A Canadian court has granted Sino-Forest Corp protection from its creditors and has approved an agreement with some of its noteholders to start the process of selling the embattled Chinese forestry company.

The agreement would allow for the Toronto-listed company's sale to a third party, or if no buyer emerges, a restructuring that would let noteholders buy nearly all of its assets.

Sino-Forest, whose stock tanked last year after a short-seller accused it of exaggerating its assets, made the request on Friday to the Ontario Superior Court of Justice under the Companies' Creditors Arrangement Act, the equivalent of U.S. Chapter 11 filing. It said the sale process was the best way to secure its future and normalize operations.

We believe the full value of our assets will only be achieved if we are able to continue operating the business, Judson Martin, chief executive of Sino-Forest, said in a statement.

Sino-Forest also said it was taking legal action against the short-seller, Carson Block, his firm Muddy Waters and other unnamed parties. It is seeking more than $4 billion in damages.

Last June, Muddy Waters accused Sino-Forest of exaggerating its assets and Sino-Forest's stock subsequently dropped 70 percent until regulators eventually stopped trading in the stock in August.

The Sino-Forest case is the most prominent of a series of recent accounting scandals that have tainted the image of Chinese companies listed in North America. The scandals have prompted trading halts, delistings, lawsuits and regulatory probes both in Canada and the United States.

When the Ontario Securities Commission issued a cease-trade order on the stock in August, it accused then-Chief Executive Allen Chan and other officers of misrepresenting revenue in public filings and keeping bogus accounts.

The OSC - Canada's most powerful securities regulator - also said Chan and others appeared to be engaging in acts that they should have known essentially amounted to fraud. Shortly afterwards, Chan resigned.

Sino-Forest confirmed last fall that Canada's national police force, the Royal Canadian Mounted Police, was investigating the allegations. The RCMP has not announced its findings yet.

The scandal triggered a broader OSC probe of stock listings by companies with most of their operations in China and other emerging markets.

In a report of the findings earlier this month, the agency revealed weak links at every stage of the listings process, including issuers themselves, auditors, underwriters and exchanges.

Separately, a January 31 report into the fraud allegations by what Sino said was an independent panel left many questions unanswered, most importantly around the value of the company's timber holdings and its opaque ties with suppliers.

The internal committee's report was not able to assess whether Sino had a proper arm's length relationship with the owners of land on which it had contractual rights over the timber and businesses to whom it sold its wood.

NO COMMENT FROM MUDDY WATERS

Muddy Waters said on Friday it would not comment on the lawsuit because it had not yet seen it. The firm did release a statement on the CCAA process, however.

This is yet another indication of what we have said all along, that Sino-Forest's management has committed a massive fraud and has deceived its shareholders and creditors, Muddy Waters said in an email statement.

If the company were really generating close to $2 billion in operating cash flow, it would not have had to file for a court-supervised restructuring with its creditors.

Sino-Forest said holders of about 40 percent of the aggregate principal amount of its notes have agreed to support its plan to sell or restructure.

(Editing by Frank McGurty)

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