China’s Bankruptcy Proceedings: Foreign Investors Face Risks and Rewards
While there is a growing trend of foreign investment in Chinese corporate restructuring, many foreign firms are still sitting on the sidelines because they don’t fully understand the sector’s risks and rewards. The AmCham China Quarterly spoke with Xu Yu, Managing Partner of Hylands Law Firm, about the risks involved in Chinese bankruptcy cases, opportunities for offshore investment, and what investors should know before they participate.
Since 2007, Xu Yu has served as the Director of the Management Committee and Senior Partner of Hylands Law Firm in Beijing. His areas of focus include the bankruptcy and reorganization process, as well as providing a comprehensive perspective and knowledge in cases of disputed settlement proceedings, including arbitration, lawsuit, application for enforcement and the recognition of overseas arbitration. Xu has provided legal services for many large projects in areas including, commercial litigation and arbitration, Sino-foreign joint ventures, foreign investment, capital operation, international commercial loans, listing, real estate development, and import and export. Xu received his undergraduate degree from Nanjing University, a Masters of Law from both American University in Washington and City University of Hong Kong, and an EMBA from Cheung Kong Graduate School of Business.
Photo by Jin Peng
Could you give a brief overview of Hylands and your scope of work?
Xu Yu: Hylands Law Firm is one of the top ten law firms in China. Since its establishment in 1997, we have grown into a comprehensive law firm with 32 offices, 400 partners, and over 1,500 lawyers. Through our hard work, Hylands has established working relationship with more than 150 law firms in 130 countries and regions.
What’s your personal area of expertise? What are you most passionate about?
Xu Yu: I am the managing partner of Hylands’ Beijing Office. My main practice areas are dispute resolution, and bankruptcy & insolvency. So, that means I’m mainly focused on assisting on defending my client’s legal rights through litigation, arbitration, or other remedies. I have played almost every role in the process of bankruptcy & insolvency. At Hylands, we oftentimes act as administrators, helping insolvent companies to formulate reorganization plans and get the business back to track; sometimes as creditors’ lawyers, helping clients to file and negotiate their claims in insolvency proceedings; or as counsels for the reorganizers, where we help our clients to participate in the reorganization plan in the proceedings and balance their interests.
In particular, when we are involved in the reorganization process as administrators, we use our expertise and experience to develop a reorganization plan based on the different circumstances of each insolvent company. Nothing is more professionally satisfying than when a reorganization plan can bring an insolvent company back on track. By “back on track” I mean that the creditors maximize their recoveries, employees avoid losing their jobs, the reorganizer makes a profit, and finally, we win the support from both the local government and People’s Court.
What are the opportunities and challenges in bankruptcy cases in China?
Xu Yu: Bankruptcy and restructuring can be a useful way to conduct mergers and acquisitions in different industries. There are many reasons why companies go into crisis, from insolvency, and cash flow failure, to unsustainable operations. But, no matter what the reason is, there are always high-quality assets in these bankrupt companies, that includes both tangible assets like land, plants, and equipment, as well as intangible assets such as Intellectual Property including patents, trademarks, upstream and downstream industrial chains, and market shares. Under normal circumstances, these assets are not for sale, or if they are, they are incredibly expensive. However, in the case of bankruptcy, the combination of market expectations and pressure from various parties opens the channel for these assets to be sold, while the price is usually significantly lower than the market price.
On the other hand, bankruptcy is a legal liquidation and reorganization process under Chinese law, which legally guarantees the security of assets sold through bankruptcy; the potential risks are visible and controllable. International investors can participate in the liquidation and reorganization process of bankrupt enterprises, and are able to obtain extremely high-quality and cheap assets.
What are the opportunities in this area, specifically when it comes to offshore investment?
Xu Yu: Foreign investors are seeking both industrial and financial investment opportunities in the Chinese market. Legally speaking, such investments are bound to be accompanied by risk. In terms of dispute resolution, it requires professional practitioners who are familiar with Chinese law and market assess to evaluate risk from the outset.
In the past, we represented a fund whose primary Limited Partnership (LP) was a US investor that was at risk of defaulting on its investment in the Chinese real estate market. In this case, we helped to develop a litigation plan that preserved the core assets of the underlying company. This allowed the fund to exit quickly from a crowd of creditors and successfully recover the principal and interest on their investment.
Liquidation and reorganization of Chinese companies can provide broader and better investment opportunities for foreign investors. Investors can borrow funds as a Total Interest Creditor (TIC) to obtain safe and high returns, or they can directly participate in the reorganization as a reorganizer and obtain assets, equity, trademarks and patents, as well as market shares and upstream and downstream industrial chains of the enterprise as the owner or major shareholder.
What should foreign investors know before participating in bankruptcy proceedings in China?
Xu Yu: Like I said, an investor can act as a co-beneficial creditor and borrow cash for a reorganized bankruptcy enterprise. According to the relevant provisions of China’s bankruptcy law, the borrowings of co-beneficial creditors are paid in priority over other creditors to ensure that investors obtain a more generous return on their investment on a safer and relatively more secure basis.
Importantly, US investors, or other international investors, can participate in the bankruptcy reorganization process of a company as a reorganizer of the bankruptcy enterprise and directly formulate the reorganization plan of the enterprise, thus providing comprehensive clarity on the investment, operation and exit procedures at the beginning of the investment and maximizing and securing the return on investment.
In the past, we represented a well-known US investment firm in a bankruptcy reorganization of a Chinese company. In its capacity as the reorganizer, this investment firm directly formulated the relevant reorganization plan, which clearly defined the investment, operation and exit paths of “establishing a new company”, “absorbing high-quality assets of the enterprise to be bankrupted”, “separating non-performing assets” and “listing the new company”, ensuring a safe, controlled, and substantial return on its investment.
Finally, foreign investors, who can participate in the disposal of assets of bankrupt companies, can directly participate in the auction, sale, and offsetting procedures of the assets of bankrupt companies, consequently obtaining more affordable and high-quality assets.
How has the pandemic affected your clientele? Hylands participated in a program providing welfare legal services to SMEs in Hubei. What kind of legal assistance was most in demand by these SMEs?
Xu Yu: COVID-19 has been extremely detrimental to small and micro enterprises in Hubei, with many owners even losing their businesses. Following the initial outbreak, we jumped into action to aid these small and micro enterprises in Hubei. The first part of the program, was to mobilize our partners and lawyers to donate a total of RMB one million to the Hubei Small and Micro Enterprise Assistance Fund to provide urgent financial support. After that, we established a legal aid team to help with their different legal issues during the epidemic.
Are there any case studies you can discuss from this program?
Xu Yu: Post-pandemic, many micro and small enterprises in Hubei were faced with contractual breaches. Our lawyers have done a lot of work to analyze and study each respective situation in detail, and have sought “Force Majeure” in accordance with the provisions of Chinese law. This work has helped these enterprises reduce losses, control costs, and get the business back on track.