Sino-Forest bondholders may face 100% write-down

That followed the company's decision not to make a $10 million interest rate payment on one of its bonds, Reuters reported.

Sino-Forest has been under pressure since June when short-seller research firm Muddy Waters claimed that Toronto-listed Sino-Forest overstated its revenues and assets by routing funds off its books to intermediaries in order to fabricate sales transactions. It called Sino-Forest the "granddaddy of China RTO frauds," and the news prompted shares in the company to drop approximately 80%.

The report came as a host of Chinese firms listed in North America were exposed as having falsified earnings statements. These companies went public through reverse mergers, which are cheaper, quicker and easier than an IPO - because they are not capital-raising events - but also involve less regulatory disclosure. The scandals hit stocks across the board, whether or not impropriety had been proven.

Towards the end of August, Sino-Forest's chairman and CEO resigned and three employees were suspended after the Ontario Securities Commission said the company may have misrepresented its revenue statements and exaggerated its timber holdings. However, the company announced in November that, following an independent investigation, it stood by its initial denial of Muddy Waters' accusations.

Nevertheless, its bonds carried on trading at prices that implied an extremely high risk of default. The negative sentiment wasn't so much a reflection of the fraud concerns as of Sino-Forest's dwindling cash balance, which stood at $206 million in November compared to over $600 million at the start of the year.

Paulson & Co. exited its holding in the company in June, supposedly incurring a loss of more than $500 million. Meanwhile, Mandolin Fund, which is controlled by New Zealand-born billionaire Richard Chandler, has sought to capitalize on the low share price, building up an 18% stake in July and August.

The Richard Chandler Corporation said earlier this month that it continues to have confidence in the underlying business of Sino-Forest. However, it expressed disappointment at Sino-Forest's decision not to make the interest payment on its bonds, given the company "clearly has the financial strength and liquidity to meet its bond commitments."

Chinese forestry assets have been popular with private equity investors in recent years, but opaque regulation and uncertainty about ownership represent a strong challenge to investor oversight. China Forestry, a portfolio company of Carlyle Asia Growth Partners III, has fielded fraud accusations similar to those leveled at Sino-Forest.

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