Credit risk incidents have occurred frequently among China’s property developers since the second half of 2021. Even developers with a nationwide footprint have collapsed, such as Evergrande and Sunac.
The number of delistings or winding-up petitions filed abroad against property developers has also reached an all-time high, most notably the High Court of Hong Kong ordering the liquidation of Evergrande on 29 January 2024.
Senior Partner
Zhong Lun Law Firm
Tel: +86 755 3325 6666
E-mail:
xushengfeng@zhonglun.com
In turn, the widespread liquidity crunch and debt crisis of troubled property developers have dealt a heavy blow to the financial system, real economy, and even social stability; with the complex debt chain of developers having a notable spillover effect on the macro economy.
Although no nationwide developer has entered bankruptcy proceedings yet, numerous restructuring cases are emerging among regional developers or development project companies, and these face many difficulties and challenges. Not only does such restructuring involve subjects with intense right conflicts – such as homebuyers, project contractors and mortgagees. It also relates to complicated social issues, such as people’s livelihoods and social stability, as well as many frontier legal issues.
Restructuring proceedings
The Enterprise Bankruptcy Law provides relatively loose acceptance criteria for restructuring cases, clarifying that restructuring applies to insolvent enterprises, and can also be applied earlier to businesses with the probability of being saved from failure.
It aims to provide a rescue mechanism in the early stage to promote the success of restructuring.
In judicial practice, however, courts are often more cautious about commencing the restructuring process, due to complex issues such as ensuring housing delivery to homebuyers, mass-related financial crimes involving both criminal and civil liabilities, and the co-ordination of domestic and overseas restructurings. Besides, the supportive attitude of local governments towards developers tasked with ensuring housing delivery to homebuyers usually serves as an important consideration in accepting and examining a case.
Overseas and domestic
Mainland property developers rushed for Hong Kong IPOs around 2010, with many top developers successfully listed. Typically, an overseas listed company acquires equity interests in domestic enterprises through the equity chain that involves multiple tiers of shareholding platforms in the mainland, but it does not hold real assets and usually undertakes overseas debts.
Under this mode, the mainland company holds real assets and development projects. Therefore, the Hong Kong-listed developer in trouble can initiate overseas debt restructuring proceedings legally, such as in Hong Kong, while the mainland project company that owns real assets – in which the developer holds a stake – can initiate reorganisation proceedings under China’s bankruptcy law.
On 14 May 2021, the Supreme People’s Court (SPC) and the Hong Kong government signed the Record of Meeting on Mutual Recognition of and Assistance to Bankruptcy (Insolvency) Proceedings between the Courts of the Mainland and of the Hong Kong Special Administrative Region. This has created a co-operation mechanism for recognition and assistance in bankruptcy proceedings between the two sides, enabling the co-ordination of domestic reorganisation, Hong Kong winding-up proceedings, and corporate debt restructuring proceedings.
Therefore, to figure out the best solution to defusing risks across the board, distressed property developers listed in Hong Kong can also explore a co-ordinated mechanism for overseas debt restructuring and domestic reorganisation proceedings. Even so, there are limited cases of mutual recognition and assistance in bankruptcy between the mainland and Hong Kong to date. Its function in defusing the risks of troubled developers remains to be seen.
In addition, as Hong Kong-listed property developers and mainland companies holding real assets are both independent legal persons, the liquidation of a listed developer by the High Court of Hong Kong will not directly affect the operation of the mainland company and its work “ensuring housing delivery to homebuyers”.
Consolidation and bankruptcy
Most developers in trouble involve many affiliated companies. For large-scale reorganisation of conglomerates, substantive consolidation is instrumental to overall risk mitigation and efficiency enhancement. For example, in 2021 Hainan Higher People’s Court effectively and efficiently heard the HNA Group case involving substantive consolidation of 321 enterprises.
In recent years, however, the SPC has adopted a more cautious guiding spirit towards substantive consolidation, requiring that courts should, when considering the applicability of substantive consolidation, strictly examine whether the corporate personalities of affiliated companies are highly confused, whether the fairness in liquidation is severely impaired, and whether distinguishing assets of affiliated companies is too costly.
However, nationwide developers often have complex equity structures and operations across business areas. Their real assets are mostly held by project companies and there is fuzzy mix-up of business segments across fields. All these factors imply difficulties in large-scale substantive consolidations and bankruptcies across segments.
Complicating matters, project companies of property developers are, meanwhile, spread across provinces and cities, and letting only one court hear the substantive consolidation case of affiliates located in different provinces does not conform to current national policy obliging local governments to “ensure housing delivery to homebuyers to stabilise people’s livelihood”. This makes it hard to establish an effective government-court linkage mechanism.
For nationwide property developers, therefore, it is quite difficult to carry out substantive consolidation to the whole group in bankruptcy. It may be more realistic and feasible to substantively consolidate the affiliated companies within a specified scope, such as within the same business segment or same geographical area, provided they are eligible for it.
In addition, on 20 April 2023 the SPC published and implemented the Official Reply on Issues Concerning the Protection of the Rights of Commercial Housing Consumers. To boost the confidence of homebuyers and maintain market stability, it stipulates that in dissolving the risks of distressed developers, the commodity housing consumers’ claim for housing delivery – or creditor’s right for housing price – takes precedence over the project contractors’ claims, while the project contractors’ claims take precedence over the mortgage claims of banks.
Therefore, when determining the order of payment in the reorganisation of developers, in addition to the order of creditors specified in article 113 of the Enterprise Bankruptcy Law, priority should be given to commodity housing consumers and project contractors, pursuant to judicial interpretation.
Xu Shengfeng is a senior partner at Zhong Lun Law Firm. He can be contacted by phone at +86 755 3325 6666 and by email at xushengfeng@zhonglun.com
