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.
REGULATORY GUIDANCE
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 analysed 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 optimising 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 Enterprise 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 enterprises that are operating normally. The draft is a response to this issue,” he adds.
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 regu-lators,” 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.
FUTURE TRENDS
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 in the future. In the north-eastern 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 manage-able 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,” he says.
“Bankruptcy lawyers will need to be able to allocate resources, which are not limited to legal resources,” he adds.
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 mobilising resources in the future. Law firms with a more competitive internal system will be able to mobilise a bigger team, thus seizing business opportunities,” Zhou says.
Meanwhile, Xu says team members are now required to 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, to take everyone’s interests into consideration to benefit everyone in the proceedings,” he adds.
To contact the editorial team, please email ALBEditor@thomsonreuters.com.