SHANGHAI - For China's program of economic reform, which sees the country
opening its doors to the outside world, its newly passed bankruptcy law has
twofold significance: to boost its credit market as it gives full access to
foreign lenders, and to deal a final blow to the "iron rice bowl" employment
system at its state-owned enterprises (SOEs).
Following its commitment to accession to the World Trade Organization (WTO),
China will fully open its banking sector at the
end of this year to foreign lenders, which will then compete with their Chinese
rivals on an equal footing. This will no doubt boost the development of China's
credit market. But such development requires a legal basis, and that is where
the new bankruptcy law comes into play.
The law, to be effective from June 1, 2007, gives creditors' claims top
priority when the debtors undertake the process of liquidation, which is more
in line with the international practice. This would certainly give foreign
banks some legal assurance when issuing yuan loans, particularly to SOEs.
In contrast, under the current regulation governing the bankruptcy of SOEs,
workers' interests would be given top priority. In other words, when an SOE
goes under, its assets, even those pledged for loans, are to be used to pay
workers' salaries and other benefits first, while the creditors can only get
what would be left. Such protectiveness of workers' interests reflects
Beijing's deep concern with possible social unrest caused by laying off SOE
workers. But under such circumstances, it is very unlikely that foreign lenders
would be willing to grant loans, even with guarantees.
In this sense, the law should also help boost China's market-economy status,
which is still not recognized by its major trade partners such as the United
States and the European Union.
"The successful enactment of the law could significantly improve China's
profile in the WTO, since the law will eliminate some concerns of foreign
investors by establishing a legal framework and market environment with
credibility, efficiency, assurance and expectation," said Li Shuguang, one of
the drafters of the law and a professor at Beijing's China University of
Political Science and Law.
Executives of domestic lenders, particularly the four big state-owned banks -
the Industrial and Commercial Bank of China, Bank of China, China Construction
Bank and the Agricultural Bank of China - will also applaud the new law. The
banks have had to dispatch "policy loans" on government orders to SOEs, and
they suffer badly when their debtors become bankrupt.
The four banks bear a crushing burden of bad loans that threatens the stability
of the institutions and China's financial system. The government has injected
huge amounts of capital to help them lower their non-performing-loan (NPL)
ratio ahead of opening the sector to foreign competitors. With government help,
Chinese banks' NPL ratio shrank by 4.2 percentage points by the end of 2005 to
8.6%, according to the China Banking Regulatory Commission.
One of the major purposes of the current bankruptcy law, which was enacted in
1986, is to rescue and improve the management of SOEs, not to let them go out
of business. How to readjust debtor-creditor relations in the process of
liquidation was not on the decision-makers' agenda. Therefore, bank creditors
can often only recover from the "bankrupt" SOEs 3-10% of the book value of
their loan.
Xie Ping, general manager of the Central Huijin Investment Co, the central
government's investment arm, which holds majority stakes in three of the big
four banks, has long criticized the lack of a real bankruptcy law to protect
creditors. "A good bankruptcy law can establish effective market constraints,
push enterprises to improve governance, and stick to the principle of paying
off obligations, as well as protecting the creditors' and debtors' rights."
Nowadays in China, most of the collateral creditors are banks. Because the
banks' claims are given a low priority, they became excessively cautious in
lending, resulting in a credit crunch on mid-sized and small enterprises.
From this viewpoint, the new bankruptcy law is expected to help boost China's
credit market. In this sense, it will also likely help foster the social value
of respecting credit, which is lacking in traditional Chinese culture.
The new law will apply to all sorts of companies, including listed and
non-listed companies, domestic and foreign companies, privately run or
state-owned, as well as financial institutions.
The law epitomizes the gradual nature of China's market-oriented economic
reform, which has largely centered on figuring out a viable way to close down
insolvent SOEs.
In theory, the current bankruptcy law also acknowledges that claims in
liquidation should be given priority. In practice, however, the priority has in
effect been subordinated by the so-called "policy bankruptcy", or bankruptcy
ordered and administered by the government, which trumps the protection of
creditors. The State Council stipulated in 1994 that even land owned by an SOE
pledged for loans can be used to pay off laid-off workers.
Since 1994, under the "policy bankruptcy", all assets of the bankrupt SOEs,
including guarantees and collaterals, have been literally used up to pay
laid-off workers. Sometimes the government subsidizes the bankruptcy if the
assets are not enough to cover such obligations. Along the way, the government
has been arranging the market exit of exhausted mining companies and big and
middle-sized SOEs under "severe difficulties". So far, two-thirds of such SOEs
have been closed down and 7.19 million workers laid off and "settled" by
governments at various levels. In coastal regions, most SOEs that need to go
out of business have made such deals.
At present, courts must get permits from the government before triggering the
bankruptcy process. The new law ushers in the professional "bankruptcy manager"
system in line with international business practice. Some analysts liken the
reorganization practice to that under Chapter 11 of United States Bankruptcy
Code.
Nevertheless, the new law is still a compromise between implementing an
international standard and concern over social unrest. Therefore, an additional
2,116 SOEs already lining up for "policy bankruptcy" will be allowed to enjoy
the "Last Supper" until 2008, exempted from the new law. The State Council has
this year set aside 33.8 billion yuan to help these SOEs settle with their
laid-off workers, which could number up to 3.51 million.
Under some "special circumstances", the priority will be given to workers'
obligations. The "caveat" addresses the interests of marginalized people during
the transition to a free-market economy.
Scott Zhou is a freelance journalist based in Shanghai.
