The recent default of Suntech Power Holdings Co. Ltd. (“Suntech”) on its convertible bonds is a reminder of the challenges that foreign creditors may face in the event that the Chinese company they have invested in becomes the subject of bankruptcy or insolvency proceedings.
As a result of Suntech’s default, cross-defaults on its debt obligations in China were triggered. Eight Chinese banks subsequently petitioned for the insolvency and restructuring of Suntech’s principal operating subsidiary in China, Wuxi Suntech Power Co. Ltd (“Wuxi Suntech”). On 21 March 2013, Suntech announced the Wuxi court’s acceptance of the petition.
The challenges that Suntech’s bondholders may face is a stark reminder of the challenges often faced by foreign creditors of Chinese companies.
Two big challenges for foreign creditors
Foreign creditors have historically had an uphill struggle in Chinese bankruptcies and restructurings, with domestic creditors taking the largest slice of the pie, or even the entire pie.
One of the main problems that foreign creditors of Chinese companies face is structural subordination. Structural subordination arises where the creditors of a company do not have access to the assets of the company’s subsidiary until the creditors of the subsidiary have been paid off and there are assets remaining which can be upstreamed to the equity holders of the subsidiary. In the case of Suntech, the bondholders are creditors of the offshore holding company, Suntech, and not the onshore operating subsidiary, Wuxi Suntech. As the majority of Suntech’s assets are held by Wuxi Suntech, in a bankruptcy scenario the bondholders will be repaid only if assets remain after the creditors of Wuxi Suntech are paid off and any remaining assets are paid to Suntech.
The heavy intervention of the Chinese government in Chinese company restructurings poses another challenge to foreign investors. For example, in the restructuring of the Asia Aluminum Group (“Asia Aluminum”) in 2009, Norsk Hydro ASA, a Norwegian company, withdrew its rescue offer for Asia Aluminum due to the Chinese government’s unfavourable reaction. Asia Aluminum was eventually restructured via a management buyout. The Chinese government approved the buyout because it was seen as likely to maintain social stability and employment – both key considerations for the Chinese government. We can expect that, likewise, the restructuring of Wuxi Suntech will be influenced by the Chinese government’s own agenda and considerations.
It’s unclear whether Suntech’s bondholders will be able to recover anything from the Wuxi Suntech restructuring. The Chinese government’s priorities to maintain social stability and employment may be a factor in ensuring that Wuxi Suntech remains in operation, which might help to preserve the bondholders’ position.
In general, foreign creditors may fare better in consensual, out-of-court restructurings. Regardless, investors are reminded to conduct thorough due diligence of companies to ascertain the long-term cash-flow status of the company they have invested in, the location of operations and assets within the corporate group structure and the likely level of long-term support by the Chinese government.