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Transfer of business and insolvency

2020-05-31

Introduction

Under section 3 of the Transfer of Business (Protection of Creditors) Ordinance (Cap. 49) (“TBO”), the transferee of a business will assume all the liability of the business transferred to him. The TBO aims to prevent fraudulent transfer of businesses which may leave creditors without any assets to satisfy their claims. Under such circumstance, to what extent is it legally possible to wind up an existing business and start a new business (the “New Business”) similar to the old one (the “Old Business”) without triggering the TBO?

Meaning of “transfer of business”

To determine whether there is a transfer or sale of a business (which would trigger the application of the TBO), the court will consider all surrounding circumstances. The court outlined relevant factors indicating a transfer of business in the case of BNP Paribas v GC Luckmate Trading Ltd [2002] 2 HKLRD 156, and they include the use of the same or similar name, the use of the same personnel, and conducting the same or similar type of business etc. Ultimately, the issue is “whether the effect of the transaction was to put the transferee in possession of a going concern the activities of which he could carry on without interruption” (Kenmir Ltd v Frizzell and others [1968] 1 WLR 329).

Factors indicative of a transfer of business

Common shareholders or management

The fact that the transferor and the transferee company had common directors and shareholders was relevant in finding that there was a transfer of business. Having a nominee shareholder in the transferee company was also taken into account by the court in holding that there was a transfer of business in Liu Hon Ying T/A United Speedoc Co v Hua Xin State Enterprise (Hong Kong) Ltd & Anor [2003] 3 HKLRD 347. Further, a director of the Old Business who takes up a management role of the New Business may also be a relevant factor as in the case of Elson-Vernon Knitters Ltd v Sino-Indo-American Spinners Ltd [1972] HKLR 468.

Use of same or similar business name

Using the same or a similar name of the Old Business is another indicator of a transfer of business. It is therefore advisable to use a completely different name when setting up the New Business in order to avoid the trigger of the TBO.

Use of the same personnel

In Liu Hon Ying, the court held that staff of the transferor company became employees of the transferee company was a relevant factor in considering a case of transfer of business. It is noteworthy that hiring former staff indirectly through other companies may also be relevant as the court is “not concerned with the mechanics of the transfer but with the fact of transfer” (Elson-Vernon Knitters Ltd).

Conduct of the same or similar type of business

Slight differences in the services or products provided by the Old and New Businesses may not be sufficient to negate an inference of a transfer of business. In Elson-Vernon Knitters Ltd, although the old business was engaged in knitting wool and the new business focused on knitting largely synthetic fibres, the court gave little weight to that fact and held that there was a transfer of business.

Servicing of the same customers

Inheriting the clientele of the Old Business may indicate that the New Business is gaining advantage from taking over the Old Business and therefore constitute a transfer of business. In particular, informing clients about the New Business and suggesting them that future transactions may be made with the New Business will indicate a transfer of business as in the case of Liu Hon Ying.

Case law shows that presence of multiple factors mentioned above can establish a transfer of business. Under the TBO, the transferee will become liable for the transferor’s debt unless notice is served in accordance with the provisions. A notice should be given not more than 4 months and not less than 1 month before the date of transfer, and if no proceedings are instituted against the transferor regarding its liability after 1 month of the publication of notice, the transferee ceases to be liable for the transferor’s debt. However, if proceedings are instituted within that one-month period and are served on the transferor or the transferee, the transferee remains liable for the transferor’s debt until final determination of the proceedings. In other words, if a creditor of the transferor is not aware of the notice and 1 month has passed, the transferee will not be liable for the debt under the Ordinance.

Interface between the TBO and the winding-up regime

In Hong Kong, the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32) (“Cap. 32”) governs the winding up regime, and there are generally two modes of winding up – voluntary winding up and compulsory winding up. Shareholders of a company may, in a general meeting, resolve by a special resolution that the company be wound up voluntarily, and if the company is solvent, it may undergo the members’ voluntary winding up while if the company is insolvent, it may undergo the creditors’ voluntary winding up. Alternatively, a company may be wound up by the court upon the petition of a creditor if the company is unable to pay its debt.

The major difference between voluntary winding up and compulsory winding up is that the shareholders or creditors of the company can choose their own liquidator under voluntary winding up. In contrast, the court has the power appoint liquidators under compulsory winding up, and the court may appoint the Official Receiver or any other person that the court sees fit.

Assuming one is closing the Old Business because it is insolvent, then the option would be between a creditors’ voluntary winding up and compulsory winding up. Under creditors’ voluntary winding up, the shareholders may nominate a person to be a liquidator of the company at the meeting where the resolution of winding up is passed whilst the creditors may nominate one at the Meeting of Creditors. If the shareholders and creditors nominate different persons, the person nominated by the creditors shall be the liquidator. However, in practice, creditors seldom object to the person nominated by the company. In other words, the shareholders may procure the appointment of a “friendly” liquidator and instruct him to transfer assets back to them, and here is where the TBO steps in. Section 10 of the TBO provides that it does not apply where the transfer is effected by the Official Receiver or by the liquidator in compulsory liquidation – transfers effected by a liquidator in voluntary liquidation are still covered by the Ordinance. This provision is to prevent collusion between the business owner and the voluntary liquidator to effect a transfer of business.

Winding-up the Old Business and starting the New Business

Although the Old Business may have debts that it is unable to repay, one may want to keep the assets e.g. intellectual property rights, database, goodwill and to start up the New Business without being liable for the debts. The possible way would be to compulsorily wind up the Old Business and buy back those assets from the Official Receiver or the liquidator appointed by court as any transfer effected by them will not be caught under TBO. Upon making the application to court for compulsory winding up, the court may appoint a provisional liquidator to oversee the business and after a formal winding up is granted, the provisional liquidator becomes the formal liquidator who could then transfer the assets.

Conclusion

When considering whether to wind up the Old Business and start afresh, one has to be aware of the TBO. In order to avoid being liable for debts of the Old Business under TBO and to preserve the assets of the Old Business to the maximum extent, it is prudent to consult insolvency practitioners and be advised of all the potential liabilities.


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Important: The law and procedure on this subject are very specialised and complicated. This article is just a very general outline for reference and cannot be relied upon as legal advice in any individual case. If any advice or assistance is needed, please contact our solicitors.

Published by ONC Lawyers © 2020

 

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