Key points on acquisitions of non-performing claims

By Xu Bangwei, Jingtian & Gongcheng
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The most common investment object of non-performing assets is the package of non-performing claims. Investors, in acquiring non-performing claims, often pay too much attention to the realisation and recovery value of the collateral, and ignore some special matters affecting the disposal cycle of non-performing claims, thus affecting the investment yield. This article suggests the key issues that investors should pay attention to when purchasing non-performing claims.

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

Debtor’s entry into bankruptcy

In addition to confirming whether a debtor enters bankruptcy proceedings when purchasing non-performing claims, investors should also judge that possibility after purchasing non-performing claims. The debtor’s entry into bankruptcy proceedings will have the following effects.

Extend the disposal time of the collateral

According to articles 19 and 21 of the Opinions of the Supreme People’s Court on Several Issues Concerning the Implementation of the Enterprise Bankruptcy Law (for Trial Implementation), after an enterprise enters bankruptcy proceedings all the judicial procedures for the enterprise shall be suspended. They shall be transferred to the bankruptcy court after being taken over by the administrator. Meanwhile, the known creditors shall be notified and the information of acceptance shall be announced.

Therefore, in practice, the debtor will apply for bankruptcy (especially bankruptcy reorganisation) as the means of resisting collateral auction. Bankruptcy proceedings involve many stages, such as the appointment of administrator, creditor’s declaration of claims, formulation and submission of the bankruptcy reorganisation plan, etc., and can last for a long time, which is not conducive to the rapid exercise of the priority of the mortgagee to recover the claims. Once the case enters bankruptcy reorganisation, it generally takes two to three years from the formulation, deliberation and approval to the implementation of the bankruptcy reorganisation plan, which will also delay the fund recovery of the mortgagee.

The amount of repayment obtained by the mortgagee will be reduced

According to article 113 of the Enterprise Bankruptcy Law, the order of liquidation of the bankruptcy property, after prioritised payment of the bankruptcy expenses and the common benefit debt, is wages of the staff and workers and relevant insurance expenses of the bankrupt enterprise, taxes owed by the bankrupt enterprise, and claims in bankruptcy.

Accordingly, the proceeds from collateral auction in bankruptcy liquidation proceedings shall be distributed to the preferred creditor, after deduction of the above-mentioned amounts. Compared with the execution procedure, the reduction of the amount obtained by the preferred creditor in bankruptcy proceedings is not conducive to the protection of the interests of the preferred creditor.

Prior seizure of general creditor

If the collateral for non-performing claims is first seized by the general creditor, and the mortgagee is waiting for seizure, that is, the collateral is not first seized by the mortgagee, the disposal progress of the collateral may be delayed, although the seizure does not affect the priority right of the mortgagee over the collateral. Investors should pay close attention to the transfer of execution power between the first seizure court and the execution court of preferred claims.

According to the Replies of the Supreme People’s Court on Issues Relating to Disposal and Seizure of Property of the First Seizure Court and the Execution Court of Preferred Claims, the first seizure court has the power to dispose of the collateral. If the preferred claim has entered the execution stage, and the first seizure court has not issued an auction notice, or entered a sale procedure for 60 days from the date of seizure, it can be transferred to the court of preferred claims for execution.

In case of a dispute between the first seizure court and the execution court of preferred claims over the transfer of the seized property, it may be submitted, step by step, to the common superior court of both courts to appoint the court of execution of the property.

Therefore, if the collateral for non-performing claims is first seized by the general creditor, the investor will suffer the problem of co-ordinating the transfer from the first seizure court to the court of preferred claims for execution. If the first seizure court is unwilling to transfer, or the court of preferred claims is unwilling to accept the execution power, both courts shall apply to the common superior court to appoint the execution court.

If the disposal value of the collateral can only cover the principal and interest of the preferred creditor, and cannot repay the claims of the general creditor, the general creditor has no motivation to request the first seizure court to promote the execution of the auction procedure, and may even hinder the promotion of the legal auction in exchange for the possibility of negotiating with the preferred creditor to obtain compensation.

Small owners of split sale

Investors should pay particular attention to the following effects if the collateral of non-performing claims can be sold separately, and the collateral has been divided up and sold to small owners.

On the one hand, if small owners meet article 28 of the Provisions of the Supreme People’s Court on Some Issues Concerning the People’s Courts’ Handling of Cases of Objections to Execution and Reconsideration, that they have signed a legal and effective written sales contract, legally possessed the real estate, and paid the whole price, and have not handled the transfer registration for reasons unrelated to the small owners before the seizure of the people’s court, small owners may raise an objection to execution and will be upheld by the court. The mortgagee may not be able to recover the claims through the process of advancing the disposal process of collateral.

On the other hand, even if the small owners do not meet the conditions of exclusion of execution stipulated in the above-mentioned law, and the court rejects the execution objection of the small owners, the promotion of the disposal and auction of the preferred creditor will lead to the complete loss of the small owners’ capital. As a result, the small owners may initiate mass incidents, causing adverse social impact.

As a countercyclical investment product, non-performing assets have the characteristics of high risk and high return. In recent years, they have been the hot spot of market investment.

However, investment in non-performing assets is also accompanied by high risks, and a high professional threshold. It is suggested that investors should hire a professional advisory team before and after the acquisition of non-performing claims, to strive for maximum returns for investors.

Xu Bangwei is a partner at Jingtian & Gongcheng

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Jingtian & Gongcheng

34/F, Tower 3
China Central Place, 77 Jianguo Road
Beijing 100025, China

E-mail: xu.bangwei@jingtian.com

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