Default case highlights cavalier attitude toward law

Chaori Solar restructuring plan flouts rules governing debt repayment

The Fourth Plenary Session of the 18th Communist Party of China (CPC) Central Committee kicked off Monday. According to reports, this high-level meeting will focus on comprehensively promoting rule of law.[Special coverage]

Of course, rule of law is an enormous topic, one with relevance for nearly every situation and aspect of life. Let's look at one specific case - involving Shenzhen-listed Shanghai Chaori Solar Energy Science & Technology Co - to show the extent of the work that authorities still have ahead of them.

Chaori was thrust into the headlines in March, when it stated that it would be unable to make an 89 million yuan ($14.52 million) interest payment to its bondholders, a fateful announcement that put the company on course to become China's first ever corporate debt defaulter. After Chaori's repayment difficulties become public knowledge, experts and observers speculated on whether authorities would organize a bailout or leave the company to fix its own financial mess. Historically, corporate bonds have been seen as implicitly guaranteed by authorities. Such views have solidified over the years thanks to the bailouts that were unfailingly offered to financially impaired issuers.

On October 7, Chaori Solar was back in the news with a tentative debt-restructuring plan, one that would see it bring in a new controlling shareholder and two bond guarantors: Great Wall Asset Management Co and Shanghai Eternal Sunshine Investment Management Centre. These managers will likely assure full repayment of principal and interest of Chaori Solar's defaulted bonds.

China's securities regulator announced on October 17 that the company's creditors can continue to pursue interest appeals through judicial channels. Still, municipal authorities in Shanghai seem willing to support the company with their involvement in its restructuring bid. What's more, authorities in the city were said to have invited a consortium of investors led by Jiangsu Golden Concord to acquire a controlling stake in the company for 1.46 billion yuan.

Despite the hoopla earlier about China finally recording its first ever corporate debt default, here again we see local authorities interfering with market processes. What's more this debt restructuring plan, which has yet to be approved by the local court, may violate relevant financial laws. According to reports, restructuring blueprints from Chaori Solar call for creditors to be repayed in proportion to the size of their holdings, rather than in accordance with existing regulations which prioritize certain investors ahead of others when it comes to seeking compensation. Large holders of secured Chaori Solar debt, who have the most to lose if the plan is eventually rejected on legal grounds, have a right to protest the proposed arrangement.

Many believe that risks are mounting across China's corporate debt landscape. The precedent set in the case of Chaori Solar could have a major bearing on how future defaults are handled. At present, investors might still take it for granted that the government will help companies that encounter financial trouble.

As China's leaders set their sights on legal reforms, law professionals and experts are looking forward to the ongoing plenary session for signals on how the government plans to promote adherence to the law. Those engaged in China's financial market are, of course, waiting for their share of guidance as well.

Many companies encounter repayment problems. The consensus among experts seems to be that these companies should be dealt with in a way that honors both the laws of market discipline and the laws which underpin the health of the financial market. Only in this way will the market continue to mature. If authorities resort to measures of dubious legal merit to support troubled companies, this will only promote a greater sense of false security and the further misallocation of resources.