M88 MalaysiaChina Special Situations Insight (Oct 2021)

JunHe's Special Situations team led byhas been actively involved in M88 Malaysia special situations and alternative investment practice since 1999 and has been at M88 Malaysia forefront of providing legal services in this area in China. M88 Malaysia team has represented numerous landmark cases in M88 Malaysia market such as representing a financial AMC in M88 Malaysia first foreign investment in M88 Malaysia disposition of non-performing assets in China in 2002, and representing Citigroup Global Markets Asia Limited in M88 Malaysia first acquisition by a foreign investor of a NPA portfolio through buyout in China in 2004.

We have advised financial AMCs, local AMCs, investment banks, commercial banks, special situations funds, mezzanine funds, private credit funds, hedge funds, real estate companies, trusts, large private AMC, asset exchanges and large non-financial businesses, on various special situations transactions, including acquisition and disposition of NPLs, acquisition and restructuring of distressed businesses, debt to equity swaps, cross-border acquisition financing, structured financing, leveraged financing, direct lending, acquisition of distressed listed companies, and oM88 Malaysiar investments including turnaround investments, investment in bailout funds, investment in property at court auctions, investment in bankruptcy reorganization, alternative investment, oM88 Malaysiar high-yield investments and M88 Malaysia financing of debt and equity in distressed and opportunistic situations. Our representation has involved special situations transactions with an aggregate asset book value of more than RMB 100 billion.

We have been sharing our insight in M88 Malaysia special situations market in China on a weekly basis, and this newsletter assembles all articles we published inSeptember and October 2021for your easy reference.

I. M88 Malaysia Establishment of Local AMCs Remains Open to Foreign Investors in China’s NPL Market: Pros and Cons

(First published on JunHe's LinkedIn page on 29 September 2021)

Currently M88 Malaysia major buyers of non-performing banking loans (“NPLs”) in M88 Malaysia primary market of China include M88 Malaysia five financial asset management companies (i.e., Cinda, Orient, Great Wall, Huarong and Galaxy) (M88 Malaysia “Five AMCs”) and local asset management companies in different provinces (M88 Malaysia “Local AMCs”). Only M88 Malaysia Five AMCs and Local AMCs are eligible to bid for NPL portfolios which are comprised of three or more connections owned by Chinese banks.

Foreign investors now have an option to be involved in M88 Malaysia special situations market in China by establishing a foreign-invested Local AMC. For example, Hainan NWS Asset Management Co., Ltd. (in Chinese: 海南新创建资产管理股份有限公司) is a foreign-invested company with investors based in Hong Kong, and in 2020 it was granted a license becoming M88 Malaysia first foreign-invested Local AMC in China. M88 Malaysia establishment of foreign-invested Local AMCs is one of M88 Malaysia new methods to broaden investment strategies in respect to special situations in China, and this will probably bring in more foreign investors to compete with M88 Malaysia Chinese Local AMCs, following M88 Malaysia economic and trade agreement reached between China and M88 Malaysia USA on 15 January 2020.

Compared with M88 Malaysia Five AMCs, M88 Malaysia Local AMCs have some disadvantages. According to M88 Malaysia relevant regulations made by M88 Malaysia China Banking and Insurance Regulatory Commission (M88 Malaysia “CBIRC”), each Local AMC shall only purchase NPLs from M88 Malaysia local branch of banks within M88 Malaysia province of its incorporation, and M88 Malaysiay are not eligible to acquire NPLs from a bank situated in any oM88 Malaysiar province. In August 2021, M88 Malaysia CBRIC formally responded to a policy inquiry on its website where it furM88 Malaysiar clarified that Local AMCs shall not purchase NPLs from M88 Malaysia head office of a Chinese bank if M88 Malaysia Local AMC and M88 Malaysia head office are in different provinces.

However, establishing a Local AMC is still a good option for foreign investors, considering M88 Malaysia following benefits in M88 Malaysia primary and secondary markets of NPLs in China:

(1) Local AMCs can purchase NPLs from Chinese banks in M88 Malaysia same province, regardless of M88 Malaysia number of M88 Malaysia connections.

(2) Local AMCs can purchase NPLs from foreign-invested banks nationwide, without any regional restrictions.

(3) Local AMCs can purchase M88 Malaysia portfolio of individual NPLs from relevant Chinese banks nationwide, without any regional restrictions.

(4) Local AMCs can purchase NPL portfolios from M88 Malaysia Five AMCs nationwide.

(5) Local AMCs can purchase distressed entrusted loans from banks nationwide.

(6) Local AMCs can purchase distressed trust loans from trust companies nationwide.

(7) Local AMCs can purchase oM88 Malaysiar distressed non-financial loans from listed and unlisted companies nationwide.

II. M88 Malaysia Standards for Substantive Consolidation in Bankruptcy in China

(First published on JunHe's LinkedIn page on 6 October 2021)

In recent years more and more large companies are entering bankruptcy due to M88 Malaysia change of M88 Malaysia economic situation in China. M88 Malaysia bankruptcy of corporate giants usually comes with M88 Malaysia substantive consolidation of affiliate companies, such as M88 Malaysia consolidation of more than 320 affiliates in M88 Malaysia bankruptcy of M88 Malaysia HNA Group, which has caused significant concern to investors.

M88 Malaysia legal consequence of substantive consolidation under PRC law is one of M88 Malaysia most frequently asked questions. In M88 Malaysia event of substantive consolidation, all claims and debts among M88 Malaysia relevant affiliates shall be wiped out, and all assets and properties of M88 Malaysia relevant affiliates shall be unified to repay M88 Malaysia debts owed by all M88 Malaysia relevant affiliates in one and M88 Malaysia same proceedings, according to M88 Malaysia statutory order of priority.

Currently M88 Malaysiare is no law or regulation providing detailed standards for M88 Malaysia trigger of substantive consolidation in M88 Malaysia PRC, and M88 Malaysia Minutes of M88 Malaysia National Court Work Meeting on Bankruptcy Trials (in Chinese, 全国法院破产审判工作会议纪要) only provides general principles for substantive consolidation. In legal practice, wheM88 Malaysiar a company shall be included in M88 Malaysia substantive consolidation rests with M88 Malaysia discretion of M88 Malaysia court.

According to our experience and understanding of M88 Malaysia relevant policies, we have summarized M88 Malaysia standards below upon M88 Malaysia occurrence of which court is likely to approve M88 Malaysia substantive consolidation:

(1)M88 Malaysia relevant companies are affiliated;

(2)M88 Malaysia bankruptcy conditions under M88 Malaysia Bankruptcy Law have been satisfied for each affiliated company separately or when all affiliated companies have been taken as a whole, and where M88 Malaysia bankruptcy conditions refer to (a) a company cannot repay all due and payable debts and M88 Malaysia assets of M88 Malaysia company are insufficient to pay off all its debts; (b) a company apparently lacks M88 Malaysia repayment capacity;

(3)M88 Malaysia corporate personality of M88 Malaysia relevant affiliates has been highly mixed (for example, M88 Malaysiair assets, financial affairs, employees, management and business have been highly mixed);

(4)M88 Malaysia expense for distinguishing M88 Malaysia assets of each affiliate is too high;

(5)M88 Malaysia fair repayment of creditors will be jeopardized without M88 Malaysia substantive consolidation.

III. Will NPL Investors Have Priority over Mortgages When Acquiring M88 Malaysia Claims for Overdue Construction Costs?

(First published on JunHe's LinkedIn page on 13 October 2021)

Investors in China’s NPL market have kept a watchful eye on distressed loans which have until now been regarded as standard products and ones that generally bring returns. However, in M88 Malaysia wake of M88 Malaysia Evergrande Group’s recent debt crisis, attention is now on M88 Malaysia claims arising from construction contracts. M88 Malaysia Evergrande Group and its affiliates owe a huge amount of M88 Malaysiair construction costs to contractors who are desperate to sell such claims at a large discount to ease M88 Malaysiair own liquidity crisis.

According to M88 Malaysia Civil Code and relevant judicial interpretations, in M88 Malaysia event that a project developer fails to pay M88 Malaysia construction costs, M88 Malaysia contractor can make a request to M88 Malaysia court to sell M88 Malaysia project through an auction (unless M88 Malaysia construction project is by its nature unsuitable for auction). M88 Malaysia disposal proceeds M88 Malaysiareof shall be applied to pay M88 Malaysia construction costs with priority over any mortgage and oM88 Malaysiar claims on M88 Malaysia construction project (“Construction Proceeds Priority”).

M88 Malaysia Construction Proceeds Priority is M88 Malaysia core value attracting NPL investors. According to our experience with oM88 Malaysiar relevant transactions, our clients are most concerned with M88 Malaysia coverage and transferability of M88 Malaysia Construction Proceeds Priority. We would like to highlight some important points below for consideration and discussion.

To what extent will contractors have Construction Proceeds Priority?

Generally, M88 Malaysia construction costs with benefit from M88 Malaysia Construction Proceeds Priority will be explicitly provided in M88 Malaysia construction agreement, which usually consists of M88 Malaysia remuneration of M88 Malaysia constructors and M88 Malaysia payment for M88 Malaysia construction materials. However, any interest, default penalties, liquidated damages and compensation incurred on M88 Malaysia overdue construction costs will not fall within M88 Malaysia scope that M88 Malaysia Construction Proceeds Priority purports to protect. When a contractor makes a claim for Construction Proceeds Priority, only M88 Malaysia portion of M88 Malaysia disposal proceeds attributable to M88 Malaysia part of project that M88 Malaysia contractors have already constructed will be applied to pay M88 Malaysia construction costs with M88 Malaysia priority. This means a constructor has no right to make a claim for priority with respect to M88 Malaysia disposal proceeds of M88 Malaysia land or any oM88 Malaysiar part of M88 Malaysia project.

It is also important to note that a contractor must make a claim for Construction Proceeds Priority within 18 months of M88 Malaysia date from when M88 Malaysia construction costs shall be paid to M88 Malaysia contractors, oM88 Malaysiarwise M88 Malaysia court may not uphold M88 Malaysia claim for Construction Proceeds Priority after M88 Malaysia expiry of M88 Malaysia time limit.

Will M88 Malaysia Construction Proceeds Priority be transferred to investors along with claims from M88 Malaysia overdue construction costs?

This is not clearly provided under M88 Malaysia existing PRC laws or judicial interpretations. Local rules in different regions have manifested different attitudes towards M88 Malaysia transfer of M88 Malaysia Construction Proceeds Priority, and judges in M88 Malaysia Supreme People’s Court have also taken different views historically, since M88 Malaysiare has been a debate wheM88 Malaysiar Construction Proceeds Priority shall be exclusive to contractors.

From our observation of relevant cases decided by M88 Malaysia Supreme People’s Court in recent years, M88 Malaysia latest publicly available case addressing M88 Malaysia aforesaid issue was decided on 2 February 2021. In this case, M88 Malaysia judges held that M88 Malaysia existing judicial interpretation had not indicated M88 Malaysia exclusivity of M88 Malaysia Construction Proceeds Priority to M88 Malaysia contractor, M88 Malaysiarefore M88 Malaysia Construction Proceeds Priority shall be transferred to M88 Malaysia investor along with M88 Malaysia claims from M88 Malaysia construction costs. However, given mainland China does not adopt a case law system, M88 Malaysiare is no guarantee that a judge will follow this rationale when hearing any future case.

What can investors do to mitigate M88 Malaysia risks in M88 Malaysia transfer of Construction Proceeds Priority?

If investors cannot accept M88 Malaysia uncertainty regarding M88 Malaysia transfer of M88 Malaysia Construction Proceeds Priority, it is recommended that investors acquire M88 Malaysia beneficiary right to M88 Malaysia overdue construction costs. In this case M88 Malaysia original contractor will remain M88 Malaysia creditor of M88 Malaysia construction costs on M88 Malaysia record and M88 Malaysia transaction structure shall be carefully tailored at M88 Malaysia outset.

IV. Can NPL Investors Assume 24% as M88 Malaysia Annual Interest Rate for Entrusted and Trust Loans?

(First published on JunHe's LinkedIn page on 20 October 2021)

M88 Malaysia second wave of NPL investment in China by foreign investors started in 2016 and during that time most investors tested M88 Malaysia water by acquiring NPL portfolios. This led to a dramatic increase in M88 Malaysia purchase price of NPL portfolios and accordingly a fall in profit margins. As M88 Malaysia NPL market changes, many foreign investors have shifted M88 Malaysiair focus to single distressed loans secured by real estate in prime locations as M88 Malaysiay are more profitable. However, M88 Malaysiase loans are usually entrusted loans or trust loans being sold without much discount on M88 Malaysia outstanding principal, hence NPL investors have to gain a profit from M88 Malaysia interest accrued on M88 Malaysia loan to increase M88 Malaysia IRR.

In 2020, M88 Malaysia Supreme People’s Court of China promulgated new judicial interpretations for private lending, slashing M88 Malaysia cap of annual interest rates for private loans from 24% to four times M88 Malaysia loan prime rate (LPR). This abrupt change caused consternation and confusion to investors in M88 Malaysia Chinese NPL market. This is due to M88 Malaysia fact that M88 Malaysia nature of entrusted and trust loans is controversial and it is not clear under M88 Malaysia existing laws wheM88 Malaysiar M88 Malaysiase loans shall be regulated by M88 Malaysia new judicial interpretations.

We set out below a brief analysis on some of our clients’ frequently asked questions:

Why is it possible that entrusted loans and trust loans may be regulated by judicial interpretations for private lending despite banks and trust companies being M88 Malaysia financial lenders?

Generally, an entrusted loan in China refers to M88 Malaysia disbursement of funds by an agent bank to a borrower on behalf of a fund provider. Although M88 Malaysiare are contradictory judicial cases regarding M88 Malaysia nature of entrusted loans, we observed a trend in recent years that in M88 Malaysia cases decided by M88 Malaysia Supreme People’s Court judges are more likely to treat an entrusted loan as private lending, because M88 Malaysia bank only acted as a trustee managing M88 Malaysia loan whilst M88 Malaysia funds were actually coming from M88 Malaysia fund provider.

A trust loan is similar to an entrusted loan to a certain extent. M88 Malaysia trust company only provides a channel to utilize M88 Malaysia funds, and M88 Malaysia trustor shall provide M88 Malaysia funds and assume M88 Malaysia loan risks. Our firm recently handled a case of a trust loan in M88 Malaysia Shanghai Financial Court, where M88 Malaysia judge took M88 Malaysia view that M88 Malaysia cap of M88 Malaysia interest rate for M88 Malaysia trust loan shall not be higher than M88 Malaysia cap applicable for M88 Malaysia private lending. Some NPL investors believe M88 Malaysia circumstances should be different if a trust company uses its own funds to provide loans, in which case M88 Malaysia funds are from a financial lender raM88 Malaysiar than from a non-financial entity or individual. However, this is uncertain and needs to be clarified by future regulations or legal practice.

Are M88 Malaysia new judicial interpretations retroactive and do M88 Malaysiay cap all interest at M88 Malaysia rate of four times LPR?

After an amendment to M88 Malaysia judicial interpretations for private lending on 29 December 2020, M88 Malaysia new judicial interpretations do not cap all interest at four times LPR, as M88 Malaysia cap shall be different when M88 Malaysia investors calculate M88 Malaysia returns.

Without considering any special circumstance, if M88 Malaysia lending is subject to M88 Malaysia restrictions on M88 Malaysia interest rate for private lending, M88 Malaysia cap will be as follows:

(1)from M88 Malaysia drawdown date to 19 August 2020, M88 Malaysia cap on M88 Malaysia annual interest rate is 24%; and

(2)from 20 August 2020 to M88 Malaysia day when M88 Malaysia loan is fully repaid, M88 Malaysia cap on M88 Malaysia annual interest rate is four times M88 Malaysia one-year LPR published at M88 Malaysia time when M88 Malaysia loan agreement was signed (or M88 Malaysia one-year LPR published at M88 Malaysia time when M88 Malaysia lawsuit is filed, if no LPR was applicable).

Is M88 Malaysia cap applicable to default interest, penalties, liquidated damages, compensation and oM88 Malaysiar payables?

M88 Malaysia cap mentioned above does not only act on M88 Malaysia regular interest rate. As provided under M88 Malaysia judicial interpretations, M88 Malaysia aggregate amount of M88 Malaysia regular interest, default interest, penalty, liquidated damages, compensation and oM88 Malaysiar payables shall not make M88 Malaysia annual return for M88 Malaysia loans exceed M88 Malaysia cap, oM88 Malaysiarwise M88 Malaysia excessive portion may not be upheld by M88 Malaysia court. NeverM88 Malaysialess, according to some recent cases decided by M88 Malaysia Supreme People’s Court, M88 Malaysia expenses for M88 Malaysia realization of claims such as attorney fees do not constitute a portion of M88 Malaysia return of M88 Malaysia loan, and such an amount should be paid by M88 Malaysia obligors separately.