Bankruptcy Reform: China a Safer Bet

By Fisher, Kevin B. | American Banker, April 8, 2005 | Go to article overview

Bankruptcy Reform: China a Safer Bet


Fisher, Kevin B., American Banker


Bankruptcy in China often seems more like a melee than a systematic process. That may soon change under China's proposed new bankruptcy law.

The law will incorporate a Chapter 11-like reorganization concept similar to that used in the United States and will modernize China's bankruptcy code to comply with World Trade Organization requirements.

For U.S. banks and other foreign investors involved in or considering opportunities in one of the world's fastest-growing economies, this reform should be a giant step in improving their confidence.

China's current bankruptcy law can charitably be described as incomplete, inconsistent, and opaque. The rules currently do not apply to all entities throughout the country, and they grant creditors very few rights in bankruptcy proceedings and no effective mechanism for enforcing contractual obligations or protecting their interests.

Though not yet finalized, China's new PRC Enterprise Bankruptcy and Reorganization Law (which may take effect as soon as June) will address many of these problems and more closely mirror the laws of many developed countries.

First, with limited exception, it will apply to all types of business entities, including State Owned Enterprises (SOEs), non-SOEs, and foreign invested enterprises. Second, it will a corporate reorganization concept similar to that in Chapter 11 -- a clear departure from current rules, which focus on liquidation as the sole mechanism for dealing with a bankrupt enterprise. Below are some of the provisions most relevant to U.S. banks.

Bankruptcy initiation. The proceedings will now be initiated with an application to the court -- not by formally obtaining prior government approval.

Causes for filing. While the Chinese government traditionally viewed mismanagement as the primary reason why a company failed, the new law recognizes that an enterprise may encounter financial difficulty for numerous reasons, including changing market factors. Thus the proposed law defines bankrupt entities as those that do not have sufficient assets to pay off all liabilities, or cannot pay off debts when they become due. This definition closely corresponds to the balance-sheet and cash-flow insolvency tests in the U.S. Bankruptcy Code.

Administration of debtor. Under the current rules, the liquidation and disposition of a debtor's assets are put under the management of a court-appointed team of government officials, many of whom are typically local officials. According to critics, this has led to many instances of local favoritism or protectionism. …

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