Suntech’s lessons for China’s bankruptcy regime

Author: Ashley Lee | Published: 6 Nov 2013
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  • Solar panel producer Suntech announced yesterday that it had filed an application for provisional liquidation proceedings in the Cayman Islands;
  • This follows bankruptcy filings in China, by a local subsidiary, and the US;
  • The Chinese exacerbating concerns about local government involvement;
  • The filings follow Suntech becoming the first ChinaCo to default on its US bonds;
  • As the bonds are structurally subordinated, under Chinese law the bondholders do not have recourse to Suntech’s onshore assets. It is unclear whether they will be seen as a significant stakeholder in the Chinese bankruptcy case;
  • Although there is a considerable lack of transparency in the bankruptcy process, lawyers emphasised that China’s bankruptcy process is new and developing.

US-listed solar panel producer Suntech announced on Wednesday that it had filed an application for provisional liquidation proceedings in the Cayman Islands, its jurisdiction of incorporation.

It’s the latest twist in Suntech’s default and bankruptcy saga, which should remind investors to adequately price default risk into future ChinaCo bonds.

In March, Suntech became the first ChinaCo to default on its bonds. Its Chinese subsidiary Wuxi Suntech subsequently filed for bankruptcy in China rather than under US Chapter 11, leaving bondholders to contend with China’s untested and often unclear bankruptcy process.

Speaking at a Latham & Watkins seminar on Wednesday, O’Melveny & Myers’ Mark Fairbairn said that because returns in China are not good, comparisons would be made between its restructuring process and Chapter 11. But, he noted that the market in China is finding its own way of dealing with its problems.

"Speaking from the outside, if you’re not happy with likely outcomes, re-price your deals on the way in, rather than thinking about it when it’s too late," he added.

Chinese bankruptcy and structural subordination

Compared to established restructuring processes such as the US’s Chapter 11 and the UK’s scheme of arrangement, China’s insolvency process is still relatively untested.

The country’s bankruptcy laws were introduced on a trial basis just 18 years ago in 1995, said Fairbairn. The enterprise bankruptcy law took effect in 2006 and is an embryonic piece of legislation that has not been tested fully with either corporates with offshore exposures or wholly-domestic corporates.

Further, bondholders are structurally subordinated. Restructuring lawyers have warned investors about ChinaCo bonds, because they do not have recourse to any onshore security.

Chinese companies cannot guarantee offshore bonds. Instead notes are typically issued from a Cayman or BVI wholly-owned foreign entity. While investors have recourse against an issuer’s assets outside China, it is unlikely that international bondholders have any say in an onshore bankruptcy process.

Further reading

Sino-Forest restructuring analysed

Restructuring first for outbound Chinese M&A

Why investors should avoid ChinaCo USD high-yield

Local government involvement

Following reports that Suntech was about to default on its US bonds, its Chinese subsidiary Wuxi Suntech Power filed a petition for the insolvency and restructuring in the Wuxi Municipal Intermediate People’s Court.

The court appointed an administration committee comprising local government representatives and accounting and legal professionals, ostensibly to facilitate an orderly process for both Wuxi Suntech and its creditors.

"The primary goal is to restructure Wuxi Suntech’s debt obligations, which continuing production and operations," said a Suntech press release.

But the local government’s involvement has raised concerns. Its representative administrator wants to ensure social stability and employment, said Bingham McCutchen’s Mark Fucci, and is no doubt mindful of the 5000 to 6000 employees in his neighbourhood.

"You’re starting out with a process where this administrator has duties to all creditors and stakeholders," he said. "One could assume that the agenda of social harmony and employment is pretty high up on his list of priorities."

Fairbairn added that China’s legislation begins with dealing with creditors’ and debtors’ rights and obligations, but also focuses on maintaining the socialist market economy.

He noted the presence of a dialogue with the local governments under other restructuring regimes, citing the US government’s involvement with Chrysler and General Motors as an example.

"It’s not surprising that China’s government is involved in major restructurings, and that it’s more likely to get involved because of the infrastructure of its society," he added.

What’s next

On October 14, bondholders owning $1.5 million of Suntech bonds – less than 0.3% of the aggregate principal amount – filed a petition to put the company into involuntary bankruptcy protection under Chapter 7 of the US Bankruptcy Code.

Panelists agreed that bondholders resorted to this measure upon realising they may not successfully recover in China.

On October 31 Suntech announced that it would challenge the Chapter 7 petition and on November 6, it filed an application for provisional liquidation proceedings in the Cayman Islands. In a press release, the company also announced that it would consider pursuing a Chapter 15 filing in the US following the grant of the application in the Cayman Islands.

In the meantime, Suntech found two strategic investors: Hong Kong-listed solar company Jiangsu Shunfeng, which was named as the preferred bidder for Suntech’s Wuxi manufacturing assets, and Wuxi Guolian Group, which may inject $150 million to restructure the group.

This process seemed similar to that of the auction process under section 363(b) of the Bankruptcy Code, which applies to going concerns. But it did not feature some key characteristics of that provision, namely an open bidding environment with a stalking horse.

Fucci said that his guess was that offshore investors aren’t going to say that this was a transparent process.

"They’ll feel uncertain about the selection process and whether this is the best price for the assets or the best value for creditors and equity holders," he added. "But let’s face it: is there anywhere in Asia where creditors say this happens?"

What to expect

While the process seems taxing on bondholders, it is an important step in learning how to enforce ChinaCo bonds.

Investors have said that they wanted to see the bond structures tested when it really mattered – in a default situation. Suntech’s default on its $541 million in convertible notes is finally testing these structures. Its international bondholders’ success or failure could affect the pricing of ChinaCos’ structurally subordinated bonds in the future.

The judgment of creditors historically may look harsh, but in the context of what China is trying to do and what it started from, it is establishing a model, Fucci said. Concerns of transparency and creditor influence will, however, eventually have to be dealt with.

Regardless, restructuring lawyers continue to warn investors about structural subordination. But given the popularity of Chinese bonds issued by offshore entities, it seems that these warnings are falling on deaf ears.

Neil McDonald of Hogan Lovells noted that structural subordination is also an issue in Indonesia and India. "For someone who works solely in the default space, these bonds are not adequately priced in terms of risk weighting," he said.

He added that what strikes him is that investors don’t fully understand the risks of these structures and that markets don’t price them properly.

Further, he predicted more defaults ahead. During the credit squeeze he’s seen significant property workout situations.

"We can expect a lot of pain for foreign investors if we see any sort of credit downturn in China," he said.

See also

Sino-Forest restructuring analysed

How Chinese real estate credits are using credit enhancement

Restructuring first for outbound Chinese M&A