From Part One of Financier Worldwide’s 2006 Restructuring & Insolvency Review
Whether the 21st century will be the century of The People’s Republic of China remains to be seen. It is clear, however, that the increasing globalization of the world’s economies, together with the dramatic rise of mainland China as a major exporter to the United States and other developed economies, will have an impact on the established insolvency proceedings of the world’s developed free-market economies. The surge in Chinese production, driven by low-cost labor and economic policy to provide jobs to a continually growing population is expected to increase the role of China in the world’s markets.
Global economic dynamics have already immersed China in the economic scramble to maximize recovery of financial obligations due from insolvent businesses in foreign jurisdictions. Many Chinese companies suffered significant losses during the recent peak of commercial bankruptcy filings in the United States, and have signaled they will utilize whatever leverage they have to obtain full recovery of pre-filing obligations. Accordingly, insolvency professionals working with USA-domiciled insolvent debtors will have to pay special attention in the planning phase of an insolvency proceeding where critical relationships exist with companies in mainland China, to determine how the Chinese relationship might affect the outcome and cost of the proceeding.
In the last few years our firm has been involved in the roles of chief restructuring officer or financial advisor to an increasing number of bankrupt debtors having extensive dealings with both state-owned and private-sector companies in mainland China, as well as vendors in other Pacific-rim countries, Latin America and Europe Such dealings have ranged from simple supply relationships to more intricate joint-venture manufacturing operations, and in one case the debtor was owned by a Chinese conglomerate. In all cases, the relationship with the Chinese company was critical to either the reorganization of the U.S. debtor or sale of the business under section 363 of the US Bankruptcy Code.
While dealing with off-shore vendors and joint venture partners in any insolvency proceeding adds additional difficulties, experience to date has indicated that dealing with many Chinese companies in these circumstances is particularly difficult.
In a recent situation, the majority of the debtor’s assets (including a significant minority interest in a joint-venture manufacturing operation in Beijing) were sold to a European strategic buyer. In a face-to-face meeting, the Chinese partner refused to recognize the sale of the debtor’s interest in the joint venture unless all pre-petition debts (in the high six figures) and all post-petition administrative claims were paid in full immediately. The Chinese partner further refused to return certain important assets of the estate that were on loan to the joint venture. Obviously, the Chinese partner indicated no recognition of US insolvency laws regarding priority of payments or the automatic stay. This situation is still pending with no resolution.
In another instance, a key Chinese partner refused to sell the debtor a product critical to continue operations on a cash-in-advance basis until all pre-petition debt was paid immediately. In another situation, the Chinese vendor doubled the price of its product.
While lawyers and other insolvency professionals have a basis to argue the solution, several of these cases were resolved pragmatically (with bankruptcy court approval) by acquiescing to the demands of the offshore partner or vendor. Attempting to resolve the issue through the still developing insolvency laws and legal system of China was judged by all the insolvency professionals involved in these cases as not being a realistic or cost-effective attempt at resolution.
While a good number of US insolvency professionals take a negative view on critical vendor motions which provide payments to pre-petition debtors on what is usually a very subjective basis (see August 24, 2005 of The Daily Bankruptcy Review), critical vendor status might be the only way to deal effectively with the entrenched attitude of key Chinese suppliers.
While critical vendor motion are granted routinely in most jurisdictions of the Federal bankruptcy courts, the well-publicized Seventh Circuit ruling regarding critical vendor payments made by Kmart will lessen the ability of debtors in this jurisdiction to find a means to satisfy the ruling and find a means to deal effectively with a key, but recalcitrant vendor, particularly a vendor outside the jurisdiction of US bankruptcy laws.
Nevertheless, insolvency professionals of the world’s developed economies, having established protocols and traditions of dealing with insolvent situations, will have to find ways to deal with situations where such protocols are not recognized. This is of particular importance for US debtors filing in the Seventh Circuit.
To advise clients effectively and anticipate the special problems of dealing with offshore partners or vendors, insolvency professionals need to recognize that special problems are likely to arise if the offshore vendor or partner is critical to the operation of the US debtor, and should anticipate having to plan accordingly.