China’s Evergrande files for Chapter 15 Bankruptcy
In breaking financial news, China’s troubled developer Evergrande has just filed for Chapter 15 bankruptcy in a New York Court yesterday. In this article we will explore both what a Chapter 15 bankruptcy is and how this bankruptcy is showing the cracks in the Chinese financial system.
What is Chapter 15?
Bankruptcy Abuse Prevention and Consumer Protection Act in 2005, stands as a pivotal legal framework fostering cooperation and synergy among international courts. The core purpose of Chapter 15 is twofold: safeguarding cross-border investments, trade relationships, and job stability while ensuring the equitable administration of global insolvency cases that uphold the interests of all stakeholders. With its inception influenced by the United Nations Commission on International Trade Law (UNCITRAL) in 1997, Chapter 15 serves as a vital mechanism for corporations beyond the United States’ borders to seek refuge under its bankruptcy laws. A testament to its significance, 48 nations, including the United States, have adopted analogous provisions in response to the UN commission’s recommendations, enhancing the international legal landscape. By enabling companies undergoing restructuring to navigate their path while avoiding creditor lawsuits, Chapter 15 extends protection to these entities. Notably, accredited representatives of foreign debtors can petition a U.S. bankruptcy court, invoking recognition of a foreign proceeding. The influence of the “Model Law on Cross-Border Insolvency,” originally championed by UNCITRAL, has further catalyzed its adoption by 19 nations, in various forms, solidifying Chapter 15’s role in international financial jurisprudence.
Who Can Seek Security with a Chapter 15 Filing?
As China’s Evergrande files for Chapter 15 bankruptcy, many people may wonder how a Chinese company can file for bankruptcy in the United States? Eligibility for seeking security through a Chapter 15 filing extends to debtors with an international presence. This avenue becomes viable when a corporation operates abroad and simultaneously contends with a legal proceeding or case in a foreign nation. A crucial factor in this process is the cooperation between the United States and the foreign country, involving courts, trustees, examiners, debtors, debtors in possession, and competent authorities engaged in cross-border insolvency cases. However, the designation of competency for certain foreign courts, including those in China, might raise valid concerns. Operating under a mandatory recognition rule, Chapter 15 sets itself apart from typical court cases, which are typically filed in the jurisdiction aligned with the corporate entity or debt location. Venue determination is guided by distinct provisions, including scenarios where the debtor holds a principal place of business or assets in the US. In cases lacking a business location, venue selection hinges on ongoing actions against the debtor in federal or state courts, or where justice and convenience for all parties align.
Foreign enterprises, like China’s Evergrande, pursuing recognition within Chapter 15 commence the process by submitting a petition through a foreign representative before they can file for bankruptcy. This petition carries the potential to secure provisional relief for various aspects. These include preventing the execution of actions against the debtor’s assets in the country, granting the foreign representative authority over assets within the United States, permitting the examination of witnesses and evidence related to the debtor’s assets, obligations, and affairs, and even enabling the suspension or approval of specific transfers.
The current instance of a foreign corporation seeking refuge under Chapter 15 in the United States is not an isolated occurrence. A notable case is that of Brazilian telecommunications giant Oi SA, which has resorted to this avenue twice since the inception of Chapter 15 bankruptcy laws. Back in 2016, Oi SA, Brazil’s primary fixed-line phone carrier and fourth-largest mobile operator, sought the protection of Chapter 15 in response to creditors holding $19.3 billion in bonds, bank debts, and operating liabilities. Fast forward to March 2023, and Oi SA once again turned to Chapter 15, filing for protection against creditors with $5.6 billion in loans and bonds, showcasing the enduring relevance of this legal recourse, even after six years from the initial filing.
Who is Evergrande?
Evergrande, a prominent figure in the global real estate sector, recently made a significant move by filing for Chapter 15 bankruptcy in the United States on August 17, 2023. This strategic filing, which took place in Manhattan, serves to shield the company from creditors while it devises a fresh and comprehensive restructuring plan. Ranked as China’s second-largest real estate developer, Evergrande wields significant influence domestically and on the global stage, focusing its operations within China while maintaining key corporate hubs in Hong Kong, the Cayman Islands, and the British Virgin Islands. This pivotal filing occurred within New York’s southern district, underscoring the gravity of the situation. With an extensive portfolio encompassing 1,300 properties spanning 280 cities, Evergrande’s financial challenges have become increasingly apparent, characterized by accumulated losses of $81 billion over a two-year period and staggering liabilities reaching $300 billion. In a notable display of diversification, Evergrande’s interests extend beyond real estate, encompassing sectors such as theme parks, energy, electric vehicles and ownership of a football club. This is not the first instance of Evergrande grappling with financial turmoil. In 2021, Evergrande was accused of using retail investments in the form of bonds and other Wealth Management Products (WMP) to plug funding gaps. Now, in 2023, the company faces yet another critical crossroads that could reshape its trajectory within the global economic landscape.
China Real Estate
The real estate sector in China has assumed a significant role within its financial industry, comprising a substantial 30% of the country’s GDP. This prominence stems from its appeal to retail investors seeking a secure, long-term investment option, especially given the uncertainties of the stock market, where company finances lack transparency, and perceived risks within banking institutions for Chinese investors. Consequently, real estate has become the favored channel for savings among Chinese households. In their pursuit of development opportunities, Chinese developers collaborate closely with local governments in their respective provinces. These developers acquire land from local governments, often contributing a substantial share of the government’s budget in return.
To address an overheated budget housing market in China, where companies like Evergrande have extensively employed leverage to expand their operations, President Xi Jinping introduced the “Three Red Lines” law aimed at facilitating a controlled soft landing for the housing market. Notably, defaulted developers in China now account for a staggering 40% of the country’s home sales. The “Three Red Lines” law, instituted in August 2020, delineates the following provisions:
- Liabilities should not surpass 70% of assets.
- Net debt should not exceed 100% of equity.
- Monetary reserves must amount to at least 100% of short-term debt.
Evergrande isn’t the only major developer in China to consider filing for bankruptcy under Chapter 15 or locally. Country Garden had to suspend trading of their onshore bonds after stocks plummeted during August of 2023 due to talks of debt restructuring.
China’s troubled financial landscape
As people see that China’s Evergrande files for Chapter 15 Bankruptcy, concerns are mounting about China’s financial sector and how their slow growth in a post covid world will affect the global markets. China has enacted a new anti-espionage law which took effect on July 1, 2023. The law has spooked foreign investors because of its ambiguity, making foreign nationals working in China even more of a target for the Chinese Communist Party (CCP) to examine every aspect of foreign corporations and foreign workers opening up the possibility of being arrested or prosecuted on arbitrary charges.
These new laws couldn’t have come at a worse time. During COVID, many big American companies have realized their reliance on the Chinese supply chain was in a state of overdependence at the very least, and that they need to diversify as no one can predict black swan events such as COVID-19. American powerhouse mobile manufacturer Apple has definitively decided to expand their parts suppliers vastly from China to India and Vietnam. Youth employment has such a grim outlook that the CCP has decided to stop publishing the rates of employment of their college graduates who have reached record breaking numbers.
The Chinese financial crisis is exacerbated by various factors including sluggish economic growth, a declining population, and tightening controls on technology and education sectors. With exports and investments experiencing sharp declines, job opportunities have become scarce, leading to economic strain. The severity of the situation has prompted the government to cut interest rates and contend with deflation while the global trend is inflation. Government crackdowns on technology and education sectors, coupled with concealed youth unemployment figures, compound the challenges. The declining population and reductions in government employee wages further contribute to the complex economic downturn.