Pre-reorganisation, or pre-packaged bankruptcy, enables companies to negotiate a restructuring plan with creditors and other stakeholders ahead of court-led reorganisation, when the agreed plan covering major issues such as debt liquidation, business restructuring and change of management is submitted to the court for review.
In its Legislative Guide on Insolvency Law, The United Nations Commission on International Trade Law (UNCITRAL) notes that proceedings like pre-reorganisation “allow the approval of the restructuring plan obtained in the voluntary negotiations to be used to achieve a reorganisation that will bind creditors, while at the same time providing the protections of the insolvency law to affected creditors”.
In recent years, pre-reorganisation has enjoyed increasing attention in China’s legal academic circles, while also seeing plenty of action in practice. The rapidly developing regime is proving more vital to the rescue of struggling businesses with each passing day.
ORIGIN AND EVOLUTION
Development of pre-reorganisation in China largely went through four stages: experimentation; authorisation; wide exploration; and standardisation.
The 2015 out-of-court restructuring and subsequent reorganisation of China National Erzhong Group and China Erzhong Group (Deyang) Heavy Industries is generally recognised by legal practitioners as the debut of pre-reorganisation in China.
Before court acceptance of the reorganisation case, the financial institution concerned – guided by the China Banking Regulatory Commission (CBRC) and led by the State-owned Assets Supervision and Administration Commission of the State Council (SASAC) – arrived at a basic debt repayment scheme with the companies.
During reorganisation, the administrator strove to maintain the existing restructuring plan within the judicial framework, successfully inserting it into court procedures, much to the creditors’ satisfaction.
Since then, a series of national provisions have come out, including: the Notice of the Supreme People’s Court on Issuing the Several Opinions on Providing Judicial Guarantees for Improving the Business Environment; the Minutes of the National Court Work Conference on Bankruptcy Trials; and the Reform Plan for Accelerating Improvement of the Exit System for Market Participants. Each have added to the exploration of pre-reorganisation and related systems, and various regional courts have also issued relevant guidance documents.
CHARACTERISTICS AND VALUE
Distinct from both out-of-court restructuring based on voluntary negotiation and court-led reorganisation (which is part of the judicial procedure), pre-reorganisation represents a new and more efficient path to a company’s rescue and revival. Compared to bankruptcy reorganisation it saves both time and costs, while also playing to the strengths of out-of-court restructuring when observing relevant rules.
First, pre-reorganisation can complete most work under the reorganisation process in advance, saving time and costs in the formal bankruptcy procedure. Second, while bankruptcy is irreversible in the sense that a failed bankruptcy can turn only to liquidation, pre-reorganisation exhibits much more flexible exit options.
Finally, out-of-court restructuring is subject to the “acting in concert” problem, which happens when certain creditors abuse the requirement of “unanimous approval” by purposefully holding off their consent until others agree to their additional demands, sacrificing some of their benefits in exchange for a consensus.
By seamlessly connecting to the formal bankruptcy procedure and replacing “unanimous consent” with “majority approval”, pre-reorganisation eliminates the above-mentioned problem and allows the negotiation result to gain court affirmation.
Additionally, the comprehensive back-and-forth negotiation process between stakeholders can be conducive to assessing the company’s market potential. Early settlement of debts also helps to reduce the corporate debt leverage and protect all parties’ interests, and it is a boon to the current supply-side structural reform.
Companies should begin planning for possible bankruptcy at the earliest sign of a debt crisis and remain highly sensitive to the timing and conditions of applying pre-reorganisation.
If there is cause for bankruptcy, but the company for whatever reason cannot yet access reorganisation, it may consider launching pre-reorganisation to begin the process of debt risk mitigation. As there is currently no national regulation on pre-reorganisation, companies should consult local court guidelines and other relevant rules in practice, and communicate with local courts in relation to conditions for launching a pre-reorganisation case.
After entering pre-reorganisation, companies are advised to:
- Delineate the boundary of creditor participation and communicate with select or key creditors;
- For the most part, confirm the investors and form a viable reorganisation plan, which is vital to the success of transitioning to reorganisation;
- Value the support from local government and judicial guidance from the court, without which pre-reorganisation cannot succeed;
- Protect the creditors’ rights to cast “informed votes” when consulting them on the pre-reorganisation plan (in other words, disclose information thoroughly and honestly); and
- Pay attention to connecting pre-reorganisation to reorganisation at all times – including asset liquidation, creditor claim review and voting on the restructuring plan – so results of the pre-reorganisation can remain valid.
A successful pre-reorganisation can be a highly cost-effective way to rescue a distressed company. The process, from determining timing and implementing various pre-reorganisation tasks to subsequent transition and bankruptcy reorganisation, reflects a high degree of complexity and specialisation.
Throughout the process, the professional agency, serving at first as pre-reorganisation administrator/supporter and subsequently as reorganisation administrator, plays a consistent and co-ordinating role indispensable to success of the project.
Looking back at Dentons China’s past cases, the reorganisation of Huayi Jiaxin (now FS Development Investment) – the first such case among Beijing-based listed companies – and the consolidated reorganisation of 16 companies led by Chongqing Energy Investment Group were high-profile examples of pre-reorganisation smoothly transitioning to reorganisation, leading to swift conclusion.
Gao Meili is a senior partner at Dentons China. She can be contacted by phone at +86 10 5813 7019 and by email at firstname.lastname@example.org