The pre-organization process offers a voluntary system for distressed companies, capital providers, creditors and reorganizing investors to resolve their issues in a flexible way under the control of the courts. At present, there are no clear provisions on the pre-reorganization system in Chinese law, but the system is taking shape on the basis of the provisions of the main documents of several government departments of the State Council and of the Supreme People’s Court (SCC), as well as the abundant regulations and practices of local governments and courts.

With the economic fallout from covid-19, many higher provincial jurisdictions have released documents to promote the relief of valuable troubled businesses through pre-reorganization, and the pre-reorganization system has been further developed.

Advantages and disadvantages

Through pre-reorganization, companies can save more time for self-help and a greater voice in the process. The advantages of pre-reorganization include:

(1) if companies enter into pre-reorganization during the bankruptcy examination phase, bankruptcy filings can be withdrawn;

(2) companies can still operate independently;

(3) the procedure is flexible and conducive to attracting investors in reorganization;

(4) companies and capital providers can be heavily involved in the preparation of the pre-reorganization plan; and

(5) some regions allow companies to make suggestions on the selection of interim directors.

There are also risks in the procedure, including:

(1) The level of effectiveness of pre-restructuring arrangements is low and they are controversial, so the degrees of acceptance and co-operation by competent bankruptcy courts vary;

(2) some of the substantive provisions of the corporate bankruptcy law, such as the cessation of accrued interest after the acceptance of the bankruptcy application, cannot be applied;

(3) the procedural provisions are crude and can be controversial in practice;

(4) the authority of the court and the administrator is high and the level of difficulty of supervision is high, which means that the interests of the parties may be harmed and it may be difficult to obtain remedies;

(5) there is great uncertainty about the position of creditors and their opinions, and the results of the votes;

(6) the constraints on pre-reorganization investors are limited; and

(7) the reorganization administrator and the interim administrator may be different.

Compromises

The parties involved must evaluate and weigh carefully before choosing a pre-reorganization process.

On the one hand, a successful pre-reorganization requires the support of outside forces within the framework of the “government-court liaison mechanism” and the “government-court-bank coordination mechanism”.

On the other hand, the feasibility and effectiveness of pre-reorganizing struggling companies may be affected by the nature of the business (e.g. listed or state-owned companies), the composition of claims ( for example, security claims or the characteristics of creditors (for example, bank creditors or creditors entering an enforcement proceeding), and the status of potential investors and their expected investment methods. Various factors may affect the feasibility and effectiveness of pre-reorganization of companies in difficulty.

If a party intends to opt for pre-reorganization, it is necessary to further assess the conditions for reorganization and the possibility of acceptance by the competent court, taking into account the situations of the company and the competent court.

(1) Assessment of baseline conditions

If the business is in an equivalent state of reorganization, or in a worse situation. Some parties may have filed for bankruptcy before the pre-reorganization, and some parties may have to forgo some of their interests in the pre-reorganization. The pre-reorganization business is generally expected to have the same or more severe difficulties as “apparent insolvency,” the reorganization condition.

If the business has the value to reorganize and the potential for rescue. According to the minutes of the National Bankruptcy Courts Labor Conference, the value of the reorganization is mainly reflected in “assets, technology, production and sales, industry outlook, etc.” In addition, shareholders, core team, qualifications and licensing, industry status and brand value are important factors to consider in practice.

The pre-reorganization must be approved by the company in difficulty. The applicant for a pre-reorganization is not limited to the debtor, but a pre-reorganization will only be carried out until the consent of the company – i.e. after the resolution of a certain percentage of shareholders at the general meeting – is obtained. With reference to Article 112 of the rules for handling bankruptcy reorganization cases before the Beijing bankruptcy court (for the implementation of the lawsuit) and the degree of influence of the pre-restructuring on each party, this percentage voting rights must comply with the articles of association, and not less than two-thirds.

(2) Probability of acceptance

If there are specific regulations of the relevant courts (for example, Beijing, Guangdong, Zhejiang, Jiangsu, Sichuan, Fujian, Chongqing, etc.) on pre-reorganization, companies can assess the probability of acceptance according to the terms of pre-reorganization requests. .

While there are no specific rules for the competent court, given that there are a large number of pre-reorganization cases in local courts, and there are also many local innovations in the mechanisms pre-reorganization, the following factors may be taken into account to assess the likelihood of acceptance by the competent jurisdiction.

(I) Previous cases of pre-reorganization of the competent court;

(ii) The main regulations of higher courts on pre-reorganization (eg court documents related to bankruptcy / business / covid-19);

(iii) Pre-reorganization rules / pre-reorganization cases of other courts within the jurisdiction; and

(iv) Relevant local government support systems, policies and measures on pre-reorganization.

If, after assessment, the possibility for the competent court to accept the pre-reorganization request is limited, the parties may consider other options.

In summary, before starting the pre-reorganization process, parties should consider their own needs, business situation, external support, advantages and disadvantages, and their possible voice in the pre-reorganization / reorganization process (especially the right to propose and decision / veto on key issues), as well as the possibility for the competent court to accept the pre-reorganization. It is only then that the parts make a decision after weighing these issues in order to legally maximize their own interests. Given the highly specialized nature of the aforementioned process, parties may also consider seeking professional advice and making arrangements in advance.

Xu Bangwei is a partner and Zhang Rongsheng is a partner at Jingtian & Gongcheng

Jingtian and Gongcheng

34 / F, Round 3
China Central Square, 77 Jianguo Road
Beijing 100025, China

Phone. : +86 10 5809 1266
Fax: +86 10 5809 1100

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