Chinas New Bankruptcy Law Encourages Investment

Chinas New Bankruptcy Law Encourages Investment

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As this issue goes to press, China experts are reporting that the Standing Committee of China's National People's Congress has just adopted a new bankruptcy law, which will become effective June 1, 2007. This new law represents an enormous step forward in aligning China with international legal standards. By offering creditors more protection and an improved legal infrastructure for dealing with insolvent companies, it provides new incentives for foreign investment.

Currently, the principal focus of China's bankruptcy law, which is applicable only to state-owned enterprises (SOEs), is liquidation. Further, current Chinese law mandates that claims of employees of insolvent companies have priority over creditors' claims.

Media reports on the new law have highlighted several new approaches that will facilitate commercial growth. The new bankruptcy law, like its earlier drafts, is largely modeled after the U.S. chapter 11 and introduces its brand new reorganization mechanism. Translation of the concepts and terminology of U.S. law to Chinese practices will undoubtedly present challenges to implementation. However, several new approaches in China's new bankruptcy law are expected to facilitate restructuring and market exit of insolvent businesses and promote commercial growth.

First, the new bankruptcy law reportedly addresses the limitations in current law by extending coverage from SOEs to privately owned companies and generally requires debtors to satisfy secured creditors' claims before employees' claims created after the effective date of the new law, and before other obligations. Furthermore, the bankruptcy and reorganization of insolvent banks, brokerage firms, insurance firms and other financial institutions, which was carved out of earlier drafts of the law, was restored and will now be governed by the same law as other business enterprises.

According to George Kelakos, managing director of Kelakos Advisors LLC in Greenwich, Conn., and ABI's Vice President-International Affairs, "China's adoption of the new Enterprise Bankruptcy Law is a positive step that will be undoubtedly be embraced by the foreign investment community, particularly as the new law now provides for the reorganization of viable private entities as well as SOEs. China's next challenge will be to develop the necessary capabilities and expertise in its bench and bar and in surmounting the inevitable obstacles that will arise when implementing the new law."

The bill has moved slowly through the Chinese congress. The bankruptcy reform efforts trace back to 1994, and the new law is based on draft language submitted to the Standing Committee in 2004. Opponents allegedly slowed action on the legislation largely due to concerns that the law would hurt workers in state-owned companies and cause social unrest. Nevertheless, according to reports in the Wall Street Journal, 3,658 state-sector companies were placed in bankruptcy proceedings between 1994 and 2005, even without the law. Authorities at the Chinese Assets Supervisions and Administration Commission estimate that an additional 2,000 companies are currently planning to file for bankruptcy. The compromise law therefore applies the requirement that creditors be paid first for bankruptcies commencing after the June 1 effective date. Time will tell whether bankruptcy filings will parallel recent American experience, and a large number of filings will likely occur before the new law's implementation.

As China becomes increasingly more capitalist, both foreign and Chinese investors have been concerned that the lack of sufficient legal protection afforded creditors has been stilting growth and chilling investment. The new law should allay those concerns, given that the statute provides for priority treatment of secured creditor claims, the reorganization of private enterprises and SOEs, and for insolvent financial institutions.

James Yong Wang, an expert on China's bankruptcy law and an attorney at Kirkland & Ellis who was involved in discussions of the new bankruptcy law, commented: "The new law represents China's long-time legislative efforts to strike a balance between bringing the law in line with international norms and addressing concerns about unemployment and social unrest." Wang expects the new law to be supplemented by implementing rules and believes that its effectiveness still needs to be tested in practice, but he is optimistic about the prospects of the new law and believes that it will create new opportunities for Western distressed investors (including private investment funds), as well as restructuring intermediaries such as law firms and accounting firms.

China's new bankruptcy law is a complex and voluminous statute containing 12 chapters and 136 articles. Watch subsequent issues of the Journal for a more comprehensive analysis.

Journal Date: 
Sunday, October 1, 2006