Evergrande commences 2023’s largest chapter 15 filing

On August 17, 2023, China Evergrande Group, one of China’s largest real estate developers, and its affiliates filed chapter 15 petitions in the US Bankruptcy Court for the Southern District of New York in Manhattan seeking recognition of foreign restructuring proceedings in the High Court of Hong Kong and in the High Court of the Eastern Caribbean Supreme Court in the British Virgin Islands. 

Evergrande seeks to have the schemes of arrangement it is pursuing in Hong Kong and the British Virgin Islands recognized and given effect to in the United States.  Scheme creditors were scheduled to vote on the Hong Kong scheme on August 28, 2023; however, the meetings for creditors to vote on the schemes have been postponed to September 25-26, 2023 to allow the creditors more time to consider, understand, and evaluate the proposals.

Overview of Evergrande’s businesses

Evergrande is the ultimate parent and holding company of a group of businesses that have three main business segments which collectively have over US $300 billion in liabilities[1]:

• Property development business: Evergrande’s main business line, which had contracted sales of approximately RMB 33.8 billion (US $4.65 billion)[2] and about 4.9 million square meters of gross floor area from January to May 2023.
  
  
• Property management business: Evergrande Property Services Group Limited, an Evergrande subsidiary that provides property management services primarily to real estate projects developed by Evergrande’s property development business.
  
  
• New energy vehicle business: Evergrande’s subsidiary, China Evergrande New Energy Vehicle Group Limited, develops industrial parks and health management businesses as well as the new energy vehicle and battery businesses.

Events preceding commencement, and the commencement, of foreign proceedings

Evergrande historically adopted a high-debt, high-leverage, high-turnover model to expand operations, which created substantial risks that inflated its debt burden and resulted in the deterioration of capital with respect to its main sector of real estate business.  Chinese regulations, including the 2020 “three red lines” policy, put caps on debt-to-cash, debt-to-assets, and debt-to-equity ratios.  The regulations were designed to curb the highly leveraged property sector and significantly restricted liquidity for Evergrande.

Since the second half of 2021, Evergrande’s real estate transaction volumes, area sold, and amount of sales have declined, leading to reduced cash generation and challenges accessing external capital.  Despite recent efforts by the Chinese government to support the sector through the introduction of various new policies, the Chinese real estate market has remained stressed as the market sentiment is weak and development projects and foreign investments have stalled.

In December 2021, Evergrande defaulted on notes and ceased making payments on those notes.  Creditors have tried to enforce their applicable security agreements and a winding up petition was filed against Evergrande in the Hong Kong court in June 2022, which has so far been the subject of several adjournments while restructuring discussions continued.

Against this backdrop, Evergrande engaged with noteholders and other stakeholders, with such negotiations culminating in the execution of three separate restructuring support agreements providing for the commencement of scheme of arrangement procedures in Hong Kong, the Cayman Islands (which Cayman Scheme is not part of the chapter 15 cases), the British Virgin Islands, and chapter 15 proceedings in the United States.  The goal of the chapter 15 cases is to give effect to the foreign schemes of arrangement in the US against creditors that might seek to enforce the terms of US law governed notes in the US. 

General overview of chapter 15 proceedings

Chapter 15 allows for the efficient administration of cross-border insolvency cases and a US Bankruptcy Court’s recognition of the foreign proceeding and relief granted in them. 

In a chapter 15 case, a foreign debtor’s “foreign representative” may petition a US Bankruptcy Court for “recognition” of a “foreign proceeding.”  A “foreign representative” is a person or entity authorized in a foreign proceeding to administer or act on behalf of a foreign debtor.

A “foreign proceeding” is:

[A] collective judicial or administrative proceeding in a foreign country, including an interim proceeding, under a law relating to insolvency or adjustment of debt in which proceeding the assets and affairs of the debtor are subject to control or supervision by a foreign court for the purpose of reorganization or liquidation.

“Recognition” can be either of a foreign “main” proceeding – a case pending in the country where the debtor has its center of main interests (COMI) – or a foreign “non-main” proceeding, which may be pending in countries where the debtor has an “establishment.”  A debtor’s COMI is presumed to be the location of the debtor’s registered office. An “establishment” is “any place of operations where the debtor carries out a non-transitory economic activity.”

Ultimately, recognition of the non-US proceeding is an acceptance of the foreign proceeding, after which the US court may give the foreign representative additional assistance in the United States.

Cross-border considerations

Irrespective of whether a creditor whose debt is governed by US law submits to the jurisdiction of a foreign court by participating in the meetings to vote on a scheme of arrangement, a US bankruptcy court may provide the foreign representative with assistance in making the terms of the scheme apply within the territorial jurisdiction of the US. The effect of the assistance is to compromise or extinguish creditors’ claims against the scheme company by applying the terms of the scheme in the US.  The terms of a scheme may include releases and waivers of existing claims of scheme creditors in return for scheme consideration.

This point was reinforced last year by US Bankruptcy Judge Martin Glenn in the Modern Land[3] chapter 15 case.  The Modern Land case served as a response to dicta made by Justice Jonathan Harris in the Rare Earth[4] decision in Hong Kong. In the Rare Earth decision, Justice Harris questioned the efficacy of compromising US law governed debt via a scheme in an offshore jurisdiction coupled with a chapter 15 application in the US (as opposed to using a chapter 11) and flagged a potential risk of US law governed debt holders being able to pursue enforcement action in the Hong Kong courts notwithstanding the terms of the offshore scheme.  Given the potential implications of the dicta in Rare Earth, it is perhaps unsurprising that Evergrande is promoting parallel schemes in Hong Kong and in those offshore jurisdictions, as well as seeking recognition in the US under chapter 15.

Learn more about Evergrande’s restructuring and current cross-border restructuring trends by contacting any of the authors.