Cross-border insolvency between Mainland China and Hong Kong

Mainland China and Hong Kong fall under the so-called "one country, two systems" principle. Accordingly, the Mainland and Hong Kong can retain two different legal systems under one sovereign state. In this case, it's a bit like oil and water – it doesn't mingle, as the Mainland is a civil law jurisdiction, while Hong Kong is a common law jurisdiction. With the significant growth in cross-border business between the two, there has been an increasing need for cross-border judicial assistance among these systems.

The relationship between Mainland China and Hong Kong Special Administrative Region (HKSAR) is prescribed in the Constitution of the People's Republic of China and the Basic Law of the HKSAR, which dates from 1997. Article 95 of the Basic Law states that "the Hong Kong Special Administrative Region may, through consultations and in accordance with law, maintain juridical relations with the judicial organs of other parts of the country, and they may render assistance to each other." However, with regard to the process of creating a legal framework for cross-border insolvency matters, there has been a deafening silence.

And then, suddenly, in the midst of 2021, it was there! On 14 May 2021, the Supreme People's Court (SPC) of the People's Republic of China (PRC or Mainland) and the Government of HKSAR published a "Record of Meeting on Mutual Recognition of and Assistance to Bankruptcy (Insolvency) Proceedings between the Courts of the Mainland and of the Hong Kong Special Administrative Region" (Record of Meeting), accompanied by:

• the SPC's "Opinion on Taking Forward a Pilot Measure in Relation to the Recognition of and Assistance to Insolvency Proceedings in the Hong Kong Special Administrative Region" (Opinion); and
• the HKSAR's "Procedures for a Mainland Administrator's Application to the Hong Kong SAR Court for Recognition and Assistance Practical Guide" (Practical Guide).

The 2021 arrangement

What does this "2021 arrangement" entail? In short, the new Record of Meeting lays down the bedrock for future cooperation in insolvency matters. Yet the 2021 arrangement is just a rough charcoal sketch, without considering necessary details. It should be noted that the 2021 arrangement is limited in territorial scope. The Opinion designates three cities – Shanghai, Xiamen, and Shenzhen – as the pilot areas, where the intermediate courts in these cities are empowered to take forward pilot measures on recognition and assistance to Hong Kong insolvency proceedings. The Practical Guide issued by HKSAR is a reference guide for Mainland administrators to file applications to the Court of First Instance of the High Court of the HKSAR. As a result, selected courts in the Mainland and HKSAR courts may mutually recognise and give assistance to insolvency proceedings opened in the other jurisdiction, which only governs cross-border cases having been opened in the Mainland and the HKSAR respectively.

"Recognition" as such has a limited basis in the 2006 Chinese Enterprise Bankruptcy Law (EBL), which is the major legislation governing Chinese insolvency systems. In its article 5, the EBL says that a Chinese court can recognise a foreign insolvency judgment, on the condition that: (a) the rendering jurisdiction has an international agreement with Mainland China; or (b) there exists reciprocity between the rendering jurisdiction and Mainland China, subject to the conditions that:

• recognition would not violate the basic principles of Chinese law;
• recognition would not jeopardise the State sovereignty, security or public interest; and
• recognition would not undermine the interests of Chinese creditors.

Since the enactment of the EBL, there has not been a case in which a Mainland court has recognised a Hong Kong insolvency judgment.

This is of course a bothersome, uncertain legal situation that is now addressed with the 2021 arrangement in which intermediate Mainland courts in selected cities are equipped with the authority to recognise Hong Kong proceedings or give assistance to such proceedings. The SPC's Opinion seems to follow the well-developed doctrine in international insolvency law; in particular, the "modified universalism" principle. Accordingly, recognition can be granted to Hong Kong proceedings in which Hong Kong is the debtor's centre of main interests (COMI), and the COMI has been in Hong Kong continuously for at least six months.

Hong Kong insolvency proceedings eligible for recognition include compulsory winding up, creditors' voluntary winding up, and schemes of arrangement promoted by a liquidator or provisional liquidator and sanctioned by a court of the HKSAR. Subsequent to recognition, relief can be granted to Hong Kong administrators who can then perform the same duties within the territory of the Mainland as those of Mainland administrators. Also, upon the request of Hong Kong administrators, a court may appoint a Mainland administrator to assist the case. Additional relief that may be granted include the realisation of bankruptcy property, the distribution of bankruptcy property, a debt restructuring arrangement and termination of bankruptcy proceedings. The Opinion seems to mirror principles from the 1997 UNCITRAL Model Law on Cross-Border Insolvency (MLCBI), which serves as the basis for similar rules in the UK and the US and sets out a more comprehensive and detailed framework when compared to article 5 of the EBL.

Seven flaws

Compared to cross-border insolvency systems in other jurisdictions, including the European Union's system laid down in its European Insolvency Regulation of 2015 (EIR 2015), the 2021 arrangement still leaves many issues unaddressed; outlined here as the "seven flaws".

COMI

First, the SPC's Opinion adopts the concept of COMI. The Opinion applies to Hong Kong insolvency proceedings, where the HKSAR is the COMI of the debtor. In the Opinion, COMI "generally means the place of incorporation of the debtor," which is the registration place of the debtor. In addition, the courts shall consider other factors, such as the place of the debtor's principal office, principal place of business, and principal assets, "etc". The concept of COMI and the determination of this norm is based on an assessment of circumstances which seems to be unlimited (through the use of the term "etc"). It notionally appears to be in line with the MLCBI and the EIR 2015. However, the MLCBI and the EIR 2015 also require the COMI of a debtor to be "ascertainable by third parties," being especially creditors. This is not clearly stated in the Opinion. Further, the adoption of the concept of COMI is only set out in the SPC's Opinion, but not in the HKSAR's Practical Guide.

Establishment

Second, the Record of Meeting does not mention the possibility of opening, based on a debtor's "establishment," a non-main/secondary proceeding, nor does the Practical Guide. Such an establishment acts as a basis for a court's international jurisdiction to open such a non-main/secondary proceeding, though the Opinion confirms that there might be parallel proceedings in both the Mainland and Hong Kong. However, it does not make a distinction between main and non-main/secondary proceedings. The opening of parallel proceedings seems to be beyond the scope of the 2021 arrangement.

In contrast, under the EIR 2015, an "establishment" requires the presence of a structure consisting of a minimum level of organisation and a degree of stability necessary for the purpose of pursuing an economic activity. The presence alone of goods in isolation or bank accounts does not, in principle, meet that definition. So, in such a case with just real estate as property owned by a Mainland debtor, non-main proceedings in HKSAR cannot be opened.

Applicable law

Third, the Record of Meeting seems to follow the MLCBI framework without stipulating the applicable law, unlike the EIR 2015 where the applicable law is stipulated to be that of the country where the insolvency proceeding is opened. Applicable law is, indeed, a complex theme. But it is presently on UNCITRAL's global agenda. In the context of the 2021 arrangement, it may be one of the next steps to consider.

Communication and cooperation

Fourth, cross-border (although within one country) cooperation is highlighted in the Opinion. For example, insolvency practitioners in the two jurisdictions should strengthen their communication and cooperation. Without further detail, this provision is, however, rather abstract. A reference to a recommended use of cross-border insolvency protocols is lacking. While courts in the pilot areas in the Mainland "shall actively communicate and take forward cooperation with the courts" in HKSAR, without further elaboration, the obligation to cooperate is a rather empty one. The MLCBI and the EIR 2015 provide that, in implementing cross-border cooperation with insolvency proceedings pending in EU Member States, the respective insolvency practitioners shall:

• as soon as possible communicate to each other any information which may be relevant to the other proceedings;
• explore the possibility of restructuring the debtor and, where such a possibility exists, coordinate the elaboration and implementation of a restructuring plan; and
• coordinate the administration of the realisation or use of the debtor's assets and affairs.

Group of companies

Fifth, the Record of Meeting does not mention group insolvency, which is added in the EIR 2015. The insolvency of a group of companies or enterprises requires much deeper cooperation and coordination. This subject may have been allocated for further consideration on a future agenda.

Public policy exception

Sixth, the Opinion generally provides that the People's Courts shall refuse to recognise or assist Hong Kong proceedings if the basic principles of the law of Mainland China are violated, or public order and good morals are offended. This is similar to article 6 of the MLCBI and the EIR 2015, which also prescribe a "public policy" exception. However, the Opinion stipulates many more circumstances where refusal of recognition can be made, including on the basis of other circumstances in which the People's Courts consider that recognition or assistance should not be rendered. It seems that the Opinion grants  Mainland judges overly broad powers to refuse recognition of Hong Kong insolvency proceedings. In theory, already this last possibility may create a barrier to effective cross-border recognition of insolvency proceedings.

Equal treatment of creditors

Finally, the Mainland maintains strong powers that are contrary to the principle of equal treatment of creditors. If a Mainland court recognises and assists the Hong Kong insolvency proceedings, "the bankruptcy property of the debtor in the Mainland shall first satisfy preferential claims under the law of the Mainland. The remainder of the property is to be distributed in accordance with the Hong Kong Insolvency Proceedings provided that creditors in the same class are treated equally." This rule of protecting "own" Mainland first is against the fundamental tenet to treat creditors on the basis of equality before the law.

In all, the 2021 arrangement misses key terms and constituent elements, lacks detailed implementation guidance for judges, and does not align with globally accepted approaches. How will courts handle complex issues without a well-considered solid basis in cross-border insolvency regulation?

Improving the 2021 arrangement

The conclusion is, in mild words, that the present arrangement is unfinished and contains inadequacies. To start to think about improving the present mechanism, I propose five recommendations for the reforms of future Mainland-Hong Kong cross-border insolvency.

Learn from other "mixed legal" systems

The Mainland and Hong Kong maintain a "one country, two systems" political regime that also forms the basis of two different legal systems; the Mainland being a civil law jurisdiction and Hong Kong being a common law jurisdiction. On a global scale, the Mainland-Hong Kong situation is not unique. There many jurisdictions with mixed legal systems in the world that can set examples for enhanced mutual understanding or stimulate alignment between rules. For example, Canada (Quebec), South Africa, Scotland, and Malta are countries which include political entities where two (or more) legal systems apply cumulatively or interactively to a certain extent. Evidently, the social-cultural environment, the social-economic policies and the economic scale of certain cases may differ greatly. However, the way the "mix" of systems work, or can work, for example, in training and educating role players (insolvency practitioners and judges), in aligning procedural matters, and in understanding each others' legal terminology, could set examples for further developing the 2021 arrangement. Global insolvency is unique, in that it has several non-binding sets of guidelines to have courts cooperate together, such as the Judicial Insolvency Network "Guidelines for Communication and Cooperation between Courts in Cross-Border Insolvency Matters."

Better alignment with UNCITRAL Model Laws

The 2021 arrangement has its feet in the sand of the MLCBI. The concept of COMI, the definition of the public policy exception and the possibility of having a parallel non-main/secondary proceeding opened because the company has an "establishment" in the other jurisdiction, as well as the system for cross-border cooperation, should be brought in line with the MLCBI. Interestingly, in the 2022 landmark case of Re Global Brand Group Holding Ltd, the Hong Kong Court officially adopted COMI as a formal test for cross-border insolvency. The elements that the Hong Kong Court adopted were based on the SPC's Opinion, common law, the EIR 2015 and the MLCBI, which are practically in line with each other. The windows, therefore, are open for winds of change, coming from international developments.

China's inter-regional cross-border insolvency arrangement (CICIA)

In literature, six years ago, it has been recommended to create a China inter-regional cross-border insolvency arrangement (CICIA). Such a regime includes basic rules for any regulation's overriding objectives, rules for international jurisdiction, recognition and relief, the public policy exception (limited), a stay/moratorium, protocols, a standing judicial committee, a functional dispute settlement system, and an inter-regional case register. Some of the rules are similar to global practices. References can be made to the 2012 American Law Institute (ALI)-International Insolvency Institute (III) "Global Principles for Cooperation in International Insolvency Cases and Global Guidelines."

The recommendation includes the establishment of a standing judicial committee which can serve as a functional dispute settlement system and provide proper interpretation of present and future provisions of a cross-border cooperation mechanism. Members of the judicial committee should be internationally recognised experts on cross-border insolvency matters and can provide consistent and predictable clarification on the rules. Evidently (sensitive) details (for example, the selection and appointment of judges and their independent position) should be negotiated. The role of the judicial committee is to make decisions in specific cases, which should be binding, unless the judges hearing the cases disagree or the SPC or the Hong Kong Court of Appeal rule otherwise.

Light legislative regime for small and medium enterprises (SMEs)

Special attention should be given to SMEs. Given the close geographical relation and close economic ties, there are a large number of companies involved in cross-border businesses. It is proposed that automatic recognition should be granted for insolvency proceedings of SMEs of a certain size. It would take away some formal, costly, and time-consuming burdens. Evidently, courts ex officio should have some measures to test the fairness of the system, including a limited public policy exception.

A hybrid approach

My final suggestion is that a hybrid approach could be adopted, combining both a CICIA type of regime and specific agreements with a targeted/tailor-made ad hoc protocol for each individual large cases. Apart from the standing judicial committee that may deliver opinions, case-specific agreements or protocols may also be an option to further regulate and detail judicial coordination and insolvency practitioner/debtor-in-possession cooperation. Inspiration can be taken from European Model Protocols developed in 2021.

Conclusion

The current Mainland-Hong Kong 2021 arrangement is still a rough one due to its lack of necessary detail and comprehensive implementing rules. Inspired by other examples from all over the world, additional rules should be formulated that can provide clearer and more certain guidance for debtors and insolvency practitioners, as well as judges. For courts, it is acknowledged that their direct communication can be quite challenging, since normally judges may have strong reservations about being included in discussions about personally adhering to agreements with judges of another jurisdiction. There may be constitutional and procedural objections. However, in other areas in the world, courts are getting an open eye for the interests of global business, and they understand their crucial role in taking a pragmatic approach.

I do not doubt that in Asia there will be an equivalent of the Dutch saying: "A lot of water still has to run through the Rhine before something will happen."

The Mainland China-Hong Kong relationship in cross-border insolvency has been silent for over two decades. Efficient and effective courts, including in matters of (cross-border) restructuring and insolvency, serve the general interest of smooth business transactions, which are global "by nature." For this reason, the aforementioned proposals may provide some ideas to leap into the future.

Author

Professor Bob Wessels is an independent legal counsel, advisor and arbitrator, with 45 years of business experience. For over 25 years he acted as a deputy justice in the Court of Appeal in The Hague. From 1988-2014 he was a law professor (civil law, commercial law, insolvency law) at the Vrije University in Amsterdam and the University of Leiden. 

References

This International Restructuring Newswire contribution is based on a presentation made during the conference 'One country Two Systems and Cross-Border Legal Harmonization' organised by Faculty of Law, the University of Hong Kong and the Asian Institute of International Financial Law (AIIFL) on 5 November 2022. All sources can be assessed in two articles, see Shuai Guo and Bob Wessels, 'Cross-border Insolvency between Mainland China and Hong Kong: A First Glance from A Global Perspective' (2021) 18 International Corporate Rescue 247, and Bob Wessels and Shuai Guo, 'Cross-border insolvency between Mainland China and Hong Kong 2: New proposals from a global perspective' (2023) 20 International Corporate Rescue (forthcoming).