On September 13, 2021, the world witnessed a historic moment when Evergrande, an enormous Chinese real estate company, defaulted on its debts. Thousands of angry consumers and small investors gathered in the lobby of Evergrande’s headquarter in Shenzhen, demanding their money back. One homebuyer sat feebly against the wall, sobbing, as she recounted using her life savings to purchase one Evergrande-developed home. She will have nowhere to go if the company does not return her money. 

Evergrande was the biggest real estate developer in terms of property sales in China. It had over 1300 projects across 280 cities when the default happened. But its fast growth was built on borrowed money. The debt that the company owes to global investors is over 300 million dollars, equivalent to 2% of China’s GDP. Its reorganization or insolvency not only caused shockwaves throughout China’s real estate industry but also put the households of 1.6 million  in jeopardy.

To understand the situation that homebuyers are facing, one must understand the business model of Chinese real estate developers. First, real estate developers obtain the right to use certain lands from the local government. Then, they enlist construction contractors to build housing properties. To pay for rights to the land and the construction expenses, developers usually pledge the land and the construction to banks to obtain financing. To back the loan, developers use consumers’ pre-payments and complete a transaction circle.There is a risk that homebuyers of projects under construction might not see their home get completed. The construction contractors are unlikely to risk their own money by advancing the building expenses when Evergrande is already in default. Even for completed housing projects, homebuyers are unable to transfer title of the property to their names because banks and contractors also have security rights over the same property until Evergrande compensates them in full. 

Can Evergrande refund homebuyers where they cannot deliver properties as they promised? This is an open question under the Civil Code of China and its interpretations. The current Supreme Court Interpretation of Construction Contracts invalidated a 19-year long provision that granted consumers a priority right over construction contractors. 

According to earlier interpretations, the Supreme Court ranked certain consumers’ unsecured claims above those of contractors  and secured creditors’ claims in recognition that the bankruptcy of real estate developers might cause significant social security issues. Courts later defined that protected consumers are those who purchase properties for family use and pay at least 51% of the house price before the commencement of bankruptcy procedures. However, such a provision has resulted in uncertainties within the bankruptcy system. In practice, courts have been very reluctant to apply this interpretation to grant the priority right to consumers because it would contravene a fundamental principle in bankruptcy laws, that is the secured claims prevail over the unsecured claims. Secured creditors have been complaining that they cannot fully count on their securities if unpredictable factors will influence their priority for repayment in a bankruptcy procedure. 

Evergrande is likely to be the first case to challenge the new interpretation of priority claims under the Civil Code. The worst-case scenario for homebuyers is that courts will treat homebuyers as if they were like any other general unsecured creditors.

How might the U.S. bankruptcy system react to a similar situation, if Evergrande were a U.S. corporation selling houses to U.S. consumers? Professor Don De Amicis from Georgetown University Law Center predicted that under the U.S. bankruptcy system, the Evergrande case would still put homebuyers in a tenuous situation. Indeed, the U.S. Bankruptcy Code grants consumers who had made a deposit with bankrupt merchants a seventh priority among the unsecured creditors and caps each consumer’s claim to $3,025.  It requires the deposit must have been made “in connection with the purchase, lease, or rental of property, or the purchase of services, for personal, family, or household use” of the individual creditor; and the debtor must have failed to deliver the property or services. This provision is not without controversy. It wasn’t until In re James R. Corbitt Co., where three couples paid the debtor deposits to construct their homes, that the bankruptcy courts re-prioritized Congress’ legislative focus on protecting the unwitting consumer in general. Therefore, the priority has been extended to consumers who made a down payment on a house. 

Evergrande consumers’ claim would fall squarely under the protection of the seventh priority of the Bankruptcy Code, 11 U.S.C. § 507 (7), because the down payment they made to Evergrande can be seen as a deposit for a good the company failed to deliver. However, the homebuyers might still get nothing because there are secured creditors, administrative expenses, and employee wages and benefit plans that will take priority before the homebuyers are compensated from the bankrupt estate. Even if the homebuyers were to be refunded, the maximum amount that each homebuyer could receive is only $3,025. Compared to the standard down payment of 20% of a house’s value, this amount of prioritized compensation is a drop in the ocean. 

Consumers are not in a favorable situation in either jurisdiction. The prepayment transactions essential to Evergrande’s business model created a trust-like relationship in which consumers were not able  to evaluate trustees’ financial stability nor bargain for a better payment schedule. Both jurisdictions tried to recognize this possible predicament and grant consumer protection, but the protection is insufficient. The Chinese law leaves the consumer priority issue open under the new Civil Code and its interpretations. The U.S. law provides limited protection to consumers with a maximum amount cap. It won’t be an easy task, but legislators must strike a more delicate balance between maintaining the order of the priority repayments mechanism and protecting disadvantaged consumers. After the history of Lehman Brothers, AIG and other economy-shaking bankruptcies, consumers like those protesting at Evergrande headquarters deserve more legal protection for their rightful claims. 

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Tianyubo Bai is a LL.M. Digital Advisor for the Georgetown Journal of International Law. Her study interests are project finance, corporation compliance and arbitration. Before Georgetown Law, she worked as a legal specialist in China Export and Credit Insurance Cooperation, responsible for project financing and claim investigation. Prior to this experience, she worked for two years as a litigator at Wei Heng LLP.