CHINA Law and Practice Contributed by: Nelson Zhou, Yifeng Yuan, Jianwei Yang and Jingbo Zhou, JunHe LLP
of PRC assets prefer, or are asked by investors, to set up an offshore investment holding struc- ture and place their PRC operating companies or assets under such offshore holding compa- nies. The acquisition is usually constructed as a sale and purchase of shares in offshore holding companies. In such a deal construct, the senior loans nor- mally comprise two tranches: • one offshore tranche extended to the acquisi- tion vehicle of the buyer financing the pur- chase 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 the offshore loan is technically structurally subordinated to the onshore loans. For real estate loans, offshore lenders will seek to have a second lien mort- gage over the onshore real estate properties to improve their subordination position, which may face challenges as outlined in the upstreaming security section in 3.4 Bonds/High-Yield Bonds (Offshore Issuer). Hence, this request is rarely accepted in sponsor-financed transactions. Many offshore lenders also manage to enter into intercreditor agreements with onshore lenders to share security or achieve co-ordinated secu- rity enforcement arrangements, which can also prove to be quite challenging, as discussed in 4. Intercreditor Agreements . For those domestic LBO deals where both lend- ers and borrowers are PRC entities, an offshore investment holding structure is not a must. There will be only one senior acquisition loan, to be provided by onshore lenders to the onshore bor-
rower for its acquisition of the equity interest of the onshore target company from the seller. 3.2 Mezzanine/Payment-in-Kind (PIK) Loans Mezzanine loans are not commonly seen in sponsor financing, as PE sponsors may easily access 60‒65% LTC loans from senior lenders in this market (with combined use of onshore and offshore loans, since onshore lenders are sub- ject to a regulatory cap of 60% LTC for acquisi- tion loans). Mezzanine loans are more frequently seen in real estate financing extended to real estate develop- ers, which 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 regu- latory financial ratios. Such real estate develop- ers will place their onshore development compa- nies under an offshore holding company, which will utilise mezzanine loans from credit funds and then infuse equity into onshore project compa- nies. Such a mezzanine loan will normally yield 12‒18% interest but will obviously be structurally subordinated to onshore senior creditors without the protection of an intercreditor arrangement. A new mezzanine structure has been seen in continuity fund deals, as discussed in 1.2 Cor- There are bridge loans in LBO deals, where the target is cash-rich but cannot provide cash secu- rity 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 porates and LBOs . 3.3 Bridge Loans
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