I INSOLVENCY LAW, POLICY AND PROCEDURE
i Statutory framework and substantive law
The most important legislation in the bankruptcy system in mainland China is the Enterprise Bankruptcy Law of the People's Republic of China promulgated on 27 August 2006 (the 2006 Law), which entered into effect on 1 June 2007, replacing its predecessor, the Enterprise Bankruptcy Law of the People's Republic of China (Trial) passed in 1986 (the 1986 Law). The 2006 Law applies only to corporate entities. Organisations other than corporates may be liquidated by reference to the application of the 2006 Law, provided that other laws have provisions for their liquidation, and that the liquidation is bankruptcy liquidation. Individuals are still unable to seek relief in mainland China.
Compared with the 1986 Law, new provisions with the 2006 Law include, but are by no means limited to:
- enabling organisations other than corporate entities to be liquidated;
- setting up three distinct bankruptcy procedures – liquidation, reorganisation and conciliation – indicating that the 2006 Law also has the function of the rescue of distressed enterprises when necessary;
- establishing the central position of the bankruptcy administrator in bankruptcy proceedings;
- clarifying the functions of the creditors' meeting and the creditors' committee; and
- giving bankruptcy administrators the right to revoke any biased behaviour, such as repayments to individual creditors.
The judicial interpretation by the Supreme People's Court also has significant influence in practice. The power of judicial interpretation by the Supreme People's Court comes from two sources. The first is the Organisation Law of the People's Court of the People's Republic of China. It states that 'judicial interpretation' is the interpretation of the principal application of law in judicial work by the Supreme People's Court.2 The second is the Resolution of the Standing Committee of the National People's Congress on Strengthening Legal Interpretation. It states that the issues concerning the specific application of laws and decrees in court trials are explained by the Supreme People's Court.3 At present, the Supreme People's Court has formulated a number of judicial interpretations for current insolvency law, covering topics such as designation of administrator, remuneration of administrator, issues relating to case acceptance, debtors' property, and the rights that creditors can exercise. Such judicial interpretations are legally binding and can be directly cited in the judgment. In addition, the trial work meetings held by the Supreme People's Court and the minutes of those meetings, including the Summary of Minutes of the Symposium on the Trial of Cases concerning Bankruptcy Reorganization of Listed Companies; the Minutes of Bankruptcy Trial Proceedings of National Courts; the Minutes of the National Courts' Civil and Commercial Trial Work Conference; the Guiding Opinions (Part II) of the Supreme People's Court on Several Issues of Properly Hearing Civil Cases concerning the COVID-19 Pandemic, etc., have similar power to judicial interpretation, which explains the bankruptcy jurisprudence and can be cited as legal reasoning in court judgments. These Minutes of Meeting also have important reference significance for bankruptcy trials and practice.
There have been some developments worthy of mention, including:
- a revision of the 2006 Law has been launched in accordance with the Legislative Planning of the Standing Committee of the Thirteenth National People's Congress (announced in 2018);
- the pre-package system has developed significantly;
- there has been a strong call for legislation on individuals' insolvency law, and the Supreme People's Court and relevant government departments have expressed support for this. In practice, on 2 June 2020, the Standing Committee of the People's Congress of Shenzhen City published Regulation of the Shenzhen Special Economic Zone on Individuals' Insolvency, which represents the legalisation on individuals' insolvency law in China has taken a substantial step forward;.
- several bankruptcy courts were set up throughout 2019 under the official reply of the Supreme People's Court, such as Beijing Bankruptcy Court, Shanghai Bankruptcy Court, Hangzhou Bankruptcy Court, etc., which creates good conditions for enhancing a court's ability to hear bankruptcy cases, and also provides a solid foundation for the implementation of bankruptcy law; and
- the relevant authorities have been discussing the establishment of a separate financial institution insolvency law, and the relevant officials are open to this.
In general, society's attitude towards the debt crisis experienced by enterprises has gradually become more rational. The public are open to distressed enterprises being regenerated through insolvency proceedings that can maximise the overall interests of a debtor and its creditors.
All aspects of insolvency law are developing rapidly, and the number of bankruptcy cases has been rising fast. For instance, in Zhejiang Province, in the southeast of China, the number of insolvency cases accepted by the courts has exceeded 1,000 for two consecutive years. At the same time, the number of bankruptcy administrators, bankruptcy practitioners and scholars engaged in bankruptcy law practice and research has increased significantly. The administrative departments associated with insolvency proceedings have become increasingly concerned about the bankruptcy field, such as the necessary cooperation with bankruptcy judicial activities.
The understanding of insolvency law has also changed, from a unilateral recognition of bankruptcy liquidation under the 1986 Law to its necessary function as a means of rescuing distressed enterprises, which is reflected in the order of Chapters in the 2006 Law – Reorganisation (Chapter VIII) and Conciliation (Chapter IX) are placed before Liquidation (Chapter X). The Supreme People's Court and local courts have repeatedly stressed that the court shall be construed as a 'hospital' for distressed enterprises, and that reorganisation is preferable to liquidation. For example, Article 14 of the Minutes of the National Courts of Bankruptcy Trial Work Conference in 2018 emphasises that the People's Court should review whether or not a debtor has a reorganisation value and consider the possibility of reorganisation based on a debtor's assets, technical processes, production and sales, industry prospects and so on.
From the perspective of the debtor and local government, reorganisation proceedings are favoured by all parties above liquidation proceedings, because the operational value of the enterprise and the value of the intangible assets can be maintained. Up to now, all the bankruptcy cases of listed companies have preferred reorganisation without exception. Large non-listed companies often also choose reorganisation, such as Bohai Iron and Steel Group (a debt scale of nearly 200 billion yuan) and Liaoning Huishan Dairy Group (Shenyang) Co Ltd (a debt scale of nearly 50 billion yuan).
iii Insolvency procedures
Insolvency can be resolved by one of three procedures – liquidation, reorganisation or conciliation. The characteristics of each of these procedures can be summarised as follows.
This is a straightforward process in which the value of the debtor's property is realised in a relatively short space of time and distributed in accordance with the order stipulated in the 2006 Law. The registration of the debtor shall be cancelled once the procedure has been concluded.
This is a more complicated and complete regeneration procedure, with an emphasis on maintaining the debtor's operating value. A variety of measures can be adopted, including but not limited to automatic freezing (especially the freezing of security interests), reorganisation financing, realising necessary assets, sustaining the debtor's business operations, introducing investors, and even compulsory approval of the reorganisation plan.
A simpler and faster regeneration procedure, emphasising the negotiation between the unsecured creditors and the debtor. The measures that can be adopted are mainly the freezing of unsecured claims, while the security interest is not restricted by the procedure. Mandatory approval can not be applied.
To a certain extent, it is possible to convert from one procedure to another. If there is no reasonable probability of success in a reorganisation or conciliation procedure, it could be converted to liquidation. Equally, liquidation can be converted to reorganisation. Although there is no explicit provision in the legislation for conversion between conciliation and reorganisation procedures, or of a liquidation procedure to a conciliation procedure, in practice these measures are applied in many cases, subject to the approval of the creditors' meeting and the recognition of the court.
It is not practical to start an auxiliary (non-main) bankruptcy procedure in mainland China under the 2006 Law, because a bankruptcy case shall be under the jurisdiction of the people's court of the debtor's domicile,4 that is to say the location of the principal office of the debtor.5 If the debtor has no office, the domicile will be taken to mean the place of registration.6 In other words, a debtor who has to file for bankruptcy in China must either have a principal office located in China, or be registered as having a residence in China. Although there are different definitions of the centre of main interest (COMI) theoretically, insolvency proceedings initiated in China may only be the main process, not the non-main process.
iv Starting proceedings
The commencement of insolvency proceedings is the date of the acceptance of insolvency applications by the court, rather than the filing of the applications. All remedies provided by insolvency law can only be triggered after the insolvency application has been accepted.
The creditor, the debtor and the company's liquidation obligor of dissolution (in a specific case) all have the right to apply to initiate insolvency proceedings. However, according to Article 2 of the 2006 Law,7 the burden of proof for each is quite different.
A creditor that applies for insolvency only needs to prove that the debtor cannot pay the debt due.8 Once the creditor proves this, the burden of proof is transferred to the debtor. If the debtor is unable to provide evidence or otherwise prove that it is not the case that its 'assets are insufficient to pay off all debts' or that it 'apparently lacks the ability to pay off his debts',9 the court shall accept the insolvency application promptly.
A debtor that applies for insolvency is required to prove that he or she meets all the conditions set out in Article 2 of the 2006 Law.
The premise of a company's liquidation obligor of dissolution for insolvency is where an enterprise legal person has been dissolved but has not started or completed liquidation and does not have enough assets to pay off his or her debts. The person responsible for liquidation according to law shall make an application to the people's court for liquidation.10 In this situation, the liquidation application is an obligation for the company's liquidation obligor rather than a right, and the obligor can only apply for liquidation.
When a creditor applies for insolvency, the debtor has the right to raise an objection. The rights of other creditors to challenge an application, or to file an objection when a debtor has filed for insolvency are not stipulated specifically in the legislation and judicial interpretations; however, these rights are protected in practice.
v Control of insolvency proceedings
In practice, the entire bankruptcy process is controlled by the administrator. The duties of the administrator include, but are not limited to:
- taking over the property, seals, account books, documents and other data of the debtor;
- investigating the financial position of the debtor and preparing a report on such position;
- deciding on matters of internal management of the debtor;
- deciding on the debtor's daily expenses and other necessary expenditures;
- deciding whether to continue or suspend a debtor's business (before the first creditors' meeting, when the debtor has not filed an application for self-management, or the debtor's application has not been approved by the court);
- managing and disposing of the debtor's property;
- participating in litigation, arbitration or any other legal procedure on behalf of the debtor;
- proposing that a creditors' meeting should be held;11
- choosing whether or not to continue to perform a contract;12
- exercising the right of revocation so as to recover a debtor's property;13
- examining the claims declared;14
- supervising a debtor while managing a property and business operations on his or her own (reorganisation);15
- formulating a reorganisation plan and organising the voting (except when managed by the debtor itself);16 and
- supervising the implementation of the reorganisation plan (reorganisation).17
The duties of the court are mainly aligned to the supervision of the insolvency proceedings, including:
- the review of insolvency applications;
- designating administrators and determining their remuneration;
- hearing the trial for bankruptcy revocation;
- confirming the claims that have been declared;
- approval of debtor-in-possession;
- executing an automatic freeze (revocation of violations, approval of freeze release);
- approving a reorganisation plan (including mandatory approval); and
- ruling on the termination of the procedure.
The powers of boards of directors are largely taken over by an administrator during insolvency proceedings. This is less straightforward in a reorganisation procedure. If the debtor is managed by the administrator, the administrator may appoint the debtor's management personnel to be responsible for business affairs. If the debtor applies for self-management, the obligations of the relevant personnel of the debtor (the people's court can be interpreted as including the board of directors) include:
- properly preserving the property, seals, account books, documents, etc., that are in their possession and under their management;
- proceeding with the work as required by the people's court and the administrator, and truthfully responding to their enquiries;
- attending the creditors' meetings as non-voting participants and truthfully answering the creditors' enquiries;
- remaining at their domiciles, unless otherwise permitted by the people's court; and
- not taking up any post as director, supervisor or senior manager in any other enterprise.18
vi Special regimes
The insolvency of commercial banks, securities companies, insurance companies and other financial institutions has special features.19 First, it can be applied to the takeover and custody procedures of the financial supervision and administration authority of the state council, as well as reorganisation or liquidation. Second, the proceedings applicable to those financial institutions are decided by the financial supervision and administration authority of the state council, rather than by the debtor.
There are also special rules for affiliates (which can be interpreted as including enterprise groups). One is substantive consolidation. When there is a high level of variation in the corporate personality of affiliated enterprises, which can have serious consequences for a fair settlement for creditors, and the cost to distinguish the members' property of each affiliated enterprise is too high,20 the rule of substantive consolidation of affiliated companies could be applied.
The other special rule is the coordination of judicial practice. When a number of affiliated companies that are in different locations are at risk of bankruptcy and apply for insolvency, but do not meet the conditions for substantive mergers, the insolvency proceedings of those affiliated companies can be coordinated, including under the jurisdiction of one court.21
vii Cross-border issues
The main requirement for making an application for insolvency in China is that the debtor's domicile is in China. Once the procedure for insolvency is initiated according to the 2006 Law, it shall come into effect in respect of the debtor's property outside the territory of the People's Republic of China, if applicable.22
According to Article 5, Paragraph 2 of the 2006 Law, when a legally effective judgment or ruling made on a bankruptcy case by a court of another country involves a debtor's property within the territory of the People's Republic of China, and the said court applies with or requests the people's court to recognise and enforce it, the people's court shall – according to the relevant international treaties that China has concluded, or to which China has acceded, or on the basis of the principle of reciprocity – conduct an examination thereof and, on finding that the said judgment or ruling does not:
- violate the basic principles of the laws of the People's Republic of China,
- jeopardise the sovereignty and security of the state or public interests, or
- undermine the legitimate rights and interests of the creditors within the territory of the People's Republic of China, and decide to recognise and enforce the judgment or ruling.
According to Article 50 of the Minutes of Bankruptcy Trial Proceedings of National Courts in 2018, 'when a legally effective judgment or ruling made on a bankruptcy case by a court of another country has been recognised by the people's court, the remaining property of the debtor within the territory of the People's Republic of China may be distributed in accordance with the provisions of the foreign court after the creditor's right of security right, employee's creditor's right, the social insurance premiums and the taxes which the bankruptcy fails to pay have been paid in full'.
As regards cooperation in cross-border insolvency cases, according to Article 49 of the Minutes of Bankruptcy Trial Proceedings of National Courts in 2018, the people's courts should properly resolve legal conflicts and contradictions that have occurred, and determine the jurisdiction in reasonable terms. Under the principle of equal protection of the same kinds of creditors' rights, a balance should be struck between the interests of foreign creditors and those of Chinese creditors, and protect the repayment interests of the priority of the creditors' rights, including employees and tax claims in China. The country will actively participate in and promote the negotiation and signing of international treaties on cross-border insolvency, explore new ways to apply the principle of reciprocity, strengthen cooperation between Chinese courts and administrators in cross-border bankruptcy, and promote the healthy and orderly development of international investment.
II INSOLVENCY METRICS
In the light of the 2020 Government Work Report,23 the economic perform stably in 2019. China's gross domestic product grew by 6.1 per cent in 2019 and total volume reached 99.1 trillion yuan. As regards employment, 13.52 million new urban jobs were created, and the surveyed unemployment rate is under 5.3 per cent. The consumer price index rose by 2.9 per cent. The stable performance of economy created a better environment for the crisis treatment of enterprises in trouble. Those enterprises in trouble that still have some value were saved through reorganization or conciliation procedures. According to statistics24, in 2019, 4,626 bankruptcy reorganization cases were concluded properly, involving 687.8 billion-yuan debts, and saving 482 promising companies to get out of financial crisis through reorganization and helping 108,000 employees keep their jobs.
According to the data from the National Bureau of Statistics, before 21 December 2019, there were 3,777 listed companies in China holding 3,875 listed shares, with a total market value of 59,293.46 billion yuan. The Chinese economy is on the right track, but the business environment is complex, and uncertainties are increasing. According to incomplete statistics, the number of corporate credit bond defaults in 2019 is similar to the number in 2018 (130 bonds default). Few defaulters of corporate credit bonds in 2019 entered bankruptcy reorganisation process, such as Neoglory Holdings Group Co., Ltd., Dandong-Port Group Co., Ltd., Yiyang Group Co., Ltd., among others. The disposal of single bonds default improves the credit risk pricing mechanism, speeds up the market clearance and facilities the improvement of the economic structure.
In the Yangtze River delta region, Jiangsu Province and Zhejiang Province have already published the 2019 annual bankruptcy trial work report. According to their reports, bankruptcy cases are relatively concentrated in industries with excess production capacity and high leverage, such as chemical, manufacturing, construction and real estate industries. The bankruptcy cases also present strong regional features. Compared with last year, the process efficiency of bankruptcy cases of the courts at all levels in Zhejiang Province and Jiangsu Province have significantly improved in 2019. In Zhejiang Province, the cases accepted and concluded increased by 17.2 per cent and 14.9 per cent respectively compared with 2018. There were 2,777 bankruptcy applications, and 2,373 of them (97.7 per cent) were accepted officially after review, among them 2,318 (97.7 per cent) cases resulted in liquidation, 54 (2.3 per cent) cases were reorganisations and one case reached conciliation. A total of 1,704 bankruptcy cases were concluded, including 1,654 liquidations (97.1 per cent), 48 reorganisations (2.8 per cent) and two conciliations (0.1 per cent). In Jiangsu Province, 3,320 bankruptcy cases were accepted in 2019, increasing 15.64 per cent year-on-year and showing a continuous growth trend. A total of 2,889 bankruptcy cases were concluded, increasing 25.66 per cent year-on-year.
The rise in the number of cases has been linked to the cleaning up of 'zombie enterprises' and the policy of 'cutting overcapacity', which refers to industries such as coal and steel. Some coal and steel enterprises have been closed down through insolvency proceedings. One of the common reasons that so many enterprises have been in crisis is the high cost of financing. Lending institutions have usually invested in state-owned enterprises and battalion enterprises with a very high profile in their locality, while a large number of small and medium-sized private enterprises still obtain loans through the use of material guarantee (especially real estate, listed companies and other collaterals, the value of which is relatively stable, and can be circulated rapidly). Another common reason is that a large number of enterprises are surrounded by a 'guarantee circle'. When a certain enterprise encounters risks, associated enterprises and cooperative enterprises are often faced with having to bear their guarantee responsibility. This can result threats to the cash flow of those enterprises, or the generation of regional risks.
In all likelihood, the number of insolvency cases will continue to rise and the number of large company insolvencies will also increase. First of all, with the uncertainty created by the covid-19 pandemic, the economic environment faces many challenges, such as overseas trade war and the transformation of industry within China. In some industries, such as coal and steel, consolidation and withdrawals will continue for a while. Second, the popularity of insolvency is increasing steadily. An increassing number of debtors have begun to understand the relevant law and tried to find a way out of their debts by means of insolvency. Third, the insolvency process itself is expanding. For example, the introduction of pre-packaged resolutions would reduce the time and costs of formal insolvency process, therefore more and more debtors, especially corporate groups, prefer to implement it before applying for bankruptcy reorganisation. In addition, the mechanism of insolvency for individuals is also being explored and might be incorporated into the law in the near future. Forth, the profitability of some large enterprises tends to decline results in their solvency has declined. Some companies in the bond market will face bond defaults.
The following areas of industry and types of companies are likely to be affected by developments in the coming year.
i Large private group company
One of the main characteristics of this type of company is family governance, rather than a professional management system. Another is its source of funds, a large proportion of which comes from private loans rather than financial loans with high rate interests. Large private group companies can occur in diverse industries. The high financial costs and scattered business operations make them relatively vulnerable to risks, and most of them are not well prepared for the risks they may face the future. In the event of a trade war or a reduction in capacity, they can be vulnerable to financial crisis.
ii Holding company or parent company of a listed company
The shareholders of listed companies tend to maximise the use of listed companies as financing tools. The high stock pledge rate of listed companies has been of wide concern during 2018, having triggered the need for loan recovery via forced liquidation by financial institutions. To resolve this crisis, many local governments introduced funds for shareholders of listed companies through acquisition and restructuring from various channels. However, this policy was adopted for only a few high-profile enterprises and industrial support enterprises. It is also only a short-term solution, and there is therefore the potential for serious risks resulting from distrust and non-cooperation between the restructuring party and the original controllers.
iii Real estate companies
The real estate market, especially in terms of commercial real estate companies, is showing a trend of uneven development. The market in mega cities and central cities has been buoyant for a long time; many places have even issued lottery policies to regulate it. In contrast, a large number of small and medium-sized cities, and even suburban areas of large cities, have developed blindly in the past few years. Some commercial real estate companies rely more on the possibilities for follow-ups rather than the buildings themselves. However, if the level of investment fails to reach expected targets, it can be difficult for them to collect payments and pay their due debts (especially in the case of after-sales leaseback and buyback).
iv New economy and new financial corporates
These types of companies are those promoted by high-profile enterprises and founded by entrepreneurs who are over-optimistic about the future and rely on sharing, platform and other similar concepts. Following the removal of the requirement for the paid-in contribution ratio under the Company Law, the threshold for setting up a company is greatly reduced, which has stimulated a wide range of entrepreneurial enthusiasm. However, these companies are often 'chasing the wind gap'. They are significantly affected by market forces and other non-specific factors, and have almost no anti-risk capabilities. This year, the incidence of financial crisis experienced by online peer-to-peer companies indicates that these types of companies could potentially be at great risk.
v Developments in insolvency
Integration with asset trading markets
An increasing number of asset management companies and distressed asset investors are starting to invest in distressed debts and bankrupt companies. They have already gained considerable income based on their advantages of information (compared to peer companies), profession (compared to bankruptcy administrators) and funds. Some companies have even established funds specifically to invest in bankrupt companies. To a certain extent, the insolvency area is considered an opportunist's paradise.
The pre-package solution
The reorganisation procedure is time-consuming and expensive, especially for large group companies. To accelerate the reorganisation process, a method of drafting debt and asset restructuring plans, before the acceptance of the reorganisation application, is explored, which is called 'pre-package'. After the reorganisation application is accepted by the court, the bankruptcy administrators formulate the draft reorganisation plan in a shorter time frame, based on the debt and asset restructuring plan that has been formed in the pre-package procedure. This draft reorganisation plan would pass the creditors' meeting as soon as possible and get the approval of the court later. The reorganisation procedure can be much quicker through this process.
Regeneration of bankrupt enterprises
Credit repair, business recovery and debt exemption are all difficult for bankrupt enterprises to resolve solely under the regime of the insolvency law. Better coordination between insolvency law and numerous other laws and regulations is therefore necessary. There have been some attempts in this regard, and investigations have been carried out through various 'coordination between government and court' policies, but, in practice, there are still significant difficulties that need to be overcome.
vi Expectations in legislation
- Personal insolvency will be formally legislated for, either separately or incorporated into the existing insolvency law. We remain cautiously optimistic;
- the bankruptcy system of affiliated companies is expected to be clarified;
- special enterprises, such as banks, securities companies and insurance companies, may be governed by special laws;
- pre-packaged resolution may be incorporated into regulations, in preparation for being part of formal insolvency proceedings in the near future;
- a procedure for summary bankruptcy may become a special system, similar to simple trial in litigation. With more and more bankruptcy cases occurring, the use of a summary bankruptcy procedure would improve efficiency greatly; and
- enterprise group insolvency will be included in the field of law enforcement, and may be regulated by a specific provision in the insolvency law.
The cross-border insolvency system will be gradually improved. At present, the Supreme Court has initiated judicial interpretative work to draft and pilot the system, which may be regulated in a specific chapter in the forthcoming insolvency law.
1 Ren Yimin is a managing partner and Zhu Yun is a partner at Capital Equity Legal Group. The authors would like to thank Dr Guo Dongliang for his contributions to this chapter.
2 Organisation Law of the People's Court of the People's Republic of China, Article 18.
3 Resolution of the Standing Committee of the National People's Congress on Strengthening Legal Interpretation, Article 2.
4 2006 Law, Article 3.
5 Civil Code, Article 63.
6 Provisions on Several Issues Concerning the Trial of Enterprise Bankruptcy Cases, Article 1.
7 If an enterprise legal person cannot pay off the debts due and the assets are insufficient to pay off all the debts, or the person apparently lacks the ability to pay off his or her debts, the debt shall be liquidated in accordance with the provisions of the 2006 Law. If an enterprise legal person is under the circumstances as specified before or has apparently forfeited the ability to pay off his or her debts, he or she may undergo reorganisation.
8 2006 Law, Article 7.2.
9 ibid., at Article 2.1.
10 ibid., at Article 7.
11 ibid., at Article 25.
12 ibid., at Article 18.
13 ibid., at Articles 31 to 39.
14 ibid., at Article 57.
15 ibid., at Article 73.
16 ibid., at Article 80.
17 ibid., at Article 90.
18 ibid., at Article 15.
19 ibid., at Article 134.
20 Minutes of Bankruptcy Trial Proceedings of National Courts in 2018, Articles 32 to 37.
21 ibid., at Articles 38 and 39.
22 2006 Law, Article 5.1.
24 From 2020 Supreme People's Court Work Report, made by Zhou Qiang, the President of Supreme People's Court on 25 June 2020.