Key points for leasing companies joining bankruptcies as creditors

Operating and financial leases are becoming more and more common, and the number of cases where leasing companies participate in bankruptcy reorganisations as creditors has also increased. What are key points the lessor should pay attention to when facing the lessee’s entry into bankruptcy reorganisation?

The lease deposit and the bank letter of credit or letter of guarantee provided by the lessee. In most leasing businesses, the lessor will require the lessee to pay a cash deposit, or provide a bank standby letter of credit or letter of guarantee of the same amount. When there is a sign that the lessee is entering bankruptcy reorganisation, the lessor first needs to consider whether to apply the cash deposit and draw down the letter of credit or letter of guarantee from the bank. As different legal rules apply for application of a cash security deposit and the application of a letter of credit or letter of guarantee, the lessor should consider the following:

• • If the lessor deducts and applies the cash deposit, its legal basis will be the lease contract and the offset right in bankruptcy stipulated in the Enterprise Bankruptcy Law. Since the administrator is entitled to choose whether to continue to perform the lease contract after the lessee enters bankruptcy procedure, and the Enterprise Bankruptcy Law has certain restrictions on the exercise of the offset right, it is advisable for the lessor to complete the deduction before the bankruptcy reorganisation procedure starts.
  • If the lessor cashes the bank standby letter of credit or letter of guarantee to deduct any outstanding payment, its legal basis will be relevant provisions on standby letters of credit and enforcement of third-party guarantees. As long as the letter of credit or letter of guarantee is still valid, the bankruptcy reorganisation of the lessee will not directly affect its validity. However, if the letter of credit or letter of guarantee may expire during the bankruptcy reorganisation, considering that it is difficult for the lessee to obtain additional credit from banks during bankruptcy reorganisation, the lessor should complete the cashing in and deduction before the expiry at the latest.

Continued performance of operating lease contracts and common-benefit debts. After the lessee enters bankruptcy reorganisation, the lessor of the operating lease is often very concerned about whether the operating lease contract will be continued, and whether the lessee can continue to pay rent during the reorganisation. According to the Enterprise Bankruptcy Law, the lessee’s administrator can choose whether to continue to perform the operating lease contract within two months after the reorganisation procedure starts (or within 30 days of the lessor’s demand). An operating lease contract that is not continued will be terminated, and the lessor shall retrieve the leased property and declare the arrears of rent and other damages arising from the early termination of the lease. When deciding whether an operating lease contract will continue to be performed, the lessee, the administrator, and the bankruptcy court will often consider factors such as the value of the leased property to the lessee and the rent level of the lease contract. If the operating lease contract is confirmed to be continued, the rent under the lease contract should be paid during the bankruptcy reorganisation as part of the common debt.

Filing of lease claims. Normally, the claims filed by the lessor with the administrator include the pre-bankruptcy debts (including rents owed and accumulated penalty interests on rents) as of the date when the bankruptcy reorganisation petition is accepted by the court, and the damages arising from the termination of the lease contract pursuant to article 18 of the Enterprise Bankruptcy Law.

When the lessor prepares various kinds of claim filing documents, it is very important to sort out the evidence of its claims. The lessor needs to count the lease arrears and losses, summarise and sort out the provisions and the method used to calculate damages in the case of the lessee’s bankruptcy as stipulated in the contract, collect and sort out the evidence of expenses and losses, and ensure the claim amount has sufficient basis and evidence.

Overseas lessors further need to arrange in advance the certificates of incorporation and authorisation documents. such documents need to be notarised by the notary office in the country where the lessor is located and legalised by the Chinese embassy or consulate in that country. After the lessor files claims and receives the administrator’s confirmation of the claims, it should check whether the confirmed result is consistent with the filed information. If there is any inconsistency, it needs to raise an objection with the administrator within the period notified by the administrator, or file a lawsuit to the court for confirmation of the claims.

Claim filing for special lease structures. In practice, the leasing company will also develop certain special structures according to the needs of the lessee. The most common ones are joint leases and sub-leases.

Under the joint lease structure, the lessor needs to determine whether it can file all claims against each lessee based on the obligations of each lessee under the joint lease agreement.

For the sub-lease structure made through a special purpose company, normally it is the sub-lessee who actually possesses and operates the leased property and the lessor relies on the sub-lessee’s credit. Therefore, if the sub-lessee goes bankrupt but the intermediate special purpose company is not bankrupt under this lease structure, the lessor needs to determine whether it can directly file claims against the sub-lessee with the administrator based on the lease documents. In this regard, the lessor can focus on the following factors: whether the lease document stipulates the lessor’s direct recourse against the sub-lessee; whether the lessee has transferred its rights under the sub-lease agreement to the lessor; and whether the lessee neglects to file its claims against the sub-lessee thus endangering the realisation of the lessor’s claims.

Changes in lease conditions. In practice, for the lease contract which continues to be performed, the lessee may request to negotiate with the lessor to change and restructure the lease conditions (including the lease term and rent). In this regard, the lessor shall pay special attention to the effective time of the lease conditions after the change, and the restoration of previous lease conditions when the restructuring fails, and reserve the rights to make a supplementary filing of claims for all losses in such a failure.

Wang Shu is a partner at Han Kun Law Offices. She can be contacted on +86 10 8525 5526 or by email at shu.wang@hankunlaw.com

Zhu Jun is a partner at Han Kun Law Offices. He can be contacted on +86 10 8525 4690 or by email at jun.zhu@hankunlaw.com