Randall Arthur, Kobre & Kim
To get an overview of the major insolvency law-related developments that occurred in 2014 and a summary of the likely trends in 2015, we reached out to Randall Arthur, a locally-qualified practitioner in Kobre & Kim’s Hong Kong office, who focuses his practice on insolvency litigation, international judgment enforcement and offshore asset recovery.
Can you give us an overview of the major insolvency law-related developments that occurred in 2014?
China – Increasing Debt and Defaults on Loans
2014 saw China’s growth trajectory slow to around 7 percent under a weak property market. China’s corporate debt continued to increase in 2014, with estimates that up to 30 percent of this debt fell under the shadow banking sector – trust companies, company lenders such as state-owned enterprises (“SOEs”) and other non-bank financial entities. These structures are riskier with no guarantee backing, low levels of risk ratings and transparency.
- The first half of 2014 saw a string of defaults on inter-company loans with several listed firms reporting missed loan repayments, often in cases where firms with excess cash made loans to real estate developers which struggled with falling property prices due to oversupply. One example is property developer Nanjing Fudi Real Estate Development Co. Ltd defaulting on interest payments on a RMB 900 million loan owed to listed shipbuilding firm Sainty Marine Corp Ltd.
- There were a number of defaults on payments due on entrusted loan structures with high interest rates in typically risky industries such as solar panel manufacturing. According to stock exchange filings, solar equipment manufacturers, Baoding Tianwei Baobian Electric Co. Ltd and Sichuan Chuantou Energy Co., failed to receive payments due on entrusted loans to their own subsidiaries.
- In March, Shanghai Chaori Solar Energy Science and Technology Co. defaulted on interest payments on RMB 1 billion worth of bonds, China's first domestic bond default. However, it was bailed out by a state-owned bad-loan bank suggesting that even risky credit continues to enjoy the protection of a government guarantee.
- Suntech Power Holdings Corp., the Chinese solar-panel maker that defaulted on $541 million of bonds, filed for Ch. 15 bankruptcy in the US courts seeking protection from US creditors while it undergoes restructuring efforts in the Cayman Islands (“Cayman”).
- These trends have provided plenty of opportunities for insolvency related litigation in China. 2014 has seen an increase in cross border insolvency administrations such as Suntech.
Cross border insolvency litigation:
There has been a notable increase in applications to the Hong Kong courts to wind-up foreign incorporated companies not registered in Hong Kong, in light of the absence of cross border insolvency legislation in Hong Kong. The Hong Kong courts have a discretionary power to wind up a foreign incorporated company if it can be demonstrated, on the 3 core tests outlined in Re Pioneer Iron & Steel, unrep., 6 March 2013, HCCW 322/2010, that the company has a sufficient connection with the territory pursuant to s. 327 of the Companies (Winding-up and Miscellaneous Provisions) Ordinance (“CWO”).
- A number of cases commenced in the Hong Kong courts seeking to wind-up foreign companies were determined in 2014. In the China Medical Technologies, Inc., unrep., 28 August 2014, HCCW 435/2012 decision handed down on 28 August 2014, the Companies Judge, the Hon. Mr. Justice Harris held, following two separate hearings and a successful application by the petitioner to introduce new evidence, that there was a sufficient connection with Hong Kong and a sufficient benefit in making the winding up order (see also China Medical Technologies, Inc.  2 HKLRD 1997, decision handed down on 9 April 2014). Conversely, in Insigma Technology Co Ltd, unrep., 15 October 2014, HCCW 224/2013, a Swiss company failed in its petition to wind-up PRC listed company Insigma following the registration of an arbitral award in Hong Kong, on the basis that Insigma’s interest in a Hong Kong company formed only a small part of its assets – and thus there was insufficient connection with Hong Kong.
- In Re A Company, unrep., 21 July 2014, HCMP 902/2014, the Hong Kong High Court recognised a Cayman liquidation and made disclosure orders against parties situated in Hong Kong following a letter of request issued by the Cayman Court. This enabled the foreign liquidators to obtain information and documents without having to commence an ancillary winding up in Hong Kong.
- In the case of LDK Solar Co., Ltd. (in provisional liquidation) 10 December 2014, HCMP 2215/2014, HCMP 2216/2014 & HCMP 2218/2014 the second most-indebted solar manufacturer in 2013, the Hong Kong High Court sanctioned a scheme of arrangement. The Grand Court of the Cayman Islands gave a favourable ruling leading to the US Bankruptcy Court granting a final approval on 21 November 2014 to restructure over US$700 million in claims owed by LDK and its subsidiaries incorporated under multiple jurisdictions.
- The Hong Kong government concluded its consultation to revise the corporate insolvency provisions under the CWO in May. The underlying objectives of this exercise are to facilitate a more efficient administration of the winding-up process, increase protection of creditors and enhance regulation of the winding-up process in the context of cross-border experience. The government also developed detailed proposals on the introduction of a new statutory corporate rescue procedure and consulted stakeholders on these proposals in 2014. Notably absent is any proposal to introduce cross border insolvency laws.
How do you predict the insolvency law landscape will evolve in 2015?
In China, throughout 2015 there is speculation that we will see an acceleration of trust failures and continued default risk in high-yield bonds and entrusted loan structures, particularly in typically risky industries such as the solar panel manufacturing, non-ferrous metals and property sectors.
- While risk continues to mount, there are no signs of listed companies losing enthusiasm for offering entrusted loans. 2014 saw companies Lingyun Industrial Corp. Ltd, Atlantic China Welding Consumables Inc. and Tianjin Songjiang Co. Ltd announce new entrusted loans and this trend is expected to continue in 2015.
- These risky loan structures in a fragile property market with slowing GDP growth are likely to lead to continuing defaults by borrowers, including property developers from smaller Chinese cities, this year. Chinese real estate companies will be a group to watch closely this year (the new year has already seen a default in loans and interest payments on offshore bonds by real estate company Kaisa Group Holdings Ltd).
- It is anticipated that there will be a continual stream of financial litigation by creditors seeking to enforce against defaulting borrowers, and that a large number of these defaults will be due to failures to repay high rates of interest on loans in volatile industries.
There has also been a recent growing trend of PRC and Hong Kong listed companies and investment funds incorporating in offshore jurisdictions such as the Cayman and BVI, to take advantage of more flexible tax structures.
- It is reported that more than 75 percent of companies that have listed in Hong Kong in the past 10 years are incorporated in the Cayman Islands, including SOEs. The start of 2015 saw Hong Kong tycoon Li Ka-shing announce a sweeping restructuring of his business empire by switching its base of incorporation from Hong Kong to the Cayman Islands.
- It is expected that Cayman and BVI will continue to dominate as China’s and Hong Kong’s hubs for offshore investment funds, and creditors seeking to enforce against defaulting Chinese borrowers commencing litigation in these offshore jurisdictions. 2013 saw an increase in winding up petitions filed against Cayman incorporated entities in respect of loans from the 2008 financial crisis by creditors tired of waiting for restructuring efforts to materialise, and it is expected that 2014 figures will show a similar pattern with this trend continuing into 2015. These petitions are likely to involve a number of Chinese entities.
- The absence of cross border insolvency legislation in Hong Kong means that common law principles of comity will continue to be applied in relation to cross border issues. Thus, in 2015 the Hong Kong courts are likely to see further petitions to wind-up foreign companies in Hong Kong, as was the case in 2014. Liquidators and other appointment takers from overseas jurisdictions seeking further information and documents in respect of companies subject to an foreign insolvency administration are likely to resort to the letter of request route following the decision in Re A Company, unrep., 21 July 2014, HCMP 902/2014. Such applications may, however, be affected by the recent Privy Council decision in Singularis  UKPC 36.
- The Hong Kong government is aiming to introduce to the Legislative Council an amendment bill in 2015, to revamp the corporate insolvency provisions under the CWO and to adopt a corporate rescue procedure, after obtaining widespread support in 2014. The government will continue to consult industry professionals in this exercise.
The effects of globalisation are seeing companies increasing their international presence by opening offices in multiple jurisdictions or via cross-jurisdictional mergers and acquisitions to amp up their global profiles. This is likely to bring about many cross-border financial and insolvency litigation opportunities.
How do you anticipate the liberalisation of the practice of law in China will impact your practice or law firm?
The liberalisation of the practice of law in China is spearheaded by the setting up of a free trade zone (“FTZ”) in Shanghai, and an MOJ approved Pilot Work Scheme for Exploring China-Foreign Law Firm Business Cooperation Methods and Mechanisms in the China (Shanghai) Free Trade Zone (Shanghai FTZ) (“Scheme”). This will encourage continued economic growth in China and business for local companies, as well as attract foreign investment into the area. 2015 saw the creation of three further FTZs in Guangdong, Tianjin and Fujian, China, as reported by state-newspaper Xinhua. This will bring about greater access to the local market and enhance the exchange of knowledge between foreign and local law firms.
The prospect of working closely with local law firms in China is exciting and is likely to bring about many opportunities to work on insolvency cases for Kobre & Kim, including cross border cases, in a climate of increasing debt and defaulting loans. The types of financial and insolvency litigation trends that are being seen in China are likely to result in an increase in matters incoming to the firm, enabling its global network of offices to work closely together from key locations in the US, UK, Cayman, BVI and Hong Kong.