Protecting Chinese businesses' Financial Position in the UK: Managing Credit Risk (Part 2: Debt Enforcement and distressed acquisitions)

In part 2 of this series, we explore what Chinese businesses or investors can do in the event of having to enforce a debt and the opportunities that exist for acquiring distressed assets. This includes both loans and investments in the UK, as well as international agreements governed by the laws of England and Wales. 

Insolvency Waterfall 

In the event of insolvency, secured creditors with fixed charges are paid first, followed by the costs of the insolvency process, preferential creditors (including employees and HMRC), floating charge holders, and finally unsecured creditors. Shareholders are only entitled to any assets remaining after all creditors have been satisfied. 

This hierarchy reinforces the importance of security, priority and timing when structuring investments or lending arrangements as discussed in Part 1.

Enforcement Options

When a borrower enters financial difficulty, lenders will often engage with the borrower outside of an enforcement. Under the protection of a reservation of rights letter, a lender governed by English law may negotiate an extension, a variation of the terms or a refinancing through a formal or informal arrangement.

However, where this is not possible or desirable, Chinese creditors have a range of formal enforcement options under English law. These include:

Administration: a UK insolvency procedure in which a licensed insolvency practitioner is appointed to take control of the business from its directors, during which time the company benefits from a moratorium, preventing claims against it without the consent of the administrators or a court order. 

Whilst administration is available to any creditor through a court application, only the directors of the company or, importantly, a lender holding a "Qualifying Floating Charge" (that is a properly registered floating charge over all or substantially all of a company's assets) can appoint an administrator using an out of court procedure. 

This can be done in a single day and is a powerful enforcement tool for a lender.

Receivership: an out of court enforcement process, which can be used either by a fixed charge holder or a landlord of property to take control of a specific secured asset. The lender appoints a receiver to manage, protect, and sell the charged asset. 

Unlike in an administration where the administrator owes duties to all of the company's creditors, a receiver owes duties only to the lender.  During this process, management stays in place. Assets will be marketed and sold at the best price reasonably obtainable in the market with proceeds repaying the lender and meeting the costs of the receivership, with any balance going back to the borrower. There is no moratorium. 

Winding-up (liquidation): a court-led process where a creditor makes a petition to the court to wind up a company when the borrower cannot pay its debts. If the court grants the winding‑up order, the company enters compulsory liquidation. The Official Receiver (a UK government official) is appointed as liquidator, taking full control of the company’s assets. 

This is usually a last resort as the lender effectively loses control of the process. However, the threat of a winding-up petition (which must be publicly advertised within a period after presentation) can be used strategically as a pressure point in negotiations.

Administration and Pre-Pack Sales: A Strategic Tool

Administration is often perceived as a negative outcome for the affected company, but it can also present strategic opportunities.

The out of court administration process referred to above (available only to directors and a lender holding a "Qualifying Floating Charge" is extremely fast and flexible, permitting the use of a pre-packaged ("Pre-Pack") sale, where a sale of the business and / or its assets is negotiated between the company, buyer and prospective administrators before they are formally appointed. 

The Pre Pack is then executed by the administrators immediately on appointment. This can:

• Preserve value
• Protect continuity of operations
• Enable acquisition opportunities at a discount

Administration sales can be a significant opportunity to a lender or third party looking to acquire assets of an ongoing business, quickly and potentially at a significant discount to their normal market value. 

As the liabilities of the debtor company remain with the administrators the buyer takes the assets free and clear and with no risk of clawback claims from the debtor company's estate.

Key takeaways 

Very different from the approach in China, in the UK and for any English law governed international agreements, it is important to develop the right strategy before proceeding with enforcement. We would always recommend that Chinese lenders consider all strategic options before taking any actions. 

Our Insolvency and Restructuring team have extensive experience in advising banks, development finance funders and debt financing, together with our Banking and Finance team we provide one-stop solution from transaction to debt recovery. The team has significant experience supporting China-headquartered businesses and investors in the UK and globally 

Please get in touch if you would like to have a conversation of your investment or require assistance in acquisition and restructuring debt positions, enforcement strategies and recovery in distressed loans.