The Notice on Standardising the Classification of Trust Business of Trust Companies, issued by the China Banking and Insurance Regulatory Commission (CBIRC), classifies trust business into three categories with a total of 25 business varieties, and clearly defines the risk disposal service of trust business as a special business category. This article describes the application of a service trust according to its practice in current bankruptcy management and risk disposal.
A risk disposal service trust is divided into an enterprise bankruptcy service trust and an enterprise market-oriented restructuring service trust, which provides trustee services for enterprise risk disposal, sets up trusts to pay debts, and improves efficiency of risk disposal.
Enterprise market-oriented restructuring service trust. Trust companies provide trustee services for the risk disposal of enterprises facing debt crisis, debt restructuring or equity restructuring, and set up trusts to pay debts.
Enterprise bankruptcy service trust. Trust companies provide trustee services for the risk disposal of enterprises subject to bankruptcy restructuring, compromise or liquidation pursuant to the Enterprise Bankruptcy Law, and set up trusts to pay debts.
ADVANTAGES AND FUNCTIONS
A trust as a financial instrument can play the following (but is not limited to) roles in bankruptcy proceedings:
- Segregating the contingent and pending risks between entrusted assets and debtors;
- Divesting specific assets from debtors to meet the specific business and asset needs of investors;
- Giving full play to the professional capability of trust companies in asset operation and management, and realising the preservation and appreciation of assets;
- Balancing conflicts among all parties and distributing different creditors’ rights within controllable time ranges by setting up preferred beneficial rights to improve the efficiency of debt restructuring;
- During debt-to-equity swaps with a large number of persons, avoid limiting the number of partners or shareholders;
- Shelving asset disposal that cannot be achieved in time, reducing the pressure of disposal and liquidation, and avoiding the risk of sharp depreciation of property caused by liquidation.
COMMON TRADING PATTERNS
Sale-based restructuring + service trust. In the restructuring plan, the high-quality qualifications or specific assets of the debtor will be transferred to the new company, and the new company will transfer part of the equity to the restructuring investors and the other part to the trust plan, so that the debt is finally repaid with the funds invested by the restructuring investor and the trust share. A typical case is the restructuring of Peking University Founder Group.
In this mode, after the assets divested from the debtor are transferred to the trust plan, the doubts among restructuring investors about remaining risks, unresolved risks and contingent risks of the debtor can be effectively reduced, and fair quotation can be given in full competition; similarly, the debt-to-equity swap operation in the restructuring proceedings can be exempted from the limitation on the number of partners or shareholders.
This mode is mainly applicable to circumstances where the debtor has diversified industries and accumulated historical risks in business operations, investors only wish to invest in a portion of the debtor’s effective assets, the transfer cost of core assets is low, and it is difficult to sell off divested assets in the short term, or the assets are sold off at abnormally high prices.
Survival-based restructuring + entrusted disposal of equity. In the restructuring plan, while the debtor is still in existence, all shares enjoyed by the debtor’s actual controller or major shareholder will be divested to set up a trust plan, and distribute trust beneficial rights to creditors as debt repayment resources. A typical case is the restructuring of ZK Engineering.
In this mode, the actual controller or major shareholder of the debtor usually hands over its equity to the shareholding platform that focuses on restructuring and debt repayment. As a trustee in the trust plan, the shareholding platform takes the debtor’s equity held by it as trust property, entrusts a trust company to set up a self-benefit trust plan, and distributes the corresponding trust beneficial rights to creditors according to the restructuring plan so that creditors can enjoy the underlying asset proceeds corresponding to the equity. This mode is mainly applicable to the circumstances where the debtor’s business situation has not deteriorated substantially, profitability can be restored through debt clearing and business resumption, and debt repayment funds can be obtained through equity dividends, equity transfer, etc., which are essentially derived from the proceeds from operating the underlying assets and disposal of assets.
In practice, if a case involves a substantial merger and restructuring, it is necessary to collect the shares of the subordinate companies to the shareholding platform free of charge to complete the full equity control of the shareholding platform, and avoid the investment structure of two or more tiers, and the transaction costs generated by equity distribution under complex structures. The capital contribution not paid in full will be subject to capital reduction.
Serving as a platform for debt retention or equity conversion. According to the specific needs of investors or the number of equity conversion creditors, the debtor’s assets are entrusted to set up a trust plan, to retain debts or convert debts into equity by distributing the beneficial rights to specific creditors. A typical case is the restructuring of TEWOO.
In this mode, the trust property is usually the debtor’s property not included in the investment scope by the restructuring investors, whose value will be significantly depreciated by accelerated selling off. After the establishment of the trust, creditors can retain debt or hold equity by acquiring the beneficial right of the trust. Its essence is still that creditors hold part of the debtor’s untraded assets through the trust plan to restore the asset value through management. In practice, this mode is usually accompanied with partial settlement by cash and proportional equity conversion.
In practice, a trust can also be used for restructuring of enterprises with a small number of creditors, an abnormally high value of the debtor’s underlying assets, and strong professional management, which not only keeps the operation rights in the debtor, but also satisfies the creditors’ control and supervision over the project. Due to the increasing number of complex issues in enterprise debt restructuring, it is expected that more financial and capital market tools will be introduced in the future.
Wang Zhenxiang is a partner at Jingtian & Gongcheng
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