China Builders With Upcoming Lawsuits Just Got a ‘Wake-Up Call’

(Bloomberg) — Defaulted Chinese developers facing key court dates in coming weeks received an abrupt reminder that it’s actions not words that count in restructurings, if you want to avoid getting liquidated.

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Jiayuan International Group Ltd., a residential and commercial builder focused on areas northwest of Shanghai, received a winding-up order from a Hong Kong court last week despite having launched a debt exchange offer.

That made it the first developer during China’s property crisis to face court-ordered liquidation after public efforts to restructure debt. The ruling came as a surprise to many observers. It marks a new era in which talking about steps to win over creditors won’t necessarily help buy more time in the courts. While two other developers received such orders previously, they hadn’t rolled out restructuring plans, making the outcomes less of a shock.

“This will be a wake-up call that they can’t be complacent,” said Richard Woodworth, a Hong Kong-based partner at law firm Linklaters LLP, referring to defaulted Chinese property firms. “It’s a reminder that when a company is insolvent and going through a restructuring, you’ve got to listen to your creditors and get them to buy into your process.”

A number of Chinese developers with outstanding winding-up lawsuits face a reckoning: they have to show the court a detailed restructuring plan and material creditor support. The next test case is the offshore units of Logan Group Co., whose hearing is scheduled for next week. The builder has been in talks with creditors over its proposal, but has so far yet to release any plan publicly.

Winding-up lawsuits, which if successful can lead to a firm’s dissolution, became a popular tool for creditors to recover debt after Chinese developers’ defaults surged to a record.

“The court’s decision to wind up Jiayuan demonstrates that Hong Kong courts are keen to protect against abuse by debtors who might be looking to buy time or frustrate the process without a meaningful or tangible restructuring proposal on hand,” said Daniel Margulies, a partner at Dechert LLP who specializes in restructuring matters in Asia.

Jiayuan’s debt-restructuring efforts dragged on for more than eight months. It launched the exchange offer in August and repeatedly extended the offer deadline. Eventually the developer scrapped the offer in April and said it would explore a holistic restructuring instead.

During Tuesday’s hearing, a Jiayuan representative said about 70% of bondholders by value backed the exchange offer, near the 75% support level needed for a holistic restructuring. The amount of noteholders accepting the exchange offer outstripped the creditors who appeared and supported the petitioner, she said.

That didn’t convince Judge Linda Chan, who said “the so-called restructuring is really not a concrete proposal but just an idea put forward by the company,” before announcing her decision to issue a winding-up order. Such petitions can be filed against a company in Hong Kong court when a creditor is owed at least HK$10,000 ($1,274), making it accessible for creditors big and small alike.

Potential Backfire

But Jiayuan’s case serves as a reminder to creditors that the legal strategy to pressure issuers to talk may backfire and get out of their hands.

The petition was filed in September by a bondholder named Yeung Man over $14.5 million of unpaid debt. Nine other parties later joined as supporting creditors.

In March, Yeung’s representative requested a further adjournment, citing a negotiation between Yeung and the debtor. But other creditors, who said they weren’t involved in any debt discussions, objected and asked to proceed.

The prevailing views from the supporting creditors led to the ultimate liquidation. Yeung’s lawyer said during Tuesday’s hearing that she was “neutral” to a request from Jiayuan to further adjourn the proceedings. But an attorney for The Hong Kong and Shanghai Banking Corp., a supporting creditor, demanded an immediate wind-up.

“There is always a risk that these things snowball and the company loses control of the situation,” James Warboys, a Linklaters restructuring & insolvency and special situations partner, said during an interview last year. “Ultimately it’s on the company to manage its creditors including very small creditors because you can hold a very small portion of debt and still bring up a winding-up petition.”