Many foreign funds are seeking to divest from their real estate equity investments in mainland China following the sector’s significant downturn in recent years. When a disagreement over divestment arises between a foreign fund and its domestic partner, effective resolution of the dispute is crucial.
Investment and divestment methods
Investment: A fund will typically have its foreign holding company establish a new domestic real estate project company with its domestic partner, which will then acquire the target property. Alternatively, the foreign fund will buy the equity of the existing project company that owns the target property (at the level of either the domestic project company or an overseas holding company of the project company).
Divestment: A foreign fund will usually divest either by way of a property sale or equity transfer.
Divestment dispute key points
Where discussions are not possible, or repeatedly put off by the domestic partner, the foreign fund has no option but to turn to dispute resolution and needs to heed the following.
Investment in a domestic real estate project by a foreign fund usually involves a series of agreements covering different aspects, with demands of validity and enforceability. These may not be subject to the same laws or dispute resolution methods. It is, therefore, necessary to conduct an internal review and select professionals with a range of relevant legal experience to advise.
Foreign funds entering litigation or arbitration must prepare themselves for a protracted effort of one to two years, or even longer, before reaching a conclusion. It is particularly important that they take timely and effective interim steps to secure evidence and property. Otherwise, the opposing party may divert assets and hide evidence.
The foreign fund, the domestic partner and its affiliated parties are usually involved in a divestment dispute. As the investment structure crosses borders (potentially involving mainland China, Hong Kong and the British Virgin Islands, for example), the other party’s assets may also cross borders, even though the target property is in China. Accordingly, when the party fails to comply with a judgment/award, domestic and foreign enforcement may be involved simultaneously to enable the foreign fund to obtain the money it is entitled to.
Why HK arbitration is favoured
The four main means to dispute resolution are domestic litigation, domestic arbitration, foreign litigation and foreign arbitration. In divestment disputes, the referral of a dispute to a domestic organisation is unacceptable to most foreign entities, while foreign litigation is time consuming, costly and has the added uncertainty of whether mainland courts will recognise and enforce foreign court judgments. Parties are therefore more likely to select foreign arbitration of divestment disputes.
Tax considerations mean that project structures usually involve a Hong Kong company. Foreign funds, therefore, tend to opt for Hong Kong arbitration, which offers the following further advantages.
The selection of arbitrators. Hong Kong has a relatively large number of arbitrators to choose from with combined backgrounds in common law, Hong Kong law and mainland law, and who are bilingual in Chinese and English.
Interim measures. The other party to a dispute (the domestic partner) is usually a real estate developer that owns many properties in China. Only mainland courts have the power to provide interim measures for such domestic assets, and the mainland system for such judicial measures is open only to Hong Kong arbitration proceedings.
Pursuant to the Arrangement Concerning Mutual Assistance in Court-ordered Interim Measures in Aid of Arbitral Proceedings by the Courts of the Mainland and the Hong Kong Special Administrative Region, effective from 1 October 2019, a party to Hong Kong arbitral proceedings may apply to a mainland court for interim measures before the acceptance of an application for arbitration, or before the rendering of the arbitral award by mainland courts. There have been many successful applications since the implementation of the arrangement. There are no similar arrangements for other foreign arbitration cases, for which mainland courts typically won’t provide interim measures.
Enforcement advantage. Concerning enforcement against domestic property, under the Arrangement of the Supreme People’s Court Concerning Mutual Enforcement of Arbitral Awards Between the Mainland and the Hong Kong Special Administrative Region and the Supplementary Arrangement, an application for the recognition and enforcement of a Hong Kong arbitral award can be made to a mainland court to seek enforcement against the domestic assets of the other party to the dispute.
In contrast, an application made by other foreign arbitral institutions will be reviewed under the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the New York Convention) or the reciprocity principle. In practice, relatively more Hong Kong arbitral awards are recognised and enforced in mainland courts.
For enforcement against overseas property, Hong Kong arbitral awards may be recognised and enforced by certain foreign courts according to the New York Convention. Also, Hong Kong arbitral institutions have extensive experience handling cross-border disputes and can effectively collaborate with foreign courts in enforcement against the foreign property.
Wu Ming is a senior partner at Dentons Law Firm. He can be contacted at +86 21 2028 3818 or by e-mail at email@example.com
Shen Junjie is an associate at Dentons China. She can be contacted at +86 21 2028 3818 or by e-mail at firstname.lastname@example.org
Luo Yue, a legal assistant at Dentons Law Firm, also contributed to the article