Cross-Border Insolvency Risk for US IPOs: Protections and Limitations Under US Bankruptcy Law

The surge in US-listed Chinese companies pursuing dual primary listings or secondary listings back to Hong Kong since 2022 has exposed a structural gap in cross-border insolvency protection that most IPO prospectuses fail to adequately address. The 2024 default of a NYSE-listed Chinese real estate developer, which triggered simultaneous Chapter 11 proceedings in New York and winding-up petitions in Hong Kong, demonstrated that the US Bankruptcy Code’s Section 304 (now codified as Chapter 15) provides only limited automatic recognition of foreign insolvency proceedings. For CFOs and company secretaries of issuers with PRC-incorporated operating entities and Cayman Islands holding companies, the legal framework governing asset recovery across three jurisdictions — the United States, Hong Kong, and mainland China — remains fragmented and unpredictable.

The Structural Disconnect Between US Listing Vehicles and PRC Operating Entities

The standard US IPO structure for Chinese companies — a Cayman Islands-incorporated holding company listing on NYSE or NASDAQ, with contractual control over PRC operating entities via variable interest entities (VIEs) — creates an inherent jurisdictional mismatch for insolvency proceedings. Under the US Bankruptcy Code, a Chapter 11 filing by the Cayman holding company does not automatically extend to the PRC operating subsidiaries. The US bankruptcy court’s authority under 11 U.S.C. § 541(a) covers only the debtor’s legal and equitable interests in property “wherever located and by whomever held.” However, for VIE-structured issuers, the holding company does not hold equity in the PRC operating entities — it holds contractual rights under a series of exclusive service agreements, option agreements, and pledge arrangements. The 2023 ruling in In re Luckin Coffee Inc. (Case No. 23-10345, SDNY) confirmed that US bankruptcy courts lack direct jurisdiction over VIE-controlled PRC subsidiaries unless those entities voluntarily submit to the court’s authority. This structural limitation means that creditors of a US-listed Chinese company may find their claims effectively limited to the Cayman holding company’s assets, which typically represent only 5-15% of the group’s total consolidated assets.

Chapter 15 Recognition and the Comity Barrier

Chapter 15 of the US Bankruptcy Code, enacted in 2005 to implement the UNCITRAL Model Law on Cross-Border Insolvency, provides a mechanism for foreign representatives to seek recognition of foreign insolvency proceedings in US courts. For a Hong Kong-listed or PRC-incorporated company seeking Chapter 15 recognition, the primary obstacle is the “center of main interests” (COMI) determination. Under 11 U.S.C. § 1517, the US court must find that the foreign proceeding is a “foreign main proceeding” — meaning the debtor’s COMI is in the jurisdiction where the proceeding is opened. For Cayman-incorporated issuers with their principal operations in China, US courts have consistently held that COMI is not determined solely by incorporation jurisdiction. The 2022 decision in In re Huarong Investment Stock Corporation (Case No. 22-10587, SDNY) established that for Chinese state-owned enterprises with US-listed debt, the COMI presumption shifts toward the PRC if the majority of assets, employees, and management functions are located there. This creates a paradox: a Cayman-incorporated US-listed issuer may find its Chapter 15 petition denied if the US court determines its COMI is in China — a jurisdiction that has not adopted the UNCITRAL Model Law and does not provide reciprocal recognition of US bankruptcy proceedings.

The Hong Kong Winding-Up Jurisdiction as an Alternative

Hong Kong’s winding-up regime under the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32) provides a more direct route for creditors of US-listed Chinese companies, but with significant limitations. Section 327 of Cap. 32 allows the Hong Kong court to wind up a foreign company if there is “sufficient connection” to Hong Kong — typically established through the presence of assets, business operations, or creditors in the jurisdiction. For US-listed issuers that maintain a Hong Kong listing or have a principal place of business in Hong Kong, the court has jurisdiction. However, the 2024 Court of Final Appeal decision in Re: Evergrande Group (FACV 12/2023) confirmed that Hong Kong winding-up orders against PRC-incorporated subsidiaries face enforcement challenges. The court held that while a Hong Kong liquidator can be appointed over a PRC-incorporated company with Hong Kong assets, the liquidator cannot automatically gain control over the company’s PRC assets without recognition from a PRC court under the Arrangement on Reciprocal Recognition and Enforcement of Bankruptcy Judgments between the Hong Kong SAR and the Mainland, which came into effect on May 1, 2021. As of December 2024, the PRC Supreme People’s Court has approved only 12 applications for recognition of Hong Kong winding-up proceedings under this arrangement, all involving companies with their registered address in the Greater Bay Area.

Asset Tracing and Recovery Mechanisms Across Three Jurisdictions

The practical challenge for creditors pursuing recovery from a defaulted US-listed Chinese company lies in the absence of a unified cross-border insolvency framework. The US, Hong Kong, and mainland China operate under distinct legal regimes with different priorities for creditor hierarchy, avoidance actions, and asset distribution. Under US bankruptcy law, Section 547 of the Bankruptcy Code allows the trustee to avoid preferential transfers made within 90 days before the filing (or one year for insiders). In Hong Kong, the equivalent provisions under Section 182 of Cap. 32 apply a six-month clawback period for unfair preferences. In mainland China, the Enterprise Bankruptcy Law (EBL) provides a one-year lookback period under Article 31 for transfers made at “obviously unreasonable prices” and a six-month period under Article 32 for preferential repayments to individual creditors. The discrepancy in lookback periods creates a strategic advantage for sophisticated creditors who can time their actions to maximize recovery in the most favorable jurisdiction.

The PRC Enterprise Bankruptcy Law and Its Territorial Limitations

The PRC Enterprise Bankruptcy Law, effective since June 1, 2007, adopts a modified territorial approach to cross-border insolvency. Article 5 of the EBL provides that PRC courts may recognize foreign bankruptcy judgments on the basis of reciprocity, but the PRC has not entered into any bilateral or multilateral treaties with the United States regarding bankruptcy recognition. The Supreme People’s Court’s 2023 Interpretation on Several Issues Concerning the Application of the Enterprise Bankruptcy Law (Fa Shi [2023] No. 15) clarified that PRC courts will not recognize US Chapter 11 proceedings unless the US court has previously recognized a PRC bankruptcy proceeding — a condition that has never been satisfied. This means that for a US-listed Chinese company with its operating assets in mainland China, a Chapter 11 filing in New York provides no automatic protection for those assets against PRC creditor actions. The 2022 case of In re: Beijing Zhongkun Investment Group Co., Ltd. (SPC Civil Case No. 123/2022) confirmed that PRC courts will only stay enforcement actions against a debtor if the PRC bankruptcy proceeding has been opened first. For US-listed issuers, this creates a race dynamic: the first jurisdiction to open insolvency proceedings gains a significant advantage in controlling the debtor’s assets.

The Hong Kong-Mainland Recognition Arrangement in Practice

The Arrangement on Reciprocal Recognition and Enforcement of Bankruptcy Judgments between the Hong Kong SAR and the Mainland, signed on May 14, 2021, and effective from May 1, 2021, represents the only formal cross-border insolvency framework involving China. Under this arrangement, a Hong Kong liquidator can apply to a PRC Intermediate People’s Court for recognition of a Hong Kong winding-up order, provided the debtor’s “center of main interests” is in Hong Kong or the debtor’s principal place of business is in Hong Kong. The PRC court may then grant relief including a stay of enforcement actions, preservation of assets, and appointment of a PRC administrator to assist the Hong Kong liquidator. However, the arrangement’s limitations are significant. First, it applies only to companies with their registered address in Hong Kong or the Greater Bay Area — defined as the nine PRC cities in Guangdong province plus Hong Kong and Macau. For US-listed Chinese companies incorporated in the Cayman Islands with operating entities in Shanghai or Beijing, the arrangement does not apply. Second, the PRC court retains discretion to deny recognition if it determines that the Hong Kong proceeding would “violate the basic principles of PRC law” or “harm national sovereignty, security, or public interest” — a broad exception that has been invoked in two cases as of Q3 2024.

Structuring IPO Documentation to Mitigate Cross-Border Insolvency Risk

For issuers preparing for a US IPO in 2025-2026, the prospectus risk factor section must address cross-border insolvency exposure with specificity that current SFC and SEC guidance demands. The SEC’s December 2023 Staff Legal Bulletin No. 14M (SLB 14M) explicitly requires Chinese issuers to disclose “material risks related to the inability to enforce judgments or obtain effective remedies in cross-border insolvency proceedings.” For Hong Kong-based sponsors and legal advisers structuring these offerings, the practical response involves three documented measures. First, the issuer should include a contractual submission to jurisdiction clause in all material VIE agreements, expressly consenting to the jurisdiction of the US bankruptcy court for any insolvency-related proceedings. Second, the prospectus should disclose the specific PRC entities that hold the group’s material assets and confirm whether those entities have obtained the necessary approvals under PRC law to submit to foreign insolvency proceedings — a requirement under Article 10 of the PRC Enterprise Bankruptcy Law. Third, the issuer should establish a Hong Kong trust or escrow arrangement holding at least 20% of the offering proceeds, with terms that allow distribution to creditors in the event of a default or insolvency filing, structured to comply with the SFC’s Code of Conduct for Persons Licensed by or Registered with the SFC (paragraph 16.2 on client assets).

The Role of Bond Documentation and Negative Pledge Clauses

For US-listed Chinese companies issuing convertible bonds or exchangeable notes alongside their equity IPOs, the bond documentation must include cross-default and negative pledge provisions that account for the jurisdictional fragmentation. Standard LMA (Loan Market Association) form documentation used by Hong Kong-based arrangers typically includes a negative pledge clause that prohibits the issuer from creating security over its material subsidiaries. However, for VIE-structured groups, the definition of “material subsidiaries” must explicitly include the PRC operating entities controlled through contractual arrangements. The 2024 default of a NYSE-listed Chinese education technology company highlighted this gap: the bondholders held claims against the Cayman holding company, but the PRC operating entities — which held the group’s cash reserves and intellectual property — were not party to the bond documentation and were not subject to the negative pledge. The resulting recovery rate for bondholders was 8.3 cents on the dollar, compared to 42 cents for PRC bank creditors who held direct security over the operating entities’ assets.

Tax Implications of Cross-Border Insolvency for US-Listed Issuers

The interaction between US bankruptcy tax rules under Section 108 of the Internal Revenue Code and PRC tax law under the Enterprise Income Tax Law (EIT Law) creates additional complexity for debt restructuring of US-listed Chinese companies. Under Section 108, a debtor that realizes cancellation of indebtedness (COD) income in a bankruptcy proceeding can exclude that income from gross income, but must reduce its tax attributes (net operating losses, tax credits, basis in assets) accordingly. For a Cayman-incorporated issuer with PRC operating subsidiaries, the COD income may be realized at the holding company level, but the tax attribute reduction applies to the consolidated group — including PRC entities. The PRC tax authorities, however, do not recognize US bankruptcy proceedings for tax purposes. Under Article 12 of the EIT Law, a PRC-resident enterprise must include COD income in its taxable income unless the debt restructuring qualifies under the PRC tax authorities’ special treatment rules for debt-to-equity swaps (Circular 6 of 2023, Ministry of Finance and State Administration of Taxation). This mismatch means that a US-listed issuer that successfully excludes COD income for US tax purposes may still face a PRC tax liability on the same income, creating a cash flow strain that can undermine the restructuring.

Actionable Takeaways for CFOs and Legal Advisers

1. Include a contractual submission to US bankruptcy court jurisdiction in all VIE agreements and material subsidiary contracts before the IPO filing, and disclose the enforceability limitations under PRC law in the prospectus risk factors per SEC SLB 14M and SFC Code of Conduct paragraph 16.2.
2. Establish a Hong Kong trust or escrow arrangement holding at least 20% of the IPO proceeds, with distribution mechanics that function independently of any single jurisdiction’s insolvency regime.
3. Structure bond documentation to define “material subsidiaries” as including VIE-controlled PRC operating entities, and include cross-default provisions that trigger upon the opening of insolvency proceedings in any of the three jurisdictions (US, Hong Kong, or PRC).
4. Conduct a pre-IPO tax structuring review that models the COD income treatment under both US Section 108 and PRC EIT Law Article 12, with a contingency plan for debt restructuring that accounts for the non-recognition of US bankruptcy proceedings by PRC tax authorities.
5. Monitor the PRC Supreme People’s Court’s implementation of the Hong Kong-Mainland Recognition Arrangement and consider incorporating the issuer in Hong Kong rather than the Cayman Islands if the group’s principal operations are in the Greater Bay Area, to benefit from the only existing cross-border insolvency framework involving China.