By: Liu Yanling, Partner and head of King & Wood's Bankruptcy, Restructuring & Insolvency Practice
Stellar Megaunion Corporation ("SMC") was in serious debt, as it could barely repay its liabilities. New World China Land ("NWCL"), which was seeking an opportunity to go public, proposed to acquire SMC as a shell company which has no assets, but is publicly listed. To achieve this goal, NWCL conducted several rounds of negotiations with SMC's creditors to settle SMC's debts and clear the roadblocks for the acquisition. However, the parties were unable to make much progress in the negotiations due to the large number of SMC's creditors involved. As SMC needed to solve its debt crisis as soon as possible and its negotiations with NWCL were deadlocked, the company decided to reorganize to completely release itself from the heavy debt burdens in a short period time.
A. Reorganization initiated by SMC's creditors
As SMC failed to repay it debts due, a third party creditor petitioned the proper Intermediate People's Court (the "Court") to reorganize SMC. The Court accepted the petition on March 11, 2008 ([2008] Yusanzhongbozi No.1).
SMC's Reorganization
B. Confirmation of Creditors' Rights
According to the proposed reorganization plan the administrator of SMC (the "Administrator") submitted to the Court and the first SMC creditors' meeting, 70 creditors filed claims and the total value of confirmed claims was nearly RMB 2.5 billion. [continue reading to find out the outcome]
C. The Reorganization Plan
The Administrator proposed the following reorganization based on SMC's financial status and characteristics.
a. SMC would repay the secured creditors with the asset(s) over which the security was created. Where the asset(s) is converted into cash, the corresponding secured creditor enjoys priority of repayment and a cash payment equivalent of 30% of the principal of the secured claim would be paid to the secured creditor.
b. The employees' claims and tax claims should be paid in full.
c. The unsecured creditors should be repaid 30% of the principal of the unsecured claims.
d. The shareholders of non-tradable shares of SMC transferred 50% of their equity shares they held to an outside company in Shanghai as consideration for funding SMC's cash repayment to its creditors. Up to 40 million of the non-tradable shares were transferred to the Shanghai company could be converted into cash at RMB 5/share and used to repay the creditors. The secured and unsecured creditors may apply in writing for repayment from SMC on a voluntary basis.
e. SMC then transfers all its existing assets (excluding those over which secured claims were created) to a Corporate Management and Consultancy company ("CCCMC") as consideration for CCCMC to repay the remaining claims outstanding upon cash repayment by the Shanghai company and the stock repayment for non-tradable shares.
On April 18, 2008, SMC convened the first creditors meeting and the Administrator submitted the proposed reorganization plan to the Court and to a creditors meeting for to vote. The plan was passed during the meeting and approved by the Court.
The Reorganized SMC
Upon the completion of the reorganization, SMC repaid claims of RMB 560 million and the creditors discharged claims of RMB 1.9 billion in total. All the assets and the outstanding portion of the creditors' claims were transferred to CCCMC. SMC was released from the said portion of liabilities and became a shell company without any assets or liabilities.
Compared with the reorganization of other listed companies, the reorganization of SMC had its own features. First, SMC's reorganization timeframe was short — the proceeding was concluded within 41 days from the day the Court accepted the reorganization petition. Second, SMC utilized shares, a fictitious “currency”, to fund a portion of cash repayment under the reorganization plan. This approach not only lowers the cost to the Shanghai company that assumed shares, but also provides reasonable compensation for SMC's creditors with the reevaluation of the company shares upon further asset restructuring.
The Importance of Reorganization for Listed Companies
By April 30, 2008, more than 10 listed companies in China had completed their reorganizations. Reorganization offers those companies that face a debt crisis due to their poor operation an opportunity of survival. To distressed public companies, reorganization is not only a means to gain a second life but also a tool to better protect their creditors and shareholders, alleviate the unemployment pressures of their employees, and stabilize the local economy.
As the most efficient method to solve a debt crisis, reorganization has been increasingly used in the debt restructuring of listed companies. It is also the most popular approach for parties to release the debt burden of a target company in merger and acquisition transactions in China.
Compared with other conciliation proceedings, reorganization has some advantages.
First, reorganization is time efficient. The company under reorganization does not need to negotiate with each of its creditors. The reorganization can be adopted with the consent of the majority of the creditors. Even if the creditors in a certain voting group rejects a proposed plan, the court may rule approve it if certain requirements are met.
Second, reorganization has a better chance of success. So far, no company has entered bankruptcy proceedings following an unsuccessful reorganization.
Third, as the number of companies qualified for becoming a shell company is small, more and more investors with substantial financial strength prefer to acquire shell companies via reorganization. Reorganization can lower the investment costs by alleviating the debt burden of the distressed company and repaying a portion of the creditors' claims with the stocks of the company and leave the investors with more funds for further asset restructuring.
Fourth, once the reorganization plan is approved by the court, the plan is binding on all creditors. This ensures that the distressed company is completely free from further claims by the creditors and becomes a shell company.
As an effective means of saving distressed companies and conducting debt restructuring in M&A transactions, reorganization creates a new mechanism that benefits all stakeholders of distressed companies.
