December 22, 2011 / 9:23 AM / in 6 years

Sino-Forest structure leaves bondholders facing wipeout

(Reuters) - It’s tough enough for offshore creditors of Chinese firms to get their money back when businesses run into trouble. The complex corporate structure of Chinese timber firm Sino-Forest TRE.TO could make it tougher still for its bondholders.

The company, which was set up 16 years ago and lists its shares in Toronto, this week received a default notice on two of its bonds after it failed to file third-quarter results on time.

That followed its decision to not make a $10 million interest rate payment on one of its bonds, a move that fixed income experts saw as a sign that bondholders could face a near-100 percent writedown.

“I‘m shocked as to why the installed management would decide to default on a coupon payment, it doesn’t benefit any of its stakeholders and dissuades its customers from continuing to do business,” said Scott Bennett, head of Asia Credit at Aberdeen Asset Management, which sold all its Sino-Forest bond holdings more than two months ago.

Sino-Forest has been under pressure since Carson Block at short-seller Muddy Waters accused it six months ago of fraudulently exaggerating the size of its forestry assets.

The saga is the most prominent of a series of accounting scandals to taint the image of Chinese companies listed in North America, prompting trading halts, delistings, lawsuits and regulatory probes. Sino-Forest’s market value has slumped 75 percent to below $1.2 billion and high-profile investors have fled, including billionaire hedge fund manager John Paulson.

Its bondholders have included some of the world’s biggest asset managers including Fidelity, whose Asian high yield fund and global high yield funds between them held some $70 million of the company’s 2017 bonds at end-October, according to eMAXX, a Thomson Reuters company.

The company denies the allegations, and an independent committee last month found no evidence of fraud, although it did say it was unable to verify all of the company’s forest holdings.


When Chinese firms hit the skids, offshore creditors are behind domestic lenders in the queue to get their money back, and China’s exchange controls make it difficult to shift funds out of the country.

Sophisticated bond investors will know those risks, but in Sino-Forest’s case the picture is bleaker still, given the uncertainty around the main issue raised by Block: what rights does the company have over timber plantations in China that make up the core of its business?

As of end-June, the company had close to 900,000 hectares of plantations and manufacturing operations in China, according to its website. (

The committee report found that Sino-Forest’s control over around 80 percent of its timber holdings is through contractual agreements rather than outright ownership.

The company says it is prevented by law from owning the assets directly, but analysts say the precise nature of the contractual rights over forests on this land is unclear.

“It’s very difficult if most of a company’s assets are contractually controlled, because creditors face a lot of issues as to whether or not liquidators can exercise any right over them,” said Fredrik Oqvist, a freelance consultant who advises on ownership structures in China.

Added to the creditors’ headache in trying to assess what assets they can get their hands on in Sino-Forest’s complex web of subsidiaries.

While the company’s sole business is buying and selling timber - from whole trees to wood pulp - it has 149 separate entities, dozens of which are domiciled in the British Virgin Islands and China, plus others in Hong Kong, Canada, Barbados and elsewhere.

“It’s not necessarily the case that every complex corporate structure is in place for bad reasons, but they can be used for bad reasons,” said a Canadian lawyer who specializes in restructuring and insolvency issues.


This will make it tough for Sino-Forest’s bondholders when it comes to debt restructuring talks, as they won’t have a clear idea of how much the company’s underlying assets are worth - the normal starting point in any bargaining.

“We’re looking at a company which may now have little or no cash. If it stops operating, all that’s left will be its timber holdings, and then it’s not clear what rights the company has or will have,” said Bennett at Aberdeen Asset Management.

This uncertainty could give Sino-Forest the upper-hand in negotiations with bondholders.

“Since creditor remedies are untested, borrowers have some degree of leverage, and they know it,” said Joel Rothstein, a Beijing-based banking and finance partner with law firm Paul Hastings. “The company could be using this as a bargaining chip to try to bring the creditors to the table to try and work out some sort of deal.”

Sino-Forest’s bonds due in 2014 and 2017 have actually seen their prices perk up since the default notice, to trade at 26/31 cents on the dollar from lows of 20/21 on speculation that distressed debt investors would be interested.

However seasoned distressed debt investors feel recent buyers are too optimistic.

“I suspect a deal will be done to buy the local assets before relisting (the company) and what will be left of the company is a shell with little cash,” said Shyam Maheshwari, partner at SSG Capital Management (HK), a distressed debt specialist.

“If it (the bond) trades completely at an option value, let’s say 5 cents on the dollar, you may find buyers, but at this point the downside is still high - 20 cents doesn’t mean it can’t go lower,” he added.

So, for bondholders, and indeed shareholders who are even further back in the queue, the best tack may be to go after Sino-Forest’s auditors, board members and other backers if they can prove they failed to adequately disclose the risks involved.

“You have to go after the people that badly misled you, such as the underwriters and the board of directors and auditors and people like that,” said an accountant involved in some of the legal proceedings against Sino-Forest.

It’s that option which likely explains one of the many mysteries surrounding Sino-Forest - its missing third-quarter results.

“Why would any auditor stick their neck out in this situation?” said one Hong Kong-based lawyer who declined to be named given his involvement with the case.

Reporting By Rachel Armstrong in SINGAPORE and Umesh Desai in HONG KONG, additional reporting by Euan Rocha in TORONTO; Editing by Ian Geoghegan

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