Listed company reorganisations and frontier legal issues

By Xu Shengfeng, Zhong Lun Law Firm
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Reorganisations of listed companies have long been held as a barometer for reorganisation policies. As such cases link the capital market to the bankruptcy system, they have received widespread attention. Since the implementation of the Enterprise Bankruptcy Law in 2007, 103 listed companies have undergone reorganisation, about half of which took place during the past four years. These recent reorganisations have produced new features and raised cutting-edge legal questions, while driving reforms in and refinements to the existing reorganisation system and securities regulatory policies.

EMERGING FEATURES

Express policy support from the top level. In its Opinions on Further Enhancing the Quality of Listed Companies, the State Council stated in 2020 that “listed companies should be supported in disposal of risks by such means as M&A, restructuring and bankruptcy reorganisation”. In practice, the China Securities Regulatory Commission (CSRC) has relaxed the relevant policies by conditionally permitting listed companies to resolve such problems as illegal guarantees and appropriation of funds in the reorganisation process, supporting distressed companies with salvage value to rehabilitate through reorganisation.

Xu Shengfeng, Zhong Lun Law Firm
Xu Shengfeng
Senior Partner
Zhong Lun Law Firm
Tel: +86 755 3325 6666
E-mail:
xushengfeng@zhonglun.com

Furthermore, in recent years, the regulatory authorities have also strengthened the supervision of the pricing mechanism for converting capital reserves into shares for investors, and the lock-in period and ex-right (ex-dividend) rules of the reorganisation, in order to better protect the legitimate rights and interests of various market entities.

Wide application of prepackaged reorganisation. Since prepackaged reorganisation’s initial application to listed companies in August 2019, its value was quickly recognised, leading to wide adoption in subsequent cases. If a listed company initiates prepackaged reorganisation during the proceeding of the prior approval process, it would be able to commence or even complete certain core tasks such as drafting and negotiating on the draft reorganisation plan, effectively reducing the time required for reorganisation. In the 2022 Unifull reorganisation handled by the author, with effective linkage of prepackaged reorganisation and reorganisation, only one month elapsed between a court ruling and a successful completion.

Business retention becomes mainstream. In the early days of listed company reorganisation, many found their own operation no longer viable or profitable. With reorganisation, they sought to divest assets and debts and bring in a restructuring party to inject new operating assets, serving as a “shell” for the restructuring party to achieve a “backdoor” listing. In most cases, the listed company’s main business changes after the reorganisation.

Recent years have seen a decrease in the trend, with the majority of listed company reorganisation cases now based on the original core business. They seek synergistic and sound development of the original main business through reorganisation, introduction of investors and integration of resources, which is consonant with the goal of quality development. The CSRC is also paying increasing attention to post-reorganisation plans before giving its approval.

LEADING LEGAL ISSUES

Dovetailing of administrative and judicial authorities. Differences in the reorganisation of a listed company and that of an ordinary are that:

    1. Before the court’s acceptance, the reorganisation of a listed company must be pre-approved by the local government, the CSRC and the Supreme People’s Court; and
    2. Apart from optimising the financial structure, it is more important for listed companies to avoid delisting through reorganisation.

Currently, the pre-approval process remains troubled by lack of a sound communication and co-ordination mechanism between the company, government, court and regulatory authority; unclear review criteria; and an indeterminate review period. Pursuant to the Enterprise Bankruptcy Law, the reorganisation procedure terminates once the court approves the plan, but with the listing rules of stock exchanges, the risk of delisting is only eliminated after the reorganisation plan is implemented and completed. Reorganisation is often time-critical for listed companies. Accordingly, it is worth looking into how to improve the linking mechanism.

Information disclosure and prevention of insider trading. In early 2022, the Shanghai and Shenzhen stock exchanges issued self-regulatory guidelines based on their listing rules, detailing and strengthening information disclosure and the prevention and control of insider trading relating to listed company reorganisations. It adopts the principles of disclosing information in phases, improving disclosure requirements for key matters, and providing explanations where a disclosure cannot be made.

In practice, obtaining prior approval for acceptance by the court is the most difficult and critical part of a listed company reorganisation, as so far all court-accepted cases of reorganisation have succeeded. Prior approval involves the court, local government, CSRC and many other authorities, with the CSRC review the most crucial. Progress of the approval often has a visible effect on the stock trading price, but current regulatory rules do not require listed companies to disclose information on such progress which, to a certain extent, poses a risk of insider trading.

Pricing in conversion of capital reserves to stock for debt repayment. Since 2014, the conversion of capital reserves into stock has emerged as a highlight of listed company reorganisations. As the stock of listed companies is highly liquid, stock converted from capital reserves is used not only to bring in a restructuring party, resolve legacy issues and make distribution to shareholders, but also to repay debts.

How to determine the price of the stock for the debt repayment in a reorganisation plan is a common point of dispute, because it has a bearing not only on the actual repayment interests of the creditors, but also on the liability borne by guarantors. In some cases, the claims requiring repayment are based on the stocks available for the debt repayment, which is then used to deduce the stock price of debt repayment, aiming at the 100% discharge rate. If a guarantor argues that it does not bear security liability based on this a dispute will arise, as there are cases where the court does not recognise such debt repayment arrangements.

Accordingly, the price of the stock for debt repayment needs to be determined reasonably and fairly in the reorganisation of a listed company and, where necessary, an independent professional firm may be engaged to conduct a valuation to serve as a base reference to protect the interests of the creditors.


Xu Shengfeng is a senior partner at Zhong Lun Law Firm. He can be contacted by phone at +86 755 3325 6666 or by email at xushengfeng@zhonglun.com