Shenzhen-based commercial real estate developer South China City (1668HK) and debt investors for more than a year may be a microcosm of the difficult game between struggling real estate companies and the capital market.
Back on February 9, 2024, China South City announced that in recent years, the company's sales have fallen short of expectations, cash flow can only ensure daily operations, and the company is facing very large pressure to repay principal and interest on debt. Despite various measures taken since 2022 and several successful rollovers of offshore US dollar bonds, the company's operating and financial position has not improved, and therefore, the mandatory redemption proceeds of the October 2024 notes due on February 9, 2024 will not be paid.
Investors were angry about South China City's announcement. "This is a default that was able to pay, but was deliberately arranged. In an "open letter", the bond investor said that the amount payable was only US$11 million (about 79 million yuan), and that there was still 1.3 billion yuan in the account of China South City, and that the major shareholder of China South City, SAR C&D, was also responsible for providing liquidity to China South City due to the keepwell agreement.
The issuer, China South City, said it was short on cash flow, and investors pointed the finger at China South City's largest shareholder, the Special Zone C&D Group. Because the South China City bonds were previously extended, the SAR C&D signed a "keepwell agreement" as the keepwell pledgee, and the SAR C&D is currently in normal operation and has sufficient liquidity, the bondholders said that in the breach of contract litigation procedure, they will also pursue all the legal liabilities of the keepwell agreement provider, SAR C&D.
However, in previous cases, there was no uniform enforcement standard for whether the keepwell agreement could ultimately bring corresponding compensation to investors, and there were also different opinions in the legal profession, with some views that in previous judgments, there were cases in which the keepwell committed party compensated the plaintiff, and there were also views that the keepwell agreement was a third-party credit enhancement method, but this did not mean that the keepwell party had to repay the debt directly.
At present, there is no agreement between China South City and investors, and the tug-of-war is still ongoing.
Two-sided game. Regarding the announcement issued by China South City on February 9 that "it will not pay the mandatory redemption money of the October 2024 notes due on February 9, 2024", the company further said that the above matters will lead to a default on the bonds, which will have an impact on the company's operations and other aspects, including the possibility of bankruptcy or other forms of restructuring. "The company is currently considering different options, including but not limited to investor consent, a debt restructuring plan and an offer to exchange," China South City said.
Investors have a different view on the same matter, believing that China South City has enough money to repay the payment. "It is not that C&D and China South City are unable to arrange the repayment of the US$11 million redemption and other principal and interest thereafter, but they want to take advantage of the opportunity to maliciously evade their debts. The aforementioned open letter states.
Unable to receive the funds on time, investors have also taken steps to put pressure on China South City. According to the letter, the bondholders, who currently hold more than 25% of the bonds, have appointed a lawyer to commence the relevant breach of contract litigation procedures, and will then pursue all legal liabilities of the keepwell agreement provider, SAR C&D, in addition to the bond issuer. What are the consequences of investors suing China South City? "If the creditors holding 25% of the bonds make legal claims, all of CSC's debts will be fully and formally defaulted and irreversible," the letter said. ”
It is worth noting that this is not the first time that investors have issued an open letter on the South China City bond.
In May 2022, C&D Group, an enterprise under the State-owned Assets Supervision and Administration Commission of Shenzhen Municipality, won 19HK$100 million to subscribe to South China City 2928% of the shares, becoming the largest shareholder of South China City. On July 21 of that year, China South City issued an announcement to solicit the consent of investors, hoping to extend the maturity of five US dollar bonds due in 2022 and 2023 and reduce interest rates.
On July 22, 2022, the Boycott of China South City's Malicious Debt Evasion Concern Group published an open letter in the Hong Kong Economic Journal, calling on investors to say "no" to China South City's bond extension and interest rate cut plans.
However, in the end, based on the trust in the state-owned background of the major shareholder of China South City, especially considering that the major shareholder of China South City, SAR C&D, provided a keepwell agreement for China South City, in August 2022, the bond investors of China South City agreed to extend the above-mentioned five US dollar bonds due in 2022 and 2023 to 2024, repay a small part of the principal in installments during the extension period, and uniformly adjust the coupon rate of more than 10% to 9%.
An announcement was made in China South City.
However, the short-term extension did not make South China City once and for all. At the beginning of December 2023, China South City announced that due to tight cash flow, the non-payment of interest on a note due on November 20, 2023 will lead to a default event, and it hopes that investors will waive this interest, and at the same time, China South City hopes to extend the above five bonds (a total of about $1.3 billion) to 2024 and reduce interest rates.
The investor's open letter said that because the extension conditions proposed by China South City were extremely poor, they hoped that the interest rate would be further halved on the basis of the already lowered, and the principal could also be extended indefinitely, and China South City's extension plan was strongly opposed by creditors. Subsequently, China South City held a meeting of some creditors, and the SAR C&D stated in the creditors' meeting that "the keepwell agreement is invalid".
Eventually, the game passed the rollover of one of the dollar bonds, which extended its maturity date from July 2024 to August 2027 and lowered the interest rate from 9% to 45%, in addition, the interest due in November 2023 will also be waived until July 2024.
The dispute over keepwell agreements.
In this condemnation, the investor's appeal is undoubtedly to "get the money", and in the investor's view, because the major shareholder of China South City, the SAR C&D, signed the keepwell agreement as the keepwell pledger, and the attitude of the SAR C&D determines the direction of the incident.
China South City bond investors told Yicai that at that time (August 2022), the bond extension could be successfully passed, and the keepwell agreement signed by the SAR C&D played a very important role.
On February 19, the Special Administrative Region C&D issued an announcement saying that the failure of China South City to pay the bond maturity on time on February 9 this year was true, but the SAR C&D did not explain in the announcement whether it would fulfill the keepwell agreement and whether it would bear the responsibility for the repayment of funds for South China City.
Yicai understands that the keepwell agreement is a third-party credit enhancement method, but this does not mean that the keepwell party must directly repay the debt. According to Everbright Law Firm, a keep-well agreement or keep-well deed is a type of document agreed by the parent company to provide credit enhancement for the overseas subsidiary in which the shareholding is held, with the purpose of ensuring that the overseas subsidiary maintains sufficient equity funds and liquidity and can repay its debts on time and in full. Generally speaking, it is generally stated in keepwell agreements that "shall not be regarded as a guarantee".
Huo Wei, a partner at Zhong Lun Law Firm, also pointed out in an article that although the keepwell agreement also contains the commitment of the keepwell provider, including the provision of financial support and liquidity support to the debtor (issuer), its purpose is to help the debtor maintain its ability to perform the contract, but it does not explicitly indicate that the keepwell provider has made a commitment to perform the debt or assume the relevant guarantee liability for the debtor in the event of non-performance of the debt. This is also the essential difference between a keepwell agreement and a guarantee.
Huang Lichong, President of Huisheng International Capital, told reporters that in Chinese law and judicial practice, keepwell agreements have not yet been clearly defined as a specific framework for legal effect, and are more regarded as an agreement with ethical standards, in which the commitment is not to pay off the debts of the guarantor or issuer under the bonds. As a party to the "keepwell agreement", the specific responsibilities of the SAR C&D depend on the specific terms and contents of the keepwell agreement.
However, citing previous precedents, the investors of China South City said that the creditor's claim may be upheld by the court. In Tsinghua Unigroup's case, the Hong Kong court found that Tsinghua Unigroup was able to perform its obligations to the best of its ability, and therefore ordered it to compensate the plaintiff in accordance with the keepwell agreement. Investors told reporters that before China South City defaulted, the keepwell provider of its US dollar debt, the Special Zone C&D, was in normal operation and had sufficient liquidity, and "there is no evidence that the C&D did its best to fulfill the contents of the keepwell agreement."
At the same time, the above-mentioned investors said that the validity of the previous judgment of the Hong Kong court that CEFC Group needs to bear the liability for compensation under the keepwell agreement was also recognized by the Shanghai Financial Court in 2020. "This case also provides a practical judicial avenue for US dollar bond investors. ”
Some industry insiders familiar with Hong Kong's capital market also told reporters that Hong Kong courts have relevant cases for reference, and keepwell providers have precedents of being ruled to bear partial or full liability. However, Huang Lichong believes that even if the Hong Kong court supports the creditor, it still involves the issue of applying for the enforcement of the Hong Kong judgment in the mainland, and the SAR C&D can raise an objection in the mainland court and refuse to enforce it.
Jiang Qian, a partner in the restructuring, bankruptcy and special situations practice of international law firm Ashurst, told Yicai that whether C&D can unilaterally declare the "keepwell agreement invalid" needs to be decided by the Hong Kong court based on the lawsuit filed by the parties to the keepwell agreement in accordance with the jurisdiction clause of the keepwell agreement. If China South City defaults and triggers an overseas creditor to file a lawsuit in the court, whether the SAR C&D needs to bear the corresponding liability under the premise that the keepwell agreement is valid depends on the content of the Hong Kong court's judgment, and in addition, whether the Shenzhen court recognizes and enforces the Hong Kong court's judgment.
For China South City, the above-mentioned capital market source said that since the company has expected not to pay interest, nor will it repay part of the principal promised earlier, nor has it obtained the consent of the holders in advance, it has been a default, but it does not necessarily cause all debts to default, "whether the domestic debt is repaid, will be known later, and this does not affect the restructuring of overseas debts." ”
Insiders of other real estate companies also believe that the default of overseas debt usually does not trigger the cross-default of domestic debt, and bank loans should also depend on whether they are domestic or offshore. "Generally speaking, after a default on an offshore debt, the main result is to initiate debt restructuring, and perhaps reduce debt when debt restructuring is promoted. ”
Huang Lichong said that now, if China South City can provide a debt restructuring plan and get the support of creditors after being sued, the relevant problems can be solved; If the debt restructuring plan cannot be supported, "China South City will most likely be sentenced to bankruptcy in the future, and the relevant debt agreements are already very mature." "But this process usually takes years.
Jiang Qian believes that the default of China South City is not beneficial to all parties, and if the two parties negotiate in a pragmatic and sincere manner as soon as possible and improve the transparency of financial and business information, it will help to reach an agreement to restructure as soon as possible, maintain the company's continuing operating value, and protect the interests of creditors.