Local banks have been very active in leveraged buyout financings (particularly those sponsored by international private equity houses), as the terms (including tenor, pricing, financial ratios and size of loan) they can offer to the sponsors are more favourable than international banks. This trend has been evident in the leveraged financing deals for taking private those Chinese companies listed in the US. 

International banks continue to be the preferred choice of multinational companies in China for their corporate financing. Given that Chinese banking regulatory authorities have tightened the lending to the real estate sectors, international banks fill in the gap left by the Chinese local banks and provide strong support to real estate private equity firms and foreign real estate developers. 

Mezzanine debt funds have been quite active in the high-yield lending market for Chinese real estate developers who have suffered significantly from the serious shortage of liquidity in the real estate capital market. They were also found in high leverage deals of PE sponsors by providing junior facilities to increase the total LTV/LTC ratios and investment return.

The most frequently seen LBO transactions are going-private deals for those Chinese companies listed on NASDAQ, NYSE or HKSE. The tightened regulatory scrutiny on Chinese companies listed in the US and the uncertain future caused by the inability to meet the SEC’s requirement to submit audit material have been the major drivers contributing to those going-private attempts. Private equity houses are the most active sponsors for these transactions, and Chinese commercial banks provide good financing support to PE sponsors and founders. Loan documentation is largely based on LMA standards and is well accepted by Chinese commercial banks.

There are also many large-scale LBO transactions in the consumer, real estate, new infrastructure and healthcare sectors. Both international and Chinese domestic banks have shown strong interest and commitment in these deals under a general credit ease environment.   

No information is available in this jurisdiction.

For complex acquisition finance/LBOs where the borrower is an offshore entity, HK law is frequently used and accepted by lenders and sponsors.

PRC law has been the prevailing choice for domestic corporate and acquisition loans where both lenders and borrowers are onshore entities.

APLMA (Asia Pacific Loan Market Association) standard documents are widely used in cross-border transactions in this region.

For domestic transactions (particularly where the lenders are Chinese banks), the Chinese local banks normally encourage using the template documents formulated by each bank or those prepared by the China Banking Association.

For complicated leverage financing transactions with foreign sponsors, Chinese banks can accept and execute the English version of loan documents (with no Chinese translation or Chinese version) according to the PRC counsel’s opinion in reconciling the consistency of English terms with their credit committee approvals.

PRC branches of international banks can only accept and execute the Chinese version of loan documents when their borrowers are PRC local companies, while the prevailing market practice is to adopt the English version for the facility agreement (with the Chinese translation or summary) and the Chinese version for security documents to accommodate local registration requirements. 

Counsels are expected to cover the following aspects in their opinion: due incorporation and valid existence of borrower, authorisation of finance documents, due execution, not conflicting with the law, legality, validity and enforceability of finance documents, creation of security, applicable tax, choice of law and dispute resolution and venue.

PRC lenders may also look for opinions on compliance with certain regulatory requirements, including compliance with LTV/LTC regulatory ratio.

To contemplate an easier route of investment exit given the cross-border foreign exchange control (from the investor perspective) and enjoy certain tax benefits offered by an offshore sale structure (from the seller perspective), sellers of PRC assets prefer to or are asked by investors to set up an offshore investment holding structure and place their PRC operating companies or assets under such offshore holding companies. The acquisition is usually constructed as a sale and purchase of shares in offshore holding companies.

Given such a deal construct, the senior loans normally comprise two tranches:

• one offshore tranche extended to the acquisition vehicle of buyer financing the purchase consideration; and
• one onshore tranche extended to the main onshore operating company to take out the existing corporate or construction loans. 

The offshore tranche is still categorised and priced as a senior loan, but technically, the offshore loan is structurally subordinated to the onshore loans. For real estate loans, offshore lenders will seek to have a second lien mortgage over the onshore real estate properties to improve their subordination position, which may face challenges as outlined in the upstreaming security section. Hence, this request is rarely accepted in sponsor financing transactions.

Many offshore lenders also manage to enter into intercreditor agreements with onshore lenders to share security or achieve coordinated security enforcement arrangements, which also proves to be quite challenging, as discussed below.

Mezzanine loans are not commonly seen in sponsor financing, as PE sponsors may easily access 60‒65% Loan-to-cost (LTC) loans from senior lenders in this market (with combined use of onshore and offshore loans since onshore lenders are subject to a regulatory cap of 60% LTC for acquisition loans). 

Mezzanine loans are more frequently seen in real estate financing extended to real estate developers, who cannot use bank loans to finance their land acquisitions or are restricted to bank loans to finance their operating expenditures or capital expenditures when they fail to meet certain regulatory financial ratios. Such real estate developers will place their onshore development companies under an offshore holding company, which will utilise mezzanine loans from credit funds and then infuse equity into onshore project companies. Such a mezzanine loan will normally yield at 12‒18% but obviously, be structurally subordinated to onshore senior creditors without any protection of an intercreditor arrangement.

There are bridge loans in leveraged buyout deals, where the target is cash-rich but cannot provide cash security to the acquirer due to financial assistance restrictions. In a typical reverse merge deal, the lenders may extend a cash bridge facility to the merger subsidiary of the sponsor, supported by the agreed amount of cash from the target company being placed into an escrow account opened with the lender (not a security given the financial assistance restriction). Such escrow arrangement will be replaced by a cash pledge or account charge arrangement after closing the contemplated merge. The cash bridge loan will remain if the target’s PRC operating subsidiaries do not want to pay dividends from the charged cash to the offshore borrower due to the potential tax leakage but will otherwise be paid off if they want to distribute dividends to an offshore borrower.

PRC companies may adopt two different types of issuer structures to issue bonds/high-yield bonds in the offshore capital market:

• offshore issuer; and
• onshore issuer.

Offshore Issuer

The founders of a PRC company may establish a Cayman entity as an offshore holding company and bond issuer, which will, in turn, own a series of PRC operating entities via one or more BVI and/or HK intermediary holding companies. Bonds issued by such issuer may utilise the following credit enhancement routes.

• Pure credit bond. Investors may be entirely comfortable with the credit profile of the issuer and its onshore subs and request no other credit enforcement.
• Guarantee of Listco. Some HK Listcos may carve out some PRC assets and place them under a standalone Cayman issuer, which will issue bonds/high-yield bonds. Listco will still guarantee these bonds to enhance its credit profile.
• Upstreaming security. To improve the bondholder’s structure subordination position, PRC operating entities may provide asset collateral (including real property mortgage, equity pledge, etc) to secure the offshore bonds. This is regarded as an outward security securing offshore debt under PRC law, which must be registered with the State Administration of Foreign Exchange (SAFE). Such registration is a merit review and will not survive SAFE scrutiny unless the offshore bond issuer (on a standalone basis) may prove that it has stabilised cash flow to service offshore debts, and the likelihood of the upstreaming security being enforced is low. Failure to complete the registration will not render the guarantee/security documents invalid, however, outbound remittance of the enforcement proceeds or performance payments could be delayed or blocked as the account banks processing such remittance are under regulatory obligations to verify the SAFE registration certificates.
• Keepwell. Considering the challenges from the guarantee or upstreaming security structure, Keepwell undertakings from the onshore parent of the issuer is also commonly adopted. Typically, the parent acting as the Keepwell provider will undertake to investors that it will disburse funds offshore from the PRC to provide certain financial or liquidity supports to the offshore issuer. Parties will acknowledge that the Keepwell arrangement is not a guarantee.

Domestic Issuer

PRC companies may, saving setting up the offshore holding structure, issue bonds/high-yield bonds directly in the offshore capital market. Typical credit enhancement measures may include:

• standby letter of credit (SBLC) issued by a commercial bank;
• guaranteed by the parent group if the issuer is separated from its parent group; and
• if the issuer is separated from its parent group or guaranteed by the parent group.

The structure for Private Placements/Loan Notes is almost identical to that outlined in 3.4 Bonds/High-Yield Bonds.

In the acquisition finance area, direct purchase of the assets may not a preferred choice mainly due to tax considerations as we understand. As mentioned, PE sponsors typically carry out the acquisitions by way of equity instead of asset transactions.

Therefore, in the PRC market, asset-based financing deals are not frequently seen in industries other than the real estate sector. For real estate loans, lenders usually adopt similar secured lending structures discussed in 3.1 Senior Loans, with the typical security package comprising of the following, with the purpose to ring-fence the asset values and the future cash flows of the borrower:

• mortgage over the property;
• pledge over account receivable of the property leases; and
• assignment of rights under the material contracts (including insurance policies and leases (to the extent of such rights not being subject to the receivable pledge above)).

In asset-based lending, considering the assets (together with the cash flows generated during the loan tenor) will be the core repayment sources; this structure is less attractive to international banks if there is an offshore tranche because of the structural subordination issue.

Some PRC banks, on the contrary, will consider extending the offshore tranche loans through their free trade zone (FTZ) branches. As the FTZ branches are PRC entities, second lien mortgages created in favour of those bank branches will not constitute outward security requiring SAFE registration. As such, PRC banks with FTZ branches are the key participants in this niche market.

A typical intercreditor agreement under an offshore/onshore due tranche transaction includes the following arrangement. 

Standstill

All lenders refrain from taking any action to accelerate the loan or otherwise enforce any part of the security package within 90 days (and if agreed, a further 90 days) of the occurrence of an event of default and use their best efforts to reach a consensus on how to enforce the security package (either an offshore sale of shares, or an onshore sale of real properties and other operational assets). 

Sharing of Security Proceeds

Onshore and offshore lenders agree to share the security enforcement proceeds on a pro-rata basis. This is not easily achievable due to PRC foreign exchange control rules, including:

• PRC lenders are not allowed to voluntarily waive part of their entitlement to the outstanding loan amounts or security proceeds unless getting special approval from the banking regulator; and
• PRC borrowers or security providers may not provide upstreaming security to offshore lenders unless such security is registered with the State Administration of Foreign Exchange (SAFE), which is a merit review and conditional to specific conditions that are not easy to satisfy. 

Call Option

Onshore and offshore lenders will grant each other a call option to purchase the entire portion of outstanding loans held by another group of lenders when both sides cannot reach a consensus on how to enforce the security package.

The approach to bank/bond deals is similar to that detailed in 4.1 Typical Elements.

The role of hedge counterparties is similar to the roles described in standard LMA ICA documents. The hedging arrangements could be put in place prior or post to signing. Typically, the hedging liabilities for the senior debt and the senior debtor will rank pari passu, and the hedging counterparties will benefit from the same guarantees and security package of the senior debt.

In sponsor financing, the borrower will also request that it is entitled to decide a hedge counterparty that is not a syndication lender at its discretion, but the lender will usually ask for first right to offer and last right to match the hedging terms, therefore, limiting the possibility that a third-party creditor comes in to share the guarantees and securities.

Shares

Pledges can be created over shares in a limited liability company.

Inventory

A fixed mortgage or floating charges on the inventory can be created.

Bank accounts

A pledge over bank accounts (in essence, pledge over the deposits therein) will only be recognised when:

• the pledgee has actual control over such account; or
• inflow and outflow of funds are for one specific category of use.

Receivables

Pledges of account receivables can be used rather than the security assignment or the debenture as frequently used in other jurisdictions.

IP Rights

Mortgage of IP rights can be used.

Real Property

Mortgages over real properties.

Movable Properties

A pledge over movable properties is possible when possession of such properties could be delivered to the creditors. If possession is not deliverable, then a mortgage over movable properties can be created. 

There are no such form requirements under PRC law.

Share Pledge

Shares of a non-public company to be registered with local branches of the State Administration of Market Regulation, and the shares of a listed company to be registered with China Securities Depository and Clearing Corporation (CSDCC).

Bank Account Pledge

No registration requirement, however, the pledgee should either control such an account or designate an agent to control the account.

Receivables Pledge

To be registered with the online registration platform of the People’s Bank of China.

IP Rights Mortgage

To be registered with the China National Intellectual Property Administration.

Real Property Mortgage

To be registered with the real estate exchange centre in different localities.

Movable Property Mortgage

To be registered with the National Online Movable Property Mortgage Platform maintained by the People’s Bank of China. 

When both the parent company (ParentCo, LBO loan borrower) and operating subsidiaries (Opco) are PRC domestic companies, there do not seem to be any legal constraints preventing Opcos from providing upstream security to ParentCo. When the Opco is a joint venture with a partner outside of the ParentCo group, then such upstreaming security must be approved by the shareholders meeting of the Opco with the ParentCo refraining from voting.

When the ParentCo is an offshore company and Opcos are PRC domestic entities, Opcos are unwilling to provide upstream security to ParentCo unless they can manage to register such upstream security with SAFE as an outward security securing offshore debts, which is not easily achievable as discussed in the bond section. 

The Administration Rules for Listco Takeover provide that a listed company in PRC is not permitted to provide financial assistance to an acquirer.

Such restriction does not apply to non-public companies which could provide security to support the financing of acquirers as long as such security is property approved by shareholders/directors.

PRC law does not have a general corporate benefit test requirement, although, if a company is to provide security for indebtedness of a third party, this security must be approved by the shareholders meeting or board meeting. 

The PRC company law provides that the connected shareholder shall refrain from voting on resolutions regarding the company providing security to a creditor for the benefit of such connected shareholder to avoid the majority shareholders of a company from abusing the assets and resources of the company.

In a typical onshore/offshore PRC acquisition financing, there are three principal methods of loan enforcement for the offshore lender.

Option 1: Enforcement of the Offshore Security 

The sale of an offshore borrower pursuant to the enforcement of the relevant share charge; or sale of the PRC wholly foreign-owned entity (WFOE), which is owned by the offshore borrower pursuant to the enforcement of the equity pledge. 

The offshore lender has contractual rights under the borrower share charge to effect certain self-help remedies to sell the shares of the offshore holding company to a third party.  This would be the quickest method if the offshore lender can locate a third party purchaser ready to close the deal.

Option 2:  Sale of the Onshore Business/Assets in Connection with an Exercise of the Offshore Security 

By enforcing the security over the shares in the offshore borrower (by appointment or a receiver; or, if permitted, sale to a nominee of the offshore security agent), the offshore lender can effectively control the borrower and the WFOE from offshore. 

Upon taking such control, the offshore lender can:

• initiate the onshore sale of the business/assets;
• to the extent possible, repatriate sale proceeds by way of dividend;
• if there is a shareholder loan, cause the WFOE to repay the shareholder loan in full; or
• cause the directors of the WFOE to commence onshore liquidation and repatriate the remaining funds post liquidation proceeding.     

Option 3: Enforcement of the Onshore Property Mortgage 

Enforcement of the first priority mortgage over onshore assets (including real property and other movable assets); and then the repayment of the onshore loan and repatriation of the sale proceeds outside the PRC to repay the offshore loan through repayment of a shareholder loan, declaration of dividends or winding up of the WFOE.

The attractiveness of enforcing through the property mortgage will depend on a number of factors, including:

• who benefits from the mortgage (ie, just the onshore lender or also the foreign shareholder) relative to who is initiating the enforcement process (eg, offshore lender or onshore lender); and
• the degree of mortgage coverage and the likelihood of other creditors. 

Unless the onshore borrower agrees, enforcement of mortgages is a court process. This could be time-consuming.  An offshore lender is unlikely to look to the mortgage as a means of enforcement if it has no or limited mortgage coverage (often the case), while an onshore lender will view mortgage enforcement as one of its primary means of enforcement.

Under PRC law, a creditor with a mortgage over a debtor’s property may enforce its remedies under the mortgage through a consensual sale and/or a judicial sale. In each case, the creditor will have lien priority over all junior secured creditors and all unsecured creditors with respect to the proceeds of the sale for the sale of the property.

Since sponsor deals are usually non-recourse deals, there will be no sponsor guarantees, and the typical type of guarantees will include:

• before acquisition closing, guarantees from the acquisition SPV and the intermediary holding companies underneath it; and/or
• after acquisition closing, guarantees from the target company (if not merged with the acquisition SPV) and its operating subsidiaries.

When both the parent company (ParentCo, LBO loan borrower) and operating subsidiaries (Opco) are PRC domestic companies, we do not see any legal constraints preventing Opcos from providing upstream guarantees to ParentCo.

When ParentCo is an offshore company and Opcos are PRC domestic entities, Opcos are unwilling to provide upstream guarantees to ParentCo unless they can manage to register such an upstream guarantee with SAFE as outward security, which is not easily achievable. 

The Administration Rules for Listco Takeover provide that a listed company in PRC is not permitted to provide financial assistance (including a guarantee) to an acquirer.

Such restriction does not apply to non-public companies. Non-public companies could provide security (including guarantee) to support the financing of acquirers as long as such security is duly approved by shareholders/directors.

In the market, it seems that an affiliated guarantor will not charge guarantee fees to another guaranteed affiliate.

There are no enacted laws or regulations clearly recognising equitable subordination. Contractual subordination agreements between senior and junior lenders are generally recognised by PRC law.

When the target company provides security to an acquirer within the claw-back period of the target company (one year before the court’s acceptance of a bankruptcy petition), then such security may be viewed as a fraudulent asset transfer of the target company, and the bankruptcy administrator may decide to unwind such security provision if they can prove that there is no fair consideration granted to the target company. There are not many such precedents in PRC insolvency law practice. 

The main mitigant could be that such security creation be approved by the shareholders meeting of the target company with the connected shareholder refraining from voting on the same resolution.

PRC tax authorities will generally charge stamp tax on each lender and borrower of 0.05% of the committed loan amount.

There is no such concept.

According to the PRC Enterprise Income Tax Law, the interest expenses paid by a PRC company to its affiliates for outstanding loans not exceeding the prescribed ratio of the debt investment and equity investment from its affiliates are deductible for corporate income tax (“CIT”) purpose, while the interest expenses for the excess portion of loans may not be deductible.  

The prescribed ratio of debt investment and equity investment is generally 2:1, except in the case of financial enterprises where the ratio will be changed to 5:1.  

In respect of a tender offer on a listed target, the financial advisor shall conduct due diligence over the acquirer's financial capability and source of funds. The acquirer shall provide at least one of the following facilities to demonstrate its payment ability:

• for cash consideration, the acquirer must deposit cash in an amount of no less than 20% of the total consideration with a bank designated by CSDCC; for stock consideration, the acquirer shall deposit all stock consideration with CSDCC for custody;
• a bank guarantee to secure the payment of the entire offer consideration; or
• joint and several undertakings from the financial advisor to pay any shortfall of purchase consideration not paid by the offeror.

For leveraged deals where banks provide financing, the lenders can provide debt commitment to sponsors on a certain fund basis, which are on terms conforming to LMA standards.

Please see above. No regulatory guarantee concept in PRC.

There are no other relevant acquisition finance issues.