A look at the ‘pre-reorganization’ system

pre-reorganization is a model for resolving corporate difficulties that fall between in-court reorganization and out-of-court restructuring. As pre-reorganization incorporates the feature of private negotiations that is stressed in out-of-court restructuring, it is possible, through the pre-reorganization plan generated during pre-reorganization, to secure enforcement with the approval of the court, thereby moving to an in-court reorganization.

This unique mechanism that emphasizes the efficiency and a bridging of procedures, and precipitates a consensus among the parties in the midst of a dynamic situation to discover the value of a reorganization, is making pre-reorganization increasingly popular.

Unfortunately, China has not yet provided for a pre-reorganization system at the level of law, and article 115 of the Minutes of the 9th National Work Conference on Civil and Commercial Adjudication by Courts only vaguely uses the expression, “mechanism for bridging out-of-court reorganization and in-court reorganization”. The function of pre-reorganization is insufficiently recognized in judicial practice, and the space available for the pre-reorganization system to play a role is quite narrow.

This article takes a comprehensive look at the functions of the pre-reorganization system and clarifies its functional differences with out-of-court restructuring and bankruptcy reorganization.

Buy time

Pre-reorganization can effectively resolve irreversible problems that a debtor faces once it enters the reorganization procedure. Pursuant to the Enterprise Bankruptcy Law, judicial reorganization is an irreversible procedure, and once a debtor enters a reorganization procedure, it can only face the following possible outcomes: (1) submission of a draft reorganization plan within nine months that successfully passes a vote; (2) submission of a draft reorganization plan within nine months, which, although it fails to pass the vote, satisfies the conditions for compulsory approval by the court, and the court gives its compulsory approval; (3) submission of a draft reorganization plan within nine months, which, however, fails to pass the vote and cannot be compulsorily approved by the court, followed by entry into a bankruptcy liquidation procedure; or (4) failure to submit a draft reorganization plan within nine months, followed by entry into a bankruptcy liquidation procedure.

Based on the above-mentioned provisions, it is very difficult for the parties to a reorganization to come up with the best reorganization plan, faced as they are with the dual pressures of time and the draft reorganization plan. In contrast, pre-reorganization can effectively relieve the pressure of bankruptcy liquidation arising due to the debtor’s or administrator’s failure to punctually submit the draft reorganization plan, or the failure of the draft reorganization plan to secure approval, thereby according the parties to the pre-reorganization more time to communicate and negotiate.

Better chance of acceptance

Pre-reorganization can discover and strengthen the value of, and potential for, reorganizing an enterprise, enhancing the chance of acceptance of the reorganization. Determining whether it is worth reorganizing, and possible to reorganize, the debtor may be the key in the court’s examination of whether the enterprise can be reorganized. As a judicial adjudication authority, not the personnel that operate and manage a company, a court assessing, within a limited period of time, whether the debtor is worth reorganizing clearly requires full discovery and consideration by the parties to the reorganization.

However, through the pre-reorganization procedure, the court can clearly judge whether the debtor is worth reorganizing thanks to the pre-reorganization work report submitted by the pre-reorganization administrator, thereby improving the court’s efficiency in handling the case, and the credibility of the court’s decision. The administrator can effectively determine the assets that the debtor ought to dispose of and those it ought to retain, and clarify the debtor’s current operating difficulties and future business direction, thereby enhancing the possibility of reorganization and directly improving the chance of acceptance of the reorganization.

Increased efficiency

During the pre-reorganization period, the interim administrator can familiarize himself or herself with the true situation of the debtor, enhancing the efficiency of the reorganization. The interim administrator performs the duties of the reorganization case manager, including comprehensively investigating the debtor’s basic particulars, its assets and liabilities, reviewing the claims, etc. Once the reorganization application is accepted, the court will designate the interim administrator as the reorganization case administrator.

The interim administrator’s understanding of the business positions and reorganization intentions of the debtor, creditors, capital contributors and reorganization investors, as obtained during the pre-reorganization stage, can serve as the foundation for the performance of his or her duties as reorganization administrator at the reorganization stage. This can assist in effectively and comprehensively understanding the true situation of the debtor, and carefully analyzing the true causes of the debtor’s business difficulties when arranging for the formulation of a business plan that is consistent with the realities of the debtor’s business, in enhancing work efficiency, and in shortening the time required for the reorganization.

Controlling costs

Pre-reorganization can reduce reorganization costs and enhance the chance of success of the reorganization. Once the reorganization application is accepted, the pre-reorganization plan jointly formulated by the materially interested parties – such as the creditors, debtor, capital contributors, reorganization investors, etc. – under the guidance of the interim administrator can directly serve as the basis for formulation of the draft reorganization plan for the bankruptcy reorganization stage.

Such contents of the pre-reorganization plan as the classification of claims, adjustment and discharge of claims, adjustment of the investors’ interests, governance and operation of the debtor, etc., can be converted into the details of the debtor’s assets and liabilities, the debtor’s business plan, the classification of claims, the claim adjustment plan, and the claim repayment portion of the draft reorganization plan.

Easier to implement

Pre-reorganization can enhance the ease of implementing the draft reorganization plan, increasing its chance of success. As the schedule for the administrator to bring in strategic investors and formulate the draft reorganization plan is relatively tight in the traditional reorganization procedure, he or she is unable to conduct an in-depth investigation and detailed analysis of the past and future of the enterprise during the limited time available, making the viability of the draft reorganization plan uncertain.

However, with pre-reorganization the parties to the reorganization have a greater amount of time to understand the asset structure, human resources and management level of the enterprise. They can, based on negotiations conducted on the basis of equality and free will, adjust the claims against the debtor, make commercial arrangements consistent with the laws of the market in respect of the debtor’s business plan, and make dynamic adjustments to the draft reorganization plan, thereby enhancing the ability to implement the draft reorganization plan and improving the chance of success of the reorganization.

Yang Guang is a partner and Wang Yao is an associate at Lantai Partners

Lantai Partners
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wangyao@lantai.cn
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