Assessing the feasibility of pre-reorganisation process

By Xu Bangwei and Zhang Rongsheng, Jingtian & Gongcheng
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The pre-organisation process gives an optional system for troubled companies, capital contributors, creditors and reorganisation investors to solve their problems flexibly under the supervision of courts. At present, there are no clear provisions on the pre-reorganisation system in Chinese law, but the system is taking its shape based on the provisions of the principal documents of several government departments of the State Council and the Supreme People’s Court (SPC), as well as the regulations and abundant practices of local governments and courts.

With the economic fallout of covid-19, many provincial high courts have issued documents to promote relief for valuable distressed enterprises through pre-reorganisation, and the pre-reorganisation system has been further developed.

徐邦炜, Xu Bangwei, Partner, Jingtian & Gongcheng
Xu Bangwei
Partner
Jingtian & Gongcheng

Pros and cons

Through pre-reorganisation, companies may gain more time for self-help, and a greater voice in the process. The advantages of pre-reorganisation include:

(1) if companies enter pre-reorganisation during the bankruptcy review stage, the bankruptcy fillings can be withdrawn;

(2) the companies can still operate independently;

(3) the procedure is flexible and conducive to attracting reorganisation investors;

(4) the companies and capital contributors can be deeply involved in the formulation of the pre-reorganisation plan; and

(5) some regions allow companies to make suggestions on the selection of interim administrators.

There are risks also existing in the procedure, including:

(1) The level of effectiveness of pre-restructuring provisions is low, and they are controversial, so degrees of acceptance and co-operation by courts with bankruptcy jurisdiction vary;

(2) some of the substantive provisions of the Enterprise Bankruptcy Law, such as the cessation of interest accrual after the acceptance of bankruptcy petition, cannot be applied;

(3) the procedural provisions are coarse and may be controversial in practice;

(4) the authority of the court and the administrator is large, and the level of difficulty with supervision is high, meaning the interests of the parties may be damaged, and it may be difficult to obtain remedies;

(5) there is great uncertainty in the situation of creditors and their opinions, and voting results;

(6) the constraints on pre-reorganisation investors are limited; and

(7) the reorganisation administrator and the interim administrator may be different.

张榕晟, Zhang Rongsheng, Associate, Jingtian & Gongcheng
Zhang Rongsheng
Associate
Jingtian & Gongcheng

The trade-offs

The parties involved need to evaluate and weigh carefully before choosing a pre-reorganisation process.

On the one hand, a successful pre-reorganisation requires the support of external forces under the “government-court linkage mechanism” and the “government-court-bank co-ordination mechanism”.

On the other hand, the feasibility and effectiveness of pre-reorganisation of troubled enterprises may be affected by the nature of the enterprise (e.g., listed or state-owned enterprises), the composition of claims (e.g., security or employee claims), the characteristics of creditors (e.g., bank creditors or creditors entering enforcement proceedings), and the status of potential investors and their expected investment methods. A variety of factors may affect the feasibility and effectiveness of pre-reorganisation of troubled enterprises.

If a party intends to opt for pre-reorganisation, it is necessary to further assess the conditions for reorganisation and the possibility of acceptance by the competent court, taking into account the situations of the enterprise and the competent court.

(1) Assessment of basic conditions

Whether the enterprise is in an equivalent condition of reorganisation, or in a worse predicament. Some parties may have filed for bankruptcy before the pre-reorganisation, and some parties may need to give up some of their interests in the pre-reorganisation. The pre-reorganisation enterprise should generally have the same or more serious difficulties as the “apparent insolvency”, the reorganisation condition.

Whether the enterprise has the value to reorganise and the potential to rescue. According to the Minutes of the National Court Work Conference on Bankruptcy, the value of reorganisation is mainly reflected by the enterprise’s “assets, technology, production and sales, industry prospects, etc.”. In addition, the shareholders, core team, qualifications and licences, industry status and brand value are important factors to consider in practice.

The pre-reorganisation should be consented by the troubled enterprise. The applicant for pre-reorganisation is not limited to the debtor, but a pre-reorganisation will not be carried out only until the consent of the enterprise – i.e., after the resolution of a certain percentage of the shareholders at the shareholders’ meeting – is obtained. By reference to article 112 of the Rules for Handling Bankruptcy Reorganisation Cases in Beijing Bankruptcy Court (for Trial Implementation) and the degree of influence of the pre-restructuring on each party, such percentage of voting rights shall be in accordance with the articles of association, and not less than two-thirds.

(2) Likelihood of acceptance

If there are specific regulations of the competent courts (e.g., Beijing, Guangdong, Zhejiang, Jiangsu, Sichuan, Fujian, Chongqing, etc.) on pre-reorganisation, enterprises may assess the likelihood of acceptance according to the conditions of pre-reorganisation applications.

If there are no specific rules for the competent court, considering that there are a large number of pre-reorganisation cases in local courts, and there are also many local innovations in pre-reorganisation mechanisms, the following factors can be taken into account to assess the likelihood of acceptance by the competent court.

(i) Prior pre-reorganisation cases of the competent court;

(ii) The principal regulations of higher courts on pre-reorganisation (e.g., bankruptcy/commercial/ covid-19-related judicial documents);

(iii) Pre-reorganisation rules/pre-reorganisation cases of other courts in the jurisdiction; and

(iv) Relevant systems, policies and supporting measures of the local government on pre-reorganisation.

If, after assessment, there is limited possibility for the competent court to accept the application of pre-reorganisation, the parties may consider other options.

In summary, before starting the pre-reorganisation process, the parties should take into account their own needs, business situation, external support, advantages and disadvantages, and their possible voice in the pre-reorganisation/reorganisation process (especially the right to propose and decide/veto on key matters), as well as the possibility of the competent court accepting the pre-reorganisation. Only then should the parties make a decision after weighing these issues together in order to legally maximise their own interests. Considering the highly specialised nature of the above-mentioned process, the parties may also consider seeking professional advice and making arrangements in advance.

Xu Bangwei is a partner and Zhang Rongsheng is an associate at Jingtian & Gongcheng

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