Viable and sustainable business to warrant continued listing

1. The HKEX’s primary concern in enforcing Listing Rule 13.24 is to protect investors’ interests. The HKEX’s approach is to only suspend trading of shares in extreme cases with the following characteristics, and this approach has been similarly endorsed by the Court of Appeal in China Trends:

(a) The listed company has a very low level of operating activities and revenue;

(b) The listed company has been operating on a very small scale and incurring losses for years, and the current operation does not represent a temporary downturn; and

(c) The assets do not generate sufficient revenue and profits to support a continued listing.

2. It is important to note that the requirements under Listing Rule 13.24 are not satisfied simply because an issuer is solvent. While GL106-19 cites insolvency as a circumstance that might indicate non-compliance with Listing Rule 13.24, solvency only relates to the adequacy of assets and cannot conversely demonstrate that the issuer has sufficient operations. The Court of Appeal provided helpful clarifications in China Trends on this aspect:

(a)  Viability and sustainability have to be examined from the perspective of whether the continued listing is warranted, and such examination is different from considering whether the listed company is viable and sustainable based on solvency.

(b)  As stated by the Court of Appeal, “… the continued listing of a company without a viable and sustainable business of substance would attract speculation on their possible acquisitions in the future and lead to opportunities for market manipulation, insider trading and unnecessary volatility in the market which are not in the interest of the investing public. This is obviously a different consideration from the financial health of the company in terms of its solvency since a 'blue sky company' can be financially stable and solvent.” (emphasis added)²

(c)  The Court of Appeal held that there is no justification to read in a “proximity to insolvency” requirement in the application of Listing Rule 13.24 as this would lead to the absurd result that the HKEX would not be entitled to suspend the listing of a dormant issuer or one with negligible business activity so long as it has assets which have not been, and will not be, meaningfully deployed in the course of business.

Qualitative assessment

3. The Court of Appeal in China Trends reconfirmed that the application of Listing Rule 13.24 is a qualitative and not a quantitative assessment, in that the assessment has to be fact and company specific as opposed to a ‘counting exercise’ under which the assets and revenue of the listed company are measured against a quantitative or universal benchmark. This recognises that each issuer operates under different business and industry conditions and a one-size-fits-all approach is overly prescriptive and inflexible. The fact that the HKEX did not specify a benchmark could not be considered as procedural unfairness to form the basis of the application for judicial review.

4. It was also held that in conducting the qualitative assessment, the specific circumstances of a listed company should be considered holistically, and the level of operations and the level of assets should not be looked at in isolation from the listed company’s actual business. As such, the Court of Appeal held that it might not be helpful to compare the listed company in question with other companies based on several isolated factors to show that the requirements of Listing Rule 13.24 have been satisfied.

5. Furthermore, the Court of Final Appeal in Sanyuan Group indicated that it is not for the HKEX to propose an alternative business plan, or to specify alternative operating, capital or profitability levels that the issuer needs to achieve. The management of the issuer is in the best position to formulate such business plans or provide financials that would be achievable. The issuer should therefore aim to demonstrate compliance with Listing Rule 13.24 to the HKEX on a subjective and not an objective basis.

The court accords a wide margin of discretion to the HKEX based on its professional judgment

6. The Court of Appeal in China Trends emphasised that there is a great deal of flexibility in the application of Listing Rule 13.24. Determining whether the threshold of viability and sustainability warranting continued listing has been met is primarily a matter of professional judgment for the HKEX. Absent any error of law, failure in taking into account of relevant factors or taking irrelevant factors into account, the court should not intervene with such professional judgments. Likewise, per the comment of the Hon Stone J of the Court of Appeal in Sanyuan Group, the court should “hesitate long and hard” before interfering with a market regulator’s decision.

The impact of the COVID-19 pandemic and U.S.-China trade disputes

7. The HKEX has stated in paragraph 8(b) of its GL106-19 that an issuer who faces a temporary reduction or suspension of operations due to market conditions or business strategies would not be considered as failing to meet the requirements under Listing Rule 13.24 just because of such temporary circumstances.

8. The HKEX similarly reassured issuers in its Listed Issuer Regulation Newsletter in December 2020 that it would not take action immediately against a company if the company can demonstrate that any material disruption to its business operations were indeed caused by external circumstances. The HKEX offered examples including a small-scale property development consultant suffering from poor business performance due to the U.S.-China trade disputes and government policies. This company would still be considered to have complied with Listing Rule 13.24 if it could demonstrate with supporting evidence that the market conditions were only temporary and that its business will recover.

9. It is unclear, however, whether and for how long the HKEX will continue to afford issuers this reprieve as business and market conditions improve and there are growing expectations that issuers’ business operations should regain momentum and a degree of normality.

Conclusion

As confirmed by the Court of Appeal, the HKEX is expected to make a qualitative assessment as to the issuer’s compliance of Listing Rule 13.24, and this is both company-specific and subjective.

While judicial review is an option for an issuer seeking to challenge the HKEX’s suspension and delisting decisions, the case authorities have shown that the prospect of success is low, and the courts are in general slow to interfere with the professional judgment of the HKEX absent compelling factors. Therefore, issuers should avoid placing reliance on this avenue to stave off delisting. Instead, upon the HKEX raising concerns about the issuer’s compliance with Listing Rule 13.24, the issuer should focus on bolstering its financial position and making a persuasive business case with concrete plans to improve business operations and overall profitability. This will help the issuer to proactively demonstrate to the satisfaction of the HKEX that it is in recovery and has a viable and sustainable business with sufficient assets to warrant its continued listing status.

1. The Main Board Listing Rule 13.24(1), the amended version of which came into effect on 1 October 2019, reads as follows: “[a]n issuer shall carry out, directly or indirectly, a business with a sufficient level of operations and assets of sufficient value to support its operations to warrant the continued listing of the issuer’s securities.” The previous version of Listing Rule 13.24(1) reads as follows: “[a]n issuer shall carry out, directly or indirectly, a sufficient level of operations or have tangible assets of sufficient value and/or intangible assets for which a sufficient potential value can be demonstrated to the Exchange to warrant the continued listing of the issuer’s securities”. While listing decisions and judgments that concern material events happening before 1 October 2019 would refer to the previous version of Listing Rule 13.24(1), the analyses of the key principles are applicable to the amended rule.
2. “Blue sky companies” have been described by the HKEX as companies where public investors have no information about their business plans and prospects.

Client Alert 2021-244