'This is an important test case,' said a financial lawyer. 'China should have moved to a stage where it does not expropriate value from offshore creditors for political reasons. The government ought to be neutral and receptive to any deal or solution that can improve the returns of foreign creditors and employees alike.'

In a letter to creditors, the local government implied that if western lenders did not, by June 30, accept the restructuring plan, they could lose everything.

Legal experts said the government might freeze Asia Aluminum's assets, locking the bondholders and hedge funds out of the possibility of recovering any cash. They speculated it could also use its powers to push the firm into bankruptcy.

Courts on the mainland, unlike those in Hong Kong, are directly controlled by local governments.

An English translation of the letter from the Zhaoqing foreign economy and trade committee states: 'You must finalise this transaction by the end of June ... Failing which, we shall proceed with legal action to protect the [mainland] creditors' interests.'

An expert with knowledge of the case said the local authority was concerned with social stability, not foreign investors' rights.

Asia Aluminum employs 10,000 workers in Zhaoqing. Since early March, the staff have protested periodically over the potential loss of their 'iron rice bowl', or jobs for life.

'The government is likely to freeze the company's assets, pay wages to employees and suppliers' bills, then start selling factories to repay this expenditure,' the expert said. The company also owes HK$2.6 billion to mainland banks. 'They (the government) would make sure mainland banks are repaid. They are unlikely to worry about foreign lenders.'

A source close to Asia Aluminum's international creditors said a mainland bankruptcy or asset freezing would realise their worst fears.

'It would be a very unhealthy state of affairs,' he said. 'Our recoveries would be highly uncertain.'

In 1998, Guangdong International Trust & Investment Corp went bankrupt. Foreign banks that lent money to Gitic lost virtually everything.

Tang Haizhou, the director-general of the Zhaoqing foreign economy and trade committee, said the committee had not decided what legal action it might take.

'If the restructuring process is prolonged, other problems may arise,' Mr Tang said, referring to the concerns of Asia Aluminum staff.

Asia Aluminum entered provisional liquidation in Hong Kong in March. In February, chairman Kwong Wai-chun proposed to buy back its debt from foreign creditors at a discount. The international lenders rejected his offer.

This or nothing

Foreign creditors have been offered 1 cent to 20 cents on the dollar

The amount lent by international investors to the company, in US$:$985m

Heavy metal

If foreign lenders continue fighting for debts owed by Asia Aluminum Holdings, they risk losing everything in the mainland unpredictable bankruptcy courts

Twists and turns in the Asia Aluminum saga

June 12 Zhaoqing government threatens legal action if bondholders and hedge funds do not accept management buyout

June 4 Hedge funds launch legal action to remove Asia Aluminum from liquidation and find alternative buyers for business

April 30 Asia Aluminum executives offer US$475 million for company. Bondholders and hedge funds offered 20 cents on the dollar and 1 cent respectively for their loans

March 16 Asia Aluminum enters provisional liquidation, owing Chinese banks HK$2.7 billion, foreign hedge funds US$535 million and international bondholders US$450 million

February 13 Offers to buy bondholders out at 27.5 cents in the dollar. Payment- in-kind note holders offered 13.5 cents. Both sets of investors reject offer

Source: Bloomberg