How strategic investors can become involved in bankruptcy reorganisation

With respect to enterprises that have slipped into a debt crisis, some strategic investors have injected capital and effected acquisitions at their bankruptcy reorganisation stage which, while allowing the enterprises to recover their business capacity, also reduces the acquisition costs.

In terms of legal nature, bankruptcy reorganisation is a system established by the Enterprise Bankruptcy Law. It is a special legal process where a debtor that is in danger of going or has already gone bankrupt, but has prospects of resurrection, can – through consultations among the involved parties, and by virtue of a legally mandated adjustment of their interests and a reorganisation of the debtor’s production and operations, and straightening out of its claim and debt relationships – extricate itself from its financial difficulties and recover its business capacity.

A bankruptcy reorganisation procedure is completely different from a commonplace debt restructuring or corporate restructuring. The outcome of a bankruptcy reorganisation is not just a simple “new lease of life”, because if the reorganisation is unsuccessful, the debtor will undergo a bankruptcy liquidation procedure.

Basic procedure

When the grounds for a reorganisation as specified in the Bankruptcy Law arises, namely the enterprise “becomes insolvent and its assets are insufficient to discharge all of its debts, or it clearly lacks the capacity to discharge such debts”, the creditors and debtor submit a reorganisation application directly to the court. Furthermore, when a creditor applies for the bankruptcy liquidation of a debtor, the debtor, or an investor whose capital contribution accounts for at least 10% of the debtor’s registered capital, may apply to the court for reorganisation after the court accepts the creditor’s application and before it declares the debtor bankrupt.

If the court finds the application legitimate, it will render a ruling for the reorganisation of the debtor and notify the known creditors, and make an announcement within 25 days from the date on which it ruled to accept the bankruptcy petition. The contents of the announcement will include the basic particulars of the administrator appointed by the court, the deadline for reporting claims and the time when, and the place where, the first creditors’ meeting will be held (which should be within 15 days of the date of expiration of the deadline for reporting claims).

The creditors are to report their claims to the administrator by the specified deadline – at minimum 30 days and at maximum three months from the announcement date – and the administrator will review the claims reported, prepare a list of the claims and submit it to the first creditors’ meeting for verification.

Once the bankruptcy reorganisation stage has commenced, the debtor may, subject to an application by it and the approval of the court, manage its property and operate its business under the supervision of the administrator. Within six months – and subject to a petition, the court may rule to extend that period by three months – from the date of the ruling by the court, the debtor should submit a draft of its reorganisation plan to the court and the creditors’ meeting. If it fails to submit a plan by the deadline, the court is required to render a ruling terminating the reorganisation procedure and declare the debtor bankrupt, at which point the bankruptcy liquidation procedure begins.

The court will call a creditors’ meeting within 30 days of receiving the draft reorganisation plan. If each of the voting classes votes for the draft, the reorganisation plan is adopted. If it is not adopted, bankruptcy liquidation commences pursuant to article 87 of the Bankruptcy Law.

Application for approval

The debtor and administrator are required to submit to the court an application for approval of the draft reorganisation plan within 10 days of adopting the reorganisation plan. If the court deems it lawful after review, it will render a ruling approving it, terminate the reorganisation procedure and make an announcement within 30 days from the date of receipt. The draft reorganisation plan approved by the court is binding on the debtor and all of the creditors. The enterprise then enters into the reorganisation plan execution procedure, with the debtor responsible for execution.

The administrator supervises the execution of the reorganisation plan during the supervision period specified in the plan. During the supervision period, the debtor has to report to the administrator on the execution of the reorganisation plan and its income and financial position. At the expiration of the supervision period, the administrator submits a supervision report to the court. The administrator’s supervision duties terminate on the report date. Subject to an application by the administrator, the court may rule to extend the supervision period.

If the reorganisation plan is executed successfully, the reorganisation procedure terminates and the company returns to normal operations. If the debtor is unable or fails to execute the reorganisation plan, the court is required, subject to a petition from the administrator or a materially interested person, to render a ruling terminating execution of the reorganisation plan and declare the debtor bankrupt. Thereafter, the company enters the bankruptcy liquidation procedure.

Issue of strategic investment

A reorganisation process is a game process played out among the creditors, the debtor enterprise, the existing investors and strategic investors. The author is of the opinion that when a strategic investor gets involved in a restructuring, it should focus on the following key tasks: relying on the information on the existing debts of the debtor enterprise ascertained by the court and administrator to get a lock on the debts, and communicating with the creditors on reducing the existing debts; conducting a check on the assets and operations of the debtor enterprise and assessing the enterprise’s likely business position and solvency after the capital injection and reorganisation; securing the support of financial institution creditors and communicating with them on a debt restructuring plan involving the extension of the term of long-term loans, continuation of short-term loans and control of financing costs; determining with the existing investors the conditions for transferring equity; re-establishment of the debtor enterprise’s governance structure and the means for establishing and realising internal controls; and assurance of external conditions, such as tax matters, support of the local government, etc.

On this basis, the strategic investor proposes an investment plan and directs the administrator in proposing a reorganisation plan – proposing a specific plan addressing subsequent operations, adjustment and discharge of claims, the reorganisation and supervision periods, corporate governance and realisation of internal control objectives – to secure passage by the creditors’ meeting.