China's murky bankruptcies expose hazards for foreign investors

Highlights:

• Investors, lawyers air concern over risks in China's bankruptcy process
• China bankruptcies are rising amid economic slowdown, property slump
• Chuming case raises investor concern over enforcement of bankruptcy laws
• Chuming, judicial authorities did not respond to questions about its bankruptcy

When a Chinese pork producer filed for bankruptcy in 2019, the news came as a jolt to Alan Hill.

The retired Apple executive from Albuquerque had invested about $100,000 last decade in Dalian Chuming Meat Processing through a US-listed holding company, Energroup Holdings. Chuming had not paid dividends for many years, but it supplied pork to Walmart , and had been profitable at least as recently as 2016.

A decision by a Chinese court in Dalian to place Chuming into liquidation in 2021, a three-year process during which the company auctioned off assets and repaid debt, meant US shareholders had to drop their pursuit of unpaid dividends.

For Hill, who turns 86 in May, the loss of his funds has been painful.

"I feel cheated," he said. "I would have liked to have that money to pass on to my children."

But a bigger surprise greeted Hill and other shareholders in June 2024: They learned from China's food regulator that Chuming was still operating, almost four months after the court had declared its liquidation complete.

A health and safety certificate issued last June verified that Chuming had passed an inspection that month, according to a copy of the document published by the Dalian Administration for Market Regulation. Pork bearing Chuming's name was on the market as recently as November, according to photos seen by Reuters, which showed the meat was packed last May. The regulator didn't respond to a request for comment.

Reuters couldn't determine whether Chuming is still trading. In March, Reuters found a factory operating at Chuming's last registered address in Dalian, where signs bore Chuming's logo but a slightly different name, Dalian Chengsan Chuming Food Processing. That company didn't respond to questions about its relationship with the liquidated Chuming.

In three markets and a grocery store around Dalian, Chuming signs were displayed prominently where pork was on sale, though labels on packaged meat showed the name of the other entity, in Chinese.

Reuters reviewed dozens of court and company records and interviewed nine people, including lawyers and investors, who described growing concern about the potential misuse of China's bankruptcy process and the heightened risks it poses for investors as insolvencies rise during the country's economic downturn.

Gaps in enforcement of China's insolvency laws can leave creditors vulnerable to opaque dealings and malicious bankruptcy filings by firms seeking to evade payment obligations, or by individuals trying to appropriate company assets, they said.

In the case of Chuming, some of its investors assert that it violated Chinese regulations by failing to obtain shareholders' consent for the bankruptcy; refusing to allow shareholders to examine its accounts; and continuing to operate after liquidation.

Shareholders, including Hill, successfully sued Chuming executives in Nevada in August 2018 over the illegal transfer of assets out of the company. But they say they have not been able to obtain any redress through Chinese courts.

Details of the case, and another involving a Chinese developer's contested bankruptcy, haven't been previously reported. China's justice ministry didn't respond to questions about courts' handling of the cases and bankruptcy matters broadly.

Chuming and a lawyer for the company didn't respond to requests for comment about its bankruptcy. Energroup said that after several legal proceedings regarding the group's assets it has no relationship with Chuming.

Walmart didn't respond to questions.

THEORY AND PRACTICE

Bankruptcies are increasing in China, where a protracted economic slowdown and property slump have triggered high-profile collapses, including developer China Evergrande Group and shadow bank Zhongzhi.

Chinese courts handled some 30,000 bankruptcy cases last year, up from 10,132 in 2020, data released by China's top court in March shows.

While the figures don't identify the proportion of bankruptcies considered malicious, four lawyers told Reuters that such cases had increased as China's economy had slowed.

"Now, you could say there are a lot" compared with a couple of years ago, said Zhu Xinpeng, a lawyer at Shanghai Rongying Law Firm, declining to estimate a figure.

For company managers, there can be an upside to filing for bankruptcy: Doing so triggers a stay on enforcement of payment obligations against the firm, said Sven-Michael Werner, partner at Bird & Bird in Shanghai.

But it is illegal for a company to continue trading after a court has liquidated it, said Werner, describing the rules generally rather than Chuming's case specifically. Three other lawyers in China told Reuters a company must cease to exist within 10 days of a court finalising its liquidation.

Chinese law also specifies that in some circumstances, shareholders have a right to check the accounts of an entity filing for bankruptcy. Companies can be fined for failing to provide accounts during the process.

Jin Kun, board chief at Chuming's sole direct shareholder, Dalian Precious Sheen Investments Consulting Limited, said Chuming refused to allow investors to inspect its accounts, even after a court on appeal ordered the company to do so.

This prevented creditors such as Precious Sheen, a wholly owned foreign enterprise held indirectly by US-based Energroup, from assessing whether Chuming was really bankrupt, he said.

Kun also alleges Chuming filed for bankruptcy without shareholder consent, as is required under Chinese law.

Kun said he complained to Dalian police about Chuming's actions during the bankruptcy, but they declined to pursue it due to insufficient evidence. The police didn't respond to a request for comment. In 2022, Kun sued the manager of the bankruptcy proceedings for failing to disclose information on the company, but court documents show the judge rejected the case as lacking legal basis.

China's bankruptcy law has existed in its current form for only two decades. It differs from rules in developed markets such as the US, and creditors often wait years for outcomes.

To enter a Chapter 11 reorganisation in the US, for example, a company need only have difficulty paying its debt. In China, the bar is higher - in theory.

But Chinese courts sometimes don't enforce the requirement that a company seeking to enter bankruptcy or liquidation must demonstrate it is unprofitable, which can leave creditors exposed, the lawyers and investors told Reuters.

In the case of Chuming, the investors said the company did not submit sufficient evidence. Court documents don't indicate whether Chuming did so, and the Dalian court didn't respond to a request for comment.

LOCAL INTERESTS

Since the 1970s, China's local governments have raised funds by selling land to developers. But construction went into free-fall several years ago after policymakers moved to rein in leverage and speculation.

The ensuing collapse of developers such as Evergrande left local and foreign shareholders relying on China's bankruptcy laws and their fair application.

One goal of bankruptcy law "is to identify whatever value a failed business or an individual has and to distribute that as fairly as we can among creditors to spread the loss," said Jason Kilborn, law professor at the University of Illinois Chicago.

Zhou Jianmin was left dismayed by his experience of China's bankruptcy law, following the fate of Hunan United Real Estate Development, of which he was chairman and key shareholder.

In 2019, a creditor, Fangtai Construction Group, following a payment dispute alleged Hunan United was insolvent, public company records show. Zhou alleges Fangtai, which didn't respond to questions, took the step to strip his company of its assets.

A court in Huaihua placed Hunan United into bankruptcy in December 2019 because its assets didn't cover its debts, court records show.

In an echo of the Chuming case, Zhou says Hunan United wasn't insolvent. He told Reuters he argued unsuccessfully in court that the firm's asset value exceeded its debt. The court didn't respond to questions about the case.

For investors and company owners, the lack of transparency during bankruptcy proceedings can be galling. Foreign investors face even greater difficulties in engaging Chinese courts to enforce foreign judgements and obtaining information in accordance with the law.

"The local, regional courts in China always favour their local citizens and seem to ignore the rights of US shareholders," said Hill.

Even in purely domestic cases, Chinese courts generally side with local authorities and interests, three lawyers told Reuters. This can disproportionately influence cases connected to local governments, such as developer bankruptcies, they said.

Kun, who said he lost hundreds of millions of dollars in Chuming's demise, hopes China's government steps up to shield private companies from malicious bankruptcies.

China's State Council did not respond to a request for comment.