Representing one more step in a push to create a legal infrastructure, a new bankruptcy law took effect last month in China.
Twelve years in the making, the new law gives creditors a lot more cover – at least on paper – but its significance goes beyond the bricks and mortar of a bankruptcy process.
“All the laws in China are being updated,” said Ted Osborn, business recovery services partner at PricewaterhouseCoopers. “The Chinese government has placed a lot of importance on this new piece of legislation.”
Western countries with developed legal systems have long standing bankruptcy legislation and Chinese lawmakers borrowed from around the world to create a comprehensive law that has received positive reviews.
“It’s a very modern law. Very similar to the American bankruptcy code with elements borrowed from the UK system and others,” said Alan Grover, a partner at White & Case, an international law firm.
“This law replaces not just the absence of insolvency law in China but a very negative experience.”
“There is going to be an intense focus on whether the law will be applied credibly, reasonably and transparently or whether it is going to be, in a sense, a farce.”
The Standing Committee of the National People’s Congress adopted the law on August 27, 2006. Throughout 136 articles in 12 chapters it covers insolvencies at private businesses, state owned and foreign enterprises. Marking a major shift, the new law gives secured creditors priority over the assets of bankrupt companies. Workers are next, ahead of all unsecured creditors.
Certainly, the new law will clarify a very obscure approach to bankruptcies. With no dedicated legislation, judges have traditionally resisted dealing with bankruptcies and a lack of statistics makes it difficult to say how necessary the law is – there are certainly more than a few thousand bankruptcies every year.
“I used to think that since you didn’t read about it there were no bankruptcies in China,” Osborn said.
Recovery specialists like Osborn and bankruptcy lawyers have plenty of work and according to Derek Lau, national leader of reorganization services at Deloitte Touche Tohmatsu, the existing number may be a little skewed.
“China should have more bankruptcy cases,” he said.
The new law creates a clear process that allows both creditors and debtors to seek bankruptcy protection or a legally mandated reorganization. The process is dictated by the courts and supervised by a court appointed administrator.
And that is a development that could lend strength to the bankruptcy legislation or prove to be its Achilles heel. The courts have a disproportionate amount of say in the proceedings, the disposal of the assets and remuneration for bankruptcy administrators. It still remains to be seen how they handle this newfound authority.
Potential problems include the lack of experienced judges and different interpretations between courts in different places. The law provides a framework but questions of process and implementation still have to be sorted out.
“Certainly [the law] will have a lot of impact, the extent of which we don’t know” said Lau. “It’s quite early to tell.”
Judges are already being trained and the Supreme People’s Court, the country’s top judicial authority, is issuing opinions that may provide some uniformity.
One obvious issue is how foreign courts will react to decisions by Chinese courts. For example, would foreign jurisdictions accept judgments from a judiciary they see as corrupt or incompetent? This will become more pressing as Chinese corporations continue to invest abroad.
“A not-so-implied objective is to create a viable legal system that is not corrupt,” said Grover. “They have a huge country. They can’t declare transparency.”
Bankruptcy law: Key provisions
- Applies to state and privately owned enterprises
- It does not apply to SOEs made bankrupt before the law came into effect
- Debtors and creditors can initiate bankruptcy, reorganization and conciliation proceedings
- To start proceedings debtors have to show they cannot pay debts and have insufficient assets or ability to pay
- Creditors only have to prove debts are not being paid
- Court-appointed administrator controls debtor's assets
- Secured creditors get priority
- Workers are next, ahead of unsecured creditors
- Investors holding more than one tenth of registered capital can apply for reorganization
