The New Corporate Bankruptcy Law: It is only the Beginning

August 28, 2006 After about 12 years of deliberations and drafting and amendments by the relevant authorities, China’s top legislature, the Standing Committee of the NPC had finally adopted a Corporate Bankruptcy Law on August 27, 2006. This was indeed, a symbolic moment for China towards a market economy. However, due to the strategic nature of PRC law along with the maxim “general is more preferred that great detail” style of drafting, the new Corporate Bankruptcy Law is merely a framework and guide, and there are still areas of uncertainties pertaining to its implementation rules and procedures. The primary aim of this law seek to protect both creditors and employees of bankrupt enterprises. It will come into effect on June 1, 2007. The current enterprise bankruptcy law will be abolished at the same time.

 (Source: The Beijing News)

Wal-Mart Establishes its 1st Trade Union in China

July 29, 2006 After years of reluctance in line with the world’s leading retailer - Wal-Mart’s global policy of non-encouragement in the setting of trade unions, we had finally

witnessed the birth of its first trade union in China established on Saturday morning in Quanzhou, South-Eastern of Fujian Province. The move came after more than two years' efforts by the All-China Federation of Trade Unions (ACFTU) to push the giant retailer to set up labor unions in its 59 outlets around the country. According to China's Trade Union Law, enterprises or institutions with 25 employees and above should establish trade unions. The primary purpose is to safeguard the economic, political and cultural rights of workers.

(Source: Xinhua)

FEATURE TOPIC
Policy-Oriented vs. Market-Oriented Bankruptcy: 
A Tour on the PRC New Enterprise Bankruptcy Law

by Will Fung
Lehman, Lee & Xu - Beijing

Historically, the Chinese legal system has never formally recognized the concept of bankruptcy, ‘debts incurred by the father shall be assumed by the son’, has been a cultural tradition passed down from generation to generation. The first attempt to create bankruptcy laws took place in 1906 during the late Qing Dynasty, however, had proven too difficult to implement and from that unimpressive beginning, bankruptcy law had never really taken off in China. 

For another approximately 30 years thereafter, the Chinese government did not have any concrete insolvency laws in place, particularly after establishment of the People’s Republic of China in 1949. The Chinese Government had always worked on a system whereby State-owned enterprises would have any losses offset by subsidization by the State. This meant that bankruptcy was never an issue. If, however, the State-owned enterprises were in serious financial difficulties, they would either be closed, suspended, consolidated or business model would be changed. Bankruptcy, it seemed, would occur without any legal recourse and nothing would be due or owing to the creditors.

Problems faced by the “Old” Enterprise Bankruptcy Law (Trial Implementation)

The problem faced by the “Old” Bankruptcy Law (Trial Implementation) was that the legislation allowed significant discretion by the administrative authorities in view of the fact the it was stipulated, inter alia, State-owned enterprises required government approval before bankruptcy could occur. This was because employees and existing assets needed to be resettled before bankruptcy could even be considered. As a result, only ‘leftovers’ were paid to creditors, which meant creditors had very little rights and remedies in the participation of bankruptcy procedures. The issue was further plagued by the long tradition of ‘identity’ and ‘instability’, as State employees or the so-called government servants (to the outside world) were to be a guaranteed an “Iron Rice Bowl” or life-time employment. 

The 1986 Enterprise Bankruptcy Law of the People’s Republic of China, promulgated on December 2, 1986 which took effect on October 1, 1988, had clearly been the first reserved attempt at bankruptcy law in China since the Qing dynasty. However, this was not seen to be adequate enough in regulating bankruptcy issues and was, to a general extent, applicable only to State-owned enterprises. As a result, a large number of State-owned enterprises incurred significant losses, but had their debts and loans written off by State-controlled banks.

Statistics 

From 1989 until 1994 only a few courts saw bankruptcy cases. In 1989 the courts accepted 98 cases; in 1990, 32 cases; in 1991, 117 cases; and in 1992, 428 cases.

By 1994 the government decided to attempt to draft a new national bankruptcy law, even though there was a high level of concern on issues pertaining to unemployment. The first draft was completed in 1995. This was then redrafted in 1998 and many other laws were drafted for comments, resulting in the newer draft of 2004, which incorporates most of the 2002 draft.

Between 1994-2004, 3,484 state companies went bankrupt, with US$28.5 billion in repayment debts, written-off by State-controlled banks, and about 1,828 State-owned enterprises still awaiting approval for declaration of insolvency, amounting to US$14.7 billion.

In reality, it seemed that from a slow start in 1988, the number of bankruptcy cases steadily increased. More than 16,000 enterprises declared bankruptcy. In 1994 only 395 of the total 1,624 bankrupt enterprises were State-owned, but in 1997, around 3,060 were State-owned, while the remainder out of the 5,396 were private and Sino-foreign joint enterprises, which indicated that there was a mix of enterprises filing for bankruptcy. 

Be that as it may, this is not the only bankruptcy law pertaining to insolvency in China. In April 1991 (at the fourth Session of the Seventh National People’s Congress (“NPC”), the NPC issued the amended 19th Chapter of the Code of Civil Procedure, for e.g., in Chapter XIX, procedure for bankruptcy repayment of enterprises as legal persons; Articles 199-206 discuss bankruptcy for non-state-owned enterprises, the Articles specify repayment procedures (Art. 199) and clearly give some rights to the creditors to file for claims to the People’s Courts, giving a 3-month time period for notifying the courts of a claim (Art. 200). In Art.204 the order of repayments are laid out in the following order (1) wages of employees and labour insurances (2) taxes that are owed (3) and finally the bankruptcy claims.

Even though these rights seemed to exist for the creditors, it was clear that the 1986 Enterprise Bankruptcy Laws of the People’s Republic of China had problems. The issue of heavy intervention from government departments meant the roles of the courts were not effective and creditors rights were not upheld in equity. It seemed that even though there was a 3-month time period for claims, such claim would be seen as abandoned if the creditor was unable to notify the courts in time.

Another issue faced by the courts pertains to issue of interpretation, for example in the Civil Procedure Law the instrument used to identify rights between parties is the use of Judgment or (‘Panjue’) and Ruling or (‘Caiding’). These methods are often confused with bankruptcy law and deprives parties the right to challenge evidence and appeal, in some cases assets were distributed to local creditors but not creditors from other jurisdictions , in other instances major creditors such as commercial banks had a very big influence in court proceedings and smaller trade creditors were ignored or even not even notified at all. The miscarriage of justice from even one incorrect judgement clearly damages the rule of law. However the problem cannot be solely based on incorrect judgements from the courts (though some judges lacked capacity and experience, especially in smaller, undeveloped cities in comparison to bigger and more advanced cities, where judges in these regions have more experience in handling bankruptcy proceedings) but, again, implementation of the poorly drafted bankruptcy legislation (old) being the major contributory factor for its failure. 

If we look at certain cases such as Liquidation Group of Wenzhou Trust Company v. Xinfu Industrial Co. Ltd 03-21-2000 the Higher People’s Court of Hubei Province, The Supreme People’s Court 07-18-2002, the authority eventually realised that there was a need to protect creditors’ rights; however, a year later, in 2003, the Higher People’s Court of Guangdong province, was still abiding by the legislation and putting creditors’ rights being the least prioritized group where only leftovers were allotted to them. This inconsistent approach adopted by the Courts at different levels is indeed, mind-boggling to some quarters to a great extent.

The New Law

On August 27, 2006, with the adoption of the new Enterprise Bankruptcy Law in China, the attempt by the government to carefully shift bankruptcy via a more market-oriented policy seems promising. The new law, which will come into effect on June 1, 2007, has an expanded scope and includes legal corporate persons, encompassing not only State-owned enterprises, but also private and public companies, be it foreign or Chinese, and to a certain extent, is applicable to financial institutions as well. This will certainly boost investor confidence, particularly for foreign investors, for the law now allows creditors to commence bankruptcy proceedings against companies whose management are not willing to honour their financial commitments. 

The new law also seeks to protect creditors’ rights as well as workers’ rights. The legislation will not only allow creditors’ to take actions against debtors / companies which are unwilling to file for bankruptcy, it will also apply to State-owned companies with limited intervention by the State. Another upside to the new legislation is that companies or enterprise in financial difficulty may have a chance to reorganise, restructure and/or rectify their financial problems prior to filing for bankruptcy (Art. 73).

Previously, bankruptcy administrators were comprised of State-appointed personnel thus the impression of affairs pertaining to the liquidation process would be greatly interfered by the same is not unfounded. The new law gives wide flexibility to creditors, for instance the role of bankruptcy administrator may be assumed by a liquidation group comprised of the relevant departments and organs or by some intermediary agencies and may nominate a law firm, accounting firm, managers and receivers which have been established in accordance to law (Art. 24).

Conclusion

The abovementioned are just some of the examples of good and constructive insertion to the new law. The general perception of the 136 Articles in total in the new law should suffice for the time being, and of course, judging from experience that happened in the past few years, the relevant authority would be more than willing and open to feedback to further enhance and improve on the Enterprise Bankruptcy Law. Any reservation, if at all, is to adopt an open mind and awaiting a series of implementation guidelines and bylaws to make the new law NOT a “toothless-tiger”.The new law is still in its infant stages, to effectively execute and implement the new law would still need the cooperation of many parties. Experts and experienced professionals in handling liquidation processes must be engaged; the fee arrangement by creditors to appoint any bankruptcy administrator / private managers and receivers should not be interfered by the Courts save only for the qualification of such appointment; in the event of non-compliance by the debtors to cooperate with the instructions of bankruptcy administrator, any effective recourse in an expedited manner should be put in place; and lastly, in fact, most important of all, to perhaps consider an immediate practical as well as feasible first move, would be in my humblest proposal of the creation of a specialized court, or division within the People’s Courts, to deal specifically with Enterprise Bankruptcy cases.

-End-

LAW UPDATES

Law of the People’s Republic of China on Enterprise Bankruptcy 

- State Council -

Order of the President of the People’s Republic of China (No. 54)

The Law of the People’s Republic of China on Enterprise Bankruptcy, adopted at the 23rd meeting of the Standing Committee of the 10th National People’s Congress of the People’s Republic of China on August 27, 2006, is hereby promulgated and shall take effect on June 1, 2007. 

Hu Jingtao

President of the People’s Republic of China

August 27, 2006

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