An issuer’s perspective of bond default disposal and solutions

The implicated government guarantees in China’s bond market have been gradually broken in recent years. The Chaori Solar bond default in 2014 marked the first default on a publicly offered bond in China. According to the iFinD search results, 77 bonds were in default in 2021, involving RMB154.08 billion (USD24.3 billion); in 2022 defaults involved RMB53.76 billion and the 41 bonds in default in 2023 involved about RMB30.4 billion.

This article briefly outlines how bond issuers can take proactive measures to effectively manage risk and handle the situation after a bond default.

The primary issues

Information disclosure.
Disclosure begins at the application stage for a bond issuance, and continues throughout the life of the note to beyond any default.

Companies must strengthen internal disclosure management requirements and establish a comprehensive risk control system. During the bond’s existence, timely disclosure of information and reporting of significant events should be carried out, and effective communication with the lead underwriter (trustee) should be maintained. In the event of a bond default, the issuer should actively communicate with the trustee, regulatory authorities, etc., and propose viable solutions. The issuer should also engage in discussions with bondholders to seek options such as a payment extension and credit enhancement.

Furthermore, when applying for a bond issuance, the issuer must have an accurate and clear understanding of the risks and terms of the bonds. Many issue bonds without fully understanding the consequences of defaults – not only facing civil disputes but also risking administrative penalties or even criminal liability for a fraudulent issuance.

Cross-default.
In 2017, the 16th Machine Tool SCP003 bond defaulted, marking an early typical case of cross-default in the bond market.

Cross-default refers to a situation where the debt of a bond issuer or any affiliated entity, encompassing corporate bonds, debt financing instruments, corporate debentures, offshore bonds, financial institution loans or other forms of financing, is considered in default under one or more of several circumstances. These include the failure to pay principal and interest in a timely manner, defaulting after any grace period (if any), or if the debt amount or accumulated debts reach a specific percentage of the issuer’s consolidated financial statements. The Model Investor Protection Clauses issued by the National Association of Financial Market Institutional Investors (NAFMII) include model clauses on cross-protection. In addition, cross-default is provided for in the Minutes of National Symposium on Court Trial of Bond Disputes.

Henan Yongcheng Coal and Electricity Holding Group and Henan Energy and Chemical Industry Group set cross-default clauses for bonds totalling more than RMB20 billion. Therefore, the default of 20 Yongcheng Coal SCP003 not only triggered cross-default of other bonds of Yongcheng Coal, but also resulted in accelerated maturity of some bonds issued by Henan Energy and Chemical Industry Group.

Diverse solutions

As bond defaults occur in various forms in the market, technical and atypical defaults have emerged one after another. As a result, a variety of disposal solutions have been developed.

Bond buyback.
In November 2020, the NAFMII issued the Notice on Trial Implementation of Cash Tender Offer in China’s Non-financial Enterprise Debt Financing Instruments Market. The Shanghai Stock Exchange has also stipulated in its guidelines on the application of rules for the review of bond issuance and listing that the issuer’s prospectus may include clauses on bond swap or buyback.

Xinzheng New Area Development Investment Company made a cash tender offer for 16 Xinzheng Development PPN001 on 4 December 2020. It was the first case of a cash tender offer in China’s interbank bond market.

Bond swap.
In June 2020, the People’s Bank of China, the National Development and Reform Commission and the China Securities Regulatory Commission jointly issued the Notice on Matters Concerning the Disposal of Corporate Credit Bond Defaults, noting that the issuer and the bondholders may enter into debt restructuring arrangements, such as a bond swap and extension, on the basis of equal negotiation and free will. Bond swap cases in the market include 17 Sound Environmental Engineering MTN001, 17 Huachangda 01 and 17 Wafangdian 02.

Discounted payment, deferred payment and third-party payment.
For example, Yongcheng Coal, after its bond default occurred in 2020, went through the resolution process of the bondholders’ meeting and deferred 50% of the bond payments that would become due soon, thus easing the issuer’s liquidity stress and debt pressure with extended time allowed for debt payments.

Litigation and arbitration.
Litigation mainly involves bondholders initiating legal proceedings on their own behalf or trustees representing either all or a portion of the bondholders in the lawsuit. In addition to the bond default claims, investors can also file tort claims against the issuer and its supervisors and senior managers, controlling shareholder, actual controller and related intermediaries, such as the lead underwriter.

Debt restructuring and bankruptcy reorganisation.
If the issuer is debt-ridden, the issuer usually adopts debt restructuring or bankruptcy reorganisation to address bond payments, such as what happened with Huachangda Intelligent Equipment Group, Anhui Shengyun Environment-Protection Group and Chengdu Techcent Environment.

Suggestions

Based on the issuer’s experience in the disposal of bond defaults, here are some suggestions:

1. The issuer should be familiar with the rules, latest developments and regulatory approaches in different bond markets and for different types of bond.
2. The issuer should establish a risk management system internally to ensure proper risk screening and early warning.
3. When a bond may trigger a default, the issuer should actively communicate and co-ordinate with the lead underwriter, trustee and bondholders, seeking to reach a debt settlement plan without triggering a default.
4. In addition to traditional debt repayment measures, such as repaying both principal and interest, it is advisable to design a diversified range of solutions tailored to the issuer’s specific circumstances.

Wang Xiaodong is a senior partner and Shanghai-based director at Hai Run Law Firm. He can be contacted by +86 10 6521 1808 or by e-mail at wangxd@myhrtr.com