By Charlie Zhu and Umesh Desai
WUXI, China/HONG KONG, March 21 (Reuters) - The local government in Suntech Power Holdings Co Ltd's home town is seeking to bail out China's biggest solar panel maker to stave off its collapse, a person with knowledge of the matter told Reuters on Thursday.
One proposal under consideration is allowing Wuxi Guolian, the local government's investment arm, to take over Suntech's Wuxi business through a restructuring, and test a bankruptcy law introduced in 2007.
"Production has to continue," said the source in the city of Wuxi, where Suntech's headquarters are located. "The Wuxi government is still seeking to bail out Suntech in one form or another. It has no intention to let it collapse as, if that happens, it would damage its reputation."
With an estimated 10,000 employees in Wuxi, the local government would be keen to keep the company afloat.
Such a move would also test the notion - widespread in Chinese bond markets - that local governments will always bail out important companies without inflicting pain on domestic creditors.
However, what happens to the offshore holders of Suntech's bonds will have wide implications for investors who have flocked to Chinese dollar-denominated debt in search of yield.
A Wuxi government spokesman said he had no information on any plans for a Suntech bailout. But the spokesman added: "If there is any news regarding the restructuring, it will be released through Wuxi Guolian."
The Yangtze Evening News, a local official newspaper, said authorities would try their best "to maintain normal production of the company, social stability, safeguard the security of company assets and protect the interest of creditors."
Suntech defaulted on $541 million of its dollar-denominated bonds due on Friday, triggering cross-defaults on loans from International Finance Corp (IFC) and Chinese lenders.
At the end of March 2012, Suntech had total debt of $2.2 billion - including a $50 million convertible loan from the IFC, the private sector arm of the World Bank.
Domestically, nine banks, including Industrial and Commercial Bank of China , Agricultural Bank of China and Bank of China had outstanding loans of 7.1 billion yuan ($1.1 billion) to Suntech at the end of February, according to state news agency Xinhua.
Eight Chinese banks that have lent money to Suntech want the company's main unit, Wuxi Suntech Power Holdings Co Ltd, declared insolvent.
Suntech said on Thursday that the Wuxi Municipal Intermediate People's Court in Jiangsu Province had formally accepted the petition for the insolvency and restructuring of Wuxi Suntech.
The court appointed a committee consisting of local government representatives and accounting and legal professionals to administer the restructuring.
"The primary goal is to restructure Wuxi Suntech's debt obligations, while continuing production and operations," Suntech said.
Suntech shares, which resumed trading on the New York Stock Exchange after being halted on Wednesday, fell 49 percent to a lifetime low of 30 cents. At that price the company has a market value of $54 million, down from a peak of about $16 billion.
In its heyday, Suntech was a symbol of China's green technology ambitions. China's solar manufacturing industry grew rapidly to become the world's largest in just a few years, but the sector has now been crippled by over-supply.
A bailout of Suntech would mean the industry will remain under pressure.
"We are expecting that the government will step in and provide liquidity to keep the fabs running in order to preserve jobs," said Pavel Molchanov, a U.S.-based analyst at Raymond James. "Without fabs actually getting shut down, bankruptcy does not inherently change the over-capacity picture."
A research report published late last year said that over-capacity in the solar industry is likely result in at least 180 panel makers going bust or being acquired by 2015.
The report by the GTM Research consultancy estimates that solar products supply will exceed demand by 35 gigawatts on average annually over the next three years.
At Suntech's big solar panel factory in Wuxi, 120 km (75 miles) west of Shanghai, employees reported for work as usual on a chilly morning on Thursday.
The company's headquarters office is nearby, with one side of its facade entirely made up of solar panels that supply 85 percent of the energy it uses.
Asked whether he was aware of the news that lenders were pushing for bankruptcy of Wuxi Suntech, one employee taking a smoking break at the factory gate said, "No I don't know. Actually I don't read newspapers."
The man, who declined to give his name, snuffed out his cigarette and headed into the factory.
China has a history of bailing out companies on the brink of failure, and investors had assumed Suntech would be no exception. But the move by domestic creditors on Wednesday has introduced some doubt and there is no guarantee that foreign creditors will be treated on par.
The company's shares are listed on the New York Stock Exchange, but it is registered in the Cayman Islands and its assets are in China.
"The Suntech situation is a good reminder that offshore investors can have difficulties in enforcing their rights," said Paul Boltz, a Hong Kong-based partner with law firm Ropes & Gray.
"The offshore holding companies which are used to list overseas often have fewer assets than the onshore entities. In that case, they face a disadvantage compared with onshore lenders like Chinese banks which can have direct recourse against the assets."
China passed a new bankruptcy law in 2007 that is rarely tested because local officials generally mediate between creditors behind closed doors. Beijing has used the law cautiously, fearing the failure of large companies and widespread layoffs could lead to social unrest.
Suntech employs around 20,000 people worldwide, with about half of that number in Wuxi, Chinese media and the company's web site say.
China's domestic bond market has not been much affected by the news.
"Most investors think it's an offshore bond, so it's not a problem for the onshore market," said Ethan Mou, China credit strategist at Bank of America-Merrill Lynch in Hong Kong.
"But going forward, (onshore) investors will take note of the government's stance towards this default. It takes time, but I think the market will digest the significance behind this default and realize that the implicit backstop of local governments may not appear every time."
Foreign debt holders are however in a more difficult situation.
"Offshore debt holders are on shaky legal ground (their claims are to a piece of paper in the Caymans, whereas STP's operating assets are effectively all in China)," said Charles Yonts at CLSA in Hong Kong.
"And even if not, they would have the rather daunting task of fighting to the front of the queue of Chinese creditors in China. Good luck with that."
New York law firm WilmerHale, representing about 1 percent of Suntech's bondholders, questioned whether there would be a fair process to determine the rights of foreign bondholders.
"If the bondholders are left out entirely, it will have an impact on how people think about investing in Chinese companies in the future," said James Millar, a partner at WilmerHale.
Suntech bondholder Trondheim Capital Partners LP previously told Reuters it would sue the company for the bond default.
If Wuxi bails out the company, "Wuxi benefits, the state lenders benefit, Suntech benefits," said Shyam Mehta, an analyst at renewable energy consultancy GTM Research in New York.
"But Western bondholders and shareholders, having poured hundreds of millions of dollars of debt and equity into the company, are left with nothing."