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The centenary celebration of the first ever law on bankruptcy in China (1906) is aptly met with the birth of the fist bankruptcy law in the PRC in 2006. In the past, China has not had a unified bankruptcy law. The 1986 Enterprise Bankruptcy Law had an unstable foundation; it was then put on "trial implementation". The significance and impact of the 1986 Law was the cultural, ideological and conceptual breakthrough of the Chinese tradition, and in a communist regime, permitting bankruptcy of stated-owned enterprises SOEs. The 2006 Law puts bankruptcy firmly as a centre piece of legislation in modern-day China. It took a little less than 10 years for the 1986 Law to have answered the question "How can a SOE, effectively the State, be bankrupted?" It took 12 years to answer the question, among others, of "How are employees to be dealt with in a bankruptcy?" The latest round of legislation produced a first draft law in June 2004 (1st Draft), followed by the second draft in October 2004 (2nd Draft). The 2006 Law was promulgated by an Order of the President of the PRC made on 27 August 2006, and will take effect on 1 June 2007. The PRC is now set to put in practice a new bankruptcy regime that will shape the investment climate and play a crucial role in maintaining investor confidence. The 1986 Law has six chapters and 43 articles, as supplemented by the "Opinion of the Supreme People's Court on Several Issues in the Implementation of the Law of the People's Republic of China on Enterprise Bankruptcy (Trial Implementation)"
(最高人民法院關於貫徹執行<中華人民共和國企業破產法(試行)>若干問題的意見)
issued in 1991 and the "Rules of the Supreme People's Court on Several Issues About the Hearing of Enterprise Bankruptcy
Cases" (最高人民法院《關於審理企業破產案件若干問題規定》)
issued in 2002. The 2006 Law has 12 chapters and 136 articles. It should be noted that not all of the provisions in the 1991 Opinion or the 2002 Rules have been incorporated into the new law. Comparison of key provision
A snapshot comparison of some of the key provisions in the 1996 Law and the 2006 Law is discussed below. Where appropriate, the major changes between the 1st Draft, the 2nd Draft and the 2006 Law are also discussed. In many respects, the 2006 Law is similar to the 2nd Draft. 
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Purpose of the Law
From the opening lines of the 2006 Law, it is clear the purpose of the law has changed significantly following some 20 years of PRC reform from a "socialist planned commodity economy" to a "socialist market economy". The 1986 Law focuses on "economic reform", "improvement", "promotion" and "strengthening", whereas the 2006 Law focuses on "regularisation", "fairness" and "equity" in the handling of bankruptcy proceedings. It is thus clear that the 2006 Law is meant to be the answer to a whole host of questions that have arisen through the initial 18 years (i.e. phase 1, 1988 - 2006) of the practice of the 1986 Law. The PRC will enter phase 2 of the bankruptcy regime in June 2007.
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Basis and scope of application
In the old days, the 1986 Law was primarily applied to SOEs only.
With the recent rapid reform in China, the 1st Draft of the new bankruptcy law has extended its application from SOEs to include
"enterprise legal persons; partnerships and their partners; sole proprietorship and their business owners, other profit-making organisations which are established in accordance with the PRC law and natural persons engaging in business activities".
Yet, a provision in the 1st Draft states that the State Council will prescribe what happens in relation to the bankruptcy of SOEs. There is no doubt that this provision was drafted deliberately to cater for SOEs which are still heavily laden with historic government "policy loans". The 2nd Draft and the 2006 Law demonstrate the complete about-turn in thinking that has taken place since the 1st Draft was written. The 2006 Law brings the entire SOE sector back within the scope of the new bankruptcy law by making an exception for specific SOEs which are currently subject to "policy bankruptcy" under a State Council stipulation. It is expected that these "policy bankruptcy" arrangements will involve about 2,000 ailing SOEs which need to be "bankrupted" or "restructured" under the "Capital Structure Optimisation Programme" (CSOP)
(優化資本結構計劃)
by 2008. All other SOEs are supposed to fall under the new law. The 2nd Draft also brings a major change in the scope of application of the new bankruptcy law. Partnerships and sole proprietorships are no longer subject to the new law. Yet, the 2nd Draft states that the applicability of the draft bankruptcy law to partnerships and sole proprietorships shall be prescribed by the relevant laws. As this is another conceptual breakthrough for the PRC, it may need some time to introduce partnership bankruptcy as well as individual bankruptcy in the next phase of bankruptcy law reform.
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Eligibility for bankruptcy
Under the 1986 Law, a debtor may be bankrupted by reason of its "serious losses due to mismanagement"; it may be subject to a petition for bankruptcy by its creditors if it is unable to pay its matured debt under a "cash-flow" test or it may apply for its own bankruptcy with permission and approval from its supervising body. The grounds for bankruptcy were not clearly defined. This has caused uncertainty over their applicability.
The 2006 Law introduces the concept of the "balance-sheet" test. The 2006 Law enables a debtor to be petitioned for bankruptcy by its creditors if:
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it cannot meet its obligations for repayment of debts due ("cash flow" test) and |
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its assets are less than its liabilities ("balance sheet" test) or |
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it is obviously unable to repay its debts.
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The 2006 Law breaks with the provisions of the 1986 Law, which requires approval from the supervisory body of the SOE in question before bankruptcy proceedings can be initiated. Under the 2006 Law, any enterprise may file a bankruptcy petition directly to the court.
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Cross-border insolvency
Although the PRC has not adopted the UNCITRAL Model Law on cross-border insolvency, the 2006 Law includes provisions for dealing with both "inbound" and "outbound" cross-border insolvency.
The 1986 Law requires the liquidation committee to recover the debtor's assets which are located outside of the PRC. The 2006 Law is now universal in application and bankruptcy proceedings initiated under that Law have extra-territorial effect on the debtor's assets outside of the PRC. Given its potential effect on parties that are not ordinarily subject to the PRC laws, it will be interesting to see how the PRC authorities ensure compliance with the new law.
When confronted with an "inbound" cross-border insolvency, the 2006 Law goes on to provide that an application or a request may be made to a PRC court for the purpose of recognising and enforcing any order or ruling in any bankruptcy proceedings legitimately made by a court outside of the PRC against assets in the PRC. The PRC court will recognise and enforce any such orders in accordance with terms of any relevant treaties or international agreements between the country in question and the PRC; or on grounds of comity on a reciprocal basis, provided that such recognition and enforcement:
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will not contradict the basic principles of the PRC laws; |
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will not violate the sovereignty, security or public interests of the PRC; or |
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will not impair or prejudice the legal interests or rights of creditors in the
PRC.
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It is expected that much legal argument will arise in the PRC courts as to what the legal interests or rights of creditors in the PRC are and how they rank with those of foreign creditors over assets in the
PRC. |
In Part Two, we will continue to look at other key provisions with reference to the creditors' committee, reorganisation
(重整), resettlement of employees, bankruptcy offences and - something of more interest to international professionals - the new concept of the office of an administrator.
anita.so@gthk.com.hk
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