Restructuring & Insolvency Newsletter

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Restructuring & Insolvency

Global

June 2014

In this issue:

Challenges faced by foreign creditors of Suntech

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. > Read more

Using English or US proceedings to restructure Asian businesses

Asian businesses with substantial debt packages governed by the laws of England or the US have become the subject of formal restructuring procedures in those jurisdictions. David Walter explains why. > Read more

Challenges facing the Islamic finance industry in relation to default,

debt restructuring, insolvency and bankruptcy

The Islamic finance industry has been struggling to find a common ground and harmonized practice for dealing with default, debt restructuring, insolvency and bankruptcy. Mohammad Delwar Hossain explores the immense challenges the industry faces.> Read more

Are exit consents a way out of English insolvency proceedings?

Two recent English cases illustrate the thin line between legal incentives to induce creditors to approve financial restructuring proposals and illegal threats and bribes. Charles Thomson explains where that line now lies. > Read more Restructuring & Insolvency contacts:

Europe, the Middle East & Africa

Ian Jack London +44 20 7919 1700 [email protected] North America David Heroy Chicago +1 312 861 3731 [email protected] Asia Pacific Maria O'Brien Sydney +61 2 8922 5222 [email protected] Latin America

Jose Augusto Martins Sao Paulo

+55 11 3048 6977

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Challenges faced by foreign creditors of Suntech

The bankruptcy of Suntech Power Holdings Co. Ltd. ("Suntech") is a reminder of the challenges that foreign creditors face when a Chinese company goes into bankruptcy.

As a result of Suntech's default on its convertible bonds in March 2013, cross-defaults on its debt obligations in China were triggered. A number of banks subsequently petitioned for the insolvency and restructuring of Suntech's principal operating subsidiary in China, Wuxi Suntech Power Co. Ltd ("Wuxi Suntech"). In April 2014, Hong Kong-listed Shunfeng Photovoltaic International Ltd. approved an acquisition of Wuxi Suntech. However, the bondholders, who are creditors of Suntech and not Wuxi Suntech, still face a rough road ahead.

Challenges

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. This article takes a look at some of the challenges that Suntech's bondholders face.

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 paid up to the equity holders of the subsidiary. In the case of Suntech, the bondholders are creditors of Suntech, the offshore holding company, and not Wuxi Suntech, the onshore operating subsidiary. As the majority of Suntech's assets are held by Wuxi Suntech, the sale of Wuxi Suntech will effectively render Suntech an empty shell.

Government policies

Another source of challenge to foreign creditors is the heavy intervention of the Chinese government in restructurings involving Chinese companies. 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 unfavorable reaction. Asia Aluminum was eventually restructured via a management buyout, which had obtained the approval of the Chinese government as the restructuring was able to maintain social stability and employment – both key considerations for the Chinese government. At one stage, Suntech received a letter of intent from a state-owned enterprise, Wuxi Guolian Development Group Co. Ltd., offering to make a USD150 million injection into Suntech to support Suntech's comprehensive rehabilitation and restructuring of its financial and operational affairs. This was likely a move by the local Wuxi government to try to ensure that it had a role in any restructuring of Suntech and may have been part of an attempt to avoid a forced liquidation of Suntech.

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3 Restructuring & Insolvency Newsletter June 2014

Outlook

After the sale of Wuxi Suntech, it is very unlikely that the bondholders will recover anything. Their only recourse may be to look to the potential restructuring of Suntech in the Cayman Islands (where it is incorporated) involving a debt-to-equity swap and proposals to convert the company from a manufacturer of solar panels into a distributor. The case of Suntech confirms the difficulties faced by foreign creditors when Chinese companies become bankrupt, even where there is support from the Chinese government. Given these difficulties, 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 nature of support by the Chinese government.

Kwun Yee Cheung

Partner

Baker & McKenzie

23rd Floor, One Pacific Place 88 Queensway

Hong Kong SAR

Direct line: +852 2846 1683 Fax: +852 2845 0476

Email: [email protected]

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.

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Using English or US proceedings to restructure

Asian businesses

The last year has seen a systemic change in approach to financial restructuring of Asian businesses. Asian businesses with substantial debt packages governed by the laws of England or the US have become the subject of formal restructuring procedures in those jurisdictions. With the wide usage across Asia of US-law bonds (and loans) and English-law syndicated bank loans, this approach may be expected to be used more frequently in Asia region restructurings.

Financial restructurings in England and the US

Both the English and the US possess robust schemes for implementation of binding, Court-driven financial restructurings. The "Chapter 11" bankruptcy plan, implemented pursuant to Chapter 11 of the United States Bankruptcy Code, needs no explanation. Similarly, the English "scheme of arrangement" procedure, available under the English Companies Act, is prominent in large, complex restructurings. Both proceedings offer robust "cram down" procedures, whereby dissenting minority creditors may be bound to outcomes accepted by the requisite majority.

Recent global developments

A key development has been the recognition of the expansive jurisdictions of the US and English courts to approve restructuring plans using these two procedures, where the target is a foreign corporation.

In the context of an English scheme of arrangement, it is now clear that a "sufficient connection" with England may be established when there would be some purpose served by the English court sanctioning the scheme. A syndicated loan facility governed by English law, with an English Courts "exclusive

jurisdiction" clause and at least one UK-based lender, is sufficient.

In contrast to English schemes of arrangement, a non-US company may open a Chapter 11 proceeding only if it has assets or operations in the US. US-law obligations or US-resident creditors will not suffice. That said, it appears that the presence of any asset will suffice. An asset as relatively trivial as the deposit of a retainer in a law firm's trust account in the US was sufficient to support the opening of a Chapter 11 proceeding for the Taiwanese shipping business "TMT". Of further importance is the English scheme implemented in relation to Magyar Telecom B.V. (a Dutch company) in December 2013. That restructuring makes clear that an English scheme may be used to compromise US bonds and may also be recognized by the US Bankruptcy Court, under Chapter 15 of the United States Bankruptcy Code (which adopts the UNCITRAL Model Law on Cross-Border Insolvency), as a "foreign main proceeding." In this way, an English scheme compromising US bonds may be given full effect in the US.

Developments in Asia

So, the door is wide open for Asian businesses to pursue the US and English procedures. The past twelve months has now seen:

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enterprise which had substantial syndicated loan facilities governed by English law.

 Commencement of US Chapter 11 proceedings by both TMT Shipping (mentioned above) and STX Pan Ocean, a Korean shipping business.

Key themes and insights

Those first few steps by Asian businesses toward using English and US restructuring techniques raise several key insights for market participants:

 Both procedures are best used only for a financial restructuring of a distressed business' balance sheet, as opposed to an operational

restructuring. The procedures offer flexibility in dealing with a group (or groups) of financiers, who are present in those jurisdictions and whose claims are governed by the laws of those jurisdictions. Where claims requiring restructuring are localized in the debtor's home jurisdiction, for instance claims of employees, suppliers and litigation claimants, a procedure in the debtor's home jurisdiction will likely be necessary, either on its own or in tandem with the English/US procedure.

 An English scheme or US Chapter 11 bankruptcy for an Asian business may not meet the "Centre of Main Interests" (or "COMI") requirements for cross-border recognition of insolvency procedures under the UNCITRAL

Model Law and the European Insolvency Regulation. In the context of a financial restructuring, however, availability of cross-border recognition will be practically irrelevant. The English and US Courts will have personal jurisdiction over the affected financial institution creditors, by virtue of the physical presence of those financial institutions in the UK and the US.

 Typically, selection of an English scheme or a US Chapter 11 bankruptcy plan will be driven by the governing law of the claims to be compromised and the location of the claimants. Debtors with US bonds would be expected to commence a US Chapter 11 proceeding, while debtors with English syndicated loans would pursue an English scheme of

arrangement. Of course, there will always be exceptions, such as the English scheme for Magyar Telecom.

Obviously, every debtor business and restructuring will have its own nuances and particular drivers, but the above insights are a sound starting point. Like any aspect of a well-executed and successful restructuring, however, early analysis and planning for these cross-border proceedings will invariably contribute to a better outcome.

David Walter

Partner

Baker & McKenzie Level 27, A.M.P. Centre 50 Bridge Street Sydney, NSW 2000

Direct line: +61 2 8922 5294 Fax: +61 2 9225 1595

US and English courts

now enjoy expansive

jurisdiction to approve

restructuring plans where

the target is a foreign

corporation

US and English

restructuring procedures

are best used for a

financial restructuring of a

foreign business' balance

sheet, as opposed to a

restructuring of its

operations.

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Challenges facing the Islamic finance industry in

relation to default, debt restructuring, insolvency

and bankruptcy

What is Islamic finance?

Islamic finance, which complies with the principles of Islamic law (Shari'a), has become a well-established global industry transcending the boundaries of Muslim countries. The Islamic finance industry, in which both Muslims and non-Muslims participate, is currently thought to be worth over USD 1.3 trillion. At its current rate of growth, it is expected to reach USD 2.6 trillion by 2017.

The common techniques used for structuring Islamic finance transactions are: (i) profit- and loss-sharing structures, (ii) sale-based structures, and (iii) lease-based structures. All Islamic finance structures and documentation are required to comply with Shari'a precepts. These include asset based/backed financing arrangements, prohibition of interest (riba), elimination of uncertainty (gharar) and speculation (maisir). The very nature of an Islamic finance transaction and the techniques used in structuring it make it, from a Shari'a compliant point of view, both challenging and structurally difficult to deal with default, debt restructuring, insolvency and bankruptcy.

Default in Islamic finance and Western legal regimes

The treatment of some significant debtor-creditor issues related to default, debt restructuring, insolvency and bankruptcy under prevailing Western secular legal regimes (e.g., Chapter 11 of the US Bankruptcy Code) either is not compatible with Shari'a precepts or will require further consideration from a Shari'a

perspective. For example:

 In a default scenario, are individual and corporate creditors to be treated equally or differently?

 Can a bankrupt debtor be released without its creditors' consent?

 Can a liquidator nullify a pre-bankruptcy transaction in order to protect the interests of creditors?

 Can a debtor initiate its own bankruptcy?

 How should unmatured debts be dealt with?

 The permissibility of classes and priorities of creditors and preferable treatment to the debts payable to government, employees or any other categories of creditor.

 What is considered fair to a debtor may not be in the best interests of creditors or vice versa.

 When a combination of conventional and Islamic finance is used to finance a project, how should issues of collateral and pari passu ranking of security be resolved?

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Keeping in mind the Shari'a precepts mentioned above, two broader questions may arise: Can the existing secular (Western or Western influenced) legal regimes, with necessary modifications, provide a Shari'a compliant insolvency legal regime for the Islamic finance industry? Or, must a separate and novel

Shari'a compliant insolvency legal regime be created for the industry? The Islamic finance industry is yet to agree on, or receive a conclusive response from

legislators to, these questions.

The lack of harmonization within the Islamic finance

industry

With the notable exception of Malaysia, the Islamic finance industry has grown in different countries without appropriate underlying regulatory frameworks and enabling infrastructures. The lack of regulatory harmonization and the absence of uniformity in market practices among countries where Islamic finance is prevalent have resulted in fragmentation and non-integration amongst Islamic finance providers and their practices, products and services.

The current Islamic finance industry largely relies on edicts (fatwa) of a few prominent Shari'a scholars who structure, supervise and certify as to the Shari'a

compliance of the Islamic finance products and their applications. Each of the four major Sunni and the prominent Shi'a schools of thought (madhhab) of Islamic jurisprudence often has majority and minority views on pertinent issues involving the current practices of Islamic finance. Shari'a scholars' attachment to different schools of thought, their presence in different geographical locations and their independence in reasoning and decision making have also resulted in the divergence of opinions and practices affecting the Islamic finance industry. In view of the above, it is undoubtedly an immense challenge for the Islamic finance industry to find a common ground and harmonized practice for dealing with default, debt restructuring, insolvency and bankruptcy.

Mohammad Delwar Hossain

Associate

Baker & McKenzie Limited 18th Floor, West Tower Bahrain Financial Manama Bahrain Direct line: +973 17 10 2006 Fax: +973 17 10 2020 Email: [email protected]

The treatment of some

significant debtor-creditor

issues under Western

secular legal regimes

either is not compatible

with the precepts of

Islamic law or will require

further consideration from

that perspective.

Will a separate and novel

insolvency system be

created to comply with

Islamic law, or will the

existing secular legal

regimes, with necessary

modifications, be

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Are exit consents a way out of English insolvency

proceedings?

Companies seeking to exit from insolvency proceedings or to otherwise

restructure their corporate affairs often offer inducements for creditors to approve their financial restructuring proposals. Two recent English cases examine the thin line between legal incentives to consent and illegal threats and bribes.

Cash for consent

In Azevedo1 a company offered cash payments to noteholders who voted in favour of the proposal, but excluded those who voted against or did not vote at all. The Court of Appeal upheld the High Court's holding that such "consent

solicitations" as part of a restructuring proposal were lawful. It rejected the contention that such a scheme failed to treat noteholders on a pari passu basis and amounted to "buying" votes with bribes.

Certain guiding principles to consent solicitations may be drawn from the judgment:

 A "consent payment" offered on clear terms, to all members of the same class, conditional upon some action within their power, does not

contravene English law.

 The offer of a payment to only those noteholders who voted in favour of the proposal did not amount to differing treatment of noteholders of the same class.

 There is no issue of bribery where a scheme operates openly and if no noteholders are incapacitated from voting.

 Companies must take care in structuring a proposal not to require noteholders to act in a way which is oppressive or unjust to the minority.

 Pari passu treatment is a principle of insolvency law, but there is no requirement to distribute funds on a pari passu basis between all noteholders.

 Companies must structure a deal which can be considered beneficial for the majority, rather than one which does not provide any value to the class as a whole.

Inducing consent by threatening loss of investment

By contrast, in Assenagon2 the debtor proposed to exchange notes due to mature in 2017 for new notes maturing in 2011 and having only 20% of the nominal value of the 2017 notes. The terms required noteholders who exchanged their notes to

1

Azevedo v. Imcopa Importacao [2013] EWCA Civ 364

2

AssenagonAsset Management v Irish Bank Resolution Corporation Ltd [2012] EWHC 2090 (Ch)

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vote in favor of a resolution which would effectively remove all rights attaching to the 2017 notes, which would then be redeemed for nominal consideration. Although Assenagon did not involve a "bribe", the court held the incentive to agree was by virtue of a "threat". A noteholder who did not agree ran a real risk the majority noteholders would agree, thereby rendering minority notes worthless. The court found that by voting in favor of the resolution, the majority noteholders abused their power and acted in a way which was oppressive and unfair to the minority.

The difference between Azevedo and Assenagon is that in the former, the company offered an incentive to all the noteholders who voted in favor of the restructuring proposal. In Assenagon, it was the majority noteholders' approval of the company's proposal that acted as a threat encouraging all noteholders to accede to the exit consent. In Azevedo the proposal was potentially beneficial to all noteholders, whereas in Assenagon the proposal was designed to destroy, rather than enhance, the value of the 2017 notes.

Inducements made to all creditors of a particular class in an effort to persuade them to accept the terms of a reconstruction can be made to work. But if there is any question of a majority threatening a non-compliant minority with devaluation or expropriation of their investment, the arrangement may be set aside. Any "exit consent" must be persuasive rather than by force.

Charles Thomson

Associate

Baker & McKenzie LLP 100 New Bridge Street London EC4V 6JA England

Direct line: +44 20 7919 1879 Fax: +44 20 7944 1879

Inducements made to all

creditors of a particular

class in an effort to

persuade them to accept

the terms of a

reconstruction can be

made to work.

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For more information about any of these articles, please contact the individual authors or your usual Baker & McKenzie contact. To subscribe or unsubscribe to the Newsletter, or for reprint requests contact Danielle Jerums:

Baker & McKenzie LLP 100 New Bridge Street London

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[email protected] www.bakermckenzie.com

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