A Q&A guide to restructuring and insolvency law in China.
The Q&A gives a high level overview of the most common forms of security granted over immovable and movable property; creditors' and shareholders' ranking on a company's insolvency; mechanisms to secure unpaid debts; mandatory set-off of mutual debts on insolvency; state support for distressed businesses; rescue and insolvency procedures; stakeholders' roles; liability for an insolvent company's debts; setting aside an insolvent company's pre-insolvency transactions; carrying on business during insolvency; additional finance; multinational cases; and proposals for reform.
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This Q&A is part of the PLC multi-jurisdictional guide to restructuring and insolvency law. For a full list of jurisdictional Q&As visit www.practicallaw.com/restructure-mjg.
Common forms of security. The most common types of security for immovable property are:
Mortgage. This is an interest created over the debtor's property without transferring possession or the legal title to the creditor. If the debtor defaults, the creditor has a preferential right to compensation from the mortgaged property. The creditor may be compensated through the transfer of the property, provided the debtor agrees, or may be compensated with the proceeds from the property sale. If the parties cannot agree, the creditor can initiate court proceedings.
Maximum claim mortgage. This is an arrangement in which the parties agree to use the mortgaged property to secure a series of creditors' claims within a certain period of time and up to an agreed amount.
Formalities. A mortgage must be:
Given pursuant to a written contract.
Registered with the relevant authority (if required (see below)).
Certain types of mortgages must be registered. For example, mortgages over buildings and fixtures, land-use rights with respect to construction land, rights to contracted management of barren land, and buildings under construction must be registered. Otherwise, registration is not mandatory.
Similarly, the relevant authority for registration depends on the type of property, so for example, land use rights on land with no structure or building must be registered with the local land administration authority, and urban real estate must be registered with the real estate administration at or above county level.
Effects of non-compliance. A mortgage which must be registered is effected from the date of registration, which determines the priority of competing mortgages over the same asset. If the parties fail to register, the creditor does not take priority over a third party claiming the secured property, even where registration is optional. Property not listed as requiring registration can be voluntarily registered with a local public notary, so as to obtain priority.
Common forms of security. The most common types of security for movable property are:
Mortgage and maximum claim mortgage. See above, Immovable property.
Pledge. This gives the creditor a right to possess the pledged asset, while the debtor retains the legal ownership, and is created on actual delivery to the creditor. In addition to ordinary types of movable property, pledges of rights (for example, bills of exchange, shares, intellectual property rights) are also possible, but creation may differ depending on the nature of the pledged asset (see below).
Lien. This gives the creditor a right to possess a debtor's property under contract, and to retain that property if the debtor is in breach. A lien depends entirely on possession and is lost when the creditor ceases to hold the property. Domestic entities, including foreign investment enterprises (FIEs), cannot offer liens as a form of security to any foreign party or to any foreign-funded financial institution in China.
Formalities. The following formalities must be observed:
Mortgage over movable property. A mortgage must be:
given pursuant to a written contract;
registered with the relevant authority (if required).
The relevant authority depends on the type of property, so for example, mortgages relating to forestry trees must be registered with the forestry administration department at or above county level, aircraft, ships and vehicles must be registered with the transport registration department, and equipment or other movable property must be registered with the local State Administration for Industry and Commerce.
Pledge. The parties must enter into a written contract, taking effect from when possession of the pledged property is transferred to the creditor. Registration is generally not required, but pledges in relation to certain securities, intellectual property rights, and book debts are only effective upon registration with the relevant authority. For example, a pledge of funds or shares registered in the securities depository and clearing institution is created when registered in that authority, pledges of trade marks are created when registered with the relevant administration authorities and pledges of receivables are created when registered with the relevant credit rating institution.
Lien. This is created by operation of law and not by contract. However, the parties can agree in a contract that no lien should be formed and the court must recognise this express intention.
Effects of non-compliance. The effect of non-compliance is as follows:
Mortgage over movable property. See above, Immovable property.
Pledge. Where registration is required, the pledge will not take effect unless it is registered with the relevant authority.
The term 'enterprise bankruptcy' refers to a corporate insolvency. On a company's insolvency, the payment of claims is made in the following order (Enterprise Bankruptcy Law 2007):
Secured creditors. These are paid from the sale proceeds of the secured property and have payment priority to the extent of the value of such property, but subject to payment of any employees' claims (mentioned in the fourth bullet point below).
Bankruptcy expenses. These include the following expenses incurred after the court accepts the bankruptcy petition:
court costs in the bankruptcy case;
expenses for the management, sale and distribution of the debtor's property;
expenses incurred by the administrator in the performance of his duties, his remuneration and expenses for engaging other personnel.
Creditors of common interest liabilities. These include the following liabilities incurred after the court accepts the bankruptcy petition:
liabilities incurred as a result of the administrator or the debtor requesting counterparties to perform contracts which have not been completely performed by the parties;
liabilities incurred in connection with the debtor's property other than those relating to the management of the property;
liabilities incurred as a result of improper gains obtained by the debtor;
labour remuneration and social insurance premiums payable by the debtor to continue the operations and other liabilities arising as a result of this;
liabilities arising from injuries to persons caused by the performance of duties by the administrator or relevant persons;
liabilities arising from injuries to persons caused by the debtor's property.
Preferential creditors. Liabilities owed to the debtor's employees, including:
wages, medical and disability subsidies and pensions;
basic old-age insurance and medical insurance premiums payable into their individual accounts;
compensation payable in accordance with laws and administrative regulations.
If any of the above three claims had accrued before and on 27 August 2006 (the date the Enterprise Bankruptcy Law was adopted) and cannot be discharged in full after exhausting the unsecured properties of the debtor, they will have priority over secured creditors in the secured properties.
Social insurance premiums and taxes owed by the debtor. These are for debts that are not already listed in the above bullet under preferential creditors.
Unsecured ordinary creditors. These are for ordinary unsecured debts.
Shareholders. Any remaining assets are used to repay shareholders' capital contributions.
Trade creditors can use the following mechanisms to secure unpaid debts:
Lien. See Question 1, Movable property. Where a debtor fails to pay, its creditor has the right to take lien of the debtor's chattels that are lawfully possessed by the creditor. The chattels taken as lien by the creditor and the creditor's rights fall into the same legal relationship, except for the lien between enterprises.
Retention of title clause. Parties to a sale and purchase contract can agree that the seller retains title to goods if either (Contract Law 1999):
the seller does not receive full payment for the goods;
the buyer breaches other terms in the contract.
The procedures used to recover a debt are:
Property preservation order. If a creditor can show a substantial risk of the debtor disposing of, or dissipating, assets that are to be used to pay a debt, it can apply to the court for this order before legal proceedings have begun (Chapters IX and XXVI, Civil Procedure Law 2008). The most common applicants for this type of order are secured creditors whose security assets are at risk.
Before applying for a property preservation order, a creditor must provide a bank guarantee or security backed by its own assets. The guarantee should be equal to the value of the assets over which the order is sought. The creditor must bring a formal action before the court within 15 days, or if the case involves foreign elements, 30 days of the property preservation order being granted.
Subrogation proceedings. If a debtor is not actively seeking to recover a debt owed to it by a third party, the creditor can petition the court to bring subrogation proceedings against the third party (unless the claim is personal to the debtor). The debtor must pay the expenses incurred by the creditor in bringing subrogation proceedings.
Rescission and nullification. If a debtor has waived its right to recover a debt from a third party or transfers its property to a third party with little or no consideration, the creditor can petition the court to rescind or nullify the transaction. The debtor must pay the expenses incurred by the creditor in bringing proceedings for rescission.
An application must be made within both:
one year of the date on which the creditor knew, or should have known, the ground for rescission;
five years of the date of the rescindable transaction.
Cross-border debt recovery. See Question 12.
A set-off claim is available to a creditor who owes debts to the debtor before the acceptance of a bankruptcy application. However, it is not available where:
The creditor acquires claims against the debtor from others after the bankruptcy application is accepted.
The creditor knows that the debtor is unable to pay off debts as they become due or has filed a bankruptcy application, and the creditor nevertheless incurs debts to the debtor, or acquires claims against the debtor, except that this will not apply where the claims arise by operation of law, or arise from causes occurring one year prior to the bankruptcy application.
Chinese local governments have been providing support to distressed businesses in various ways, including:
Providing, arranging and securing credits and loans to them.
Offering them tariff refunds for export.
Providing relief from tax and other administrative payments.
Establishing development funds.
Sending representatives or agents to help administer their business and affairs.
The Supreme People's Court (People's Court) handed down an opinion in June 2009 providing guidance to the courts when handling enterprise bankruptcy cases. If the enterprises have viable future prospects and are in line with the national structural adjustment policy, the courts should make the most effective use of restructuring and compromise procedures and actively seek to rescue companies instead of winding them up. Under the supervision of the local Party Committee, the courts should also give full effect to the risk management policies and funding protection mechanisms formulated by local government to maintain stability. When necessary, the local government can use stability maintenance funds set up by the government, or encourage third parties to provide interim financing for settlement of workers' claims.
Objective. Extended restructuring procedures are introduced in the Enterprise Bankruptcy Law to prevent the bankruptcy of enterprises that have plentiful assets, but are experiencing cash flow problems.
Initiation. The debtor or its creditor can apply directly to the People's Court for restructuring. Where a creditor has filed a bankruptcy application against the debtor, the debtor or a shareholder holding more than 10% of the debtor's registered capital, can also apply to the court for restructuring after the court has accepted the application and before the court declares the debtor bankrupt. The restructuring period begins on the date on which the court agrees to restructuring. Any enterprise established in China can use the restructuring procedure.
The restructuring plan must be approved by a majority of the creditors in each voting class present at the creditors' meeting representing at least two-thirds in value of total claims in that class. The creditors are classified according to whether they are secured creditors, employees, agencies with outstanding tax claims, and ordinary claims. Shareholders may attend the creditors' meeting to discuss the restructuring plan in a non-voting capacity.
Shareholders can vote as a separate class on matters that involve adjusting their rights and interests.
If the restructuring plan is adopted by all classes of creditors, the administrator or debtor must file an application to the court for approval within ten days from the date of adoption.
If the restructuring plan is not adopted by any class of creditors, the administrator or debtor may still apply to the court for approval of the plan in the following circumstances:
Under the restructuring plan, the claims of secured creditors are fully discharged, the losses incurred from the delay in discharge are equitably compensated, the security rights over such properties are not materially impaired, or alternatively, that voting class has approved the plan.
Under the restructuring plan, the claims of employees and tax agencies are fully discharged, or alternatively, those voting classes have approved the plan.
Under the restructuring plan, the proportion of ordinary claims to be discharged will not be less than that available pursuant to the bankruptcy liquidation procedure (see below, Bankruptcy), or alternatively, that voting class has approved the plan.
The adjustment of the rights and interests of the shareholders under the plan is fair and impartial, or alternatively, the shareholders have approved the plan.
The restructuring plan treats members within the same voting class fairly and equally, and the repayment priority under the plan is not contrary to that under normal bankruptcy procedures (see below, Bankruptcy).
The debtor's business plan is feasible.
The court will determine whether to approve the restructuring plan within 30 days of receipt of the application. If the plan is not approved, the court can terminate the restructuring procedure and declare the debtor bankrupt (see below, Bankruptcy).
Substantive tests. Where the debtor is the applicant, it must prove that either:
The debtor is unable to pay its debts when due (the cash flow test), and has insufficient assets to pay off its debts or is obviously lacking in the capability to repay the debts (balance sheet test).
There is an obvious possibility that it will lose the capability to repay its debts.
Where a creditor is the applicant, they will only need to show that the debtor satisfies the cash flow test.
Supervision and control. Upon accepting a bankruptcy application, the court appoints an administrator who thereafter takes control of the running of the debtor.
The administrator's duties and responsibilities include the following:
Taking possession of the debtor's property, seals, accounting books and documents.
Investigating and reporting on the financial status of the debtor.
Determining the debtor's internal management affairs.
Determining the debtor's daily expenses and other necessary expenses.
Determining whether to continue or suspend the debtor's business and getting the permission of the court to do so (before the first creditors' meeting).
Managing and disposing of the debtor's property.
Representing the debtor in litigation, arbitration or other legal proceedings.
Convening the creditors' meetings.
Other duties and responsibilities that the court deems necessary to be performed by the administrator.
However, upon application to the court, the debtor may regain control of its property and business affairs, and will be responsible for the implementation of the plan with the supervision of the administrator.
Protection from creditors. The secured creditors are subject to a moratorium during the restructuring period. However, the secured creditors can apply to the court to enforce their security rights if it is likely that the secured properties will suffer damage or diminution in value that will prejudice their security rights.
Length of procedure. A restructuring plan must be submitted to the court and creditors' meeting by the administrator or debtor-in-possession within six months of the date of the court ruling for restructuring. A three-month extension can be granted by the court on the application of the administrator or debtor with justified reasons.
Within 30 days of receipt of the restructuring plan, the court must convene a creditors' meeting to vote on the plan. If no restructuring plan is submitted within the deadline, the court will terminate the restructuring procedure and declare the debtor bankrupt (see below, Bankruptcy).
Conclusion. Any restructuring plan approved by the court is binding on the debtor and all its creditors. As stated above, there is a moratorium on creditors' claims during the restructuring period. Those creditors who have not filed their claims cannot exercise their rights until after the implementation of the restructuring plan and then only in accordance with the discharge conditions for the same class of claims provided in the restructuring plan. The creditor's rights in respect of any guarantor of the debtor or other joint debtors are not affected by the restructuring.
During the restructuring period, the debtor's shareholders cannot ask for distribution of returns on their investment and the debtor's directors and senior officers cannot transfer the equity in the debtor held by them to any third party.
The court can terminate the restructuring procedure and declare the debtor bankrupt (see below, Bankruptcy) at the request of the administrator or an interested party, if either:
The debtor is unable or fails to implement the restructuring plan.
The debtor's business and financial condition continues to deteriorate and there is no prospect of a turnaround.
The debtor engages in fraud, wilfully dissipates its property or commits other acts that are obviously prejudicial to the creditors.
The administrator is unable to carry out his duties due to acts by the debtor.
When the court terminates the restructuring procedure, the undertakings made by the creditors as to adjustment of their claims in the restructuring plan no longer have effect. However, the payments made to creditors during the implementation of the restructuring plan remain valid, and the portion of their claims that is not discharged is deemed a claim in the bankruptcy procedure.
After the restructuring plan has been implemented, the administrator submits a supervision report to the court and his supervision duties end. The debtor is discharged from the debts that have been reduced or waived in accordance with the restructuring plan.
Objective. The Enterprise Bankruptcy Law sets out the procedure for an enterprise to compromise and settle its liabilities with its creditors. This can save a viable business that would otherwise go bankrupt while maximising the return to creditors.
Initiation. The debtor applies directly to the court by submitting a compromise proposal, after the court has accepted a bankruptcy petition against the debtor and before the court declares it bankrupt. Any enterprise established in China can use the compromise procedure.
Any compromise proposal must be both:
Approved by a majority of the creditors with voting rights present at the meeting representing more than two-thirds in value of the total unsecured claims.
Then submitted to the court for approval. However, there is no time limit for the submission.
If the compromise proposal is not approved by either the creditors' meeting or the court, the court terminates the compromise procedure and declares the debtor bankrupt (see below, Bankruptcy).
Substantive tests. See below, Bankruptcy.
Supervision and control. If the compromise agreement is passed at the creditors' meeting, the court will rule to acknowledge the conciliation agreement. The debtor discharges its liabilities under the compromise proposal. The administrator hands over the property and business to the debtor and reports to the court on the performance of his duties.
Protection from creditors. The secured creditors are not subject to a moratorium and may exercise their security rights during the compromise procedure. If any creditor covered by the compromise has not filed its claim, it cannot exercise its rights until after the implementation of the compromise proposal is completed and in accordance with the discharge conditions in the compromise proposal.
Length of procedure. If the court decides, after an application is made to it (see above, Initiation), that the compromise application complies with the legal requirements referred to above, it will:
Permit the compromise.
Announce the compromise.
Convene a creditors' meeting to vote on the compromise proposal.
However, there is no time limit for the court to make the ruling and convene the creditors' meeting.
Conclusion. Any compromise proposal approved by the court is binding on the debtor and all the conciliating creditors. A creditor's right in relation to any guarantor of the debtor or other joint debtors is not affected by the compromise procedure.
If the debtor is unable or fails to implement the compromise proposal, the court can, at the request of the creditors covered by the compromise, terminate the compromise procedure and declare the debtor bankrupt (see below, Bankruptcy). When the court terminates the implementation of the compromise proposal, the undertakings made by the creditors covered by the compromise as to adjustment of their claims no longer have effect, but the payments made to them as a result of the implementation of the compromise proposal remain valid, and the portion of their claims that is not discharged is deemed a claim in the bankruptcy procedure.
After implementation of the compromise proposal is completed, the debtor is discharged from the debts which have been reduced or waived under the compromise proposal.
Objective. The Enterprise Bankruptcy Law provides a unified bankruptcy system for all enterprises with legal person status. The aim of bankruptcy is to liquidate an insolvent enterprise and distribute its assets to creditors.
Initiation. A bankruptcy proceeding is commenced by an application with the court. The application may be filed by either the debtor or a creditor.
A bankruptcy petition must be approved by the court.
Substantive tests. Where the debtor is the applicant, it must satisfy both the cash flow test, and the balance sheet test. A creditor applicant need only show that the debtor satisfies the cash flow test.
Supervision and control. See above, Restructuring.
Protection from creditors. Once the court accepts a bankruptcy application, any attachment with respect to the debtor's property is lifted, and enforcement procedures will be suspended. Further, any civil litigation or arbitration against the debtor will be suspended until an administrator is appointed, and new civil lawsuits can only brought in the same court which accepted the application.
Length of procedure. If a bankruptcy petition is filed by a creditor, the court notifies the debtor within five days of receiving the petition. The debtor can object to the petition within seven days of receipt of the notification. The court should rule on whether to accept the petition within ten days of the expiration of the seven-day period. In other cases, the court makes its decision within 15 days of receiving the petition. If necessary, the deadline can be extended for 15 days, subject to court approval at the next level.
Bankruptcy proceedings begin as soon as the court has accepted the petition. A declaration of bankruptcy is likely to follow in due course. The length of the proceedings depends on the complexity of the case.
Conclusion. Upon accepting a bankruptcy petition, the court appoints an administrator from the liquidation committee, which includes members of the relevant departments and authorities or intermediary organisations such as law firms, accounting firms and bankruptcy liquidation firms.
The court notifies the debtor within five days after accepting a bankruptcy petition, and the debtor must submit certain financial statements to the court within 15 days of receipt of this notification.
The court also notifies known creditors and makes a public announcement within 25 days of accepting a bankruptcy petition specifying a deadline for filing claims (apart from employees' claims) of between 30 days and three months from the date of publication. The creditors that have filed their claims have the right to attend and vote at a creditors' meeting.
A creditor can ask for debts owed by the debtor to that creditor to be set off against debts owed by that creditor to the debtor (see Question 4).
If a creditor fails to file its claim by the deadline set by the court, a late claim can be filed before the final distribution, but no supplementary distribution can be made to it from any previous distributions. Any expenses incurred for considering the late claim are paid by the creditor making the application.
The administrator can decide whether to terminate or fulfil the debtor's ongoing contractual obligations. If the administrator fails to notify any counterparty within two months of the date of acceptance of the petition or fails to reply within 30 days of receipt of a demand notice from any counterparty, the administrator is deemed to have terminated the relevant contract. If a contract is terminated, the counterparty can file a claim for damages incurred.
The administrator should prepare a list of claims and submit it to the first creditors' meeting for verification. If the debtor or a creditor objects to the list, it can institute a legal action in the court that accepted the petition (see Question 2).
The first creditors' meeting is convened by the court and held within 15 days after the deadline for filing claims. Subsequent creditors' meetings are held as deemed necessary by the court or when proposed to the chairman of the creditors' meeting by any of the following parties:
The creditors' committee.
A group of creditors representing more than one-quarter in value of the total claims.
Secured creditors do not have the right to vote on the adoption of settlement agreements or on adopting plans to distribute the debtor's property, unless they have waived their rights to priority in payment.
Resolutions at the creditors' meetings require a majority of the creditors with voting rights present at the meeting representing more than one-half in value of the total unsecured claims. These resolutions are binding on all creditors.
The creditors' meeting can establish a creditors' committee comprising a maximum of nine representatives from the creditors and including a representative of employees or the labour union of the debtor. The members of the creditors' committee should be approved by the court. The creditors' committee supervises the management, disposal and distribution of the debtor's property and convenes the creditors' meetings. The administrator reports to the creditors' committee on material transactions involving the debtor's property.
The administrator is answerable to the court and supervised by the creditors' meetings and committee. The creditors' meeting can apply to the court to have the appointed administrator removed for failing to discharge his duties properly. The court has the final say in the appointment of the administrator.
A bankruptcy declaration applies to all assets located around the world and not just to the debtor's assets in China.
Once the final distribution is completed, the administrator reports this to the court. The court should decide within 15 days whether to conclude the bankruptcy proceedings. Within ten days of the date of conclusion of the bankruptcy proceedings, the administrator should carry out deregistration procedures and then cease his duties.
Objective. The aim of liquidation is to dissolve a solvent enterprise, in most cases without involving the court.
Initiation. The liquidation procedure can be used by any limited liability company or company limited by shares, which is incorporated in China. Specific provisions apply to FIEs (see Question 1, Movable property) such as equity joint ventures (EJVs), co-operative joint ventures (CJVs) and wholly foreign-owned enterprises (WFOEs). A company can be liquidated if:
The period for operation as set out in the articles of association (articles) expires or for any other reason for dissolution specified in the articles.
At least a two-thirds majority, in value, of the shareholders at a shareholders' meeting votes to dissolve the company.
Liquidation is necessary due to the merger or division of the company.
The company's business licence has been revoked or the company is ordered to close down because it has violated laws or administrative regulations.
The court orders its liquidation because at least 10% of the shareholders petition for dissolution on the basis that:
serious difficulties have arisen in the operation and management of the company;
its continued existence would cause a material loss to the shareholders; and
the difficulties cannot be resolved though other means.
Unless dissolution is because of a merger or division, the company must arrange for a liquidation committee to commence the liquidation within 15 days from the date of occurrence of the event which triggered it.
An FIE can be liquidated if:
The term of the FIE expires.
The FIE incurs serious deficits, or suffers severe losses as a result of force majeure, making it impossible to continue operating.
The FIE is a joint venture, and a party to it does not perform its obligations under the joint venture contract or the FIE's articles, which makes it impossible to continue operating.
There is any other situation giving rise to liquidation under the joint venture contract or the articles.
The FIE is an EJV that fails to achieve the desired objectives and has no prospects for future development.
The FIE is a CJV that is ordered to close down because it has violated legal or administrative regulations.
The FIE is a WFOE whose right to operate is revoked as a result of violation of law or regulations, or in the public interest.
A special resolution of shareholders (passed by a two-thirds majority in value) is usually needed to liquidate companies.
An FIE's liquidation commences without the approval authority's consent if caused by:
Expiry of its term.
Determination by the judiciary.
Revocation of its business licence.
If liquidation is due to a breach of the joint venture contract or the FIE's articles, either the approval authority's consent or the relevant court's determination is required. In any other circumstance the approval authority's consent is required. The FIE must arrange for a liquidation committee to complete the liquidation.
The party applying for the approval authority's consent or the relevant court's determination is either the FIE itself or the non-defaulting party to the joint venture contract, depending on the grounds of liquidation.
Substantive tests. See above, Initiation. There are no specific criteria for granting approval for a liquidation of an FIE. Approval is at the discretion of the approval authority or the relevant court.
Supervision and control. See below, Conclusion.
Protection from creditors. The liquidation committee must notify the creditors within ten days of its formation, and within 30 days of notification, the creditors must declare their claims. The liquidation committee cannot discharge any of the claims during the period of declaration.
Length of procedure. As soon as any of the specified events occur (see above, Initiation), the company immediately goes into liquidation. There is no time limit for carrying out the liquidation of a company.
Conclusion. After liquidation begins, a liquidation committee, made up of the shareholders or their nominees, or the nominees of the relevant court, is established to:
Examine the property of the company and prepare a balance sheet and property list.
Notify creditors and relevant authorities.
Dispose of unfinished business.
Pay outstanding taxes and debts.
Dispose of any remaining assets after the enterprise's debts have been paid.
Participate in civil litigation on behalf of the company.
Publicly announce the liquidation in local or national newspapers.
Register creditors' claims.
After thoroughly examining the enterprise's assets, the committee formulates a liquidation plan for approval by a shareholders' meeting or the relevant court. The order of priority for the enterprise to pay its debts is:
Wages of staff and labour insurance premiums.
Debts of the enterprise.
Only after all debts have been fully paid are any remaining assets distributed to the shareholders in proportion to their capital contributions.
If the liquidation committee discovers that the enterprise's assets cannot cover its debts, it must immediately apply to the court for a bankruptcy declaration.
During liquidation, an enterprise cannot engage in any business activities unrelated to the liquidation.
After the process has been completed, the liquidation committee produces a report, which is presented to and approved by the same bodies that confirmed the original plan, as well as the company registry. The liquidation committee arranges for the enterprise to be deregistered with the tax and customs authorities, and the State Administration for Industry and Commerce.
Despite the participation of the administrator and creditors in the restructuring process, the court has the most significant role in the outcome of restructuring.
The process is initiated by application directly to the court, which decides whether to accept or reject it. If accepted, the court appoints the administrator to take custody of the debtor's property and administer the business and affairs. The creditors do not have a say in selecting the administrator. The administrator is answerable to the court and supervised by the creditors' committee, whose members must be approved by the court. While the creditors can apply to the court to remove an administrator for failing to properly discharge his duties, and the administrator can resign for a good reason and with court approval, the final discretion relating to the administrator rests with the court.
The court also has a final voice in a restructuring plan. Any restructuring plan approved by the creditors must be approved by the court. Even if it is not approved by the creditors, the court can still approve it provided:
Secured creditors, workers and the tax authority are fully paid.
Unsecured creditors are not in an inferior position than if the debtor were liquidated.
The plan is feasible.
Once a restructuring plan is approved, it becomes binding on the debtor and all creditors.
Only the court can terminate restructuring. During the process, the court can declare the debtor bankrupt on application made by the administrator or an interested party if it is satisfied that, for example, the debtor's business and financial condition continues to deteriorate and there is no prospect of a turnaround. The court can also declare the debtor bankrupt when either:
No restructuring plan is submitted to the court and the creditors' committee within the six-month period or additional three-month extension period.
The restructuring plan is not approved by the court, following the holding of creditors' meetings.
If a director, supervisor or member of the senior management of the debtor commits a breach of his obligation of loyalty or due diligence, causing the debtor's bankruptcy, he bears civil liability and can be disqualified from serving as a director, a supervisor or a member of the senior management of another enterprise for three years from the conclusion of bankruptcy proceedings.
If the debtor commits any acts referred to in Question 9, prejudicing the interests of the creditors, the legal representative and other directly responsible persons of the debtor can be liable for damages.
If the administrator fails to perform his duties with due diligence and good faith, he can be liable to a fine and can also be liable for damages if the creditors, the debtor or a third party incurs a loss as a result.
A parent company is a separate legal entity and is not liable for an insolvent subsidiary's debts, unless it has given a guarantee for these. However, if a Chinese or foreign investor of an FIE disposes of the FIE's property during liquidation, that investor can be ordered by the approval authority to:
Pay compensation to the liquidated FIE.
Restore the property to the liquidated FIE.
An enterprise can be ordered to remedy the situation and pay a fine if it:
Falsifies the balance sheet or list of assets.
Distributes assets before paying the liquidation expenses and repaying its debts.
Fines can be between 1% and 5% of the value of the property concealed or the assets distributed.
The officers in charge of the liquidated enterprise and other employees responsible for the offences can also be liable for a fine.
Liability can also arise under criminal law.
The following transactions occurring within one year prior to the acceptance of the bankruptcy application may be avoided:
Transferring property without consideration.
Dealing at an obviously unreasonable price.
Providing collateral for any unsecured debt.
Prepaying any debt before it came due.
Giving up claims.
The repayment of a debt to an individual creditor within six months before the court's acceptance of the bankruptcy application when the debtor was insolvent may also be avoided, unless the debtor's property benefited from the specific payment.
The following transactions will also be null and void at any time:
Concealing or transferring property for the purpose of escaping repayment of debt.
Fabricating debts or recognising false debts.
Who can challenge. The administrator has the right to request the court to avoid the above transactions.
Third party rights. The administrator has the right to reclaim the debtor’s property obtained by anyone as a result of the above transactions.
Directors, supervisors and senior management personnel may be personally liable for any property of the debtor misappropriated by them and any extraordinary income obtained through the abuse of their positions.
Who can challenge. The administrator can recover by application to the court.
Third party rights. The liability should fall on the directors, supervisors and senior management personnel personally.
Bankruptcy. When accepting a bankruptcy petition, the court concurrently appoints an administrator. Before the first creditors' meeting, the administrator decides whether to continue carrying out the debtor's business and obtain the approval of the court to do so. The creditors' meeting can also decide whether to continue carrying out the debtor's business.
Restructuring. During the restructuring period, the company is given protection from creditors while still being able to continue to carry on business (see also Question 6, Restructuring).
Liquidation. A liquidation committee takes control of the enterprise, which cannot engage in any business activities that are not related to the liquidation (see also Question 6, Liquidation).
Bankruptcy. The administrator takes control of the debtor's assets and is entrusted with a wide range of administrative responsibilities to supervise or carry on the company's business during the bankruptcy process.
Restructuring. During the restructuring period, on application by the debtor and subject to the approval of the court, the debtor can manage its business under the administrator's supervision. If the administrator is responsible for managing the business, he can appoint the operation and management personnel of the debtor to run the business.
Liquidation. The role of the liquidation committee is to organise the valuation and disposal of the debtor's assets, as well as to settle debts (see also Question 6, Liquidation).
Bankruptcy. In a Bankruptcy, intellectual property (IP) liabilities may be regarded as 'common interest liabilities' if the:
Debtor is a licensee to an IP licence agreement.
Liabilities are generated from such agreement (for example, licence renewal fees falling due).
Liabilities occurred after the court has accepted the bankruptcy application and are not discharged (therefore requiring further performance by the administrator or debtor).
These common interest liabilities can be settled through the debtor's assets at any time during insolvency (see Question 2).
In the event that the debtor’s assets are not enough to pay off both the bankruptcy expenses and the common interest liabilities (arising from an existing IP licence), then the bankruptcy expenses must be paid off in priority. If the debtor’s assets are not enough to pay off the bankruptcy expenses or common interest liabilities, they must be settled proportionally to the total amount of the bankruptcy expenses and common interest liabilities (as the case may be).
Restructuring. During the restructuring period, there is a moratorium on creditors' claims and the company will continue to carry on business. Therefore, the enforceability of existing IP licences is not affected during this period.
Liquidation. During a liquidation, an existing IP licence remains as an executory contract (that is, a contract that has not yet been fully performed and where both parties still have remaining obligations). Although the company will continue to exist during the period of liquidation, it must not engage in any operational activities that are not related to the liquidation. In these circumstances, the liquidation committee may terminate the licence. If this happens, the amount of compensation to the other party will constitute a debt, to be discharged in accordance with the order of priority under the liquidation plan (see Question 6, Liquidation).
The Enterprise Bankruptcy Law states that in the context of restructuring, if an administrator or debtor enters into a loan for the continuing of the business, a security interest may be created for the loan. There is no provision which prohibits post-insolvency financing in other insolvency procedures.
The courts generally review whether to enforce any ruling or court order obtained in another jurisdiction that is either party to an international treaty or to a reciprocal arrangement with China. Rulings or orders are enforced if they do not:
Violate the fundamental principles of Chinese law.
Undermine the sovereignty, security or public interest of the state.
Prejudice the lawful rights and interest of creditors in China.
If no international treaty or reciprocal arrangement applies (which is most often the case), the parties can theoretically begin fresh legal proceedings to enforce a foreign court order. However, this process is often difficult.
The courts do not usually assist insolvency practitioners appointed outside China. However, the position is improving and the reciprocal recognition and enforcement of judgments signed on 14 July 2006 between the Courts of China and the Special Administrative Region of Hong Kong is a significant step. The scope of application of this arrangement is limited to money judgments on commercial contracts.
The courts only co-operate in foreign insolvency proceedings if their duty towards the other jurisdiction can be balanced against ensuring that Chinese creditors receive fair treatment.
China is not a signatory to any significant international treaty relating to insolvency.
Apart from debt approval and registration requirements set by the State Administration of Foreign Exchange, there are currently no special procedures for foreign creditors. It is often more difficult for a foreign creditor to recover assets from a Chinese debtor due to the lack of recognition procedures.
The Enterprise Bankruptcy Law was passed on 27 August 2006. While the old law only applied to the bankruptcy of state-owned enterprises (SOEs), the new law applies to all enterprises with legal person status (those that can own property, have civil rights and can be civilly liable), including both SOEs and privately owned companies. However, individuals and partnerships are not covered by this statutory regime.
Further details of the procedures provided in the Enterprise Bankruptcy Law are expected to be set out in additional subsidiary legislation and regulations. There have already been various regulations announced and adopted by the Supreme People's Court.
*The assistance of Natalie Yu, Trainee Solicitor, in the preparation of this article is acknowledged.
Qualified. Hong Kong SAR, 1995; England and Wales, 1990
Areas of practice. Restructuring and insolvency; finance; infrastructure; corporate finance.
Qualified. Hong Kong SAR, 2003; England and Wales, 2008
Areas of practice. Restructuring and insolvency; finance; corporate finance.