Introduction

This paper reports to Members on the results of Government's consultation exercise on the Law Reform Commission's ("LRC") proposal of using the Protection of Wages on Insolvency Fund ("PWIF") to accommodate claims of employees who are laid off by companies entering into corporate rescue and inform Members of the Administration's stance on the way forward.

Recommendation

2. We propose to proceed with drafting legislation to provide for statutory corporate rescue in Hong Kong, with a condition that the company undergoing corporate rescue must be responsible for clearing all arrears of wages, severance pay and other statutory entitlement of its employees as if it is a going concern.

Background and Argument

The LRC recommendations

3. The LRC proposed in its Report in October 1996 that Hong Kong should have a statutory corporate rescue procedure which provides a 30-day moratorium for viable businesses to try to reach a voluntary arrangement with their creditors so that the company concerned can continue as a going concern, in whole or in part, thus saving it from going straight into liquidation. During the moratorium, creditors cannot petition to the court for a winding up order against the company.

4. Recognizing that the employees of the company who are laid off by the company undergoing corporate rescue (also known as provisional supervision) might be cut out and left without the prospect of getting an interim payment from the PWIF, the LRC suggested that the PWIF should be used to meet the outstanding claims of those employees who are laid off by a company under provisional supervision. Specifically, this would mean that the PWIF would need to be extended to cover the outstanding arrears of wages, severance pay and other statutory entitlement of the following categories of employees laid off by the company during the "relevant period" ((a) and (b) below) -

1. before the initiation of corporate rescue; and
   
   
2. in the first 14 days of corporate rescue, whereby their employment contracts are not accepted by the provisional supervisor under the LRC proposal.

The need for public consultation

5. In the course of implementing the LRC proposal, we identified some incompatibilities between the LRC's proposal, and the Employment Ordinance ("EO") and Protection of Wages on Insolvency Ordinance ("PWIO"), regarding the rights of employees. In view of the controversy and conflicting interests inherent in the LRC proposal, we considered it necessary to conduct a public consultation exercise to gauge the views of the various interested parties, in particular the employers' and the employees' organizations, the banking and financial sectors and practitioners who are involved in corporate rescue. We would like to take into account their views before we formulate the Administration's stance on the matter.

Public consultation and results

6. The public consultation period lasted from 22 December 1998 to 31 March 1999. Our consultation paper put forward four options for parties to comment, namely -

Option A:	the LRC proposal as set out in paragraph 4 above;
Option B:	The company must clear all arrears/statutory entitlement of employees that it laid off during the relevant period;
Option C:	Exempting employees from the moratorium so that their right to petition to wind up the company would be preserved; and this would enable employees to make a claim on the PWIF upon the presentation of a winding up petition; and
Option D:	PWIF to pay the employees first if they are laid off during the relevant period and the full amount to be recouped from the company as priority debt in a voluntary arrangement among creditors.

In total, we have received 26 submissions. A list of the respondents is at Annex.

7. We briefed the Legislative Council Panel on Financial Affairs and Panel on Manpower jointly on 1 February 1999. Views expressed at the Panel meeting were fairly divided. Some members expressed concern over whether employees' rights would be compromised under the proposed scheme. Some considered that the LRC proposal - with some modification - should be workable, whilst others expressed support for option D.

8. Among the 26 submissions, views received were diametrically opposite. Representative bodies of those who are most directly affected by the proposed rescue procedures namely, employers and employees were unanimously against all four options. They were strongly against any change in the use of the PWIF, notwithstanding their pledge of "in principle" support for the concept of corporate rescue.

9. There is widespread concern among the employer/employee sectors that there were no effective safeguards of the rescue scheme against possible abuses: namely (a) the moratorium may allow the non-viable business to delay repayment at the expense of creditors; (b) unscrupulous employers may first lay off employees and then evade the statutory responsibility of paying arrears of wages/entitlements to these employees by passing the burden to the PWIF. They considered that the PWIF should not be the vehicle for financing the proposed corporate rescue. Both the Labour Advisory Board and the PWIF Board expressed strong reservation on making use of the PWIF to bail out private corporations and implement the proposed corporate rescue scheme.

10. There was also concern that small and medium enterprises (SMEs) were unlikely to benefit from the proposed corporate rescue scheme. The professional fees to be incurred in a corporate rescue would put the proposed regime beyond the reach of average SMEs.

11. As for the insolvency professionals and practitioners who are involved in a corporate rescue, they were broadly in favour of Option A or with some modification as they believed this to be the only workable option. They considered that the concerns about possible abuse were either not well-founded or could be satisfactorily dealt with. The financial sector supported Option D as they considered this to be the fairest or most practicable option and that employees would not be prejudiced. There was marginal support for Options B and C.

Analysis of the Results

12. The consultation reveals that neither employers nor employees see any benefit in extending the use of PWIF to statutory corporate rescue. This has in effect closed the door for Options A, C and D referred to in paragraph 6 above.

13. Some respondents suggest that we should consider setting up a separate "corporate rescue fund". Funding for this option would be a major consideration. The business sector will be against any increase in the cost of doing business. We are also mindful that any subsidy by Government towards such a new fund will invite criticisms that tax-payers are made to bail out businesses.

Proposed option

14. The above analysis prompted us to revisit Option B, under which the company undergoing corporate rescue must be responsible for clearing all arrears of wages, severance pay and other statutory entitlement of its employees as if it is a going concern.

15. The merits of this option are -

1. employee's rights are fully protected in line with existing labour legislation;
   
   
2. it does not involve the PWIF in its operation;
   
   
3. it does not require any contribution from the tax-payers or increase in the $250 PWIF levy or business registration fee for the creation of a new fund; and
   
   
4. it would help remove opportunities for possible abuse of PWIF or any new fund in the course of corporate rescue.

16. One of the key conditions laid down by the LRC for extending the statutory procedures of corporate rescue to a company is that it must be a viable business worth rescuing. We understand from the market that the requirement under this option would be an effective tool to screen out the non-viable companies which should not have been qualified for statutory corporate rescue in the first place. According to market sources, the clients of most informal "work-outs" at present are public companies listed in Hong Kong with a market capitalization of $100 million - $150 million. Given their size, potentially viable companies undergoing corporate rescue are expected to be able to pay their employees. As these payments are not significant compared with the debts owed by the companies, they would unlikely pose any material impact on the success of a work-out. The more likely situation was that if a company could not even pay his employees, it should cast serious doubts on whether a corporate rescue scheme would likely succeed.

17. We believe that this option will provide an additional safeguard against possible evasion of statutory obligations towards employees by unscrupulous employers through corporate rescue. Under the LRC proposal, in the first 14 days of the rescue, the provisional supervisor has the option to accept/not to accept employment contracts that are in force immediately before the initiation of corporate rescue. In other words, the provisional supervisor may lay off (some) employees in order to rescue the company and the laying off exercise would be financed by the PWIF. Under our recommended option, any laying off exercise will be financed by the assets of the company coming into the hands of the provisional supervisor. This would help ensure that the lay-off is cost-effective and kept to an optimal scale.

Gate-Keeping Role of the Provisional Supervisor

18. Some respondents have expressed concern about the gate-keeping role to be performed by the provisional supervisor who will decide whether a company is viable and hence worth rescuing, and whose advice the Court would rely upon heavily in deciding whether the 30-day moratorium should be extended.

19. We appreciate the concern. If we are to introduce statutory corporate rescue, we should pay particular attention to the need for adequate checks and balances to ensure proper gate-keeping by the provisional supervisor to ensure that only viable businesses should be allowed to be rescued, and that the moratorium should not be used by non-viable companies to delay repayment.

The Way Forward

20. On balance, we suggest that we should modify the LRC proposal and adopt the prudent approach of requiring a company undergoing corporate rescue to be responsible for clearing all arrears of wages, severance pay and other statutory entitlement of its employees as if it is a going concern. We realize that this modification would make the company rescue operation to be conducted by a provisional supervisor more challenging than under the LRC proposal, but at least we would be able to allow the new scheme to make a start.

21. The scheme would be a first step to improve the existing voluntary corporate rescue procedures, and provide a meaningful statutory option for really viable businesses to continue operating. It would enable practitioners to build up the required expertise and experience, as well as the community to test the system for possible abuse. It would also allow the scheme to build up a good track record, and earn sufficient public confidence and respect for any possible expansion.

22. Our intention now is to complete the draft legislation and submit it to the Legislative Council for consideration in the 1999/2000 Legislative Session.


Financial Services Bureau
2 June 1999


[resc-FA panel.doc]

Annex

Chinese General Chamber of Commerce

Chinese Gold and Silver Exchange Society
Chinese Manufacturers' Association of Hong Kong
Consumer Council
DTC Association
Emirates Bank International
Employers' Federation of Hong Kong
Federation of Hong Kong & Kowloon Labour Union
Federation of Hong Kong Industries
Hong Kong Association of Banks
Hong Kong Bar Association
Hong Kong Chamber of Small and Medium Business Limited
Hong Kong Coalition of Service Industries
Hong Kong Federation of Insurers
Hong Kong Federation of Trade Unions
Hong Kong Futures Exchange Limited
Hong Kong General Chamber of Commerce
Hong Kong Institute of Company Secretaries
Hong Kong Retail Management Association
Hong Kong Society of Accountants
Labour Advisory Board
Law Society of Hong Kong
Lingnan College
Protection of Wages on Insolvency Fund Board
Securities and Futures Commission
Stock Exchange of Hong Kong


Total: 26