China's New Bankruptcy Law: A Legislative Innovation

China's much anticipated PRC Enterprise Bankruptcy Law will come into effect on June 1 2007, 12 years after the draft was first tabled. The new law is a compromise, aiming to protect both creditors and employees of insolvent companies, and complies with international practices to provide local and foreign investors with a more stable legal environment.

By Eu Jin Chua*, Clifford Chance, Beijing

After over a decade of consideration and consultation on drafts, China has introduced a new bankruptcy regime for enterprises. On August 27 2006, China's highest legislative body, the Standing Committee of the 10th National People's Congress (NPC), adopted the PRC Enterprise Bankruptcy Law (中华人民共和国企业破产法) (Bankruptcy Law), which will become effective on June 1 2007. The Bankruptcy Law will replace the PRC State Enterprise Bankruptcy Law (Trial Implementation), which was promulgated in 1986.1

As with a majority of PRC legislation, the Bankruptcy Law's effectiveness will very much depend on how it will be implemented and enforced at the provincial level. There are numerous innovations in the Bankruptcy Law, for instance, the introduction of mechanisms for corporate rescue and the appointment of an administrator to provide professional management of a troubled enterprise. However, there still are procedural idiosyncrasies and ambiguities that may, at least for private creditors, render it difficult to rein in debt-laden enterprises. The success of the new law also depends on the availability of sophisticated bankruptcy practitioners and the courts, as both will need to gain expertise in a new area of law.

Scope of application

Unlike the existing regime (or regimes), the Bankruptcy Law's bankruptcy procedures are applicable to both state-owned and privately held companies (including those with foreign investment). However, although previous consultation drafts of the Bankruptcy Law sought to extend the bankruptcy regime to partnerships and sole proprietorships, it appears that concerns over the availability of judicial resources and an immature credit-based economy have resulted in their exclusion. An individual or personal bankruptcy regime remains non-existent in the PRC.

The Bankruptcy Law provides an exception to the strict applicability of the Bankruptcy Law to financial institutions such as banks and insurance companies (Article 134). The failing of such organizations may render an economy susceptible to systemic risk and the Bankruptcy Law allows the relevant authorities to take action either under the Bankruptcy Law or other laws.

The Bankruptcy Law also recognizes China's transition from a command economy, by permitting the bankruptcy of a state-owned enterprise (SOEs) to be administered by an administrative fiat, also known as 'policy bankruptcy' (Article 133).

Commencing bankruptcy proceedings

The Bankruptcy Law contemplates three different procedures comprising of liquidation, reorganization (or restructuring), and compromise (or conciliation).2

A procedure is commenced by the court's 'acceptance' of an applicant's application. However, mere filing of the application with the court will not suffice. The court's acceptance of the application gives rise to a moratorium against litigation and enforcement proceedings against the debtor (Article 19). Generally, pursuant to Article 10, the court has to decide whether or not to accept the application within 15 days of its filing. Meanwhile, the debtor is provided with an opportunity to oppose the application.

It seems that the court is given discretion as to whether or not to accept an application. An applicant is also afforded the opportunity to challenge the court's decision not to accept the application (Article 12). However, in practice, there is a third possibility