In a recent blog post Professor Gillis talks about Chinese companies “going dark”, and the problems this can create for the US shareholders. Getting any enforcement on a decision to award shareholders compensation for their losses seems remote, and this is of course causing investors worry.
But while it’s still possible the Chinese government might change its’ tune regarding enforcing these types of decisions the case for VIE companies is looking bleak. As professor Gillis mentions investors don’t even have a legal right to the assets in these entities, so there really is nothing to enforce.
As creditors are likely realising, the same situation appears to be present with sino-forest’s contractually held assets. Something that will likely cause a lot of headaches as that tangled mess gets unraveled.
The issue is that there has really never been any forward planning for this type of situation with VIEs, and even now when some of them have fallen apart there has been little attempt to address this issue. Although Hong Kong is now reportedly demanding that new VIEs carry with them some form of system to guarantee investor rights to VIE assets it’s as yet unclear how such a system would work in practice.
The standard VIE contracts that we find in most deals are Equity pledges, exclusive call options, technical services agreements, and proxy voting agreements. None of these contracts contain anything that will give investors the right to access the assets held in the VIE, and even if they did how would they be transferred and what would be the consequences on the value of the assets?
The VIE agreements were made to allow for consolidation under US GAAP and IFRS, and as these rules do not require any rights to residual assets no such provisions were made. This situation now looks likely to leave investors without recourse should anything go wrong with the company.
As more and more Chinese companies are having issues, both legitimate and otherwise, investors ability to gain access to the assets in the company will be of increased importance. Having all of your assets in a VIE will make an investment significantly less attractive, something that will hopefully lead companies to re-examine how their VIE arrangements work.
A further developed issue is faced by Sino-forest where the complex web of contractual control could well keep creditors from gaining access to any asset held under these circumstances.