Bankruptcy Becomes Option in Addressing Debt Crisis

(Beijing) — Bankruptcy is increasingly becoming an option as the Chinese government moves to wipe out overcapacity, reorganize distressed companies and restructure the economy.

Policymakers are showing more tolerance for the collapse of debt-ridden state-owned enterprises (SOEs), which once operated with an implicit guarantee of debt payment by the government.

In early October, Dongbei Special Steel Group Co., China's largest state-owned specialty steel producer, started bankruptcy proceedings after defaulting on 3.6 billion yuan ($531 million) in debt. Shortly before, another state-owned metals company, Guangxi Nonferrous Metals Group, received court approval for liquidation, becoming China's first interbank bond issuer to go bankrupt.

The State Council, China's cabinet, on Oct. 10 highlighted bankruptcy as one measure for addressing China's corporate debt crisis, along with debt-for-equity swaps, mergers and others. It was the first time the State Council had issued a policy regarding bankruptcy since issuing an administrative order in 1994 on pilot bankruptcy restructurings for SOEs.

China instituted a modern bankruptcy law in 2007. However, the law has never been fully enforced as most debt disputes involving big companies were settled through negotiations led by local governments. Government units place a high priority on local employment and economic growth.

In 2014, 2,059 bankruptcy applications were filed across China by companies, about 6% of the annual corporate bankruptcy filings in the United States and a sharp contrast to the 505,866 cancellations of business registrations in China that year, according to Li Shuguang, a bankruptcy-law expert at the University of Political Science and Law in Beijing.

Owners of debt-laden businesses would rather flee than seek bankruptcy reorganization of debts through the legal system, Li said.

At the September G20 Summit in Hangzhou, Chinese leaders promised to improve the country's legal structure for bankruptcy to assist in the reduction of excess capacity. The State Council's Oct. 10 guidelines listed detailed measures to clarify judicial interpretation and policies for bankruptcy proceedings, improve bankruptcy administration and set up special bankruptcy courts.

But local governments have continued playing a key role in bankruptcy proceedings, raising concerns about whether cases have been fairly handled. Creditors of Dongbei Special and Guangxi Nonferrous have filed complaints with a bond market agency in which they said they were treated unfairly in the bankruptcy reorganizations.

In late September, a court in the central province of Jiangxi approved a bankruptcy restructuring plan for the province's largest solar panel maker, LDK Solar. Three of LDK's main subsidiaries, which make solar cells, solar wafers and polysilicon, are to undergo reorganization, while another subsidiary will be liquidated.

Under the plan, creditors will get back 3.4% to 11.5% of the money they were owed. Nearly 80% of LDK Solar's debt to banks was unsecured, ranking low in the repayment priority under China's bankruptcy law. Bank creditors could lose as much as 20 billion yuan of the 27 billion yuan they were owed.

A source close to the Jiangxi provincial government told Caixin that the government cannot afford to rescue solar companies, and so the burden must fall on creditors.

The case has drawn complaints that the government-led restructuring was designed to force banks to swallow the losses, according to a bankruptcy lawyer who declined to be named.

There are also critics of the Dongbei Special and Guangxi Nonferrous cases, as some of the companies' debt holders complained that the government-led procedure allowed the companies to transfer good assets and left creditors with losses. Most of the profitable subsidiaries of Dongbei Special and Guangxi Nonferrous remain in operation after the debt-laden parent companies declared bankruptcy.

According to a document drafted by the Liaoning provincial government on tackling the debt crisis at Dongbei Special that came to light in July, the company's ratio of debts to assets had surged to 120% from the previously disclosed 85%, and its liabilities jumped by 10 billion yuan to 55.6 billion yuan in May since September 2015.

The sudden debt surge sparked skepticism among investors.

"The figures indicate that Dongbei Special either falsified figures in previous financial reports or intentionally evaded its debt obligations through bankruptcy," said one investor in the company.

Creditors of Guangxi Nonferrous also charged that the reorganization committee, made up of local government and party officials, "violated rules to reveal information regarding the restructuring to the public and creditors," said the written complaint, which was reviewed by Caixin.

According to documents seen by Caixin, Guangxi Nonferrous owed 14.51 billion yuan to 108 creditors, including China Development Bank, Minmetals International Trust and Shanghai Pudong Development Bank.

Creditors from both companies have filed complaints with the National Association of Financial Market Institutional Investors, which oversees the interbank bond market, accusing the companies of ignoring creditors' interests. Investigations are underway, Caixin learned from sources close to the matter.

A lawyer specializing in bankruptcy cases said falsifying financial reports and asset transfers has often occurred in SOE bankruptcy cases to escape obligations. Meanwhile, local governments' intervention has also often disrupted the fairness of such cases.

Yin Xiuchao, senior partner of Beijing Dacheng Law Offices, said bankruptcy as a measure to reduce excess capacity and allow distressed companies to fold must be carried out under market rules. Otherwise, it will hurt market competition.

Contact reporter Han Wei (weihan@caixin.com)

Part1: China Confronts Danger of Large Debts With Broad Restructuring

Part2: China's Debt-to-Equity Push Triggers Concern

Part3: Public-Private Partnerships May Have Added to Debt Overhang

Part4: Government-Backed Investment Funds to Help With Deleveraging

Part6: Closer Look: China's Debt Crisis Has Similarities to 1998 Situation