Major Changes to Bankruptcy Regime in China

                                                                  Susan Sun

The new Enterprise Bankruptcy Law of PRC was adopted on August 27,2006 and will take effect on June 1,2007, superseding the 1986-enacted Enterprise Bankruptcy Law(Trial) (the “1986 Law”). The new Bankruptcy Law offers for the first time a unified regime applicable to all types of enterprises in China and also provides much clearer procedures for insolvent enterprises to restructure or exit the market. The important amendments contains within the revised versions are as below:

Scope of Regulation

The 1986 Law only applies to the bankruptcy of State-owned Enterprises (“SOEs”), while the new Bankruptcy Law governs all enterprises with legal person status, covering both SOEs and privately-owned companies, foreign investment enterprises and domestic companies, listed companies and non-listed companies, limited liability companies and companies limited by shares. Thus the new Bankruptcy Law provides a unified legal regime to all kinds of market player. Even the bankruptcy of partnership enterprises may refer to the revised versions. Meanwhile, individual is not covered.

Ground for Bankruptcy Petitions

The 1986 Law allows a creditor to file a bankruptcy petition only when the debtor is unable generally to pay its debts as they fall due. Under the new Law, both the debtor and its creditors are allowed to file reorganization or bankruptcy petitions to the People’s Court if the debtor is unable to pay its debts as they fall due and has insufficient assets to pay off all debts or obviously lacks the ability to do so.

Administrator

The 1986 Law authorizes a “liquidating committee” to take control of the assets of the debtor which consisting of government officials and related parties. To address creditors’ concerns about transparency, the new Law has introduced the concept of an independent administrator who is appointed by the People’s Court. Law firms, accounting firms and bankruptcy liquidation firms or professionals from such firms are among those eligible to serve. The duties of the administrator includes taking over, managing and disposing of the assets of the subject insolvent enterprise, managing its daily affairs, reviewing and adjudicating claims, investigating affairs of the enterprise and making distributions.  Having a professional, independent organization such as a law firm as an administrator in bankruptcy proceedings is very important to protect the rights of the creditors.

Prevention of “Deceptive Bankruptcy”

To overcome many cases of deceptive bankruptcy, the new Law imposes stringent duties on the debtor such as: take proper control and management of its assets; answer truly all questions posed by the People’s Court and the administrator; attend and answer truly all questions at creditors’ meetings. In addition, Article 31 of the new Law provides that, the administrator has the right to apply the People Court to cancel the following actions occurred within one year of the application for bankruptcy: gifts, transfer at an undervalue, guarantee given for unsecured debts, repayment of debts prior to their due dates, abandonment of rights to repayment.

Reorganization

Another key provision in the new law introduces a mechanism for corporate reorganizations that could allow some troubled companies to avoid bankruptcy. This will help to avoid social ramifications as a result of liquidation such as unemployment and loss of social wealth. Under the new Law, either the debtor or the creditor has the right to apply to the People’s Court for reorganization of the debtor. When a creditor petitions to bankrupt a debtor, the debtor, or its investors holding more than one- tenth of the debtor’s registered capital, may apply to the court for reorganization after the court has accepted the bankruptcy petition, but before the debtor is declared bankruptcy. The debtor or administrator must submit a draft reorganization plan to the court within six months of the court’s ruling for reorganization. The draft reorganization plan must be approved by a majority of the number of creditors , representing at least two-thirds of the total amount of confirmed claims. All creditors who have declared a claim are allowed to note on a draft plan, but the secured creditors may not vote on plan to sell the business or distribute assets.

Priority of Payments

The 1986 Law gives higher priority to unpaid employer wages and social insurance premiums. The new Law stipulates that form June 1, 2007, all insolvent enterprises will pay credit guarantees to creditors first, and use other assets to pay laid off workers. The provision is a compromise that aims to protect both creditors and workers of insolvent corporations. Under Article 109, secured creditors have payment priority to the extent of the value of the secured properties. Payment of claims in a liquidation must be made pursuant to the following order:

(ⅰ)Bankruptcy expenses and joint interest debts;

(ⅱ)Unpaid employees’ salaries and basic social insurance premiums;

(ⅲ)Outstanding tax; and

(ⅳ)Ordinary unsecured credits.

Cross-border Insolvency

The new Law for the first time stipulates specific provisions governing cross-border bankruptcy. In relation to “outbound” insolvency cases involving the overseas assets of a China debtor, the new Law provides that the validity of any bankruptcy proceedings commenced in accordance with this Law shall extend to the properties of the debtor outside of China. In relation to “inbound” cases, a foreign representative form another country may seek recognition of a foreign court ruling in China, the China court may decides whether to permit the recognition of a foreign court bankruptcy ruling depending on conditions provided by the new Law.

Conclusion

The new Bankruptcy Law is the most important law for the market economy. China will have a unified legal framework for bankruptcy of all kinds of enterprises. It will bring sweeping changes to the administration of creditors’ claims. More streamlined procedures will help enhance the transparency of bankruptcy proceedings. New rules will bring China’s enterprise bankruptcy closer to international standards.