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:
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.
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.
The typical timelines and milestones that apply to formal reorganisation proceedings are as follows:
If the petition is made by:
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.
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:
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:
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:
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.
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.
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.
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.
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.
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.
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:
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.
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.
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.
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.
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:
The PRC Bankruptcy Law also provides that directors may be held liable if:
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:
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.
This chapter introduces trends and developments in Chinese bankruptcy law in 2020, divided into three parts. The first part reviews the negative impact of COVID-19 and the international situation on the financial markets and emphasises that the debt crisis in the automobile industry, real estate companies and financial institutions deserves attention. The second part points out that the adoption of the Civil Code will have a far-reaching impact on the implementation of bankruptcy law, and discusses areas in which China has made progress, such as, the individual bankruptcy system, the pre-packaged system and the establishment of the unified co-ordination mechanism linking the government and the courts. The third part describes the development of bankruptcy practitioners, including the professionalisation of trials and the widespread establishment of bankruptcy administrators' associations. In general, although China's bankruptcy legislation is still evolving in 2020, it has made remarkable progress.
1. External Environment and Key Industries
The impact of COVID-19 and the international situation
For the Chinese people, COVID-19 is the most prominent keyword in 2020. The damage it has done to the economy and to society is huge. Affected by the epidemic, economic activities were forced to slow down, some industries almost stopped for a time, and the cash flow of a large number of enterprises was suddenly interrupted. In addition, the epidemic has accelerated the deterioration of the financial situation of distressed companies that were already on the verge of bankruptcy and seeking to be rescued.
At the same time, Chinese enterprises have also encountered extremely severe challenges in foreign trade. The US government has imposed a number of sanctions on Chinese companies, such as the sales ban on Huawei’s chips, the trading ban on TikTok and the usage ban on WeChat. The further escalation of the trade war has added many uncertainties to China-US relations and the world economy at the macro level, as well as to business operations at the micro level.
Notable key industries
There are a number of sectors where the debt crisis is unfolding and needs particular attention. Among them, there are industries in which debt problems have occurred before and are still continuing, industries in which the severity of the debt problem has gradually been highlighted in recent years, and industries in which the debt problem has not yet exploded on a large scale but which should be vigilant and guard against this.
The real estate industry
The debt crisis of small and medium-sized real estate companies first attracted attention several years ago, particularly among those mainly engaged in commercial property development. In the past year, the debt crisis of the large real estate groups has been frequently reported. Such groups are more complex, involving different regions and industries. In August 2020, the capital monitoring and financial management rules of key real estate enterprises, formed by the People's Bank of China and the Ministry of Housing and Urban-Rural Development, have strengthened their control over leading companies, which will bring new variables to the real estate industry.
The automobile industry
China's traditional automobile industry has been hugely successful over the past few decades, with foreign and domestic brands competing for development. However, with the competitive differentiation within the industry, some enterprises lacking in brand and technological advantages or with backward management have been gradually eliminated from the market. Since last year, several listed companies in the auto industry have entered into bankruptcy restructuring. In the field of new-energy vehicles, in order to promote the development of this area, the government has issued special support and subsidy policies. Some enterprises are highly dependent on these and if these policies are reduced or disappear, it is highly possible that the new-energy vehicle manufacturers will face the risk of debt and even go into bankruptcy.
The bond market
Defaults in the corporate bond market are no longer rare. Bond defaults in 2018 and 2019 were already at a high level, and due to the external environment this year, with the pandemic, the situation in terms of bond defaults in 2020 is not optimistic. The word "bankruptcy" appeared dozens of times in the Summary of the Symposium on Bond Dispute Cases Heard by National Courts, released by the Supreme People's Court, and it can be predicted that bankruptcy proceedings will be used as a powerful measure to deal with bond defaults.
Financial institutions, especially banks, have strong public trust in China, but the debt problems of financial institutions cannot be avoided. The recent joint takeover of the Baoshang Bank by the People's Bank of China and the China Banking and Insurance Regulatory Commission is a typical example. Particular attention should be paid to local small and medium-sized banks, which, on the one hand, have a large gap in management level and risk awareness compared with large banks, and on the other hand, often have private-owned enterprises participating in their equity, which constitutes an additional source of risk for them in practice. At the National People's Congress this year, a number of deputies put forward proposals for regulation of the bankruptcy of financial institutions.
2. Changes in the Laws and Judicial Policies
The release of the judicial interpretation of bankruptcy trials during the epidemic
Affected by COVID-19 and the epidemic's prevention and control measures, the number of bankruptcy filings across the country has increased sharply. Believing that many enterprises were only enmeshed in temporary operating difficulties, the Supreme Court issued a special judicial interpretation in order to further exert the salvage function of bankruptcy law. The main measures adopted in the interpretation include:
The adoption of the Civil Code
The Civil Code of the People's Republic of China was adopted by the National People's Congress on 28 May 2020 and will take effect on 1 January 2021. On the basis of absorbing General Rules of the Civil Law of the People’s Republic of China, the Property Law of the People's Republic of China, the Contract Law of the People's Republic of China and other existing civil laws, the Civil Code has also undergone many modifications or changes. In the area of bankruptcy law, the impact of the Civil Code mainly includes:
Influence on the identification of the debtor's properties
The Civil Code stipulates that: the parties to a sales contract may agree on retention of ownership, but may not contest a bona fide third party without registration. The owner of the lease item in a financial leasing contract may not contest a bona fide third party without registration. Under these two types of contracts, it is difficult for the seller or the lessor to claim ownership of the subject matter based solely on the contract provisions and then exercise recall rights in the bankruptcy proceedings.
Influence on the determination of the creditors' rights sequence
First, the types of guarantee are expanded to include ownership retention, financial lease, alienation guarantee and other atypical guarantees. Second, it clarifies the prioritisation rule of registration publicity and negates the priority effect of implicit guarantee in bankruptcy proceedings. Third, the mortgage of purchase price can be exempted from the restriction of prior rules of publicity under specific conditions. Fourth, it eases the binding force of the fluidity clauses and recognises its effectiveness as a guarantee measure. Fifth, it ensures that the buyer who operates normal business activities is not subject to floating mortgage and chattel mortgage restrictions. Sixth, it establishes the status that the surety and other joint debtors, after performing their compensatory obligations, obtain legal creditor's rights but are inferior to the creditor. These rules will have a direct impact on the determination of the creditors' rights sequence in bankruptcy proceedings.
Exploration of the personal bankruptcy system in Shenzhen city
The current bankruptcy law in China refers to the Enterprise Bankruptcy Law. The subject of this law is the legal body of the enterprise (including financial institutions), and organisations other than the legal body of the enterprise can refer to this law for bankruptcy liquidation. The legislation of natural person bankruptcy has been blank for a long time. In practice, however, business owners often run into financial troubles when their companies fail to repay their debts, as loans from various institutions often require personal guarantees from them, and even from their family members. At the same time, it is not unusual for individual consumers to become effectively bankrupt because of excessive debts. Whether out of the pursuit of the integrity of the bankruptcy legal system or the need to solve practical problems, the theory field and practice field are both full of expectation for the enactment of the personal bankruptcy law. In Zhejiang province, which has the most developed private economy, eg, in Taizhou and Wenzhou, the courts have begun a practical exploration of individual debt liquidation mechanisms.
On 26 August 2020, the Standing Committee of Shenzhen Municipal People's Congress passed Regulations on Personal Bankruptcy of Shenzhen Special Economic Zone, which is the first personal bankruptcy legislation in mainland China. The ordinance takes into account the following ideas:
Shenzhen's regulations will take effect on 1 March 2021, but experience and further study of the regulations are needed before the enactment of a national personal bankruptcy law, a process that could take years or more.
Exploration of the pre-packaged procedure
The pre-packaged system has the advantages of both out-of-court reorganisation and in-court reorganisation. In recent years, it has received a great deal of attention from practitioners and scholars. In the absence of written provisions, the pre-packaged solution is full of vitality and uncertainty. Article 115 of the Minutes of the National Courts' Civil and Commercial Trial Work Conference, issued by the Supreme People's Court in 2019, stipulates the convergence between out-of-court reorganisation and in-court reorganisation, and admits the effectiveness of out-of-court reorganisation agreements. This is an important basis of the pre-packaged solution. Courts in Zhejiang province, Nanjing, Shenzhen etc have also issued judicial documents on the pre-package. In the exploration of the pre-packaged procedure, the following issues need to be mentioned:
The formulating body and form of the pre-packaged plan
Should the pre-packaged plan be formulated by the administrator or the debtor? And what is the relationship between the pre-packaged plan and the reorganisation plan?
Several factors affecting the results of the pre-packaged procedure
It includes changes to the amount of debt, changes to the debtor’s property, the determination or withdrawal of investors, and changes in the debtor’s governance structure.
Recognition of the effectiveness of the pre-packaged plan
It is the convergence of pre-packaging and reorganisation. To admit the creditor’s approval of the pre-packaged plan in the reorganisation procedure, there are two necessary pre-conditions: the creditor’s consent is based on the full disclosure of information, and the content of the pre-packaged plan and reorganisation plan must be consistent.
In order to protect the procedural rights of creditors, their right to object to the modification of the pre-packaged plan and to object to the continuation of binding should still be maintained.
Cross-border insolvencies received attention during the implementation of the "Enterprise Bankruptcy Law (for Trial Implementation)" in 1986. After the 1997 Asian financial crisis, during the bankruptcy case of Guangdong International Trust and Investment Corporation, the Hong Kong court suspended the litigation case in the seizure order based on its discretion. It was the first time that the bankruptcy ruling of a Chinese court had been recognised outside the territory. In 2007, Article 5 of the Enterprise Bankruptcy Law realised the "ice-breaking" of the cross-border bankruptcy law in China. However, due to limited practical experience in cross-border bankruptcy, Article 5 only provides principle guidance.
At the end of 2019, the Hong Kong High Court recognised and assisted in the implementation of the bankruptcy of Huaxin International Group Co., Ltd., accepted by the Shanghai Third Intermediate People's Court. This was only the second time that Hong Kong had recognised and assisted in bankruptcy procedures in the mainland. Soon after, on 26 May 2020, the Hong Kong High Court made a ruling, approving the bankruptcy proceedings of Shenzhen Nianfu Supply Chain Co., Ltd. under the designated bankruptcy administrator and carried out by the Shenzhen Intermediate People’s Court. At the same time, it issued an authorisation order for the administrator to perform their duties. It was the first time that the bankruptcy administrator had been allowed to represent the parent company to fully exercise the rights of the Hong Kong subsidiary.
Beside these cases, there are no significant cross-border bankruptcy cases in mainland China. However, the Supreme People’s Court and the National Development and Reform Commission have jointly expressed the need to improve the provisions for cross-border bankruptcy and affiliated enterprise bankruptcy, in order to promote the resolution of judicial problems such as cross-border bankruptcy and the bankruptcy of complex entities.
3. The Bankruptcy Practitioners
It has been 13 years since the Enterprise Bankruptcy Law 2007 came into effect. The bankruptcy law has received increasing attention not only from banks and state-owned companies, but also from private companies and entrepreneurs, who have gradually become aware of the bankruptcy risks of their own companies and the positive functions of bankruptcy proceedings. At the same time, bankruptcy practitioners, including judges and intermediary organisations, have also developed significantly.
The growth of bankruptcy professionals
Along with the more frequent acceptance of bankruptcy cases by the courts has come recognition of the uniqueness of bankruptcy trials and the professions involved. The number of judges has greatly increased in the last few years. Bankruptcy courts have been set up in Beijing, Nanjing, Shenzhen, Shanghai, Hangzhou, Wenzhou, Qingdao, Chongqing and other large cities one after the other, where the courts exercise centralised jurisdiction over bankruptcy cases.
The establishment of administrators’ associations
Bankruptcy administrators have also strengthened their team through certain measures. The most noteworthy aspect has been the establishment of administrators’ associations in many cities. In 2019, administrators’ associations were mainly established in areas with more bankruptcy cases, but the number of associations quickly grew in 2020. By 30 September 2020, 94 administrators’ associations had been established, 11 of them at provincial level, 80 at prefecture level, and three at county level. Except for Hainan, Yunnan, Shaanxi, Inner Mongolia, Xinjiang and Tibet, all the other provinces have established administrators’ associations at different levels.
The functions of these administrators’ associations in the various regions are slightly different, mostly including promoting inter-industry communications and formulating professional guidelines. In addition, some administrators’ associations have assumed the management function of members. Taking Zhejiang province as an example, the administrators' association co-operates with the courts to implement dynamic management of its members and plays a role in pre-job training, daily training, assessments of individual cases and annual assessments.