Evergrande's crisis puts Hong Kong-China debt restructuring accord to the test before ink runs dry on pilot agreement

A cross-border arrangement between Hong Kong and Beijing over corporate restructurings could soon face its first real test as China Evergrande Group, the world's most indebted property developer, teeters back and forth on the brink of default.

The May 14 agreement was designed to facilitate and better protect offshore debt holders in the enforcement of asset claims during a cross-border winding up and provide greater assurance to foreign investors who have added hundreds of billions of dollars in Chinese bonds into their investment portfolios in recent years.

The agreement is facing a crucial test, as 2021 is set to be another record year of bond defaults among China's borrowers, especially the heavily leveraged real estate developers, squeezed between the slowest economic growth pace in years and a wary central bank with a tight grip on releasing loans.

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Evergrande, with more than US$300 billion in liabilities, missed at least five interest payment deadlines on its offshore debt since late September, paying a US$83.5 million coupon last week just as a 30-day grace period was running out to stave off a default. Fantasia Holdings Group, founded by the niece of China's former vice-president Zeng Qinghong, failed to pay US$205 million of debt on October 5. Sinic Holdings warned of default on US$250 million of bonds a week later, while Modern Land scrapped plans to pay US$250 million in a portion of its bond last week.

Sources: Evergrande, SCMP Research. alt=Sources: Evergrande, SCMP Research.

Technically, if one of Evergrande's Hong Kong-listed or incorporated entities is being wound up, the liquidator could seek to enforce claims against its mainland assets under the pilot programme, according to Ronald Sum, a senior partner at the law firm Addleshaw Goddard, which focused on commercial litigation.

"Practically, it is unlikely," said Sum.

China Evergrande Group's founder and chairman Hui Ka-yan, also known as Xu Jiayin in mainland China, speaking at a press conference with Fabio Cannavaro, the head coach of his Guangzhou Evergrande Football Club, on November 9, 2017. Photo: Getty Images. alt=China Evergrande Group's founder and chairman Hui Ka-yan, also known as Xu Jiayin in mainland China, speaking at a press conference with Fabio Cannavaro, the head coach of his Guangzhou Evergrande Football Club, on November 9, 2017. Photo: Getty Images.

The bilateral pilot scheme allows Hong Kong liquidators to apply to courts in mainland China for insolvency proceedings in the city to be recognised, and for bankruptcy administrators in Shenzhen, Shanghai and Xiamen to receive the same recognition in Hong Kong courts.

The framework is aimed at enabling the rescue of financially troubled businesses, while providing better protection of the assets of the debtor company as well as the interests of the creditors, Hong Kong's Secretary of Justice Teresa Cheng said at the pact's launch in May.

The agreement was described by Hong Kong officials and legal experts at the time as a "milestone" in cross-border cooperation on insolvency matters.

"The protocol deals largely with a Hong Kong liquidator being granted help and recognition in the mainland rather than the other way round," said Jonathan Leitch, a partner at the legal firm Hogan Lovells. "This is because the common law in Hong Kong has already evolved to enable the Hong Kong Courts to recognise mainland appointed administrators in certain situations."

Sources: Northeast Securities and Tianfeng Securities. SCMP Graphics. alt=Sources: Northeast Securities and Tianfeng Securities. SCMP Graphics.

In the case of Evergrande, with its holding company incorporated in the Cayman Islands as an entity with limited liability, concerns are growing whether the May 14 bilateral framework is adequate to protect offshore creditors even if an Evergrande unit becomes insolvent in Hong Kong.

For starters, there are some conditions required by the bilateral pact that may not be satisfied. One sticking point is the so-called centre of main interests, which generally means the place of incorporation, legal experts said. Being incorporated in Hong Kong alone is not enough to meet the standard, they said.

"The liquidators of such a company must be able to demonstrate that the centre of main interests of that company has been in Hong Kong continuously for at least six months," said Evelyn Chan, a partner at dispute resolution law firm Gall, adding that the term generally refers to a company's principal office, principal place of business or where most of its assets reside.

Source: Ke.com. SCMP Graphics. alt=Source: Ke.com. SCMP Graphics.

If an Evergrande company with substantial assets in one of the mainland pilot cities enters into liquidation in Hong Kong, "then theoretically the company's liquidators can make use of the arrangement," said Chan.

Evergrande, at one stage China's largest developer by sales, operates throughout the country, with at least two projects underway in Hong Kong, making the geographic pin point impractical. The Shenzhen-based developer's largest sales market was in Guangdong, making up 12.2 per cent of contracted sales last year, according to its 2020 annual report. Shanghai made up 2.5 per cent of sales, Fujian 2.3 per cent while Hong Kong contributed to 0.65 per cent.

As a result, the effectiveness of the bilateral mechanism may be limited, Chan said. However, the asset holdings of individual subsidiaries "may be a completely different landscape," she said.

Offshore creditors also might not be keen on using the cross-border framework, given those limitations, according to legal experts.

At the same time, offshore creditors may be reluctant to pursue claims under the agreement until the Chinese government decides on whether it will intervene, they said.

Source: Jefferies. SCMP Graphics alt=Source: Jefferies. SCMP Graphics

For now, a lifeline from Beijing is nowhere in sight. A senior People's Bank of China official blamed the developer's "poor management" for its financial imbroglio on October 15 and said it had "expanded blindly". Other officials have simply said China can "contain" the risks in the Evergrande crisis.

The office of Hong Kong's Secretary of Justice declined to comment, saying it does not comment on individual cases.

"Even where recognition and help is given to the Hong Kong liquidator, the property of the debtor in the mainland must first be used to satisfy preferential claims under the law of the mainland," said Leitch of Hogan Lovells.

That means offshore creditors might not be first in line with their claims.

Compared with other high-profile restructurings, such as HNA Group and Anbang, most of Evergrande's assets are in China, meaning offshore creditors have less direct access to its assets, according to Alexander Aitken, partner of Herbert Smith Freehills' Hong Kong office.

SCMP Video: How bondholders can recoup their investments in the Evergrande crisis

This article originally appeared in the South China Morning Post (SCMP), the most authoritative voice reporting on China and Asia for more than a century. For more SCMP stories, please explore the SCMP app or visit the SCMP's Facebook and Twitter pages. Copyright © 2021 South China Morning Post Publishers Ltd. All rights reserved.

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