Requirement satisfied

Carnival Group (the company, which is not affiliated in any way with Carnival Corporation & plc) was a Bermuda-incorporated investment and property development holding company with shares listed in Hong Kong (HK:996). It had subsidiaries in Hong Kong, the mainland and the BVI (the group). The group developed and operated restaurants and theme-based leisure complexes in the mainland.

The company got into financial trouble and a winding up order was made on 10 March 2020. In all the affirmations filed by the company, the company did not dispute that the three core requirements for the court to exercise its discretionary jurisdiction to wind up the company were satisfied.

The court was dismissive of subsequent attempts by the company to argue that the second core requirement (that there was no reasonable possibility that a winding up order would benefit those applying for it) had not been satisfied. Had the company genuinely believed this, one would have expected the company to ask the court to dismiss the petition on jurisdictional grounds at a much earlier stage.

In this regard, the court noted that the company's primary listing was in Hong Kong, and maintained a principal office in Hong Kong where the directors managed the affairs of the group. Evidence showed that the company had substantial assets which could be realised for the benefit of the unsecured creditors.

The company's contentions that there would be "cross-border insolvency hurdles" was, in the view of the court, equally without merit. There was no evidence that the directors of the mainland subsidiaries would refuse to cooperate with Hong Kong-appointed liquidators and in any event, once the liquidators take control over the Hong Kong subsidiaries, they would have be able to gain access to the mainland subsidiaries.

A fruitless restructuring

The only ground advanced by the company in opposition to the petition was that there had been an ongoing restructuring effort in respect of the company's indebtedness which it said would result in a higher return to the unsecured creditors.

Linda Chan J observed that the so-called restructuring effort had come to nothing. The history of the matter showed the company had used this pretext "to obtain multiple adjournments of the Petition" and had failed to comply with court orders requiring the company to file affidavit evidence to deal with the progress of the supposed restructuring. There was no evidence before the court to show that in the past two and a half years, the company had made any real effort in pursuing the restructuring proposals.

The court noted that in the absence of a viable restructuring proposal which had the necessary support of the requisite majorities of creditors, "it would be incumbent upon the directors to take steps to put the company into liquidation so as to bring into operation the statutory scheme of winding up its affairs and assets."

Linda Chan J said that despite knowing that the restructuring was unviable, the directors "saw fit to cause the Company to continue to oppose the Petition" and had "even instructed senior counsel to make the case."

Creditors' cheer

The directors involved in causing the Company to oppose the petition are now required to file and serve evidence on why they should not be liable to pay costs. The decision is potentially good news for creditors. In the absence of any wrongful trading legislation in Hong Kong, the court appears to be going out of its way to underline that directors have a duty to consider whether there is any reasonable prospect of the company avoiding going into insolvent liquidation.

The court explained the nature of the duty, which it said was:

"Enshrined in the avoidance provisions under the [Companies (Winding Up and Miscellaneous Provisions) Ordinance] such as s.266, which renders unfair preferences made at the time the company is unable to pay its debts voidable, and s.275 which imposes liability on directors for fraudulent trading.

It also accords with the principle that where a company is insolvent or of doubtful solvency, the interests of the company are in reality the interests of the creditors as it is the creditors' money which is at risk. The directors, when carrying out their duty to the company, must consider the interests of the creditors as paramount and take those into account when exercising their discretion."

The court had previously taken aim at Hong Kong-listed companies that are incorporated offshore, carry on business primarily in the mainland and that appear to want to engineer de facto moratoria on winding-up actions often to the detriment of the company's creditors.

In a series of judgments, the court had previously warned that insolvency proceedings launched from offshore "letterbox" jurisdictions – and where the powers of the provisional liquidators to properly supervise any restructuring appear light – would be less likely in future to receive recognition and assistance in Hong Kong (see Hogan Lovells alert "A Magical Incantation" – Hong Kong court warns it will carefully examine restructuring viability).

This line of reasoning was given additional force by Linda Chan J in her judgment in Re Up Energy Development Group Limited [2022] HKCFI 1329, that where the three core requirements for winding-up a foreign company under section 327(1) of CWUMPO are satisfied, the Hong Kong court will be ready to assume winding up jurisdiction (see Hogan Lovells alert Deja vu – Hong Kong court orders winding-up of Bermuda-based listco despite PLs' objections).

Add to that, the decision of the Honourable Mr. Justice Harris that, going forward, it should be the company's Centre of Main Interests that should take precedence over the place of incorporation when it comes to recognition and assistance (see Hogan Lovells alert Hong Kong court highlights COMI over place of incorporation when recognising foreign insolvency processes), and you have the signs of a distinct course correction when it comes to the operation of so-called "soft touch" corporate insolvency.

The new warning to directors in Carnival appears to strengthen the courts' toolbox when it comes to protecting the interests of creditors. It is a timely reminder that directors should be ever conscious of the risks of personal liability whilst continuing to cause their company to carry on trading whilst insolvent.

Authored by Jonathan Leitch and Nigel Sharman.