Bankruptcy law to protect China
investors By Olivia Chung
HONG KONG - China's new
corporate-bankruptcy law, which came into effect
this month, will strengthen protection for foreign
investors in the country, as it provides a stable
legal environment for dealing with problematic
investments through insolvency or restructuring
proceedings. However, experts say the bankruptcy
law still has some inadequacies that need to be
addressed.
As China moves closer to
becoming a "socialist market economy" from a
"socialist planned economy", it has improved its
investment environment for
domestic and foreign investors. However, many
foreigners have been worried about investing in
China because of the lack of a legal framework
that can protect their interests if debtors
default.
To rectify this problem, the new
law, which was passed last August after 12 years
of drafting and deliberation, offers guidelines
for failed businesses seeking to declare
bankruptcy. Besides, it brings China's bankruptcy
system more in line with international practices
by giving creditors greater protection.
The precursor of this law was formulated
in 1986 on a test basis and was only applicable to
state-owned enterprises (SOEs). But the old
bankruptcy rules have long been criticized for not
giving creditors enough protection, allowing
laid-off workers to be paid before creditors
because of the government's concerns about
provoking social unrest.
According to the
State-owned Assets Supervision and Administration
Commission, a total of 3,658 loss-making SOEs went
bankrupt between 1994 and 2005, and all were
administered by the government. The SOEs closed
with the assistance of government subsidies. In
2006, the central government set aside 33.8
billion yuan (US$4.4 billion) to help bankrupt
SOEs settle with laid-off workers.
About
2,000 SOEs declaring bankruptcy by this month can
be closed under the old rules.
The new law
states that secured assets will belong to secured
creditors. It also follows the international
practice that anyone, including the debtor
company, can file a bankruptcy claim.
Ted
Osborn, a Hong Kong-based business recovery
services partner at international accounting firm
PricewaterhouseCoopers (PwC), said the new law
demonstrates China's acknowledgement of the
importance of bringing its bankruptcy regime in
line with those in more developed jurisdictions.
He said that if the new law is applied
consistently across the country, it should give
some comfort to foreign parties investing in
China.
"The main benefit of the new law to
foreign investors is that it provides them with
some clarity on what the endgame will be should
the investment get into difficulty," said Osborn.
Osborn said that as China was in essence
starting from scratch when it created its new
bankruptcy law, it could incorporate the best
elements from such laws of other jurisdictions.
"Take, for example, the new law's
provision of a third-party administrator to
oversee the bankruptcy or reorganization process,"
said Osborn. "The concept of administrators was
likely taken from UK legislation. But a criticism
of the UK law is that there is no provision for
management to oversee a reorganization of a debtor
enterprise - like the debtor in possession
provision found in Chapter 11 of the US bankruptcy
code. The new law provides the best of both
worlds, as either the administrator or the debtor
can take control of a debtor company and oversee
its affairs - the creditors get to decide which
path they prefer."
However, Osborn said
the real test and challenge still lie ahead.
"Due to China's lack of local experienced
insolvency practitioners and judges [especially in
some rural provinces], it may take some time
before the new law can be implemented smoothly and
consistently across China," he said. "The success
of the new law will ultimately be measured by the
cumulative outcomes of its implementation, and
this remains to be seen."
He said he does
not think there will be a significant increase in
the number of companies filing for bankruptcy in
China as a result of the new law, simply because
it is new and untested.
"I suspect the
first companies to be placed into bankruptcy will
be ones where a creditor has initiated the
application after it has exhausted all other
consensual options," he said.
However, Li
Shuguang, one of the drafters of the new law and a
professor at the China University of Political
Science and Law in Beijing, told Asia Times Online
that the number of bankruptcy claims filed will
increase in the coming years, as some companies
will not apply for bankruptcy until the new rules
are applied.
The new law applies to all
types of enterprises, including private firms,
SOEs, financial institutions and foreign-invested
companies, so the number of bankruptcy filings
will be higher than last year's 6,000, he said.
The peak number of bankruptcy filings in
the country was 20,000 in 2003, close to the
figure for 2002, Li said.
Li also said the
new law has some inadequacies and it will take
time to improve it. One of its shortcomings is the
lack of provision for personal bankruptcy.
"Corporate-bankruptcy law and
personal-bankruptcy law [are] the basis of the
overall credit system of a market economy, so the
bankruptcy law in China now is incomplete," he
said.
"Given the increasing number of card
slaves, property loans and the funds flowing into
the stock market, a personal-bankruptcy law is
needed to provide an orderly exit for individuals
trapped in debt and strengthen protection for
creditors," he said. "As scholars, we are now
talking about the need to press forward in the
implementation of complete bankruptcy laws."
Li also said the new 12-chapter,
136-article bankruptcy law in China is simple when
compared with the bankruptcy laws of some mature
market economies, so the country needs time to
improve the law.
"The new law lacks
sufficient detail and depth in some aspects; for
example: the relations [among] creditors, debtors,
employees and employers. It will take time for
detailed rules and procedural guidelines to be
made," he said.
Olivia Chung is
a senior Asia Times Online reporter.
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