China's New Bankruptcy Laws: Good For Business

Today's Wall Street Journal has the best article on China's just enacted new bankruptcy laws.  Entitled, "China Puts Creditors First With New Bankruptcy Law," [subscription may be required], the article assesses the new laws, set to take effect on June 1, 2007, as "enhancing the market-oriented rules governing the world's fourth-largest economy." China's old bankruptcy laws technically applied only to state-owned enterprises (SOEs). 

Under China's current bankruptcy rules, insolvent companies are required to pay their employees before they pay their creditors.  The new law requires companies "that go bankrupt to pay guarantees to creditors first, with employee salaries and other obligations paid out of what remains." This is obviously more creditor friendly and "backers of the measure described it as a milestone for Chinese economic overhauls that will strengthen the rights of creditors and bring China closer to international legal standards:" 

"This is the most important law for the market economy," said Li Shuguang, director of the Bankruptcy Law and Restructuring Research Center at the China University of Political Science and Law in Beijing. Mr. Li, who has helped draft the legislation, said "it's a very important step for further market economic reforms" and one that will "give foreign investors a more stable legal environment."

The "creditors-first requirement applies only to bankruptcies that are initiated after the new law takes effect."  The new laws had been slowed down, in part, out of a fear that it would lead to a rash of state sector bankruptcies:

Efforts to draft a new bankruptcy law began in 1994, but opponents had blocked it for years, in part because they worried it would lead to a rash of new bankruptcies at troubled state-sector companies. But government-administered bankruptcies of such firms have taken place even without the law -- 3,658 of them between 1994 and 2005, according to the State-owned Assets Supervision and Administration Commission.

Xinhua said an additional 2,000-odd government companies are planning bankruptcy. It said the central government this year has set aside 33.8 billion yuan ($4.2 billion) to help those companies settle with their laid-off workers.

The China Economic Review mentions that the new law "makes an exception for around 2,000 ailing state-owned enterprises which can be closed down with the aid of government bailouts and can pay laid-off workers first if they announce bankruptcy before June 2007."

The new bankruptcy law also appears to allow for companies to reorganize themselves -- perhaps similar to U.S. style Chapter 11:

Another key provision in the new law introduces a mechanism for corporate reorganizations that could allow some troubled companies to avoid bankruptcy, said An Jian, vice chairman of the standing committee's legislative-affairs committee. "This will help to avoid social ramifications as a result of liquidation such as unemployment and loss of social wealth," Mr. An said at a news conference yesterday.

We will write more on these new laws as their enactment comes closer.