Category Archives: Commercial law

The tidal wave of Chinese shadow banking disputes

the "pyramiding" private lending  (potentially crushing the banks)
“Pyramiding” private lending (potentially crushing the banks)

My article in The Diplomat on shadow banking disputes was recently published. It highlights what few outside of China have noticed–that shadow banking/private lending disputes account for a substantial proportion of civil/commercial disputes in Chinese courts, creating a particular burden on the courts.  In some places, the percentage hovers close to 50%!  These disputes raise a range of issues and the law is particularly unclear.  Although some provincial (and municipal) courts have issued guidance in the absence of a more detailed judicial interpretation, the lower courts are looking to the Supreme People’s Court for a more comprehensive national legal framework.

Supreme People’s Court releases big data on civil litigation in 2014

The Supreme People’s Court (Court) recently issued a report on civil litigation in the Chinese courts in 2014 with some big data and analysis. (The graphics in this blogpost are from the report.)  What are the trends relating to commercial disputes and what do they mean?

# of civil/commercial cases accepted (in 10,000s)

Trend #1–the number of civil and commercial cases has almost doubled in the past 10 years, despite obstacles to filing law suits, well documented elsewhere in blogposts and academic articles (and recognized as a major issue by the Court).

According to the commentary provided by Ma Jian of the Court’s research office, it reflects:

  • Dynamics and fluctuations in society and the economy;
  • Multiple effects of the government’s macro-control policies;
  • Outcomes of implementing legislation regulating the economy and society.
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55.8% contracts; 25.47% ownership etc., 18.63% family/inheritance law

Over 9 million civil/commercial cases were accepted by the Chinese courts in 2014, up 7.41% compared to 2013.  1.2 million cases were carried over to 2015, reflecting a change in performance indicators for the courts, described in this earlier blogpost.

In recent years, civil and  commercial cases have constituted 63% of all litigation in the Chinese courts.  As the Court report noted, the enormous growth in the caseload places even more pressure on the judges.  The large caseload, poor pay, lack of respect, and responsibilities unrelated to hearing cases have motivated a significant number of judges to leave (as this recent article highlights).  The personnel changes announced in the judicial reforms have exacerbated these trends (and were anticipated by the drafters).

Contract disputes

Trend #2.  In 2014, contract disputes constituted more than half of all civil/commercial disputes in the Chinese courts, far outweighing any other category.The proportion of contract disputes in proportion to other civil/commercial disputes has been rising. In 2014, the Chinese courts accepted 4.5 million contract cases, an increase of 11.36% in comparison to 2013. The top five types of contract disputes, accounting for 73% of first instance cases were:

  • loans;
  • sales;
  • labor;
  • service; and
  • real estate development & management cases.

The following types of contract disputes have increased most quickly:

  • credit card;
  • construction;
  • loans;
  • insurance.
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1st instance loan contracts (in 10,000s)

Loan disputes

Trend #3. Loan disputes have more than doubled in the past 10 years.  In 2014, they increased by almost 18% in comparison to 2013, to reach 1.7 million cases, Since 2012, loan disputes have exceeded divorce cases. Reasons for this according to the Court:

  • the government’s prudent money policy;
  • monetary/funding tightening;
  • impact of the new company law reforms [more small companies coming onto the market needing funding];
  • effects of changes to capital market system;
  • large amount of private lending [民间, generally known as shadow lending outside of China], leading to many more disputes. (I will publish an article on these disputes in the near future).

Other contract disputes

In 2014, the courts accepted almost 700,000 sales contract disputes, an increase of 12.28%. According to Court research, many of these cases involved small companies (SMEs). Many of these cases involved small family companies, with inadequate contract templates, leading to disputes.

New real estate construction cases accounted for 118,700 cases, an increase of 18.7%, while 173,000 real estate development cases were accepted by the courts, a increase of 5.53%。  The large increase in real estate construction cases is related to the tightening of funding for real estate development and the hot and cold in the real estate development market.

Other ownership disputes

New first instance ownership disputes accepted in 2014 reached 2 million cases, an increase of 3.67%.  Tort cases accounted for 1.6 million of those cases.  New shareholder disputes accounted for about 26,0000, an increase of almost 37%, with a smaller number of commercial paper disputes (48000), an increase of 15.46%.

The Court commented that SMEs have been most affected by the overall macro-economic downturn, which has indirectly led to all sorts of shareholder disputes.  The new Company Law has made it possible for funds to come in and out easily, but because many of these companies lack secure sources of operating capital and have to depend on private lending (shadow banking), if one party to these transactions has a funding problem, it causes a multi-party chain reaction and creates many complex shareholding disputes.

Mediation

Mediation/withdrawal of case rate for civil/commercial 1st instance cases

As can be seen from the above bar graph, the rate of settlement of first instance civil (and commercial) cases by mediation or other settlement is now back to 2007 levels.  The Court did not set forth reasons for the significant drop in cases resolved by mediation. In my view, two of the factors include:

1) the rate of cases resolved by year end had been an important performance indicator for the courts. Since December, it has no longer been the case; and

2) The Court has moved away from a simplistic policy of “mediation first” to a more nuanced approach to dispute resolution, as indicated by its initiative regarding diversified approaches to dispute resolution.

Comment

Chinese civil litigation reflects what is going on in the real economy and society (this will be even more the case when the effects of case filing reforms are documented) and the effects of government policies and controls on both.  Although the US and the European Union are negotiating bilateral investment treaties (BITs) with China, it appears from news reports that no one in either negotiating team has considered the impact of the current state and ongoing reforms of the Chinese judiciary on those BITs.  These issues deserve more serious attention. Foreign investors (or more often, subsidiaries of foreign investors) in China are increasingly finding themselves in Chinese courts and this trend is likely to continue.

Does money matter when determining which Chinese court will hear your dispute?

imgresFor commercial cases, the amount of dispute does matter in determining which Chinese court will hear your dispute.

On 30 April, the Supreme People’s Court adjusted the jurisdiction of higher and intermediate level courts, both the civilian and military courts in first instance civil/commercial cases in 关于调整高级人民法院和中级人民法院管辖第一审民商事案件标准的通知 (Notice on adjusting jurisdiction for higher and intermediate courts in 1st instance Civil/Commercial cases).  The rules described in the notice, which went into effect on 1 May gave Chinese commercial litigators no advance warning.  They are not applicable to the following types of cases:

  • maritime;
  • foreign, Hong Kong, Macau, and Taiwan related civil cases (there are separate rules on these); and
  • IP cases.

This means that these rules are applicable to cases brought by (or against) foreign invested enterprises (and domestic enterprises), with the above exceptions.  “For the avoidance of doubt,” the notice does not use the term “tier.”

The notice gives a rough idea of the size of business disputes in different parts of China and has special rules to deal with local protectionism, by enabling higher courts to take cases with smaller amounts in dispute if one party is registered outside of the jurisdiction (the Chinese version of diversity jurisdiction in the US federal courts).

First tier jurisdictions

The higher people’s courts of Beijing, Shanghai, Jiangsu, Zhejiang, and Guangdong will now have jurisdiction over cases with an amount in dispute of RMB 500 million or more, (300 million if one party is not registered locally) and intermediate courts, if the amount in dispute is at least RMB 100 million (50 million if one party is not registered locally).

Second tier jurisdictions

The higher people’s courts of the following jurisdictions will now have jurisdiction over cases with an amount in dispute of RMB 300 million (100 million if one party is not registered locally), and intermediate courts if the amount in dispute is at least RMB 30 million (20 million if one party is not domiciled locally):

  • Tianjin;
  • Hebei;
  • Shanxi;
  • Inner Mongolia;
  • Liaoning,
  • Anhui,
  • Fujian,
  • Shandong,
  • Henan;
  • Hubei,
  • Hunan;
  • Guangxi;
  • Sichuan;
  • Chongqing.

Third tier jurisdictions

The higher people’s courts of the following jurisdictions will now have jurisdiction over cases with an amount in dispute of RMB 200 million (50 million for non-locally domiciled parties) and intermediate courts will now have jurisdiction over cases with an amount in dispute of RMB 10 million:

  • Jilin;
  • Heilongjiang;
  • Jiangxi;
  • Yunnan;
  • Shaanxi;
  • Xinjiang and the Xinjiang Construction &Production Corp. Court {this latter court deserves a closer look).

Fourth tier jurisdictions

The higher people’s courts of the following jurisdictions will now have jurisdiction over cases with an amount in dispute of RMB 100 million (20 million for a non-locally domiciled party) and intermediate courts will now have jurisdiction over cases with an amount in dispute of RMB 5 million:

  • Guizhou;
  • Tibet;
  • Gansu;
  • Qinghai;
  • Ningxia.

Basic level courts:

Are generally to hear the following types of cases:

  • family law,
  • inheritance,
  • real estate management,
  • personal injury,
  • traffic accident,
  • labor,
  • infringement of right to one’s name and
  • group litigation.

Military courts:

  • The PLA Military Court has jurisdiction over civil cases with an amount in dispute of RMB 100 million or more; and
  • Military region military courts have jurisdiction over civil cases with an amount in dispute of RMB 20 million to 100 million.

Judgments from the military courts are not yet published on the Court’s database.  Earlier this year, (as reported here), a PLA legal academic suggested a change in that policy.

Rules to be applied flexibly

There is some flexibility in the rules for cases considered important, difficult, of a new type, or raising issues of general application, in which a higher court can decide to take the case, or alternatively a lower court can apply to hear such cases.

Can Communist Party organizations sue or be sued in Chinese court?

The answer to this question (in some Chinese courts, at least), is yes.  A recent legal blogpost flagged a ruling in a labor case published in the Supreme People’s Court’s case database: Su Qiao v. the Taian (Shandong) Municipal Communist Party Disciplinary Inspection Commission.  The author of the blog cited in support of his view Articles 48 of the 2012 Civil Procedure Law and Article 52 of the 2015 Civil Procedure Law Judicial Interpretation (concerning organizations that can be parties to civil litigation).

A subsequent (partial) database search revealed some other civil cases in which Communist Party organizations have appeared in variously as plaintiff, defendant, third party, and party against which the enforcement of an arbitral award was sought, including one decided by the Supreme People’s Court (Court):

General Office of the Jinan (Shandong) Communist Party Committee v. two individuals (leasing dispute,)(application to withdraw the lawsuit);

Three Gorges United Vocational University v.Chongqing Jianan Construction (Group) Ltd.Beibei District, Chongqing Muncipal Communist Party Committee School [Chongqing Jianan is listed as one of Chongqing’s top 100 companies in 2010],  (construction dispute)(ruling by the Court in application for re-trial);

Ms. Luo Yun vs. Jiangbei District Chongqing Municipal Party Committee Old Cadre Bureau, Taiping Property Insurance Co. Ltd, Chongqing branch (traffic accident claim);

Mr. She Xuejun vs. Sheqi County (Henan) Communist Party Committee Old Cadre Bureau (leasing dispute);

Beijing Forbidden City Film Co. Ltd. v. Jiangchuan County (Yunnan) Communist Party Committee Propaganda Bureau (enforcement of a Beijing Arbitration Commission arbitral award).

 

Supreme People’s Court “soft consults” on company law

L0U[3WLR5~U}00CSV6VUSZLThe Supreme People’s Court often organizes experts meetings (论证会) when drafting judicial interpretations, which are analogous to what in Hong Kong is called “soft consultations” (closed door consultation with market participants).

In late March, the Shenzhen Court of International Arbitration (SCIA)  and the #2 civil division of the Supreme People’s Court held a experts meeting in Shenzhen to obtain comments from the market on a draft of the #4 interpretation on company law. It was attended by a packed roomful of SCIA arbitrators (as attested by these photos from the report on the SCIA website). Participants included lawyers from the Shenzhen Stock Exchange (SSE), chief counsel for listed companies (primarily on the SSE), law firm partners with a broad range of clients, and the author of this blog.

Judge Wang Dongmin of the #2 Civil Division chaired the half-day proceedings. Vice President of the #2 Civil Division, Yang Yongqing, and Judge Liu Min of the #1 Circuit Court [Tribunal] based in Shenzhen, and other Supreme People’s Court judges also attended.

The review of the draft proceeded in five sections, mirroring the sections of the draft:

  • when can a court declare invalid or cancel a decision of a board of directors/shareholders meeting;
  • procedures by which a shareholder’s right to know can be enforced;
  • how can a shareholder enforce his right to have profits distributed;
  • issues related to the transfer of shareholding;
  • issues related to derivative litigation.

The commentators raised some issues not previously raised in previous experts meetings, as well as a broad variety of drafting comments, and practical issues, including many relating to cross-border issues.

The judicial interpretation is being drafted to provide guidance to the lower courts (and the market) in hearing cases concerning these basic company law issues that the Company Law itself does not yet address in sufficient detail.  We look forward to a revised draft being issued for public comment, so that the drafting team can receive an even broader range of comments.

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Shenzhen courts steer the way in divorce and shadow banking law

u=2655505232,2779536896&fm=21&gp=0 The Shenzhen courts, dealing with the “new normal” in China’s social and economic changes ahead of the rest of the country, often find current legislation and Supreme People’s Court interpretations inadequate to deal with the issues that come before them. Divorce law and shadow banking (loans made outside the formal banking system) are two types of cases inundating the Shenzhen courts (and yes, there is a connection).

At the end of last year, the Shenzhen intermediate court issued local court guidance (with an accompanying explanation–these are not “interpretations of law”), binding only on the Shenzhen courts, on two important issues:

In Shenzhen, which is wealthy and where women are relatively rights conscious (at least in divorce), the local courts found that existing rules failed to deal with the issues that came before them regularly.Some of those issues include:

  • marital property (particularly rights to real property);
  • the business that a couple may have built up together;
  • children born outside the marital relationship, and
  • issues relating to cross-border marriages.

As in so many areas of Chinese law, legislation lags behind social reality.  The 2011 interpretation by Supreme People’s Court of the Marriage Law, as it relates to marital property, has been controversial both inside and outside of China, as highlighted by many articles and books addressing the issue because it has meant that in divorce, women often lost possession to home(s) to which they or their parents had contributed substantial funds.This has been particularly true in Shenzhen. The local intermediate court highlighted that over 80% of the divorce cases that are heard locally involve disputes over real property.   In divorces, women have continued to argue that they should be awarded possession of the home.

Another issue leading to disputes in and out of the courtroom is the practice of some courts. when dealing with divorces, to split ownership of the family business. The guidance directs judges to consider the family law issues only, and have the division of the business considered in separate proceedings.  These rules also contain provisions relating to Hong Kong, where there are many cross border marriages and couples whose lives and property  crisscross  the border. The court guidance, besides setting out new legal rules, provides a deep dive look into what goes on in many local marriages, judging from the rules relating to children born outside of the marital relationship.

banks turn off funding tap, shadow banking comes
banks turn off funding tap, shadow banking comes to the rescue

Shadow banking loans, which the Supreme People’s Court has finally recognized to be valid (if they meet certain conditions) constitute about 20% of civil disputes in the Chinese courts, according to President Zhou Qiang’s report to the NPC, and the numbers are even greater in Shenzhen.  In the court in the business district of Futian, for example, the statistics are as follows:

  • 2012: 1153 cases;
  • 2013: 1627 cases
  • first half of 2014: 976 cases.

The court guidance in substance an answer to FAQs of the Shenzhen courts on  the following questions (and many more):

  • what if the loan relates to a gambling debt?
  • What if one spouse lends money to a third party without informing the other spouse?
  • How can shadow banking be distinguished from the crime of illegal fund raising?
  • What if the legal representative of a company loans out company money in his own name?
  • What are the ceilings, if any on interest, penalties and other fees?

We can expect that the Supreme People’s Court will be monitoring the success of these rules in practice when issuing its next judicial interpretation in these areas.  And with the Supreme People’s Court Circuit Court (Tribunal) located in Shenzhen, it is likely that discussion of these issues occurs from time to time behind the scenes.

Supreme People’s Court president says court reforms in “deep water area”

566929On 12 March 2015, Zhou Qiang, president of the Supreme People’s Court (Court) delivered his work report to the NPC, putting the best face on where the Chinese courts are and where they’re going. He described court reforms as being in a “deep water area” (深水区)(a high risk area).  This blogpost will highlight issues that other commentators (outside of China) have so far missed:
  • the mismatch between the focus of the work report and the work of the courts;
  • what the work report (on other than criminal cases reveals); and
  • the challenges to the Court leadership in the year ahead.

What is the mismatch?

charts for SPC
© Tiantong & Partners; charts illustrating SPC report
The primary focus of the work report (as always) is law and order, as seen from the perspective of Communist Party leadership, particularly state security related offenses (including terrorism and “splittism”) as well as ordinary crimes.  A big difference in this year’s report is that President Zhou Qiang apologized for previous miscarriages of justice and highlighted efforts to prevent future ones.  Other commentators have already focused on these both of these important developments and and other issues related to the criminal justice system.
2014 cases in chinese courts
bar chart: 2010-2014 increase in cases resolved by courts (in 10K) Pie chart: civil/commercial/IP; admin; re-trial/govt compens/enforcement/; parole; other/criminal

What the work report reveals is that most cases heard in the Chinese courts are not criminal and that the number of cases heard by the courts is rising.

What are cases are the Chinese courts hearing?

The pie chart (distributed as an attachment to President Zhou Qiang’s report at the NPC), illustrates that over 63% of the cases heard in the Chinese courts are civil cases (including commercial, family law and intellectual property cases), not criminal. Criminal cases (including parole related cases) account for something over 10% of cases (as others have discussed, many minor offenses are handled as administrative, rather than criminal offenses).

A closer look at civil cases in the Chinese courts

 A bit of arithmetic reveals (unfortunately the authors of the Report did not set out a corresponding chart), that 34% of civil cases (2,782,000) in 2014 were commercial cases (up 8.5% year on year), while 66% were what classified as civil cases (in the narrow sense, described below).

Commercial cases:

(These cases are illustrated in the chart to the left that has the ¥ sign.)
1. Finance cases (824,000)(a broad category including various types of loans, credit cards, securities, futures, insurance etc.).
2.  Sales contracts disputes (664,000).
3.Intellectual property (110,000, up 10% year on year)(I  the detailed analysis of this can be found here, by my fellow blogger, Mark Cohen, at the ChinaIPR blog);
4. Corporate disputes (12,000) (shareholder, merger and acquisition, creditor initiated bankruptcy);
5. Maritime cases (12,000).
Foreign-related cases (5804), )these, although a focus of foreign law firms alerts and the press, are a tiny drop in the sea of Chinese civil cases.  Many cases involving foreign companies actually involve their China incorporated subsidiaries.
The number of finance cases suggests a large number of disputes relating to loans by financial institutions.

Civil cases

(These cases are illustrated in the chart that has two people standing next to one another and the pie chart below.)
2014 civil cases in the Chinese courts
2014 civil cases in the Chinese courts
In 2014,  5,228,000  civil cases were heard in the Chinese courts (up almost 6% year on year):
1.  Family law cases (1,619,000),(this category includes  contested divorces, inheritance, support cases), accounting for about 30% of civil cases. The chart above 13% year on year increase in inheritance cases (showing an increasing number of people have assets worth fighting in court over, and perhaps also inadequate estate planning).
2.  Loan cases not involving financial institutions (between individuals, company and individual, or two companies) (1,045,600), accounting for almost 20% of civil cases. (The categorization has changed, making a year on year comparison not easily possible).
3. Labor cases (374, 324), accounting for 7.16% of all civil cases.  These include appeals from labor arbitration as well as cases that can be directly brought in the courts).
4.  Environmental tort cases (3331) (up 51% year on year).
5. Product liability cases are up 44%, but the base or total number for 2014 is not set out.
6.  Cases involving rights of rural residents (219,00)(rights to rural residential land, transfer of contracted land) migrant laborers seeking unpaid wages).
7.  Construction disputes are up almost 18% (base or total number for 2014 not set out).
These numbers speak to:
1. changes to the Chinese family;
2. a large number of loans that are under the radar of the financial authorities;
3. employees who are increasingly rights conscious;
4. continued litigation risk for foreign companies doing business in China (including through subsidiaries), because as perceived “deep pockets”, Chinese litigants often target them in product liability cases.

Administrative cases

 First instance administrative cases (companies or individuals suing the government) (131,000) continue to be a tiny number, although up 8.3%, and it remains to be seen whether the amended Administrative Litigation Law (Administrative Procedure Law) will lead to an increase in cases.

 Enforcement cases

Enforcement cases (compulsory enforcement of court judgments or orders, arbitral awards, etc) account for 3,430,000, a 14% increase year on year.  This suggests that fewer people (companies) are complying with dispute resolution voluntarily.
10% increase in cases accepted (will be a challenge to the courts if this trend continues because the intent is to cut the number of judges), amount in dispute is up 15%.

Court reforms already in a “deep water area”

Zhou Qiang highlighted that court reforms are already in a “deep water area” (high risk area) and the courts:
  • need to penetrate interest group barriers;
  • have the courage to move their own “cheese”;
  • need to use “the knife” against itself (presumably to cut out corrupt, poorly or non-performing judges);
  • deal with many deep-seated problems;
  • make progress on a long list of reforms:
    • continue and expand pilot reforms on changing the financing and personnel appointments of the local courts to all provinces/directly administered cities;
    • implement hearing-centered litigation reforms;
    • make progress on case filing reforms (to resolve the long term problem of litigants facing obstacles when they file suit);
    • put in place a system with dealing with assets seized and confiscated by the courts (to avoid violation of property rights and further judicial corruption in this process);
    • implement the prohibition against defendants wearing prisoner’s garb in court;
    • further implement judicial reforms related to petitioning;
    • promote alternative dispute resolution, such as arbitration, people’s mediation, administrative mediation etc.
    • continue work on pilot projects on expedited criminal procedures (for minor matters);
    • improve the people’s assessors system.

All of these reforms create tremendous challenges for the courts.  The number of cases accepted by the courts in 2014 (15,651,000) was up about 10%.  The judicial reforms to petitioning and other reforms will channel more disputes into the court system. Planned personnel reforms are leading to an exodus of young judges.  Many of the planned judicial reforms are intended to the way the courts operate internally and interact with other institutions. The 4th Five Year Court Reform Plan sets out target dates for accomplishing certain major judicial reforms.  The salary gap between what an experienced lawyer in private practice in a major law firm and a counterpart in the judiciary is large, leading many talented people to prefer the greater financial benefits and professional flexibility that comes with being a lawyer.

The political leadership has approved the 4th Five Year Court Reform Plan.  Issuing it raises expectations among ordinary people as well as those in legal profession. The pressure is on for the Court leadership to deliver on the promised judicial reforms.

Supreme People’s Court, CSRC, SAIC, and PBOC tighten the regulatory net

e8fade90gw1ek1l57pt9jj2050050t8sOn 19 December 2014, the Supreme People’s Court (Court) and China Securities Regulatory Commission (CSRC) announced that they were linking their blacklists and regulatory systems, following the arrangements the Court has made with other regulators since it established its judgment debtor database in October, 2013.  One of the major issues for the court system in having judgments enforced is interdepartmental regulatory silos that enable judgment debtors to avoid enforcement against their assets.

As of today, the Court’s database includes over 100,000 companies and almost 700,000 individuals. The goal is to tighten the net around non-compliant companies and individuals.  This initiative of the Court and CSRC is related to the State Council policy document issued in February, 2014,  on registered capital reform, in particular, the requirement that government departments improve interdepartmental sharing of information. Additionally, the Court names and shames one corporate and individual judgment debtor each day on social media.

The arrangement with the CSRC will involve the Court linking its system with the CSRC’s database of almost 700,000 entries concerning individuals and companies that have committed securities violations, and to prevent judgment debtors from accessing the capital markets.

Other arrangements the Court has made include:

  • an October, 2014, arrangement with the State Administration of Industry and Commerce (SAIC), which links  the SAIC’s credit information disclosure system (corporate disclosure system), described here, with the Court’s database (and requires SAIC cooperation in enforcing judgements);
  • a November, 2013  arrangement with the People’s Bank of China, directed at preventing judgment debtors from obtaining loans or financing through the banking system.

A search through the Court’s database is useful to a variety of users:

  • Lawyers, financiers and others engaged in due diligence on Chinese companies and individuals;
  • Companies, Chinese or foreign, contemplating doing business with a Chinese company or individual; and
  • Scholars and students researching the local operation of the Chinese economy and court system.

Report from the Supreme People’s Court courtroom on hearing in foreign-court appointed liquidator case

422775
On June 11, the 4th Civil Chamber of the Supreme People’s Court (Court) held a public hearing in the case of Sino-Environment Technology Group vs. Thumb Environmental Technology Group (Thumb Env-Tech). Nils Pelzer [seen in the audience in the photo below], research fellow at the Max Planck Institute Luxembourg and visiting scholar at the KoGuan Law School of Shanghai Jiaotong University, attended the hearing. The Supreme People’s Court Observer made it possible. A slightly amended version of his report follows.

422788

The litigious PRC subsidiary

This hearing was the latest of a series of lawsuits between the parties.  The earlier blogpost on this case (linked here) concerned a related lawsuit between the parties but the Fujian Higher Court decision in the current case was not available on-line.

Summary of the facts

Thumb Env-Tech is a Chinese wholly-owned subsidiary of Sino-Environment Tech, a company registered in Singapore (now in liquidation). The Singaporean liquidator (the former judicial manager) had dismissed the former management board of Thumb Env-Tech and appointed the insolvency firm’s own managing partner as the new chairman of the board of directors (and legal representative). The liquidator had also decided to reduce the registered capital of Thumb Env-Tech. However, because Thumb Env-Tech’s old management did not comply with the directives of new management, these measures were not registered with the local Administration of Industry and Commerce (AIC) Bureau.

Thumb Env-Tech’s original management – on behalf of Thumb Env-Tech – sued the parent company in the Fujian Higher People’s Court to pay a capital contribution of RMB 45 million (approximately USD 7.23 million), ignoring both their own removal and the order to implement the capital reduction and challenged the right of the judicial manager (later the liquidator), appointed by the Singapore High Court, to remove the original legal representative and directors. Thumb Env-Tech alleged that the judicial manager had no right to remove the directors and legal representative. Thumb’s new legal representative, on the other hand, filed a motion to withdraw the lawsuit.  Sino-Environment Tech put forward the argument because of the lack of power of representation, filing the lawsuit was not the “real declaration of intention” of Thumb Env-Tech.

Surprisingly in the first instance, the Fujian Higher People’s Court decided in favor of Thumb, ordering Sino-Environment Tech to pay the full sum of RMB 45 million. The court reasoned that Sino-Environment Tech was unable to prove that the old management board, which was still officially registered and had used the official company stamp, had no power of representation.

The decision of the Court

On appeal by Sino-Environment Tech, the Court (unanimously) rejected this argument in the second and final instance. The Court decided that while the registration with the AIC was sufficient to file a lawsuit on behalf of the company, things have to be treated differently when it comes to the substantial claim of the subsidiary against its parent company. The aim of the AIC registry is to protect third parties acting in good faith, but this does not apply to the internal relationship between a company and its shareholders. There, the real situation overrides the good-faith protection of the registry.

Even more importantly, the Court expressly recognized the power of the Singaporean liquidator to represent the parent company in liquidation. As far as the foreign liquidator’s powers are concerned, the Court ruled that the law of the place of the registered office of the relevant company is applicable.

Evaluation

This outcome had been expected by both Chinese and foreign legal experts. Not only does it clarify that just possessing a chop and an official registration does not always come along with absolute authority, but it is also a step towards to insolvency rules in China consistent with uniform international insolvency rules in China. Further, if the Court had upheld the ruling of the first instance, this would have basically meant that parent companies might completely lose control over their Chinese subsidiaries. From this point of view, the ruling strengthened the investment environment in China.

From a political perspective, this case might mark the beginning of a more open attitude to grant access to court hearings to foreigners. As reported by Chinese newspapers, this was the first hearing of the Court that foreign diplomats were explicitly invited to attend.

Lastly, the similarities of a hearing of the Court and of Western supreme courts were striking (at least in this case). The proceedings were skilfully led by Judge Luo Dongchuan [chief judge of the 4th Civil Chamber], and the quality of the debate between the Court and the lawyers of both parties was generally very high. It is not only for this reason that the 4th Civil Chamber will probably submit the case as a suggestion for a new guiding case.

Power of foreign court appointed liquidator of overseas listed company to take over Chinese subsidiary comes before the Supreme People’s Court

 

Sino-environment hearing notice
Sino-environment hearing notice

HEALTH WARNING: PLEASE SEE THIS BLOGPOST FOR THE MOST RECENT DEVELOPMENTS.

On 11 June 2014, the Supreme People’s Court will hear a shareholders dispute.  The facts of the case (described below) are familiar to the Hong Kong and Singapore legal and investment community. They touch on the power of overseas insolvency/bankruptcy professionals to take over assets in China.

The parties to the case are Sino-Environment Technology Group Limited (Sino-Environment Tech) (a company originally listed in on the main board in Singapore (but now in liquidation) and one of its wholly owned subsidiaries, Thumb Env-Tech Group (Fujian) Co., Ltd (Thumb Env-Tech).

The case has all the elements of a China deal gone very, very bad.

What we know

The case was originally brought in the Fuzhou Intermediate Court by Thumb Env-Tech (i.e., the original management group).  It challenged the right of the judicial manager (later the liquidator) (appointed by the Singapore High Court) to remove the original legal representative and directors.  Thumb Env-Tech alleged that the judicial manager had no right to  remove the directors and legal representative and it was arbitrarily implementing an order of a Singapore court, violating China’s judicial sovereignty.  The Fuzhou Intermediate Court rejected Thumb Env-Tech’s claim, determining that it was not a proper party.Thumb Env-Tech appealed to the Fujian Higher People’s Court.  The decision can be found here, on the court’s website. The Fujian Higher People’s Court rejected Thumb Env-Tech’s appeal, stating that the case is not a simple matter of private rights but involves issues of public policy, and that Article 119 of the Civil Procedure Law did not permit Thumb Env-Tech to bring the case. Thumb Env-Tech has brought a petition to have the case reviewed by the Court. (summary from the Fujian Higher Court decision)

Sino-Environment Technology Group Limited was a listed Singapore company that was principally engaged in the provision of environmental protection and waste recovery through its subsidiaries in PRC with over SG$165 million debt. Its liquidators investigated SG$84 million worth of suspicious transactions undertaken by the group, taking steps to secure control over the company’s PRC subsidiaries by removing all existing legal representatives and directors of the PRC subsidiaries and commencing legal proceedings against them, securing the company’s cash held with a PRC bank and assessing and defending legal proceedings. (from the liquidator’s website)

Morgan Stanley sold $US 109 million in Sino-Environment Technology Group Limited convertible bonds. The company defaulted on repayment of the bonds. (from a first press report and a second press report.)

Related litigation in the Hong Kong courts can be found here.

What will the outcome be?

We will wait the outcome of this case in the Court.  It is a “typical case” in its own way, because there are many cases in which foreign companies with Chinese subsidiaries, some of them listed, get into financial difficulties.  It is part of international insolvency practice that  bankruptcy trustees/judicial managers/administrators/liquidators appointed by foreign courts will take over control of subsidiaries in China.  Chinese law and practice do not make this an easy process.  This a classic example of why Chinese legal experts, as well foreign governments, Taiwan, and Hong Kong need to persuade the Chinese government  that it is important for China that it become an active part of the international legal framework governing bankruptcy (insolvency) proceedings.