The Yangtze River Delta (YRD), a growth engine during China’s boom years, has become the centre of defaults, non-performing loans and even bankruptcies recently as debts sour, a sign of the worsening credit shortage suffered by private companies as the economy slows down further.
YRD, which accounted for half of China’s exports and 57 percent of the country’s foreign investment in 2012, became the source of a third of bad loans in the country, according to data from China’s six largest domestic banks.

The region has claimed China’s first domestic bond default, with Shanghai Chaori Solar Energy Science and Technology Co Ltd failing to pay bond interest for the previous year in March this year. This was followed by the bankruptcy of a polyester manufacturer in Zhejiang, whose ability to pay bond interests due in July is under serious doubt. Media reports also show that some real estate developers failing to repay loans are on the run.

A chain reaction to credit problems are also expected from steel and textile companies which always provide loan guarantees for each other for easier access to bank credit, as defaults or bankruptcies of a few companies will threaten the others on the chain of guarantee; even some profitable ones.
With China witnessing economic slowdown, restructuring and industrial updates are now the keywords for the country, including the YRD, says Zheng Jindu, director of Zhejiang L&H Law Firm.

Demand for legal services is increasing, although not as quickly as in the boom years, observe lawyers. Lawyers have also noted changes in legal demands, such as increases in M&As, bankruptcy administration and litigation from the market due to the economic downturn.

Challenges to the economy

After a period of robust expansion, the YRD has witnessed slow sales and price reduction in the real estate market due to its strong wait-and-see attitude, high financing costs and breaks in capital chain, observes Qian Miao, a senior partner with the Hangzhou office of Allbright Law Offices.
Shen Haiqiang, a partner with Zhejiang T&C Law Firm, notes that traditional industries in the YRD such as exports and real estate face many challenges, and says that he has seen increasing cases of bankruptcies and defaults, partly due to the overall macroeconomic slowdown and partly due to insufficient support from the financial sector for private companies, especially small- and medium-sized enterprises (SMEs), which account for the majority of YRD companies.

Zheng observes a vicious circle in the YRD economy, as credit shortage results in increases in non-performing loans, with companies having to turn to private lending with high interest rate, which further increases the pressure on local companies.

Bridging loans, granted by some bonding companies with relatively high interests for companies to avoid running out of cash, are quite common in the Zhejiang Province, especially Wenzhou, a city known for its overwhelming number of SMEs, according to Zheng.

Ni Defeng, investment director with Hangzhou-based Hengyi Petrochemical Co Ltd, is quite pessimistic about the economic situation in the YRD. “Overcapacity and slack demand threaten the manufacturing sector and private companies also face credit shortage.”

Although Hengyi did not suffer much from capital shortage thanks to its large scale, it has faced troubles in returning funds it had borrowed from its downstream distributors. Contract disputes too have been a cause for a lot of its troubles.

This situation has continued since the second half of 2012, says Ni, who believes it may last for at least another two years.

In comparison, lawyers are more optimistic about the economy.

Qian from Allbright believes the overall economy will be restructuring stably if no significant price drops in housing and land market happen.

Although bad loans has risen noticeably, banks enjoying rich profits will give back their profits to offset losses caused by bad loans; relocation of production factors will happen as a result, according to Qian.

He suggests that companies getting into trouble should make the decision of restructuring assets and liabilities based on clear understanding of their profit models and careful analysis of their situation.

Despite various challenges, there will be no economic recession, because the YRD has good  economic foundation, including innovation, talent and technology, says Shen.

Pains exist in the process of economic restructuring, including a rising number of bankruptcies, but the economy will develop in the right direction if good money drives out bad -- elimination of outdated production capacity and even outdated sectors. For them, liquidation or restructuring can be good paths for economic transformation and updates, he adds.

“But as someone falls down, someone stands up,” Shen says.

The YRD has seen an increasing number of innovative companies, such as e-commerce giant Alibaba, indicating the great potential of such companies, says Shen. “As long as technological innovation and entrepreneurship exist, the YRD economy will not break down.”

In order to bolster its economic growth amid downturn, China has announced new measures in June including plans to build airports, railways and roads along the Yangtze River and create the Yangtze River economic belt.

Shen believes the plan will lead to higher demands for the machinery, financial industry and legal services, but the country needs to avoid overcapacity in an infrastructure and investment-driven economy. Hopefully, the new measures will truly boost the economy and benefit all, says Shen.

Qian says government-led investment will rise remarkably in the sectors of environment protection and peoples’ livelihood, which will see a flow of production factors from the real estate sector.

Changes in business

As companies earn small profits, the smallest dissatisfaction regarding product packaging and services will snowball into a reason for capital defaults and disputes, explains Ni of Hengyi Petrochemical.

Therefore, the legal services provided by law firms have also changed in keeping with an increasing number of litigations, says Ni.

Law firms have noted the same change in their businesses.

“The magic of the legal market lies in that economic expansion brings a lot of business, while contraction afterwards will bring another big wave of new businesses,” Qian notes.

For Allbright’s Hangzhou Office, legal demand for IPOs, real estate and construction are still quite high at present, but changes in these have also been noted, Qian says.

In a departure from the past, Allbright’s Hangzhou office has witnessed a noticeably increasing number of clients planning IPOs overseas, a greater number of transfers of whole commercial residential building projects and buyers of pre-selling apartments seeking refunds, as well as more enthusiasm on hydraulic engineering and national defence constructions.

Qian also notes a drastic surge in the business of handling non-performing loans, especially since the beginning of 2014.

In order to deal with business changes, his office has established specialised teams in a timely manner to meet the increased legal demand.

“As we expect constant increase in businesses handling bankruptcy reorganisation, we have built three bankruptcy administration teams led by seasoned partners with corporate restructuring experience; since 2013, we have noticed increasing cases of handling non-performing loans, and I, who have provided legal services in the sector since 2000, have established a team beforehand and have dispatched some resident lawyers to companies with such needs,” Qian says.

T&C focused on IPOs and other equity financings while the economy performed well; but with the economic slowdown, there were more defaults and bankruptcies, and T&C now finds that the number of its  litigation, arbitration and bankruptcy liquidation  cases have risen. As of now, for instance, T&C is dealing with a bankruptcy case at the value of more than 10 billion yuan ($1.61 billion).

At the same time, the M&A business has increased, which Shen believes is important business with big potential for law firms, because lawyers didn’t play a big and active role in 70 to 80 percent of previous M&As.

He believes there will be greater demand for intellectual property and asset securitisation, and says T&C provides services to help private companies ensure sound cash flow.

L&H has also noted rising demands for financing from local companies.

Gao Jinbang, a lawyer with Zhejiang L&H Law Firm who focuses on equity and bond financings, says that in 2013 alone, L&H has advised a dozen local companies on trading on the Zhejiang Equity Exchange and/or issue private placement bonds on the exchange. As a result, L&H was honoured as the “best service provider” by the exchange in 2013.

Gao has recently advised a medicine manufacturer on the issuance of private placement bonds, which is set to be a success because of the stable operation and good industrial prospects of the company.

Private placement bonds and equity financings, compared to traditional ways of financing, are easier for companies to handle, which can help credit-hungry private companies to get capital, says Gao. However, for an overwhelming number of SMEs, the requirements of these methods of financing are still quite high, and so their difficulties in financing are still quite hard to be solved.

“Law firms have also seen an increasing number of litigation businesses recently, but we don’t want to see such situations happen. We hope that we can expand non-litigation businesses including overseas investments and M&As so that everybody is happy,” says Zheng with L&H.

Although risks in the YRD are rising, clients of L&H tend to have sound operations. L&H has maintained stable growth in its revenue over the past years, says Zheng, who believes the reason lies in the law firm’s clear positioning of “being based on legal advice and focusing on non-litigation businesses.”

L&H has taken the initiative to provide “legal examination” services, encouraging lawyers to help companies prevent risks from happening.

“We’d like to serve as a pilot to lead our clients away from reefs ahead, rather than a lifeguard,” says Zheng.

Enhancing competitiveness

The development of legal services in Zhejiang is in line with the highly developed local economy in terms of number of lawyers, revenue and average income, according to Zheng, who is also vice-president of the Zhejiang Bar Association.

Zheng says “going out” moves have enjoyed increasing popularity among local companies, promoting higher professional and language standards for local lawyers. Although there is no urge for a local lawyer to understand French to advise companies acquiring African firms since they can turn to law firms in Beijing and Shanghai; use of English does provide competitive advantage for local law firms to extend better international legal services to their client.

Hangzhou may not have as many foreign businesses and high-end businesses as Beijing, Shanghai and Guangdong, but it is still the fourth-largest legal market in China only after the three areas which boasts many opportunities but less working pressure, says Zheng, believing that local Zhejiang people prefer returning to Hangzhou after graduation.

The big market not only attracts talents, but also big rivals. National law firms and even some international law firms have opened offices in the YRD, posing greater threats to the local ones.

Allbright is one of them.

Operational for 14 years, the Hangzhou office of Allbright deems itself as a local law firm as well as a part of the Shanghai-headquartered Allbright, which is able to combine the strength of a national law firm with good reputation and localised talents, says Qian, noting that the 90 lawyers and staff in the Hangzhou office are locals.

Shen says that large-scale Beijing-headquartered law firms with advantages in talent, organization management and a robust operational system are bringing a great deal of competition to local peers, but T&C believes they will not threaten its leading position in Zhejiang because different from other places, the development of law firms in Zhejiang relies a lot on good partners, local resources, social networks with private enterprises.

Geographical convenience and improved services have also helped T&C to maintain stable cooperation with clients and win their trust, according to Shen.

L&H also believes Zhejiang is special to some extent in that most leading law firms are local ones, mainly because of a clear understanding of local companies and targeted services.

Nevertheless, local law firms have been aware of the intensified competition and have made preparations on various aspects.

T&C stresses on incentives for employees and provides good compensation and career opportunities to attract talent, says Shen.

L&H is quite strict in selecting top talent now, not only in terms of legal professionals, but also for management staff. Most employees and all assistants must be graduates from top universities in China or overseas colleges, and they must be interviewed by the management committee of L&H to ensure they have enough potential for growth, according to Zheng.

L&H also has guiding groups and training classes for young lawyers. In addition to having invited well-known partners from Shanghai for training classes in June, it is planning to invite partners from Beijing for classes this month.