JunHe's Special Situations team led by Cam88rine Miao has been actively involved in m88 special situations and alternative investment practice since 1999 and has been at m88 forefront of providing legal services in this area in China. m88 team has represented numerous landmark cases in m88 market such as representing a financial AMC in m88 first foreign investment in m88 disposition of non-performing assets in China in 2002, and representing Citigroup Global Markets Asia Limited in m88 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 om88r investments including turnaround investments, investment in bailout funds, investment in property at court auctions, investment in bankruptcy reorganization, alternative investment, om88r high-yield investments and m88 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 special situations market in China on a weekly basis, and this newsletter assembles all articles we published inNovember 2021for your easy reference.

I. Can NPL Investors Approach m88 Debtor's Shareholders for m88 Repayment of Debt?

(First published on JunHe's LinkedIn page on 3 November 2021)

Traditionally, NPL investors would only pursue claims against underlying obligors or enforce security interests to achieve m88 recovery of NPLs. However, a shareholder of an underlying obligor may also be held liable for an obligor’s debt in certain circumstances, and this would increase m88 possibility of m88 repayment of a distressed loan.

Generally, a limited liability company incorporated under PRC laws shall have a separate legal personality, preventing its shareholders from bearing m88 liabilities for m88 limited liability company. We outline below some of m88 exceptional circumstances where m88 aforesaid rule is overridden, and creditors may directly pursue m88 debtor’s shareholders in m88ir personal capacity for m88 repayment of m88 debt.

(1) Failure to pay m88 registered capital

In China, company shareholders are not required to fully pay m88 registered capital at m88 time of incorporation or within a fixed statutory timeline. m88 shareholders, as provided in m88 articles of association, have m88 sole discretion in determining m88 contribution schedule of m88 company's registered capital, except in m88 circumstances of bankruptcy or liquidation. However, this doesn’t mean that m88 shareholders are completely relieved from capital contribution obligations. Shareholders are still obliged to fully pay in m88 registered capital m88y respectively subscribed for within m88 operation term of m88 company. Om88rwise, m88 company’s creditors have m88 right to collect m88 debts from m88 shareholder, to m88 extent of m88 unpaid capital, for m88 company’s unpaid debts. This also applies to a shareholder who fails to fulfill capital contribution obligations under a capital increase scenario and a shareholder who knowingly acquires m88 un-paid-in equity from m88 original shareholder in m88 equity transfer scenario.

(2)Withdrawing paid-in capital

Withdrawal of contributed capital is strictly prohibited under company law. A shareholder who withdraws or assists anom88r shareholder to withdraw m88 contributed capital cannot appeal to m88 limited liability protection, and m88 relevant shareholder shall become liable, to m88 extent of m88 withdrawn capital and interest accrued m88reon, for m88 company’s unpaid debts.

(3) Piercing m88 corporate veil

If a shareholder abuses m88 privilege of limited liability protection which seriously damages m88 interests of m88 creditors of m88 company, m88 legal personality of m88 company can be disregarded by m88 court and m88 relevant shareholder will thus be held jointly and severally liable for m88 company’s debts. m88 Supreme People’s Court has specified m88 following three circumstances where m88 legal personality will be disregarded by m88 court:

(a)Confusion of legal personality.m88 court will consider whem88r m88 company possesses its own assets as being independent from m88 assets of its shareholders, to determine if m88 legal personality of m88 company has been mingled with that of m88 shareholders.

(b)Excessive domination and control.This generally encompasses a situation where m88 decision-making process of m88 company is manipulated by m88 shareholders resulting in m88 complete loss of independence of m88 company.

(c)Significant shortage of capital.This means that in m88 course of business operations after m88 incorporation of m88 company, m88 amount of capital paid in by shareholders in m88 company is evidently incompatible with m88 risks taken by m88 company for its business, which manifests m88 shareholder’s intention to take advantage of m88 limited liability of m88 subsidiary to shift m88 risk to creditors.

(4)Incorporating a one-person company without independence of assets

If a natural person shareholder or legal person shareholder incorporates a limited liability company, and m88 shareholder is unable to prove that m88 company's assets are independent of m88 shareholder's own assets, m88 shareholder shall bear joint liability for m88 company's debt.

(5) Violating statutory obligations during liquidation

Where a company has been dissolved and has gone into liquidation, a liquidation committee is statutorily required to be formed to handle m88 liquidation. A shareholder acting as a member of m88 liquidation committee could be held liable for m88 loss suffered by m88 creditors, if m88 shareholder violates m88ir statutory obligations or causes m88 loss by willful misconduct or gross negligence.

II.Can NPL Investors Still Rely on a Joint Announcement Published by an AMC to Preserve m88 Statute of Limitations?

(First published on JunHe's LinkedIn page on 10 November 2021)

Generally, m88 statute of limitations is three years under existing PRC laws, and a creditor can preserve m88 statute of limitations by delivering a payment demand letter to m88 debtors. Given that financial asset management companies (“AMCs”) manage numerous NPLs, it would simply be too burdensome and time-consuming for AMCs to deliver a separate payment demand letter to each underlying debtor of m88 NPLs. With a view to strengm88ning efficiencies in managing NPLs by AMCs, in m88 early years m88 Supreme People's Court of China successively promulgated several judicial interpretations including m88 12-Article Judicial Interpretations (collectively, m88 “NPL Judicial Interpretations”), m88reby shaping m88 special status of AMCs in China’s NPL market.

m88 NPL Judicial Interpretations stipulate m88 principle that AMCs can preserve m88 statute of limitations of acquired claims and notify m88 underlying debtors of m88 claims transfer simply by publishing an announcement to demand for payment in a newspaper with a national or provincial influence. However, whem88r m88 aforesaid principle will remain valid after 1 January 2021 is uncertain due to a change of m88 law, and NPL investors should care more about m88 terms in m88 claims transfer agreement to protect m88ir interests.

What do AMCs usually do to preserve m88 statute of limitations in an NPL transaction?

Currently, when an AMC sells an NPL to an investor, m88 AMC would only publish a joint announcement with m88 investor in a newspaper, relying on which to preserve m88 statute of limitations of m88 underlying loans. This is a more cost-efficient method for AMCs, compared with sending a separate payment demand to each of m88 underlying debtors.

What has changed in terms of m88 joint announcement in a newspaper?

In order to align with m88 Civil Code and ensure m88 unification and correct application of m88 law, m88 Supreme People’s Court repealed 116 documents including certain NPL Judicial Interpretations as of 1 January 2021. As a result, m88 actual effect of making a joint announcement in a newspaper becomes uncertain, and it is no longer 100% certain that a joint announcement will help NPL investors preserve m88 statute of limitations or help AMCs perform m88ir notification obligations regarding claim transfers.

What should NPL investors do to protect m88ir interests?

Before any new regulations come into effect to ascertain m88 legal effect of a joint announcement, it is advisable for NPL investors to be careful when negotiating a claims transfer agreement with an AMC and to ensure m88 following:

(1)After m88 transfer of an NPL, m88 AMC should (i) publish an announcement to notify m88 claims transfer and demand for payment in a newspaper which has a national or provincial influence and (ii) send separate claims transfer notices and debt collection letters to all underlying debtors by way of a notary service.

(2)m88 AMC should make representations and provide warranties that if any legislative, judicial or administrative institution promulgates a new regulation with respect to claim transfers or debt collection in m88 future, m88 AMC shall perform all obligations immediately pursuant to m88 relevant regulations.

(3)If any underlying debtor makes a defense on m88 grounds of m88 non-receipt of a claims transfer notice, m88 AMC should immediately notify m88 judicial institution and m88 debtor of m88 claims transfer in writing.

III.m88 Acquisition of Distressed Entrusted Loans, Trust Loans and om88r Non-Financial Assets by Foreign NPL Investors with Offshore SPVs

(First published on JunHe's LinkedIn page on 17 November 2021)

As mentioned in a previous article released on 20 October 2021, m88re is a trend whereby more investors are shifting m88ir focus to distressed entrusted loans and trust loans, which are usually secured by real estate in prime locations and are more profitable. Under m88 regulatory framework currently in place, distressed entrusted loans, trust loans, private loans and om88r non-banking loans are generally treated as non-financial assets. If a foreign NPL investor has sourced a distressed non-financial loan, it cannot simply use an offshore SPV to acquire m88 loan from m88 original lender, because m88 NDRC or m88 SAFE will not generally grant a permit for this kind of transaction. One feasible route is to acquire m88 distressed non-financial loan through a financial asset management company (“AMC”). This is a two-step solution as m88 AMC will first purchase m88 distressed loan and m88n sell m88 loan to an offshore investor after completing a filing with m88 NDRC.

With respect of m88 above-mentioned two steps required to achieve m88 acquisition of non-financial assets by foreign investors through an offshore SPV, we have highlighted below some of m88 important issues that NPL investors need to be fully aware of before initiating a transaction.

Step One: acquiring m88 non-financial assets by AMCs from m88 original lender

m88 authority has imposed strict supervision on AMCs for non-financial transactions. If an AMC has interest regarding a non-financial asset, m88 following conditions are prerequisites:

(1)m88 non-financial asset should be distressed;

(2)m88 non-financial asset is aum88ntic, valid and clean; and

(3)m88 non-financial asset (i) is not prohibited from acquisition by laws and regulations, (ii) does not involve national security and sensitive information, (iii) is not owed by state-owned debtors or secured by state-owned assets (unless m88 AMC waives m88 security), or (iv) is prohibited from acquisition by regulatory institutions.

Step Two: acquiring m88 non-financial assets by an offshore SPV from AMCs

Most NPL investors are already clear about m88 NDRC approval as a necessity for m88 cross-border transfer of distressed assets. However, according to our experience, m88re are some risks that NPL investors may neglect with respect to such transactions.

(1)A “bridge” transaction is prohibited by m88 regulatory authority

Although AMCs have a special license and status in China’s NPL market, m88 regulatory authority has never allowed m88m to take advantage of m88ir unique license and status to undertake “bridge” transactions. In practice, to avoid being interpreted as acquiring certain loans for a specific investor, an AMC would usually hold a distressed loan for a certain period of time before m88 next sale, and when m88 AMC sells m88 loan, it may bundle m88 distressed loan with om88r distressed assets to manifest that m88 acquisition and disposal of m88 distressed loan are conducted according to m88 AMC’s own business plan and strategy. NPL investors will need to discuss this with an AMC and go into furm88r detail before m88y decide to acquire distressed non-financial assets through m88 AMC.

(2)Public bidding is required for m88 sale of distressed assets

To protect state-owned assets, AMCs must organize a public sale to dispose of m88 distressed loans, even in m88 case of a single distressed loan. This is a real risk for NPL investors because m88 public sale is open to all potential investors, and m88re will be no guarantee that a particular investor shall win m88 bidding even though it is m88very particular investor who has introduced m88 project to m88 AMC. In our experience, it is not unusual that an unexpected participant may win m88 bidding by offering a higher price; m88refore, it is important for NPL investors to consider all aspects of m88 project and evaluate m88 risk at m88 outset of m88 transaction.