Insolvency 2020 Comparisons

Last Updated November 19, 2020

Contributed By Fangda Partners

Law and Practice

Authors



Fangda Partners is one of the most prestigious law firms in China, with offices in Beijing, Shanghai, Guangzhou, Shenzhen and Hong Kong. The insolvency and restructuring practice is highly regarded, with a team of nearly 30 lawyers who are experienced in using both their legal and business skills. On the contentious side, the team has experience in enforcement and asset tracing, court-appointed administration, corporate control battles and compulsory liquidation; on the transactional side, it regularly represents investors, debtors, secured and unsecured creditors, creditors’ committees, bondholders, trustees, and government rescue funds in complex transactions where businesses are in financial difficulties. The firm has particular expertise in corporate rescues, debt restructuring and special assets acquisitions. The team works closely with the firm's market-leading professionals in real estate and construction, banking, M&A, funds, capital markets, antitrust, intellectual property, and labour, depending on the matter in hand. Recently, Fangda advised an ad hoc committee of noteholders in relation to notes issued by Huachen Energy, and acted as administrator in the bankruptcy reorganisation of Dalian Shipbuilding Industry Offshore Co, Ltd.

Steep Rise in Bankruptcy Cases

According to the statistics released by the Supreme Court in March 2019, the number of bankruptcy-related cases accepted by courts across the People's Republic of China (PRC) in 2018 was 18,823, increased by a year-on-year rate of 97.3%. Meanwhile, a total number of 11,669 cases were closed in 2018, representing an increase of 86.5% compared to the same period in 2017. The Supreme Court has not released the official number of bankruptcy-related cases accepted and closed in 2019, but has reported that 4,626 bankruptcy and restructuring cases were closed, amounting to debts of CNY678.8billion. As for regional statistics, 2019 saw a bankruptcy boom in the city of Shanghai, with the number of bankruptcy cases accepted by the courts increased by 83.5% compared to 2018. In Shenzhen, the number of bankruptcy cases closed in 2019 totalled 394, representing an increase of 62.9%.

As the economy has shifted from a state of high-speed growth into a period of moderate growth, the financial restructuring and insolvency regime has been regarded as a powerful tool in improving and accelerating market-exit efficiency, which can play a crucial role in boosting supply-side structural reforms. There has been a great wave of industrial integration in the past few years in various sectors such as iron and steel manufacturing, shipbuilding, solar photovoltaic and the coal chemicals industry.

Corporate Bond Defaults

An outbreak of corporate bond defaults has also posed enormous challenges to the health of the bond market and the stability of the economic environment and, to some extent, has pushed forward the development of market-oriented financial restructurings and insolvencies. In 2019, the total amount of bond default reached CNY149.4 billion, representing a yearly peak since the first case of corporate bond default in 2014. In 2020, there was a moderate decline in the total amount of bond default, which totalled CNY112.8 billion by the end of September, as the total volume of financing slumped because of the COVID-19 epidemic. However, the default rate is still high, due to the economic downturn. As a result, more market entities may seek to utilise financial restructurings and insolvencies to address the difficulties and risks affecting them.

Banks Taking a More Active Role

According to the 2019 China Financial Non-performing Assets Market Survey Report (the latest year for which data is available), the amount of non-performing loans in commercial banks totalled CNY2 trillion and the amount of special mention loans had reached CNY3.4 trillion by the end of 2018. The aggregate amount of these two types of loan accounted for 5.05% of national banks’ total credit. The report also shows that in 2019 and 2020, the non-performing loan ratio of Chinese commercial banks will continue to rise. Such a severe situation has pushed the banks to take a much more active role in the restructuring and insolvency market. There have been several large cases where the banks have played a leading role by way of establishing a financial creditors’ committee and engaging in pre-proceeding works as a powerful co-ordinator.

The Bankruptcy Law

The Supreme Court issued a third judicial interpretation relating to the implementation of the PRC Enterprise Bankruptcy Law (the Bankruptcy Law), which came into effect on 28 March 2019. The new judicial interpretation clearly prescribes on several issues where there was previously a lack of statutory guidance. 

Additionally, strong emphasis has been placed on the importance of the bankruptcy regime at the administrative and judicial level. The National Development and Reform Commission (NDRC), the Supreme Court and 13 other relevant departments issued, in July 2019, the “Plan to Accelerate the Improvement of the Reform of the Exit Mechanism of Market Entities", recognising the Bankruptcy Law to be a pivotal point in the development of the market economy. The National Court Conference on Bankruptcy Trials created the requirement that restructuring and bankruptcy tools be fully used by the judicial system. On 15 April 2020, the Supreme Court also issued “Opinions on Promoting Efficient Trial of Bankruptcy Cases in Accordance with the Law”, emphasising the optimal use of bankruptcy methods to support economic growth, especially during the COVID-19 pandemic.

The main legal sources governing reorganisations, liquidations and insolvencies in the PRC include:

  • the Enterprise Bankruptcy Law of the People's Republic of China, which came into effect on 1 June 2007;
  • the Provisions of the Supreme People's Court on Several Issues Concerning the Application of the Enterprise Bankruptcy Law of the People's Republic of China (I), which came into effect on 26 September 2011;
  • the Provisions of the Supreme People's Court on Several Issues Concerning the Application of the Enterprise Bankruptcy Law of the People's Republic of China (II), which came into effect on 16 September 2013; and
  • the Provisions of the Supreme People's Court on Several Issues Concerning the Application of the Enterprise Bankruptcy Law of the People's Republic of China (III), which came into effect on 28 March 2019.

There are three types of proceedings available under the Bankruptcy Law – reorganisation, reconciliation and bankruptcy liquidation. Reorganisation and liquidation can be voluntary or involuntary, depending on who makes the petition to initiate proceedings.

In the course of voluntary liquidation, if the liquidation committee finds the company insolvent during the process of liquidation, the committee is obliged to initiate a bankruptcy liquidation proceeding to clear the debts of the company. However, the law does not specify a time limit for the initiation of bankruptcy liquidation. 

Creditors can petition for the commencement of involuntary proceedings by submitting an application to the court against the debtor for restructuring or liquidation when the debtor is unable to repay its debts as they fall due.

If a debtor fails to pay off its debts due, and its total assets are not enough to pay off all its debts, or it is obviously insolvent, it can be subject to reorganisation or liquidation proceedings under the bankruptcy law. 

If the debtor is highly likely to be insolvent, it can also be subject to reorganisation proceedings under the law.

In voluntary proceedings, a debtor has to adequately prove its insolvency by submitting to the court an audit, or other equivalent documents, showing that the debtor’s assets are not enough, or are unlikely to be enough, to cover all its debts. 

In involuntary proceedings, a creditor must prove the fact that the debtor cannot pay debts owed to the creditor when they fall due.

Where a commercial bank, securities company, insurance company or any other financial institution falls under any of the bankruptcy tests stipulated in Article 2 of the Bankruptcy Law, the financial supervision and administration authorities of the State Council may apply to the court for a reorganisation or a bankruptcy liquidation of the financial institution. 

However, there are no specific implementation measures governing the reorganisation and bankruptcy of financial institutions, or other types of public institution, apart from the Securities Companies Risk Disposal Regulations, which regulate the insolvency of securities companies.

It is believed by bankruptcy professionals that out-of-court restructuring will help improve restructuring efficiency and greatly reduce costs. However, the PRC market is not mature enough for this perception to be widespread yet. Bankruptcy practitioners do, however, have an incentive to promote out-of-court workouts, as the market is growing very fast and insufficient court capacity means the number of cases is still limited.

Lender support for borrower companies varies from case to case, and depends on factors such as the internal policy of the bank in question on dealing with non-performing loans, the reputation and integrity of the debtor, the support of the local government and bank regulator, etc. 

Since there are no applicable rules available for informal workouts at present and out-of-court agreements only have the effect of a contract, market participants have begun to explore a practice similar to pre-pack administration in the US, where the major stakeholders agree on a restructuring plan out of court and then file for bankruptcy reorganisation and have the agreed plan confirmed by the court relatively swiftly.

There is no requirement, however, for mandatory consensual restructuring negotiation before the commencement of a formal statutory process.

The concept of standstill has been used in most out-of-court efforts in the market, but it may not actually be able to bind every major creditor due to the lack of unified practice rules or corresponding consequences for not abiding by them.

There might be obligations for the debtor company during a consensual restructuring/workout to disclose financial information to the creditors’ committee to assist with the formulation of a viable plan. The debtor may also be required to preserve its assets and ensure their safety and integrity during the restructuring.

There are no specific rules specifying the roles and functions of the ad hoc committee, though it is widely believed that the purpose of such a committee is to adopt timely and effective actions to protect the creditors’ interests and to contain, where possible, social and financial risks.

The expenses of creditors’ committees are normally borne by the creditors themselves while, in some cases, the debtor bears the expenses for hiring a financial adviser to assist in due diligence and the formulation of the restructuring plan.

For most cases on the market, an ad hoc creditors’ committee is commonly formed by banks or financial institutions that have large claims against the debtor. In a few cases, government authorities or other types of creditor representatives may be involved.

Information such as financial statistics, books or detailed assets lists, as well as important contracts or materials, will be required by the creditors from the debtor.

From a practical point of view, it is difficult to make material modifications to the hierarchy and nature of existing claims. Normally, debt extension is widely accepted, and a reduction of debt may be achieved sometimes, but it is rare for the priorities of claims to be changed on a contractual basis.

If new money is being injected by any creditor or new investor during out-of-court restructurings, super-priority security can only be granted if the existing creditors agree.

There are no specific rules or laws related to conduct during out-of-court restructuring. The most relevant legal principle will be that of good faith, which is required by Chinese civil law in all civil matters.

It is rare for credit agreements to include terms permitting a majority or super-majority of lenders to bind dissenting lenders to changed credit agreement terms.

Informal consensual processes are perceived as extremely difficult because of the holdout issue. In some cases, where the dissident creditors only hold a limited amount of the claim, the majority creditors who have reached a restructuring plan will decide to pay the dissident creditors’ claims in full.

Cram-down mechanisms only exist in bankruptcy reorganisation proceedings.

All kinds of security permitted by PRC Property Law are available to secured creditors, such as a mortgage over the debtor’s real estate, a pledge over equity interests owned by the debtor, a lien on movable assets, as well as pledges over bank accounts or other types of rights or properties owned by the debtor.

Outside bankruptcy, a secured creditor may bring a summary proceeding or a full-blown civil action to exercise its security interests. PRC law is not clear as to the effect of intercreditor covenants. 

Secured creditors cannot block or disrupt a bankruptcy proceeding. In bankruptcy, secured creditors enjoy first priority in receiving proceeds realised from the secured property.

In bankruptcy reorganisation, enforcement of the security interest will be stayed, unless the secured creditor’s interest is at risk and no adequate protection is provided by the bankruptcy administrator. 

The secured creditor has no special procedural protection other than the rights discussed in 4.2 Rights and Remedies.

No distinction is made between members of the class of secured creditors – all will have the same rights and priorities. Unsecured creditors, however, may sometimes be divided into a small-claim group and an ordinary unsecured class depending on necessity and individual cases.

The secured creditor enjoys priority of payment in respect of the collateral’s value, while the unsecured group is repaid on a pro rata basis. The small-claim group creditors may obtain comparatively higher repayment than the ordinary unsecured group in many cases.

Unsecured trade creditors will be treated as ordinary unsecured creditors and receive the same repayment as other creditors in the same group. There are a few cases where unsecured trade creditors enjoy a higher repayment rate than unsecured financial institution creditors for practical reasons, such as maintaining social stability or sustaining the debtor’s operation, provided that other unsecured creditors (mainly the financial institution creditors) agree to the arrangement.

Unsecured creditors do not have the power to disrupt the insolvency/restructuring process or achieve any stay or deferral of a liquidation. 

However, unsecured creditors do have the right to raise an objection to the administrator’s review of the claims and to initiate litigation if they are unsatisfied with the administrator's response to the objection. In addition, an unsecured creditor enjoys rights prescribed by the Bankruptcy Law, as does every creditor, such as the right to obtain information, to participate in a creditors’ meeting, to vote on various motions and plans made by the administrator, etc. 

Outside bankruptcy, pre-judgment attachments are allowed and widely used. Once the debtor enters bankruptcy, all antecedent attachments will be lifted.

There are two types of priority claims pursuant to PRC law. One comprises bankruptcy expenses, including administration expenses, remuneration of the administrator and other procedural expenses; the other is debt incurred during the proceeding for the common benefit of the creditors, including new money borrowed for the purpose of continuous operation and liabilities incurred for assumption of contracts.

Secured creditors enjoy priority to the extent of the value of the collateral, except for claims related to (or arising from) administration of the collateral.

Reorganisation

When half or more of the creditors in the same voting group, representing two thirds or more of the total amount of the creditors' claim, vote in favour of the draft restructuring plan, the plan is deemed as passed by this group. When all voting groups vote in favour of the plan, the draft plan is deemed to be passed by the creditors’ meeting. 

If one or more voting groups vote against the plan, the court will have, upon an application made by the administrator, discretion to decide whether to exercise its cram-down power, subject to certain criteria prescribed by law. For the criteria that need to be met for the court to exercise this power, please refer to 6.4 Claims of Dissenting Creditors.

In principle, the hierarchy of claims is not subject to modification. However, the modification of claims can be achieved if the claimholder, whose claim is subject to modification, voluntarily agrees to the arrangement. 

The requirements for commencing restructuring/reorganisation can be found in 2.4 Commencing Involuntary Proceedings

The purpose of a restructuring proceeding is to settle the debts of the company fairly through an adjustment plan, so as to safeguard the legitimate interests of the creditors and rescue the debtor’s value as a going concern. Debt avoidance or liability evasion through the proceeding is strictly prohibited.

Formal reorganisation proceedings are court-driven and court-supervised processes.

A creditor, debtor or a debtor’s capital contributor, whose capital contribution makes up 10% or more of the debtor’s registered capital, can petition the court for reorganisation.

The court will decide to accept the petition for reorganisation and make a public announcement when the petition fully complies with the legal requirements. 

Timelines

The typical timelines and milestones that apply to formal reorganisation proceedings are as follows:

If the petition is made by:

  • a creditor, the court shall decide whether to accept the case within 22 days of the creditor submitting their petition; or
  • a debtor, the court shall decide whether to accept the case within 15 days of the debtor submitting their petition.

Under special circumstances, these two periods may be extended for another 15 days upon the approval of a higher-level court. 

The court will, within 25 days as of the date it accepts the case, notify known creditors and publicly announce its decision. 

The term for lodging the creditor’s claim will be determined by the date on which the court announces its acceptance of an application for reorganisation. Claims must be lodged within a period ranging from 30 days to three months from this date. 

The first creditors’ meeting will be held by the court within 15 days of the expiry of the term for lodging a claim. 

The debtor or administrator should, within six months of the court accepting the reorganisation petition, submit a draft restructuring plan to the court and the creditors’ meeting. The six-month period can be extended for another three months if the court approves.

An expedited process for reorganisation is not available in China.

The administrator will conduct material examinations of the claims upon reviewing the documents and evidence submitted by the creditors. The results of this review will be filed for further review at the creditors’ meeting, and the undisputed claims will be confirmed by a court ruling which serves as final recognition. Interest on the claims (if any) shall be calculated based on the date when the proceeding commences.

Contingent claims can also be registered with the administrator during the proceeding. The administrator will examine the claims and preserve the portions for such claims before the final results are determined.

Restructuring

A restructuring plan, if approved by the court, will have binding power over the debtor and all creditors, including the “unknown” creditors or contingent claimants.

A restructuring proceeding is not confidential, but the Bankruptcy Law itself does not require public disclosure of the key terms of the restructuring plan. Where the debtor is a public company, it will be subject to disclosure rules issued by the securities regulator.

The judgment made on a reorganisation proceeding cannot be appealed procedurally. However, if the debtor’s business and assets continue to deteriorate and reach a hopeless state; or the debtor conducts acts of fraud and maliciously reduces its assets; or behaves in a way that similarly damages the interests of the creditors; or the administrator is unable to perform its duty due to the behaviour of the debtor; the court will, upon the application of the administrator or interested parties, terminate the proceeding, declare the debtor insolvent and convert the proceeding into a bankruptcy liquidation.

The creditors will be divided into several groups to cast votes on the restructuring plan and where the level of support satisfies the legal requirements, the plan will be deemed as approved by the group. 

If the plan is passed by the creditors’ meeting, the court will issue a ruling to confirm the plan upon an application by the administrator. After that, the court will rule to terminate the proceeding and the execution period of the plan starts. During this period, value will be distributed to the creditors according to the legal hierarchy and on a pari passu basis unless the plan stipulates otherwise.

After the court accepts an application for reorganisation, an automatic stay will be granted to the debtor which prevents the creditors from taking further action to seek litigation or enforcement against the debtor. Interest calculation will cease and payment of debt to any individual creditor is prohibited.

The administrator has the power to decide whether to continue the debtor’s operation (upon court approval) before the first creditors’ meeting is convened. The creditors’ meeting also has the power to decide whether to continue or suspend the debtor’s business under such a proceeding.

The court will appoint an administrator to take charge of the debtor’s management. An administrator will be appointed from a roster published by the courts in the different provinces. See 9.3 Selection of Officers for details. In reorganisation proceedings, the debtor can also apply to the court to manage its own business, in which case, the administrator will only take a supervisory role and not be involved in daily operational decision-making.

The administrator, or a debtor in a state of self-management, may borrow funds to continue the debtor’s operation if the creditors’ meeting allows it to do so, or with the court’s approval before the first creditors’ meeting is convened.

The creditors are classified into four groups: the secured creditors’ group, the employees' group, the tax group, and the unsecured creditors’ group.

A creditors’ committee shall consist of creditors selected by the creditors’ meeting plus one employee representative of the debtor or a representative from the labour union. A creditors’ committee may include at most nine members. 

The creditors’ committee has the following powers and duties:

  • to supervise the management and disposal of the debtor’s assets; 
  • to supervise the distribution of the insolvent assets; 
  • to propose to hold the creditors' meeting; and
  • to perform other duties as entrusted by the creditors' meeting. 

When the creditors' committee performs its duties, it has the right to require the administrator and debtor to give explanations or provide the relevant documents on matters relating to the scope of its functions and duties.

The expenses of the creditors’ committee are usually compensated as part of the bankruptcy expenses.

A creditor has the right to review the debtor’s financial status report, resolutions of the creditors’ meeting, resolutions of the creditors’ committee, the administrator’s supervision report, and the debtor’s financial and operational information necessary for the creditor to participate in the proceeding.

Where there are one or more voting groups, or votes against the draft restructuring plan, the court may exercise the power to cram-down the plan if it meets the following requirements: 

  • the secured creditors will be paid off from the value of the collateral and the losses incurred from postponed payment will be compensated in a fair manner, provided that the secured claims have not been materially damaged, or the relevant voting group has approved the draft plan; 
  • wages and other expenses for the employees, and taxes, shall be paid off, or the relevant voting group has approved the draft plan; 
  • the repayment proportion of an unsecured creditor’s claim shall not be lower than that in a liquidation scenario at the time when the draft plan is submitted for approval; 
  • the draft plan can bring a fair and just adjustment to the rights and interests of capital contributors; 
  • the draft plan treats the members of a same voting group fairly and the hierarchy of the creditors' claims does not violate the provisions of Article 113 of the Bankruptcy Law; and
  • the debtor's business plan is feasible.

When the creditor assigns or trades its claims, a notification must be sent to the debtor and the administrator in writing. Otherwise the assignment or trading will have no effect against the bankruptcy estate. Once the duty of notification is fulfilled, the legal position of the previous creditor will be assumed by the new creditor.

Substantive consolidation of group companies in bankruptcy proceedings is possible in the PRC, though there are no statutory provisions on implementation. In practice, where the assets and liabilities of entities within a corporate group are commingled to such an extent that separating them would be infeasible or prohibitively costly, the court may – upon petition by the administrator – include all affiliates within the group in one combined procedure.

The administrator will manage and dispose of the debtor’s assets after taking the assets into custody under the proceeding. The use or sale of assets should be subject to the asset management plan and the assets disposition plan made by the administrator and then approved by the creditors’ meeting. 

Normally, the sale of assets during the proceeding is conducted by public auction, unless the creditors’ meeting agrees otherwise.

Contractual transactions regarding the sale of assets are only enforceable with the approval of the creditors’ meeting.

The administrator is responsible for executing the asset disposition plan if that plan is approved by the creditors’ meeting. A purchaser will acquire good title in a sale executed pursuant to such a restructuring proceeding, free and clear of claims. Neither bidding by creditors nor their acting as stalking horses in a sale process is allowed under the proceeding.

If a contract of transaction was signed prior to the proceeding and it has not been fully performed by both parties, the administrator will have the power to decide whether to rescind or adhere to the contract on the basis of maximising the debtor’s asset value. 

No secured creditor liens or any security arrangements will be released pursuant to a restructuring.

The administrator or the debtor-in-possession may borrow funds so that the debtor can continue its operation during the proceeding. It is permitted for the debtor's assets to be used as security for such a loan. If the assets encumbered by pre-existing secured creditors have a value large enough to guarantee the new loan and the investor consents to this, the law does not prohibit the practice as long as the newly established encumbrance will not be detrimental to the pre-existing secured creditor. 

A creditor’s claim can be determined through statutory processes under the Bankruptcy Law, which authorises the administrator to examine and determine the value of a claim and submit it to the court for ruling after review by the creditors’ meeting.

A reorganisation plan will be submitted by the administrator or the debtor for the approval of the creditors’ meeting. If all groups of creditors vote in favour of the plan, the court will normally approve the plan upon application. While there are one or more dissenting groups voting against the plan, the administrator may apply to the court to exercise the power of cram-down over the dissenting groups, the standard for which is discussed in 6.4 Claims of Dissenting Creditors

The administrator has the power to decide whether to rescind or continue to adhere to a contract that was established before the proceeding, but has not been fully performed by both parties. The administrator will send written notice to the contractual party stating its willingness to continue or desire to terminate the contract, within two months of the commencement of the proceeding. If the administrator fails to do so within the two-month period, the contract is automatically deemed to be terminated.

If the contract is terminated, the counterparty can make a claim against the debtor on the basis of the right to be compensated for damage incurred.

Non-debtor parties, such as guarantors, will not be released from liability due to the statutory insolvency procedure. 

When a creditor is indebted to the debtor before the commencement of a proceeding, the creditor can make an assertion to the administrator for offset. However, offset is not allowed if a creditor obtains the claim from other creditors of the debtor after the commencement of a proceeding, or a creditor assumes liability to the debtor or obtains the claim against the debtor in the awareness of the debtor’s insolvency (except where the assumption of liability or obtaining of a claim arises from an event that occurred at least one year prior to the commencement of the bankruptcy proceeding).

A reorganisation plan approved by the court has binding power over the debtor and all creditors. The court will not impose unobserved terms on the parties. If the plan cannot be implemented, the court shall, upon petition by the administrator or any interested party, terminate the implementation of the plan and declare the debtor bankrupt. The party that fails to perform the terms of the agreement may bear liability for breach of contract or otherwise be held responsible according to the specifics of the non-performance.

When the debtor is in a state of bankruptcy, the existing owners’ equity has no value. It is unreasonable to allow the owner to retain any value in or from the debtor unless the new investor agrees to this on a negation basis. The law does not expressly prohibit existing equity owners from retaining ownership of the debtor upon conclusion of the reorganisation. In practice, it is up to the creditors and investors (if any) to decide whether to approve or accept the draft reorganisation plan that lets the existing equity owners retain some ownership.

There are two types of statutory liquidation proceedings available in China: bankruptcy liquidation and involuntary company liquidation.

A bankruptcy liquidation is a court-supervised proceeding by which a debtor company can settle its debts with fairness to all its creditors through unified procedures before dissolution. Under this proceeding, the debtor’s assets will be disposed of to maximise returns to the creditors under judicial supervision and creditors in the same class will be paid on a pari passu basis. The proceeding, in practice, can be long and costly.

An involuntary company liquidation proceeding is governed by the PRC's Company Law and is also subject to court supervision. In this proceeding, the company is solvent and can pay off all debts with its assets. The judicial role in the proceeding is to ensure the distribution is fair and just, without discrimination to any of the creditors and that no creditor will be left out before the shareholders of the company get back what’s left at dissolution. An involuntary company liquidation can also be time-consuming and costly. 

There is no court-supervised voluntary liquidation for a solvent company in China. 

Under bankruptcy liquidation, the people’s court will appoint a bankruptcy administrator to carry out the proceedings.

How Proceedings Are Commenced

Bankruptcy liquidation can be commenced under the following circumstances:

  • upon petitions made by either a debtor or a creditor to the court;
  • upon application by the liquidation committee if it finds the debtor insolvent in an involuntary company liquidation;
  • upon the consent of either the debtor or the creditor in a judicial enforcement procedure where sufficient assets cannot be located to satisfy the creditor; and
  • upon petitions made by an administrator or other interested parties when a bankruptcy reorganisation proceeding fails. 

Involuntary company liquidation can be commenced upon the application of a creditor or a shareholder of the company, where an event of dissolution has occurred, and no liquidation committee is established within the statutory time period to conduct voluntary liquidation. 

Statutory Requirements

The statutory requirements for commencing a bankruptcy liquidation are discussed in 6.1 Statutory Process for a Financial Restructuring/Reorganisation. The requirements for an involuntary company liquidation can be found above in this section. 

Creditors' Claims

How a creditor's claims in the case of a bankruptcy liquidation are calculated and recognised, at what point and by whom is discussed in 6.1 Statutory Process for a Financial Restructuring/Reorganisation.

In involuntary company liquidations, creditors also need to declare their claims to the liquidation committee. The requirements regarding the submission of evidence and the examination procedures adopted by the liquidation committee are similar to those adopted in bankruptcy liquidations. However, interest on claims (if any) will continue to accumulate until the date on which such claims are fully compensated.

Contingent claims will not be preserved by the liquidation committee in the case of an involuntary company liquidation. If contingent claims become liquidated claims after liquidation is completed, the creditor is entitled to seek compensation from the shareholders of the dissolved company to the extent of the value received by the shareholders from the liquidation.

Timelines

A bankruptcy liquidation is deemed to be commenced when the court issues an order accepting the bankruptcy liquidation petition.

An involuntary company liquidation is deemed to be commenced when the court issues an order accepting the petition for a court-designated liquidation committee. 

See 6.1 Statutory Process for a Financial Restructuring/Reorganisation for the timelines relevant to bankruptcy liquidations.

The difference in timelines between a bankruptcy reorganisation and a bankruptcy liquidation is that the law does not provide a time limitation for the latter, thus the duration of bankruptcy liquidation proceedings varies greatly on a case-by-case basis.

The High Court of Shanghai issued, in 2018, The Guidelines on Expedition of Bankruptcy Trials by Simplifying the Procedures (the Guidelines), which mandate that cases satisfying certain conditions will be tried under summary procedures in which statutory periods are substantially shortened. The Guidelines requires that a summary procedure must be closed within six months of its commencement date.

The timelines that apply to involuntary company liquidation ensure that the liquidation committee notifies known creditors within ten days and makes an announcement in public newspapers within 60 days of its formation. 

Under involuntary liquidation proceedings, the liquidation committee is required to complete the procedure within six months of its formation, but can apply to the court for an extension if necessary. 

Trading Claims

This is dealt with in 6.5 Trading of Claims Against a Company.

Stays and Moratoriums

This is dealt with in 6.2 Position of the Company, which contains information on moratoriums or "stays" of legal proceedings or enforcement actions in the case of a bankruptcy liquidation.

No automatic stay or moratorium will be granted to a company in the context of an involuntary company liquidation.

Continuation of Company Business

See 6.2 Position of the Company as well as 9.2 Statutory Roles, Rights and Responsibilities of Officers and 9.3 Selection of Officers for details of how a business will continue to be run in the event of a bankruptcy liquidation.

In involuntary company liquidations, the court will designate a liquidation committee to perform the duty of liquidating the company under the court’s supervision. The liquidation committee is responsible for clearing the company’s assets, making a balance sheet and checklist of assets, notifying and making a public announcement to creditors, dealing with unfinished company business, clearing the taxes of the company, dealing with the remaining assets after payment of debts, and representing the company in legal procedures. 

Contracts

See 6.12 Restructuring or Reorganisation Agreement for information on the rejection of contracts established before the bankruptcy liquidation.

The law does not provide any special rules on dealing with the contract in an involuntary liquidation. Executory contracts in execution will be treated as if the company is in its normal state, and the liquidation committee does not have a separate legal ground to terminate executory contracts at its discretion.

Rights of Set-Off

Refer to 6.14 Rights of Set-Off for details of set-off rights in bankruptcy liquidations.

Set-offs between a creditor and the debtor in involuntary company liquidations are allowed and can be made in accordance with the PRC Contract Law. Set-offs are not subject to any special suspension or restrictions because of involuntary liquidation.

Information

See 6.3 Roles of Creditors for details of bankruptcy liquidations during involuntary company liquidations. There is no specific legal requirement to disclose information about the proceeding to the creditors,as long as their claims are paid in full. However, in practice, the liquidation committee will make reasonable disclosure to the creditors at its own discretion.

Distribution of Value

In a bankruptcy liquidation, after full payment of the bankruptcy expenses and debts incurred for the common good of the creditors, the debtor's assets will be distributed according to the following hierarchy: labour claims, social securities and tax claims, unsecured creditors’ claims.

If no assets can be distributed, or after completion of asset distribution, the administrator will apply to the court to terminate the proceeding. Upon receipt of the application, the court will, within 15 days of the day when the administrator applied to terminate the proceeding, make a decision on whether to do so.

In the case of an involuntary company liquidation, after the liquidation committee has finished distributing the company’s assets, paying the remaining value to shareholders, and has completed de-registration of the company, it will apply to the court for a ruling to terminate the proceeding. 

Refer to 6.8 Asset Disposition and Related Procedures for details regarding bankruptcy liquidations.

In involuntary liquidations, a liquidation committee has broad discretion in asset disposition under the supervision of the court. The liquidation committee has the responsibility to dispose of the assets in a way that is in the best interests of both the company and its creditors.

Refer to 6.3 Roles of Creditors for details on bankruptcy liquidation. 

There is no creditors’ committee in involuntary liquidation.

Article 5 of the Bankruptcy Law prescribes that a foreign bankruptcy judgment shall be recognised and enforced according to treaties or conventions, or the principle of reciprocity. However, the article only provides a general basis for recognition of foreign bankruptcy proceedings without any guidance on implementation. 

Recognition of foreign restructuring or bankruptcy proceedings in China is decided on a case-by-case basis. 

The PRC has entered into protocols or treaties with 37 countries and independent economic areas on civil judicial assistance but none of these explicitly includes protocols or arrangements co-ordinating cross-border bankruptcy proceedings.

Since PRC law does not currently provide detailed guidance on cross-border proceedings, there are no specific rules determining the governing law. If a PRC court recognises a foreign proceeding, the rules of international private law as well as the PRC Civil Procedure Law might be referred to as the primary legal sources.

Foreign creditors will receive the same treatment as domestic creditors under a PRC proceeding, without discrimination.

In the minutes of the National Court Work Conference on Bankruptcy Trials issued by the Supreme Court in 2018, it is pointed out that the interests of domestic and foreign creditors shall be balanced subject to the principle of equal protection of claims in the same group. Domestic employee claims, tax claims and secured claims, however, shall be protected adequately and preferentially. 

Under the PRC regime, statutory officers are appointed by the courts as administrators in reorganisation and liquidation proceedings. There is no other type of statutory officer under PRC law.

The responsibilities of the administrator include:

  • taking control of the debtor’s assets;
  • investigating the debtor's assets and preparing the assets report;
  • determining the debtor’s internal business;
  • determining the debtor's daily and necessary expenses;
  • determining whether to continue or cease the business of the debtor before the first creditors’ meeting;
  • managing and disposing of the debtor’s assets;
  • representing the debtor in litigation, arbitration and other legal procedures;
  • proposing to convene the creditors’ meeting; and
  • other duties entrusted to the administrator by the court for the sake of the proceeding.

The administrator reports directly to the court and is under the supervision of the creditors’ meeting as well as the creditor’s committee (if established). The fiduciary duty of the administrator requires it to perform its role diligently and with due care in accordance with the law.

Appointment

According to the Provisions of the Supreme People's Court on Designating the Administrator during the Trial of Enterprise Bankruptcy Cases (the Provisions), courts can appoint administrators – through a random draw, competitive bidding or direct designation upon recommendation – from the regional administrators’ rosters issued by the High Courts in different provinces. 

The High Courts are responsible for preparing the administrator rosters in their area of jurisdiction according to certain statutory criteria. The rosters may include institutions such as law firms, accounting firms, bankruptcy liquidation firms and qualified individual practitioners. 

In most cases, the court will randomly appoint a firm on the roster to act as administrator by way of lucky draw. Individual practitioners acting as administrators are hardly seen in judicial practice. In significant cases, the court may use competitive bidding to select an administrator from the roster.

Replacement

Administrators can be replaced at the request of the creditors’ meeting, to the court, on grounds of incompetence or unlawful and improper conduct. The court will examine the facts and decide whether to replace the administrator as requested by the creditors’ meeting, within 12 days of the request being submitted. 

The administrator can voluntarily resign from its position with fair and proper reasons upon the court’s approval. 

The court has the discretion to replace the administrator ex officio under certain legal conditions.

Responsibilities

The company management and directors have a statutory duty to co-operate and support the work of the administrator. In practice, it is crucial that the administrator forms an active and co-operative relationship with the management and directors, which will effectively facilitate the bankruptcy process and maximise value for stakeholders.

The administrator will normally take the place of the previous management and the board will cease to function. If the debtor applies for, and the court approves, debtor in possession, the management will remain in place and continue to operate the debtor under the supervision of the administrator.

Qualifications

Apart from the liquidation committee, institutions such as law firms, accountancy firms as well as liquidation firms can serve as administrators. No creditor, creditor representative, owner, officer or director can serve as the administrator. 

In most cases, law firms or accountancy firms serve as the administrator. It is uncommon for other restructuring professionals who do not have licences to practice law or accounting to serve as administrator, but they may be engaged as advisers or interim management by the administrator.

The PRC Bankruptcy Law is silent on directors’ duties, such as putting financially troubled companies into insolvency proceedings or stipulating any positive actions to be taken by directors before opening the proceedings. However, the law provides that legal representatives of distressed companies or, at the insolvency court’s decision, financial officers and other specific managers, shall perform the following duties during insolvency proceedings:

  • take good care of the assets, financial books and other documents that are held by them;
  • carry out work under the instructions of the insolvency court and the administrator, and answer enquiries truthfully;
  • attend creditors’ meetings and respond to creditors' enquiries;
  • not leave their domiciles without the insolvency court’s permission; and
  • not undertake the role of director, supervisor or senior manager of other companies.

The PRC Bankruptcy Law also provides that directors may be held liable if:

  • their breach of duties of fiduciary loyalty and diligence have caused the bankruptcy of the debtor;
  • they are directly involved in fraudulent and preferential transactions that have been set aside or annulled by the court upon request by the administrator; or
  • it is found that directors have assisted, or been negligent, when a shareholder has failed to contribute its subscribed capital in full or has illegally withdrawn its capital.

Directors may also bear criminal liabilities under the PRC Criminal Law, which prescribes penalties for officers who are directly in charge of or responsible for concealing company assets, making false balance sheet or asset records, or illegally distributing assets before repaying debts; if severe losses are caused to the creditors or other stakeholders during liquidation.

If directors are involved in any of the negative behaviours set out in 10.1 Duties of Directors, administrators can assert claims against those directors. If the administrator fails to take prompt action, the creditors may also initiate action against those directors. 

Historical transactions that took place within one year of the proceeding can be set aside if they are:

  • gratuitous transfers of assets;
  • transactions at obviously unreasonable prices;
  • providing collateral for antecedent unsecured debts;
  • payments of debts that are not due; or
  • acts of abandonment of creditors' rights.

Also, when a debtor cannot pay its due debts and becomes insolvent or obviously lacks liquidity, any payment of debt to an individual creditor that took place within six months of the proceeding can be set aside unless the payment is beneficial to the debtor’s assets as a whole.

Acts of concealment or the transfer of assets for the purpose of debt evasion, as well as the fabrication of debts or the acknowledgement of untruthful debts, no matter if prior to or after the commencement of the proceeding, will be deemed as invalid.

Refer to 11.1 Historical Transactions.

The administrator has the statutory power to set aside or annul historical transactions before the court, while an individual creditor has no such power. However, creditors are entitled to supervise the work of the administrator by making requests or propositions regarding questionable transactions, if they have certain evidence of their questionability.

Claims against the aforesaid transactions can be brought in both reorganisation and bankruptcy proceedings.

Fangda Partners

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HKRI Taikoo Hui
288 Shi Men Yi Road
Shanghai
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+86 21 2208 1166

+86 21 5298 5599

Lingqi.wang@fangdalaw.com www.fangdalaw.com
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Law and Practice in China

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Fangda Partners is one of the most prestigious law firms in China, with offices in Beijing, Shanghai, Guangzhou, Shenzhen and Hong Kong. The insolvency and restructuring practice is highly regarded, with a team of nearly 30 lawyers who are experienced in using both their legal and business skills. On the contentious side, the team has experience in enforcement and asset tracing, court-appointed administration, corporate control battles and compulsory liquidation; on the transactional side, it regularly represents investors, debtors, secured and unsecured creditors, creditors’ committees, bondholders, trustees, and government rescue funds in complex transactions where businesses are in financial difficulties. The firm has particular expertise in corporate rescues, debt restructuring and special assets acquisitions. The team works closely with the firm's market-leading professionals in real estate and construction, banking, M&A, funds, capital markets, antitrust, intellectual property, and labour, depending on the matter in hand. Recently, Fangda advised an ad hoc committee of noteholders in relation to notes issued by Huachen Energy, and acted as administrator in the bankruptcy reorganisation of Dalian Shipbuilding Industry Offshore Co, Ltd.