Brief report on bankruptcy litigation in the Chinese courts

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Declaration of bankruptcy meeting of Guangdong company

The soft Chinese economy means that an increasing number of Chinese companies are in financial difficulties.  But, according to the Supreme People’s Court, the number of bankruptcy cases have been decreasing rather than increasing, with over a thousand cases accepted nationally in 2014.  Earlier this fall, the All China Lawyers Association held a conference for its bankruptcy practitioners, to which were invited the head of  #2 Civil Division of the Supreme People’s Court, Judge Liu Min (principal author of the bankruptcy law judicial interpretation),  KPMG partner, Cao Chunye, SASAC officials, and others.  What more can be said about the decrease in cases, why the decrease in cases and what is the Court doing about it?

Some Statistics

According to a 2014 Court study by Ma Jian of the Court’s Research Office, from 2003-2012, the Chinese courts accepted about 40,500 bankruptcy cases, decreasing an average of 12.23% a year, only increasing in Henan and Tianjin, which Ningxia, Hunan, Hebei, and Qinghai decreasing at a rate of 20% a year or more. In almost 70% of cases, the debtor company applied for bankruptcy, with only 30% creditor initiated.  The Court analysis was that creditors didn’t have a clear picture of the business operations of their creditors, or still believed that the debtor would be able to repay, or believed that because asset recovery in bankruptcy was so little, they did not want to bother initiating bankruptcy. Practically all the companies in bankruptcy proceedings were domestic companies, with 55% state owned companies, 26% collectively owned. Almost half of the cases took a year or more to resolve.

Why?

Ma Jian set out the following factors:

  • In a Chinese bankruptcy, the judge has more of a societal function than legal.
  • Most companies misunderstand bankruptcy law;
  • Local government interference in the acceptance, and trial of bankruptcy cases, with local governments closing down companies through administrative means, leaving unresolved debts and workers who have not been resettled;
  • Many obstacles stand in the way of realizing assets: 1) many companies in financial trouble have old equipment that is not worth much on the market or no one appears at the auction; 2) many SOEs occupy allocated land (land given by the government for free), and when the government takes possession of the land, it is impossible to sell the buildings on the site; 3) some companies use collective land, so that only other collectively owned entities can purchase the buildings built on the land.
  • It is very difficult to recover bankruptcy assets.  The debts are generally very old, and often times the statute of limitations has expired; additionally it is often difficult to find company debtors;
  • Resettlement of workers, is the primary issue to be considered in a bankruptcy case, particularly with the social safety net in such a fragile situation (according to Ma Jian).
  • Additionally, reorganization is very difficult to do, with multiple government approvals, difficulties in obtaining creditor agreement, difficulties in changing a company’s line of business, etc.
  • KPMG partner Cao Chunye highlighted the unfavorable tax treatment of companies in bankruptcy restructuring;
  • As to why courts do not want to accept cases, Ren Yimin of the All China Lawyers Association Bankruptcy and Restructuring committee mentioned that a bankruptcy of private company may cause a chain of other companies to fail, and it is difficult to resolve a chain of linked cases.

Measures

Some of the many measures under consideration or being explored include:

  • Moving bankruptcy cases out of the local courts where the company is located, to centralize jurisdiction in certain courts;
  • Making it easier for creditors to switch from enforcement proceedings to bankruptcy;
  • Improving the system for bankruptcy administrators.;
  • Looking to have a fast track system for small cases;
  • Exploring better restructuring systems.
  • Looking to foreign law, particular US bankruptcy law, for concepts that could be used to improve the bankruptcy system.

(Those with a greater interest in this topic can review this law review article–in the current situation, this area of law deserves closer attention by concerned professionals than it is currently receiving.)

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