Foreign investors in Chinese groups that have gone bankrupt could be given powers to liquidate assets on the mainland in a deal with Hong Kong that aims to boost business confidence in the country’s legal system.

The mechanism will obligate courts in Shanghai, Shenzhen and Xiamen to recognise insolvency orders filed by company creditors in Hong Kong, conduit for Chinese companies raising money from global investors. It means that investors can more easily seek to wind up Chinese businesses’ assets on the mainland to recover their money. The scheme could be expanded to more Chinese cities in future.

The scheme, which was launched this month, comes as international investors increase their exposure to China. The country has at the same time been hit by a spate of defaults and corporate restructurings. China’s court system, which is controlled by the ruling Communist party, has historically not recognised insolvency decisions made in Hong Kong and elsewhere.

“This is potentially a game-changing step,” said Patrick Cowley, head of restructuring services in Asia at KPMG.

The lack of an agreement had been a sticking point for investors. A Hong Kong court declined a petition from investors to wind up Huiyuan Juice Group, one of China’s biggest juice makers, in November after it defaulted on its bonds. The court believed it unlikely the Hong Kong-appointed liquidators would be recognised in mainland China.

This left its creditors without much recourse, lawyers said.

While Hong Kong’s status as a global finance hub has come under pressure after Beijing imposed a controversial national security law last year, the city’s commercial legal system remains well regarded.

The deal “has brought company assets on the mainland within reach for liquidators outside of China for the first time”, said a veteran insolvency lawyer in Hong Kong.

The mechanism also means Hong Kong courts will recognise some insolvency proceedings in the mainland’s legal system.

“Once a creditor has appointed liquidators over a group in Hong Kong, that liquidator can apply to mainland Chinese courts to have equal rights over the group’s assets in the mainland,” said Kevin Song, an insolvency practitioner at restructuring specialist Borrelli Walsh in Beijing.

However, the scheme has not been tested and it does not guarantee that all applications made through it will be granted. Lawyers said that China still needs to demonstrate that international creditors can recover assets from insolvent mainland groups, warning that some might attempt to argue they are outside the agreement’s jurisdiction.

Mainland courts can also refuse to assist Hong Kong-appointed liquidators if they deem it would “offend public order or good morals” or if “mainland creditors are unfairly treated”, according to a legal opinion published by the Supreme People’s Court, China’s top court.

“What we are going to need now is to come up with the right cases to take to the Shenzhen, Shanghai or Xiamen courts . . . to set the examples and to show that it works,” said KPMG’s Cowley.

An insolvency expert in mainland China cautioned that authorities would also scrutinise the scheme for any damaging economic repercussions.

“There will be concerns over potential consequences such as causing bankruptcy at Chinese companies as foreign creditors look to take control of assets like factories or warehouses that employ large numbers of people,” the expert said. “This could destabilise local economies.”

Still, lawyers believe the agreement will boost Hong Kong’s reputation as a platform for investing in Chinese companies.

“At the moment they invest and it’s a bit of a gamble,” said Davyd Wong, an insolvency specialist at law firm YTL. “When [Chinese companies] sell shares or bonds in Hong Kong . . . the security given for those debts is pledges to assets on the mainland.”