New Hong Kong Companies Ordinance: Reduction of capital and share buy-backs

01 Dec 2013 | Newsletter/briefing

WHEN IN FORCE: 3 March 2014

COMPANIES AFFECTED: All Hong Kong incorporated companies

NEW PROVISIONS: Part 5 of new CO: ss203-273

WHAT ARE THE NEW CHANGES CONCERNING REDUCTION OF CAPITAL?

Summary of changes

  • under the existing legislation, a company must go through a court-sanctioned process in order to reduce its share capital
  • the new CO introduces a new court-free process for capital reduction. The court-free process requires directors to give a solvency statement in order to reduce the company’s capital
  • the new CO also retains the existing court-sanctioned process for reduction of share capital, so there are two separate ways to reduce capital

Implications for practice

  • the court-free process simplifies the procedures for reducing share capital. It will be a faster and cheaper alternative to the court-sanctioned process

HOW TO USE THE NEW COURT-FREE CAPITAL REDUCTION PROCESS

  • under the court-free process:
    • the proposed capital reduction must be approved by the directors of the company
    • each director must sign a solvency statement
    • within 15 days of the date of the solvency statement, the shareholders of the company must pass a special resolution approving the reduction of share capital
    • certain public notices must be published in the Government Gazette, in one specified Chinese newspaper and in one specified English newspaper; and certain forms (including the solvency statements in specified Form NSC17) must be filed with the Companies Registry
  • any creditor or non-approving shareholder of the relevant company may, within 5 weeks of the date of the special resolution, apply to the court for cancellation of the resolution. Upon such application, the court must either make an order confirming or cancelling the special resolution for the reduction of share capital
  • if no application is made to a court by a creditor or a non-approving shareholder, a return setting out the share capital of the relevant company must be filed with the Companies Registry no earlier than 5 weeks and no later than 7 weeks after the date of the special resolution. The reduction of share capital takes effect from the date on which such return is registered by the Companies Registry

WHAT DOES THE SOLVENCY STATEMENT SAY?

  • the solvency statement is a uniform solvency statement that applies not only to the court-free process for reduction of share capital but also to share buy-backs out of capital
  • for this purpose, the solvency statement must be in the form prescribed by the Companies Registry (Form NSC17)
  • the solvency statement must be made by all directors of the company
  • in the solvency statement, each director must form the opinion that:
    • immediately after the transaction there will be no ground on which the company could be found to be unable to pay its debts
    • either (a) if it is intended to commence the winding up of the company within 12 months after the date of the reduction of share capital, the company will be able to pay its debts in full within 12 months after the commencement of the winding up; or (b) in any other case, the company will be able to pay its debts as they become due during the period of 12 months immediately following the date of the reduction of share capital
  • in forming their opinion, the directors must:
    • inquire into the company’s state of affairs and prospects
    • take into account all the liabilities of the company (including contingent and prospective liabilities)
  • it is a criminal offence for a director to make a solvency statement without having reasonable grounds for such opinion. Such director may be liable for a fine of up to HK$150,000 and imprisonment of up to 2 years

Implications for practice

  • Directors should carefully enquire as to the state of affairs of the company before signing a solvency statement. This may include instructing professional accountants and financial advisers to assess the current financial status of the company and the projected financial health of the company after the capital reduction
  • the basis for forming the opinion in a solvency statement should be recorded by the directors in writing. The directors’ resolution approving the capital reduction should also set out clearly the factors that the directors have taken into account and the reasons for forming their opinion in the solvency statement

RESERVES ARISING FROM A REDUCTION OF SHARE CAPITAL

  • it is unclear under the existing legislation whether reserves arising from a reduction of share capital can be regarded as distributable reserves
  • section 214 of the new CO clarifies that reserves arising from a reduction of share capital may be regarded as realised profits and may be distributed to shareholders as dividends

WHAT ARE THE NEW CHANGES CONCERNING SHARE BUY-BACKS FOR LISTED COMPANIES?

New provisions: Part 5, Division 4 of new CO: ss233 - 273

Summary of changes

  • at present, a Hong Kong incorporated company that is listed on the Hong Kong Stock Exchange may buy back its shares by way of (a) a general offer, (b) an on-market share buy-back or (c) an off-market share buy-back, in each case, subject to the Securities and Futures Commission’s Code on Share Repurchases
  • the new CO retains the same regime except that share buy-backs by a listed company may now be funded out of capital (other than for on-market share buy-backs)
  • share buy-backs funded out of share capital must be approved by a special resolution passed by disinterested shareholders and supported by a solvency statement signed by all directors of that company. Similar to the court-free process for capital reduction, there are requirements for publishing public notices and making filings with the Companies Registry

WHAT ARE THE NEW CHANGES CONCERNING SHARE BUY-BACKS FOR UNLISTED COMPANIES?

Summary of changes

  • the existing legislative position remains largely unchanged - a share buy-back must be approved by a special resolution of the shareholders
  • the new CO clarifies that a special resolution of the shareholders will not be effective unless a contract or memorandum of the terms of the buy-back contract is sent or made available to shareholders in accordance with the procedures set out in the new CO
  • similar to the existing legislation, the new CO permits an unlisted company to fund a share buy-back out of capital. The new procedures are aligned with the court-free process for reduction of share capital in that the shareholders of the company must pass a special resolution, all the directors must sign a solvency statement, and similar requirements apply for publishing public notices and making filings with the Companies Registry
  • under the new CO, a share buy-back funded out of capital does not need to be expressly authorised by the company’s articles of association (as is required under the existing legislation), but there must not be an express prohibition in the articles of association against so funding a share buy-back
  • the new CO also removes the existing requirement for an auditor’s report to be prepared when funding a share buy-back out of share capital
  • in April 2013, the Financial Services and Treasury Bureau published a consultation paper titled "Improvement of Corporate Insolvency Law Legislative Proposals". In this consultation paper, it was proposed that where a company has redeemed or bought back its own shares by payment out of its capital and the company is subsequently wound up insolvent within one year of the redemption or buy-back, the following persons should be jointly and severally liable to contribute to the assets of the company an amount not exceeding the payment made by the company in respect of the shares redeemed or bought back by the company so as to meet the deficiency in the company’s assets:
    • the recipient of the payment of the redeemed or bought-back shares
    • the directors who made the solvency statement which supported the redemption or buy-back without having reasonable grounds for the opinion expressed in the statement

Implications for practice

  • unlisted companies may fund a share buy-back out of capital under the simplified procedures in the new CO
  • although the requirement to prepare an auditor’s report has been removed, directors should nonetheless consider whether an auditor’s report should be prepared to assist them in forming the opinions in their solvency statements
  • assuming the proposals made by the Financial Services and Treasury Bureau are implemented, directors who make a solvency statement which supports a share buy-back and recipients of the payment from a share buy-back should be made aware of their potential liabilities if the relevant company is wound up insolvent within one year of the share buy-back

Contacts

Neil Hyman (partner), Lisa Chung (partner), Peter Lake (partner)


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