Chaori default will provide resolution template

The resolution of China’s first onshore bond default will mark out a path for any further defaults, which are expected to happen this year.

The bond default by Shanghai Chaori Solar Energy Science and Technology should provide a template for resolving similar issues in addition to breaking the implicit guarantee inherent in China’s financial market.

A bondholder meeting will be held on March 26 to decide the next steps: namely, whether to compel the bond underwriter -  China Securities - to pursue a civil lawsuit against the company, sell some of the collateral backing the defaulted securities, or participate in restructure, negotiate with or bankrupt the company. 

However, according to sources and legal experts, entering a bankruptcy or restructuring process would be the last option for both the company and investors.

“The ideal resolution is to reach a settlement between creditors and the company or new investors. I don’t think the company will go bankrupt or take a restructure procedure,” said a source close to Chaori.

The source said the company is trying its best to liquidate some assets to pay for the corporate bond interest and some of its bank loans, and reaching out for other means of financial support.

Lawyers also suggested the first bondholders meeting is the first step in resolving Chaori’s bond default and the process would last for a long period.

The whole market is observing the fallout from China’s first onshore bond default, which is expected to positively impact on the market in a long term, according to credit analysts.

According to Standard & Poor’s research, China’s corporate debt market had a size of $12 trillion at the end of 2013. Haitong Securities listed some highly-risky bonds that may have a greater chance of default in the near future (see the table below).

“How the onshore restructuring would play out and how the local government might provide support in such situation is also relevant to the offshore market given that many offshore issues are backed by mainland group companies and assets,” said Howard Lam, a partner with global law firm Latham & Watkins in its financial department.

Far from legal process

Negotiations on adjusting the terms of the bonds is a more realistic next step, despite market speculation of a possible bankruptcy or company restructuring.

Two conditions need to be satisfied before the company can file a bankruptcy or restructure request to the court, according to the Enterprise Bankruptcy Law of the People's Republic of China. First, its debts must be more than assets. Second, it can’t pay maturing debt.

Chaori owned total assets of Rmb6.19 billion ($1 billion) in 2013. But its gross liabilities already amounted to Rmb6.39 billion as of the third quarter of 2013 (the end-2013 debt data has not been released by the company).

The company could not pay all of the Rmb89.8 million interests due on March 7 on the Rmb1 billion 5-year bond it issued in 2011. In additional, it couldn’t pay the Rmb1.46 billion of outstanding short-term debt, according to the company semi-annual report in 2013.

It is difficult, however, for the company to enter a legal process, even though the two conditions are satisfied, said legal experts.

The bonds are listed in the Shenzhen stock exchange and thus held mostly by retail investors, which is one of the major challenges for the Chaori creditors.

The first bondholder meeting will be held in Shanghai on March 26, leaving many retail investors who live across the country in difficulty to turn up in the meeting.

“It [the bonds may be held by lots of retail investors] makes it difficult for them to get the majority needed for enforcement action or approval for any restructuring,” said Lam.

Meanwhile, most retail investors usually lack professional knowledge, time and energy, as well as experience to handle such a complicated legal process. 

“They might consider seeking intervention from the local government or authorities. I won’t be surprised if it happens,” said Lam.

As of March 10, at least nine Chaori bond investors appealed to the government, the Chinese market regulator and the media for help, the official Xinhua News Agency has reported.

“Financial products are often held by a wide and vast population, which makes any problem of the products a great issue to the whole society,” said Zhou Yao, a lawyer with a Heilongjiang-based law firm Yuanchen, who has more than ten-year experience in corporate restructuring and bankruptcy.

Zhou said the government would like to see creditors and debtors reach agreement on the terms of processing debtors’ equities, assets and loans instead of appealing lawsuits, for the purpose of social stabilisation.

Either the creditors or the debtors can apply the bankruptcy law if they desire. Even so, China’s bankruptcy law requires more involvement from the appointed administrator and the court, which is very different from the US’s Chapter 11, which calls for a debtor-led process.

Money is another problem for Chaori bond retail holders in terms of starting a legal process. “In offshore cases, the company will reimburse the bondholders for the [legal and financial advisory] fees if a restructuring is ultimately successful. But before solutions are reached, the bondholders would have to pay for their expenses. That’s made it difficult for small and disparate retail investors to drive the process,” said Lam.


23 corporate bonds with high default risks*

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