THE 2006 PRC ENTERPRISE BANKRUPTCY LAW: THE WAIT IS FINALLY OVER

Citation(2008) 20 SAcLJ 275
Date01 December 2008
Published date01 December 2008

The lengthy Chinese bankruptcy law reform process that began in 1994 ended on 26 August 2006, with the enactment of the PRC Enterprise Bankruptcy Law. This article discusses five controversial areas that were debated throughout the drafting process — the scope of the law, bankruptcy administration, corporate reorganisation, priorities and the protection of employee rights, and cross-border issues — and how they have been resolved in the new law. The article also discuses recent developments since the new law came into operation on 1 June 2007.

I. Introduction

1 For well over a decade, observers of China’s insolvency system awaited word of the enactment of a new bankruptcy law. On 27 August 2006, the Chinese Government finally enacted the Enterprise Bankruptcy Law (“2006 PRC Enterprise Bankruptcy Law”), which came into operation on 1 June 2007.2 The drafting process commenced in March 1994 when the Financial and Economic Committee of the 8th National People’s Congress (“NPC”) set up a Working Group for Drafting the New Chinese Bankruptcy Law (“Bankruptcy Law Drafting Working Group”). The road to enactment progressed in a series of fits and starts, with several interruptions and delays to enable the various constituents to reach agreement on some of the more controversial recommendations that emerged during the drafting process. But the drafting process finally concluded in 2006, and the new law has now been in operation for roughly one year.

2 An earlier piece that the author co-authored discussed the 2002 draft Chinese bankruptcy law in detail3 and another highlighted seven areas of the proposals in that draft.4 A more recent piece offered an update of the law reform process from 2002—2004 and considered five of the more controversial areas that were debated during the drafting process — the scope of the law, bankruptcy administration, corporate reorganisation, priorities and the protection of employee rights, and cross-border issues.5 This article returns to these five areas and discusses how these issues were resolved in the 2006 PRC Enterprise Bankruptcy Law. It will also comment on recent developments since the new law came into operation on 1 June 2007.

3 Part II of this article offers a brief overview of the pre-law reform legal landscape and the weaknesses therein that gave rise to the bankruptcy law reform process in China. Part III puts the Chinese bankruptcy law reform process in a broader context of legal and administrative reforms in China, and Part IV updates the five areas noted above.

II. The pre-law reform legal landscape6

4 Given China’s currently booming economy, it is easy to forget that not all that long ago the Chinese economy was a centrally-planned socialist economy comprising large state-owned enterprises (“SOEs”) that were funded through government-directed “policy loans” by the state-owned commercial banks (“SOCBs”), with little concern given to the ultimate ability of the SOEs to repay these loans.

5 Once China decided to make the transition from a centrally-planned economy to a market-based economy, it was necessary to enact a bankruptcy law to deal with those inefficient, insolvent SOEs that were unable to repay their debts. China enacted the Law of the People’s Republic of China on Enterprise Bankruptcy (Trial Implementation) on 2 December 1986, and it came into operation on 1 October 1988 (“1986 Chinese Bankruptcy Law”).7 This law applied only to SOEs. On 9 April 1991, the PRC Civil Procedure Law was approved,8 with Chapter XIX applying to the bankruptcy of non-SOE enterprises with legal person status. Thus, by 1991, China had a bifurcated insolvency system, with one law for SOEs and another for non-SOE enterprises with legal person status.

6 Since these laws were quite short — the 1986 Chinese Bankruptcy Law included only 43 articles, and Chapter XIX of the PRC Civil Procedure Law, only eight — they lacked sufficient detail, and there were many gaps and omissions in coverage. There were also some inconsistencies between the bankruptcy procedures for SOEs and those for non-SOE legal personal enterprises. The People’s Supreme Court issued a series of judicial interpretations to address these problems. For example, the Opinion on Questions Concerning the PRC Enterprise

Insolvency Law (Trial Implementation) issued on 7 November 1991 (“1991 PRC Supreme People’s Court Opinion”)9 interpreted the 1986 Chinese Bankruptcy Law, and with 76 articles was almost twice as long as the law it was interpreting. Following in 1992 was the PRC Supreme People’s Court’s Application of the PRC Civil Litigation Law Several Issues Opinion for non-SOE enterprise legal persons (with 14 articles).10 One of the significant issues that arose at this stage was whether certain provisions in the 1986 Chinese Bankruptcy Law for SOEs were also applicable to non-SOE bankruptcies.11

7 In addition to the 1986 Chinese Bankruptcy Law and Chapter XIX of the PRC Civil Procedure Law, completing the national insolvency framework were a few other provisions in the PRC Company Law12 and in the PRC Liquidation Procedures of Foreign Investment Enterprises13 regarding solvent liquidation procedures that specified when, in the course of administering solvent liquidations, if it appeared that the debtor was in fact insolvent, the case should be fed into the insolvency law provisions in the PRC Civil Procedure Law. Article 189 of the PRC Company Law supplemented the provisions of the PRC Civil Procedure Law in bankruptcies involving PRC companies.

8 The final part of the pre-insolvency law legal landscape was at the local level. Some local governments had enacted their own local bankruptcy regulations, procedures and rules, for example, the Shenzhen SEZ Enterprise Bankruptcy Regulations, enacted by the Standing Committee of the Shenzhen People’s Congress on 10 November 1993.14

9 Relatively few bankruptcy cases were commenced in the first few years after the enactment of the new laws. From 1989 until 1993, the courts accepted a total of only 1,153 cases: 98 in 1989, 32 in 1990, 117 in 1991, 428 in 1992, and 478 in 1993.15 Of these cases, the number of successful reorganisations was close to zero.16 Significantly, the number of bankruptcy cases did not accurately reflect the dire straits of many SOEs. This was but a small fraction of the poorly performing enterprises in China — it has been estimated that in pre-1996 China there were over eight million enterprises and commercial households,17 and that close to, if not a majority, of these enterprises were operating at a loss. For example, a national survey conducted in 1997 of 14,923 large and midsized SOEs found that 40.5% were losing money.18 The 1986 Chinese Bankruptcy Law and the other bankruptcy laws and provisions were intended to create market discipline, but by 1994 it was clear that more needed to be done.

III. Putting the bankruptcy law reform process in a broader context19

10 In March 1994, the Chinese Government formed the Bankruptcy Law Drafting Working Group, which completed a first draft in 1995. After a hiatus that was caused in part by a concern about the

high level of unemployment quite likely to arise from subjecting many SOEs to the bankruptcy law,20 the drafting process resumed in 1998. Further drafts of the law were released for comment, including drafts in 2000, 2001, 2002, June 2004 and October 2004. By 2004, most of the provisions in the draft law had been agreed — roughly two-thirds of the 2002 draft was incorporated into the June 2004 draft — but disagreements remained in regard to several important issues that were not resolved until the promulgation of the 2006 PRC Enterprise Bankruptcy Law.

11 The bankruptcy legal reform process was an important development, but it cannot be viewed in a vacuum. The law reform efforts were but one part of the Chinese Government’s arsenal of reforms and remedies to address the historical overhang of problems from the centrally-planned market economy, including SOEs’ high level of non-performing loans (“NPLs”), the resulting weak balance sheets of the main SOCBs, and the complicated issues relating to the resettling of workers of bankrupted or reorganised SOEs. The Chinese Government pursued these various reforms and remedies simultaneously.

12 The most significant remedy was the use of bankruptcy policy decrees. Starting in 1994, the State Council and other administrative organs issued a series of decrees to facilitate debt restructuring on a large scale through merger and acquisition and bankruptcy under the Capital Structure Optimization Program (“CSOP”).21 On 25 October 1994, the State Council issued the notice entitled Proposal for Carrying Out State-Owned Enterprise Bankruptcy Law in Some Cities (“1994 PRC Notice”),22 which addressed problems involving the resettlement of workers of state-owned industrial enterprises (“SIEs”) made bankrupt in 18 pilot cities, including Shanghai. This notice provided special treatment for the resettlement of workers — resettlement rights were entitled to the first priority from the selling of an SIE’s land use rights by auction or tender. The 1994 PRC Notice was followed by the Notice on Certain Issues on Trial Implementation of Mergers and Insolvency on State-Owned Enterprises, which was issued by the former State Economy and Trade Commission (“SETC”) and the People’s Bank of China on 25 July 1996,23 and increased the number of trial cities to 56. On 2 March 1997, the State Council issued a further Supplementary

Notice concerning the Problems Pertaining to the Trial Implementation of State-Owned Enterprise Merger and Bankruptcy and Re-employment in Certain Cities (“1997 PRC Notice”), which increased the number of trial cities to 111.24 Section 2 of the 1997 PRC Notice provided for the formulation of a Mergers and Bankruptcies of Enterprises Program to be established under the co-ordination of the former SETC, whereby in various trial...

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