As recent blogposts  (and academic studies) have shown, Chinese bankruptcy courts have been acting as underused morgues rather than hospitals for ailing Chinese companies.  The Supreme People’s Court (SPC) anticipates major changes, because (as highlighted on this blog) the government has decided that a stake needs to be driven through the heart of zombie companies.

This blogpost will focus on the role that courts are to play in clearing up zombie enterprises.  But because the role of the courts in bankruptcy is linked to other government policies, it will also flag some significant ones that have not yet come to the attention of observers outside of China. It appears that behind the scenes, officials have been working on putting together the policy machinery to do so and that the process is ongoing.

In late February, the SPC convened a conference of bankruptcy judges and other officials on dealing with zombie enterprises in Hangzhou, Zhejiang Province, both to transmit the newest judicial policy on bankruptcy and to find out from local judges and other officials what the issues are.

Judge Du Wanhua, a senior SPC judge, has been designated to take the lead on bankruptcy law reforms. The location of the conference is intentional, because (as mentioned in an earlier blogpost), Zhejiang Province has been piloting new approaches to bankruptcy law. The Zhejiang Higher People’s Court has been working with government to promote bankruptcy related policies, but at the same time has emphasized that the courts need to hear cases independently. In 2015, the courts of that province accepted over 600 bankruptcy cases.

According to Judge Du, the “courts are to become hospitals for sick companies.” Listed below is the approach that the SPC is intending for the lower courts to take (with some of my comments).

• The courts should promote more bankruptcy reorganization and conciliation, and diminish liquidation cases (a contrast to what has occurred in recent years).  (The SPC has promoted this approach through recent reports promoting reorganizations by the courts and is continuing to promote this in its pronouncements. Local governments are adopting policies to promote reorganization of companies.)
• A market-oriented mechanism should be established which classifies zombie enterprises.  The mechanism should distinguish ones than can be saved through restructuring or conciliation procedures from the ones that should be liquidated.  The classification should fulfil the industrial development goals, targets, and other principles of the central government.  (But, Professor Liu Zhibiao, a leading economist suggested in a recent interview that it should the market to determine this, not government.)
• The rights and interests of the state, workers, creditors, and investors should be protected (listed in this order).
• A corporate restructuring bankruptcy information platform mechanism that uses modern information technology tools should be created to promote the greatest degree of success of corporate restructuring, and better use of economic resources.  (This is consistent with government (including SPC) policy promoting the use of information technology tools);
• A unified coordination mechanism for bankrupt enterprises needs to be created under the local Party committee’s strong leadership and support of the relevant government departments to ensure cases are handled in an orderly manner. (However, in the fall of 2015, Ma Jian of the SPC’s research office pointed to local government interference in the acceptance, and trial of bankruptcy cases, as being an major issue.
  • A local court judge writing recently described a judge’s role: “bankruptcy involves the vital interests of many people, and directly affects social harmony and stability. Thus the social dimension of bankruptcy cases determines that the court can not ” go it alone” in bankruptcy cases. Some local governments do not want companies to go bankrupt for statistical , performance, maintenance of stability and other considerations.  [According to Professor Liu, it can have a negative effect on the performance evaluation of local officials.] The court should actively seek the support of the local government where the debtor is located, to provide good placement of workers of bankrupt enterprises, payment of wages, disposal of plant or other fixed assets disposal.  By communicating with relevant departments, policy support can be provided to help pay taxes , apply for transfer [of property], coordinate the interests of creditors, debtors , investors, employees and others) ;
• Orderly mechanisms should be established to deal with wages, state tax, and the priority and realization of secured claims, unsecured claims.
• Local courts should establish bankruptcy divisions and provide bankruptcy judges with better bankruptcy law training;
• Procedures should be established to consolidate related bankruptcy proceedings in different courts;
• Procedures for bankruptcy administrators should be drafted and their status should be improved;
• Special funds should be established to pay for bankruptcies and bankruptcy administrators.

Related to this are the following government initiatives:

• Local governments, such as Guangdong, are starting to issue policy programs on “supply-side reforms.” The Guangdong program, issued on 28 February, contains a section on bankruptcy. The policies reiterate and further detail the principles Judge Du enounced (and merit further analysis).
  • The Guangdong policies mention separate databases for bankrupt state-owned and non state owned enterprises, mentioning that special policies would be forthcoming for state owned enterprises and that courts would be given the “green light” to deal with the bankruptcy of zombie companies. Reflecting policies seen elsewhere, the Guangdong government is seeking to encourage private enterprises to assist in reorganizing state-owned zombie enterprises and is considering establishing special funds to assist companies to upgrade.
• The central government is also looking to simplify procedures by which companies with no debts can be closed.  During 2015, the State Administration of Industry and Commerce announced that it was piloting reforms in a number of locations, first designating Shenzhen, the Pudong district of Shanghai, and several other locations, and subsequently expanded the locations.
• Training sessions on bankruptcy law, either within the courts or with related government agencies and institutions. In late February, the Changsha (Hunan) Intermediate People’s Court held a training session with experts from the SPC (First Circuit Court) and professors of bankruptcy law from Beijing, while the local government in Quanzhou organized cross-institutional training.
• Local courts (such as this one in Quzhou, Zhejiang Province) are providing reports to local government/Party Committees on what the courts can do.

But what are bankruptcy judges really doing?  If a recent message on Wechat is any indication, they are reaching out to their fellow judges for guidance and creating a chat group on how to deal with the many legal and social complexities that bankruptcy cases pose.

Can bankruptcy court “doctors” save zombie enterprises and their millions of employees?  It is very early days. What can safely be said is that bankruptcy and zombie enterprise related policies merit close monitoring by lawyers, the business community and others.