The Milky Way

A failed milk empire … When a Chinese mainland enterprise registered in The Caymans goes bust the Enterprise Bankruptcy Lawis not much help to investors … Things looking better for creditors of Virgin Islands based Chinese businesses … Still, Honkers remains the pre-eminent financial centre in the region … Percy Lo-kit Chan reports

The PRC modernized its bankruptcy law in 2006 with the introduction of theEnterprise Bankruptcy Law.

There is now (notionally) a code in place which provides for the liquidation of companies in China.

There is still no personal insolvency law in China – the Hong Kong law which was previously based on the 1914 Bankruptcy Act of the United Kingdom was brought up to date in 1999. Prior to that, there was no possibility of automatic discharge – a bankrupt had to pass between one of the “gateways” provided in section 30 of the old Act – and they were narrow gateways, so that a bankrupt could languish in that unfortunate condition forever!

But it is one thing to have a bankruptcy law, and another to be able to enforce it.

Yoghurt maker Hunan Taizinai appears to have gone under owing creditors 2.7 billion yuan – about AUD$500 million.

As with so many entities in this part of the world, the assets of the business are on the mainland, but the corporate entity exists via a Cayman Islands holding company and it is to that entity that a large number of foreigners appear to have advanced their funds.

Judicially, the Caymans (like the British Virgin Islands) was once something of a judicial backwater and a murky place, ideal for concealing off-shore funds – think The Firm and the Gene Hackman character visiting the Caymans with a young Tom Cruise.

The position has changed in the British Virgin Islands and other tax havens in the East Caribbean.

A former London silk, Edward Bannister QC, has been brought in on three year contract especially to head up the corporations list so that the dispatch of business should markedly improve.

Formerly, a favoured tactic of Hong Kong litigators was to obtain an injunction over the holding company in the British Virgin Islands or the Caymans without a “return date” so that the claim against the Hong Kong subsidiary disappeared forever into the judicial ether, or for so long as it took the Caribbean Court of Appeal to decide any appeal – which was substantially the same thing.

It will be very interesting to see what impact on forensic tactics the appointment of the new judge will have of the speed and certainty of litigation.

The company produced a probiotic drink similar to Japan’s Yakult, which sells gallons of the stuff here in Hong Kong. The fermentation is meant to assist the consumer’s digestion.

The founder, Mr Li, was the usual self-made billionaire so beloved of modern Chinese business, who built the company from scratch in 1990 with the proverbial $50 in his back pocket.

By August 2008, Deloittes suspected that the company was broke. Mr Li had over expanded on a large scale. One facility at Zhuzhou contained several enormous yoghurt factories that were, so it is claimed, built like ancient Roman temples, complete with columns and marble cladding.

The founder (a little like Lord Copper in E. Waugh’s Scoop) had erected a solid jade statue of himself in the grounds of his factory!

Unfortunately for them, it would appear that foreign investors have waded in and lent hundred of millions of yuan by way of syndication. There was the inevitable talk of an IPO to reap a rich reward.

It would appear that the books were cooked and a large number of fictitious sales were recorded. What should have been a net profit was in fact a considerable loss. As well as over expanding, events conspired against management.

First came the dreadful earthquake which badly hit the company, based as it was in central and western China.

Then came the melamine scandal when several milk companies were convicted for adding melamine (a protein substitute) to their milk products, injuring some 300,000 babies.

The company was not, of course, in this market at all, but was hit by a general scandal involving milk enterprises.

What is to be done? The writ of the Cayman Islands court does not run on the mainland. Frequently, if a mainland enterprise goes south, it is impossible to get the local court to take control of the assets, or even to get hold of the company’s “chop” – the official seal which is indispensable to the conduct of business by a PRC company.

So it would appear that the loans made to the holding company in the Caymans are effectively without security and may need to be written off.

It may be attractive to deal via a Caymans entity (it is a tax haven and corporate services are easy to obtain there), but as ever it is good to have something tangible to seize when the enterprise founders.

It is one thing to have a great set of laws on the books and another entirely to be able to enforce them.

For this reason alone, Hong Kong’s own position as a pre-eminent financial centre in the region appears likely to continue for quite a while yet.

In Hong Kong, the men from Deloittes (with or without the assistance of the police) can seize assets in Wanchai from a delinquent borrower’s office as soon as the taxi can take them there!

Percy Lo-kit Chan