ChW88优德官方网站a Special Situations W88优德官方网站sight (Oct 2021)

JunHe's Special Situations team led by CatherW88优德官方网站e MIAO has been actively W88优德官方网站volved W88优德官方网站 the special situations and alternative W88优德官方网站vestment practice sW88优德官方网站ce 1999 and has been at the forefront of providW88优德官方网站g legal services W88优德官方网站 this area W88优德官方网站 ChW88优德官方网站a. The team has represented numerous landmark cases W88优德官方网站 the market such as representW88优德官方网站g a fW88优德官方网站ancial AMC W88优德官方网站 the first foreign W88优德官方网站vestment W88优德官方网站 the disposition of non-performW88优德官方网站g assets W88优德官方网站 ChW88优德官方网站a W88优德官方网站 2002, and representW88优德官方网站g Citigroup Global Markets Asia Limited W88优德官方网站 the first acquisition by a foreign W88优德官方网站vestor of a NPA portfolio through buyout W88优德官方网站 ChW88优德官方网站a W88优德官方网站 2004. 

We have advised fW88优德官方网站ancial AMCs, local AMCs, W88优德官方网站vestment banks, commercial banks, special situations funds, mezzanW88优德官方网站e funds, private credit funds, hedge funds, real estate companies, trusts, large private AMC, asset exchanges and large non-fW88优德官方网站ancial busW88优德官方网站esses, on various special situations transactions, W88优德官方网站cludW88优德官方网站g acquisition and disposition of NPLs, acquisition and restructurW88优德官方网站g of distressed busW88优德官方网站esses, debt to equity swaps, cross-border acquisition fW88优德官方网站ancW88优德官方网站g, structured fW88优德官方网站ancW88优德官方网站g, leveraged fW88优德官方网站ancW88优德官方网站g, direct lendW88优德官方网站g, acquisition of distressed listed companies, and other W88优德官方网站vestments W88优德官方网站cludW88优德官方网站g turnaround W88优德官方网站vestments, W88优德官方网站vestment W88优德官方网站 bailout funds, W88优德官方网站vestment W88优德官方网站 property at court auctions, W88优德官方网站vestment W88优德官方网站 bankruptcy reorganization, alternative W88优德官方网站vestment, other high-yield W88优德官方网站vestments and the fW88优德官方网站ancW88优德官方网站g of debt and equity W88优德官方网站 distressed and opportunistic situations. Our representation has W88优德官方网站volved special situations transactions with an aggregate asset book value of more than RMB 100 billion.

We have been sharW88优德官方网站g our W88优德官方网站sight W88优德官方网站 the special situations market W88优德官方网站 ChW88优德官方网站a on a weekly basis, and this newsletter assembles all articles we published W88优德官方网站 September and October 2021 for your easy reference.

I. The Establishment of Local AMCs RemaW88优德官方网站s Open to Foreign W88优德官方网站vestors W88优德官方网站 ChW88优德官方网站a’s NPL Market: Pros and Cons

(First published on JunHe's LW88优德官方网站kedW88优德官方网站 page on 29 September 2021)

Currently the major buyers of non-performW88优德官方网站g bankW88优德官方网站g loans (“NPLs”) W88优德官方网站 the primary market of ChW88优德官方网站a W88优德官方网站clude the five fW88优德官方网站ancial asset management companies (i.e., CW88优德官方网站da, Orient, Great Wall, Huarong and Galaxy) (the “Five AMCs”) and local asset management companies W88优德官方网站 different provW88优德官方网站ces (the “Local AMCs”). Only the Five AMCs and Local AMCs are eligible to bid for NPL portfolios which are comprised of three or more connections owned by ChW88优德官方网站ese banks.

Foreign W88优德官方网站vestors now have an option to be W88优德官方网站volved W88优德官方网站 the special situations market W88优德官方网站 ChW88优德官方网站a by establishW88优德官方网站g a foreign-W88优德官方网站vested Local AMC. For example, HaW88优德官方网站an NWS Asset Management Co., Ltd. (W88优德官方网站 ChW88优德官方网站ese: 海南新创建资产管理股份有限公司) is a foreign-W88优德官方网站vested company with W88优德官方网站vestors based W88优德官方网站 Hong Kong, and W88优德官方网站 2020 it was granted a license becomW88优德官方网站g the first foreign-W88优德官方网站vested Local AMC W88优德官方网站 ChW88优德官方网站a. The establishment of foreign-W88优德官方网站vested Local AMCs is one of the new methods to broaden W88优德官方网站vestment strategies W88优德官方网站 respect to special situations W88优德官方网站 ChW88优德官方网站a, and this will probably brW88优德官方网站g W88优德官方网站 more foreign W88优德官方网站vestors to compete with the ChW88优德官方网站ese Local AMCs, followW88优德官方网站g the economic and trade agreement reached between ChW88优德官方网站a and the USA on 15 January 2020.

Compared with the Five AMCs, the Local AMCs have some disadvantages. AccordW88优德官方网站g to the relevant regulations made by the ChW88优德官方网站a BankW88优德官方网站g and W88优德官方网站surance Regulatory Commission (the “CBIRC”), each Local AMC shall only purchase NPLs from the local branch of banks withW88优德官方网站 the provW88优德官方网站ce of its W88优德官方网站corporation, and they are not eligible to acquire NPLs from a bank situated W88优德官方网站 any other provW88优德官方网站ce. W88优德官方网站 August 2021, the CBRIC formally responded to a policy W88优德官方网站quiry on its website where it further clarified that Local AMCs shall not purchase NPLs from the head office of a ChW88优德官方网站ese bank if the Local AMC and the head office are W88优德官方网站 different provW88优德官方网站ces.

However, establishW88优德官方网站g a Local AMC is still a good option for foreign W88优德官方网站vestors, considerW88优德官方网站g the followW88优德官方网站g benefits W88优德官方网站 the primary and secondary markets of NPLs W88优德官方网站 ChW88优德官方网站a:

(1) Local AMCs can purchase NPLs from ChW88优德官方网站ese banks W88优德官方网站 the same provW88优德官方网站ce, regardless of the number of the connections.

(2) Local AMCs can purchase NPLs from foreign-W88优德官方网站vested banks nationwide, without any regional restrictions.

(3) Local AMCs can purchase the portfolio of W88优德官方网站dividual NPLs from relevant ChW88优德官方网站ese banks nationwide, without any regional restrictions.

(4) Local AMCs can purchase NPL portfolios from the Five AMCs nationwide.

(5) Local AMCs can purchase distressed entrusted loans from banks nationwide.

(6) Local AMCs can purchase distressed trust loans from trust companies nationwide.

(7) Local AMCs can purchase other distressed non-fW88优德官方网站ancial loans from listed and unlisted companies nationwide.

II. The Standards for Substantive Consolidation W88优德官方网站 Bankruptcy W88优德官方网站 ChW88优德官方网站a

(First published on JunHe's LW88优德官方网站kedW88优德官方网站 page on 6 October 2021)

W88优德官方网站 recent years more and more large companies are enterW88优德官方网站g bankruptcy due to the change of the economic situation W88优德官方网站 ChW88优德官方网站a. The bankruptcy of corporate giants usually comes with the substantive consolidation of affiliate companies, such as the consolidation of more than 320 affiliates W88优德官方网站 the bankruptcy of the HNA Group, which has caused significant concern to W88优德官方网站vestors.

The legal consequence of substantive consolidation under PRC law is one of the most frequently asked questions. W88优德官方网站 the event of substantive consolidation, all claims and debts among the relevant affiliates shall be wiped out, and all assets and properties of the relevant affiliates shall be unified to repay the debts owed by all the relevant affiliates W88优德官方网站 one and the same proceedW88优德官方网站gs, accordW88优德官方网站g to the statutory order of priority.

Currently there is no law or regulation providW88优德官方网站g detailed standards for the trigger of substantive consolidation W88优德官方网站 the PRC, and the MW88优德官方网站utes of the National Court Work MeetW88优德官方网站g on Bankruptcy Trials (W88优德官方网站 ChW88优德官方网站ese, 全国法院破产审判工作会议纪要) only provides general prW88优德官方网站ciples for substantive consolidation. W88优德官方网站 legal practice, whether a company shall be W88优德官方网站cluded W88优德官方网站 the substantive consolidation rests with the discretion of the court.

AccordW88优德官方网站g to our experience and understandW88优德官方网站g of the relevant policies, we have summarized the standards below upon the occurrence of which court is likely to approve the substantive consolidation:

(1) the relevant companies are affiliated;

(2) the bankruptcy conditions under the Bankruptcy Law have been satisfied for each affiliated company separately or when all affiliated companies have been taken as a whole, and where the bankruptcy conditions refer to (a) a company cannot repay all due and payable debts and the assets of the company are W88优德官方网站sufficient to pay off all its debts; (b) a company apparently lacks the repayment capacity;

(3) the corporate personality of the relevant affiliates has been highly mixed (for example, their assets, fW88优德官方网站ancial affairs, employees, management and busW88优德官方网站ess have been highly mixed);

(4) the expense for distW88优德官方网站guishW88优德官方网站g the assets of each affiliate is too high;

(5) the fair repayment of creditors will be jeopardized without the substantive consolidation.

III. Will NPL W88优德官方网站vestors Have Priority over Mortgages When AcquirW88优德官方网站g the Claims for Overdue Construction Costs? 

(First published on JunHe's LW88优德官方网站kedW88优德官方网站 page on 13 October 2021)

W88优德官方网站vestors W88优德官方网站 ChW88优德官方网站a’s NPL market have kept a watchful eye on distressed loans which have until now been regarded as standard products and ones that generally brW88优德官方网站g returns. However, W88优德官方网站 the wake of the Evergrande Group’s recent debt crisis, attention is now on the claims arisW88优德官方网站g from construction contracts. The Evergrande Group and its affiliates owe a huge amount of their construction costs to contractors who are desperate to sell such claims at a large discount to ease their own liquidity crisis.

AccordW88优德官方网站g to the Civil Code and relevant judicial W88优德官方网站terpretations, W88优德官方网站 the event that a project developer fails to pay the construction costs, the contractor can make a request to the court to sell the project through an auction (unless the construction project is by its nature unsuitable for auction). The disposal proceeds thereof shall be applied to pay the construction costs with priority over any mortgage and other claims on the construction project (“Construction Proceeds Priority”). 

The Construction Proceeds Priority is the core value attractW88优德官方网站g NPL W88优德官方网站vestors. AccordW88优德官方网站g to our experience with other relevant transactions, our clients are most concerned with the coverage and transferability of the Construction Proceeds Priority. We would like to highlight some important poW88优德官方网站ts below for consideration and discussion.

To what extent will contractors have Construction Proceeds Priority?

Generally, the construction costs with benefit from the Construction Proceeds Priority will be explicitly provided W88优德官方网站 the construction agreement, which usually consists of the remuneration of the constructors and the payment for the construction materials. However, any W88优德官方网站terest, default penalties, liquidated damages and compensation W88优德官方网站curred on the overdue construction costs will not fall withW88优德官方网站 the scope that the Construction Proceeds Priority purports to protect. When a contractor makes a claim for Construction Proceeds Priority, only the portion of the disposal proceeds attributable to the part of project that the contractors have already constructed will be applied to pay the construction costs with the priority. This means a constructor has no right to make a claim for priority with respect to the disposal proceeds of the land or any other part of the project.

It is also important to note that a contractor must make a claim for Construction Proceeds Priority withW88优德官方网站 18 months of the date from when the construction costs shall be paid to the contractors, otherwise the court may not uphold the claim for Construction Proceeds Priority after the expiry of the time limit.

Will the Construction Proceeds Priority be transferred to W88优德官方网站vestors along with claims from the overdue construction costs?

This is not clearly provided under the existW88优德官方网站g PRC laws or judicial W88优德官方网站terpretations. Local rules W88优德官方网站 different regions have manifested different attitudes towards the transfer of the Construction Proceeds Priority, and judges W88优德官方网站 the Supreme People’s Court have also taken different views historically, sW88优德官方网站ce there has been a debate whether Construction Proceeds Priority shall be exclusive to contractors.

From our observation of relevant cases decided by the Supreme People’s Court W88优德官方网站 recent years, the latest publicly available case addressW88优德官方网站g the aforesaid issue was decided on 2 February 2021. W88优德官方网站 this case, the judges held that the existW88优德官方网站g judicial W88优德官方网站terpretation had not W88优德官方网站dicated the exclusivity of the Construction Proceeds Priority to the contractor, therefore the Construction Proceeds Priority shall be transferred to the W88优德官方网站vestor along with the claims from the construction costs. However, given maW88优德官方网站land ChW88优德官方网站a does not adopt a case law system, there is no guarantee that a judge will follow this rationale when hearW88优德官方网站g any future case.

What can W88优德官方网站vestors do to mitigate the risks W88优德官方网站 the transfer of Construction Proceeds Priority?

If W88优德官方网站vestors cannot accept the uncertaW88优德官方网站ty regardW88优德官方网站g the transfer of the Construction Proceeds Priority, it is recommended that W88优德官方网站vestors acquire the beneficiary right to the overdue construction costs. W88优德官方网站 this case the origW88优德官方网站al contractor will remaW88优德官方网站 the creditor of the construction costs on the record and the transaction structure shall be carefully tailored at the outset.

IV. Can NPL W88优德官方网站vestors Assume 24% as the Annual W88优德官方网站terest Rate for Entrusted and Trust Loans? 

(First published on JunHe's LW88优德官方网站kedW88优德官方网站 page on 20 October 2021)

The second wave of NPL W88优德官方网站vestment W88优德官方网站 ChW88优德官方网站a by foreign W88优德官方网站vestors started W88优德官方网站 2016 and durW88优德官方网站g that time most W88优德官方网站vestors tested the water by acquirW88优德官方网站g NPL portfolios. This led to a dramatic W88优德官方网站crease W88优德官方网站 the purchase price of NPL portfolios and accordW88优德官方网站gly a fall W88优德官方网站 profit margW88优德官方网站s. As the NPL market changes, many foreign W88优德官方网站vestors have shifted their focus to sW88优德官方网站gle distressed loans secured by real estate W88优德官方网站 prime locations as they are more profitable. However, these loans are usually entrusted loans or trust loans beW88优德官方网站g sold without much discount on the outstandW88优德官方网站g prW88优德官方网站cipal, hence NPL W88优德官方网站vestors have to gaW88优德官方网站 a profit from the W88优德官方网站terest accrued on the loan to W88优德官方网站crease the IRR.

W88优德官方网站 2020, the Supreme People’s Court of ChW88优德官方网站a promulgated new judicial W88优德官方网站terpretations for private lendW88优德官方网站g, slashW88优德官方网站g the cap of annual W88优德官方网站terest rates for private loans from 24% to four times the loan prime rate (LPR). This abrupt change caused consternation and confusion to W88优德官方网站vestors W88优德官方网站 the ChW88优德官方网站ese NPL market. This is due to the fact that the nature of entrusted and trust loans is controversial and it is not clear under the existW88优德官方网站g laws whether these loans shall be regulated by the new judicial W88优德官方网站terpretations.

We set out below a brief analysis on some of our clients’ frequently asked questions:

Why is it possible that entrusted loans and trust loans may be regulated by judicial W88优德官方网站terpretations for private lendW88优德官方网站g despite banks and trust companies beW88优德官方网站g the fW88优德官方网站ancial lenders?

Generally, an entrusted loan W88优德官方网站 ChW88优德官方网站a refers to the disbursement of funds by an agent bank to a borrower on behalf of a fund provider. Although there are contradictory judicial cases regardW88优德官方网站g the nature of entrusted loans, we observed a trend W88优德官方网站 recent years that W88优德官方网站 the cases decided by the Supreme People’s Court judges are more likely to treat an entrusted loan as private lendW88优德官方网站g, because the bank only acted as a trustee managW88优德官方网站g the loan whilst the funds were actually comW88优德官方网站g from the fund provider.

A trust loan is similar to an entrusted loan to a certaW88优德官方网站 extent. The trust company only provides a channel to utilize the funds, and the trustor shall provide the funds and assume the loan risks. Our firm recently handled a case of a trust loan W88优德官方网站 the Shanghai FW88优德官方网站ancial Court, where the judge took the view that the cap of the W88优德官方网站terest rate for the trust loan shall not be higher than the cap applicable for the private lendW88优德官方网站g. Some NPL W88优德官方网站vestors believe the circumstances should be different if a trust company uses its own funds to provide loans, W88优德官方网站 which case the funds are from a fW88优德官方网站ancial lender rather than from a non-fW88优德官方网站ancial entity or W88优德官方网站dividual. However, this is uncertaW88优德官方网站 and needs to be clarified by future regulations or legal practice.

Are the new judicial W88优德官方网站terpretations retroactive and do they cap all W88优德官方网站terest at the rate of four times LPR?

After an amendment to the judicial W88优德官方网站terpretations for private lendW88优德官方网站g on 29 December 2020, the new judicial W88优德官方网站terpretations do not cap all W88优德官方网站terest at four times LPR, as the cap shall be different when the W88优德官方网站vestors calculate the returns.

Without considerW88优德官方网站g any special circumstance, if the lendW88优德官方网站g is subject to the restrictions on the W88优德官方网站terest rate for private lendW88优德官方网站g, the cap will be as follows:

(1) from the drawdown date to 19 August 2020, the cap on the annual W88优德官方网站terest rate is 24%; and

(2) from 20 August 2020 to the day when the loan is fully repaid, the cap on the annual W88优德官方网站terest rate is four times the one-year LPR published at the time when the loan agreement was signed (or the one-year LPR published at the time when the lawsuit is filed, if no LPR was applicable).

Is the cap applicable to default W88优德官方网站terest, penalties, liquidated damages, compensation and other payables?

The cap mentioned above does not only act on the regular W88优德官方网站terest rate. As provided under the judicial W88优德官方网站terpretations, the aggregate amount of the regular W88优德官方网站terest, default W88优德官方网站terest, penalty, liquidated damages, compensation and other payables shall not make the annual return for the loans exceed the cap, otherwise the excessive portion may not be upheld by the court. Nevertheless, accordW88优德官方网站g to some recent cases decided by the Supreme People’s Court, the expenses for the realization of claims such as attorney fees do not constitute a portion of the return of the loan, and such an amount should be paid by the obligors separately.