed form of the ship mortgage only contains basic details of the parties and the underlying transaction, the local practice is to supplement the ship mortgage with a collateral deed of covenants setting out further obligations for the mortgagor. Both the mortgage and the collateral deed must be registered with the CR (see above).
It is worth noting that under the New CO, the time period for registration of a charge will be shortened to one month and that the list of registrable charges/mortgages will also be updated (see Question 35).
It is necessary to differentiate between:
Directly held shares/securities, where a charger (or its nominee) is the registered holder.
Indirectly held shares/securities, for example, shares/securities listed in Hong Kong are held in the Central Clearing and Settlement System (CCASS), administered by the Hong Kong Securities Clearing Company Limited (HKSCC). Shares held with CCASS are registered in the name of a HKSCC nominee company and recorded by the HKSCC as being held in a CCASS participant's account.
The most common forms of security over directly held shares/securities are:
Legal mortgage. A legal mortgage over directly held shares/securities is created in writing and usually executed as a deed. To perfect the legal mortgage, the legal title to the shares must be transferred to the mortgagee (or its nominee) through an instrument of transfer, which is subject to a HK$5 (less than US$1) stamp duty (see Question 33, Documentary taxes). Following the stamping, the shares can be registered in the mortgagee's (or its nominee's) name in the company's register of members.
Equitable mortgage/charge. In this context, an equitable mortgage and an equitable charge essentially refer to the same security arrangement. A mortgagor/chargor retains legal title to the mortgaged/charged shares until the security becomes enforceable. To create an equitable mortgage/charge over such shares, it is sufficient to deposit the relevant share certificate(s) with the mortgagee as security. To perfect the security, a mortgagor/chargor must deliver certain ancillary documents (including blank forms of transfer and contract notes), together with share certificates, to the mortgagee/chargee.
For shares/securities listed in Hong Kong, a depositor has proprietary rights over securities held by a CCASS participant within CCASS. As such, the security interest most commonly granted in securities in CCASS will be an equitable mortgage/charge over the security collateral provider's proprietary interest in those securities. In addition, the mortgage/charge usually includes an assignment by way of security of its rights against CCASS or the CCASS participant. To perfect the assignment/charge, notice of the assignment/charge must be given to the CCASS participant.
Strictly speaking, a mortgage/charge over shares is not a registrable charge requiring registration with the CR (see Question 3, Formalities). However, a mortgage/charge over shares usually extends to cover the relevant dividends, which arguably constitutes a book debt. Local practice, therefore, is to submit the mortgage/charge over shares for registration anyway, if the mortgagor/chargor is a company incorporated in Hong Kong or a foreign company registered in Hong Kong as a non-Hong Kong company.
Claims and receivables include debts (for example book debts), cash deposits or rights under contracts.
The most common forms of security over claims and receivables are assignment and/or charge (fixed or floating). Unless the underlying contract provides otherwise, the debtor's consent is not required.
To obtain a fixed charge over book debts, it is necessary to exert control over the debts' proceeds. A charge over book debts which, in practice, allows a charger to freely collect and deal with proceeds in the ordinary course of its business, may be categorised by the courts as a floating charge, even if the relevant security document labels it as fixed (see Question 3, Common forms of security).
A statutory assignment requires the following:
The assignment must be in writing under the hand of the assignor.
The assignment must be absolute (that is, of the whole of the benefit) and not by way of charge only.
Notice must be given to the assignee (who is usually a party to the assignment).
Express notice in writing must be given to the debtor.
If any of the above conditions are not fulfilled, the assignment may still stand as an equitable assignment, provided that the intention to assign is clear. In practice, the main difference between a legal and an equitable assignment is that notice is not given to the debtor under an equitable assignment. The advantage of a legal assignment is that if an assignor defaults, the assignee can sue the debtor in its own name and does not need to join the assignor as a party to the action. It is also common in Hong Kong to require an acknowledgement of the notice from the debtor.
Competing securities over receivables rank according to the order in which written notice of assignments are given to the debtors, subject to:
Registration at the CR (see Question 3, Formalities).
The absence of actual or constructive notice of a prior encumbrance.
The most common forms of security over cash deposits, which are considered to be choses in action, are a charge (fixed or floating) or a mortgage by way of assignment.
In Hong Kong, there are specific registries for patents, trade marks and designs. However, there is no registry for copyright works.
Patents and registered designs. The common forms of security over patents/registered designs are:
Mortgages.
Charges.
Assignments.
Trade marks. Security over a trade mark usually takes the form of a mortgage/charge.
Copyright. Copyrights can be freely assigned provided that the work/works in question is/are sufficiently identified.
Patents and registered designs. A mortgage/charge must be made in writing and recorded at the Hong Kong Patents Registry by filing Form P19 or the Designs Registry by filing Form D5, as the case may be. An unregistered security interest is ineffective against a person who later acquires the patent/registered design and who does not know at the time of the acquisition of the unregistered security interest.
Trade marks. The grant of any security interest (including a fixed or floating charge) over a registered trade mark must be registered with the Trade Marks Registry by filing Form T10. If the security interest is not registered, it is ineffective against a person who subsequently acquires a conflicting interest in the registered trade mark without notice of the security interest. It is therefore advisable to register the security interest as soon as possible. Although there is no time limit for registration, it should be registered within six months from the transaction date, otherwise the security holder will be prevented from claiming damages or an account of profits in relation to any infringement of its rights that occurs after the date of the creation of the security and before registration. Unregistered trade marks do not require registration with the Trade Marks Registry.
Copyright. A legal assignment of copyright must be in writing. An equitable assignment can be created in the same manner as an equitable assignment over a chose in action (see Question 5, Formalities).
In general, security can be granted over all assets, including future or fungible assets.
However, it may be difficult to create a fixed charge over future and fungible assets, since a fixed charge requires that:
The charged assets are clearly identified.
The chargor can only dispose of the charged assets with the chargee's consent (that is, the chargee has real control over the charged assets).
Security is usually released by a deed. Under the CO, on the application by a company or a chargee/mortgagee, the CR may enter on the company's register of charges a memorandum of satisfaction where the CR is satisfied that the debt for which a registered charge was given has been paid or satisfied in whole or in part. These applications are made by filing a specified form (Form M2).
In addition, if the security has been registered with the relevant registry of the specific assets (for example, land, ship, certain intellectual property rights, and so on), the relevant registry must also be informed of the release, by the submission of the prescribed form and/or document.
The most common practice is to take security over both the shares of the SPV and the underlying assets of the SPV. To the extent possible, to preserve its rights over the assets against competing claims, financiers prefer to take security over the underlying assets of the SPV, instead of shares of the SPV.
Sale and leaseback, factoring, hire purchase and retention of title are all common in Hong Kong. There is a risk that such transactions may be recharacterised as a security interest. In that case, if it is created by a company incorporated in Hong Kong or a foreign company registered in Hong Kong as a non-Hong Kong company, it must be registered with the CR (see Question 3, Formalities).
The transaction may be recharacterised as a security interest if:
The underlying document does not represent the parties' true intention or is a sham.
The seller has a right of equity of redemption, that is, it is entitled to redeem the underlying assets on discharge of its obligations (see Question 3, Common forms of security).
There is a recourse element against the seller (for example, the buyer has a right of direct recourse against the seller in certain specified circumstances).
Negative pledge clauses are commonly used in both secured and unsecured loan transactions in Hong Kong. Such clauses usually take the form of prohibition on the borrower (and the other obligors and other member of the group) from creating any security over its assets and from disposing of any of its assets. These clauses are particularly important in the case of unsecured loan transactions as the finance parties rely on these clauses to ensure that the obligors and the other members of the group have sufficient unencumbered assets to be shared among the unsecured creditors pari passu in case of liquidation.
Guarantees are commonly used in both secured and unsecured finance in Hong Kong. A guarantee takes effect as a secondary obligation that depends on the validity of the primary obligation. Therefore, in order to get around this limitation, a guarantee is usually coupled with an indemnity. Unlike a guarantee, an indemnity is the primary liability of the guarantor. Under an indemnity, the guarantor has a separate and independent obligation to make good loss suffered by the beneficiary.
The usual principles of law of contract apply to guarantees and indemnities. Therefore, to avoid any dispute over consideration, guarantees and indemnities are usually executed as deeds.
A Hong Kong company or any of its Hong Kong-incorporated subsidiaries cannot directly or indirectly provide financial assistance:
For any acquisition of its shares.
To reduce or discharge any liability incurred for such acquisition.
The term "financial assistance" is widely defined in the CO and includes financial assistance given by way of loan, transfer of rights in respect of loans, guarantee, security or indemnity. There are certain exceptions to the prohibition against financial assistance where it is given by an unlisted company. In particular, the CO provides for "whitewash" procedures to enable an unlisted company to give financial assistance, subject to certain net assets and other requirements being met.
The restrictions on financial assistance will be streamlined and relaxed under the New CO (see Question 35).
Directors of a Hong Kong-incorporated company have a fiduciary duty to act in what they believe is for the commercial benefit of the company, and not just in the interests of the corporate group as a whole. Determining this is a matter of fact and directors are advised to seek shareholders' approval in uncertain circumstances. This duty is particularly significant in relation to upstream guarantee, cross guarantee and third party security transactions.
Subject to a few exceptions (most notably transactions among group companies), a Hong Kong company cannot make loans to, or guarantee or provide security for the obligations of, its directors or persons connected to its directors.
Breach of this prohibition may affect the enforceability of the underlying loan agreement, guarantee or security document.
Under the New CO, the restrictions on companies making loans to directors will be tightened. However, there will be a relaxation of the restriction for public companies and their subsidiaries (see Question 35).
Hong Kong law provides protection and relief against excessive interest rates and extortionate stipulations in respect of loans under the Money Lenders Ordinance (Cap. 163, Laws of Hong Kong) (MLO). In particular:
Any person who lends or offers to lend money at an effective rate of interest that exceeds 60% per annum commits an offence. Any agreement for the repayment of any loan or for the payment of interest on any loan and any security given in respect of any agreement or loan is unenforceable.
Any agreement for the repayment of a loan or for the payment of interest on a loan in respect of which the effective rate of interest exceeds 48% per year is presumed to be an "extortionate" transaction and the court may reopen the transaction to do justice between the parties having regard to all the circumstances, and, for that purpose, make orders and give directions in respect of the terms of the transaction or the rights of the parties as the court may think fit.
Environmental protection legislation imposes duties on owners and operators of land and premises in relation to:
Water, waste disposal and air pollution.
Noise restrictions.
Responsibility rests with the person who breaches the relevant statutory provisions. Therefore, if the lender is merely holding or enforcing a security, no environmental liability will be imposed on the lender, unless the lender steps into the security provider's shoes by actively participating in the operation of the security provider's business and causes the pollution in breach of the statutory provisions.
Contractual subordination of debt is possible and common in Hong Kong. This can be achieved by a contingent debt agreement between the debtor and a junior creditor, under which the junior debt is not payable until all senior debt has been repaid.
Structural subordination is also common in Hong Kong. For example, the senior lender will lend to the operating subsidiaries (that own the main assets) directly and require any other debt to be incurred at a higher level in the group. The other lenders will effectively be subordinated to the senior lender because in the event of insolvency the senior lender will be paid first before any surplus is returned to the parent company as a shareholder.
Inter-creditor arrangements consist of an agreement between a senior and junior creditor under which a junior creditor agrees to transfer to a senior creditor any distribution it receives on the debtor's insolvency. The debtor may be a party to this arrangement. Such an agreement leaves the junior creditor's rights against the debtor intact and avoids benefiting other creditors of the debtor at the expense of the senior and junior creditors.
Secured debt is traded in Hong Kong through one of the following transfer mechanisms:
Assignment. A lender's rights under any security can be assigned together with the debt, unless the underlying contractual arrangement restricts this. Only the benefit, and not the burden, of an agreement can be assigned. Subject to certain conditions, an assignment can take the form of a legal assignment. Otherwise, it will be equitable (see Question 5, Formalities).
Novation. Novation transfers both the rights and obligations of an outgoing lender. This is achieved by an agreement between all parties to the loan and security contracts and the new lender so that the new lender is substituted for one of the existing lenders in relation to other existing lenders.
Novation is particularly suitable where the loan is undrawn or partly drawn, or where there are other continuing obligations on the outgoing lender's part. However, in the novation of a secured loan, the security can be prejudiced as novation discharges the original debt and creates a new debt instead. To avoid this, the outgoing lender must transfer the security to a security trustee who will hold the security for a class of beneficiaries. This class will include the outgoing lender and any persons who may become lenders under the novation procedure.
Sub-participation. A sub-participation involves an arrangement under which one of the original lenders transfers part of its loan to a new lender (a sub-participant) without affecting the existing rights and obligations between the other original lenders and the borrower. This can be funded (where a new lender funds the loan, as well as assumes the credit risk) or unfunded (where a new lender undertakes the credit risk but does not fund the loan). New rights and obligations are created between the original lenders and the new lender. The borrower does not need to be aware of this arrangement. This method is useful when the underlying loan agreement contains restrictions on assignment (see above).
The agent concept is generally recognised under Hong Kong law, provided that the authority and the extent of that agent's authority is clear.
The trust concept (including security trusts) is generally recognised under Hong Kong law. A security trustee can enforce its rights in the Hong Kong courts.
Different types of security do not need to be documented separately unless a prescribed form must be used with respect to certain types of asset (for example, for a ship mortgage) (see Question 3, Formalities).
There are no specific rules on how loans should be documented in order to be enforceable. However, in documenting the loans, the parties should carefully consider the general application of the law of contract and the law relating to the due execution and approval of the document.
The relevant security agreement usually specifies the circumstances in which a secured creditor can enforce its security. This is usually on or after an event of default, as defined in the security document.
Common events of default include:
Non-payment. Where debt is payable on a certain date, the debtor is in default if payment is not made on that date. A notice or demand is not required. Where debt is payable on demand, the demand must be served before the debtor can be considered to be in default.
Insolvency.
Breach of covenants.
Holders of a legal charge or mortgage, or equitable mortgage that is executed by deed have certain implied powers on enforcement (see Question 23). However, these are subject to statutory requirements under the CPO.
The following remedies are available to the lender under a legal or equitable charge over land, which is executed by deed:
Sale. Sale is the most commonly used remedy. A court order for sale is not required and the sale does not need to be public. The lender (or receiver) must:
act in good faith; and
take reasonable care to obtain a proper price under the common law principles.
However, the lender (or receiver) does not have to wait for better market conditions and can sell at any time.
Possession. The lender can recover possession of the secured property against the debtor (or any person in the property without the lender's consent), including by eviction action if necessary. If the property is occupied by a tenant whose tenancy is binding on the lender, the lender may enter into possession by giving notice to the tenant to pay rent to him. If the debtor is a corporate entity, the chargee must give notice of entering into possession to the CR within seven days of entering into possession.
A lender in possession:
becomes the manager of the mortgaged land;
has a duty to take reasonable care of the land; and
may become liable to the debtor for any profits it should have received if the property had been properly managed.
Foreclosure. A lender can apply to the Hong Kong courts for a foreclosure order to terminate the debtor's right of redemption. The property will vest absolutely in the lender on foreclosure. However, the courts are reluctant to grant this order without giving the debtor every opportunity to redeem the property first. Stamp duty is payable on the foreclosure order.
Appointment of receiver. The appointment must be in writing and registered with the Land Registry. In the case of a corporate debtor, the CR must be notified of the details of the appointment within seven days of the appointment. Although the receiver is usually appointed by the lender, it is usually provided in the underlying security documents that the receiver is the debtor's agent. In these circumstances, the lender should not interfere with, or direct, the receiver's activities. The receiver's powers are generally regulated by the underlying security documents and normally include powers to take possession and to sell the property.
In the case of an equitable mortgage over a purchaser's interest under a sale and purchase agreement of land, the mortgagee may execute a legal charge over the land in its favour or execute all documents and do all acts required to carry into effect the sale and charge.
An equitable mortgage that is not executed by deed can only be enforced by judicial sale.
It is market practice to provide in the security documents for the appointment of receivers with wide powers to enforce the security. Usually, the receiver will have the power to sell the assets and to apply the proceeds to satisfy the outstanding obligations. Where the receiver takes physical possession of the assets, the receiver may require the assistance of the court to enter the premises in which the assets are held.
There is no corporate rescue legislation similar to the UK administration order or Chapter 11 of the US Bankruptcy Code. However, a scheme of arrangement is possible and will be binding on the company, and all its creditors and members, subject to the following two conditions having been met:
More than 75% in value and majority in numbers, of the company's members and creditors agree to the scheme.
The scheme is sanctioned by the court.
The start of insolvency procedures generally does not affect a secured creditor's rights to enforce its security, unless the security transaction can be set aside or payments can be clawed back by the liquidator (see Question 26).
The following transactions can be made void on the insolvency of the security provider:
Unfair preference. A security interest constitutes an unfair preference and is therefore invalid if:
it puts the creditor in a better position than other creditors and the security provider desired to put the creditor in a better position;
at the time of giving the preference, the security provider is insolvent or becomes insolvent (that is, it is unable to pay its debts as they fall due or the value of its assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities) as a result of granting the security; and
the security was granted within six months before the start of the security provider's insolvency. The period is extended to two years if the charge is given to an associate of the security provider (which includes companies controlled by the security provider through either board composition or one-third of the voting power).
Invalid floating charge. A floating charge given within one year before the start of the chargor's insolvency may be invalid, except to the extent of the amount of any new money paid to the chargor at the time of, or subsequent to, the creation of and in consideration for the floating charge. If no new money was paid, the security holder must prove that the chargor's company was solvent immediately after the creation of the floating charge.
Extortionate credit transaction. A liquidator can apply to the court to set aside or vary a credit contract entered into by the insolvent company within three years from the start of insolvency where the debtor's obligations under that contract appear extortionate, compared with the risk assumed by the lender.
Fraudulent conveyance. Any disposition of property made with intent to defraud creditors is voidable on the application of the prejudiced creditor.
Onerous property. A liquidator may, with leave of the court, disclaim onerous property held by the insolvent company (for example, land burdened with onerous covenants).
Generally, the priority of payments of an insolvent company is as follows:
First, fixed charge holders are entitled to the proceeds of sale of the secured asset, subject to the receiver's costs and expenses.
Secondly, payments of costs and expenses of the winding up, and payments to preferential creditors, including:
employees' wages;
statutory debt due to the government, for example tax claims.
Thirdly, floating charge holders are entitled to realisation proceeds from the secured assets.
Unsecured creditors rank last, behind preferential and secured creditors, and any liabilities to them are settled on a pari passu basis.
Generally, the priority between competing security interests of the same kind over the same asset is determined by its date of creation (the first prevails). The following rules apply to specific types of security interest, which are created on the same date:
A legal chargee/mortgagee ranks above an equitable chargee/mortgagee.
Priority between competing floating charges is determined by the date of crystallisation (the first prevails).
Priority between competing security interests over receivables is determined by the order in which written notice is given to the debtor.
However, these principles are subject to:
An overriding rule that a bona fide purchaser, including a subsequent chargee/mortgagee, only loses priority if it has notice of the prior encumbrance. Therefore, a prior equitable charge or mortgage will only rank above a subsequent legal charge or mortgage if the subsequent chargee or mortgagee has notice of the prior security interest. It is particularly important to register a registrable charge, to prevent a subsequent creditor taking a higher-ranking security interest without notice.
Any specific registration requirements, for example:
registration requirement of security over real estate at the Land Registry (see Question 2, Formalities);
registration requirement of security over certain intellectual property with the Patents, Designs and Trade Marks Registries (see Question 7);
registration requirement of ship mortgage with the Hong Kong Shipping Registry (see Question 3, Formalities).
Non-compliance with certain perfection requirements affects the priority of the security interest or renders the security interest void against third parties. For example, if a registrable charge created by a Hong Kong-incorporated company or a foreign company registered in Hong Kong as a non-Hong Kong company is not registered at the CR within five weeks of its creation, the charge will be rendered void against the liquidator and every creditor of the company (see Question 3, Formalities). In most circumstances, a security holder whose security interest has not been validly perfected must recover the debt pari passu with other unsecured creditors.
Generally speaking, there is no restriction on granting security over all forms of property to foreign lenders.
There are no exchange controls that restrict payments to a foreign lender under a security document or loan agreement.
Hong Kong courts usually recognise and apply the parties' choice of law subject to certain exceptions, for example:
When the choice of foreign law is not bona fide.
When the choice of foreign law contradicts public policy.
However, Hong Kong courts will not apply foreign law in relation to procedural rules, revenue matters, penalties or confiscation of property.
There are generally no stamp duties or notary fees payable on the grant, perfection or enforcement of security, except for the nominal stamp duty (HK$5 (see Question 4)) levied on a transfer instrument in relation to granting a legal mortgage over registered shares.
If a security holder exercises its power of sale and sells the secured assets, certain registration fees and ad valorem (that is, in proportion to the asset value) stamp duty may be payable, but they are usually paid by the purchaser.
The registration fees (per security document) at the main registries are as follows:
Companies Registry: HK$340.
Land Registry:
HK$230 per mortgage per property for consideration of not more than HK$750,000;
HK$450 per mortgage per property for consideration of HK$750,000 or more.
Trade Marks Registry: HK$800.
Patents Registry: HK$325.
Designs Registry: HK$590.
Generally speaking, loans, guarantees and security documents do not require notarisation to be registered in Hong Kong or enforced in Hong Kong courts.
This is not applicable.
In July 2012, the Legislative Council in Hong Kong passed the new Companies Ordinance (New CO). When the New CO comes into operation all the provisions in the existing CO concerning existing companies will be repealed. The market currently expects that this will happen in 2014.
The New CO is a virtual rewrite of the CO. Some of the changes will affect financing-related transactions.
The main relevant changes are:
Directors. Under the New CO, the restriction on loans to directors will cover a wide category of entities and individuals connected with a director. A public company and its subsidiaries can provide loans to its directors, and entities and individuals connected with them, subject to disinterested members' approval. There are also new exceptions to the restriction, one example of which is a de minimis threshold of 5% of the net assets of the company.
Administrative matters. The New CO contains rules for proposing, passing and recording a written resolution. The adoption and use of a common seal will become optional. If a company chooses to have a common seal for executing documents, the seal must be used in accordance with the requirements in its articles of association.
Financial assistance. Previous restrictions under the CO will be relaxed. Under the New CO, companies (whether listed or unlisted) are generally allowed to provide financial assistance to another party to acquire the company's own shares or the shares of its holding company, subject to a solvency test and to one of the following conditions having been met:
if the financial assistance, and all other financial assistance previously given and not repaid, is in aggregate not more than 5% of the paid up share capital and reserves;
if the financial assistance is approved by written resolution of all members of the company; or
if the financial assistance is approved by an ordinary resolution, and no court order has been made restraining the giving of the assistance on the application of shareholders holding at least 5% of the total voting rights or members representing at least 5% of the members of the company.
Registration of charges/mortgages. The New CO updates the list of registrable charges/mortgages and specifically states that:
charges over bank accounts, ship owner's lien on subfreights and charges securing issue of debentures will not be registrable;
charges over aircrafts (or any of their shares) will be registrable.
The time period for registration of a charge will be shortened from five weeks to one month. There is, however, no longer an automatic acceleration of the charge as a consequence of such a failure to register.
Also, in registering particulars of a charge and its release at the CR, a certified copy of the charge document (or the release document, as the case may be) must be registered with the CR, so that the documents are generally available to public access (subject to the payment of inspection fees).
