Legal Remediation Pathways for Distressed Real Estate Projects in China

Real estate sector: from economic pillar to systemic crisis

The aspiration of “adequate housing for all” has constituted a fundamental pursuit for ordinary Chinese households, engendering market demand in the residential property sector. Over the past two decades, real estate development has emerged as a pivotal pillar industry, interconnecting over twenty upstream and downstream sectors while contributing substantially to national GDP growth and fiscal revenue. The sector’s deep integration with financial systems and local government finance has precipitated the formation of entrenched interest networks, exerting material influence on national economic policymaking and public administration. This structural over-reliance on real estate has created systemic vulnerabilities within China’s economic framework.

Since 2016, the central authorities have implemented the “housing for living, not speculation” regulatory doctrine. Multidimensional controls have been instituted across land development, commercial housing sales, mortgage financing, development capital, and taxation frameworks, supplemented by restrictive measures including mortgage limitations, purchase quotas, and price ceilings. These interventions proved insufficient until August 2020, when enhanced policy instruments were deployed: the “Three Red Lines” (三道红线) metrics for developers, centralised banking-sector exposure caps, and unified land use rights auctions. These combined measures ultimately stabilised market speculation by late 2021.

Commencing in the first quarter of 2022, compounded by the effects of the COVID-19 pandemic and geopolitical tensions, the domestic economic downturn drove a sectoral reversal. High-profile defaults were seen among leading private developers typified by Evergrande Group, with consecutive declines in investment volumes, sales figures, and property values transitioning the industry from its “golden era” to crisis conditions. Subsequent regulatory easing failed to counteract systemic headwinds, including economic contraction, demographic shifts, changing marital norms, and diminished household incomes. Investment demand evaporated while discretionary and essential housing consumption contracted, exacerbating sectoral distress marked by proliferating developer defaults, distressed enterprises, and stalled urban renewal projects.

According to official statistics from the China Real Estate Industry Association’s website, approximately 235 real estate developers issued bankruptcy-related filings in 2023, with over 20 companies filing for bankruptcy by 29 February 2024. The majority of these bankruptcy applicants are small and medium-sized developers from third- and fourth-tier cities. A substantial number of de facto insolvent real estate developers are encountering judicial access barriers to entering statutory restructuring procedures, resulting in a “disposal logjam” phenomenon for distressed property enterprises.

The communiqué from the Third Plenary Session of the 12th Central Committee of the Communist Party of China last year emphasised the need to “improve the enterprise bankruptcy mechanism, explore the establishment of a personal bankruptcy system, advance supporting reforms for business deregistration, and enhance the enterprise exit framework”. This underscores the imminent necessity for comprehensive revisions to China’s current Enterprise Bankruptcy Law.

Real estate project rescue pathways: government-led interventions and market-driven restructurings

Government-led interventions

The July 2022 Politburo Meeting of the CPC Central Committee mandated local governments to reinforce accountability through city-specific measures to support basic and upgrading housing needs, while formally establishing “ensuring housing delivery and stabilising people’s livelihoods” (保交楼、稳民生) as a core policy objective.

The central government’s “housing delivery guarantee” framework emphasises localised responsibility enforcement. Financially distressed developers increasingly seek project partnerships or equity collaborations with state-owned enterprises (SOEs), or cede development rights entirely to SOEs. In such cases, SOEs directly assume the developer role, displacing distressed private entities to take over stalled projects and ensure completion. These interventions are driven by social responsibility rather than economic returns.

Market-driven restructurings

As the nationwide campaign to ensure housing delivery completion continues to gain momentum, the market-oriented rescue mechanisms for distressed real estate projects have demonstrated increasingly professionalised operational characteristics. Typically spearheaded by specialised distressed asset management institutions (such as Asset Management Companies (AMCs) and private investors), these mechanisms employ trust structure arrangements for risk segregation while injecting fresh capital, ultimately achieving the resumption and completion of distressed real estate projects.

Debt restructuring and corporate bankruptcy reorganisation represent two distinct approaches for professional institutions to resolve distressed developers’ risks: the former emphasises achieving a soft landing through negotiated debt structure adjustments, whereas the latter implements hard restructuring constraints via judicial procedures. The following analysis will delve into the operational mechanisms and implementation strategies underpinning these two resolution models.

Debt restructuring

Project debt restructuring is principally implemented through amicable negotiations among creditors, debtors, and investors/distressed asset specialists, and becomes enforceable upon achieving consensus regarding interest concessions and risk-return equilibrium.

In light of the differentiated characteristics of distressed real estate projects, rescue parties generally adopt two strategies: “Project-Only Rescue” (preserving the original development entity’s status) or “Project-and-Entity Joint Rescue”, with risks mitigated through three innovative models.

Model 1: Equity restructuring via a limited partnership framework

The original project company retains its legal entity status, while equity restructuring is executed through the establishment of a structured limited partnership. Newly injected capital subscribes to senior partnership interests with super-priority rights, existing creditors’ claims are converted into intermediate partnership interests, and original shareholder equity is downgraded to subordinated partnership interests. The proceeds from the revitalised project will be allocated/distributed according to the “Last In, First Out” (LIFO) principle, ensuring priority repayment to new capital. This model preserves the original development qualifications while safeguarding investors’ interests through tiered equity arrangements.

Model 2: Rights restructuring and risk segregation via trust instruments

Without altering the project company’s legal entity, equity restructuring is implemented through a layered service trust. New capital holds priority trust beneficiary rights entitling it to preferential distributions, existing creditors’ claims are transformed into intermediate trust beneficiary rights, and original shareholders’ equity is reduced to subordinated trust beneficiary rights. The trust deed explicitly stipulates the priority order of asset disposal proceeds, guaranteeing new capital’s priority exit. This structure achieves precise alignment of risks and returns through financial instrument design.

Model 3: Risk containment via entity isolation

Where the original project company faces material risks such as debt irregularities or asset freezes, a wholly-owned Special Purpose Vehicle (SPV) is established as the new development entity. Core entitlements – including project development rights and government permits – are legally transferred to the SPV, accompanied by regulatory filings for development entity modification. The SPV assumes project entitlements exclusively, entirely isolating historical liabilities of the original company, thereby establishing a dual safeguard mechanism (“clean asset platform plus risk segregation”). This approach is more commonly seen in urban renewal project relief efforts within the Guangdong-Hong Kong-Macao Greater Bay Area.

The above three models leverage legal techniques – including priority structuring, equity layering, and risk segmentation – to achieve project rescue objectives while balancing the competing interests of all parties.

Bankruptcy reorganisation

When projects involve complex creditor-debtor relationships and stakeholders fail to reach consensus on debt restructuring, such restructuring efforts often prove unviable. These projects typically deteriorate further, meeting statutory insolvency criteria under Article 2 of China’s Enterprise Bankruptcy Law. Through the binding authority of bankruptcy proceedings, court-appointed administrators, judicial enforcement, and government-court collaboration mechanisms, rehabilitation via bankruptcy reorganisation becomes feasible. For intricate projects resistant to conventional debt restructuring, bankruptcy reorganisation emerges as the principal and ultimate remedial measure.

Within bankruptcy reorganisation proceedings, restructuring sponsors may extend loans or inject liquidity into distressed enterprises. These funds, classified as debts incurred for the common benefit of creditors, enable the continuation of business operations and project completion. Post-restructuring revenues are statutorily prioritised for repaying such claims pursuant to Article 42 of China’s Enterprise Bankruptcy Law.

Bankruptcy reorganisation may be further delineated into two distinct legal methodologies under insolvency frameworks: “corporate reorganisation of real estate enterprises” and “operational reorganisation of real estate projects” (business undertakings). The former preserves the debtor’s juridical personality, encompassing both the conventional survival-style reorganisation and the innovative liquidation-style reorganisation model, whereas the latter abandons the original entity’s legal existence to rehabilitate the project’s operational value rather than its corporate structure, giving rise to mechanisms such as business transfer reorganisation (operational assignment model) and reorganisation-style liquidation.

The following section provides a concise analysis of the liquidation-style reorganisation and reorganisation-style liquidation models as applied to distressed real estate entities.

Liquidation-style reorganisation

Liquidation-style reorganisation refers to a restructuring model applied in bankruptcy reorganisation proceedings for distressed real estate developers. Under this approach, the creditor repayment rate is first calculated by simulating bankruptcy liquidation procedures. Based on this rate, strategic investors are then introduced to raise restructuring funds. The funds raised are used to repay the developer’s debts up to the simulated liquidation repayment rate, thereby minimising the financial burden on investors. Crucially, the original corporate entity retains its legal status and project development qualifications. The strategic investor subsequently acquires 100% equity of the original enterprise and resumes real estate development to achieve the developer’s strategic revival (ie, shedding non-core liabilities while preserving operational continuity).

Despite its name, liquidation-style reorganisation is legally classified as a reorganisation (not a liquidation), and must comply with reorganisation statutes under the Enterprise Bankruptcy Law (eg, Article 70 or 73). Specifically:

• the enterprise must meet statutory bankruptcy reorganisation conditions (eg, reorganisation feasibility, creditor support);
• the court must formally approve the enterprise’s entry into reorganisation proceedings;
• the applicability of this model depends on the developer’s asset-liability profile, reorganisation value, and the availability of qualified investors

Restructuring-style liquidation

Where distressed real estate enterprises lack reorganisation value, traditional bankruptcy reorganisation models face significant challenges in application, while conventional bankruptcy liquidation procedures prove inadequate to resolve conflicts among various creditors. In such circumstances, the "restructuring-style liquidation" model – a relief mechanism for real estate enterprises that integrates the value-driven principles of bankruptcy reorganisation into liquidation proceedings, thereby combining the advantages of both regimes – demonstrates greater efficacy.

For insolvent real estate developers, whose assets are unfinished real estate projects, the restructuring-style liquidation model prioritises the resumption and completion of stalled projects. This approach involves the bundled sale of ongoing construction projects, with the obligation to resume and complete such projects imposed as ancillary duties transferred to the purchaser. The bidding notice will require prospective investors submit qualification certificates and a concrete, actionable plan for project resumption and completion. Subsequently, the insolvent enterprise will utilise the sale proceeds to satisfy creditor claims, undergo liquidation, and formally dissolve in accordance with law, ceasing all operations.

This procedural framework establishes an insulating firewall between the corporate entity and the underlying real estate project value, thereby fully resolving creditor-debtor conflicts arising from stalled projects and eliminating investor apprehensions.

Conclusion

China’s real estate sector is undergoing a transformative “structural realignment” marked by profound systemic adjustments, where current crises simultaneously incubate new opportunities. Within the legal services market addressing this sector, risk resolution for existing projects, particularly distressed assets, will dominate legal service demands in China’s real estate sector, necessitating attorneys’ deep engagement in designing debt restructuring and bankruptcy reorganisation frameworks. This requires strategic deployment of instruments including asset divestiture, debt-to-equity conversions, structured special-purpose vehicles (SPVs encompassing limited partnerships/service trusts), and beneficial debt financing mechanisms to facilitate distressed real estate remediation. Legal practitioners must synthesise these tools to achieve market stabilisation objectives.