Community Liability Funding for Struggling Real Estate Developers

An almost without exception, property developers plagued by the prospect of bankruptcy find themselves stretched thin in terms of cash. Given the day and night difference in the market value of a property, the costs and difficulties of disposing of it, before and after project completion, and the need to maintain social stability, developers are under considerable pressure for funding to continue and complete construction. These financing needs can be met either by investors seeking a healthy return or by urban investment companies with a mission of social governance, but both must exercise caution to control financing risks. .

COMMUNITY RESPONSIBILITY FUNDING

Depending on the stage of debt liquidation, developer financing is categorized into: “community liability financing,” which occurs during debt restructuring and pre-restructuring before bankruptcy; and “community liability funding”, occurring during bankruptcy, which has a clearer legal definition and has therefore seen more active legal practice.

Wang Zhenxiang
Partner
Jingtian and Gongcheng

The legal basis for community liability funding is mainly found in Articles 26 and 42(4) of the Enterprise Bankruptcy Law (EBL) and Article 2 of the Provisions (III) of the Supreme People’s Court on several questions concerning the application of the law on business bankruptcy. (the provisions III), under which the promoter, after the acceptance of the application for bankruptcy and with the approval of the meeting of creditors or the court, can borrow funds to continue the exploitation and to enjoy certain priority reimbursement rights with reference to the regulations on community commitments.

As a result, real estate developers in financial difficulty, after initiating bankruptcy proceedings, can borrow funds to continue their activities, including the sale of commercial housing and the guarantee of an acceptable quality delivery condition. In order to secure a favorable position for financing, the parties must ensure that the promoter fulfills all of the following conditions:

    1. in terms of timing, the legal funding relationship must be formed and the obligation performed after the acceptance of the bankruptcy petition;
    2. in terms of procedure, depending on the stage, the financing must be approved either by the meeting of creditors or by the court; and
    3. in terms of common benefits, the funds raised should be used for the realization, reception and delivery of its real estate projects.

With Provisions III expanding the regulations on community liabilities under the EBL, it has been clarified that funding in this way can be placed after community debt in the liquidation order, a market-stimulating move that is secured at the judicial level. By participating in community liability financing, investors will be granted repayment priority right after the rights of creditors secured by the property. Ultimately, developers will be allowed to continue with their real estate projects, and when completed, properties will increase in market value and creditors will be repaid from a richer pool of resources.

As property developers experience general financial difficulties and growing pressure to secure delivery of properties, investors are taking a wait-and-see approach. Developers who recklessly go bankrupt may find it difficult to solicit suitable offers within the statutory reorganization deadline (six months from acceptance of the file, subject to a three-month extension). To maintain both property value and social stability, urban investment companies and some investors may need to offer capital support before developers go bankrupt, forming “liability-type financing”. community”.

If the developer has entered pre-reorganization and the funds provided by the investors meet the second and third of the above conditions, it may be considered “community responsibility funding” as defined by the Supreme People’s Court and the policies local courts. A dozen local courts, including those in Shenzhen, Zhengzhou and Suzhou, have established funding rules to “reference” the community liability settlement order in their respective pre-reorganization policies.

If the developer has not entered into the pre-reorganization, funds raised at this stage generally cannot be recognized by the courts as community liability funding. However, in the civil judgments of Zhejiang Asia Real Estate Development v Songdu Chengye Investment Management (2017)and Jinsailong Industrial vs. Hehuang Hotel Management & Argos Resort Hotel Management (2018)Hangzhou Intermediate People’s Court and Deqing County People’s Court, respectively, have determined that capital investments that meet certain conditions (government designation, administrator ratification, etc.) can be repaid as debts of the community.

RISKS AND DILEMMAS

Currently, laws and regulations on community accountability funding are not transparent, which leads to certain risks. First, even if the investment is considered community debt financing, there are discrepancies between laws and judicial interpretations. While Provision III privileges the repayment of community debt financing over the rights of common creditors, the EBL provides that it is secondary only to the rights of creditors secured by property.

Second, judicial interpretations and some judgments have been flexible with the above-mentioned “timing” condition, obscuring the procedure with uncertainty. Third, while trustees can legally provide property security for debtor financing, in the case of developers, they have likely by this point exhausted the well of financing attached to their properties, with little to use as collateral.

INVESTOR ADVICE

If funding prior to acceptance of the bankruptcy petition is absolutely necessary, depending on the exact situation, investors are advised to do the following:

    1. If funds are required to meet construction costs, for each creditor’s right created from the funder’s entry through acceptance of bankruptcy, the funder must enter into separate transfer agreements with each debtor and each construction unit. Once creditors’ rights have been confirmed between the developer and the building unit, the lender can then transfer the funds to the building units as payment for the construction costs, although one should be aware of the risks of transfer. ;
    2. Financing must be approved in writing by major general creditors, or in the pre-reorganization process, approved in writing by the administrator or the court; and
    3. Community responsibility funding can be conducted in conjunction with reorganization investment, the former being applied first to support construction, and the latter at a later stage to assume overall control of the developer, and in turn its project.

Wang Zhenxiang is a partner at Jingtian and Gongcheng

collateral

Jingtian and Gongcheng

Room 3001, Area A, China Resources Tower
No.1366 Qianjiang Road, Hangzhou 311500, China

Tel: +86 571 8992 6523

Fax: +86 571 8992 6501

Email: [email protected]

www.jingtian.com

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