ABSTRACT: The 1999 bankruptcy of Guangdong International Trust & Investment Corporation (GITIC) remains as China's largest bankruptcy of a state owned enterprise. Passive foreign investors constituted the majority of the general creditors. This article recounts some particulars of contentious issues which were decided adversely to the general creditors. Some shortcomings of the proceedings are explained, especially relating to the identification of the Chinese governmental entities which owed large amounts of money to GITIC. Questions are raised regarding possible application of the GITIC decision-making process to bankruptcies involving non-state owned enterprises.

Police, teachers and firefighters pension funds, insurance companies, investment bankers, stock brokers, American banks, Hong Kong banks, Chinese banks, Swiss banks, Japanese banks, Eurodollar investors: what do they have in common? Collectively, they lost over US$3 billion in the largest bankruptcy China has ever seen. It is the first bankruptcy of a Chinese financial institution and includes the first default of a Chinese issuer of international obligations. With a return now estimated by the professional advisers of the Liquidation Committee (LC) of Guangdong International Trust and Investment Corporation (GITIC) to be close to 12.5 percent after over four years of proceedings1, GITIC has set the bar for bankruptcies of State Owned Enterprises (SOE) in China. The GITIC bankruptcy cries out an anguished warning to everyone considering a passive investment in the opening investment fund windows in the People's Republic of China.2
QUESTIONS FOR THE FUTURE

In this far too brief article, many further observations have been omitted in the interest of brevity. Yet important key lessons of the GITIC bankruptcy remain as questions for the future. First, as China's economy moves towards larger participation by non-SOE financial institutions, will the decisions of the Beijing appointed liquidators of GITIC become precedent for bankruptcy and liquidation of private financial institutions. Second, what steps can passive foreign investors take in documenting their investments to eliminate the questionable handling of situations similar to those experienced in the GITIC case. And finally, will Chinese courts exercise more independence in cases, which do not involve state owned enterprises.

1 Creditors Satisfied with GITIC Bankruptcy Settlement, China Daily, March 1-2, 2003, page 1.

2 Compare Materials for Meeting of the Chairman Committee of Creditors Held on 25th February 2003, which reported the likelihood of another 1.78 percent distribution before the end of 2003, bringing the recovery rate to 14.3 percent, plus an additional estimated recoverable amount in respect of debts due ... that may be recovered in the future, the amount of which is, for the time being, estimated at approximately RMB 1.162 billion [US$141 million], at page 10.

 
3 At the First Meeting of Creditors' in May 1999, a Chairman Committee of 9 parties representing over 65 percent of the claims in the bankruptcy was created by the Liquidation Committee and confirmed by the Court. The parties were: Bank of China, Guangdong Finance Trust & Investment Corp., Hang Seng Bank Limited, Citibank, N.A., The Dai-ichi Kangyo Bank, Limited, The Sakura Bank Limited, Union Bank of Switzerland, Industrial and Commercial Bank of China, and Armstrong Teasdale LLP. This committee met frequently with the Liquidation Committee and the bankruptcy panel of the Court.

4 See Wu Jiesi, Chinese Phoenix: The Debt Restructuring of the Guangdong Enterprises Group, ISI Publications, Hong Kong 2001.

5 The Liquidation Committee, Liquidation Progress Report, The Fifth Meeting of Creditors, Guangdong International Trust & Investment Corporation, 28 February 2003.

6 See Gordon G. Chang, Examination of Technical Bankruptcy Issues Crucial for Gitic Creditors, China Law & Practice., February 1999, pp. 67-78.

7 Id. page 69.

Thomas H. Bottini, Partner, Armstrong Teasdale LLP

Thomas H. Bottini is a senior partner at Armstrong Teasdale LLP, a leading law firm headquartered in St. Louis, Missouri, USA, which has a licensed Chinese Foreign Law Office in Shanghai. Mr. Bottini has been working on Chinese projects since 1984.

Copyright St. Louis University, John Cook School of Business, Boeing Institute of International Business Spring 2003
Provided by ProQuest Information and Learning Company. All rights Reserved

In China, bankruptcy is a process reserved only for SOEs. At the outset of this proceeding, the unassailable watchwords of transparency, compliance with Chinese law and attention to international insolvency standards were to be the GITIC bankruptcy guiding principles as announced by the Guangdong Higher Peoples Court (the Court) at the First Meeting of Creditors in May of 1999. Yet, after years of experience on the Chairman Committee3 as the representative of the single largest creditor in the GITIC bankruptcy, the guiding principles remain foggy beacons somewhere just beyond the horizon.

There is no question that the professional advisers faced unique problems and rendered good advice. Nor is there any question that the LC and the Court strove to achieve those principles. The experience, however, has confirmed the sage advice of China investment counselors: don't let the money out of your sight or you will turn out to be the fool that the recipients of the money believe you to be.

OBJECTIVES AND STRATEGIES FOR GENERAL CREDITORS

Bankruptcy of an SOE means liquidation; there is no alternative. If restructuring of an enterprise were an alternative, it would be considered and selected prior to any bankruptcy filing.4 Once filing has taken place, the gravestone is set in place. Thus the GITIC bankruptcy filing on January 16, 1999 came on the heels of a thorough review by Goldman Sachs of GITIC business operations, which was commissioned by the Peoples Bank of China, China's Central Bank. Financially and managerially, GITIC was too crippled for there to be any other alternative. The LC's task was to sort through the claims, sort through the assets and to distribute money remaining after liquidation of the assets to the general creditors.

Counsel to claimants falling in the general creditor category usually adopt a strategy to minimize the claims against the bankrupt estate and to maximize the assets and the liquidation of the assets. Minimizing the claims translated into finding reasons why purported claims should be denied. Maximizing the assets translated into denying any special status for specific assets.

In pursuing these aims, observers learned a lot about the way Chinese authorities handled these sorts of matters. First and foremost, even the largest creditor did not discover a list of the claimants in the bankruptcy. This lack of transparency seriously eroded efforts to disqualify claimants. Equally astounding was the LC's refusal to identify and list specific assets and the largest category of assets, the parties that owed money to GITIC. Since both lists were spiked with goodly numbers of other SOEs, apparently it was deemed politically expedient to conceal these identities in the interest of protecting those SOEs. Ostensibly the LC claimed that these disclosures, even on a limited basis to the confirmed general creditors, was a matter of privacy for the claimants as well as the debtors. Later it was asserted that the disclosure protected the privacy since the categories covered alleged claims and debts. Yet when disclosure was finally made of the claimants, it came in the context of a list of confirmed claimants. These were parties whose claims were already accepted and thus there was no ability to attack these claims. As attempts were made to obtain these lists, curious discourse abounded at the Chairman Committee sessions. Argument for disclosure: One of the reasons to disclose the debtors is to put other prospective lenders on alert as to the lack of credit-worthiness of such an SOE. Argument against disclosure: If everyone learns that a particular SOE is a major debtor to GITIC, the SOE will no longer be able to borrow.

The Guangdong Higher People's Court had final jurisdiction of this bankruptcy. There was no appeal. Thus whenever some novel issue of Chinese law arose, the Court would come to a tentative conclusion and forward this conclusion to the Chinese Supreme Court for comments. After receiving comments and guidance, the Court was ready to announce its decision. So much for judicial independence. In an attempt to outflank this system, counsel found ways to submit informative and argumentative memoranda directly to Supreme Court justices while they were considering these matters.

GOVERNMENT GUARANTEED LOANS

The largest of the major asset groupings was loans owed to GITIC and guarantees of those loans. GITIC operated as a holding company. GITIC issued the Eurodollar floating rate notes, the Yankee bonds (offered in the USA), the Samurai bonds (offered in Japan) and collected the proceeds of these security issues. It then dispensed the money as loans and investments to a vast group of subsidiaries and affiliates, many of which were in the real estate or construction businesses.

For example, one of GITIC's subsidiaries owned the Guangdong Exhibition Center, the huge trade show facilities in which the semi-annual Canton Trade Fairs were held. Other investments included:

* partnering with McDonalds for all of the McDonalds's restaurants in Guangdong province

* owning a chain of 8 stock brokerages

* building, owning and operating the 63 story Guangzhou International hotel and office building (Guangzhou's tallest)

* partnering to build an electricity generating plant

* serving as a guarantor of the Guangzhou to Shenzhen express highway.

In short, GITIC was involved in the lifeblood of the economic development of Guangdong Province. These particulars emerged slowly, over the course of the four years of bankruptcy proceedings. But the tentacles of GITIC did not stop at Provincial boundaries. Investments were made in hotels in Beijing, and real estate in other provinces. The investments extended to Hong Kong, the USA, Australia, Thailand and other countries.

Many of these loans and investments were guaranteed by provincial and municipal organizations. Virtually all of the makers of the loans reneged on them after the filing of the bankruptcy, and the LC was required to bring lawsuits in the Court to obtain judgments against them and their loan guarantors. In the course of the litigation, the Court determined that most, if not all, of the governmental organizations had issued the guarantees illegally and, thus, they were invalid. On the other hand, the Court determined that the governmental entities had a 50 percent liability for the amount of the loan on a reliance type theory. These entities in turn declared their inability to pay even the 50 percent guaranteed amount.

The list of Government Organizations Which Failed to Perform the Obligations to Pay Compensation in this bankruptcy was not released until the recent Fifth Meeting of Creditors in late February 2003, far too late to be of any assistance to the efforts of the general creditors.5

KEY RULINGS ADVERSE TO THE GENERAL CREDITORS

There were many political tradeoffs in the making of key decisions early on in the bankruptcy. The first issue dealt with the rights of secured lenders. Under the bankruptcy law, secured creditors are first in line. Article 28 of the bankruptcy law provides that property subject to a security interest is not considered bankruptcy property. secured creditors also are prioritized ahead of the expenses of the bankruptcy. After some initial confusion, the Court agreed with the plain language of the law on this point and the nervous secured creditors breathed a sigh of relief.

Not surprisingly there were situations that did not exactly fit the law. For example, at the time of the bankruptcy, the People's Bank of China, which issued licenses to foreign companies to engage in the insurance business, had issued very few such licenses and forbade any foreign ownership of indigenous Chinese insurers. One large American financial institution had taken a position with a Chinese insurance company by paying the money for the investment to GITIC, which, in turn, bought part of the insurance company-a typical fronting transaction which was one way around the strict Chinese rules. The investment in the insurance company stood on the GITIC books as an asset of GITIC. In the bankruptcy, the creditors sought to liquidate the investment, as there was no indication that it was secured or otherwise owned. This was a good ploy since the asset was basically contraband if the American company stepped forward to claim it. In any event, it was not secured and, as such, should have been an asset at the disposal of the general creditors. Much to the consternation of the general creditors, the LC declared that the insurance company investment did not belong to GITIC at all since it held it in some sort of trust. The investment was turned over to the American company that made a double recovery (the investment as well as an otherwise forbidden direct ownership in a Chinese insurer) and, as a result, the general creditors lost a substantial asset. Chinese insiders, including this very influential American financial institution, legitimized a highly irregular transaction.

This development, however, was dwarfed by the highly questionable confirmation of the claims of the holders of unregistered debt, another politically motivated decision. Chinese law provides that the debt of domestic entities to foreign lenders must be approved by and registered with the State Administration of Foreign Exchange (SAFE). Non-registered debt is unenforceable according to general provisions of Chinese law.6 During the course of the Chinese bubble economy in Guangdong province, foreign financial institutions introduced a host of American derivative financial products to the already murky Chinese scene. Yet few if any of these derivatives were registered with SAFE. In addition, a British law firm had issued an opinion that a US$450 million Eurodollar debt offering of GITIC was not required to be registered with SAFE. Both of these situations were targeted by the SAFE-registered claimants for elimination as confirmed claims in the bankruptcy. Success in this endeavor would have eliminated close to US$1 billion of claims and substantially increased the recovery rate for the remaining general creditors. As Gordon Chang mentioned in the referenced article, The priority of unenforceable obligations in bankruptcy has not been addressed.... At first glance, it would appear that all valid claims must be paid in full before anything is paid on unenforceable ones. As a practical matter, this would mean that holders of unregistered debt would receive nothing in Gitic's bankruptcy.7 In the final event, all of these unregistered claims were confirmed and given the same status as the general creditors. Apparently the lobbying (and perhaps subtle threats to stop the flow of investment capital into China) of these financial institutions and the Eurodollar market makers clarified the vision of the Liquidation Committee's members in this decision.

 (www.taxlaw.org.cn)