For some companies the pandemic was the last straw, but there may yet be redemption and a chance to start again. Frankie Wang explains the latest developments in bankruptcy and restructuring in China
LeTV, a GEM-listed company that in 2015 was worth RMB170 billion (US$24 billion), was the first video streaming company to go public in China, but has now been delisted forcibly with over RMB10 billion in debt. Its founder, Jia Yueting, found himself trapped in a long trail of debt for giving a personal guarantee for LeTV and related businesses. Jia, who once majored in accounting, decided to take advantage of the personal bankruptcy system to survive.
On 21 May, the Chapter 11 personal bankruptcy and restructuring proposal filed by Jia was approved by a bankruptcy court in California. Although once being accused of consistently engaging in “untrustworthy behaviour” by the US Trustee of the Department of Justice, Jia’s resort to personal bankruptcy offers lessons to beleaguered entrepreneurs. The lack of a personal bankruptcy regime in China at national level has long been a concern for Chinese entrepreneurs, and the law is often described as “half of a bankruptcy law” in China.
“The actual controllers usually need to be joint, and have several guarantors when the [private] companies raise funds, which means that even though the companies may resort to bankruptcy law, the entrepreneurs are seldom exempted from the debt by virtue of the same proceeding,” says Zhang Wenliang, a partner at Merits & Tree Law Office in Beijing. “A lack of a personal bankruptcy system adds a burden on the private entrepreneurs.”
Local courts have embarked on some relevant experiments, from the pilot programmes of personal debt clearance cases with de facto bankruptcy functions in Zhejiang and Jiangsu provinces, to the consultation draft of Personal Bankruptcy Rules of Shenzhen Special Economic Zone. The latter, now soliciting public opinions on the website of the Standing Committee of the Shenzhen Municipal People’s Congress, if approved, could herald personal bankruptcy legislation in Shenzhen, the first of its kind in China.
Nafisa Nihmat, a partner at Zhong Lun Law Firm’s Shanghai office, believes that this tendency reflects a practice-comes-first and bottom-up legislation logic of China, which means that a national personal bankruptcy system will be built on the best practices of pilot localities. “The personal bankruptcy law might be enacted sooner than expected,” she says.
Personal bankruptcy, which aims to relieve “honest but unlucky debtors”, has drawn a great deal of attention across the nation of late because of the small and medium-sized companies in the private sector that have borne the brunt of damage from the pandemic. Many entrepreneurs are in financial trouble as a result of company bankruptcy, which was an issue even before the pandemic, due to the economic downturn.
As reported by Legal Daily and Xinhua News Agency, the courts nationwide accepted 8,436 company bankruptcy and restructuring cases in 2019 (up 14.8% year-on-year), and closed 4,500 cases (a 174% increase). Shanghai alone has heard 750 bankruptcy and restructuring cases, up 83.4% on the same period the previous year.
“For some time, Chinese companies were blessed with easy money, which was lavished on M&A to shore up their extensive expansions,” says Zhang, from Merits & Tree. “As the short-term loans are invested in long-term projects, the net incomes are not enough to cover the financing cost, and when credit is tightened, the companies are plunged into precarious situations.”
With downward economic pressure, the pandemic has become the last straw for some companies. So, what are the ways out for companies in such dire financial condition? And how do the parties in a proceeding secure their own rights and interests?
The pandemic has had a huge impact on the national economy. Xu Bangwei, a partner at Jingtian & Gongcheng based in Beijing and Guangzhou, estimates that a large number of companies will go into bankruptcy proceedings in the aftermath of the pandemic. Whether the current judicial resources are enough to meet this challenge merits attention.
“Eight bankruptcy courts were set up last year, many bankruptcy administrator associations are in place, and more and more bankruptcy administrators have come into service,” says Xu. “But it is still doubtful whether these increments match the explosive increase in cases.”
Han Chuanhua, a partner at Zhongzi Law Office in Beijing, believes that the complexity of the cases is the reason for the slow rate of hearings. “Quality might be compromised if we go for speed,” says Han.
The challenge of this case surge underlines the urgency with which a bankruptcy system should be put in place. In April, the Supreme Peoples’ Court issued the Opinions on the Efficient Hearings of Bankruptcy Cases, which aims to boost the efficiency of hearings and reduce costs on different fronts.
Li Jian, a Beijing-based partner at East & Concord Partners, says that, according to the opinions, information technology will be used in full during proceedings, from making announcements and notices, to the convention of creditors’ meetings and voting. “The opinions extend the use of online creditors’ meetings beyond the pandemic and into normal time, and it also acknowledges the validity of absentee voting and provides further clarification of the rules of absentee voting,” says Li.
The opinions also emphasize a crackdown on mala fide defaults, raising red flags to the legal representatives’, investors’ and actual controllers’ illegal possession, embezzlement and hiding of corporate assets, or the conduct of hiding and intentional destruction of accounting documents, accounting books and financial books, which should be kept and maintained as required by law. “Crackdowns on mala fide defaults in bankruptcy cases are expected to shoot up,” says Han, from Zhongzi.
Along with supportive measures, the local courts take a more prudent approach toward companies going into bankruptcy because of the financial difficulties caused by the pandemic. Sun Weihong, a senior partner at S&P Law Firm in Beijing, says that some local courts have issued relevant policies where companies that have sound main business operations but fail to repay due debts because of the pandemic will not be deemed to meet the conditions of bankruptcy, and the courts will not support the creditors’ bankruptcy filings. Also, the bankruptcy and restructuring proceedings may be extended for the companies that find it difficult to raise funds or produce feasible restructuring plans.
The Bankruptcy Law has provided for three proceedings, namely, bankruptcy restructuring, conciliation and liquidation. In addition, a pre-packaged restructuring system gaining momentum of late provides a prospective solution for companies that are dragged into difficulties because of the pandemic, and are worth a reorganization.
Pre-packaged restructuring is a step taken before the official proceeding, with the aim of debtors securing the creditors’ support. Restructuring will be kicked off once that goal is attained, and the supported plan will be submitted at the same time.
Xu points out that otherwise healthy and sound companies may bounce back as the pandemic ends and the economy recovers. With pre-packaged restructuring, “the commercial value of these companies will not dip as they enter the official bankruptcy proceeding, and relevant parties will be urged to come up with restructuring plans”.
Pre-packaged restructuring systems have been put into practice in many places, with detailed rules promulgated by local courts in Beijing, Shenzhen and Zhejiang province, among others. Nihmat, of Zhong Lun, says that judicial organs are more restrained with this system, tend to respect the right of the debtors and creditors to appoint administrators, and respect their commercial arrangement agreed upon during the pre-packaged restructuring period. “As a debt restructuring tool outside of court, it helps facilitate the negotiation among the debtors and creditors,” she says.
Associated companies going into bankruptcy in succession is also a common phenomenon when the overall economy shrinks. Beijing No.1 Intermediate People’s Court recently approved the restructuring plan of Zhonghang Shixin Installation Engineering (Beijing) and Zhonghang Shixin Gas Turbine, marking the close of the first merged restructuring case in Beijing.
Xu, from Jingtian & Gongcheng, says that pre-packaged restructuring played a significant role in this case, with the debtor allowed to negotiate the restructuring plan with the main creditors and would-be investors in advance, and the whole proceeding, from establishment of the case to the approval of plan and end of restructuring, taking only 43 days.
But there is room to improve. Nihmat points out that although article 115 of the Minutes of Meetings on Courts Civil and Commercial Hearings allows the outside-court agreement to be brought into the restructuring process, the lack of clear rules puts these agreements in jeopardy, which can dampen companies’ enthusiasm.
BALANCE THE INTERESTS
How to balance the interests of creditors, the bankrupted company, the restructuring party and the administrator has always been the trick. Nihmat says that the bankruptcy proceeding is under the umbrella of judicial process, not under the sway of any one party. “The restructuring plan is a result of the compromise and fighting of the investors, debtors, creditors [creditors committee in particular] and other relevant parties,” she says. “Any one party might find their goals not fully realized.”
In her experience in recent bankruptcy cases in China, she observes that debtors have now realized that bankruptcy restructuring and conciliation are in essence commercial dealings under judicial process, so they are now more willing to begin the proceedings. The shareholders and creditors also no longer find the proceedings hopeless, and are active in fighting for their interests.
The parties involved in bankruptcy proceedings mainly have the following problems, as observed by legal experts:
Debtors. Huang Guan, a partner at Tian Yuan Law Firm in Beijing, expresses concern about the reluctance of debtors to co-operate when the administrators perform duties. “The financial documents and assets in question cannot be managed as expected if they do not co-operate,” he says, adding he hopes that courts can grant some sort of coercive power so that the proceedings will not be hindered.
Liu Peifeng, a partner at Zhonglun W&D Law Firm’s Beijing office, agrees with Huang. “I suggest that the administrators are given power by regulation to ask for the assistance of public organs, or courts are required by explicit rules to provide assistance when the administrators’ work is hindered, to ensure the full performance of their duties.”
Creditors. Some lawyers believe that creditors’ awareness of their own rights should be improved. Han Chuanhua, of Zhongzi, says any creditors – be they banks, non-banks, secured or unsecured creditors – have the right to access the documents in administrators’ hands, but they sometimes leave everything to the administrators in the belief that they do not have a say in the case. “So they fail to engage lawyers with proper fees to help them fight for their rights,” he says.
Administrators. Cui Rongfeng, the deputy director of Dongwei Law Firm in Beijing, says that problems happen now and then as the administrators fail to confirm the creditorship as scheduled, or fail to report to, or disclose information to, the creditors regularly. “The fees incurred as the administrators perform duties, and their compensations, are debts of common interest,” he says. “I suggest that a working scheme is established in which administrators are required to disclose their progress regularly and report to the creditors.”
Restructuring Party. According to Li from East & Concord, the restructuring party does not have ample time to conduct due diligence, as there is a statutory time limit to the restructuring process. And some bankrupted companies fail to provide complete and honest disclosure to the administrators, hence the restructuring party cannot make informed investment decisions.
“The restructuring investment agreement should emphasize relevant parties’ obligations to disclose information, and provide for liabilities for the failure to do so,” he says. “Exit routes should be designed, and the restructuring investors should be given priority of claim in the agreement.”
INVESTMENT RISKS, OPPORTUNITIES
Transportation, wholesale and retail, culture and entertainment, and hospitality and catering sectors have all been hit hard by the pandemic. Many companies have run out of cash and come to the brink of bankruptcy as they fail to repay due debts, and their assets are not enough to cover the full debt or they are obviously incapable of repaying that debt.
Li says that financial investors should be aware that there is no certainty as to when the pandemic will end, and which areas or regions might be more or less affected. Bankrupted companies cannot guarantee sufficient profit to pay the consideration of investment. And in the case of strategic investment, as the hit is felt industry-wide, investors may come from other industries, but there is risk as they lack full knowledge of the other industry.
But opportunities come along with risks. Xing Lixin, a senior partner of Hai Run Law Firm in Beijing, believes that acquisitions of distressed creditorship, investment in debts of common interest, acquisitions of bankrupted assets, and investments in restructuring merit attention. In her view, the above-mentioned investments have the following advantages: They are cost-efficient, with high return on investment; they are highly secure, guaranteed by judicial process, and the possibility of deals being foiled is low; they are a highly focused professional field and thus less competitive, and state-owned companies and financial institutions tend not to involve themselves because of their lagged decision-making; and their threshold is low.
Nihmat says that with more companies entering bankruptcy proceedings investors have more options, including opportunities to acquire assets separated from the debt, and, in particular, some certificates and licences in short supply, including “hard-to-obtain production and operation licences in special industries facing increasingly stringent regulation and environment impact assessment, such as chemicals, ports and mining sectors”.
Li suggests that investors take advantage of restructuring proceedings to invest in otherwise sound and promising companies. As for companies already in liquidation proceedings, investors may co-ordinate with the bankrupted enterprises, or the funders, to apply to shift to restructuring.
“Capable internet companies are suggested to invest in education, healthcare, culture and entertainment sectors through technology and cash pump-in,” he says. “They may play their technological advantages to the full and proceed with ‘internet plus conventional sector’ transformation, so as to upgrade the traditional industries.”