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Law of the People's Republic of China on Enterprise Bankruptcy

Redefining the Repayment Order to Attract More Foreign Investment

During a review of the draft of the New Enterprise Bankruptcy Law, the priority of real rights for security or employee creditor’s rights aroused heated arguments and got a lot of attention. One of the important issues was how to best remove obstacles to foreign investment in China.

In foreign countries, a real right to security is considered fundamental among all security assurances as the best way to protect a creditor’s rights, while in China, mortgages and other security interests are established as the main properties of bankrupt enterprises, thus the remaining properties cannot be used to repay debts of the employee creditors who are in the first order. This causes a conflict between employees’ interests and creditor’ rights. However, if the real rights for security lack guarantees and there are problems in equal repayments of creditors’ rights, the confidence of foreign investment in China will be greatly affected.

Articles 109, 113 and 132 of New Enterprise Bankruptcy Law offer a way to resolve the problem, which is called “time division.” On the basis of a prior repayment to the right owners who have real rights for security on specific properties, the New Enterprise Bankruptcy Law gives special and temporary consideration to the employee creditors’ rights arising before the promulgation of the New Enterprise Bankruptcy Law, that is, the employee creditors’ rights that cannot be satisfied before the bankruptcy is publicized, shall take priority in repayment before the specific property guarantors are repaid. That is to say, employee creditors’ rights arising after the promulgation of the New Enterprise Bankruptcy Law shall be repaid through non-guaranteed properties.

Establishing a Reorganization System

As with advanced international experience, an enterprise reorganization system was introduced into China for the first time. Chapter Eight of the New Enterprise Bankruptcy Law makes special stipulations on the application and censorship of applications, time periods, negotiations, approval and execution of plans. In the process of reorganization, creditors, creditor’s committees, supervisors and trustees in bankruptcy are involved.

Introducing a reorganization system is meant to forestall the bankruptcy of enterprises which faces difficulties but which can be saved and revived, rather than closing. At the same time, this system provides effective protection for the rights and interests of creditors, avoiding the abuses of reorganization procedures. Its special stipulations are as follows:

      At the time of application, Article 2 of the Law stipulates that creditors may apply for reorganization when encountering a debt crisis and are likely to bankrupt to avoid that end.

      The Law introduces the principle of protecting the minority and medium stockholders. Article 70 stipulates that not only creditors and debtors, but also the contributors whose financial contributions are worth more than 10 percent of the debtor’s registered capital and stockholders of the debtor, have the right to apply for reorganization.

      On the adjustment range, considering that under this reorganization system, it takes a long time to reorganize, and the procedure is rather complex. If it is applied to all sorts of enterprises, it will cost a lot, is likely to be abused in practice and to harm the rights and interests of the creditors. So it applies to business corporations only.

      On the protection of creditors, Article 78 stipulates that in case of the debtor’s worsening business，cheating, malicious acts to reduce the debtor’s properties or any other act that is harmful to the creditor, the people's court shall make judgments to terminate reorganization and declare its bankruptcy so as to avoid debtors’ (including suitable stockholders) abuse of reorganization procedures.

Introduction of Trustee System, New Role of Agents

A trustee system and reorganization system, based in international law, are introduced into this law, too. Article 13 of New Enterprise Bankruptcy Law stipulates that the people's court, when accepting a bankruptcy application, shall appoint a trustee at the same time. The trustee appointed has the right to “take over” or “supervise” the debtor.

On the qualification of the trustee, Article 24 stipulates that the trustees shall be social agents, such as liquidation teams consisting of members from related departments and organizations, law firms established by the law, accounting firms or bankruptcy litigation firms.

Special Consideration for Bankrupt State-Owned Enterprises Ends

Using bankruptcy processes to close down State-owned enterprises through policy began in 1994. The State provides special policies for such bankruptcy projects, including making special stipulations on the cognizance of bankrupt properties and orders of repayment, and even providing financial support.

However, except for some special matters concerned within a period and a range stipulated by the State Council before the implementation of New Enterprise Bankruptcy Law, the closing down of bankrupt State-owned enterprises via policy will come to an end. From now on, State-owned enterprises will have to follow the market-oriented dictates of the New Enterprise Bankruptcy Law.