The mainland may register only a few bankruptcy cases every year but the numbers hardly tell the true story of the innumerable overseas investors who got burned in ventures there, a liquidation specialist says.
'The problem on the mainland is that only a few companies undergo formal bankruptcy procedures. In most cases, the owners simply disappear overnight,' said Alan Tang Chung-wah, a partner and head of specialist advisory services at accounting firm ShineWing (HK) CPA.
'Some factories may open normally one day but suddenly shutter the next morning, leaving in the lurch creditors and overseas shareholders who will then have to go through a lengthy and painful process to recoup their assets,' Tang said.
According to Beijing Siyuan Consultants, there were 1,973 bankruptcy cases on the mainland last year, down from 2,434 in 2009 and 2,955 in 2008. The number has been declining from a peak of 8,939 reached in 2001. Last year's number was similar to the level in 1994.
But as Tang put it, the apparent improvement was mostly because of an absence of a sound system of implementing bankruptcy laws or procedures to orderly wind down a company on the mainland.
Unlike in Britain, which has bankruptcy laws since 1542, and the United States, since 1800, China put in place its first bankruptcy law only in 1906. After the Communist Party took power in 1949, the law was scrapped. In 1986, a new bankruptcy law was introduced on a trial basis. It was updated in 2006, which, however, does not have comprehensive rules on how to implement the law.
As a result, while Western countries have clearly laid-down procedures for winding up companies and set norms on the sale of assets and distribution of the proceeds among employees, creditors and shareholders, Tang said the mainland lacked a clear legal framework or system to fully protect the interests of shareholders and creditors.
He said that if companies were to go bust in Hong Kong or in the West, a specialist accountant or other professionally trained liquidators would arrange the restructuring and sale of assets and use the proceeds to repay secured creditors first, then the outstanding salaries of employees, followed by unsecured creditors and shareholders.
But on the mainland, the courts decide how a bankrupt company's assets will be distributed and there is no procedure to appeal the court decision.
'In many cases, the court is heavily influenced by the local government in many aspects of a bankruptcy administration,' Tang said. 'According to the law, it is the employees and the government who would be placed above everything else when distributing the proceeds from the sale of assets.
'Overseas investors and lenders have little say in the process.
'Investors should be aware of the uncertainty in the process as well as the risks of losses in their investment in or lending to mainland enterprises in case of bankruptcies.'
Bankruptcies on the mainland have been under the spotlight ever since several high-profile Hong Kong-listed mainland companies went bust.
Shanghai-based Fu Ji Food and Catering Services Holdings, a supplier to the 2008 Beijing Olympics Games, went into provisional liquidation in October 2009. The company had announced a 250.23 million yuan (HK$306 million) net profit for the six months to September 2008 but did not inform investors when its business later ran into problems after it lost big contracts.
More recently, hundreds of business owners in Zhejiang province, the mainland's cradle of entrepreneurship, fled or went into hiding this year because they were unable to pay their debts.
'Before investors put their money in a mainland company, it is important they do an in-depth due diligence on their prospective partners. They need to know the owners and the managers well, otherwise they may suffer huge losses,' Tang said.
If the economic downturn deepens and more mainland companies collapse, Tang expects foreign creditors and investors to have more legal battles on their hands.
'Overseas creditors should know their rights but they should avoid litigation as there is no level playing field in mainland courts,' he said.
'They should bring in professional advisers and be prepared to compromise or cut losses. Otherwise they will end up paying a steep price for the litigation.'
The total balance of loans, in yuan, to small and medium-sized enterprises on the mainland at the end of June