Even leading real estate companies have not been exempt from the financial crisis under China’s stringent regulatory environment. As of 24 August, 244 real estate groups declared bankruptcy in 2021 – or almost one a day. As some of these businesses remain sound investment targets due to their quality land resources, investors are drawn to the potential of the reorganisation process.
Investment opportunities in such businesses are available to prospective investors from the national enterprise bankruptcy information disclosure platform, online judicial auctions, financial asset managers, trust companies and local governments. In particular, banks, trusts and financial asset management companies possess a considerable amount of information on many fiscally compromised companies yet to enter bankruptcy, as well as on their assets.
Prospective investors should prudently assess the reorganisation value of the target company based on its financial challenges, main creditors and publicly available information. For companies in the reorganisation process, investors may conduct further investigation beyond the efforts of the administrators. The right to investigate has found support in several judicial documents issued by local courts.
For example, the Shenzhen Intermediate People’s Court entitled prospective investors to view the property survey report, the asset evaluation report, the insolvency report, the audit report, the forms of creditors’ rights and other relevant documents. The Zhengzhou Intermediate People’s Court required debtors to truthfully disclose information including the state of their operations, financial position, contractual capacity, distributable property, breakdown of their liabilities, the discharge rate in simulated liquidation, major risks in reorganisation and other important matters.
While conducting financial and legal due diligence, investors should plan for continued construction, sales and mortgage operations to form a complete image of the value in and feasibility of the target company’s reorganisation. Reorganisation value is generally judged by the total realisable value of the company’s major assets such as unsold properties and car parks, the amount and costs of reorganisation investment, funding requirements for resuming construction and the method of repayment selected by the creditors. One applicable principle is that the value of continued operation should exceed that of liquidation.
To avoid bankruptcy due to the inability of submitting a draft reorganisation plan within the legal time limit or securing its approval, investors should fully communicate with all major stakeholders to understand their concerns and opinions about the asset value and flaws, the ratio and term of debt settlement, the voting mechanism and restrictions.
Investors are also advised to pay attention to risks that may derail the reorganisation: Recovery of land use rights without compensation; high land value-added tax due to a lack of planned space; any non-compliance with completion or inspection; asset impairment due to advance sales; or refusal by commercial banks to extend mortgage loans to home buyers, which makes it difficult to resume sales.
DRAFT REORGANISATION PLAN
Investors should actively involve themselves in the preparation of draft reorganisation plans according to their own capital or funding arrangements. As reorganisation consideration and funds needed for follow-up construction are often hefty with valuable target companies, financing is generally indispensable to complete the investment, which usually comes in two forms:
- A single or dual special purpose vehicle (SPV) co-established by the funder and investor serves as the reorganisation investor, restructuring the target company via co-operation between prior and posterior beneficiaries and the mezzanine; and
- The investor serves as the reorganisation investor, while the funder assumes common creditor’s rights and receives compensation in an order based on the creditor’s autonomy of will and legal requirements.
Settling on a funding scheme is a prerequisite for the implementation of a reorganisation plan. Investors should negotiate with the administrator and debtor on issues beneficial for the reorganisation, including the debtor’s operating plan, classification of creditors’ rights, plans for adjustment and compensation, period for executing the reorganisation plan, and the period of supervision.
Draft reorganisation plans are subject to voting by groups of creditors. A group is considered to have approved the draft if more than half of its members, representing more than two-thirds of the total creditors’ rights within the group, voted in favour. If approved by all voting groups, or deemed to have met all legal requirements by the court even though it was not approved through a vote, the draft reorganisation plan would be approved by the court. Subsequently, the reorganisation process would transition into the supervision period under the plan.
A court-approved reorganisation plan is binding on the debtor and all creditors. The debtor, responsible for executing the reorganisation plan, is entitled to request for resumption of construction and project acceptance, release of any mortgage on the property to ensure a sale, issuance of tax invoices and restoration of credit. On the expiry of the supervision period, the investor becomes the lawful controller of the reorganised enterprise.
Investing in reorganised real estate companies can be a convoluted and non-standard process. To troubleshoot their investment, other than enlisting professional services to conduct due diligence and offer opinions, investors are advised to:
- Consider pre-reorganisation and other means to improve efficiency and control over the project;
- Where investment must be in the form of debt restructuring, fully evaluate the probability of bankruptcy to ensure fund security;
- Acquire major creditors’ rights to secure financing support from investors of non-performing assets and ensure profit via portfolio and hedge investment; and
- Take advantage of the “government-court linkage mechanism” to enlist government and financial institution support in restoring the debtor’s qualifications, approvals, financing channels and credit.
Wang Zhenxiang is a partner at Jingtian & Gongcheng
Room 3001, Area A, China Resources Tower
No.1366 Qianjiang Road, Hangzhou 311500, China
Tel: +86 571 8992 6523
Fax: +86 571 8992 6501