(Bloomberg) -- A Hong Kong court has ruled in favor of creditors in cases involving a controversial credit protection mechanism popular among China’s borrowers, reviving the hopes of investors trying to claw back funds on defaulted bonds.

Peking University Founder Group Corp., the former commercial arm of the elite Chinese school, breached so-called keepwell provisions on its units’ dollar bonds, the Hong Kong Court of Appeal ruled Friday. With the ruling, the Chinese conglomerate now becomes liable to the offshore units — now controlled by their liquidators working for creditors — in the sum of about $1.7 billion, according to the written ruling released in a Hong Kong judiciary website.  

The judgment, which overturns previous rulings by a lower court in the city, allows the liquidators to potentially seek mainland court recognition to enforce the payment. A keepwell deed is an agreement from the parent company of a unit issuing a bond to maintain the issuer’s solvency while stopping short of guaranteeing payment. About 12% of all Chinese offshore bonds outstanding were issued with keepwell structures. 

More broadly, it also supports investors of Chinese bonds who argue keepwell provisions are legally binding obligations that must be enforced to engender confidence in the market. With defaults rising among Chinese corporate borrowers, creditors’ legal battles with Founder Group reveal the length they will go to explore all options to be repaid.    

One of the major defaulters in China, the firm entered into an onshore restructuring in 2020 under the supervision of a Beijing court. The restructuring administrator then rejected creditors’ claims for five offshore bonds that came with keepwell provisions, dealing the first major blow for bondholders to take advantage of the once-popular credit protection mechanism. 

Unpaid holders in the Founder Group case have since then waged their legal battle in Hong Kong courts. They have won court rulings to bring Founder Group’s offshore units into liquidation, and the units’ liquidators sued the parent company to seek payment. 

In a court decision last year, a judge at the High Court of Hong Kong dismissed three of the four lawsuits that alleged Founder Group had breached keepwell deeds. The plaintiffs then appealed the rulings to the appeal court, leading to the Friday ruling. 

In the lone case that wasn’t thrown out, the judge ruled that Founder Group caused 1.15 billion yuan ($159 million) of losses to the plaintiff, a sum well below the $857 million claimed. A Beijing court agreed last month to review whether it would recognize the Hong Kong court decision. 

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