Restructuring & Insolvency
Global
In this issue:
Foreign creditors of Chinese companies face big challenges
With an eye on the insolvency and restructuring proceedings of Suntech Power Holdings’ principal operating subsidiary in China, Kwun-Yee Cheung surveys the difficulties confronting foreign creditors in Chinese bankruptcies and restructurings. →
Practical tips for enhancing lender priority over pension
deficiencies in Canada
A recent decision by the Supreme Court of Canada increases the risk to secured creditors when pension plans are wound up. Christopher Besant, Frank Spizzirri, Lydia Salvi, and Shaheen Karolia offer suggestions for managing the risk. →
Spanish “bad bank” offers assets for sale
SAREB, the Spanish “bad bank”, expects to dispose of almost half its portfolio of EUR 50.8 billion of underperforming real estate assets during the first five years of its business plan. Fernando de la Mata highlights the incentives being made available to purchasers of these assets. →
Dutch Supreme Court turns back clock on criterion for
estate claims
Restructuring &
Insolvency Newsletter
August 2013
Restructuring & Insolvency contacts:
Europe, the Middle East & Africa
Ian Jack London +44 20 7919 1700 ian.jack@bakermckenzie.com North America David Heroy Chicago +1 312 861 3731 david.heroy@bakermckenzie.com Asia Pacific Maria O’Brien Sydney +61 2 8922 5222 maria.obrien@bakermckenzie.com
Foreign creditors of Chinese companies face
big challenges
Background: the Suntech insolvency
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.
• Structural subordination
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.
• Government policies
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.
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.
Asia Pacific – Financial Services & Regulatory
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What’s next?
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.
Kwun-Yee Cheung Partner
Tel: +852 2846 1683
Email: kwun.yee.cheung@bakermckenzie.com
Kwun-Yee Cheung is a commerical litigation lawyer with extensive experience in company insolvency and liquidation work including cross-border security enforcement, priority of creditors’ claims, asset recovery, directors duties and intellectual property issues. She regularly acts for office holders, creditors and other stakeholders in contentious and non-contentious insolvency matters involving public as well as private companies. She teaches the corporate rescue module of the Diploma of Insolvency for the Restructuring and Insolvency Faculty of the Institute of Certified Public Accountants.
Practical tips for enhancing lender priority
over pension deficiencies in Canada
Secured lenders to Canadian corporations have long taken the risk that their security interests in the borrower’s inventory and accounts will be subordinated to deemed trust claimants under section 57(4) of the Pension Benefit Act (Ontario) (“PBA”). But the recent decision by the Supreme Court of Canada in Re Indalex increases this risk substantially by expanding the scope of the deemed trust to include not only current-service plan contributions that are due and payable but also any funding deficiencies that crystallise on the wind-up of the plan.1
Existing secured lenders may now find themselves at risk of being subordinated to a large pension deficiency if a wind-up were to occur. And given the fact that it is impossible to precisely quantify the deficiency until the plan winds up, new or prospective lenders may find it difficult to assess and price the risk.
What can be done to deal with the increased risk? • Assess the risk
Lenders will want to review their current portfolios to assess what
percentage of credit has already been extended to companies with defined benefit pension plans and what future credit, if any, should be extended. Prospective lenders will have to review and revise their due diligence process to include a detailed review of the pension plan, its current funded status on a solvency basis, the reasonableness of the assumptions that underlie the plan and the company’s future abilities to fund the plan in good times and bad. Past actuarial valuations should be reviewed and updated, if possible.
• Increase the return on the loan
Lenders may need to offset some of the uncertainty resulting from the
Indalex decision by increasing the return on the loan through increased
fees and interest rates.
• Control and monitor the borrower’s behaviour
Loan documents will need specific pension-related provisions. For example, negative borrower covenants could prohibit plan amendments that increase the employer liability under the plan, wind up defined benefit pension plans or create new plans without the prior written consent of the lender. Positive covenants could require the borrower to inform the lender of any defaults in a borrower’s defined benefit pension plan and of any notices from regulators which could lead to the wind-up of the plan. Events of default should include any steps taken by the
1 Sun Indalex Finance, LLC v. United Steelworkers, 2013 SCC 6.
A recent decision by the
Supreme Court of Canada
increases the risk that
security interests in
inventory and accounts
will be subordinated to
deemed trust claimants
when a borrower’s pension
plan winds up with a
employer or regulator to wind up the plan, and remedies upon an event of default should allow the lender to appoint a new pension plan sponsor and administrator.
In addition to the usual financial reporting, borrowers should be required to provide lenders with pension-related reporting, including updates of actuarial valuations.
A lender that obtains a board seat or observer status will need to review information presented at meetings to monitor the pension plan situation. Officers’ certificates can be requested on a regular basis confirming that the borrower has made pension plan payments in accordance with the most recent actuarial valuation report and that, to the best of their knowledge, no deficiency liabilities exist.
• Obtain additional security
A prospective lender will have to consider other potential sources of recovery, such as additional collateral from the borrower and secured guarantees from third parties. Where possible, a prospective lender should lend to a company only where the value of the collateral without accounts and inventory more than adequately secures the credit facility. • Negotiate concessions from pension plan beneficiaries and unions As its price for supporting a restructuring under the Companies’ Creditors Arrangement Act (“CCAA”), a lender may be in a good position to negotiate an arrangement with the borrower, union and pension beneficiaries which eliminates, reduces or caps a wind-up deficiency and/or subordinates the deemed trust.
In a bankruptcy/liquidation the PBA deemed trust is defeated and will rank behind secured creditors. Hence, one option for existing lenders will be to seek to issue a bankruptcy application in the appropriate circumstances. This may be a bargaining chip to encourage pensioners, unions and the borrower to agree to concessions to the secured lander.
DIP lenders are protected
The Indalex decision is not all bad news for secured lenders. The decision
confirmed that the doctrine of paramountcy, under which federal legislation prevails over provincial statute to the extent the two conflict, operates as a matter of law. Accordingly, the deemed trust created under the PBA was subordinate to the super-priority charge granted to the debtor-in-possession (“DIP”) lender by the CCAA judge, even though the paramountcy issue was not raised at the initial proceeding.
The increased risk of
subordination is difficult
to price and assess, but
secured creditors can
manage it with increased
due diligence, monitoring
and restrictions on the
borrower’s behaviour.
Christopher Besant Partner
Tel: +1 416 865 2318
Email: chris.besant@bakermckenzie.com
Christopher Besant heads Baker & McKenzie’s Financial Restructuring and Recovery Group in Canada and Chairs the National Bankruptcy Insolvency & Restructuring Section of the Canadian Bar Association. He has written and spoken extensively on cross-border issues in insolvencies and restructuring and is recognised by Euromoney’s Guide to the World’s Leading Insolvency & Restructuring Lawyers and Martindale-Hubbell. Chris has worked on a broad range of major Canadian and cross-border proceedings that affect industries spanning the Canadian economy. He provides insightful advice on matters related to domestic and cross-border reorganization, insolvency, creditors rights and syndicated lending workouts. He is also seasoned in handling distressed M&A transactions, distressed and contingent claims trading and claims aggregation, as well as complex corporate litigation matters.
Frank Spizzirri Partner
Tel: +1 416 865 6940
Email: frank.spizzirri@bakermckenzie.com
Frank Spizzirri is a partner in Baker & McKenzie’s Financial Restructuring and Recovery Group in Toronto, chairs the Insolvency Law Section of the Ontario Bar Association and an executive in the Bankruptcy, Insolvency and Restructuring Section of the Canadian Bar Association. A prolific writer and speaker, he has authored numerous articles and papers on various insolvency-related topics and has spoken at key industry conferences. Frank’s practice focuses on all aspects of bankruptcy and insolvency, corporate restructurings, as well as distressed acquisitions and
financings. He also assists clients in equipment and asset-based lending, in-possession financing, and provides sound counsel on debtor-creditor rights, director and officer liability, risk management, collections and forensic investigations.
Lydia Salvi Partner
Tel: +1 416 865 6944
Email: lydia.salvi@bakermckenzie.com
Lydia Salvi co-chairs Baker & McKenzie’s Financial Services Group in Toronto. She practices business law, with a particular emphasis on corporate/commercial financings, mergers and acquisitions and corporate restructurings and insolvencies. The restructuring side of her practice focuses on corporate restructurings, distressed merger and acquisition transactions, distressed investing and director and officer liability assessment and management. Lydia has experience representing clients in a broad range of industries including telecommunications, pharmaceutical, information technology, manufacturing, transportation, retail, food and beverage and consumer products.
Shaheen Karolia Associate
Tel: +1 416 865 6958
Email: shaheen.karolia@bakermckenzie.com
Shaheen Karolia is an associate in Baker & McKenzie’s Financial Restructuring and Recovery Group in Toronto. His practice focuses on financial restructuring, creditors’ rights, securities, mergers and acquisitions, and general corporate commercial law. Shaheen regularly advises domestic and international clients on all aspects of bankruptcy and insolvency, receiverships, cross-border corporate restructuring, as well as complex corporate and transactional matters. He has experience representing clients in a broad range of industries, including banking and financial services, mining, oil and energy, retail, telecommunications, and manufacturing.
Spanish “bad bank” offers assets for sale
What Is SAREB?The creation of a “bad bank” or asset management company was one of the conditions for the bailout of the Spanish financial system established in the Memorandum of Understanding on Financial-Sector Policy Conditionality dated 23 July 2012.
By the end of February 2013, SAREB – Sociedad de Gestión de Activos procedentes de la REestructuración Bancaria – completed its initial funding needs, and as of today, SAREB has raised a total EUR 4.8 billion of capital. The company is owned 55% by private investors and 45% by the FROB (a public restructuring entity created by the Spanish government in June 2009). SAREB has already acquired from the Spanish banking sector a total of EUR 50.8 billion of problematic assets. These assets had a total gross book value of EUR 106.6 billion (i.e., the assets have been transferred with more than a 50% average discount) and include 107,000 REOs (parcels of real estate owned by the lender after foreclosure) and 90,600 NPLs (non-performing loans). Certain financial institutions may also end up being forced to contribute assets if they are not successful in completing their restructuring and recapitalisation plans. This could raise the value of NPLs and REOs acquired by SAREB from EUR 50 billion to EUR 90 billion (transfer price).
SAREB has recently approved the business plan for its 15-year life on the basis of the EUR 50.8 billion of assets already contributed. According to the business plan, during the first five years SAREB expects to dispose of almost half of its REOs portfolio.
Investing in SAREB’s Assets
Investors may acquire assets from SAREB either directly or through specific vehicles to be created, the so-called Bank Asset Funds (Fondos de Activos Bancarios, or “FABs”). FABs are a completely new investment vehicle under Spanish law, but they are much like the special purpose entities used in securitisations. So, just like in securitisation structures, an investor who is interested in acquiring a specific portfolio of NPLs from SAREB can do so by setting up an ad hoc FAB. The investor then acquires the securities issued by the FAB and thus indirectly the proceeds of the underlying portfolio.
A new Spanish regulation affords preferential treatment for the taxation of FABs and the income derived by foreign investors from their investment in these vehicles.
Investors also benefit indirectly from new tax provisions which are designed to ensure tax neutrality upon the transfer of real estate assets and loans to SAREB and upon the reorganization of the assets by SAREB for their direct sale to third parties or their assignment to FABs.
The problematic assets
acquired by SAREB may
be purchased by investors
directly or via new
investment vehicles which
benefit from preferential tax
treatment.
Moving Forward
The Spanish Government has introduced some amendments to the legal framework of SAREB. These include a number of additional insolvency protections for the transfer of assets to SAREB and from SAREB to the FABs which allow insolvency-remote structures to be available to foreign investors.
The disposition of SAREB’s assets is now underway. HIG Capital has bought a real estate portfolio for EUR 100 million, and Burlington Loan Management has bought a portfolio of NPLs for EUR 245 million.
Fernando de la Mata Partner
Tel: +34 93 206 0858
Email: fernando.delamata@bakermckenzie.com
Fernando de la Mata is the head of the Finance and Restructuring Groups in Barcelona, and a member of the European Restructuring & Insolvency Steering Committee. Fernando is ranked among the recommended individuals by Legal 500, Chambers Europe and Chambers Global. Fernando has extensive experience in corporate and financial matters, with a special focus on debt restructuring and securitization. Fernando has extensive experience in cross-border proceedings and in disputes involving financial institutions.
Dutch Supreme Court turns back clock on
criterion for estate claims
In the Netherlands, estate claims are immediately and directly enforceable against the bankrupt estate and are paid before ordinary unsecured claims. Until recently, the door to estate claims stood wide open. But after an April decision by the Dutch Supreme Court, this door remains open merely a crack.
Establishment of the “action criterion”
Estate claims are an exception to the general rule that claims arising after 00.00 hours of the day of the bankruptcy order receive no distribution from the estate. A Supreme Court decision from 2004, Circle Plastics, suggested that estate claims include all claims that satisfy the “action criterion”, i.e., that result from actions performed by the bankruptcy trustee. Thus, when the bankruptcy trustee took the “action” of terminating a lease, the trustee’s obligation to vacate the premises — and any related damages for failure to do so — qualified as an estate claim. The fact that this obligation also arose from the pre-bankruptcy legal relationship between the parties was irrelevant.
This judgement opened the door to all kinds of estate claims. Under the action criterion, any claim resulting from a legal act by the trustee could be considered an estate claim. Easy acceptance of estate claims would seriously prejudice the ordinary creditors, who already drew the short straw in bankruptcy distribution. Not surprisingly, Circle Plastics was heavily criticized.
“Action criterion” abandoned
In April’s Koot Beheer/Mr. Tideman q.q. decision, the Dutch Supreme Court took note of the criticisms surrounding the Circle Plastics case and reneged on the action-criterion. As in Circle Plastics, a lessor asserted a claim for damages resulting from the trustee’s action of terminating the lease agreement. The lessor had argued that — in line with Circle Plastics —its claim for damages must be an estate claim.
The Supreme Court did not agree. It held that that the obligation to pay damages, which became due when the lease was terminated during the bankruptcy, was not an estate claim. Rather, it was an ordinary claim against the debtor which ensued from the lease agreement itself. The mere presence of a legal act by the bankruptcy trustee was insufficient to give rise to an estate claim and a priority in distribution. Rather, the act of termination by itself—which, like other defaults by the trustee under reciprocal agreements, is authorized by the Dutch Bankruptcy Code — could lead only to an ordinary damages claim. Any other outcome, the Court said, would be contrary to the principle of equality of creditors and would simply not fit in the system of the law.
The Dutch Supreme Court’s
adoption of the “action
criterion” in 2004 paved the
way for easy acceptance
of estate claims, to the
disadvantage of ordinary
creditors.
In practice
The Supreme Court’s abandonment of the “action criterion” means that today, estate claims will arise only when:
• A statutory provision so provides (e.g., limited periods for lease, agency and employment contracts that are rightfully terminated by the trustee);
• The trustee has willingly taken on debts in his capacity as bankruptcy trustee (e.g., costs of an appraiser engaged by the trustee); or
• The trustee has taken actions contrary to obligations or commitments that he has in his formal capacity as bankruptcy trustee (e.g., claims that arise from unauthorised termination by the trustee).
Claims that ensue from pre-bankruptcy legal relationships with the debtor and that are not estate claims under one of these three grounds are ordinary claims against the debtor, regardless of whether they arise prior to or during the bankruptcy.
Some lower courts have given an extensive reach to the “action criterion” as it was announced in Circle Plastics. We expect that, with the Supreme Court’s abandonment of the action criterion, fewer claims will qualify as estate claims. In many bankruptcies, this will mean that would-be estate creditors will find the door to payment firmly shut. This legal development emphasizes the importance for creditors of contractually securing themselves to the extent possible from the very start of the contractual relationship and of taking of timely action when counterparties show the first signs of financial distress.
Marjon Lok Senior Associate Tel: +31 20 551 7976
Email: marjon.lok@bakermckenzie.com
Marjon Lok is senior associate in Baker & McKenzie’s Litigation Group in Amsterdam. She represents corporate clients and financial institutions in the national and cross-border arena in relation to a broad range of commercial and corporate disputes.
Marjon’s practice focuses on restructuring, recovery and insolvency, crisis management, with a particular focus on shareholder, director, officer liability in and outside of insolvency, security rights, fraudulent preference and clawback,
The abandonment of
the “action criterion”
underscores the importance
of being secure from the
very start of a contractual
relationship and of
acting promptly when
counterparties show the first
signs of financial distress.
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