All You Need to Know about Restructuring in China
This article outlines the regulations in China regarding bankruptcy and insolvency; Xiuchao Yin is globally recognised for his work in this exact area, and this month he speaks about options available for businesses, local and foreign, when undergoing financial issues in China.
He summaries the reorganisation process and vital documents businesses ought to be compliant with during such a process.
When companies first show signs of entering bankruptcy, what options do they have in China?
Where an enterprise is unable to repay the interests of commercial bank credit as they become due, this generally shows a significant sign of the enterprise beginning to enter bankruptcy.
When an enterprise commences to irrationally request upstream producers to increase margin and delay settlements with various reasons, or request the downstream producers to shorten payment terms and delay the process of providing the service and goods, as well as commences to cut employee salaries and reduces investment in strategic projects, it is often a sign showing the enterprise is insolvent.
Enterprises in China usually opt to repay original loans by taking out new loans with higher interest rates and get financing by accepting real estate mortgage rates that are much higher than the average rate in the credit market; they also opt to take loans from the private sector, also with a higher rate, until the enterprise is unable to pay off any more. Actually, an increasing number of enterprises tend to get out of the circumstance by filing bankruptcy application within ten years, ever since the implementation of Enterprise Bankruptcy Law in China.
What regulations/documents must the debtor be compliant with, when regarding securities?
Based on the regulation of the Enterprise Bankruptcy Law, Company Law and Contract Law in China, any of the following acts involving debtors’ assets shall be declared invalid within one year before the acceptance of a bankruptcy application by the Court, including:
- Free transfer of assets;
- Transaction committed with a clearly unreasonable price;
- Security provided for non-secured debts;
- Prepayment of debts as they are not due;
- Waiver of creditor’s rights.
The act shall be valid where the debtor pays off any individual creditor within the last six months, before the Court accepts the bankruptcy application.
A better option than the aforementioned reorganisation process is to implement pre-reorganisation outside the Court.
On the other side, is there anything creditors can do to secure recovery of any outstanding debt?
During the procedure of bankruptcy, in order to recover the asset under a pledge or a lien, the debtor shall agree a debt settlement or provide a guarantee to the creditor. The value of assets under a pledge or a lien is lower than the value of the debt that is guaranteed; it shall be calculated according to the market value of the asset at the time of pledge or a lien. Where the administrator recover the collateral, it shall report to the creditors’ meeting.
Security rights on specific assets shall be suspended during the reorganisation period. In the case that there is a possibility of damage or reduction in value of the collateral, which threatens the interest of the security holder, the security holder may apply to the Court to resume the right of the security interest.
In addition, secure creditors participating in the creditors’ meeting have their own group to vote on the draft restructuring plan. To resolve the draft restructuring plan, the secured creditor shall settle in full over the security interests on specific assets and the damage due to deferred payments shall be fairly compensated, as long as the security interests are not substantially damaged.
During the procedure of bankruptcy, secured creditors shall pay attention to preserve and improve the value of collateral, and unsecured creditors shall apply to the Court for bankruptcy, in case of the loss of debtor’s assets and illegal settlements.
Can you summarise the restructuring process for businesses? What requirements are needed for reorganisation?
Based on Article 70 of Bankruptcy Law, the following subjects are entitled to apply for reorganisation:
- A debtor or a creditor may directly file a reorganisation application to the Court;
- A creditor that files an application of liquidation of the debtor after the acceptance of the Court, but before the declaration of bankruptcy; the debtor or shareholders whose contribution represents 1/10 or more of debtor’s registered capital may file a reorganisation to the Court.
In the reorganisation period, where the Court approved the debtor’s application, the debtor may manage its assets and business under the supervision of the administrator. Under this circumstance, the administrator who has taken over the debtor’s assets and business, shall transfer the assets and business to the debtor.
The administrator or the debtor shall simultaneously submit a draft restructuring plan to the Court and at the creditors’ meeting within six months from the date of the Court’s rule for reorganisation. Where the period has expired, the debtor or administrator may apply for a three-month extension. The Court shall convene a creditors’ meeting for voting on the draft restructuring plan within 30 days from the date of receipt of the draft restructuring plan. If more than half of creditors presenting at the meeting in the same voting group approve the plan and the rights of such creditors represent 2/3 of the creditors’ rights in the group, the draft restructuring plan shall be approved by the group.
The debtor and administrator shall apply for Court approval of the draft restructuring plan within ten days from when the plan was passed. The Court shall make a ruling whether to approve the plan within 30 days from the date of receipt of application; if approved, the restructuring procedures shall be terminated.
The director, supervisor or senior manager who violates the duties of loyalty or diligence, which results in the bankruptcy of enterprise, shall bear civil liability.
Moreover, can you summarize the insolvency process, and when this is a better option than the aforementioned restructuring process?
When a creditor files a bankruptcy application, the Court shall notify the debtor within five days, whereby the debtor may raise the objection to the Court within seven days from the date of receipt of notification. The Court shall make a rule regarding whether to accept the bankruptcy application within 10 days from the date of expiration of the objection period. Under special circumstance, an extension of 15 days shall be approved by the higher-level Court.
The Court shall deliver the notice to the debtor within five days from making the ruling. The debtor shall then submit a statement of status of its assets, a list of its creditors’ rights, a list of its debts, the financial and accounting reports and the statements of payment of staff wages and contribution of social security premium.
Where the Court rules against the acceptance of application, it shall notify the debtor within five days from the delivery of the ruling. The applicant is entitled to submit an appeal to the higher-level Court within 10 days from the delivery of the rule.
The Court shall notify all known creditors and make an announcement within 25 days from the date of acceptance of application ruled by the Court. After the announcement, the administrator shall dispose assets based on the resolution passed by the creditors’ meeting.
A better option than the aforementioned reorganisation process is to implement pre-reorganisation outside the Court. In the case of a large number of creditors and complex circumstances, a bankruptcy liquidation procedure shall be firstly implemented and then an application may be made from the liquidation procedure to reorganisation procedure, which could break through the time limit of reorganisation.
Are Partners of a company or organisation ever liable for the debtor’s financial situation?
The director, supervisor or senior manager who violates the duties of loyalty or diligence, which results in the bankruptcy of enterprise, shall bear civil liability. The aforementioned personnel shall not serve as a director, supervisor and senior manager within three years from the termination of the bankruptcy procedure. Actually, there are little even no cases that such personnel bear civil liability in practice.
Can you share more on how the reorganisation process changes when a foreign entity is involved?
The bankruptcy law regulates judgments or the rulings of a bankruptcy case that affects debtor’s assets within China’s territories, so China’s Court shall make a judgment or rule of recognition and enforcement based on the international treaty China has concluded, or principle of reciprocity, where the application does not violate the basic principles of law, damage national sovereignty and security, public interests and impair the legal rights of creditors within China. In practice, China adopts more open and friendly policies; it recognises and enforces the foreign judgment and rules, although there is neither reciprocity nor bilateral agreements between the respective overseas country and China, even no recognition for judgments or rules made by China’s Court.
In addition, foreign investors involved in the bankruptcy procedure shall be treated equally. Due to language barriers, preparation time for litigation would be given for overseas subjects.
Are there any regulatory changes on the horizon, which will impact the bankruptcy and restructuring sector?
The Chinese government is implementing supply-side reforms and disposing zombie enterprises, which make the Bankruptcy Law play an increasingly significant role in the process of cutting excessive capacities. Based on the guidance of the “Doing Business” report, the Chinese government is carrying out reforms on the recovery rate of creditor’s rights and the rate of the bankruptcy framework strength, which will strengthen the support for bankruptcy practices and adopt special policies for tax and debt-to-equity swaps.
Bankruptcy law amendments have been listed in the legislation plan of the 13th China National People’s Congress and the regulation of Bankruptcy law for individual’s bankruptcy is in discussion. In addition, the Chinese Court system is pushing forward the establishment of Bankruptcy Court, and extends the acceptance scope of bankruptcy cases. Moreover, the Court in China has set rescue funds for bankrupt enterprises, has established platforms for releasing bankruptcy information and discussed the establishment of administrator institutes.
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Xiuchao Yin, a Chinese lawyer with more than twenty years practice experience, serves as a Senior Partner in Dentons (Beijing Office) and has led the Insolvency, Restructuring and Disposal of non-performing assets teams in the Denton’s China office from 2015.