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1 Finance 2008/09 Volume 1: Secured Lending Hong Kong Hong Kong Richard McKeown, Simmons & Simmons real estate 1. Please briefly state what is considered real estate in your jurisdiction. What are the most common forms of security granted over it? How are they created and how are they perfected (that is, made valid and enforceable)? Real estate is referred to as immovable property in Hong Kong, which is defined as (section 3, Interpretation and General Clauses Ordinance, Chapter 1 of the laws of Hong Kong): Land, whether covered by water or not. Any estate, right, interest or easement in or over any land. Things attached to land or permanently fastened to anything attached to land. gagee, mainly the power of sale, possession, power to lease and to appoint a receiver, except that the mortgagee cannot execute an assignment to the buyer on enforcement unless there is a valid power of attorney which provides this power. Although there is a statutory form for a legal or equitable mortgage over land, it is not compulsory to use it. Perfection. A mortgage on land, whether situated in Hong Kong or not, created by companies formed and registered under the Companies Ordinance (Chapter 32, Laws of Hong Kong), must be registered with the Companies Registry within five weeks from the date of creation (section 80(2)(d), Companies Ordinance). The mortgagor must keep at its registered office: A copy of the security document for all mortgages/charges that are registrable at the Companies Registry. The most common forms of security that are granted over immovable property are as follows. Mortgage A mortgage is security effected by the creation or transfer of a legal or equitable interest in an asset as security for the payment of a debt. It is a non-possessory, proprietary security interest. The mortgagee (the person in whose favour the mortgage is granted) has a right to sell the asset on default and undertakes to retransfer title to the asset on repayment of the debt. Depending on the nature of the title transferred, a mortgage can be legal or equitable: A legal mortgage assigns the full legal title in the secured asset to the mortgagee, subject to a contractual proviso for the retransfer of the legal title on discharge of the secured obligations. An equitable mortgage assigns the full equitable title in the secured asset to the mortgagee. An equitable mortgage can be granted over all forms of personal property, in which the mortgagor (the security provider) holds legal title, equitable title or merely a lesser equitable interest. Therefore, compared to a legal mortgage, future property and fractional interests in choses in action can be the subject of an equitable mortgage. Its own register of charges containing particulars of all mortgages/charges affecting its property and of all floating charges (section 88 and 89, Companies Ordinance). A mortgage over land in Hong Kong must be registered at the Land Registry within one month of its creation (section 5, Land Registration Ordinance, Chapter 128 of the Laws of Hong Kong). Charge A charge, unlike a mortgage, does not immediately transfer ownership of the assets, but provides the chargee (the person in whose favour the charge is granted) certain rights over the charged assets. The charge can give the chargee control over the charged assets (a fixed charge), or it can permit the chargor to use the charged assets until any default of repayment (a floating charge). On default, the chargee can require the chargor (the security provider) to sell the asset, or it can take possession of the asset, and sell it under any contractual power of sale in the charge (or if there is none, apply to a court for permission to sell the asset), to generate funds to satisfy the secured debt. Creation. A legal mortgage over land must be created by deed as a legal charge by deed (section 3, Conveyancing and Property Ordinance, Chapter 219 of the Laws of Hong Kong). However, in substance, the legal charge has the characteristics of a statutory legal mortgage. An equitable mortgage must be in writing signed by the mortgagor or its agent. It need not be by deed, but if granted under a deed it has the same statutory remedies granted to a legal mort- A charge in effect gives the chargee a claim over the proceeds of a sale of the charged assets in priority to other creditors. Creation. A floating charge over land must be in writing signed by the chargor or its agent. Perfection. A floating charge over land in Hong Kong is only registrable at the Land Registry on crystallisation. CROSS-BORDER HANDBOOKS 91 This chapter was first published in the Cross-border Finance Handbook 2008/09 Volume 1: Secured Lending and is reproduced with the permission of the publisher,

2 Hong Kong Finance 2008/09 Volume 1: Secured Lending A floating charge on land created by companies formed and registered under the Companies Ordinance must be registered with the Companies Registry within five weeks from the date of creation (section 80(2)(d), Companies Ordinance). Tangible movable property 2. Please briefly state what is considered tangible movable property in your jurisdiction, for example, machinery, trading stock (inventory), aircraft and ships? What are the most common forms of security granted over it? How are they created and how are they perfected? Movable property is defined under section 3 Interpretation and General Clauses Ordinance as being property of every description except immovable property (see Question 1). The most common forms of security that are granted over movable property are as follows. Mortgage No special form is required for the creation of a legal or equitable mortgage. A mortgage over personal chattels, for example goods, furniture, and trade machinery created by a company formed and registered under the Companies Ordinance must be registered at the Companies Registry (section 80(2)(c), Companies Ordinance). Charge No special form is required for the creation of a charge. been performed. Liens can be divided into two categories: liens created by contract and liens imposed by law (general or specific) due to the relationship of the parties: Contractual liens are often contained in bank documentation which sets out the general terms and conditions applicable to the bank-customer relationship. A general lien is imposed by law where an asset is delivered to a solicitor or banker. For example, a banker has the right to retain all documents of a customer until the customer settles all sums owed to the bank. A specific lien imposed by law is more unusual. The person holding the asset has to return the asset once the particular obligations supported by the lien have been performed. Unlike a pledge, a lien does not entitle the holder to sell the relevant asset, but simply suspends the holder s obligation to return the asset to the true owner until the debt has been paid. Contractual liens are created by agreement. Liens imposed by law arise either by common law or statute. Perfection is achieved by delivery of the secured asset to the lender. Ships A legal mortgage over ships registered under the Merchant Shipping (Registration) Ordinance (Chapter 415, Laws of Hong Kong) must be executed in the form and manner specified by the Director of Marine. A floating charge is commonly used to charge trading stock. A floating charge created by a company formed and registered under the Companies Ordinance must be registered at the Companies Registry within five weeks from the date of creation (section 80(2)(f), Companies Ordinance). A fixed charge over personal chattels must also be registered at the Companies Registry (section 80(2)(c), Companies Ordinance). Pledge A pledge is a possessory security interest under which possession of the secured asset is delivered to the pledgee (the person in whose favour the pledge is granted) as security against the performance of the pledgor s payment obligations. The pledgee has a right of sale if the debt is not repaid by the due date. Title to the relevant asset must be capable of transferring by delivery. It is not possible, for example, to create a pledge over registered (as opposed to bearer) shares, as title transfers only on registration, not delivery of the share certificate. A legal mortgage over ships registered in the Register of Ships in Hong Kong must be registered at the Register of Ships. A mortgage/charge on a ship or any share in a ship created by a company formed and registered under the Companies Ordinance must also be registered at the Companies Registry within five weeks (section 80(2)(h), Companies Ordinance). Aircraft The general rules on creation and perfection of a mortgage/charge over movable property apply (see above). If an aircraft is charged/mortgaged by a debenture, or as a floating charge, by a company formed and registered under the Companies Ordinance, it must be registered at the Companies Registry against the company within five weeks (section 80(2)(a) or (f), Companies Ordinance). Shares and financial instruments Creation and perfection are achieved by delivery (either actual or constructive) of the secured asset to the pledgee or its agent, with the intention to create a security interest over the asset. Lien A possessory lien entitles the person holding the asset to retain possession of it until the obligation supported by the lien has 3. What are the most common forms of security granted over financial instruments, such as shares and other securities? How are they created and how are they perfected? The most common forms of security granted over shares and other securities are as follows. 92 CROSS-BORDER HANDBOOKS This chapter was first published in the Cross-border Finance Handbook 2008/09 Volume 1: Secured Lending and is reproduced with the permission of the publisher,

3 Finance 2008/09 Volume 1: Secured Lending Hong Kong Legal mortgage A legal mortgage is created by a transfer of legal title of the securities to the mortgagee, and the mortgagee being entered into the relevant share register as the holder of the securities. To be perfected, the mortgagee s name must be entered into the share register as the owner of the relevant securities. Equitable mortgage A mortgage/charge over a company s book debts granted by a company formed under the Companies Ordinance must be registered at the Companies Registry within five weeks from the date of creation (section 80(2)(e), Companies Ordinance). There is no requirement to give notice of the mortgage/assignment to the debtors or contract counterparties. However, failure to do so would result in the security interest being known only to the mortgagor and the mortgagee, and the debtor would retain all its rights (including the right of set-off) against the mortgagor. An equitable mortgage over shares falls short of a transfer of legal ownership of such shares, but provides the mortgagee with the means to effect such a transfer on enforcement of the mortgage. An equitable mortgage requires delivery to the mortgagee of the relevant share certificates and the share transfer forms duly executed but both left undated. To be perfected, notice can be given to the share register of the relevant securities. Although the equitable mortgage will not be registered, it will act as a form of notice to the company that the owner has mortgaged such securities. If the mortgage includes security over dividends and other derivative assets, it is arguable that such assets constitute book debts. As such the security interest over them, if granted by a company formed or registered under the Companies Ordinance, is registrable at the Companies Registry within five weeks of creation (section 80(e), Companies Ordinance). A fixed mortgage (or charge) over shares is not registrable at the Companies Registry. Charge There is no specified form for the creation of a charge and in practice a share charge and an equitable mortgage over shares would constitute the same thing. However, it is also possible to create a charge over shares by simply delivering the share certificates and supporting papers such as the share transfer forms (see above, Equitable mortgage) to the chargee, with the intention to create security. Claims and receivables 4. What are the most common forms of security granted over claims and receivables (such as debts or rights under contracts)? How are they created and how are they perfected? Generally, claims and receivables are considered to be future assets. Accordingly, a legal mortgage over claims and receivables is uncommon. The most common forms of security that are granted over claims and receivables are as follows. Equitable mortgage/charge No special form is required for the creation of an equitable mortgage/charge over claims and receivables. It normally takes the form of an assignment of the assignor s rights in respect of the claims and receivables. If notice of the assignment is given to the debtors or contract counterparties, all future rights and defences otherwise arising in relation to their obligations relating to the receivables and claims (such as the right of set-off) will arise only against the mortgagee, not the mortgagor. Intellectual property 5. What are the most common forms of security granted over registered and unregistered intellectual property? How are they created and how are they perfected? Consider if applicable: Patents. Trade marks. Other intellectual property rights, such as copyright and registered designs. Registered intellectual property - patents, trade marks and registered designs Legal mortgage. A legal mortgage must be created in writing and signed by or on behalf of the mortgagor and made under seal. For patents, a mortgage is often created by an assignment of the patent to the assignee with a license back, together with an undertaking for reassignment on repayment. A legal mortgage over a company s intellectual property must be registered at the Companies Registry within five weeks from the date of creation (section 80(2)(i), Companies Ordinance). A legal mortgage must also be registered at the relevant registry of the Intellectual Property Department as soon as possible. Equitable mortgage/charge. No special form is required to create an equitable mortgage/charge. Registration requirements apply (see above, Legal mortgage). Unregistered intellectual property - copyright Mortgage/charge. No special form is required for its creation. Lenders usually prefer to take security in the form of an assignment of copyright and license back, with an undertaking for reassignment on repayment. A mortgage/charge over a company s copyright must be registered with the Companies Registry within five weeks from the date of creation (section 80(2)(i), Companies Ordinance). CROSS-BORDER HANDBOOKS 93 This chapter was first published in the Cross-border Finance Handbook 2008/09 Volume 1: Secured Lending and is reproduced with the permission of the publisher,

4 Hong Kong Finance 2008/09 Volume 1: Secured Lending Copyright subsists and arises automatically in certain original works and cannot be registered in Hong Kong. Accordingly, a security interest created over copyright cannot be registered with the Intellectual Property Department. For an overview of assets and related security regulations, see table, Taking security over assets in Hong Kong. Commercial security 6. What types of commercial or quasi-security (that is, legal structures used instead of taking security) are common in your jurisdiction? Is there a risk of such structures being recharacterised as a security interest? Consider the following and give brief details: Sale and leaseback. Factoring. Hire purchase. Retention of title. Other structures. All the following are common in Hong Kong. Sale and leaseback remain untreated. However, the clause will not retain proprietary rights in property which become mixed, or processed into a different form. Set-off A contractual right of set-off is commonly contained in various forms of banking documentation. It provides the bank with a right to set-off a debt owed by it to a borrower against the borrower s debt to the bank, and so reduce or extinguish such debt. However, such right will not survive the borrower s insolvency to the extent that it exceeds the statutory rights of set-off which arise on an insolvency under section 35 of the Bankruptcy Ordinance (Chapter 6, Laws of Hong Kong), unless the contract is in effect a charge (which, if granted by a company formed or registered in Hong Kong, must be duly registered at the Companies Registry). Risk areas 7. Are there types of assets over which security cannot be granted or is difficult to grant? Consider the following and give brief details: Future assets. Fungible assets (a pool of assets that are indistinguishable from each other and that may change over time). Other assets. Future assets Sale and leaseback is an agreement in which the owner of property sells that property and then leases it back again from the buyer (lessor), usually a bank or a financial institution, for an agreed period and rental. This arrangement is useful when the seller needs to realise the cash invested in the property for other investments, but the asset is still needed to operate the business of the seller. In certain cases, it may provide the seller with additional tax deductions. Factoring Factoring is the purchase of debts at less than face value (reflecting the face value of money and the risk of repayment) by a factor for the purpose of providing finance to the seller, or relieving the seller from administrative tasks. Security can be taken over future assets by floating charge. Fungible assets Security over fungible assets can be taken by mortgage or charge. If the mortgagor/chargor retains the right to remove assets from the fungible pool without recourse to the mortgagee/chargee, the security will be considered a floating charge. The assets should not be comingled with assets of the mortgagor/chargor which are not intended to be the subject of the security, but should be segregated. 8. Do company law rules affect the granting of security? In particular: Hire purchase Hire purchase is an agreement in which periodic lease payments are made in respect of goods by the lessee to the owner. The lessee has an option, exercisable only after an agreed number of lease payments have been made (commonly to ensure that a sum equal to the original full price plus interest has been paid) to purchase the goods at a predetermined price (usually a nominal sum), or return the goods to the owner. Ownership of goods is not conferred on the lessee until the final payment is made. Retention of title A retention of title clause is commonly found in supply contracts. The clause purports to retain, for example, for a supplier of raw materials, title to those raw materials, until the buyer settles the debt incurred in payment for them. If the borrower defaults, the lender can recover the raw materials from the borrower to cover the debt, if the raw materials Financial assistance rules. For example, if a company granted security to secure debt used to purchase its own shares (or the shares of its holding company), would this breach such rules? Corporate benefit rules. For example, if a subsidiary company granted security in respect of a loan to its parent, would this breach such rules? Other rules? Unlawful financial assistance Section 47A of the Companies Ordinance prohibits a company from providing financial assistance for the purchase of its own shares or those of its holding company (where the company, or the holding company, is a company formed or registered in Hong Kong). Financial assistance can be by way of gift, security, indemnity, guarantee or 94 CROSS-BORDER HANDBOOKS This chapter was first published in the Cross-border Finance Handbook 2008/09 Volume 1: Secured Lending and is reproduced with the permission of the publisher,

5 Finance 2008/09 Volume 1: Secured Lending Hong Kong Asset type Taking security over assets in Hong Kong What forms of security can be granted? How is each security interest created and made valid and enforceable? Real estate Mortgage or charge. Legal mortgage must be by deed as a legal charge by deed. Tangible movable property such as machinery Mortgage/charge. Pledge. Lien. Equitable mortgage/floating charge must be in writing signed by the mortgagor/chargor. Mortgage/charge must be registered at the Companies Registry. Mortgage must be registered at the Land Registry. Floating charge is registrable at the Land Registry on crystallisation. Mortgage/charge over personal chattels must be registered at the Companies Registry. Delivery of secured asset to the pledgee, with intention to create a security interest over the asset. Created by agreement or imposed by law. Perfected by delivery of the secured asset to the lender. Trading stock (inventory) Floating charge. Floating charge must be registered at the Companies Registry. Shares and other financial instruments Mortgage or charge. Legal mortgage is perfected by registering the mortgagee s name in the relevant share register. Equitable mortgage/charge is perfected by delivery of share certificates, the share transfer forms duly executed and both left undated. Other claims (receivables, debts and rights under contracts) Equitable mortgage or charge. If a mortgage/charge includes security over dividends and other derivative assets, and is granted by a company formed or registered under the Companies Ordinance, it must be registered at the Companies Registry. Equitable mortgage/charge must be registered at the Companies Registry. Intellectual property Mortgage or charge. Mortgage/charge for registered intellectual property must be in writing and signed by or on behalf of the mortgagor, and made under seal. Mortgage/charge must be registered at the relevant registry of the Intellectual Property Department (except for copyright) and the Companies Registry. Ships Mortgage or charge. Legal mortgage over ships registered under the Merchant Shipping (Registration) Ordinance must be in the form and executed in the manner specified by the Director of Marine, and registered at the Register of Ships. Mortgage/charge on a ship or any share in a ship must be registered at the Companies Registry. Aircraft Mortgage or charge. Mortgage/charge over personal chattels must be registered at the Companies Registry. Floating charge must be registered at the Companies Registry. loan. There are certain relaxations to the prohibition against financial assistance where it is given by an unlisted company, and sections 47E to 48 of the Companies Ordinance set out a whitewash procedure by which financial assistance by an unlisted company can be approved. Corporate benefit rules Directors owe a duty to the company to act in good faith and in the best interests of the company. Accordingly, it is necessary for a company providing security in respect of a loan to another company to prove that it derives sufficient corporate benefit from the transaction. While there may be clear corporate benefit for a parent to guarantee a loan of a subsidiary, it is often more difficult to justify a subsidiary providing security for its parent s loan. However, existing cases suggest that even if a company believes that there is insufficient corporate benefit to provide security for another company, it can still be given if both: Unanimous shareholder approval is obtained. The company is not insolvent either at the time of giving the security, or immediately following the giving of the security. CROSS-BORDER HANDBOOKS 95 This chapter was first published in the Cross-border Finance Handbook 2008/09 Volume 1: Secured Lending and is reproduced with the permission of the publisher,

6 Hong Kong Finance 2008/09 Volume 1: Secured Lending 9. Could a party holding or enforcing security over land be liable under environmental laws, even if it did not cause any pollution of the land? Some environmental offences (such as the prohibited discharge of pollutants into water of Hong Kong in Hong Kong) are strict liability offences, that is, the offence can be committed without any intention or knowledge on the part of the offender. Liability for such offences usually only lies with the offender or the occupier (or their directors, secretary or management staff), that is, the borrower. Accordingly, after enforcement, the security holder is unlikely to be liable for pollution of the land caused before enforcement. If, however, the security holder actively participates in the running of the borrower after enforcement, it may be liable for any pollution caused afterwards. The commercial debt market 10. Is contractual subordination of debt possible and common? If so, how can it be achieved, for example by an inter-creditor agreement between senior, mezzanine and junior creditors? Is structural subordination possible? is required. Although notice to the debtor is not required, it is commonly given to prevent equities set-off running against the assignor. The assignor must be a party to any action to enforce the security, either by suing the debtor in his name or by joining the assignee in the action. Accordingly, an assignee should include in the assignment an undertaking from the assignor that it will join in any action against the borrower on enforcement of the security. It is not possible to transfer the assignor s obligations under the secured debt, that is, the original lender cannot assign any undrawn commitments (or other obligations) to the assignee. To transfer both rights and obligations, a novation is required. A novation will discharge the rights and obligations of the original lender and the new lender will assume identical new rights and obligations. Consent of all the parties involved in the original loan and security documents is required, but may be obtained in advance. If it is intended that a secured debt will be traded, the security must be expressed in its terms to cover any assignment or transfer of the secured debt. If the transfer is to be effected by way of a novation, it is common to have the security granted in favour of a trustee for the lenders to avoid any argument that the security is released when the debt is discharged on the novation. Contractual subordination is possible and can be achieved by contractual agreement between the junior and the senior creditor, to the effect that the junior creditor s claim will rank after the senior debt. The junior creditor can also agree that its debt is a contingent debt and is subject to the discharge of the senior debt. Structural subordination is also possible and arises where the senior creditor lends to a company which is lower in the group structure than a holding company to which the junior creditor lends, such as an operating subsidiary of such holding company. Unsecured lenders to the parent company effectively rank behind the creditors of the operating subsidiary. This is because the creditors to the operating subsidiary have first call on the revenues of the subsidiary for repayment of the debt owed to them, before any money can be distributed to the holding company by dividend to be made available to the creditors of the holding company. 12. Is the trust concept recognised in your jurisdiction? If not: Is a trust created under the law of another country recognised in your jurisdiction? Can a security trustee enforce its rights in the courts in your jurisdiction? The trust is recognised under Hong Kong law, and Hong Kong law also recognises a trust created under the law of another country. Subject to normal procedural matters, a security trustee is able to commence an action in the Hong Kong courts to enforce rights under a security document against assets located in Hong Kong. 11. Is secured debt traded in your jurisdiction? If so, what transfer mechanisms are used? How do buyers ensure that they obtain the benefit of the security associated with the transferred debt? Secured debts can be traded in Hong Kong. A transfer of benefits under a contract can be achieved by an assignment (legal or equitable) provided that the contract does not prohibit such assignment. A legal assignment of the benefit of a contract must be by writing under the hand of the original lender (assignor). No particular form of assignment is required, although it must clearly indicate an intention of the assignor to dispose of the debt and to vest it to the buyer (assignee). Under section 9 of the Law Amendment and Reform (Consolidation) Ordinance (Chapter 23, Laws of Hong Kong), a written notice of such assignment must be given to the debtor. The assignee is entitled to sue the debtor in its own name and does not need to join the assignor as a party to the action. A legal assignment must assign the entire secured debt; partial assignment can only be achieved by equitable assignment. For an equitable assignment, consideration 13. Do the different types of security in your jurisdiction need to be documented separately or does your jurisdiction allow a single security document? It is possible to document different types of securities in one security document, such as a debenture, although it is not uncommon for different types of security to be documented separately to identify the relevant perfection requirements, covenants and remedies relating to each such security type. Enforcement and insolvency 14. Please briefly state the circumstances in which a secured creditor can enforce its security, for example, when an event of default occurs? What requirements must the creditor comply with? The loan agreement or security document normally set out the circumstances in which a secured creditor can enforce its se- 96 CROSS-BORDER HANDBOOKS This chapter was first published in the Cross-border Finance Handbook 2008/09 Volume 1: Secured Lending and is reproduced with the permission of the publisher,

7 Finance 2008/09 Volume 1: Secured Lending Hong Kong curity under events of default. However, a higher standard can be imposed, for example, that the security can only be enforced when a positive declaration has been made by the secured creditor for enforcement after an event of default has occurred. Events of defaults commonly include: Late repayment of the loan. Breach of representations and covenants. Cross default. Change of control. Insolvency of the borrower. They are generally situations in which the lender feels that the borrower s ability to perform its obligations under the security documents may be compromised or that the borrower is already in default. The creditor should be sure that the relevant enforcement event has occurred before taking any enforcement action, to avoid any liability for loss arising from wrongful acceleration of the debt and enforcement of security. 15. How are the main types of security interest usually enforced? What requirements must a creditor comply with (for example, a mandatory public sale of the secured asset through the courts)? If the mortgagee is a limited company, notice of entry into possession must be filed with the Companies Registry (section 87, Companies Ordinance). Selling the secured property. The following applies: The mortgagee must act in good faith and take reasonable care to obtain a proper price. Generally, the mortgagee can decide on the timing of the sale but should not delay sale to the financial detriment of the mortgagor. The mortgagee should act like a prudent seller and obtain expert advice on the method of sale and price. The proceeds of sale must be applied by the mortgagee in accordance with section 54 of the Conveyancing and Property Ordinance. Appointing a receiver/manager. The following applies: The receiver must be appointed in writing and is the agent of the mortgagor. The mortgagee should not interfere in the exercise of powers by the receiver. The receiver s power are defined in his appointment and will generally have similar powers of enforcement to a mortgagee, for example, power of sale and taking possession. Movable property - receivership Immovable property Immovable property security interests are usually enforced by one or more of the following: Taking possession of the secured property. Selling the secured property. Appointing a receiver/manager. These remedies apply to legal mortgages and charges, and equitable mortgages and charges executed by deed over land (section 51(1), Conveyancing and Property Ordinance). Enforcement is only allowed on occurrence of an event of default set out in section 11 of Schedule 4 of the Conveyancing and Property Ordinance. The requirements for each form of enforcement are as follows. Taking possession of the secured property. The following applies: If there is a tenancy created after the mortgage but with the consent of the mortgagee, the mortgagee cannot obtain physical possession against the tenant. If the tenancy is for less than three years, or more than three years and registered before creation of the mortgage, notice must be given to the tenant to pay rent to the mortgagee, as the mortgagee cannot take possession. Immovable property security interests are usually enforced by appointing a receiver. Security documents often provide the morgagee/chargee with the right to appoint a receiver on the occurrence of an event of default or other enforcement event (see Question 14). The receiver normally has the power to sell the assets and to apply the proceeds to satisfy the debt. 16. Are company rescue or reorganisation procedures (outside of insolvency proceedings) available in your jurisdiction? If yes, please give brief details, including voting requirements to approve such procedures. How do they affect a secured creditor s rights to enforce its security? Corporate arrangements A corporate arrangement is a contractual agreement between the borrower company and its creditors. It can only be implemented if all creditors agree to the arrangement. It does not involve the court or authorities. There is no statutory moratorium on creditors enforcing their rights while an agreement is being negotiated. Schemes of arrangement A scheme of arrangement requires the consent of 75% in value and 50% in number of the creditors (section 166, Companies Ordinance). Court approval is also required. Once approved, the arrangement is binding on all creditors, including secured creditors. Again, there is no statutory moratorium on creditors enforcing their rights while an arrangement plan is being formulated. CROSS-BORDER HANDBOOKS 97 This chapter was first published in the Cross-border Finance Handbook 2008/09 Volume 1: Secured Lending and is reproduced with the permission of the publisher,

8 Hong Kong Finance 2008/09 Volume 1: Secured Lending 17. How does the start of insolvency procedures affect a secured creditor s rights to enforce its security? The start of insolvency procedures generally does not affect a secured creditor s rights to enforce its security, unless the security is set aside under the anti-avoidance provisions (see Question 18). 18. What transactions granting security can be made void if the entity that granted the security becomes insolvent? Please briefly state the time limits that apply and the conditions that must be met for the security to be made void. Floating charge A floating charge is void if it is executed within 12 months of the start of the winding up, unless it can be proved that the company was solvent immediately after the creation of the charge (section 267, Companies Ordinance). However, the security may be valid to the extent of the amount of any cash paid to the company in consideration for the charge at the time of, or subsequent to, the creation of the charge. A preference will be void if all the following apply (section 266B, Companies Ordinance): It was made within six months of the start of winding up of a company (the relevant time is extended from six months to two years if the preference was granted to a connected person, which includes a director, his business partners and their close relatives). The company was influenced by a desire to put the preferred person in a better position on winding up (this will be presumed if the preference was granted to a connected person). The company is insolvent at the time the preference occurs. Fraudulent trading If a company enters into a transaction with an intent to defraud the company s creditors, the transaction can be challenged during the winding up of the company (section 275, Companies Ordinance). This section is rarely relied on, as it requires proof of actual dishonesty. The purpose of this is to prevent last minute floating charges by directors or the controllers of companies being created in favour of themselves. Extortionate credit transactions If a company enters into an extortionate credit transaction within three years before its winding up, the court can, on an application by the liquidator, give one or more of the following orders in relation to the transaction (section 264B, Companies Ordinance): Set aside the transaction in whole or in part. Vary the terms of the transaction. Require any person who is or was a party to the transaction to pay to the liquidator any sums paid to that person by the company, due to the extortionate credit transaction. Require any person to surrender any property held by him as security for the purposes of the transaction. Order accounts to be taken between any persons. A credit provision transaction is extortionate if: 19. Please list the order in which creditors are paid on the borrower s insolvency, assuming the security interests have been validly perfected. Consider: Statutory claims (such as tax or other government claims, expenses of the insolvency proceedings and employee claims). The secured creditors considered in Questions 1 to 5 (please state which order of priority applies between the relevant security interests). Unsecured creditors. Subordinated creditors. On the borrower s insolvency, creditors are paid in the following order: Creditors secured by mortgages or fixed charges are repaid as far as possible out of the proceeds of sales of the assets that are subject to the security interest. It requires grossly exorbitant payments to be made by the company in respect of providing credit; or The transaction grossly contravenes ordinary principles of fair dealing. Unfair preferences A preference is a transaction in which a company intentionally benefits a creditor by improving the creditor s position if the company becomes insolvent, for example, by providing new or enhanced security to such creditor. Preferential creditors, for example, employees wages (subject to caps) and tax or other government claims. Creditors secured by floating charge are repaid as far as possible out of the proceeds of sales of assets that are subject to the floating charge. Unsecured creditors. Subordinated creditors. 98 CROSS-BORDER HANDBOOKS This chapter was first published in the Cross-border Finance Handbook 2008/09 Volume 1: Secured Lending and is reproduced with the permission of the publisher,

9 Finance 2008/09 Volume 1: Secured Lending Hong Kong 20. If more than one creditor holds the same security interest over the same asset, how is priority between them determined? The priority between competing security interests of the same kind depends on the time of creation (and not the time of registration at the Companies Registry, if applicable); the first in time prevails. However, the priority between competing floating charges depends on the date of crystallisation. Accordingly, if a floating charge was created later in time but crystallises earlier than a charge created earlier, the crystallised charge has priority. For land, priority depends on the date of creation of the security interest, as long as the security interests are duly registered at the Land Registry within one month of creation (section 3, Land Registration Ordinance). If a security interest is registered outside the one-month period, its priority dates from the date of registration instead. 21. If a security interest has not been validly perfected, where does the security holder rank on the borrower s insolvency? However, if the security to be enforced against is situated in Hong Kong, in deciding whether to grant an order to enforce the security, the Hong Kong court takes into account whether the nature of such security is also recognised under Hong Kong law, (that is, whether a similar security interest over the assets can be created under Hong Kong law). Tax and fees 25. Are taxes or fees paid on the granting and enforcement of security? Consider the following and state the fee amounts and tax rates, if they are more than a nominal amount: Documentary taxes (for example, stamp duty). Registration fees. Notaries fees. Stamp duty Stamp duty is chargeable on the following instruments/documents: If a security interest has not been validly perfected, it is void against the liquidator and other creditors. The security holder will be treated as an unsecured creditor on the borrower s insolvency. Cross-border issues 22. Are there restrictions on granting security (over all forms of property) to foreign lenders? If yes, please give brief details, for example registration requirements. There are no restrictions on granting security (over all forms of property) to foreign lenders. Instrument for the conveyance on sale or lease of immovable property in Hong Kong. The duty is ad valorem and the maximum rate is 3.75% of the amount or value of the consideration provided for the conveyance. Essentially, this covers virtually all instruments which convey a beneficial interest in land in Hong Kong. However, it is not payable in relation to mortgages. Agreements for the sale of immovable residential property. The duty is ad valorem and the maximum rate is 3.75% of the amount of value of the consideration provided for the sale. Instruments for the sale, purchase or transfer of Hong Kong stock. On enforcement of a share charge, the transfer of beneficial ownership of the shares attracts stamp duty. The duty is ad valorem at a rate of 0.2% of the amount or value of the consideration provided. The transfer of legal ownership of shares also attracts a fixed duty of HK$5 (about US$0.65). 23. Are there exchange controls that restrict payments to a foreign lender under a security document or loan agreement? There are no exchange controls that restrict payments to a foreign lender under a security document or loan agreement. 24. Is a foreign choice of law clause in a security document recognised and applied by the courts in your jurisdiction? Does local law always apply in certain circumstances? A foreign choice of law clause is generally recognised and applied by the Hong Kong courts. Hong Kong bearer instruments. The duty is ad valorem at a rate of 3% of the value of the stock as at the date of issue. The duplicates and counterparts of instruments are chargeable with a nominal amount of stamp duty. Registration fees Registration fees (nominal) are payable to the relevant registry for the following types of security: Charges and mortgages. Security over land. Security over registrable intellectual property rights. CROSS-BORDER HANDBOOKS 99 This chapter was first published in the Cross-border Finance Handbook 2008/09 Volume 1: Secured Lending and is reproduced with the permission of the publisher,

10 Hong Kong Finance 2008/09 Volume 1: Secured Lending Notaries fees No mandatory notaries fees are applicable on the granting or enforcement of security. 26. If such taxes and fees make granting security too expensive, are there strategies to minimise costs? The only significant cost involved is the payment of stamp duties (see Question 25). Stamp duties are only payable on the transfer of the relevant security asset, that is, on enforcement, and not on granting of the security. Reform 27. Please summarise any proposals for reform and state whether they are likely to come into force and, if so, when. Schedule 2 to the Companies (Amendment) Ordinance 2004 will come into force on 14 December The new amendments clarify the circumstances under which a non-hong Kong company registered under Part XI of the Companies Ordinance is required to register charges on its property. A non-hong Kong company is not required to register a charge if the relevant property is not in Hong Kong at the time the charge is created, or if the relevant property in Hong Kong is acquired after the creation of the charge. The Companies (Amendment) Bill 2000 (Bill) proposes to introduce a new statutory corporate rescue procedure. Under the current law, the creditor arrangement under section 166 of the Companies Ordinance (see Question 16) does not provide a moratorium that can bind creditors while an arrangement plan is being formulated. The Law Reform Commission considers that a new statutory corporate rescue procedure with a compulsory statutory stay of proceedings is necessary. The Bill also provides that directors and senior management should be made personally liable for the debts of a company which traded while insolvent, to encourage directors and senior management to face the fact that a company was going into insolvency at an early stage and cause them to address the situation. Although the Bill has been placed before the Legislative Council, no timetable has been set for it to come into force. 100 CROSS-BORDER HANDBOOKS This chapter was first published in the Cross-border Finance Handbook 2008/09 Volume 1: Secured Lending and is reproduced with the permission of the publisher,

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