Cover Story: China Forestry’s Fall Under Corruption Cloud Reveals Weakness in State-Owned System

21 Oct 2024

China Forestry Group Corp., the central government-owned lumber giant that is teetering under the weight of its debt, faces investigations into corruption and mismanagement by top executives, including bribery allegations against former Chairman Song Quanli.

The company’s deepening financial struggles were revealed in a July response to a regulatory inquiry by timber trader Jiangsu Wanlin Modern Logistics Co. Ltd. that revealed 35.26 million yuan ($4.98 million) in overdue payments from two China Forestry subsidiaries.

Wanlin disclosed that it sold timber to the two units and the Beijing-based parent company was refusing to honor the financial obligations of its subsidiaries. According to Wanlin, China Forestry was only receiving payments, not settling debts, following its 2023 takeover by state-owned China Three Gorges Group Co. Ltd. in a rare government intervention.

This revelation has sent shockwaves through the stock market, drawing attention to China Forestry’s staggering debt load of 156.7 billion yuan as of the third quarter of 2023, when Three Gorges took control. Since early 2024, China Forestry and its subsidiaries have been embroiled in numerous lawsuits filed by creditors seeking repayment.

Long concealed behind a facade of rapid expansion and ambitious investments, the company’s collapse has exposed systemic problems in the country’s state-owned enterprises. China Forestry’s problems were compounded by flawed business strategies, including risky investments in forestry projects that stretched the company’s cash flow to a breaking point.

Rapid growth

Formed in 1999 through a merger of nine companies previously controlled by the National Forestry and Grassland Administration, China Forestry stood out as the only timber enterprise among the 97 state-owned giants overseen by the State-owned Assets Supervision and Administration Commission (SASAC). Its small size and fragile finances prompted several unsuccessful attempts at restructuring or combining the company with other SOEs.

Since 2013, under new leadership by Song, China Forestry embarked on a bold plan to reinvent itself as a global forest resource operator. The company aggressively acquired forest land across North America, Africa and Oceania. By 2017, the group controlled 20% of China’s timber imports. However, these ambitions were fueled by aggressive financial strategies, leading to mounting debt.

One of China Forestry’s most notable initiatives was its push into mixed-ownership reform, creating or restructuring 78 joint ventures between 2013 and 2018. The initiative raised 9.4 billion yuan from private investors and catapulted annual revenue from 20 billion yuan in 2011 to 204.6 billion yuan in 2020. Yet, insiders revealed that this meteoric growth was built on shaky ground—fueled by fraudulent transactions with subsidiaries and business partners.

Now facing scrutiny, China Forestry’s lofty ambitions have given way to a cascade of debt and lawsuits. Its story offers a cautionary tale of overreach, mismanagement and deceit, exposing the risks of aggressive expansion within China’s SOEs.

Fraudulent transactions

China Forestry’s financial collapse reveals a tangled web of fraudulent transactions and mismanagement. A 2017 audit by the National Audit Office found that the group’s subsidiaries issued letters of credit and commercial acceptance bills without real transactions, enabling external firms to receive 1.24 billion yuan. Several of China Forestry’s subsidiaries illegally lent 821 million yuan to outside companies disguised as advance payments. Meanwhile, China Forestry’s receivables ballooned to 75.8 billion yuan by 2020.

Further inspections in 2020 uncovered more irregularities, prompting a 2021 rectification campaign. The group vowed to review transactions with mixed-ownership partners and chase overdue payments, but a deeper investigation revealed that hundreds of suppliers and clients were enmeshed in dubious financial dealings, often using bogus prepayments to secure loans backed by commercial bills without actual transactions.

One key figure in this scheme, Hu Lingfeng, was tied to various ventures in film, real estate and trade. As of the end of 2022, several companies controlled by Hu owed nearly 5 billion yuan to China Forestry. When asked by Caixin in 2023 where the borrowed money went, Hu said: “I don’t know.”

A lawsuit involving Shanghai Xinhong International Trade Co. exposed the tip of the iceberg of the dubious practices between Hu and China Forestry subsidiaries. In one convoluted transaction, Xinhong sold 180 million yuan worth of ethylene glycol to Shanghai Juneng Industrial Co. Ltd., a Hu venture, which then sold 180 million yuan worth of electrolytic copper to Shanghai Guolin Shengtong Economic Development Co. Ltd., in which China Forestry owns a 51% stake. The parties used commercial acceptance bills to secure bank loans, which eventually led to unpaid debts and litigation.

The court later ruled that these transactions were not genuine but part of a larger financing scheme. Guolin Shengtong was ordered to pay Xinhong 182 million yuan and China Forestry to bear joint liability.

Guolin Shengtong was engaging in widespread false transactions with billions of yuan tied up in advance payments by 2022, according to people familiar with the company. Multiple sources told Caixin that Hu was taken into police custody in late 2023.

Another group of companies, known as the “Fanchang Group,” was involved in a large amount of questionable financial dealings with China Forestry. Shanghai Disheng Industrial Co. Ltd, was China Forestry’s largest coal trade supplier in 2022, while Shanghai Fanchang Supply Chain Management Co. Ltd. and Shanghai Yusheng Industrial Co. Ltd. were China Forestry’s largest coal clients, totaling 6.13 billion yuan in receivables and prepayments with China Forestry.

However, Disheng and Yusheng share the same office address, and Shanghai Fanchang and Disheng share the same contact phone number, raising red flags. In October 2023 and June 2024, Caixin visited the office of Fanchang and found a modest operation tucked behind the facade of a tea shop in Shanghai. Xu Caidi, legal representative of Fanchang, claimed her company’s coal trade with China Forestry was legitimate, but deflected questions about the 2.66 billion yuan in receivables owed to the group, pushing inquiries to China Forestry.

Both Fanchang and China Forestry were listed as defendants in a February lawsuit filed by a state-owned commercial factoring company in Wuxi, Jiangsu province. The crux of the dispute revolves around an unpaid loan provided by the factoring company to China Forestry. Xu downplayed her company’s role, saying the dealings were primarily between China Forestry and the lender. However, the case reflects the broader crisis that has engulfed the group.

As of the third quarter of 2023, the group’s receivables and prepayments surged to 121.7 billion yuan, making up 53% of its total assets. The mounting evidence of false transactions and financing schemes has left the company’s financial health in shambles, exposing a culture of deceit and pushing it to the brink of collapse.

The empty office of one of China Forestry’s trade partners in Rugao.

Port investment

China Forestry’s financial woes run deeper than unpaid receivables, with the 2014 acquisition of Rugao Port along the Yangtze River becoming a key example of its reckless investments. Initially envisioned as a hub for coal and iron ore trade, the port, backed by Hong Kong developer Goldbeach Investment Development Ltd., had been plagued with financial difficulties long before China Forestry stepped in.

Through its forestry products subsidiary, China Forestry bought 35% of Rugao Port for 1.07 billion yuan, restructuring ownership and gaining operational control through a concerted action agreement with Goldbeach’s local venture. What was intended to transform Rugao Port into a major coal-trading center soon became a cover for fraudulent activities. Insiders revealed that China Forestry used the port to mask fake trade transactions, undermining legitimate operations.