In its heyday, Wuxi, Jiangsu Province headquartered-Suntech Power Holdings was a symbol of China's green technology ambitions. In 2005, it was the first Chinese solar firm to go public and in late 2007, its market capitalisation peaked at about $16 billion. With an estimated total solar module manufacturing capacity of 2,400 megawatts, it employs 20,000 people worldwide and has offices or production facilities in every major market, having delivered more than 13 million solar panels to thousands of companies in more than 80 countries around the world.

Today, however, the situation is very different. Last month, Suntech’s market cap was down to $112 million despite a sharp rally after a Hong Kong website said Warren Buffett might be interested in buying the beleaguered company. At the end of March 2012, Suntech had total debt of $2.2 billion - including a $50 million convertible loan from the IFC, the private sector arm of the World Bank. Domestically, nine banks, including Industrial and Commercial Bank of China, Agricultural Bank of China and Bank of China had outstanding loans of 7.1 billion yuan ($1.1 billion) to Suntech at the end of February this year, according to state news agency Xinhua. And it became the first company from mainland China to default on its bonds after failing to repay $541 million of notes due March 15, breaching terms of other outstanding loans.

The fact that China’s solar power sector is mired in a deep crisis has been apparent for some time now. Companies have been badly hit by an estimated 66 percent fall in solar panel prices in the last two years as the euro zone debt crisis has led to countries like Germany slashing subsidies for renewable power. Now, they are struggling after taking on debt to expand supply that led to the glut that forced down prices and squeezed profits and, most notably, are fighting to renegotiate their liabilities and obtain flexibility over payments to creditors. Indeed, just a month after Suntech’s default, another Chinese solar panel maker, LDK Solar, reported its seventh straight quarterly loss and partially defaulted on a $24 million bond. Suntech’s case is, however, shaping up to be a landmark one. As the Wuxi Municipal Intermediate People’s Court accepted the petition of eight banks to push Suntech’s main operating subsidiary, Wuxi Suntech, into insolvency, it set into motion a chain of events that is likely to lead to the first big test of China's bankruptcy law since it was introduced in 2007. The Suntech case could also have a say in the way Chinese governments at various levels deal with failing firms, and change the attitudes of bondholders, both offshore and onshore, for good.

Untested law

In 2007, China passed a new bankruptcy law that is rarely tested because local officials generally mediate between creditors behind closed doors. Beijing has used the law cautiously, fearing the failure of large companies and widespread layoffs could lead to social unrest. Mark Hyde, head of finance for Asia-Pacific and global head of the restructuring and insolvency practice at Clifford Chance, says that this untested process will lead to a number of questions. “Ultimately, whether an insolvency law is effective or not depends on how the judges actually interpret and apply the law as they go through the process,” he says. “Most insolvencies throw up new issues, but developed jurisdictions like the U.S. have dedicated and very experienced insolvency judges. In other jurisdictions, such as Hong Kong and England, while you don’t have judges who only hear insolvency cases, you certainly have judges who’ve often practiced insolvency law whilst at the bar, and understand the issues.”

He adds that one of the key issues in relation to the development of China’s bankruptcy law is, therefore, whether there is a properly trained and experienced judiciary who will apply the laws in a consistent and coherent manner. “I think to my mind that’s what people will be looking at closely: How effective will the courts be, and by effective, I don’t just mean consistent and clear interpretations of the law which don’t, for example, distinguish or make life more difficult for foreign creditors, but also other aspects which are necessary for a clear rule of law,” Hyde says. “For example, will they issue their judgments in a timely fashion? There’s no point people piling into court making representations only for the court to take years to deliberate on its rulings. So for me, and I’m sure for other commentators, that’s really the key issue. How will the laws be interpreted? Will everybody who wishes to be heard be given a fair hearing? And will the process be effective and in a timely manner? Without attaching any criticism, the stark reality is that China has had to train up judges to interpret this new law and this might be the first time that it’s being tested in what will be a fairly significant public glare.”

Caught by surprise

China has a history of bailing out companies on the brink of failure, and investors had assumed Suntech would be no exception. But the move by domestic creditors to petition for Suntech’s bankruptcy has now introduced some doubt into the minds of investors. “Creditors may have thus far assumed that when they pushed a Chinese company very hard, they did so in the knowledge that it was unlikely that the management would carry out a threat to file the company; in other words, the threat may have been hitherto been seen as a slightly empty one,” says Hyde. “This changes that situation, and anyone trying to negotiate the financial restructuring of a substantial Chinese company has to be cognizant of the fact that if the negotiations don’t go the right way for the company, there is clearly a risk the company will file, as demonstrated by what’s happened at Suntech.”

One of the issues complicating the Suntech case is its multijurisdictional reach: The company's shares are listed on the New York Stock Exchange, but it is registered in the Cayman Islands and its assets are in China. According to Hyde, this might have pushed the Chinese authorities into allowing Suntech’s insolvency proceedings. “I suspect that in the instance of Suntech, there was a significant concern on the part of the company – and by the company, I mean the directors, the shareholders, the Chinese authorities – that there could well have been a risk of a process commencing in another jurisdiction and most obviously the U.S.,” he says. “Therefore, in this particular instance, I think that people were caught by surprise. I don’t think anyone close to the situation really thought the company would file in China precisely because the laws are untested for an insolvency of this size. However, at least what has happened is that China has control of the process for better or worse, and there hasn’t been an intervening process in another jurisdiction as could conceivably have been the case.”

Pulling the plug?

Generally, Chinese governments at various levels have been loath to bail out failing firms across sectors, instead choosing to negotiate with creditors behind closed doors. According to Ivo Naumann, managing director of advisory firm AlixPartners, this is happening as the Chinese government seeks to continue economic growth, both at the national and the provincial level. “One strategic direction is to shift away from the high dependency on export towards boosting domestic demand and consumption,” he says. “It is foreseeable that Chinese governments will keep inclining towards sectors with good domestic potential, including supporting low performing players with government resources, with the intention to speeding up the capability growth of those companies, hoping that those companies will leap forward faster than their global peers.”

Hyde at Clifford Chance says he believes no company the size of Suntech would file for insolvency without having got the clear nod from government authorities because of the political ramifications involved, and in this particular case, the authorities had decided not to support the company. “I suspect they had a pretty stark choice: They either had to put some more money on the table, or acknowledge that the company would fail, and their decision in that regard, one assumes, was part political and part economic,” he says. “There’s not much point in injecting more capital equity into a failing situation unless you’ve got some prospect of recovering that. So one assumes that the authorities took the same relatively hard-nosed position as any potential white knight investor would do in these situations anywhere around the world. Ultimately, you’re only going to make a further investment if you think you can potentially make a return on that investment.” He adds that if it’s considered to be too much of an embarrassment or political problem for the company to fail, then the company will be given very clear instructions not to file for a process in China, but instead seek to soldier on and negotiate a compromise.

Currently in Wuxi, home to Suntech, the local government is seeking to bail out the company to stave off its collapse, Reuters reported. One proposal under consideration is allowing Wuxi Guolian, the local government's investment arm, to take over Suntech's Wuxi business through a restructuring. “Production has to continue," Reuters cited an unnamed source as saying. “The Wuxi government is still seeking to bail out Suntech in one form or another. It has no intention to let it collapse as, if that happens, it would damage its reputation.” The Yangtze Evening News, a local official newspaper, said authorities will try their best “to maintain normal production of the company, social stability, safeguard the security of company assets and protect the interest of creditors.” Such a move would also test the notion - widespread in Chinese bond markets - that local governments will always bail out important companies without inflicting pain on domestic creditors.

No guarantees

However, what happens to the offshore holders of Suntech's bonds will have wide implications for investors who have flocked to Chinese dollar-denominated debt in search of yield. Naumann points out that in the Suntech case, the bankruptcy law has not been applied to the overseas-listed entity, but only to Wuxi Suntech, the entity inside China that holds the majority of the assets. International investors in the bonds were never secured by this entity but only by the offshore entity, Suntech Power in the Cayman Islands, and thus foreign creditors will only play a minor role, if any, in the bankruptcy proceedings. “While the offshore bondholders could sue Suntech Power for default in a jurisdiction outside of China, they would probably end up recovering little, if anything, in respect of Wuxi Suntech which holds the majority of assets,” he says. “Offshore creditors will be subordinated to the onshore creditors as these are fully secured. The key for any outcome will be the role the government will play and whether any ‘white knight’ rescue can be arranged.”

Reuters quotes Paul Boltz, a Hong Kong-based partner with law firm Ropes & Gray, as saying that the Suntech situation is a good reminder that offshore investors can have difficulties in enforcing their rights. “The offshore holding companies which are used to list overseas often have fewer assets than the onshore entities. In that case, they face a disadvantage compared with onshore lenders like Chinese banks which can have direct recourse against the assets,” he says. While China's domestic bond market has not been much affected by the news, with most investors thinking of it as an offshore bond, foreign debt holders are, however, in a more difficult situation. “Offshore debt holders are on shaky legal ground (their claims are to a piece of paper in the Caymans, whereas STP's operating assets are effectively all in China)," says Charles Yonts at CLSA in Hong Kong, “and even if not, they would have the rather daunting task of fighting to the front of the queue of Chinese creditors in China. Good luck with that."

Nevertheless, Hyde believes the Suntech bankruptcy will be closely followed by a number of people around the world. “It’s going to be key for all the various constituents, and key for the integrity of the Chinese insolvency laws and how they play out in practice,” he says. “Equally, it will be key for people doing business with and lending money to Chinese companies because as is the case anywhere else in the world, where a company fails, people who have exposure to a company want to know that the process for unravelling the mess is a fair and transparent one and will give them whatever return they’re entitled to, whether that’s 10 cents to the dollar or 90 cents to the dollar.”

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