China's New Bankruptcy Law

Wen Liao, attorney at Chicago-based mega-firm Kirkland & Ellis (my old law firm, actually), recently wrote an article for the Wall Street Journal, entitled, Beijing's Bankruptcy Laws, providing an excellent overview of China's newly enacted bankruptcy law.  Ms. Liao gets right to the point in explaining the need for the new bankruptcy law and its importance:

China's economy won't steam ahead forever. And when it begins to slow, Beijing will need to weed out failing businesses, fast.  From next year, China will have the means of doing so -- in the form of the country's first bankruptcy law with teeth.

To understand the importance of the new law, just look at the one it replaced. Enacted during the early stages of China's economic reforms, that 20-year-old law put the government in charge of every stage of the bankruptcy process. Politics was more important than profitability, with fear of unrest from laid-off workers acting as a deterrent to closing loss making state-owned dinosaurs. Employees' interests ranked above those of creditors. Private companies were not even mentioned in the old law, so a hodge-podge of confusing regulations sprung up to cover them.

The article goes on to note that though the new bankruptcy law comes into force on June 1, 2007, it will not apply to state-owned enterprises (SOEs) until 2008.  I would add that many (including me) are skeptical it will apply to SOEs even then. 

The new law creates a formal corporate-bankruptcy procedure with judge appointed administrators and with creditors having payment priority over employees.  "Creditor committees get a strong role in supervising the bankruptcy process, which means that professionals -- perhaps including foreign lawyers and accountants -- will be running the process, rather than Communist Party officials."  It will allow bankrupt companies to continue to run their assets, with a view to reorganizing them into viable businesses instead of going into liquidation (similar to Chapter 11 bankruptcies in the United States).

Ms. Liao notes how China's banks currently recover only about 20% to 30% of the face value of delinquent loans but the new bankruptcy law could push this "recovery rate closer to the global average of 70 cents on the dollar, according to one of its drafters, Professor Li Shuguang of China's Bankruptcy Law and Restructuring Research Center."  She goes on to discuss how the law has the potential to strengthen China's banks and, by extension, its economy.

Many years ago, I represented a creditor with a fairly small claim in one of Russia's first bankruptcies.  I sent a freshly minted law school graduate to the creditors meeting on Sakhalin Island (he was already on Sakhalin for other reasons) to monitor our client's interests.  I envisioned his role would be to babysit our client's claim.  Within days, this new associate was calling our office with all sorts of technical American law bankruptcy questions.  Turns out the Russian lawyers and the judge were essentially relying on our new associate to run the bankruptcy because none of them had any familiarity with bankruptcy law and they were looking to "the American" to explain it to them.  I can see that same sort of thing happening in some of China's courts as well, particularly if the foreign lawyer involved in the bankruptcy speaks Chinese. 

The New York Law Journal also just ran a piece on China's new bankruptcy laws.  This one, entitled, China's New Bankruptcy Law; Doing Business in China, is a fairly technical, fairly in depth, article intended more for lawyers than laymen.  Written by Deryck Palmer and John Rapisardi from bankruptcy law powerhouse Weil Gotshal & Manges, the article describes the New Chinese Bankruptcy Law as follows:

The opening provision of the New Chinese Bankruptcy Law states that it "is formulated in order to standardize the enterprise bankruptcy activities, fairly dispose creditors and debts, protect the rights and lawful interests of creditors and debtors, safeguard the economic order of socialist market economy." The new law gives investors and creditors more certainty and confidence as to their ability to recover on their invested capital and claims in the event of a bankruptcy filing.

However, the passage of the bankruptcy law alone will not neutralize the legitimate concerns of foreign investors and lenders. There remains significant skepticism as to whether the law will be applied fairly and consistently. Moreover, there is some concern whether there are adequately trained judges and professionals in China to implement this complex piece of commercial legislation.

The article notes that the new law allows for both voluntary bankruptcy filings by the debtor and involuntary bankruptcy filings against the debtor by its creditors.  The debtor that voluntarily files may choose reorganization, liquidation or conciliation.  Reorganization restructures the enterprise's debts, liquidation ends the enterprise's operations and sells all assets for the benefit of the creditors, while conciliation "allows for a quick compromise of unsecured claims without protracted bankruptcy proceedings."

We will continue posting on China's bankruptcy laws as things develop.