Enforcement of Keepwell Deeds in Mainland China

Enforceability of keepwell arrangements in the PRC

The Beijing First Intermediate Court (the Court) approved in February 2020 an application to restructure the Peking University Founder Group Limited. The restructuring process was subsequently extended to include certain subsidiaries and related companies of Peking University Founder Group Limited (collectively with Peking University Founder Group Limited, the Peking Founder Group). The Court invited creditors of the Peking Founder Group to register their claims with the Court appointed administrator (the Administrator).

The Administrator published in April 2020 a preliminary decision relating to the recognition of creditors’ claims. Claims supported by corporate guarantees granted by the Peking Founder Group were recognised by the Administrator. However, claims supported by keepwell deeds issued by the Peking Founder Group (valued at approximately USD 1.7 billion) were not recognised in the Administrator’s final decision in August 2020.

The Administrator’s decision did not explain why the keepwell claims were rejected but made it clear that such arrangement was not considered by the PRC courts to constitute a claim for a debt.

In the absence of published reasons, we can only assume why the Administrator rejected the claims supported by keepwell deeds.

One reason might be Article 18 of the PRC Enterprise Bankruptcy Law, which provides (not unlike bankruptcy or insolvency laws elsewhere) an administrator can “cherry pick” (ie accept or reject) executory contracts that are on foot when bankruptcy proceedings commence.

One such executory contract is the keepwell deed. If the obligations under the keepwell deed are not triggered (or crystallised) as at the commencement of bankruptcy proceedings in respect of the Keepwell Provider (Commencement of Bankruptcy Proceedings), the administrator can refuse performance by the Keepwell Provider of its obligations under the keepwell deed.  

The fundamental issue is that the steps necessary to trigger payment obligations under the keepwell deed will not have been taken before the Commencement of Bankruptcy Proceedings.

In the case of a keepwell deed, it is very unlikely that the Debtor (an entity related to the Keepwell Provider), will have requested the Keepwell Provider to pay the Debtor a sum (including, for example, extending a loan to the Debtor or make further capital contributions to the Debtor, as stipulated in the keepwell deed) sufficient for the Debtor to meet its obligations to the Creditor - the need for such claim is a key element to trigger a payment obligation under the keepwell deed.

Without such a request made before the Commencement of Bankruptcy Proceedings, no sum is then due and so no amount is admitted to proof in the administration.

The conundrum is that the obligation on the Keepwell Provider to pay amounts due to the Debtor under a keepwell deed cannot be triggered on or after the Commencement of Bankruptcy Proceedings  – but see “Mitigating enforcement risk” below.

Litigation is underway in Hong Kong to seek declarations with respect to rights against Peking Founder under the keepwell deeds.

A preliminary hearing rejected a number of the Administrator’s arguments to stay the proceedings.

Do keepwell deeds constitute a viable means of credit support?

Notwithstanding the Administrator’s final decision in the Peking Founder case, keepwell deeds remain a common feature in offshore financing structures involving PRC group issuers and borrowers.

The key questions remain:

• whether a keepwell deed may be re-categorised as a “guarantee”
• how a keepwell deed may be enforced in the PRC courts, and
• what, if any, steps are available to a Creditor seeking to mitigate enforcement risk. 

Whether a keepwell deed may be enforced in the PRC courts

• Article 91 of the Ninth Civil and Commercial Trial Minutes indicates that a credit enhancement mechanism can be binding even where it does not meet the requirements of a guarantee
• The Supreme Court of the People's Republic of China (the SPC) has previously determined that the obligations of a third party ‘to make up the balance due’ can be enforced as an independent contract^[1]
• ‘Disguised joint and several liability’ (whereby multiple debtors are liable for their own, rather than someone else’s, default) is recognised by the PRC courts^[2]
• PRC Contract Law^[3] recognises that a creditor may make a claim for the repayment of a debt by means of subrogation
• A recent decision by the Shanghai Financial Court^[4] (the CEFC case) is encouraging because it held that any attempt to resist the enforcement of a keepwell deed based on PRC public policy is unlikely to be endorsed by PRC courts. In that case, the claimant (an offshore bondholder) filed a claim in the Hong Kong courts for breach of a keepwell deed. A default judgment was issued ordering the defendant to pay principal, interest and costs to the claimant. The claimant subsequently applied to the Shanghai Financial Court to enforce the Hong Kong judgment. The Shanghai Financial Court ruled that the default judgment was a final decision with executive force under the Arrangement of the Supreme People's Court between the Mainland and the Hong Kong Special Administrative Region on Reciprocal Recognition and Enforcement of Decisions of Civil and Commercial Cases under Consensual Jurisdiction (the Reciprocal Arrangement). The Shanghai Financial Court did not consider how keepwell deeds would be interpreted under PRC law (the keepwell deed in question was not governed by PRC law – which is the case in almost all keepwell deeds) and held that refusal on public policy grounds should generally only be made when enforcement would be "directly" contrary to public interests. Whilst the ruling is helpful in reaffirming that an instrument that falls short of a guarantee is capable of being recognised in the PRC, it is grounds only for cautious optimism. In this respect, we note that:
  • there is no case law precedent system in the PRC and the facts of each case will be different
  • there are potential alternative public policy arguments that may be persuasive, eg whether the enforcement of a keepwell deed circumvents the requirement for SAFE approval
  • the judgment in the CEFC case was a default judgment - it is uncertain if the outcome of the case would have been different if the claim had been contested, and
  • the keepwell deed in the CEFC case was governed by English law and subject to the exclusive jurisdiction of the Hong Kong courts. The Reciprocal Arrangement only applies to a judgment of a court having sole jurisdiction to resolve disputes.

Keepwell deeds are usually drafted to be governed by Hong Kong or English law. Under each of these jurisdictions, a keepwell deed is enforceable if the obligation in the keepwell deed is sufficiently clear to show an intent to be legally bound.

However, keepwell deeds need to be enforceable against the Keepwell Provider in bankruptcy proceedings as a matter of PRC law. For contracts involving a foreign element, PRC law will generally respect and recognise the validity of a keepwell deed determined under its governing law.

Whilst the PRC courts have not directly considered how PRC law would treat keepwell deeds from a PRC law perspective, the general position appears to be that keepwell deeds are enforceable under PRC law, subject to the facts of the individual case (in particular, the circumstances surrounding the bankruptcy of the Keepwell Provider).

It follows that the answer to the question ‘what (if any) steps are available to a Creditor seeking to mitigate enforcement risk’ is of paramount importance.

Mitigating enforcement risk

In the absence of onshore PRC proceedings dealing directly with how PRC law interprets keepwell arrangements, Creditors may consider adopting one or more of the following steps to mitigate enforcement risk onshore.

• Submission to arbitration as the dispute resolution forum - Keepwell deeds commonly include clauses granting the courts in Hong Kong exclusive jurisdiction to hear any dispute in relation to the document. This would generally include any dispute as regards the enforceability of a document.

When a restructuring application against an onshore company has been accepted by a PRC court, PRC bankruptcy law provides that the PRC courts have exclusive jurisdiction to hear any dispute against the onshore company.^[5] It is likely that this would be interpreted to include a dispute regarding the enforceability of a keepwell deed. The question then arises as to whether the enforceability of a keepwell deed should be decided by the PRC courts as part of the formal restructuring process, or by the Hong Kong courts in accordance with the terms of the keepwell deed.

If a creditor seeks to enforce a Hong Kong law governed keepwell deed through the Hong Kong courts, it is unclear how the conflict between: (i) PRC bankruptcy law; and (ii) the contractual terms of the keepwell deed will be addressed if the PRC court appointed administrator objects to the jurisdiction of the Hong Kong courts. There is a risk that any decision made by the Hong Kong courts may be unenforceable if a PRC court decides that it has exclusive jurisdiction to hear any application by the creditors of an onshore company.

A keepwell deed that submits disputes to arbitration, rather than resolution via the Hong Kong courts, may avoid any jurisdictional conflict between the Hong Kong and PRC courts. The SPC has issued an interpretation of PRC bankruptcy law which indicates that the exclusive jurisdiction of the PRC court may not apply in circumstances where the parties agree to arbitration. According to the SPC, when a creditor disagrees with the PRC court appointed administrator's assessment of creditors' claims, such creditor may submit the dispute to arbitration if a valid arbitration agreement exists between the parties before the PRC courts accept the restructuring application.^[6] This means that any dispute about the enforceability of a keepwell deed could be heard by an arbitral tribunal (if the document contained a valid arbitration agreement) and would not be subject to a decision by the PRC courts.

• Self-executing claim - The keepwell deed might contain a self-executing claim mechanism. The keepwell deed could contain a list of automatic early termination events (ATEs). The ATEs will aim to identity potential defaults that trigger an automatic call under the keepwell deed prior to the Commencement of Bankruptcy Proceedings.

The ATE mechanism would be similar to the ATE mechanism employed in industry derivatives documentation, which allow derivatives to automatically terminate immediately before the Commencement of Bankruptcy Proceedings.

The amount payable will be whatever debt the Debtor then has outstanding (including under any bond issue).

Strong counterparties may object to ATE because it removes their ability to negotiate at a time when they face financial difficulty. ATE will trigger the obligation of the Keepwell Provider to start the process for taking action to fund the Debtor (whether by way of debt or equity). What is key is that the process is started before the commencement of the bankruptcy of Keepwell Provider. The amount that is due is whatever the Debtor needs in order to pay its debts. There will then follow obtaining relevant PRC approvals for the provision of the funding and then for the funding to be provided, failing which, the Keepwell Provider will breach its obligations under the keepwell deed and be liable to the Debtor for damages. The aim is to ensure the trigger for the obligation of the Keepwell Provider to start the process for taking action to fund the Debtor is, of itself, sufficient to require the administrator to admit the debt to the bankruptcy of the Keepwell Provider.

But care is needed…

Care would need to be taken to ensure the Keepwell Provider’s payment obligations under a keepwell deed is not so certain as to constitute a guarantee. There is a delicate balance that needs to be struck - drafting the keepwell deed so as to directly require the payment of amounts due under any outstanding bonds or loans will likely cause the keepwell deed to be recharacterized as a guarantee, and thereby trigger issues in relation to neibaowaidai (the provision of cross-border guarantees or security by an onshore entity to an offshore creditor to secure debts of an offshore creditor) which requires SAFE approval.

The other issue is that an aim of this approach is to enable the Creditor to prove its debt in the administration of the Keepwell Provider. Thought then needs to be given as to how the Creditor remits any proceeds from the bankruptcy proceedings out of the Mainland. The administrator might decline to procure SAFE approval to make that remittance, although the relevant PRC court has the power to approve any such remittance.

Mainland PRC approvals

The need for approval depends on the wording of the keepwell deed – keepwell deeds usually provide they do not constitute a guarantee (and so do not require SAFE registration for neibaowaidai). 

Keepwell deeds usually require the Keepwell Provider to:

• provide further capital or shareholder loans to the Debtor so as to ensure the Debtor has sufficient liquidity to meet its repayment obligations, and
• obtain all relevant PRC approvals/registrations for the purposes of such capital contribution or shareholder loans. Those approvals/registrations are not required in connection with entering into the keepwell deed itself, but will be required when the Keepwell Provider makes any such cross-border capital contributions or shareholder loans.

There are a number of possible approvals (or registrations) including from (or with) the NDRC, SAFE and Ministry of Commerce of the People's Republic of China. For example, a further capital contribution by the Keepwell Provider to the Debtor constitutes an offshore direct investment. 

Usually, the failure to obtain such approval or registration is a breach by the Keepwell Provider of the keepwell deed for which damages are payable. There is of course a question as to the measure of damages, which may not conveniently equate to the amount due under the Debtor’s loan or bond. 

Therefore, if judgment is obtained offshore in respect of that breach, and that judgment is then reciprocally enforced in the Mainland, the PRC court should consider the offshore judgment to be recognized and enforceable.

We expect that banks in the PRC handling the remittance of the judgment amount will give due regard to the PRC court ruling.

For capitalized terms which are not defined in this alert, please refer to 'Sidebar - The Words We Use' in our foreword here.

Disclaimer: This alert is provided for general information purposes only and does not constitute legal advice.

References

[1]  [2018] Zui Gao Fa Min Zhong No. 127 ([2018] 最高法民终第127号); [2019] Zui Gao Fa Min Zhong No. 1524 ([2019] 最高法民终第1524号)

[2]  For example, [2014] Min Min Zhong Zi No.266 ([2014]闽民终字第266号); [2014] Min Shen Zi No.1589 ([2014] 民申字第1589号)

[3]  Under Article 73 of the PRC Contract Law (中华人民共和国合同法第七十三条): “[i]f a debtor causes losses to the creditor concerned by being indolent in exercising its matured claims, the creditor may apply to the competent people’s court to subrogate the debtor to exercise the latter’s claims under the creditor’s name, except for claims that belong exclusively to the debtor”.

[4]  CEFC Shanghai International Group Limited - Civil Ruling (No. 1 [2019], Recognition, HK, 74, Shanghai ((2019)沪74认港1号民事裁定)) 

[5]  Article 21 of Enterprise Bankruptcy Law of the People's Republic of China (中华人民共和国企业破产法第二十一条)

[6]  Article 8 of Provisions (III) of the Supreme People's Court on Several Issues concerning the Application of the Enterprise Bankruptcy Law of the People's Republic of China (最高人民法院关于适用〈中华人民共和国企业破产法〉若干问题的规定（三）第八条)