China Special Situations Insight (Volume 2, Issue 22)

Investing in Debt for Common Interest in Bankruptcy (II): Key Issues for Legal Due Diligence

In our previous article (Volume 2, Issue 21), we introduced debt for common interest (“Common Interest Debt”) which is becoming more popular to investors. Due to its priority nature, Common Interest Debt provides valuable protection to an investment and a bankrupt company may find a way out of its distress, making this a win-win situation.

It is advisable to conduct legal due diligence before proceeding with a Common Interest Debt investment. A Common Interest Debt usually involves many different matters, therefore comprehensive legal due diligence is indispensable to provide a solid ground for the investment. We have highlighted some of the key issues that investors need to be aware of during the legal due diligence process.

• What should be covered during legal due diligence?

(1) The project to be financed by the Common Interest Debt. If a Common Interest Debt investment is used, for example, to finance a real estate project, the bankrupt company will continue the construction that is already in progress and then sell the construction upon its completion to obtain revenue for the repayment of its debts. To get an accurate evaluation of the project, an investor needs to have the full picture of the property. This includes information about the initial purchase of the land use rights from the government (including but not limited to payments for land premiums and taxes), the property area and the construction plans, the certificates and licenses already obtained, the full legal status of the construction (such as any mortgages and liens thereon), any property defects, and any other aspects that may affect the value of the project.

(2) Bankruptcy procedures. All information regarding the bankruptcy needs to be fully verified at the beginning of any investment process. Investors will need to deploy different strategies and accommodate different protections in the transaction documents, depending on the status of the bankruptcy.

(3) All assets of the bankrupt company. As discussed in the previous article, security is allowed for a Common Interest Debt; therefore, investors should investigate all assets of the bankrupt company to see if there are any clean assets available for security.

(4) All debts of the bankrupt company. A Common Interest Debt is senior to any unsecured debts, but there are still some debts that should be repaid first, such as bankruptcy expenses, construction costs and any debts owed to homebuyers who have already paid the full amount or the majority of the purchase price. It is important for investors to be aware of all the debts of the bankrupt company before they make a commercial decision.

• Collecting materials and information for legal due diligence

(1) Meet with the administrator. Because the administrator oversees the bankrupt company and possesses most of the information an investor requires, we strongly recommend an interview with the relevant bankruptcy administrator. A meeting would make it easier to collect information or documents, and more importantly, it would help to build a good relationship with the administrator and lead to a more cooperative transaction.

(2) On-site searches with local authorities. Investors usually need the administrator to provide authorization documents, and they would then be able to conduct on-site searches regarding the project, registered information, and credit records.

(3) Online searches. This is similar to legal due diligence for an ordinary transaction. Investors need to visit online systems to check the company’s information, litigation, enforcements, security records, and any other relevant matters.

For further information, please contact Catherine Miao, Head of Special Situations and Alternative Investment at JunHe LLP: [email protected] or +86-21-22086350.