China's Enterprise Bankruptcy Law - Implementation of the Corporate Reorganization Provisions

Abstract

The passage of China's Enterprise Bankruptcy Law in 2006 was a landmark in the development of China's market economy; this Law was a significant advance on earlier legislation, such as the more limited 1986 Enterprise Bankruptcy Law (for trial implementation). The new law was passed despite concerns that the rigorous enforcement of this law might lead to social upheaval as a result of the unemployment of workers in China's inefficient and loss-making state owned enterprises. After a lengthy process of assessment of law reform options, the new Law introduced features that can be found in comparable bodies of insolvency law in other countries. Most importantly, it introduced a system of corporate reorganisation or rescue that can be traced back to Chapter 11 of the US Bankruptcy Code; such provisions had by then been widely adopted in other countries and were also to be found in the new UNCITRAL Legislative Guide on Insolvency Law.

This paper reviews these new rescue provisions and goes on to examine the degree to which they have been implemented in dealing with failing Chinese companies. This research reports on the relatively small number of rescue cases which have been considered by the courts in China since the passage of the 2006 Law; thus, of the less than 100 rescue cases heard by the courts, two thirds of these arose in only three provinces (Guangdong, Jiangsu and Zhejiang). Chinese insolvency practitioners and judges have complained that they have had considerable difficulty in assessing whether companies were suitable candidates for rescue. This study found that consideration by a court of a reorganization case is unlikely to occur unless the filing of the case is supported by local government in the province where the company is based.

A majority of companies seeking reorganisation are state owned; as a result, local governments are especially concerned about the local impact of the failure of a major company. Corporate reorganization cases can also involve a large number of disgruntled small creditors and, under pressure from local governments, normal insolvency pari passu principles have often been modified to allow for the repayment in full of these small claims. Shareholders are also often given special treatment in reorganization cases, despite the absolute priority rule which would normally place them at the end of the queue of claimants on the bankrupt estate. Fear of mass meetings of shareholders causing unrest has been one reason for the use of this strategy. Thus, in 48% of listed company reorganizations, the shares held by members of the general public retained their value.

Despite the broad-minded approach taken by China's legislators in passing the new 2006 Enterprise Bankruptcy Law, China's bankruptcy judges appear to have taken an extremely cautious approach to the implementation of the new law's reorganization provisions. This paper explores some of the reasons for this caution.

Keywords: Bankruptcy, Corporate Reorganization, China, Implementation

JEL Classification: G33, G34, G28, K22, H70