As China’s real estate sector continues its downward adjustment, multiple developers are entangled in debt distress. Bankruptcy restructuring has thus emerged as a vital mechanism for reviving troubled projects. Within this crisis, strategic investors can find significant opportunities. Distressed developers often possess prime assets. Through restructuring, investors can secure land resources at a discount, facilitate project completion and secure attractive investment yields.
This article analyses prevalent investment models in such restructurings and offers practical guidance on risk prevention from an investor’s standpoint.
Investment models
Partner
Tahota Law Firm
Tel: +86 151 7147 9213
E-mail:
shaohua.peng@tahota.com
Asset-based investment model. Under this approach, the investor acquires all or selected assets of the distressed debtor – typically land-use rights or projects under construction – with the purchase funds directed towards debt repayment. The investor subsequently assumes control to finish the development. A notable application was seen in the restructuring of Wuxi Fulongcheng Real Estate Development, recognised as one of Jiangsu province’s top 10 bankruptcy cases in 2017.
With corporate equity entirely encumbered by pledges and freezes, Fulongcheng pursued a sell-off restructuring, divesting its unfinished project. Nanjing Urban Construction Development Group, under Greenland Group, stepped in as the restructuring investor, securing the Hongmei New World project assets for RMB470 million (USD67.4 million) and overseeing its subsequent completion and delivery.
This investment model offers clear risk segregation, direct asset control and relatively simple legal frameworks, usually insulating the investor from the debtor’s financial risks. Its limitations are equally apparent: elevated costs from transfer taxes and fees; administrative complexity in retitling and re-permitting assets; and the risk that existing charges, such as mortgages, could hinder the final transfer.
Equity-based investment model. Under this model, the investor becomes a shareholder in the distressed debtor, typically through a capital increase or an equity transfer. The investment is directed towards debt repayment and project continuation. In the Henan Chaoge Real Estate Development bankruptcy reorganisation, the investor purchased the entire equity stake, indirectly acquiring the debtor’s assets and assuming obligations outlined in the draft reorganisation plan – including completing construction, obtaining permits and improving supporting facilities – to revitalise the assets.
Its benefits centre on the prospect of significant returns and direct operational authority. The fundamental risk stems from the debtor’s ongoing legal existence, which poses a threat from potential hidden liabilities.
Debt-based investment model. This model involves the investor providing a loan to the debtor – typically structured as a common benefit debt – specifically to fund the restart and completion of a stalled project. Project sales proceeds are earmarked as the priority repayment source.
A case example is the restructuring of Ziyang Sihai Real Estate Development. Faced with an excessively high and opaque debt burden, which ruled out an equity-based investment route, the administrator opted for a “common benefit debt investment”. An agreement with the investor established the loan’s interest rate and secured repayment against future sales revenue from the revived project.
This model benefits investors by providing a statutory priority claim while circumventing costly asset transfer taxes. However, it offers limited project control and a repayment status that is junior to the claims of property purchasers, builders and secured lenders. The returns are typically fixed interest, precluding a share in any capital gains from the project’s success.
Operational trusteeship model. Under this model, the investor serves as a professional operator, entrusted with managing the distressed developer and its project without taking an equity stake or providing debt financing. Compensation is derived from management fees.
The key feature is the investment of non-financial capital: the investor’s professional capability, sector knowledge and network of resources. Its use is therefore conditional, generally only suitable where operational deficiencies are the root cause of the distress. It may be deployed alongside other models, for instance, in a hybrid “common benefit debt + operational trusteeship” approach.
Risk prevention measures
Restructuring investors should align their choice of investment model with their available capital, risk profile and the project’s specifics. Each model necessitates a dedicated risk management framework to address its distinct challenges.
Asset-based investment model. Essential steps include: (1) performing due diligence checks on the asset’s status and legal charges; (2) consulting tax authorities beforehand to determine cost liabilities; and (3) mapping out a viable course for the conveyance of ownership and the updating of project permits, seeking endorsement from pertinent departments.
Equity-based investment model. Under this model, comprehensive due diligence must be carried out on the debtor company and the distressed project. Safeguards should also be put in place against contingent liabilities – for example, by negotiating with the administrator to reserve repayment funds and restricting the recognition of overdue claims in the restructuring plan.
Debt-based investment model. The strategy should focus on: (1) negotiating with priority claimants to achieve a written agreement on super-priority treatment for the common benefit debt; and (2) protecting the investment by taking a mortgage over any enhanced value from project continuation, or requesting the debtor to arrange for a guarantee or collateral from a related or third party.
Peng Shaohua is a partner at Tahota Law Firm. She can be contacted by phone at +86 151 7147 9213 and by email at shaohua.peng@tahota.com
