On January 29th 2024 international creditors gained a winding-up order against China Evergrande Group (‘Evergrande’) in the Hong Kong courts.1 This is a test case for the rights and remedies available to international investors in China. The Chinese authorities, inactive up to now, face two equally damaging ways out of the corner their inactivity has backed them into.
Bargaining position of the international creditors
Evergrande’s international bonds in US$ are a small fraction of the group’s debts and on the face of it the international creditors have a very weak negotiating position.2
The bonds’ debtor – the group parent company – is incorporated in the Cayman Islands and is a holding company for shares in a string of subsidiaries in mainland China.3 These companies are only intermediary ‘holding companies that do not have significant operations’, and are the Subsidiary Guarantors of the bonds.4 The international creditors also have a pledge over the shares in these companies.
The international creditors are several steps removed from having a priority claim on any of the group’s main assets – properties in mainland China owned by subsidiaries of the Subsidiary Guarantors. The international creditors have no pledge over the shares in these property-owning companies nor a mortgage over the properties themselves. Those properties will be mortgaged to other lenders, and even the Subsidiary Guarantors can borrow from other lenders.5
The bonds’ governing law is New York state law, but that there is no exclusive jurisdiction: creditors can bring suit anywhere, with the limitation that they have no automatic right of enforcement in the place that really matters – mainland China.
The Offering Memorandum pp. 9-10 contain summaries of legal advice on the obstacles that sit between getting a positive court judgement, enforcing it, and getting money back. Advice was sought in the Cayman Islands, the British Virgin Islands, Hong Kong, and mainland China.
What has happened in the Hong Kong courts?
The creditors chose to bring suit in Hong Kong because of its England-like legal system and the consequent higher likelihood of winning the case. The Hong Kong courts accepted jurisdiction because Evergrande’s shares are listed in Hong Kong. There is an added twist of whether the Hong Kong courts applied Hong Kong law to the case or the bonds’ governing law. The defendant will have grounds for appeal if the court either applied New York state law and misinterpreted it, or applied Hong Kong law and there was a disparity of the outcome compared to applying New York state law. No doubt there will be an appeal but a judgement exists, and in this case a strong one – a winding-up order.
What might happen next?
Now a liquidator of the group parent will be appointed. The first step to getting money is to enforce the guarantees against the Subsidiary Guarantors, possibly obtaining winding-up orders against them as well. The objective would be to gain control of the shares that the Subsidiary Guarantors own in the property-owning companies, and try to force the sale of the properties.
Sale proceeds will first go to satisfying the secured creditors of the property-owning companies and then their unsecured creditors. The remainder, if any, is attributable to the creditors’ pool of the Subsidiary Guarantors, on which secured creditors – if any – of the Subsidiary Guarantors have first claim. The international creditors become unsecured creditors of the Subsidiary Guarantors by calling their guarantees, as well as being their owners by executing the pledge over their shares. The international creditors will hope that they and all the other unsecured creditors of the Subsidiary Guarantors can be satisfied and that there is something remaining for them as owners as well.
That is a long, messy legal road: a multi-year bloodbath possibly involving local creditors being steamrollered by foreign ones, or Chinese citizens being evicted, or Chinese citizens who have made prepayments on partly-built properties losing their money. It requires many assets to be sold and other creditors to be satisfied before the international creditors receive anything, and presupposes that the underlying properties can be sold and for a reasonable price.
What has been the attitude of the Chinese authorities so far?
Up to now the Chinese authorities have been content to let things take their course in the hope that they would improve of their own accord, legal proceedings could be delayed etc., but that approach has failed and the proceedings have come very close to home. The authorities now need to take a more active line i.e. to take a decision to do or not to do something.
Why no good route out of the box exists for the Chinese authorities
The consequence of deciding to continue to stand back is the multi-year bloodbath imposed by foreign creditors on China: the Communist Revolution was supposed to stop all that. Its occurrence would threaten the Party’s grip on power. The weak position of the international creditors ironically ensures that the bloodbath will be more acute and last longer as they exhaust all possible angles for getting their money back.
The other exit route is to intervene, influence the Chinese courts towards judgements that the Communist Party considers to be in the country’s interests, showing that the courts are not independent and that foreign creditors do not enjoy the same kinds of investor protections as in an open Western economy, or Hong Kong for that matter.
No pressure, then.
1 https://www.reuters.com/business/embattled-china-evergrande-back-court-liquidation-hearing-2024-01-28/ accessed on 1 February 2024.
2 The key terms applying to Evergrande’s bonds are in the Offering Memorandum for US$3.8 billion of Senior Notes issued in 2017 and maturing between 2021 and 2025.
3 ‘Holding company’ means a company whose business is solely to hold shares in subsidiary companies
4 Offering Memorandum p. 21.