(a) If a corporate debtor is in financial difficulty, is there an attitude of 'concealment' or 'denial' toward the admission or exposure of that financial difficulty?

Yes, there usually is an attitude of both concealment and denial by corporate debtors toward the admission or exposure of the financial difficulty. But, it must also be noted, corporate lenders are also frequently in denial.

(b) If so, is the reason for this based on cultural or other factors?

As for concealment - Chinese family-controlled companies in Hong Kong, China prefer to disclose as little information as necessary to their bankers. The complex organization of many of the family-controlled groups in Hong Kong, China lack transparency and make it easier to conceal developing difficulties. Even among non-family controlled companies, there is much less of a culture of quickly disclosing of bad news to the marketplace than there is in Western countries.

In Hong Kong, China, there is much less accountability to shareholders. Some bankers feel that local companies are often run more to favor the interests of the controlling tycoon's family than the interests of shareholders. There is little or no likelihood of poorly performing managers getting pushed out by angry shareholders, and even less of a likelihood of prosecution for corporate wrongdoing.

In addition, many local companies do not have independent managers - or if they do, have brought in the managers to raise money rather than to impose financial controls - so the controlling family often does not hear contrary views being voiced by senior members within the company. If an outside financial director is brought in, he frequently is an ex-banker whose responsibilities include trying to manage the banks for the company.

As for denial - until the recent economic crisis hit Asia, business had been good for quite some time and the few downturns had been relatively short-lived. Most businesses thus approach each new downturn with a look to the past and a general reluctance to acknowledge that a new downturn may be different. Some of the reluctance to disclose bad news is surely tied to inexperience in handling downturns in the economic cycles.

(c) Is it likely that a corporate debtor would:

(i) volunteer the fact of its financial difficulty to a lender or group of lenders; or

In answering this question, one respondent suggested dividing companies into two groups - in the first group are those companies that have taken on board (or are willing to take on board) the advice of professional advisors or independently thinking managers and in the second group are those that have not. Those companies in the first group (perhaps 30% or so) are often able to avoid difficulties in the first place, and if not able to do so, would be more willing to volunteer the facts relating to the company's financial difficulty.

However, those companies that fall into the second group - the majority (70% or so) - that have been reluctant to get the advice of professional advisors or to hire independently thinking managers often remain reluctant to disclose any adverse information.

 

(ii) admit or concede it only if and when confronted by a lender or group of lenders?

See Section G1(c)(i) immediately above. The companies that fall into the second group would follow this approach.

(d) If a corporate debtor is in financial difficulty, is it likely that the corporate debtor would:

(i) do nothing;

Many of the companies in the second group might well continue to follow this approach.

(ii) seek expert assistance and advice; or

Companies in the first group would likely adopt this approach. Companies in the second group that adopt this approach frequently wait until it is too late, and then prefer to hire an internal, rather than an external, advisor.

(iii) accept the appointment by a lender of an outside expert/advisor?

Some companies in the first group might be willing to adopt this approach when pushed by their bankers. However, the majority of companies - those in the second group - would be reluctant to accept this option and would thus do so only as a last resort. Overall, 90% or so of Hong Kong, China companies would likely reject this option.

(e) If it was agreed between a lender and a corporate debtor that an expert/advisor would be appointed, is it likely that a corporate debtor would give the expert/advisor unrestricted access to all relevant financial and other information regarding the corporate debtor?

It depends. Completely unrestricted access would be unusual. Nevertheless, companies in the first group would be more likely to grant freer access than would companies in the second group.

(f) In that situation, is it likely that the financial and other information regarding the corporate borrower would be:

(i) complete; and

(ii) accurate (particularly regarding the valuation of assets and the assessment of liabilities)?

It depends on the reputation of both the borrower and the external expert/advisor (who is often an accountant). For a company in the first group, the answer would more likely be yes to (i) and (ii). Interestingly, for a company in the second group, if the accountants are close enough to get a company to change, the bank might view them as not independent. Thus, there will often be lingering doubts by the corporate lender as to both (i) and (ii).

(a) Is it more common that the financial difficulty of a corporate borrower will be:

(i) volunteered by a corporate debtor; or

(ii) discovered by a lender (and, if so, how)?

It is most likely that the lenders will discover the problems themselves through a combination of quarterly internal management reviews and semi-annual or annual reviews of the company's financial statements - by noticing a deterioration in the company's payment records or financial statements. For many loans, the most common tip-off is when the company misses a scheduled interest payment. Other factors would include rising levels of overdrafts or increased litigation by creditors against the company. Thus, the overall problem should not come as a surprise.

(b) If a lender becomes aware that a corporate debtor is in financial difficulty, is it likely that the lender would seek to investigate the financial crisis of the corporate debtor itself and employ an expert/advisor to investigate the financial position?

The lender would prefer to investigate the crisis itself, but few lenders in Hong Kong, China have this expertise.

(c) If so, is the expert/advisor likely to be:

(i) an independent professional; or

(ii) an 'in-house' employee of the lender?

The preferred option would be to appoint an 'in house' employee of the lender. Of course, not all banks have this expertise. Smaller local banks and many foreign banks may need to appoint an independent professional - usually an accountant.

(d) Is it likely that information regarding the financial position of a corporate borrower as discovered from the work of an expert/advisor would be:

(i) kept secret from other lender/s or creditors;

(ii) disclosed to other/selected lenders?

The answer depends on the bank, as well as on a combination of other factors, such as the level of a bank's security and overall protection, the actions being taken by other banks and creditors, and an appraisal as to the magnitude of the corporate borrower's losses as well as to the likelihood of a turnaround.

At early stages, most banks would prefer to keep the information to themselves so as to improve their position. Later in the process, when it appears less likely that self-help strategies will work, most banks would most likely disclose the information to at least the 'core' of the banking group and attempt to cooperate and collectively try to resolve the problem with the corporate borrower. Given the confidentiality of the banker-client relationship, formal disclosure by the bank should not occur without the corporate borrower's permission. Of course, however, in a jurisdiction as small as Hong Kong, China where the players know each other quite well, there is a constant stream of corporate gossip.

Strategy plays an important role. One banker, for example, noted that his bank prefers to act unilaterally and squeeze as much money out of the corporate borrower for as long as possible. Only when that strategy has run its course will the bank throw its full efforts behind a group effort.

(e) If there were 2 or more lenders (not in a syndicate) involved with the same corporate borrower, is it likely that they would:

(i) join together to share information and endeavour to work out a common approach to the financial problems of the corporate borrower; or

(ii) act secretly and independently of one another?

See Section G2(d) above. The Guidelines on Corporate Difficulties of the HKAB provide that in multi-bank situations, once the financial problems of the corporate borrower enter the realm of public knowledge, the 'banks' initial attitude should be one of support. 'They should not withdraw facilities or hastily put the company into receivership, or issue . . . writs demanding repayment.' (para 2(a).) The Guidelines further provide that after obtaining the corporate borrower's permission, 'further decisions should only be made based on information which is reliable and shared fully with all creditor banks' (id, para 2(b)) and that '[t] he decision to offer the company financial assistance - or not - should be a collective one by the creditor banks' (id, para 2(c)).

The Guidelines provide that the banks are to abide by a standstill - which involves neither withdrawing existing credit facilities nor taking unilateral action. But as one commentator observed, a standstill can be more effective in some workouts than in others. For example, it is more likely to succeed in a workout involving a manufacturing company where the banks are likely to hold 70-80% of the total liability than in a case involving the insolvency of a contracting or building company in which the banks will likely hold a much smaller percentage of the overall corporate liabilities.

(f) If there was a group of lenders (whether in a syndicate or not) involved with the same corporate borrower, is it likely that one of them would offer or seek to be the leader on behalf of them all?

Yes, it is common for a lender to come forward and seek to act as the lead bank. Hongkong Bank serves as lead bank in perhaps 75-80% or so of all of the workouts in Hong Kong, China, including many cases in which they do not have the greatest exposure. Some bankers query whether this is, in fact, a good thing, and argue that allowing smaller, more independent banks to take the lead in some cases might well work to the advantages of all of the banks overall. Nevertheless, there are many cases in which banks with greater exposure often prefer for Hongkong Bank to lead.

The Guidelines on Corporate Difficulties provide that there be a lead bank.

(g) If so, is it likely that such a proposal would be agreed to by the other lenders?

The Guidelines provide that the workout will require unanimity. Supra, para 3(a). The lead bank and in larger lender groups, a steering committee - try hard to build a consensus. There is no doubt that there is a 'club' mentality at work and that uncooperative behavior by a bank in a workout may lead to a backlash in the future. For example, the Guidelines state: 'Whilst banks are likely to be reluctant to permit an increase in their exposure on a customer so that other banks' facilities can be salvaged, they should be aware that, if they fail to co-operate in a work-out, the same might be done to them next time if the roles are reversed.' Id, para 3(b).

In practice the larger the exposure of the bank, the more cooperative the bank will be. In contrast, it is not unusual for banks with smaller positions to try to leverage their minority status in an effort to get paid out early or otherwise improve their position.

(h) Is it likely that local lenders would have employees who are experienced in informal work outs?

The large local lenders, especially Hongkong Bank and Standard Chartered, have the most in-house expertise in informal workouts. Some of the foreign lenders rely on in-house experts who are outside Hong Kong, China. Given the magnitude of the current economic crisis, most banks in Hong Kong, China have more expertise in informal workouts than they did a year ago.

Although one of the banks with such in-house expertise often serves as the lead bank, the other banks in the group usually prefer that an independent professional - again, an accountant who is a restructuring specialist - be appointed.

(i) If there was foreign bank lending involved, is it likely that domestic lenders would:

(i) combine with; or

(ii) act independently of the foreign lender/s?

The foreign bank usually combines with other lenders, both foreign and local, in resolving the problem.

(j) Is it likely that 'junior' or 'minor' lenders might seek to trade their debt?

This rarely occurs in Hong Kong, China. See Section B9 above.