The new Chinese bankruptcy law went into effect June 1, 2007. It is China’s first bankruptcy law since 1986, which law applied only to state-owned enterprises (SOEs). Since that law was enacted before China’s 1993 economic reforms, many of its provisions were inadequate for or in conflict with China’s new more market-centered economy.
China’s new bankruptcy law mirrors the modern bankruptcy laws of other countries, particularly the United States. The new law applies to all legal entities, including foreign invested enterprises (FIEs), such as WFOEs and Joint Ventures, though it does not apply to individuals.
The law utilizes an administrator who will act much like bankruptcy trustees do in U.S. bankruptcy proceedings. The administrator’s role is to help the creditors and to assist in assuring the bankruptcy runs smoothly. The law provides who may serve as an administrator and it is expected most administrators will come from the ranks of China lawyers and China accountants.
The new bankruptcy law not only bolsters and clarifies the liquidation provisions of the 1986 law, it also adds reorganization as a legal alternative. Under a reorganization, a company is given protection from creditors while still being able to continue operating. Part of the reorganization section (Article 87) introduces a “cram down” procedure similar to that of the U.S. system. This means that a bankruptcy debtor may be able to force confirmation of its plan over the objections of dissenting classes if it can meet certain tests.
The most important difference between China’s new and old bankruptcy laws is that the new law gives secured claims priority over employee, tax, and general claims, unlike the old law which gave workers (it was communism, remember) first claim to the debtor’s assets. The new law is more in line with most developed commercial countries in that employee claims now take precedence only over unsecured creditors. We note though that many of the China attorneys with whom we have spoken are dubious about the courts actually giving priority to anyone over employees.
The new law applies to Chinese companies operating overseas and it applies to foreign companies operating in China. It also accounts for the extraterritorial effect of Chinese bankruptcy judgments and it permits enforcement of foreign judgments from countries that act reciprocally towards Chinese judgments. In other words, debtors with foreign judgments against a bankrupt Chinese company may be able to collect on that judgment in the Chinese bankruptcy.
The new Chinese law permits a single creditor to initiate an involuntary bankruptcy proceeding. The Chinese law specifically says that any creditor can initiate the proceeding, and such proceedings can be initiated against any legal entity, including against WFOEs and JVs. This provision could give creditors huge leverage. When Russia enacted its new bankruptcy law in 1998, it had a similar provision and just the threat to a creditor that we would be throwing their company into bankruptcy usually elicited huge fear and a relatively quick payment. Russian creditors feared their company being exposed to scrutiny more than just about anything else and I suspect Chinese companies might feel likewise. My firm’s China attorneys will this week be testing out this proposition on a couple of Chinese debtors and I will report back on the results.
To our knowledge no bankruptcy case has yet been filed in China. Our sources in the Chinese legal community tell us China’s courts are not prepared to hear such cases, and they do not know when the Courts will be ready to do so. The courts currently lack the necessary staff and the proper training, and the government has yet to issue any supplemental regulations. When these matters will be resolved and when the courts will be prepared is unclear. Some Chinese lawyers have told us they think it will take as long as one year.
This too reminds me of Russia as I was involved in one of the first bankruptcies under its new, more sophisticated bankruptcy law. The case involved a Sakhalin Island kolkhoz and a lawyer from an international lawyer from our office who had just graduated law school was in charge of monitoring the case on Sakhalin for our creditor client. Though this lawyer had taken only one bankruptcy course in law school, he ended up being the lawyer the Russian lawyers and even the court would turn to for explanations of how the bankruptcy should be handled. He would read US bankruptcy treatises and cases for guidance.
I predict China’s courts will also be looking to foreign lawyers, treatises, and cases for assistance on handling its bankruptcy cases, at least initially. Because so much of the new law is modeled on U.S. law, the Chinese lawyers with whom we work in China are telling us they expect U.S. law to play the leading role in the interpretation of the new bankruptcy law.
Note: Much of this post and the information for it was written by Travis Hodgkins, one of our summer associates currently resident in Qingdao.