A practice that Chinese borrowers have long used to raise hundreds of billions of dollars in bond markets is under threat, after a court ruling in Hong Kong this week.
(Bloomberg) — A practice that Chinese borrowers have long used to raise hundreds of billions of dollars in bond markets is under threat, after a court ruling in Hong Kong this week.
In a court decision Thursday, three of four lawsuits involving so-called keepwell deeds on notes from a major Chinese defaulter were thrown out.
A keepwell is basically a gentleman’s agreement from the parent company of a unit issuing a bond to maintain the issuer’s solvency, while stopping short of guaranteeing payment. The court ruling is the latest indication that creditors trying to recover at least some of their money after defaults shouldn’t bank on much help from the keepwells.
“The market hoped for a better outcome,” said Jonathan Leitch, a Hong Kong-based partner at Hogan Lovells International LLP. “This is likely to be the end for keepwell deeds.”
Revealing his decision Thursday, Judge Jonathan Harris dismissed three of the four lawsuits that alleged Peking University Founder Group Corp.’s breach of keepwell deeds. And for the one suit that wasn’t thrown out, while the judge ruled that Founder Group caused 1.15 billion yuan ($163 million) of losses to the plaintiff, that sum is well below the $857 million claimed by the latter.
Four Founder Group units, now controlled by liquidators, filed the lawsuits two years ago, claiming combined losses of at least $1.8 billion resulting from the company’s alleged failure to honor the keepwell deeds.
The ruling could further hurt confidence in China’s offshore credit market, where the keepwell structure remains a dominant feature for many bonds that have either defaulted or are facing payment risks. The decision also came as disgruntled creditors have increasingly resorted to legal action in Hong Kong and other jurisdictions to seek debt resolution following a record wave of defaults by Chinese borrowers.
The judge delivered his decision after a five-day trial in January that involved Founder Group’s keepwell bonds. Founder Group defaulted three years ago and later entered a Beijing court-led restructuring. Its onshore restructuring administrator rejected creditors’ claims on five keepwell notes in 2020.
Point of Contention
Chinese companies, especially those that don’t enjoy strong state backing, have used the keepwell structure in the past decade so as to assuage global investors’ concerns over their creditworthiness. How legally binding it is has become a key point of contention in recent years, as Beijing’s campaign to cut debt risk and an unprecedented property crisis unleashed a surge in delinquencies.
Reflecting the tough broader fundraising conditions and investors’ caution about such debt, issuance of offshore keepwell bonds has fallen to $3.07 billion, the lowest year-to-date total since 2013, Bloomberg-compiled data show. But it remains an important part of the market, taking up 14% of this year’s dollar bond sales from Chinese firms.
“The disappointing decision had added risks to all keepwell bonds on China’s market,” said Lance Jiang, a partner at Ashurst LLP who specializes in restructuring and insolvency.
In Founder’s case, its keepwell deeds contain “a number of inherent shortcomings,” Judge Harris wrote in his ruling Thursday. For instance, the structure’s design doesn’t require dollar bond issuers and guarantors to provide audited financial statements. The breaches “were only likely to come to light after the company was in serious financial difficulties,” he wrote.
In addition, despite the keepwell deeds, once an onshore company has entered reorganization, it’s unlikely to get China’s regulatory approval to transfer money overseas to pay off dollar bond liabilities, Harris added.
–With assistance from Yuling Yang and Kiuyan Wong.
(Updates with more data and comments)
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