徐羽律师告诉ALB：“以永煤、华晨、清华紫光为代表的国企债务违约让债务市场大为紧张。为此在2020年11月21日，刘鹤副总理主持召开金融委第四十三次会议，重点研究了规范债券市场发展、维护债券市场稳定工作。” 这次会议不仅分析了当时违约个案增加的原因，同时提出更深层的“解决方案” ：深化国企改革，提升运行效率。
Boom Time for Busts
The successive defaults of large companies such as Boashang Bank, Yongmei Group, Huachen Automotive and Tsinghua Unigroup recently sent shockwaves across the market. Restructuring lawyers discuss the defaults, how they feel the Chinese government will ensure orderly bankruptcy proceedings in the future, and how they are preparing for more cases in the coming year.
At the start of 2020, bankruptcy and restructuring experts had predicted more bond defaults in China. A series of surprising events eventually confirmed the prophecy. Data showed that in 2020, there were around 33,700 bankruptcy investigations in China, up nearly one-half compared to 2019. There were also around 83,600 bankruptcy cases, double of that in 2019.
“2020 reversed many of our inherent understanding. First, the insolvent companies were not limited to private companies. Second, these companies came from various sectors as if no sector was an exception. Third, more listed companies underwent bankruptcy.”
— Xing Lixin, Hai Run Law Firm
Xing Lixin, senior partner and head of insolvency and restructuring of Hai Run Law Firm, notes the characteristics of the insolvency and restructuring cases over the past year. “The year 2020 reversed many of our inherent understanding,” she says. “First, the insolvent companies were state-owned enterprises, not limited to private companies. In the second half of the year, bond defaults concentrated in SOEs, breaking the norm of rigid payment. Second, these companies came from various sectors, ranging from banking, finance, energy, automobile, technology, to real estate, catering and services, as if no sector was an exception. Third, more listed companies underwent bankruptcy, doubled to 13 in 2020 from six in 2019.”
Xu Yu, partner at Hylands Law Firm, shares the same observations. “One thing to note is that companies that recently defaulted on their bonds had a high credit score before and they were the backbone of their industries, but the promising numbers and large operations could not hide their poor cash flow. At the same time, some companies accumulated their debts, which increased the risk of defaults even the loans did not seem big,” he adds.
Although a series of bond defaults by large companies shocked the market and received negative media coverage, Zhou Jie, partner at DeHeng law Offices, does not see the rise in bankruptcy filings as a bad thing. He says the negative views show that efforts are still needed to remove the stigma associated with bankruptcy and restructuring. “Since the Enterprise Bankruptcy Law took effect in 2007, we have not paid enough attention to the bankruptcy system or used it enough, so the number of bankruptcy filings has been far too low in China. When companies encounter operational issues, they should undergo bankruptcy proceedings earlier. Only when bankruptcy proceedings and restructuring are carried out earlier can repayment rates be improved to protect the creditors interests, which would be an ideal outcome under the Enterprise Bankruptcy Law,” he says.
“Fortunately, regulators as well as participants in the market economy, such as the banks, creditors, debtors and lawyers, are coming to realise this over the past two years,” he points out.
As more bankruptcy filings come faster, what policies and laws have the Chinese regulators implemented to better handle such cases in the future?
Xu tells ALB that the bond defaults by SOEs such as Yongmei, Huachen and Tsinghua Unigroup touched on the nerves of the bond market. “Therefore, on November 21, 2020, Vice Premier Liu He convened the 43rd meeting with the Financial Committee to look into regulating the bond market development and stabilizing the bond market,” he says. The meeting not only analyzed the reason behind the rise of bond defaults, but also proposed in-depth solutions, which concern reforming the SOEs and enhancing operational efficiency.
Besides guidance from the country’s top financial leader, Zhou tells ALB that regulators have been “constantly rolling out more laws, regulations and administrative measures regarding bankruptcy during the past six months.“
“First is the newly-launched Civil Code and the many judicial interpretations, which include the judicial interpretations of the parts about guarantee under the Civil Code, as well as the revisions of the judicial interpretations of the Enterprise Bankruptcy Law and the reply of the Supreme People’s Court on whether the right to use allotted state-owned land of a bankrupt enterprise shall be classified as insolvent property,” he explains.
“The message here is that the bankruptcy system will be better incorporated into the general civil and commercial legal system. Take guarantee as an example. In the past, the law did not clearly stipulate whether the interest will continue to accrue on the guaranteed debt after the main debtor goes bankrupt. In practice, interest will continue to accrue on such debt. But the new judicial interpretation requires otherwise. It stipulates that the protection measures for ceasing interest accrual on the main debt also apply to the guarantors, which reduces the guarantors’ burden,” he adds.
Another administrative measure to note is the opinion on improving the system for enterprise bankruptcy, ensuring bankruptcy administrators perform their duties and optimizing the business environment proposed by the Supreme People’s Court and the National Development and Reform Commission (NDRC) in September 2020.
“Although the regulators are still soliciting opinion on this draft, it shows that the high-level watchdogs pay great attention to establishing a system for enterprise bankruptcy,” Zhou says. “In the past, we only relied on the Enter-prise Bankruptcy Law and three judicial interpretations, which were not solid enough to make up a well-established bankruptcy system. Hence, we need to improve the system for enterprise bankruptcy to include aspects of taxation, customs, credit report system and asset disposal. Currently, the Enterprise Bankruptcy Law is not well connected with other laws, which only regulate enter-prises that are operating normally. The draft is a response to this issue.”
Besides the laws and regulations mentioned above, Xing also cites other regulatory guidance, for example the business guidelines for bond, and the administrative measures for the information disclosure of listed companies.
On the juridical front, the Supreme People’s Court carefully defined disputes regarding company bonds, corporate bonds and non-financial institutions’ financings. On January 20, 2021, a financial court was announced to be established in Beijing to dedicate to preventing financial risks. “These are all strong signals from the national regulators,” Xing says.
Meanwhile, in the light of frequent bond defaults, Xing points out that it is urgent to overhaul the credit rating system. “Large SOEs must be rated 3A in the past. Now we need to reconsider how to give companies their credit rating to give investors a sound reference. As credit ratings become more objective and realistic, the whole credit rating system in China could be improved,” she adds.
EFFORTS FROM FINANCIAL INSTITUTIONS
The regulatory guidance also implies to strengthen the financial institutions’ role and support in the bankruptcy proceedings. Zhou tells ALB that this is included explicitly in the draft issued by the Supreme People’s Court and the NDRC.
“This came as the financial institutions, as creditors, did not do enough in large cases. They make up a big representation in the creditors’ meetings and should be the one to take part in or push forward the bankruptcy proceedings. But the decision-making process at state-owned or large banks in China is lengthy. Instead of making a decision within the required timeframe, the financial institutions would rather act negatively during the process,” Zhou explains.
He tells ALB that after the draft proposed to strengthen the role of the financial institutions, the China Banking and Insurance Regulatory Commission, NDRC, PBoC and CSRC issued the notice on the working procedures of the creditor committee of financial institutions on December 28, 2020. The notice further specifies requirements for the financial institutions.
“First, they should establish and improve the internal working procedures linked to bankruptcy proceedings. Second, they should facilitate the opening and extension of trustees’ accounts. Third, they should support the trustees in taking over or investigating the debtors’ accounts. Forth, they should give stronger financing support to companies that have undergone bankruptcy and restructuring. Fifth, they should help these companies improve directions for the future role of the financial institutions,” he explains.
Zhou is now seeing improvements on resolving certain feasible issues. “The commercial banks, in particular, are actively developing business in this area, such as establishing and improving the internal working procedures linked to bankruptcy proceedings, establishing a database or an office automation system. A lot of banks are also approaching our trustees to seek advice,” he says.
In 2020, the increase in bankruptcy filings was observed not only in China, but across the Asia-Pacific region. Take Hong Kong SAR as an example, data from the Official Receiver’s Office showed that there were 8,693 bankruptcy filings in 2020, up by 6.6% year-on-year to reach a four-year high. As Chinese companies actively go global, cross-jurisdictional collaborative efforts are also needed in bankruptcy and restructuring.
“China’s Enterprise Bankruptcy Law is more localized,” Zhou admits. “But it doesn’t mean there has not been improvements. There have been more cross-border collaborative efforts and judicial assistance under the law.”
Zhou cites two examples from the past year. The juridical documents issued by the Beijing Chaoyang District People’s Court over the bankruptcy case of Luowa Group were recognized and executed by the local courts in the U.S. Furthermore, the intermediate people’s court in Shanghai and the Hong Kong court had recognized each other’s judicial documents over the bankruptcy case of CEFC Shanghai International Group.
In the latter case, the mainland administrators first applied to the Hong Kong court for recognizing and executing the bankruptcy order issued by the mainland Chinese court, which was recognized later on. Secondly, CEFC had signed a keepwell deed agreement on behalf of its subsidiary in Hong Kong for the subsidiary’s bonds. After CEFC Group went bankrupt, the Hong Kong court ruled that bond buyers had the right to be compensated in the bankruptcy proceedings, a ruling that was indirectly recognized by the Shanghai financial court. “This is the first of its kind, which is significant for future cases. We can see the Chinese regulators and juridical authorities pay great attention to Chinese companies’ creditability,” Zhou says.
NEW APPROACHES TO NEW ISSUES
As the number and nature of bankruptcy filings are constantly changing, what new methods have the bankruptcy lawyers applied to resolve new issues over the past year, and how will they apply them in future cases?
Xu first points out that the debts of insolvent companies are increasingly complicated. “The pandemic quickly unveiled the risks that companies had long been exposed to, which complicated the relationship between creditors and debtors and made it more difficult to investigate the debt. There were even times when the debt amount could not be confirmed in a short time as criminal matters were involved. Furthermore, companies took out multiple loans, which complicated the issue with their externally mortgaged assets. This usually involves a second mortgage, preservation and sealing, and freezing of assets. And some companies had capital raised from the public, which involved the interests of many retail investors,” he explains.
To tackle these complicated issues, Xu advises local authorities to get more involved. For example, he and his team worked closely with the local government for the bankruptcy case of Dalian Donglin Food, to “eventually coordinate well with the government, who played a role in policy, taxation, industry and public opinion.”
Xing saw the huge impact the pandemic had on investors in 2020. The pandemic broke out right after her team took a case. “When we recruited investors, many of them still showed up at our briefings in early 2020. But since March, many had withdrawn because of funding issue. Then in September and October, some showed interest again, especially after the city of Beijing rolled out policies about building infrastructure and free trade zones,” she says. “But it is now difficult for industry investors to provide a huge amount of funding to restructure a large enterprise. What could be done by one single investor before has to be done by industry and financial investors together now. In the future, it will be more practical to coordinate efforts from two to three investors.”
Xu also notices that in 2020, more companies are getting active in the bankruptcy and restructuring business, and even show a keen interest in becoming an investor. “The most typical example was that in a restructuring case, the creditor took part in the restructuring after internal decision-making, and eventually became the controlling shareholder of the restructured company through transferring shares, collecting debt and investing in the company,” he says.
Speaking of the methods that were used last year, Zhou mentions that in the case of restructuring, adopting different plans to pay off the debt is a way to protect creditors’ interest. He says in the past, the ways to pay the creditors were limited and subject to legal requirements that all creditors be paid the same way or with the same ratio. When his team handled the case of Xingda Pharmaceutical, they offered different payment options to the creditors, such as converting the debt into shares or cash. “In the end, the resolution was passed by a high vote at the creditors’ meeting and they were 100% paid,” he says.
“This poses as bigger challenges for the team. They not only need to understand the bankruptcy law, but also get capital market, banking and finance lawyers involved… This implies that only a few top law firms in China
will be capable of handling large-scale cases in the future.”
— Zhou Jie, DeHeng law Offices
Zhou says convertible debt, trust plan share, retaining debt, paying with shares could be a way to pay off debt. “We’ve seen several recent cases adopting various payment plans, which can be reference for future cases,” he says.
This will make work more difficult for lawyers. “This poses as bigger challenges for the team. They not only need to understand the bankruptcy law, but also get capital market, banking and finance lawyers involved… This implies that only a few top law firms in China will be capable of handling large-scale cases in the future,” Zhou says.
All three lawyers believe that the bankruptcy and restructuring business will continue to grow in 2021. Xing tells ALB that she has been working around the clock from November to January with no rest.
“In the Yangtze River Delta, non-performing assets in the region will grow slowly. In the Bohai Economic Rim and mid-west region, non-performing assets have been growing over the past three years. In the northeastern region, bankruptcy cases will keep increasing.”
— Xu Yu, Hylands Law Firm
Xu analyses the trend of non-performing assets in 2021 from a geographical perspective. “In the Yangtze River Delta represented by Jiangsu, Zhejiang and Shanghai, the bankruptcy and restructuring business is large in general, but as the downward pressure on the economy decreases, non-performing assets in the region will grow slowly. In the Bohai Economic Rim and mid-west region, non-performing assets have been growing over the past three years, further exposing the debt problems of the local companies. This trend may continue into the future. In the northeastern region, bankruptcy cases will keep increasing, and solving the issue of non-performing assets will remain a key task,” he says.
As bankruptcy and restructuring business becomes a new area of revenue growth in the legal industry, many firms are tapping into the area. Do lawyers feel the pressure? Xing says the pressure has been manageable for her team so far. On one hand, even as the law firms are competing for the cases, the cases grow in number and the market is expanding. On the other hand, veteran lawyers with rich experiences maintain their competitive edge. “Bankruptcy cases are not something that lawyers can handle by only understanding the laws. They need to look into all the legal aspects to satisfy the creditors, investors and the courts, which requires a wealth of experience to balance the concerns of all parties. A trustee in bankruptcy is a profession that combines knowledge of the law, finance, corporate management, investment and coordination,” she says.
As for staying competitive in this area, Xing suggests building up the team, as large restructuring cases need more people to work on them. Therefore, Hai Run has expanded its bankruptcy and restructuring team by a third in 2020.
Zhou also acknowledges the importance of having a sizable team. He also stresses the overall capacity of the firm. “DeHeng now aims at providing comprehensive legal services for bankruptcy cases, from legal services, introducing strategic investors, guidance in the early stage and withdrawal in the latter stage, to financing, debt payment, disposal of non-performing assets. In the future, legal services will be more integrated and specialized. Bankruptcy lawyers will need to be able to allocate resources, which are not limited to legal resources,” he says.
Even when being capable enough, law firms still need to establish a solid system internally to provide manpower and capital support. “To handle large bankruptcy cases, the law firm will have to provide full support on mobilizing resources in the future. Law firms with a more competitive internal system will be able to mobilize a bigger team, thus seizing business opportunities,” Zhou says.
Meanwhile, Xu says team members are now required to also become business managers of sorts too. “Bankruptcy lawyers need to balance both legal principles and interests,” he says. “They need to consider the local economy where the company is in and the industry policies, so as to take everyone’s interests into consideration to benefit everyone in the proceedings.”
To contact the editorial team, please email ALBEditor@thomsonreuters.com.