As has been widely reported in the media, there has been a period of considerable stress in the real estate sector in Mainland China with a number of high-profile property developers having reportedly either already defaulted on onshore and offshore bond repayments or are on the verge of a payment default. The current credit crunch in this sector is largely a result of China’s three red lines policy which was introduced in August 2020 to improve the financial health of the real estate sector by controlling excessive leverage and a slowing ‘Covid’ economy, which is crushing domestic home sales.
The cash-strapped developers include China Evergrande Group, Kaisa Group Holdings, China Fortune Land Development, Yuzhou Group Holdings, Modern Land (China), Sunac China Holdings, Fantasia Holdings, Sunshine 100 China Holdings, Shimao Group Holdings, and China Aoyuan Group. A number of these companies have already had trading in their shares suspended on the Hong Kong Stock Exchange mostly due to failure to produce timely audited financial results.
Evergrande is perhaps receiving the most global attention as the world’s most indebted property developer. According to the BBC, Evergrande, with more than US$300 billion in liabilities, has already defaulted on interest payments to international investors, and which prompted Fitch Ratings, a top credit rating agency, to downgrade its credit rating to a substantial credit risk rating.
In the event that a financial restructuring is not possible and creditors form the view or anticipate that there will be a payment default, they will need to be ready to implement a suitable debt recovery or enforcement strategy to maximise their prospects of getting repaid.
For the many Mainland property developers listed in Hong Kong, the corporate structure often involves an ultimate holding company incorporated offshore in a jurisdiction such as Cayman or BVI (usually to minimise tax liability and with less stringent regulatory requirements) which, in turn, has multiple indirect wholly-owned operating subsidiaries in the Mainland, where ultimately the true value of the business in terms of asset value is held. This complicated and cross jurisdictional legal structure can be challenging for creditors when it comes to taking enforcement action against the defaulting property developer or its related group companies. There will usually be multiple creditors both onshore (Mainland banks, bondholders, suppliers) and offshore (international banks and international bondholders).
In order to maximise recovery prospects and develop an effective litigation strategy, it is necessary to review and understand the specific corporate structure and contractual and financing arrangements and identify the potential causes of action, the proper legal ‘target’, the proper jurisdiction to commence legal action, and to consider the physical location of assets to enforce against. This analysis is critical. As an aside, creditors should also bear in mind that senior management of Mainland companies usually prefer to try and reach an amicable solution or settlement of disputes through negotiation rather than launching into legal proceedings.
In Hong Kong, creditors can deploy a number of enforcement options, including liquidation or ‘winding-up’ proceedings against the debtor company, a debt restructuring or ‘work-out’, commencing litigation through the courts and potentially arbitration proceedings if the relevant contracts/agreements contain a valid arbitration clause. Each process has its own unique procedural requirements, advantages and limitations.
Depending on the particular circumstances, there are also various ‘interim relief’ measures available to creditors in Hong Kong to immediately identify and protect assets and/or ‘preserve the status quo’ until there has been a final determination by the court or arbitration tribunal.
We have prepared a guide below outlining in detail the various debt recovery options available to creditors in Hong Kong which might be appropriate depending on the particular circumstances of the payment default.
Insolvency co-operation between Hong Kong and the Mainland
On May 14, 2021, the Supreme People’s Court of the People’s Republic of China (‘SPC’) entered into the Record of Meeting of the Supreme People’s Court and the Government of the Hong Kong Special Administrative Region on Mutual Recognition and Assistance to Bankruptcy (Insolvency) Proceedings between the courts of the Mainland and of the Hong Kong Special Administration Region (‘Record of Meeting’) with the Government of Hong Kong SAR and promogulated The Supreme People’s Court’s Opinion on Taking Forward a Pilot Measure in relation to the Recognition of and Assistance to Insolvency Proceedings in the Hong Kong Special Administrative Region (‘SPC’s Opinion’). The Record of Meeting and the SPC’s Opinion now offer a formal channel for both insolvency practitioners in Mainland China and Hong Kong to seek recognition and assistance from courts of both sides. Prior to the Record of Meeting, the Hong Kong court had already recognised and assisted administrators appointed under the bankruptcy/ liquidation proceedings of the Mainland Enterprise Bankruptcy Law 2006 by way of common law. Hence, the Record of Meeting specified that the common law route would also extend to reorganisation and compromise proceedings under the Mainland Enterprise Bankruptcy Law 2006.
As shown above, there are a number of enforcement options and interim remedies available to creditors who may seek to recover their debts in Hong Kong. In the context of the Mainland’s real estate debt crisis, it is essential for creditors to carefully review the legal, practical and jurisdictional aspects of each distressed situation to devise an enforcement strategy which will maximise commercial pressure and ultimately be effective in terms of actually obtaining a financial recovery. This should also include close monitoring of the continuing development of cross-border insolvency cooperation arrangements between Hong Kong and the Mainland. Our well-recognised insolvency disputes team have recently provided informative updates on these evolving and important legal developments.