Restructuring

Co-Contributors: Anthony Wang and Chen Yi
More than six years have passed since the adoption of the revised PRC Enterprise Bankruptcy Law (PRC Bankruptcy Law), which was adopted on August 27, 2006 and came into effect on June 1, 2007. While there have been numerous filings by Chinese companies under the PRC Bankruptcy Law since its passage, few have received as much attention as the recent high-profile filing by Wuxi Suntech Power Co., Ltd. (Wuxi Suntech), the principle operating subsidiary of Suntech Power Holdings Co., Ltd. (Suntech Power) (NYSE: STP), at one time the world’s biggest solar module maker. Suntech Power’s and Wuxi Suntech’s defaults on offshore bonds and onshore loans, respectively, have brought renewed attention to (i) the risks confronting foreign creditors who invest in the offshore debt of Chinese companies, and (ii) the implication of the PRC Bankruptcy Law for such foreign creditors.
Background on Suntech Power
Following weeks of speculation, on March 21, 2013, Suntech Power announced that the Wuxi Municipal Intermediate People’s Court in Jiangsu Province, China had accepted the petition filed by a group of eight Chinese banks for an involuntary bankruptcy proceeding in respect of Wuxi Suntech in accordance with the PRC Bankruptcy Law. At the time, the offshore bondholders of Suntech Power were holding US$541 million of convertible bonds that were due on March 15, 2013, while the Chinese banks were reported to hold an aggregate of RMB 7.1 billion (approximately US$1.1 billion) in loans made to Wuxi Suntech. While initial rumors focused on a possible deal between Suntech Power and certain of its bondholders (with the support of the local Wuxi government), ultimately the payment default on the convertible bonds and the resulting cross-default on certain of the onshore loans led to the exercise by the onshore creditors of their rights under the PRC Bankruptcy Law. However, since the offshore bondholders of Suntech Power were not actual creditors of Wuxi Suntech, they were excluded from the onshore process.
In light of Suntech, we provide below a brief review of the key provisions of the PRC Bankruptcy Law and the challenges facing foreign creditors in dealing with distressed Chinese companies.
Chapter 8 of the PRC Bankruptcy Law
The PRC Bankruptcy Law was “formulated in order to standardize the enterprise bankruptcy activities, fairly dispose creditors and debts, protect the rights and lawful interest of creditors and debtors, and safeguard the economic order of socialist market economy.” In particular, Chapter 8 of the PRC Bankruptcy Law, which provides for a reorganization procedure that is modeled broadly on chapter 11 of US Bankruptcy Code, contemplates a scheme for the reorganization, not just liquidation, of a failing enterprise.
In connection with a Chapter 8 restructuring, once the court accepts a bankruptcy filing, the court appoints an administrator who is in charge of taking over the debtor’s business and managing its affairs. In addition, Chapter 8 also includes a modified concept of “debtor-in-possession” pursuant to which the debtor can request the court’s permission to manage the business, but subject to the administrator’s supervision.
When the bankruptcy application is accepted by the court, an automatic stay against creditor’s actions against the debtor’s property becomes effective. The debtor or the administrator (as applicable) is required to submit a draft reorganization plan to the court and the creditors’ committee within six months after the initiation of the case (which, in certain cases, could be extended for an additional three months upon court approval on justifiable grounds). If the reorganization plan fails to be submitted within the prescribed period, the court shall announce the debtor bankrupt. Thus, a Chapter 8 filing effectively gives the insolvent enterprise a six to nine month reprieve time, in lieu of sentencing it to immediate bankruptcy. The draft reorganization plan needs to be approved by a majority in number of creditors in each class representing at least twothirds in value of the liabilities for that class. If the draft reorganization plan fails to receive the requisite approval from the creditors, the debtor would be liquidated. When dividing creditor classes, creditors with security over the entity’s assets enjoy a priority status in repayment to the extent of the secured collateral; employees’ claims are payable after the expenses of the bankruptcy, but ahead of certain taxation and state claims; and, as to be expected, claims of unsecured creditors rank last.
Practical Challenges for Foreign Creditors
Structural subordination leaves offshore creditors Exposed
In recent years, most international creditors have invested in the debt of offshore holding companies that own the onshore Chinese operating entities. For a variety of reasons, including strict capital controls, Chinese companies’ ability to directly borrow from offshore sources are quite limited. Because offshore creditors of an offshore holding company are not creditors of the Chinese company, they are not only structurally subordinated to onshore creditors on any distributions, but they are also unable to participate (as a stakeholder) in any meaningful way in connection with any proposed onshore organization pursuant to Chapter 8. Thus, in the case of Suntech Power, its unsecured offshore bondholders are significantly exposed by having no say in the onshore bankruptcy proceedings of Wuxi Suntech, and what they ultimately may receive, if anything, from the Wuxi Suntech estate will depend on the reorganization plan that is approved by the onshore creditors and other stakeholders of Wuxi Suntech. On the other hand, it should be noted that Suntech Power has other operating subsidiaries and assets in China (and elsewhere) which are not subject to the Chapter 8 proceeding (which is solely in respect of Wuxi Suntech), and such subsidiaries and assets may still provide the offshore bondholders with avenues for recovery that are not structurally subordinated to the onshore lenders of Wuxi Suntech.
Below is a brief structure chart showing the current group structure of Suntech Power:

While the offshore bondholders could sue Suntech Power for default on the bonds or consider pushing for a bankruptcy proceedings against Suntech Power in a jurisdiction outside of China (e.g., chapter 11 in New York or insolvency under Cayman law), they would probably end up recovering little (if any) in respect of the Wuxi  Suntech assets, given that the onshore lenders of Wuxi Suntech would still rank ahead of them in the Chapter 8 case.
Government support is critical
While the passage of the PRC Bankruptcy Law was a significant step in providing creditors and debtors with a better legal framework to address possible restructurings of insolvent Chinese companies, as a practical matter, it’s often the case that any successful restructuring in China will require the support and active involvement from the government, and the foreign creditors’ relationship with the local government may play a role in increasing the chances for recovery in such bankruptcy cases. For example, Wuxi Suntech, which at one point had a market capitalization of US$16 billion, is known to employ thousands of people in China (particularly in the Wuxi region), and, as such, the local Wuxi government has played, and continues to play, an active role in facilitating the ongoing restructuring discussions in order to save jobs (thereby avoiding increased social unrest/instability), and to maintain the reputation of Wuxi and Jiangsu province as an investment-friendly region.
In addition to the government’s prior involvement in discussions relating to the role of Mr. SHI Zhengrong, the recently ousted founder (former CEO and Chairman), it was recently disclosed that, following the recent bankruptcy filing by Wuxi Suntech, Mr. ZHOU Weiping, an executive from the Guolian Development Group Co. Ltd. (Guolian), a state-owned enterprises owned by the Wuxi government, was appointed by Suntech’s board of directors to serve as president and executive director of Suntech Power. Moreover, the administrator committee for Wuxi Suntech includes certain local governmental representatives.
The precise role of the Wuxi government in connection with the Chapter 8 restructuring of Wuxi Suntech remains to be seen, as there is speculation that the government may (i) take a more proactive role by acquiring Wuxi Suntech from Suntech Power with its own money (i.e., through Guolian or some other state-owned entity), or (ii) act primarily as a facilitator between Wuxi Suntech and the onshore creditors in order to achieve a mutually acceptable debt reorganization plan (without acquiring Wuxi Suntech or its assets), or (iii) take some middle-ground approach by introducing local private investor(s) to acquire Wuxi Suntech or its assets.
Final Observations
While the unsecured offshore creditors of Suntech Power may not have a formal “seat at the table” in the Wuxi Suntech onshore restructuring, this case is nevertheless worth following, as it will no doubt show the continued evolvement of the PRC Bankruptcy Law.
Nevertheless, as the unsecured offshore bondholders may ultimately end up with little or nothing from the Wuxi Suntech estate following the completion of the Wuxi Suntech restructuring, it is even more critical that international investors (i) conduct in-depth due diligence investigations (legal, financial, and business) prior to the investment, and (ii) carefully monitor the target post-investment (e.g., by exercising the information rights available to them, etc.) in order to maintain an up-to-date understanding of their investment position.