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i FLR INTERNATIONAL FINANCIAL LAW REVIEW How China Netcom used Chapter 11 for its telecoms deal April 2003/A Euromoney Publication www.IFLR.com

INTERNATIONAL FINANCIAL LAW REVIEW - …/media/Files/NewsInsights/...INTERNATIONAL FINANCIAL LAW REVIEW How China Netcom used Chapter 11 for its telecoms deal April 2003/A Euromoney

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iFLRINTERNATIONAL FINANCIAL LAW REVIEW

How China Netcomused Chapter 11 forits telecoms deal

April 2003/A Euromoney Publication www.IFLR.com

About the authors

2 www.iflr.com

IFLRApril 03

Edward L. Turner III

Hong Kong Office

Office Telephone: (852) 2978-8001 Fax: (852) 2978-8099

E-mail: [email protected]

Practice

Edward L. Turner III is Shearman & Sterling's Office Managing Partner – Hong

Kong. Prior to his relocation to Hong Kong in early 1994, Mr. Turner practiced

in the Firm's New York and San Francisco Offices. Mergers & Acquisitions,

joint ventures and related financing transactions for companies in various

industries were among his active practice areas. Mr. Turner's current practice

in Asia focuses on M&A, project development and project finance and private

equity transactions.

Recent Relevant M&A Experience Includes Representation Of:

● Netcom in its acquisition of Asia Global Crossing, an Asia based telecom

carrier

● Allergan and its spin-off AMO in various China transactions

● Lear Corporation in its acquisition of a controlling equity interest in Hanyil

Co., Ltd., a Kosdaq listed auto parts manufacturer in Korea and various trans-

actions in China

● SK Corporation in its restructuring of its gas distribution business and

establishment of a gas distribution joint venture with a U.S. partner

● Singapore Airline Engineering Co. in its

proposed acquisition of an aircraft maintenance facility in China

● Singapore Telecom in a strategic private equity investment in Taiwan

Selected Professional Activities

Mr. Turner is an author of a Chapter on “Contracts” in the treatise Start-Up

Companies, New York Law Journal Seminars-Press (2001) and a speaker on

various topics, including Euromoney M&A Seminar; Structuring & Financing

Projects in the PRC; China Investment Law; and Negotiating and Structuring

International Joint Ventures, Partnerships and Strategic Alliances.

Bar Admissions

California, Hong Kong, New York

Education

Vanderbilt University, J.D. 1970; BA 1966

Corning Glass Traveling Fellowship (International Business), 1967

Harvard University, Interim Study Program, 1965

Sandor E. Schick

Singapore Office

Office Telephone: (+65) 6230-8901 Fax: (+65) 6230-3899

E-mail: sschick @shearman.com

Practice

Mr. Schick is counsel in the Bankruptcy and Restructuring group of Shearman

& Sterling. He has practiced, in New York, Hong Kong and Singapore, since

1985, representing debtors, lenders, creditors, trustees, creditors'

committees, steering committees and acquirers of distressed assets and

companies, in international and U.S.-based restructurings. Mr. Schick was

recognized by the IFLR (IFLR 1000 Year 2003 edition) as one of the “leading

[insolvency] lawyers” in Singapore and was “recommended” by the Asia

Pacific Legal 500. Mr. Schick joined Shearman & Sterling in 2000.

Recent Experience Includes Representation Of:

● The Combined Steering Committee of creditors of Asia Pulp & Paper in

the restructuring of US$14 billion of debt

● China Netcom in its acquisition of assets of Asia Global Crossing (IFLR

Asia M&A deal of the Year 2002)

● Ericsson and Siemens in the US$400 million restructuring of the debt of

Excelcomindo, the third largest Indonesian telecoms operator

● RFM Corporation, a Philippines food and beverage company, in the

restructuring of its capital markets indebtedness

● Chinese Guangdong Provincial Government as the sole shareholder of its

Hong Kong company, Guangdong Enterprises and its publicly-traded

affiliates Guangdong Investment and Guangnan Holdings, in the restructuring

of over US$6 billion of debt

● Steering Committee of creditors of PT Semen Cibinong Tbk, an

Indonesian cement producer, in the restructuring of approximately US$1.2

billion of debt

● The creditors' committee and liquidating trustee of Okura & Co. (America),

Inc., the U.S. subsidiary of a Japanese trading company

● Metropolitan Life Insurance Company in its US$1.2 billion acquisition of

General American Life Insurance Company

● News Corporation in the acquisition of The New York Post

● Various aircraft lessors in the chapter 11 case of Continental Airlines

● Various aircraft lessors in the chapter 11 case of TWA

● Various aircraft lessors in the chapter 11 case of Pan Am

Selected Professional and Business Activities

Co-author, “How China Netcom bought a bankrupt telecoms company,” IFLR

April and May 2003Author, “TWA: the end of an era?,” Global Insolvency &

Restructuring Review, March/April 2001

Author, "The Failure of Equity; Recharacterization in Bankruptcy," 27

U.C.C. Law Journal 3 (1994)

Etienne Gelencsér

Hong Kong Office

Office Telephone: (852) 2978-8059 Fax: (852) 2978-8099

Email: [email protected]

Practice

Etienne Gelencsér is an associate in Shearman & Sterling's Mergers &

Acquisitions and Project Finance and Development Practices in the Hong

Kong Office.

Recent Relevant Experience includes Representation of

● China Netcom Corporation (Hong Kong) Limited in its acquisition of

certain assets and liabilities of Asia Global Crossing Limited, including estab-

lishment of a partnership structure for investment by Newbridge Capital, LLC

and SB Asia Infrastructure Fund, L.P. and extensive vendor restructuring

connected with the acquisition

● A PRC asset management company in the formation of two U.S. funds to

dispose of US$1 billion of non-performing loans to U.S. investors

● UFJ Capital Markets Securities Co Limited in the establishment of a fund

in the Asia Pacific region for the investment in equity, equity related invest-

ments and troubled Japanese companies

● the Senior Lenders and Lead Arrangers (including IFC, KFW, ADB,

Dresdner AG, ABB Structured Finance, Norld LB and Helaba) in negotiating

and drafting the security documents, political risk insurance policies, direct

agreements and loan agreements for the financing of the Manila Airport

Terminal 3

● ING Bank Hong Kong Branch, in a structured finance transaction in

connection with ¥8,125 billion mortgage backed receivables in Korea and

Japan

● Bank of America in negotiating the finance documents for A$150 million

corporate financing of a telecommunications company in Australia

● Commonwealth Bank of Australia and other senior lenders in negotiating

and drafting the restructuring of the Dartmouth 150 MW Hydro-electric

Power project in Victoria, Australia

Bar Admission

England and Wales

New South Wales, Australia

Education

Murdoch University, Bachelor of Laws 1997

Murdoch University, Bachelor of Arts 1997

Language

Japanese and Italian

1www.iflr.com

IFLRApril 03

An affiliate of China Netcom Corporation, a Chinesestate-owned telecoms company, recently purchasedthe main assets of Bermuda-incorporated telecomscarrier Asia Global Crossing (AGC). The transactionwas groundbreaking from both a commercial and

legal perspective. It was the first purchase by a Chinese state-ownedcompany of overseas telecoms assets, and it took place during, and asan integral part of, the target’s US Chapter 11 case (see box).

Developing the deal structureWithin several months of AGC marketing its business for sale,China Netcom emerged as the leading prospective purchaser.What remained to be decided, however, was the nature of thetransaction and how to implement it.

An interest in a business operation can be acquired in twoways: buying an equity interest in the entity that owns thebusiness; or acquiring the assets of the business. Both these possi-bilities were considered for the AGC deal. China Netcomultimately chose – through Asia Netcom Corporation, a Bermudacompany formed for the purpose – to buy AGC’s assets.

A second issue concerning the structure of the transactionarose because of AGC’s financial condition. The company wasexpected to exhaust its cash within a short time, and it hadsubstantial liabilities; if AGC was not insolvent in early 2002, itseemed headed in that direction.

Buying an equity interest or the assets of a company that isinsolvent, or nearly insolvent, poses economic and legal risks forthe acquirer. An obvious risk in purchasing equity is that thisequity either is, or will be, of no value, particularly if the companyis later compelled to liquidate. To preserve the value of its equity,the buyer may need to negotiate debt relief from creditors.

Acquiring assets from an insolvent company creates its ownchallenges. The buyer may find the transaction subject to after-the-fact challenge in a subsequent bankruptcy proceeding, or mayfind that certain creditors of the seller (particularly in abankruptcy) may seek to have the buyer held liable for the debtsowed to such creditors. Either way, the transaction is subject to therights of existing shareholders and creditors. And these parties mayhave the right to block a proposed deal.

Buying the assets in the context of a bankruptcy case of theseller may address many of these concerns. However, puttingAGC into a bankruptcy proceeding was not necessarily acommercial or legal panacea.

AGC was concerned that bankruptcy proceedings wouldnegatively affect its market image and customer base. A keyquestion was whether a forum existed in which the bankruptcyregime would facilitate the type of transaction the parties chose todo. In essence, both China Netcom, as prospective purchaser, andAGC, as counterparty, faced the question of whether a deal thatmight be risky and difficult, and done outside a bankruptcyproceeding, could be accomplished more safely and effectivelywithin the framework of a bankruptcy proceeding. And if so,where such a proceeding should be started.

A digression: where to begin a bankruptcyproceeding?Bermuda would seem the logical place for starting a bankruptcyproceeding for AGC. However, AGC’s main asset was its equityin its operating companies, which had cable assets in a variety ofjurisdictions, mainly in east Asia. AGC also had offices, and opera-tions, in the US. Under the liberal jurisdictional requirements ofthe US Bankruptcy Code, having an office or property in the USconstitutes a sufficient basis for a corporation – even onedomiciled in Bermuda – to start a Chapter 11 case in the US.

The US Bankruptcy Code also contains a number of provi-sions that facilitate sales of assets by, or infusions of capital into, adebtor. Section 363 of the Code allows the debtor to sell propertyof the estate. This permits the sale to occur, subject to satisfyingcertain conditions, free and clear of any interest in such propertythat another entity may have, and that overrides pre-existingcontractual limitations on these sales. Section 365 of the Codesimilarly facilitates the sale by a debtor of its contract rights. TheBankruptcy Court must approve sales of assets under Section 363and Section 365, but creditor approval is not required.

The Code also contemplates that as part of the process ofconfirming a plan of reorganization, an investment may be madein the reorganized debtor that will result in merger or change inownership and control through issuing new securities in the

How China Netcomused Chapter 11 forits telecoms dealWhen a Chinese state-owned telecoms operator chose to acquire a near-insolvent

foreign company, it had to find the most protected and controlled environment within

which to do so. Edward Turner, Sandor Schick and Etienne Gelencsér of Shearman &

Sterling explain how this was done

China M&A

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IFLRApril 03

2

reorganized company. Thus, Section 1123(a)(5)(C) of the Codestates that a plan may provide for merger or consolidation of thedebtor with one or more persons, and Section 1123(a)(5)(J) statesthat a plan may provide for issuance of securities of the debtor, orof another entity with which the debtor has merged or to which ithas transferred its property for cash, for property, existingsecurities, or in exchange for claims or interests.

In contrast to an asset sale under Section 363, a proposed planof reorganization requires approval both of the Bankruptcy Courtand creditors, which are organized into classes for purposes ofvoting (and recovery under the proposed plan). Under the USBankruptcy Code, at least two-thirds in amount and more thanone-half in number of the allowed claims that are voted in eachclass must approve any plan.

Ordinarily, the creditors of an insolvent entity would beentitled to receive the equity issued by a company that undergoesreorganization under Chapter 11’s absolute priority rules.Creditors, however, may be persuaded to support a plan underwhich a third-party funding source delivered new value – in theform of cash – to the debtor, or to creditors, in exchange for whichcreditors would agree to share with the funding source some or allof the equity to which they would otherwise be entitled.However, the requisite majorities of creditors would need toapprove this plan. It would probably also need support from thedebtor before finally being subject to Bankruptcy Court approval.

The ability of a US Bankruptcy Court to exercise jurisdictionover AGC and the existence of statutory provisions for the kindsof transactions being considered by China Netcom and AGC,made a bankruptcy filing by AGC not only possible, but, overtime, increasingly attractive. However, whether done inside oroutside of bankruptcy, both parties still needed to reachagreement on the nature of the transaction to be done – equityacquisition or asset purchase.

China Netcom could have acquired a controlling interest inAsia Global Crossing (AGC) outside of a bankruptcy proceedingin at least two different ways.

Firstly, AGC could have issued and sold new shares in suffi-cient quantity to give China Netcom a controlling interest. Thiswould need approval by the board of directors, including directorsnominated by AGC’s two main minority shareholders. Secondly,China Netcom could have sought to acquire a controlling interestby purchasing all, or at least a majority of, the equity held byexisting shareholders. This would need an approach to, andagreement with, existing shareholders – principally, GlobalCrossing, Microsoft and Softbank. But by January 28 2002 GlobalCrossing was subject to a Chapter 11 case.

Buying Global Crossing’s equity interest would thus be subjectto approval of the bankruptcy court with jurisdiction over GlobalCrossing’s case. Consent from AGC’s bondholders to buy acontrolling interest in its equity would also be needed because ofprovisions in the Indenture concerning change of control. Forexample, Section 4.14 of the Indenture gave bondholders put rightsin the event of a change of control. These provisions had thepotential effect of increasing the purchase price because bondholderswould presumably seek concessions in exchange for giving consent.

It was thought that buying an equity interest in AGC wouldcause less disruption to the company’s business operations,customers and market image than acquiring substantially all of its

Background to the deal

AGC was formed as a Bermuda corporation in November 1999

as a joint venture between Global Crossing, Microsoft and

Softbank. In October 2000, AGC made a public offering of its

Class A shares and was subsequently listed on the New York

Stock Exchange. Global Crossing retained a controlling equity

interest, holding nearly 59% of the Class B shares. In the same

month, AGC issued $408 million worth of bonds under a New

York law-governed Indenture.

The issuer used the funds to build two costly sub-sea cable

systems – East Asia Crossing and Pacific Crossing. East Asia

Crossing consisted of around 17,900 kilometers of cable linking

Japan, Taiwan, South Korea, the Philippines, Hong Kong and

Singapore. Pacific Crossing consisted of a cable of around

13,000 route-miles between Japan and the US. To develop

these systems, however, AGC had entered into contracts with

certain equipment vendors and had incurred large liabilities

under these contracts.

AGC’s assets were held through a complex corporate

structure, with AGC as the holding company. AGC and East Asia

Crossing Limited, which in turn had various subsidiaries, owned

East Asia Crossing. A separate set of subsidiaries owned Pacific

Crossing. In all, AGC had interests in 47 different entities.

By early 2002, AGC and parent company Global Crossing

were in financial difficulty. The general problem telecoms

companies faced was worldwide over-capacity and excessive

debt. This led to numerous failures and restructurings around the

world.

Global Crossing filed a petition for relief under Chapter 11

of the US Bankruptcy Code on January 28 2002 under a large

debt burden. About that time, the US Securities and Exchange

Commission began investigating Global Crossing for possible

breach of accounting and disclosure requirements; allegations

had also been made that AGC had improperly accounted for

and disclosed certain transactions. Moreover, in December

2001 Global Crossing had failed to honour its commitments to

AGC under two subordinated standby credit facilities totaling

$400 million. At the same time, AGC had limited and dimin-

ishing liquidity and also had outstanding obligations of $408

million for the senior notes it issued in October 2000. East Asia

Crossing Limited had failed to meet payment obligations of

$130 million to a vendor, NEC Corporation. East Asia Crossing

Limited and AGC also owed around $94 million to another

vendor, KDDI Submarine Cable Systems, due on March 1

2002.

By January 2002, AGC’s shares were trading below one

dollar. On February 28 2002, the New York Stock Exchange de-

listed the company. A number of shareholder class action litiga-

tions against AGC were also started.

In early 2002, AGC did what many companies that are in

financial difficulty do: it sought to raise new funds. In particular, it

started marketing its business, including EAC Cable.

An affiliate of China Netcom was one of the potential

purchasers that contacted AGC’s investment bankers. China

Netcom is the second-largest fixed-line carrier in the People’s

Republic of China, and a state-owned enterprise.

China M&A

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IFLRApril 03

assets. However, from a buyer’s perspective, buying an equityinterest in AGC posed a number of risks.

Firstly, bondholder and shareholder consent was not assured,and the price to get consent was uncertain. Secondly, if a buyeracquired control of AGC’s equity, the company’s debt structurewould not necessarily change. AGC would still have too muchdebt and accommodations would still need to be reached with themain creditors, the bondholders and equipment vendors. Toreduce AGC’s debt burden to sustainable levels, and thus preservethe value of the equity for the buyer, China Netcom would thenbe forced to negotiate with principal creditors. If agreement couldnot be reached on the terms for buying equity, or, if after acquiringequity the buyer could not reach agreement with creditors on theterms of a debt restructuring, bankruptcy proceedings mighteventually prove necessary.

Thirdly, AGC would still be exposed to existing shareholderlitigation and other contingent claims that might be assertedagainst it. At the time of starting its Chapter 11 case, there werefive class-action suits alleging violations of federal securities lawpending against AGC. Left unresolved, the litigation and claimsmight also put pressure on the value of any equity interest.Fourthly, timing an equity purchase would be difficult to control,since to complete the transaction would require the consent ofshareholders and bondholders who might seek to obtain greatervalue by holding out. Because AGC had a limited amount of cash(it lacked sufficient liquidity to fund operations past the firstquarter of 2003) timely completion of the deal was important.Finally, there was concern that the investigation by the USSecurities and Exchange Commission might result in AGC beingheld liable; this could taint the company.

As discussed, new investors could buy a controlling equityinterest in AGC through a plan of reorganization under Chapter11. Indeed, while AGC was in discussions with potential buyers,Global Crossing, its parent, put forward a plan of reorganizationpredicated on such an equity investment. But for an investor, thisstructure presents a number of risks.

Firstly, Chapter 11 is a bit like a bazaar – everything is subjectto negotiation. Thus, the investor could expect to be drawn intothe Chapter 11 case, and in particular, into the difficult process ofseeking approval from creditors, and then the bankruptcy court,for a plan of reorganization. Secondly, (and related to the firstpoint) it could be difficult for an investor to ensure the price isfixed. Creditors – particularly well-organized bondholders as inthe AGC case – could be expected to seek to either induce theinvestor to make a larger cash contribution, or to share equity inthe reorganized company with them. Or both. Thirdly, existingshareholders might also seek to retain some equity in thereorganized company.

Fourthly, if unexpected claims were filed and allowed duringthe Chapter 11 case, creditors with these claims might also seekrecovery in the form of equity in the reorganized company. If theequity investor had to allocate a portion of equity to suchcreditors, this would further dilute the amount of the investor’sequity interest. Fifthly, potential tax attributes – like tax losses insubsidiaries – might not be carried forward in some jurisdictionsbecause of the change of control from the Chapter 11 case.Sixthly, if under the terms of a plan of reorganization creditorsobtained equity in the reorganized company, they might seek to

limit the investor’s ability to manage the company and freelyexercise the rights that a controlling shareholder might otherwiseexpect to have. Finally, in a Chapter 11 case, the fees and expensesof the professionals retained (with court approval) by the debtorand the official committee of creditors are borne by the debtor.Thus, an equity investor would ultimately bear this cost byacquiring a company whose cash balances would have beenreduced by the amount of these fees.

For the reasons stated above, China Netcom eventuallyconcluded that it did not wish to assume the level of risk anduncertainty of trying to buy a controlling equity interest in AGC –either outside or within a Chapter 11 case.

Acquisition of assetsThe acquisition of AGC’s assets was the alternative to an acqui-sition of an ownership interest. China Netcom was mainly inter-ested in acquiring the East Asia Crossing cable system. But it wasAGC’s East Asia Crossing Limited subsidiary that owned thatsystem, along with its subsidiaries that it had set up in the variousjurisdictions that the East Asia Crossing cable landed – HongKong, the Philippines, Korea, Japan, Singapore and Taiwan. SoChina Netcom concluded that it should structure its purchaseprimarily as an acquisition of AGC’s equity interests in East AsiaCrossing Limited and the other subsidiaries that held rights inrelation to the East Asia Crossing cable.

However, China Netcom did not seek to buy AGC’ssubsidiaries that owned the Pacific Crossing cable (PacificCrossing Holdings Limited and its subsidiaries) and that had beguntheir own Chapter 11 cases on July 19 2002 in the District ofDelaware.

Ultimately, three separate and parallel Chapter 11proceedings, involving three distinct tiers in the Global Crossingcorporate group, were pending before three different judgessitting in two different jurisdictions: Global Crossing and some ofits subsidiaries; AGC and one of its subsidiaries; and PacificCrossing Holdings Limited and its subsidiaries.

AGC was initially reluctant to sell its East Asia crossing cablesystem. It was understandably concerned about the reaction ofcreditors, customers and employees to a deal that would break upits corporate structure, remove some of its most valuable assets andleave behind little more than a corporate shell (apart from thePacific Crossing entities).

To buy the assets, China Netcom had the same two optionspresented by a possible purchase of equity; firstly, through agree-ments completed without judicial involvement; and secondly, asexplained below, through a sale conducted as part of the Chapter11 case under the auspices of a US bankruptcy court.

Making the purchase as part of AGC’s Chapter 11 case offeredChina Netcom a number of benefits that led it to follow that path.Firstly, a US bankruptcy court can issue an order, under Section363 of the Bankruptcy Code, conveying the purchased assets freeof liabilities, except those expressly assumed. An agreement madeoutside of a Chapter 11 case might purport similarly to conveyassets free of liabilities, but would not have the force of a courtorder. And, in contrast to a sale under Section 363, such anagreement would have no legal basis for overriding the rights thatthird parties might possess to the purchased assets or against thepurchaser.

China M&A

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IFLRApril 03

Secondly, buying assets through a US bankruptcy court givesthe buyer immunity from any subsequent challenges to the trans-action that disaffected creditors (or a trustee or other entity acting asrepresentative of these creditors) might bring. In contrast, in apurchase solely through private contract, the buyer risks the trans-action being challenged as a fraudulent conveyance, or as violatingother statutory provisions giving protections for creditors, forinstance those governing bulk sales of assets. Thirdly, if the assetpurchase were attempted out-of-court, negotiations with, andconsent from, the bondholders would have been necessary becauseof various provisions in the Indenture restricting asset sales. Forexample, Section 4.18 of the Indenture prohibited AGC fromselling more than 20% of its equity interest in East Asia Crossing.And Section 5.01 prohibited AGC from selling all or substantiallyall of its assets unless the buyer assumed AGC’s obligations underthe Indenture.

Negotiations seeking relief from these provisions might havedelayed completion of the deal, increased the price China Netcomneeded to pay, or posed insurmountable obstacles to the trans-action. In contrast, in a sale conducted under the US bankruptcycourt, limitations in the Indenture could be overridden.

An asset purchase in Chapter 11 is also inherently simpler thana transaction in which, under the terms of a reorganization plan, aninvestor seeks to buy equity in a reorganized company in exchangefor providing funding.

Firstly, a buyer of assets needs only negotiate with one party –the debtor – and does not have to become involved in discussionswith creditors. Secondly, the procedures needed for approval of anasset sale under Section 363 of the US Bankruptcy Code – theparticular statutory provision used in China Netcom’s purchase ofAGC’s assets – are less complex and time-consuming than those toapprove a plan of reorganization. For example, creditors do notvote on an asset sale under Section 363; only bankruptcy courtapproval is needed. Moreover, only 20 days’ notice to creditors andother interested parties is necessary before the court may entertainthe application to approve the sale.

In contrast, there is no statutory limit on the amount of timethat may elapse before a plan of reorganization must be confirmed,and there are consequently cases where confirmation of a plan hastaken years. Although different results occur in different cases, theChapter 11 proceedings of Global Crossing and AGC illustrate therelative speed of an acquisition through a Chapter 11 plan ofreorganization and under Section 363 of the US BankruptcyCode. Global Crossing’s Chapter 11 case began on January 282002. Though the court approved a plan of reorganization aimed atproviding a controlling equity interest to Hutchison Whampoaand Singapore Technologies Telemedia on December 26 2002,the plan has still not yet been completed because of US regulatoryconcerns over non-US ownership of Global Crossing’s cableassets. In contrast, AGC’s Chapter 11 case began on November 172002. The Bankruptcy Court entered an order approving the salearound two months later, on January 29 2003.

Thirdly, a prospective asset buyer in a Chapter 11 case needsnot be concerned with the allocation of the proceeds of thepurchase price. This is a matter for the seller’s creditors and thebankruptcy court. Finally, a prospective buyer may negotiate withthe seller, and require it to obtain a court order for various forms ofprotections for the buyer. These protections typically include a

break-up fee payable to the intended buyer if the deal fails to closefor reasons outside of its control.

These benefits, and the risks of proceeding out of court,persuaded China Netcom to make an asset purchase using Section363 of the Bankruptcy Code. China Netcom then negotiated aShare and Asset Purchase Agreement with AGC that contained aprovision requiring AGC to start a Chapter 11 case.

The Chapter 11 sale processChina Netcom and AGC executed the Share and Asset PurchaseAgreement on November 17 2002. On the same day, AGC filed apetition for relief under Chapter 11 with the US Bankruptcy Courtfor the Southern District of New York. The company also filed anapplication with the Court to approve the Share and Asset PurchaseAgreement, and filed a related application with the Court seeking toput in place bidding and auction procedures for the sale and toauthorize a break-up fee and other bid protections for ChinaNetcom.

The US Bankruptcy Code does not establish a specificstatutory standard for approving assets sales; courts typically make afinding that, among other things, the proposed purchase is thehighest and best offer for the assets in question. In the ChinaNetcom deal, the public tender process that AGC began in early2002 was part of the basis for this finding. However, as is often thepractice in Chapter 11 asset sales, AGC sought, and obtained, anorder requiring other bidders to come forward by a certain date. Inthe event that AGC accepted a higher bid, the order furtherprovided that China Netcom would be entitled to receive a break-up fee as compensation for its efforts as stalking horse.

But no other bidders surfaced. At a hearing on January 282003, the Court approved the sale to China Netcom. The dealclosed on March 10.

Bermudan considerationsThere was concern that under Bermudan law, any bondholder of aBermuda-incorporated issuer (such as AGC) would have the rightto start proceedings in Bermuda to recover against the issuer underthe terms of the Indenture, even if a US bankruptcy courtapproved a plan of reorganization otherwise binding onbondholders.

AGC therefore took the view that it was prudent to startparallel winding up proceedings in Bermuda to bind all itsbondholders and accordingly did so on November 18 2002. TheSupreme Court of Bermuda shortly thereafter appointed jointprovisional liquidators for AGC and entered its own order author-izing the liquidators to complete the asset sale.

ConclusionThis transaction was significant in more than one way: it was the firstcross-border acquisition by a mainland Chinese telecoms carrier;and it was structured in a sophisticated and innovative manner – aBermudan entity, with only a limited nexus to the US, started byagreement with the buyer a US chapter 11 case (and parallelBermudan winding-up proceedings) to facilitate the sale of its sharesin subsidiaries whose primary assets were located in east Asia.

Future buyers of distressed assets are increasingly likely to seekto conduct similar transactions through the medium of US Chapter11 proceedings. ❚