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Foreign investors from failed Chinese groups could be given powers to liquidate assets on the mainland in an agreement with Hong Kong that seeks to increase business confidence in the country’s legal system.
The mechanism will force the courts of Shanghai, Shenzhen and Xiamen to recognize the insolvency orders filed by the company’s creditors in Hong Kong, conduit for Chinese companies get money of global investors. It means investors can try to more easily wipe out the assets of Chinese companies on the mainland to get their money back. The scheme could be extended to more Chinese cities in the future.
The scheme, which was launched this month, comes as international investors increase their exposure to China. At the same time, the country has been hit by a a series of defaults and business restructuring. China’s judicial system, which is controlled by the ruling Communist Party, has not historically recognized insolvency decisions made in Hong Kong and elsewhere.
“Potentially, this is a game-changing step,” said Patrick Cowley, head of restructuring services in Asia at KPMG.
The lack of an agreement had been a stumbling block for investors. A Hong Kong court rejected an investor petition to end the Huiyuan Juice Group, one of China’s largest juice makers, in November after defaulting on its bonds. The court found it unlikely that Hong Kong-appointed liquidators would be recognized in mainland China.
This left his creditors without much recourse, lawyers said.
Although the state of Hong Kong as a global financial center has it be under pressure after last year Beijing imposed a controversial national security law, the city’s commercial legal system remains well-regarded.
The deal “has put the company’s assets on the mainland for the first time for liquidators outside of China,” a veteran insolvency lawyer in Hong Kong said.
The mechanism also means that Hong Kong courts will recognize some insolvency proceedings in the mainland legal system.
“Once a creditor has appointed liquidators of a group in Hong Kong, that liquidator can apply to the mainland Chinese courts to have the same rights over the group’s assets on the mainland,” said Kevin Song, a professional at the insolvency of restructuring specialist Borrelli Walsh in Beijing.
However, the scheme has not been tested and does not guarantee that all applications made through it will be accepted. Lawyers said China has yet to show that international creditors can recover assets from insolvent mainland groups, and warned that some might try to argue that they are outside the jurisdiction of the agreement.
Continental courts may also refuse to assist designated liquidators in Hong Kong if they consider it “would offend public order or good morals” or if “the continent’s creditors are treated unfairly,” according to a legal opinion released by the People’s Court Supreme, the highest court in China.
“What we will need now is to present the right cases to take to the courts in Shenzhen, Shanghai or Xiamen. . . to set examples and prove it works, ”Cowley of KPMG said.
An insolvency expert in mainland China warned that authorities would also examine the scheme in case there were detrimental economic repercussions.
“There will be concerns about possible consequences, such as the bankruptcy of Chinese companies, as foreign creditors want to control assets such as factories or warehouses that employ a large number of people,” the expert said. “This could destabilize local economies.”
However, lawyers believe the deal will increase Hong Kong’s reputation as a platform for investing in Chinese companies.
“At the moment they’re investing and it’s kind of a gamble,” said Davyd Wong, an insolvency specialist at the law firm YTL. “When [Chinese companies] sell stocks or bonds in Hong Kong. . . the guarantee given by these debts are the promises of assets in the continental part ”.
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