China Evergrande liquidation to test Hong Kong's legal reach

When Hong Kong judge Linda Chan ordered China Evergrande into liquidation on Monday, she opened a critical new phase in the slow-motion collapse of the world’s most indebted property developer — and set up a high-profile test of the reach of the former British colony’s courts.

How the winding up of the company’s Hong Kong entity proceeds, and how much international investors can recover of the tens of billions of dollars they invested in Evergrande, will depend mainly on the attitude of authorities and courts across the border in mainland China.

Almost all of the company’s homebuilding activity takes place in the Chinese mainland, where most of its more than $300bn in liabilities are also owed and a property slowdown has become one of the government’s most pressing challenges.

Just over two years on from Evergrande’s default, the liquidation ruling comes at a time of renewed international scrutiny of legal and political norms within mainland China, where foreign investment has slumped post-Covid pandemic. Beijing’s priorities, including the completion of unfinished residential projects, could clash with those of creditors within and outside of the country.

“It definitely won’t be straightforward to get money out of mainland China,” said Nigel Trayers, a restructuring and insolvency specialist at Grant Thornton in Hong Kong. “It’s fairly clear that the priority is delivering properties that have been sold.”

The Hong Kong court’s appointment of Eddie Middleton and Tiffany Wong, from the restructuring firm Alvarez & Marsal, as Evergrande’s liquidators should at least provide new information about the developer. Throughout the Chinese property crisis sparked by Evergrande’s default in late 2021, investors have struggled to get any detailed understanding of developers’ woes.

“When you have Hong Kong liquidators in, under Hong Kong law you can require the board to give you the books and records,” said one specialist in restructurings. “You can take over the Evergrande Group’s operations.”

Those operations are, however, far from straightforward. Like many other Chinese property groups that secured overseas funding, Evergrande is a sprawling collection of companies based onshore and offshore, with total assets of nearly Rmb1.7tn ($240bn) as of September last year. It also has individual project-level units across the mainland, where its main corporate entity is known as Hengda.

“You’d imagine a lot of these subsidiaries on the mainland have their own creditors and bank debt, so a lot of them could themselves be insolvent and not really able to deliver any value up the structure where the liquidators sit,” Trayers said.

“Are they [the liquidators] going to get the facts on the projects that have value or equity? They will only get a real insight on what those are if the company co-operates.”

It seems to me that the interests of the creditors will be better protected if the Company is wound up by the court

China Evergrande Group, the entity that is subject to the winding-up order, is a Hong Kong-based holding company that is one of the wider group’s “main offshore financing platforms”, according to court documents. Since listing in 2006, it has issued $132bn in equity, adding to more than $20bn in offshore bonds the company raised through various subsidiaries.

On five previous occasions, the world’s most indebted developer had managed to delay a decision on whether it should be wound up, arguing that it needed more time to restructure the international debts on which it originally defaulted.

But this time, Judge Chan had run out of patience. “There is no restructuring proposal,” she wrote in her final comment. “It seems to me that the interests of the creditors will be better protected if the Company is wound up by the court.”

The holding company has some assets in Hong Kong, such as an electric vehicle company and a property services company, that can now be taken over, although they also in turn hold assets in the mainland. The vast majority of the company’s funds are believed to have flowed into real estate projects across the border, where 90 per cent of its assets are based and where liquidations require separate approval from a mainland court. Part of the task for the liquidators in Hong Kong is to establish the scale and nature of such cross-border exposure.

Hong Kong’s legal system, which is based on English common law and has for decades smoothed the flow of capital into the mainland, differs markedly from China’s socialist system of law, part of the country’s political infrastructure where the Communist party has absolute authority.

A 2021 arrangement between Hong Kong and mainland China under which insolvency orders can be mutually recognised is one window of opportunity for creditors. But it requires Hong Kong liquidators to apply for approval to one of three pilot courts in Shanghai, Shenzhen or the south-east city of Xiamen.

“There may be situations where the mainland courts will refuse to recognise Hong Kong winding up orders,” Hong Kong’s Department of Justice said in November in response to a written query from the Financial Times on the arrangement. In 2021 a court in Shenzhen recognised a Hong Kong court-appointed liquidator’s authority in the case of Samson Paper. But industry practitioners said there were few instances of successful applications.

“There have only been a couple of actual cases, and they were nothing like the size or scale or substance [of Evergrande],” Trayers said.

If liquidation orders are granted in the mainland, the process of enforcing them would still require collaboration with other creditors, and equity claims of the kind widely associated with foreign inflows would rank below domestic loans. Enforcement could also be difficult given the fraught political backdrop, which has seen domestic investors in property protest over losses.

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In nearby Guangzhou, where Evergrande has relocated its headquarters from Shenzhen and which is not part of any mutual recognition pilot scheme, the company’s building was this month surrounded by police and newly erected fencing.

Hui Ka Yan, Evergrande’s founder and formerly China’s richest man, was placed under “mandatory measures” in September for suspicion of unspecified crimes.

Speaking outside court on Monday, Wong, the liquidator, said she wanted “to see as much of the business as possible retained, restructured or remain operational”.

Shawn Siu, interim chief executive of Hengda, responded to the liquidation order on Monday by emphasising that the subject was listed in Hong Kong and that the domestic subsidiaries remained independent, raising uncertainty over what assets creditors could seize.

Evergrande will continue to build homes, he said. “The Group will still strive to do everything possible to ensure the stability of domestic business and operations.”

Additional reporting by Chan Ho-him in Hong Kong