This content is from: Local Insights

Enterprise Bankruptcy Law

John J RapisardiBinghao Zhao

China's Enterprise Bankruptcy Law (EBL) is coping with business failures as the recession progresses. In the case of very large companies, the EBL has begun to have some impact and prevented complete chaos from taking hold. The EBL also makes China the first Asian country to adopt a US-style bankruptcy regime. Like Chapter 11, the EBL treats local and foreign creditors equally and creditors with security over the entity's assets enjoy a priority status in repayment to the extent of the secured collateral. Previously, the Enterprise Bankruptcy Law of the People's Republic of China (For trial implementation) – which was in existence prior to the enactment of the EBL – focused on liquidating assets and lumped all creditors together, putting them behind employees and most unsecured domestic claimants.

Moreover, the EBL, shares many other features with Chapter 11 of the US Bankruptcy Code: filings can be voluntary or involuntary; the law favours a debtor-in-possession (Dip) structure; it also favours reorganisations over liquidations; it has preference and fraudulent-transfer provisions; and it has features for creditors to file proofs of claim and receive distributions.

The EBL recognises two well-developed principles of bankruptcy law: equality of treatment of creditors and providing a fresh start to a beleaguered debtor – which are shared by the US Bankruptcy Code. However, the process to recognise and establish these principles is controversial. Not long ago, notwithstanding certain statutes, labour claims took priority over secured claims in practice. Such arrangement, if tolerated and accepted by the Enterprise Bankruptcy Law, would have negated the fundamental principle of equality of treatment among similarly situated creditors. Moreover, the Enterprise Bankruptcy Law of the People's Republic of China (for trial implementation) failed to afford the honest debtor a fresh start through bankruptcy relief by not offering the reorganisation option available to the debtor. After more than two decades of debate, Chinese lawmakers eventually realised that bankruptcy law which embodied the principles of equality of treatment and fresh start was required in the public interest and for the welfare of the country at large.

Interestingly, total bankruptcy filings in China decreased 4.4% in 2009 from 2008 (about 3000 versus 3139), according to data released from the Supreme People's Court and Bankruptcy Law and Restructuring Research Centre of China University of Political Science and Law. Many Chinese enterprises avoided filing a bankruptcy petition when they planned to wind up their business. Specifically, they either filed for deregistration without going through bankruptcy liquidation or simply exited the market after their licenses expired and were revoked without filing for deregistration. This is the primary reason for bankruptcy filing rates decreasing in 2009.

However, the EBL is being tested – initially in the case of very large companies, such as East Star Airlines, FerroChina, and Sanlu Group. In the long term, it will continue its evolution, within its own unique setting, of whatever US-based principles it chooses to adopt for the present.

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