Commencement Of The Bankruptcy
Bankruptcy commences on the making of the Bankruptcy Order. However, for the purpose of protecting creditors, the actual date of the commencement of the bankruptcy is the date of the presentation of the petition.
A bankruptcy petition can be based either on a judgment or alternatively on the grounds that the debtor has failed to comply with the requirements of a statutory demand. A statutory demand must be served personally. If not, it is probable that the court will not allow a bankruptcy petition to be filed. Indeed, if judgment has been obtained by default, or is based on substituted service it is possible the court may not allow a petition to proceed on such a claim, particularly if the creditor is unable to show that the debtor was in Hong Kong at the time of the advertisement of the proceedings.
If a judgment has been obtained in the normal course of events and the petition cannot be served personally, it is possible to effect substituted service by advertising the petition, but this has to be done in accordance with the requirements of the Court.
Once the bankruptcy order has been made, the Official Receiver becomes the trustee of the bankrupt’s estate and all the assets of the bankrupt vest in the trustee. In only a small number of cases does a private sector insolvency practitioner act as trustee. The role of the trustee is to realise the assets of the bankrupt, investigate the circumstances surrounding his failure and to distribute his assets to creditors in accordance with the priorities set out in the Bankruptcy Ordinance.
This section gives a brief overview of some of the critical issues most likely to arise in bankruptcies in Hong Kong.
Unfair Preferences
Under the old legislation there existed the concept of fraudulent preferences. However, in line with the changes in the UK in 1986, the word “fraudulent” has been dropped and changed to “unfair”. The purpose behind this was to get rid of the connotation of “fraud”, but at the same time to enhance the powers of the trustee to unravel transactions which took place in the period leading up to the bankruptcy.
An unfair preference is a transaction whereby a person who was a creditor, guarantor or surety of the debtor has been placed in a better position than they would otherwise have been in the event of bankruptcy. A good example is where a creditor has been granted security over an asset of the debtor in respect of an existing debt. If there has been no consideration for granting the security, then the creditor concerned has been put in a better position compared with other creditors.
The legislation allows a trustee to go back a period of six months to investigate such transactions. If he considers that a creditor has been preferred, he may make an application to the Court for the transaction to be set aside and for the repayment of the amount involved for the benefit of creditors.
Commercial transactions entered into in the normal course of business are generally safe from unfair preference claims. Moreover, it is a valid defence to an unfair preference claim that the debtor only entered into the transaction as a result of pressure from the creditor. An example of legitimate pressure is where the creditor concerned has commenced legal proceedings or threatened to do so unless payment was made or the security granted. However, even a transaction which has taken place pursuant to an order of Court, may under certain circumstances be considered to be an unfair preference.
However, most unfair preference actions stem from payments made to connected persons. In these cases the trustee can go back for a period of two years. The wording of the legislation is now such that, in theory, if it can be shown that the debtor was insolvent at the time of the transaction, it is presumed, subject to the preferred party proving otherwise, that the debtor was influenced by a “desire to prefer” when entering into the transaction. In those circumstances the Court is likely to order that the transaction be set aside and repayment be made to the trustee.
Unfortunately, this aspect of the legislation has been rendered almost totally ineffective by the decision of the Court of Appeal in the case of Hau Po Man, Stanley.
The debtor was a dentist who had borrowed money from his sister. He could not repay the money and as a consequence, the sister’s husband made a number of visits to the dental surgery demanding repayment. From the information available, it appears that although there was no threat of physical violence, the purpose behind the visits was to upset the normal running of the dental surgery and to try to force the dentist to repay his sister in preference to his other creditors. This he eventually did and when he was subsequently made bankrupt the trustee took the view that these payments were unfair preferences and should be repaid to the trustee for the benefit of the dentist’s general body of creditors.
In the Court of Appeal, two of the Judges held that the “intimidatory tactics” (author’s emphasis) adopted by the brother-in-law represented acceptable pressure in terms of trying to force the debtors to repay the money. What the Court of Appeal said was that in making the payments to his sister, he was influenced not by a desire to prefer, rather he was influenced by a wish to stop the harassment he was suffering from the brother in law.
It is very difficult to see how this decision fits in with the spirit of the legislation.
The wording of the Ordinance is such that if the recipient of the funds can show that they put have put pressure on the debtor to repay, this would avoid the payment being considered an unfair preference. However, it has always been thought that pressure in this context, meant legal proceedings or such like. Clearly, based on the Court of Appeal decision, the word “pressure” has a very flexible meaning.
Unfortunately, this seems to mean that in future, anyone could adopt almost any intimidatory tactics to force repayment of a debt and still not fall foul of the unfair preference legislation. Moreover, because this decision has the authority of the Court of Appeal, it is unlikely that it will be challenged, unless the amounts involved are very significant.
What is really needed is a change in the legislation!
Transactions At An Undervalue
The concept of the “transaction at an undervalue” is also one which has been imported from the UK. Its purpose is to give the trustee the power to apply to the Court for a transaction to be set aside where, although there may have been some consideration granted, it was inadequate insofar as it was significantly less than the true value of the asset. There is no numerical definition as to what represents a transaction at an undervalue, but the general feeling among insolvency practitioners is that if it can be shown that an asset was disposed of at say, 70% or less than its true market value then such a transaction may be capable of being set aside.
In this situation, the trustee can go back two years to review any transaction and there is no onus on the trustee to show that the debtor was insolvent at the time. In addition, he can go back up to five years to review any transaction if he can show that the debtor was either insolvent at the time of the transaction or became insolvent as a result of it.
Connected Persons
Connected persons are defined in S51B of the Bankruptcy Ordinance which is reproduced here.
The Matrimonial Home
It is often the case that the bankrupt is the owner or joint owner, with his wife, of a property. More often than not the property is the main residence of the bankrupt and his family. The Bankruptcy Amendment Ordinance recognised that this particular issue needed to be addressed. Whilst it accepted that the rights of creditors were paramount, it was still considered necessary to offer some degree of protection, albeit only in the short term, to the non-bankrupt spouse and other dependant members of the bankrupt’s family.
Accordingly, it followed the amendments introduced into bankruptcy legislation in the UK in 1986.
Once a bankruptcy order has been made, the Court will allow a “grace period” of six months during which the non-bankrupt spouse can remain in the property and try to negotiate with the trustee for the purchase of the bankrupt’s interest in the property. After the expiration of this six month period, unless there are exceptional circumstances, the Court will take the view that the creditors are entitled to the benefit of the bankrupt’s assets and will grant possession of the property to the trustee so that he can dispose of it for the benefit of creditors.
If the Court in Hong Kong follows the example of the Courts in the UK, it is likely that in most cases, the non-bankrupt spouse will be forced to give up possession of the property once the six month period has expired. However, in the UK there have been situations where the Court has granted a possession order but has suspended it for an indefinite period in view of the specific circumstances surrounding the occupant(s) of property.
Pensions
The position regarding the pensions is extremely complex and the case law that does exist is mainly from the UK.
Personal Pension Policies
These are effectively savings schemes and accordingly will usually vest in the trustee.
Occupational Pension Schemes
The interest of the bankrupt in any scheme established under the Mandatory Provident Fund Schemes Ordinance is not available to the trustee. Moreover, different approaches are required depending on whether or not an ORSO scheme is contributory or non-contributory.
In respect of a scheme in existence prior to the bankruptcy order, the scheme administrator should account to the trustee in respect of the debtor’s contributions up to that date. It is also possible, unless there is a forfeiture clause to the contrary, that the employer’s contributions may be available to the trustee.
In respect of contributions made after 1 December 2000, it is generally envisaged that the mandatory 5% contribution cannot be made available to the trustee. However, in the event that the debtor has made additional voluntary and possibly excessive contributions to a scheme, the trustee may be able to argue that these amounts should instead be made available to the bankrupt’s creditors by way of an income payments order.
Pensions – An Update
The position regarding pensions has recently been addressed in some detail by the Court in Hong Kong. As ever, one must always be careful to avoid reading too much into one decision, as every case is decided on its specific facts. However, the case in question could turn out to be quite significant and may have quite serious implications for bankrupts for many years to come.
Briefly, the facts of the case were that the bankrupt was a teacher at the time he was made bankrupt and continued to be employed as a teacher for many years after he had obtained his discharge.
During the course of his employment, he made contributions to a pension plan. Importantly, the contributions were not voluntary, in that he was required to make such contributions as part of his contract of employment. As is usual in these cases, his employer also made contributions to the pension scheme.
Many years after he had obtained his discharge from bankruptcy, he retired and sought to claim his pension from his employer. He discovered that the Official Receiver was claiming that the sum due under his pension scheme, which was quite substantial, should be available to his creditors rather than being made available to the debtor.
The Court considered a number of factors, including the wording of the legislation, a number of UK authorities on the question of pensions and bankruptcy, and the specific terms of the pension scheme to which the debtor was a contributory.
Ultimately the Court decided that the whole of the debtor’s pension entitlement should be available to his trustee in bankruptcy and therefore to his creditors. It might be thought that only the amount to which the debtor would have been entitled as at the date of his bankruptcy would have been available to his creditors. Or alternatively, the amount to which he would have been entitled at the time that he obtained the discharge from his bankruptcy.
Regardless of the fact that the contributions which he made to his pension policy were not voluntary, and even considering those contributions which he made after his discharge from bankruptcy, the Court decided that all the funds should be available to his creditors.
Future Implications
For Bankrupts
The potential significance of this case is for anyone who has been made bankrupt and is presently employed in the public service. If they continue to be employed in the public service, there is every chance when they come to retire, the whole of their pension entitlement will be claimed by the trustee for the benefit of their creditors.
This is the first time in Hong Kong that this issue has been tested before the Court and, as already stated, every case has to be treated on its merits. However, there must be a strong chance that this decision, unless appealed, will set the guidelines for any public sector employees who have been made bankrupt in recent years. As a result, it is quite likely that when they come to retire they will find that all of their contributions are eaten up by payments to their creditors. This is regardless of whether they have obtained their discharge.
For Creditors
It is interesting to speculate whether or not someone who has gone bankrupt would be able to avoid the effects of this decision by entering into a voluntary arrangement with their creditors. By doing so, this might have the effect of allowing them to collect their pension policy when they retire, rather than having the funds made available to their creditors. Creditors may well want to take the above into account when considering whether or not to accept a voluntary arrangement proposal being put forward by a debtor.
Income Payments Order
The income of the bankrupt after the making of the bankruptcy order is not after acquired property. However, provisions exist within the legislation to enable the trustee to apply to the Court for an Income Payments Order. The order can either be that the bankrupt makes payments to the trustee from his income, or alternatively that the bankrupt’s employer make the payments out of the bankrupt’s salary. Such an order can last for up to eight years. In other words it is possible for it to continue beyond the date of the bankrupt’s discharge.
In a recent case the Official Receiver made an application to the Court for an Income Payments Order against a bankrupt. The bankrupt challenged the application saying that the payments she was making for private schooling for her children in Australia should be taken into account when assessing her disposable income. Not surprisingly the Official Receiver disagreed with this. The Court took the side of the debtor and agreed that such payments should be considered as part of her normal expenditure when working out her disposable income for the purposes of calculating the amount payable under such an order.
In another case, that of Tam Mei Kam, the mother of the canto-pop star Anita Mui, the trustees successfully applied for an Income Payments Order to be paid out of the bankrupt’s monthly allowance from the estate of her deceased daughter.
Execution & Distress In Bankruptcy
If a creditor has levied execution against the assets of the debtor, unless the execution has been completed before the date of the presentation of the petition, the proceeds will be available to the trustee for the benefit of creditors generally. In general terms, “completion of the execution” will mean that the assets have been seized and sold and the proceeds paid over by the Court bailiff to the creditor. If the proceeds of sale are in excess of HK$100 it is a requirement that the bailiff hold onto the proceeds for 14 days before paying them over to the creditor concerned.
However, if the bailiff is given notice of the presentation of a bankruptcy petition before he has paid over the proceeds to the creditor he must account to the trustee for the proceeds, less the amount of his fees and disbursements.
A landlord can take action to distrain on the assets of a bankrupt either before or after the commencement of the bankruptcy. However, if he commences distraint action after the bankruptcy has started he may only distrain for a maximum of six months rent.
After-Acquired Property
Any property, which belongs to the bankrupt at the date of the bankruptcy order, is available for distribution to his creditors. In addition, certain assets, which come into his possession after the date of the bankruptcy order, but before the date of his discharge, are also available to his trustee for the benefit of his creditors. These would include the proceeds of any insurance policy which matures during the period, any inheritance to which the bankrupt becomes entitled, and even in an extreme case, the debtor’s winnings from the “Mark 6″.
There is a presumption that the bankrupt will notify the trustee of any after acquired property to which he becomes entitled. However, if he fails to notify the trustee and he subsequently discovers such property, the debtor’s failure to co-operate will be something which the Court will take into account when considering whether or not to grant the debtor his discharge.
After acquired property does not include post bankruptcy income or property acquired after the commencement of the bankruptcy. In addition, it is important to note that the trustee must give notice to the bankrupt of his intention to take possession of after acquired property no later than 42 days after he becomes aware of its existence.