One of China's richest men is suing six local governments for late payments on infrastructure contracts, in a rare legal action that highlights the risks of unpaid debts cascading through the country's economy.
Local government borrowing has risen steeply in recent years, with much new credit used to service existing debt, raising fears that local defaults could spark a full-blown financial crisis.
Yan Jiehe, founder of China Pacific Construction Group, said on Monday that his company's legal actions were the first such suits launched against local governments. "We will appeal all the way to the Supreme Court if necessary," Mr Yan told the Financial Times in a telephone interview. "We will surely win this case. The records and evidence are clear."
CPCG is China's largest private sector infrastructure company in an industry traditionally dominated by state-owned enterprises. Last year it was ranked 166th on the Forbes 500 list of the world's largest companies, with $60 billion in annual revenues. Mr Yan was listed as China's seventh-richest person by last year's Hurun report, with a fortune estimated at $14.2 billion.
The lawsuits involve six municipal and county governments across the country. Last week Ma Jiantang, director of China's statistical bureau, highlighted local government debt as one of the greatest risks to the economy, which last year grew at its slowest pace in 24 years.
According to China's National Audit Office, local government debt had reached Rmb 18 trillion by June last year from Rmb 10.7 trillion at the end of 2010. So-called "build and transfer" infrastructure projects, in which CPCG specializes, accounted for about 8 per cent — or Rmb 1.5 trillion — of total local government debt last year.
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"It's very rare for a private company to sue the government in general. I can't recall a similar case," said Zhiwei Zhang, China chief economist for Deutsche Bank in Hong Kong. "It's also a signal for other counterparties Pacific Construction does business with."
Mr Yan declined to reveal the total amount of money CPCG was owed but the company has provided details concerning two of the smaller lawsuits. It said Jinning county in southwestern Yunnan province owed Rmb 95 million for four infrastructure projects completed more than two years ago. Ningjin county in northern Hebei province, where CPCG had completed 16 infrastructure projects by August 2013, owed Rmb 83 million, according to the company.
Officials in Jinning county said they were looking into the matter and could not comment. The Ningjin county government could not be reached immediately for comment.
CPCG's higher-profile projects include an expressway linking Shanghai to Nanjing, capital of Jiangsu province, and a bridge across the Yangtze river. It also has a series of high-profile projects in Lanzhou, a provincial capital in western China.
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"This case will be closely watched by other creditors to local governments," said Zhong Liang, director for public finance ratings at Standard & Poor's. "If China Pacific wins its case, more cases will follow."
The lawsuit comes at a time when the central government is working to eliminate the use of opaque arm's-length financing vehicles for local-government financing.
Late last year China's cabinet said localities would no longer be permitted to borrow through such special-purpose vehicles, which were designed to skirt a ban on direct borrowing. Local governments are not legally responsible for most financing-vehicle debt, but creditors widely believe such borrowing carries an implicit guarantee.
In an attempt to "open the front door and close the back door", China's legislature ended the direct borrowing ban and the finance ministry launched a new pilot program to allow some local governments to raise funds by selling municipal bonds.
At the same time, the cabinet said that it would not provide bailouts to local governments that were unable to repay their own debts — an attempt to end implicit guarantees and the associated moral hazard. Last year the Shandong provincial government followed suit, announcing that it would not take responsibility for debt racked up by cities and counties.
Mr Liang believes creditors of small cities and counties in provinces such as Shandong, where CPCG is also suing a local government, are most likely to follow Mr Yan's lead if they believe higher levels of government will not stand behind lower-level debt. "There could be a first-mover advantage for some creditors to take legal action," Mr Liang said.