LONDON/HONGKONG, Oct 13 (Businesshala) – With China Evergrande Group’s (3333.HK) default deadline drawing closer, offshore bond investors in property developer are considering their legal options to protect their investments.
Below are some of the factors at play as offshore investors, with some $20 billion Evergrande debt outstanding, prepare to deal with a potential fallout that could become China’s biggest corporate default ever:
Do Evergrande’s offshore bonds take any guarantees from the issuer?
Chinese legal regulations prohibit mainland-incorporated parent companies from guaranteeing the offshore loans of their subsidiaries without a registration and approval process.
To work around this, offshore corporate bonds, in many cases, are issued by special purpose vehicles (SPVs) and feature a so-called keepwell structure.
The way many market participants worked around the lack of guarantees was by using keepwell deeds – an undertaking for bondholders, and offshore SPVs that issue debt, that the parent would ensure that the SPV had a positive net worth. Maintains value and remains solvent.
Keepwell structures emerged in 2012-2013, according to Fitch, which estimated that more than 16% of outstanding offshore bonds issued by Chinese corporates in 2020, or about $100 billion, would comprise keepwell structures.
Is the keepwell structure legally enforceable?
On grounds of public interest, Chinese courts are widely seen as having broad discretion to refuse to enforce a maintenance.
“The fundamental question facing investors is whether the Keepwell agreement is enforceable and what difference it might make to the recovery process if the group defaults,” said Matthew Chow at S&P Global Ratings.
Test cases for this structure have been few and far between.
Chow points to the case of Peking University Founder Group Co Ltd, where court-appointed administrators ruled last year that they would not recognize the group’s default offshore bond maintenance assignments.
But in a separate case, an offshore bondholder in CEFC Shanghai International Group Limited (CEFC), which filed a claim in Hong Kong against the company for breach of keepwell deed, obtained a default judgment in its favor.
This decision was upheld last November on the grounds that enforcement would not contrary to public interest, The law firm says Ashurst. But it notes that the decision could have been different had the proceedings been opposed.
What are the other options?
Given how strong Evergrande is in China’s economy, some analysts doubted how enthusiastic Chinese courts would be to facilitate payments to foreign creditors, potentially to the detriment of domestic ones.
David Billington, a restructuring partner at Clary Gottlieb Stein & Hamilton LLP, said creditors may have some other options.
“Instead of enforcing the keepwell, bondholders can put the offshore issuer company into liquidation or other insolvency proceedings,” Billington said.
This would essentially mean that the creditors acquire the SPV that issued the bond through a liquidator, who will then pursue the vehicle’s claims against the Chinese parent company.
Billington said such a move could improve optics for the Chinese court.
“Instead of delivering a ruling requiring direct payment to a group of foreign creditors, the Chinese court will simply uphold a promise a mainland parent made to its subsidiary, which it failed to fulfill.”
However, the nature of the issuers and the invisible hand of the authorities could prove to be a hindrance, said Carl Clorey, restructuring partner at Edleshaw Goddard in London.
“Evergrande is almost like a quasi-sovereign debt restructuring in which key stakeholders and officials no doubt know what needs to be done, although there is still room with the sponsor,” he said.
“The hands of the government and officials are never far away.”
What are the chances of cash recovery by offshore bondholders?
According to S&P, sugar rearrangements are often complex and not easily standardized. However, when it comes to dollar-bond defaults, out-of-court restructurings are common and give creditors some leeway for agreed deals with domestic creditors and on different timelines.
Tewoo Group completed an exchange and tender offer for four of its US-dollar bonds in December 2019, while the firm’s onshore in-court debt restructuring was approved almost a year later.
Even an in-court restructuring isn’t always a comfortable read when it comes to cash recovery rates—which depend on a number of factors, from asset quality to equity ownership and the complexity of the group structure. Is.
Based on a review of nearly 50 defaulters who went through in-court restructuring, S&P found that investors saw an average recovery of 23.7%.
“Everyone is watching how it goes,” said a Hong Kong-based lawyer at a major Western law firm. “The outcome of this could affect the way restructuring is done here in the future.”