BVI companies have become increasingly popular as investment vehicles for PRC companies. Harneys' Ian Mann outlines the resulting growth in Chinese litigation offshore

The enormous popularity of British Virgin Islands (BVI) companies in mainland China for foreign investors, as well as domestic joint venture partners, is well renowned.

A popular investment structure is to incorporate a BVI company, which owns the shares in a People's Republic of China (PRC) company, (known as a wholly owned foreign enterprise, or WOFE) which in turn holds assets in the PRC, more often than not, a factory or some other such enterprise. There are tax and other advantages that are particular to using BVI companies in these investment structures, but there is a new and exciting awakening in the PRC that the shareholder remedies available for BVI companies in the BVI court is just as important as the initial attraction of incorporation advantages.

The BVI court is well accustomed to having much of its court list being taken up by PRC-based matters. An increasing number of shareholder disputes are originating from PRC shareholders, and the big Russian litigation that once dominated the BVI court's list is now giving way, at least partially, to a new wave of PRC litigation.

The legal representative

The first point to understand about protecting assets in the PRC is the vital importance of the status of the legal representative in any asset recovery strategy in China. All PRC companies are required to have a legal representative. He is the main principal of the company and is the employee with the legal power to represent – and enter into binding obligations on behalf of – the company in accordance with the law or articles of association of the company.

Legal representatives have very broad powers and potentially unlimited liability. The legal representative's acts are binding on the company even if he is acting beyond its authorised scope.

The very existence of a legal representative can be infuriating to defrauded creditors or disgruntled minority shareholders of the parent BVI company because it allows all of the power of a board of directors to be exercised by one person, even if that person is no longer approved by the shareholders.

The PRC rules are strictly applied so that possession of the legal representative licence and the concomitant 'chops' that go with this potent office determine absolute authority to bind the company. Foreign liquidators have learned the hard way that foreign court orders will be meaningless in the face of the simplistic, but attractively clear, rules relating to the legal representative.

It is not uncommon for joint venture (JV) partners to fall out with each other only to find that one side of the JV wrongly refuses to give up the legal representative licence. In turn, that party is the 'client of record' for the registered agent in the BVI and, seemingly, there is no way to control the assets. This is a dangerous period for the underlying assets, and swift action needs to be taken.

Enforcement of foreign judgments

The second point to understand about protecting assets in the PRC is that typically foreign judgments will not be recognised if there is no bilateral judicial assistance treaty or agreement between the PRC and the foreign country that issued the judgment. Article 266 of the PRC civil procedure law sets out onerous statutory requirements for recognition and enforcement of a judgment or order rendered by a foreign court. The process of recognising foreign judgments in PRC courts can be both time-consuming and costly. Often it is a waste of time to pursue.

The exact opposite, of course, is true in the BVI, where the common law recognition of foreign judgments prevails. The BVI court is not hindered by the absence of any bilateral judicial assistance treaty and will enforce PRC judgments even though the same assistance is not afforded to its judgments in China.

The utility of a BVI court order without seeking enforcement

China's reluctance to recognise foreign judgments is probably to do with state sovereignty. Waving a BVI court order in front of PRC local government officials (where the underlying assets are located) or in front of a PRC judge, is likely to go down pretty badly. Instead, orders from the BVI court need to be framed so as to apply only at the BVI level where the BVI court has obvious in personam jurisdiction.

At first blush this seems like an admission that there is nothing to be done with a BVI court order in China, but, in fact, this is precisely how you achieve results in China. The PRC local government authorities and the PRC courts that regulate the affairs of WOFEs are not interested in extraterritorial court orders from small Caribbean islands, but they are interested in principle in corporate governance.

A cascade of resolutions from the BVI level resolving to affect changes at the WOFE level are perfectly enforceable in the PRC because it is the application of PRC law to a WOFE – the owner of the WOFE is entitled, depending on the constitutional documents, to control it.

It is all too common that the legal representative in China is also the 'client of record' in the eyes of the registered agent in the BVI, which means that this person controls both levels of the BVI parent and the WOFE.

Application can be made to the BVI court to rectify both the register of members and the register of directors of the BVI company and to compel the registered agent of the BVI company to recognise that rectification. Until this point, the BVI company would not have been in a position to make the necessary resolutions to change the legal representative.

Hitting them where it hurts: in their pockets

(1) Directors. The doomsayers are convinced that there is no means of sanction against a director of a BVI company because, even if a judgment for, say, director's breach of fiduciary duty to the company is awarded in the BVI, there is no means of compelling the director, residing in China, to pay.

This ignores the fact that, in the majority of these JV investment vehicles, the directors are also shareholders in the company, and so the BVI or Cayman Islands court can order that his shares be charged and/or sold to satisfy any judgment.

Equally, basic regulation of a director's behaviour is achieved by seeking relief from the court, in the right circumstances, which can be enforced by contempt proceedings which may result in confiscation of his shares. So, for example, a director of a BVI company residing in China can certainly ignore a BVI court order against him, but only if he does not care about his shares in the BVI company potentially being sequestered from him.

(2) Debtors. The fact that the BVI and Cayman courts will enforce PRC judgments under the common law without the need for any bilateral treaty provides a useful means of enforcement against PRC nationals who own shares in BVI companies and think that they are untouchable. A judgment of the PRC court for a money judgment can be recognised in the BVI, for example, and used as the basis to put a charge, with a view to sale, on the shares of the judgment debtor. Although not a direct tool for taking control of assets in China, it is a useful tool in the arsenal for compelling wayward counterparties to act.

Unfair prejudice claims

In JV arrangements where a BVI company owns a WOFE, the typical shareholder's dispute will erupt with one party being excluded from the company structure and the other party seizing control of the company's underlying PRC assets, making decisions without the ousted shareholder's consent or knowledge.

Sometimes this is fraud, sometimes it is in breach of the common intention and understanding of a quasi-partnership. A more recent phenomenon has been that, upon the death of one of the quasi-partners, the successors and heirs take a different view of how to exercise their shareholding than the deceased and immediately seek to manage the JV without any reference to the quasi-partners. Clearly, the result of such disputes is highly fact specific.

Depending on the facts of case, the ousted shareholders can bring an unfair prejudice claim in the BVI court. Typically, there is oppressive conduct by one party demonstrating a visible departure from the standard of fair dealings.

The relief that may be granted by the BVI court is wide and includes the following: requiring the company or any other shareholder to acquire the aggrieved shareholder's shares; requiring the company to pay compensation; regulating the future conduct of the company's affairs; amending the memorandum or articles of the company; appointing a liquidator over the company; directing the rectification of the records of the company; or setting aside any decisions made or taken by the company or its directors.

Once the ousted shareholder obtains relief sought from the BVI court, the company's records will be amended to reflect those changes, and enforcement in China can be effected carefully as above.

Ian Mann is head of BVI and Cayman litigation at Harneys in Hong Kong.