28 May, 2012

 

Legal News & Analysis – Asia Pacific – China – Insolvency & Restructuring

  

1. Introduction
 
1.1  Enterprise Bankruptcy Law
 
The Enterprise Bankruptcy Law of the People’s Republic of China (the “Bankruptcy Law”) was promulgated on August 27, 2006 and took effect from June 1, 2007. The promulgation of the Bankruptcy Law is a significant milestone for the development of bankruptcy legal regime of the People’s Republic of China (“PRC”). 
 
Before the implementation of the Bankruptcy Law, main PRC bankruptcy laws included the PRC Bankruptcy Law (Trial Implementation) promulgated in 1986 (the “Trial Law”) and Chapter 19 of the PRC Civil Procedure Law (the “Civil Procedure Law”) . However, the provisions of both laws were brief and of principle.  The Trial Law, with 43 articles, governed bankruptcy of state-owned enterprises. Chapter 19 of the Civil Procedure Law, with 8 articles, governed bankruptcy of non-state-owned enterprises. In addition, there were other rules, judicial interpretations and local regulations governing bankruptcy related legal issues. All these had a role in the development of the PRC bankruptcy regime. 
 
With the market economy in China evolving, the call for bankruptcy system has drawn attention of legislators. The Bankruptcy Law was finally promulgated on August 27, 2006 after more than ten years of drafting and review process.
 
The Bankruptcy Law contains 12 chapters and 136 articles, which makes significant progress and improvements to the Trial Law in both substantive and procedural aspects. The Bankruptcy Law enlarges the governing scope to comprehensively apply to all legal entities, clarifies the bankruptcy criteria and scope of properties in bankruptcy, and introduces new system such as the administrator and the creditors’ committee. In addition, the Bankruptcy Law improves the bankruptcy proceedings to make them more operative and classifies the bankruptcy proceedings into three types: reorganization, settlement and bankruptcy liquidation. 
 
The PRC Supreme Court promulgated Provisions on Certain Issues Relating to the Application of the Enterprise Bankruptcy Law (I) (the “Bankruptcy Provisions”) on September 9, 2011. The Bankruptcy Provisions is a judicial interpretation in relation to the acceptance of bankruptcy cases by PRC courts. The Bankruptcy Provisions took effect from September 26, 2011.
 
1.2  Other Bankruptcy Related Laws and Regulations
 
The PRC Company Law (the “Company Law”) and the Civil Procedure Law set out general provisions related to bankruptcy of companies and trial procedures of bankruptcy cases respectively. All these provisions remain effective unless conflicted with the Bankruptcy Law.  Article 4 of the Bankruptcy Law provides that where this law is silent on any trial procedure for bankruptcy cases, the relevant provisions of the Civil Procedure Law shall apply. 
 
Article 134 of the Bankruptcy Law sets out provisions in relation to bankruptcy of financial institutions. If a commercial bank, a securities firm, an insurance company or any other financial institution have Bankruptcy Reasons (as defined below), the relevant financial regulatory authority under the State Council may submit a petition to the court to restructure such financial institution or to have it declared bankrupt and liquidated. If the financial regulatory authority takes measures such as taking over management of or commissioning the management to a third party of a financial institution whose operations are facing a material risk, such financial regulatory authority may petition the court to suspend any civil action or enforcement procedure in which the financial institution is the defendant or is the person against whom a judgment or an order is being executed. The State Council may formulate implementing measures in accordance with the Bankruptcy Law and other relevant laws with respect to bankruptcy of financial institutions. 
 
There are other financial regulations governing the bankruptcy of financial institutions, including the Commercial Banks Law, the Insurance Law and the Securities Law, etc. 
 
There is no personal bankruptcy system in China.
 
2. National Proceedings
 
According to Article 2 of the Bankruptcy Law and Article 1 of the Bankruptcy Provisions, there are two bankruptcy reasons (the “Bankruptcy Reasons”):
 
  1. An enterprise legal person is unable to pay its debts when due and its assets are insufficient to discharge all of its debts; or 
  2. An enterprise legal person is unable to pay its debts when due and it obviously lacks the capacity to discharge all of its debts.
 
In addition, if an enterprise is characterized by any of the foregoing circumstances or there is an obvious likelihood that it will lose the capacity to discharge its debts, reorganization proceeding may be initiated.
 
Under the Bankruptcy Law, the bankruptcy proceedings are classified into three types: reorganization, settlement and bankruptcy liquidation. 
 
2.1  Reorganization
 
Reorganization refers to a legal regime of reorganizing an enterprise which is characterized by bankruptcy criteria but has likelihood of survival from such crisis by restructuring its operation, clearing up its indebtedness and other means, so as to save such enterprise and bring it into normal operation. Reorganization does have influence of Chapter 11 under U.S. Bankruptcy Code.
 
2.1.1  Petition for Reorganization
 
The petition for reorganization against an enterprise legal person can be presented by the enterprise itself (i.e. debtor), any of its creditors, or its investor, subject to the following conditions:
 
  1. The debtor may petition for reorganization where the debtor has any of the Bankruptcy Reasons as specified above or there is possibility that the debtor will obviously lose its ability to discharge all of its debts. 
  2. Any of the creditors may petition to reorganize the debtor where the debtor is unable to repay its debts when due. 
  3. Where any of the creditors petitions the court to liquidate the debtor, after the court accepts the bankruptcy petition but before the debtor is declared bankrupt by the court, the debtor or its investor(s) whose injected capital accounts for more than 10 percent of the debtor’s registered capital may petition the court for reorganization. There are two conditions for an investor to petition for reorganization. Firstly, it must hold more than 10% of the debtor’s registered capital. Secondly, its petition for reorganization against the debtor shall be submitted only after the bankruptcy liquidation proceeding is initiated by any of the creditors. 
 
2.1.2  Management of Assets during Reorganization Period 
 
Generally speaking, after the court accepts the bankruptcy petition and appoints an administrator, the administrator will take over and start to manage the debtor’s assets and business. However, the debtor is generally more familiar with its business than the administrator. In particular, in certain industries, the business operation of the debtor may need professional knowledge and expertise which the administrator does not possess. Therefore, during reorganization period, upon an application by the debtor and subject to the approval of the court, the debtor may manage its assets and business itself under the supervision of the administrator. Self-management by the debtor may help maintain the continuous operation and promote the success of the reorganization. 
 
Financing similar to the debtor in possession financing under U.S. Bankruptcy Code (the “DIP Financing”) is also available under the Bankruptcy Law. Under the Bankruptcy Law, during the reorganization period, where the debtor or the administrator makes borrowing from a lender to maintain the business operation of the debtor, such indebtedness is deemed as a “debt of common interests”  and shall be repaid before any of other creditors from unencumbranced assets. In addition, the lender may create mortgage, pledge and/or other security interests upon certain properties of the debtor for such indebtedness. Where the administrator makes any borrowing or create any property security interests in favor of a lender during the performance of its duties, (1) if such act is committed before the first creditors’ meeting is held, it shall obtain prior approval from the court; or (2) if such act is committed after the same, it shall immediately report to the creditors’ committee or (if creditors’ committee is not set up) report to the court. 
 
2.1.3  Voting on and Approval of Draft Reorganization Plan
 
A reorganization plan shall be drafted by the debtor or the administrator, depending on who actually manages the properties and business operation of the enterprise in question. The Bankruptcy Law sets out class voting system for voting on a draft reorganization plan. The creditors’ meeting shall be categorized into the following voting classes by nature of the claims:
 
  1. Claims secured by specific property of the debtor;
  2. Wages, medical and disability subsidies and support owed to staff, basic pension insurance premium and basic medical insurance premium which shall be remitted into personal accounts of staff and compensation payable to staff;
  3. Taxes owed by the debtor; and
  4. Unsecured claims. 
 
Where a majority of the creditors in a voting class agree to the draft reorganization plan and amount of the claims they represent accounts for more than two-thirds of total amount of the claims of such class, the draft reorganization plan is passed by such class. The draft reorganization plan is passed by the creditors’ meeting if and when all voting classes pass it. The draft reorganization plan passed by the creditors’ meeting shall be submitted to the court for examination and approval. Where the court approves it, the court shall rule to terminate the reorganization proceeding and make public announcement thereon. 
 
In case that any voting class(es) fail to pass the draft reorganization plan, such class(es) may negotiate with the debtor or the administrator and vote again. If such voting class(es) decline to vote again or still fail to pass the draft reorganization plan, the debtor or the administrator may still apply to the court for approval. The court has the power to “cram down” a plan if it finds the draft reorganization plan satisfies the following conditions:
 
  1. Secured claims will be fully discharged from the specific property, the losses incurred as a result of the delayed discharge will be equitably compensated and the security rights over such property will not be materially harmed, or, alternatively, such voting class has passed the reorganization plan; 
  2. Claims of wages, medical and disability subsidies and support, basic pension insurance premium and basic medical insurance premium which shall be remitted into personal accounts of staff, compensation payable to staff and taxes will be fully discharged, or, alternatively, the relevant voting class has passed the reorganization plan;
  3. Ratio of the unsecured claims to be discharged would be no less than the ratio that would have been discharged under the bankruptcy liquidation procedure at the time the draft reorganization plan was submitted to the court for approval, or, alternatively, such voting class has passed the reorganization plan;
  4. Adjustment of the rights and interests of investors is fair and impartial, or, alternatively, the investor class has passed the reorganization plan;
  5. The reorganization plan equitably treats the members of any voting class and adopts the sequence for discharge of the claims as provided by law; and
  6. The business plan of the debtor is feasible.
 
2.2  Settlement
 
Settlement under the Bankruptcy Law refers to a legal regime of reaching a settlement agreement between the debtor and the settlement creditors (as defined in Section 2.2.2) through negotiation with respect to the deferred payment, deduction and exemption of indebtedness and restructuring of the debtor, so as to avoid the bankruptcy of the debtor. The settlement shall be petitioned by the debtor and the settlement agreement as reached by relevant parties shall be recognized by the court. 
 
2.2.1  Petition for Settlement
 
Only a debtor may petition the court for settlement. Upon the following circumstances or at the following time, the debtor may petition for settlement: 
 
  1. If the debtor has any of the Bankruptcy Reasons as specified above; or
  2. If the bankruptcy proceeding has been initiated, the petition for settlement may be presented after the court accepts the bankruptcy petition, but before the debtor is declared bankrupt by the court.
 
2.2.2  Settlement Creditors
 
From the date on which the court rules on settlement, the secured creditors may exercise their secured rights against certain collaterals. Therefore, such secured creditors are not “settlement creditors” and can not enjoy any voting rights against the settlement agreement. The “settlement creditors” refer to those creditors whose credit rights are not secured by any property of the debtor at the time of the court accepting the bankruptcy petition. 
 
2.2.3  Voting on and Recognition of Settlement Agreement 
 
A settlement agreement is drafted by the debtor. Resolution of the creditors' meeting on the draft settlement agreement shall require the consent of a majority of the creditors with voting rights present at the meeting; furthermore, the claims represented by such creditors must account for more than two-thirds of the total amount of the claims not secured by any property. After the draft settlement agreement is passed by the creditors’ meeting, it shall be submitted to the court for recognition. Where the court recognizes the draft settlement agreement, the agreement becomes binding on the debtor and all settlement creditors. 
 
2.3  Bankruptcy Liquidation
 
Bankruptcy liquidation refers to a legal regime that the court declares the debtor bankrupt in accordance with the law and the administrator clears up, sells and distributes the properties of the bankrupt enterprise, thus eliminating indebtedness owed by the bankrupt enterprise. After the bankrupt enterprise completes the liquidation and carries out deregistration procedures, it loses its legal entity qualification.  
 
2.3.1  Petition for Bankruptcy Liquidation and Declaration of Bankruptcy
 
The petition for bankruptcy liquidation against an enterprise legal person can be presented by the enterprise itself (i.e. debtor), any of its creditors, or its investor, subject to the following conditions. The petition for bankruptcy liquidation may be classified into the following circumstances:
 
  1. The debtor may petition for bankruptcy liquidation where the debtor has any of Bankruptcy Reasons as specified above.
  2. Any of the creditors may petition the court to liquidate the debtor where the debtor is unable to repay its debts when due.
  3. Where an enterprise has been dissolved but it is not yet liquidated or the liquidation is not yet completed, and its assets are not sufficient to discharge its debts, the person who bears the obligation of carrying out the liquidation of such enterprise shall petition the court for bankruptcy liquidation.
 
In addition to the above, the failure of reorganization and settlement proceedings may result in initiating the bankruptcy liquidation procedure. According to Article 88 of the Bankruptcy Law, if the draft reorganization plan fails to be passed by the creditors’ meeting or approved by the court, the court shall rule to terminate the reorganization procedure and declare the debtor bankrupt. According to Article 99 of the Bankruptcy Law, if the draft settlement agreement is not passed by the creditors’ meeting or is not recognized by the court, the court shall rule to terminate the settlement procedure and declare the debtor bankrupt. 
 
After the debtor is declared bankrupt by the court, such debtor is called bankrupt enterprise, and the properties of the debtor is called properties in bankruptcy, and the claims enjoyed against the debtor at the time of the court accepting the bankruptcy petition are called bankruptcy claims. 
 
2.3.2  Distribution of Properties in Bankruptcy Liquidation
 
The Bankruptcy Law provides the sequence for discharge of the claims as the following tiers. If the properties in bankruptcy are insufficient to satisfy the claims of a certain tier, the distribution to such tier shall be effected pro rata.
 
(1) Bankruptcy expenses and debts of common interests;
 
The bankruptcy expenses include: (a) litigation costs of the bankruptcy case; (b) expenses for managing, selling and distributing the properties of the debtor; and (c) expenses incurred by the administrator in performing its duties, the administrator’s remuneration and the expenses for engaging professionals and working personnel. The debts of common interests include: (a) debts incurred from the administrator requiring any contract counterparty to perform a contract which impose obligations to both parties; (b) debts incurred from any property of the debtor being managed by any third party who has no management obligation; (c) debts incurred in connection with improper gains obtained by the debtor; (d) the labour remuneration and social insurance premium payable by the debtor to continue the debtor’s operation and other debts incurred from continuing the debtor’s operation; (e) debts arising from injuries to persons caused by the performance by the administrator and relevant persons of their duties; and (f) debts arising from injuries to persons caused by the properties of the debtor. 
 
(2) Wages, medical and disability subsidies and support owed to staff, basic pension insurance premium and basic medical insurance premium which shall be remitted into personal accounts of staff and compensation payable to staff;
 
(3) Social insurance premium other than those as specified in item (2) above and taxes owed by the bankrupt enterprise; and
 
(4) Unsecured bankruptcy claims.
 
The Administrator shall draft the properties distribution plan and submit to the creditors’ meeting for discussion and voting. Where such properties distribution plan is passed by the creditors’ meeting and recognized by the court, the administrator shall execute such plan. 
 
2.4  Several Issues regarding Bankruptcy Proceedings
 
2.4.1 Revocation and Invalidity Claims
 
After the appointment of administrator by the court in a bankruptcy proceeding, the administrator, as part of its obligation to manage the debtor’s assets, will begin to collect and pursue the debtor’s assets that was transferred prior to the court accepted the bankruptcy petition and/or was regarded as against the common interests of all creditors under the Bankruptcy Law.
 
  1.  According to Article 31 of the Bankruptcy Law, an administrator has the right to petition to the court for revocation if the debtor has transferred its assets free of charge, traded assets at an obviously unreasonable price, provided property-backed security for unsecured debts, paid off undue debts in advance, or renounced its claims within 1 year prior to the court’s acceptance of the bankruptcy petition (the “1-Year Revocation Claim”).
  2. According to Article 32 of the Bankruptcy Law, if the debtor is characterized by the Bankruptcy Reasons, however, the debtor still makes repayment to part of creditors within 6 months prior to the court’s acceptance of the bankruptcy petition, an administrator is entitled to the right to petition to the court for revocation of such action unless such individual discharges of debts were or are beneficial to the properties of the debtor (the “6-Month Revocation Claim”).
  3. In addition, the Bankruptcy Law also provides in Article 33 that if the debtor conceals or transfers properties to avoid debts, or the debtor fabricates debts or acknowledges debts that are not genuine, such actions of the debtor shall be pre se invalid no matter when occurred.
 
Therefore, under any circumstance as stated above, an administrator may demand a recovery and return of the debtor’s property directly from the creditor (transferee). In the event the creditor refuses to return the debtor’s property, an administrator may also petition to the court for a revocation or confirmation judgment to recover. 
 
To assert the above claims, the Bankruptcy Law provides a 2-year period from the date of conclusion of the bankruptcy procedure. That means, even if the court has ruled that the bankruptcy procedure is concluded and the debtor is deregistered, a creditor of the debtor could still bring a revocation or invalidity action within 2 years after the closure of the bankruptcy procedure.  The recovered property will become the debtor’s additional property and the court will therefore effect an additional distribution to creditors in accordance with the distribution plan of the debtor’s property.
 
2.4.2 Preemptive Rights and Rights to Take-Back
 
According to Article 109 of the Bankruptcy Law, secured creditors by specific properties of the bankrupt enterprise shall enjoy the priority in being repaid with the same before distribution of properties in bankruptcy liquidation. If the secured creditors cannot be repaid in full, then the un-repaid part shall be taken as common claims against the bankrupt enterprise as other unsecured claims.
 
A note is that the preemptive rights shall only be enjoyed by secured creditors with security interests such as mortgage, pledge, lien etc. 
 
Meanwhile, the properties in bankruptcy shall only refer to properties owned or procured by the bankrupt enterprise before the conclusion of the bankruptcy proceeding. For properties which have been taken by the bankrupt enterprise into his possession but nevertheless do not belong to the bankrupt enterprise, the owner could take back the properties from the administrator at any time during the bankruptcy proceeding.
 
3. International Context
 
Article 5 of the Bankruptcy Law addresses cross-border bankruptcy issues. It is provided that:
 
  1. When bankruptcy procedure is initiated in accordance with the Bankruptcy Law, it shall apply to the properties of the debtor outside the territory of the PRC. 
  2. If a legally effective judgment or ruling rendered by a foreign court in a bankruptcy case involves properties of the debtor in the territory of the PRC and an application or petition is made to a PRC court for recognition and enforcement, the PRC court shall conduct an examination thereof in accordance with the international treaties concluded or acceded to by the PRC or in accordance with the principle of reciprocity, and, if the court holds that such application or petition does not oppose the basic principles of the laws of the PRC, does not prejudice state sovereignty or security or public interest, and does not harm the lawful rights and interests of creditors within the PRC, it shall rule to recognize and enforce such judgment or ruling.
 
According to Article 265 of the PRC Civil Procedure Law, the petition for recognition and enforcement of any effective judgment or ruling rendered by a foreign court as mentioned in Item (2) above shall be submitted to a PRC intermediate-level court with jurisdiction.
 
Article 5 of the Bankruptcy Law addresses the basic approach that the PRC court adopts in a cross-border bankruptcy case. However, many practical issues still remain to be resolved. In particular, we would like to discuss here the following issues:
 
(1) Under Article 5 of the Bankruptcy Law, subject to certain examination principles, the PRC court may rule to recognize and enforce a judgment or ruling as rendered by a foreign court in a cross-border bankruptcy case. Due to diversity among the laws of nations, there are various bankruptcy proceedings in various jurisdictions. Therefore, a payment order, a mediation order or any other written form of the foreign court’s decision as opposed to judgment or ruling may be rendered and the offshore administrator or liquidator may petition the PRC court for recognition and enforcement of such order or decision rendered by the foreign court. Although it is only expressly provided that judgments or rulings by foreign courts can be recognized and enforced by the PRC court, an extensive understanding is made that orders or other forms of decisions rendered by the foreign court can also be recognized and enforced by the PRC court. 
 
In certain jurisdictions, courts may not be involved in some bankruptcy proceedings and thus no order or other form of decision is rendered by a foreign court. This may create a technical hurdle for a foreign administrator to take possession of properties in China. In such case, there are probably two approaches to resolve such problem.
 
(a) The administrator or liquidator under a cross-border bankruptcy case may petition the home jurisdiction court where the debtor in question locates to issue a judgment, ruling, order or other form of written decision and then petition the PRC court to recognize and enforce the same.
 
(b) The administrator or liquidator may directly communicate with the PRC court by addressing the bankruptcy proceedings in the jurisdiction governing the debtor and work out with the PRC court a reasonable resolution on a case-by-case basis. Hopefully, the PRC court could rule to recognize the bankruptcy proceeding which has been going through under foreign bankruptcy law. In practice, we have come across cases where the PRC court recognized receivership of an offshore debtor by a security trustee despite lack of judgment, ruling, order or other form of written decision by any foreign court.
 
(2) Under Article 5 of the Bankruptcy Law, the examination by the PRC court on the judgment or ruling rendered by a foreign court shall conform to the principle of reciprocity and such judgment or ruling shall not harm the rights and interests of the onshore creditors. However, the Bankruptcy Law does not define the principle of reciprocity or the standard used to determine whether the interests of the onshore creditors have been harmed. 
 
To persuade the PRC court to issue the ruling of recognition, the administrator or liquidator may give an introduction to the PRC court of the foreign bankruptcy law governing the bankruptcy case as well as the bankruptcy proceedings as provided in such law, and explain how the rights and interests of the onshore creditors will be protected under such bankruptcy proceedings.
 
It is inevitable that even if foreign bankruptcy law itself offers equal protection of onshore and offshore creditors, practically speaking, creditors need to face additional burden of time, efforts and costs to participate in a foreign bankruptcy. If after understanding the foreign bankruptcy proceedings, the PRC court is still reluctant to issue its recognition because of such concern. To reduce or eliminate such concern of the PRC court, the administrator or liquidator may consider appointing an agent within the PRC to facilitate filing of claims by onshore creditors. This may help relieving the court’s concern. However, such approach may have many implications which need to be carefully reviewed.
 
(3) In case that an onshore creditor files a lawsuit with the PRC court against an offshore debtor for recovery of amounts payable by the offshore debtor, under PRC procedure law, the PRC court may render a judgment, determining the amount payable to the onshore creditor by the offshore debtor. However, due to diversity of the laws of jurisdictions, such amounts as determined by the PRC court may be denied by a foreign court which governs the bankruptcy case against the offshore debtor when the creditor files the claim. To avoid such complexity, the administrator or liquidator may petition the PRC court in advance to suspend all pending litigations and arbitrations against the offshore debtor in question. However, such suspension petition is not expressly provided by the Bankruptcy Law and is subject to interaction with the PRC court on a case-by-case basis. The PRC court may have three approaches to process such suspension petition by the offshore administrator or liquidator:
 
(a) The PRC court may suspend all pending cases against the offshore debtor and refer the onshore creditors to assert claims to the offshore administrator or liquidator according to foreign bankruptcy proceedings. This would be to the largest extent deference to foreign bankruptcy proceedings.
 
(b) Under onshore bankruptcy cases, after a court accepts bankruptcy petition, any civil lawsuit or arbitration against the debtor that has commenced but not ended shall be suspended. Such lawsuit or arbitration shall proceed after the administrator takes over the management of the properties of the debtor. In addition, after a court accepts bankruptcy petition, any lawsuit against the debtor shall only be filed with the court which accepts the bankruptcy petition against the debtor.  Under cross-border bankruptcy cases, the PRC court may refer to such provisions applicable to onshore bankruptcy cases. The PRC court may refuse to accept the lawsuit that is filed with it against an offshore debtor after any foreign bankruptcy proceeding commences against the offshore debtor in the debtor’s own jurisdiction. The PRC court may suspend any pending lawsuit filed before the commencement of the foreign bankruptcy proceeding against the offshore debtor and would let them continue after the offshore administrator or liquidator takes over the properties of the debtor within the debtor’s own jurisdiction.
 
(c) The PRC court may refuse to accept any lawsuit that is filed with it against the offshore debtor after it accepts the suspension petition by the foreign administrator or liquidator. For any lawsuit filed before such time, it may suspend such lawsuit and would let it continue after the offshore administrator or liquidator takes over the properties of the offshore debtor within the debtor’s own jurisdiction. 
 
Under Items (2) and (3) as above, the PRC court will render a judgment determining the amount payable to the onshore creditor by the offshore debtor. If such amount as determined by the PRC court is denied by an offshore court, such denial probably will be deemed as harming the interests of the onshore creditors. Thus, when the offshore administrator or liquidator petitions the PRC court for enforcement against the onshore properties of the offshore debtor, the PRC court may possibly decline such petition. Therefore, all these issues may need to be coordinated and planned in advance by the foreign administrator or liquidator.
 
Onshore creditors may file lawsuits against the offshore debtor with different courts within the PRC, subject to the PRC law and their agreements with the offshore debtor. A PRC court located at a creditor’s domicile, the place of execution of contract, the place of performance of contract or otherwise may have jurisdiction over certain dispute between parties. However, the suspension petition by the offshore administrator or liquidator as mentioned above is only submitted to a PRC intermediate-level court probably with the location of properties of the offshore debtor. No matter which of the three approaches as stated above the PRC court adopts to deal with the suspension petition by the offshore administrator or liquidator, such approach will have binding effect on all cases pending at such PRC court. However, it is uncertain whether the approach such PRC court adopts will have binding effect on cases pending at other PRC courts and whether the offshore administrator or liquidator needs to submit suspension petition to other courts with pending cases against offshore debtor. If it does have such binding effect, which local court shall be the proper court to accept and rule on such suspension petition? If the offshore debtor possesses assets in different locations within the PRC, which court would have the jurisdiction? Such issues will need to be clarified in future legislation and practice.
 
4. Bankruptcy of Financial Institutions
 
Financial institutions are subject to unique supervision system that does not apply to other enterprises. 
 
Pursuant to Article 134 of the Bankruptcy Law, if a commercial bank, a securities firm, an insurance company or any other financial institution is characterized by the Bankruptcy Reasons, the relevant financial regulatory authority under the State Council may submit a petition to the court to reorganize such financial institution or have it declared bankrupt and liquidated. Therefore, the financial regulatory authorities under the State Council are entitled to submit bankruptcy petition to the court. Subject to the consent or approval from relevant financing authority, the financial institution as the debtor or any of its creditors may petition the court for reorganization, settlement or liquidation in accordance with the Bankruptcy Law. Such financial regulatory authorities include China Banking Regulatory Commission (“CBRC”), China Securities Regulatory Commission (“CSRC”) and China Insurance Regulatory Commission (“CIRC”).
 
Article 134 of the Bankruptcy Law also provides that if the financial regulatory authority lawfully takes such measures as taking over management of or commissioning the management to a third party of a financial institution whose operations are facing a material risk, it may petition the court to stay any civil action or enforcement procedure in which the financial institution is the defendant or is the person against whom a judgment is being executed. The State Council may formulate implementing measures in accordance with the Bankruptcy Law and other relevant laws with respect to bankruptcy of financial institutions. 
 
China is a country maintaining the “separate operation and separate supervision” system for the regulation of financial institutions. The bankruptcy of financial institutions is subject to the Bankruptcy Law as well as other financial laws and regulations. CBRC, CSRC and CIRC supervise the bankruptcy of commercial banks, trust companies, securities firms, fund management companies and insurance companies respectively. Please refer to the followings for details. 
 
Please note that the financial laws and regulations were promulgated in different times, in particular, some of which were promulgated far before the promulgation of the Bankruptcy Law. Therefore, the financial laws and regulations shall be applied referring to the provisions of the Bankruptcy Law. For example, Paragraph 1 of Article 71 of the Commercial Banks Law provides that where a commercial bank is unable to repay its debts when due, as approved by the banking regulatory authority under the State Council, the court shall declare such commercial bank bankrupt. However, according to the Bankruptcy Law, the normal criteria of an enterprise being declared bankrupt is that such enterprise is unable to pay its debts when due, and the enterprise’s assets are not sufficient to repay all of its debts or the enterprise obviously lacks ability to discharge all of its debts. 
 
4.1 CBRC Supervision System 
 
4.1.1 Commercial Banks 
 
According to Paragraph 1 of Article 64 of the Commercial Banks Law, where a commercial bank has had or may have a credit crisis which has a material effect on the interests of its depositors, CBRC may take over the management of such commercial bank. According to Article 38 of the Banking Supervision and Administration Law, where a commercial bank has had or may have a credit crisis which has a material effect on the interests of its depositors and other customers, CBRC may take over the management of or procure the reorganization of such commercial bank. 
 
According to Paragraph 1 of Article 71 of the Commercial Banks Law, where a commercial bank is unable to repay its debts when due, as approved by CBRC, the court shall declare such commercial bank bankrupt. Therefore, the declaration of bankruptcy of any commercial bank shall be approved by CBRC. However, since the Commercial Banks Law was promulgated earlier than the Bankruptcy Law, whether the reorganization or settlement of a commercial bank shall be approved by CBRC is not clear in the Commercial Banks Law. Please note that the Insurance Law as promulgated in 1995 and revised in 2002 has similar provision. However, after promulgation of the Bankruptcy Law, the Insurance Law was further revised in 2009. The provision similar to Article 71 of the Commercial Banks Law as well as other provisions regarding bankruptcy of insurance companies were added or amended in accordance with the Bankruptcy Law. Therefore, the Commercial Banks Law may be further amended to be synchronized with the new Bankruptcy Law.
 
According to Paragraph 2 of Article 71 of the Commercial Banks Law, when a commercial bank is liquidated, after paying for liquidation expenses, wages and labour insurance premium payable to staff, the commercial bank shall pay in priority to individual depositors for principals and interests of their deposits with the commercial bank. Please note that, according to the Bankruptcy Law, the basic pension/medical insurance premium which shall be remitted into personal accounts of staff and other social insurance premium are separated as two tiers in the sequence for discharge of the claims. Since the Commercial Banks Law was promulgated before the Bankruptcy Law, it does not clarify the scope of “social insurance premium” and it is uncertain that, with the promulgation of the Bankruptcy Law, whether the principals and interests of deposits shall be paid before paying for social insurance premium other than basic pension/medical insurance premium which shall be remitted into personal accounts of staff. 
 
The Regulation on the Administration of Foreign Invested Banks and the Implementing Rules for the Regulation on the Administration of Foreign Invested Banks, as two basic rules regulating foreign invested banks, do not formulate detailed and systematic provisions for bankruptcy of foreign invested banks, but there are certain related terms in the chapter of “Dissolution and Liquidation".  According to Article 59 of the Regulation on the Administration of Foreign Invested Banks, if an operative foreign-funded bank is unable to pay its debts when due, CBRC may order it to cease its operation and clear up its assets and indebtedness within a prescribed limit of time. If it restores its ability to discharge all of its debts during the period of clearing-up and needs to restore operation, it shall file an application with CBRC. If it fails to restore its ability to discharge all of its debts after the prescribed time limit expires, it shall be liquidated. According to Article 128 of the Implementing Rules for the Regulation on the Administration of Foreign Invested Banks, where a wholly foreign-funded bank or a sino-foreign joint venture bank is under liquidation due to dissolution, and the liquidation team finds, after completing clear-up of assets and compilation of the balance sheet and the list of properties, that the properties of the bank are not sufficient to repay all of its debts, it shall, with the consent of CBRC, immediately petition the court to declare such bank bankrupt. 
 
4.1.2  Trust Companies
 
CBRC, the supervisor of trust companies, may take administrative measures such as taking over the management of or procuring the reorganization of a trust company which has had or may have a credit crisis. According to Article 55 of the Administrative Measures on Trust Companies, where a trust company has had or may have a credit crisis which has a material effect on the interests of beneficiaries, CBRC may take over the management of or procure the reorganization of such trust company. 
 
According to Article 14 of the Administrative Measures on Trust Companies, where a trust company is unable to repay its debts when due, and its assets are not sufficient to repay all of its debts or it obviously lacks ability to discharge all of its debts, with the consent of CBRC, the trust company may submit bankruptcy petition to the court. In addition, CBRC may directly petition the court to reorganize or liquidate such trust company.  
 
Where a trust company is terminated, the trust property managed by the trust company shall not be a part of its properties to be liquidated.  The liquidating team is obligated under the law to keep the trust property and hand over the same to the new trustee. Such provision separates the trust property from the properties of the trust company and clarifies the scope of properties in liquidation.
 
4.2  CSRC Supervision System
 
4.2.1 Securities Firms 
 
The bankruptcy of securities firms shall be approved by CSRC, the securities regulatory authority under the State Council. This is provided in Article 129 of the Securities Law, Article 15 of the Regulation on the Supervision and Administration of Securities Firms, and Article 38 of the Regulation on Risk Disposal of Securities Firms. 
 
According to Article 139 of the Securities Law, where a securities firm is bankrupt or liquidated, the customers’ capitals and securities that have been settled are not part of properties in bankruptcy or liquidation. Such provision separates the customers’ capitals and securities from the properties of the bankrupt securities firm and clarifies the scope of properties in bankruptcy. 
 
The Regulation on Risk Disposal of Securities Firms (the “Risk Regulation”) has a chapter of “Bankruptcy Liquidation and Reorganization”, which formulates provisions on the bankruptcy of securities firms. Such provisions are outlined as follows: 
 
  1. CSRC may petition the court to liquidate or reorganize a security firm in accordance with the law. According to Article 37 of the Risk Regulation, where a security company is characterized by the Bankruptcy Reasons at the time of its revocation or dissolution, CSRC or the administrative clear-up team as appointed by CSRC may petition the court to liquidate such revoked or dissolved securities firm in accordance with the Bankruptcy Law after administrative clear-up works are completed. According to Article 38 of the Risk Regulation, where a securities firm is characterized by the Bankruptcy Reasons, CSRC may directly petition the court to reorganize it. 
  2. The approval of CSRC for the bankruptcy petition of a securities firm depends on whether securities investor protection fund  needs to be used. If the securities business has no need to use the securities investor protection fund, CSRC shall revoke the permit of securities business of such company before approving the bankruptcy petition and the securities firm shall cease its securities business and settle down its customers according to Article 18 of the Risk Regulation. If the bankruptcy of the securities firm needs to use the securities investor protection fund, CSRC shall disapprove the liquidation petition by such securities firm or its creditors and revoke such securities firm and conduct administrative clear-up.
  3. With respect to the approval of the reorganization plan of a securities firm, as provided in the Risk Regulation, if the reorganization plan contains any matter as specified in Article 129 of the Securities Law , the securities firm or the administrator shall apply to CSRC for its approval of such matters at the same time of submitting the reorganization plan to the court for approval. CSRC shall decide to approve or disapprove such application within 15 days after its receipt of the application.  
  4. The appointment of the administrator. According to the Risk Regulation, where the court rules to accept the reorganization or liquidation petition against a securities firm, CSRC may recommend candidate of the administrator to the court. 
 
4.2.2  Fund Management Companies
 
The Securities Investment Funds Law provides the scope of properties in bankruptcy in case of bankruptcy of a fund management company. According to Article 6 of the Securities Investment Funds Law, where a fund manager or a fund custodian is liquidated due to dissolution, revocation, declaration of bankruptcy or other reasons, the fund under management are not part of properties in liquidation. 
 
4.3  CIRC Supervision System——Insurance Companies
 
The PRC Insurance Law was revised on February 28, 2009 and the new Insurance Law (the “Insurance Law”) took effect from October 1, 2009. With respect to the bankruptcy of insurance companies, the revisions of the Insurance Law are consistent with relevant provisions of the Bankruptcy Law. 
 
According to Article 90 of the Insurance Law, if an insurance company is characterized by the Bankruptcy Reasons, as approved by CIRC, the insurance company or any of its creditors may petition the court for reorganization, settlement or liquidation against such insurance company in accordance with the law, and CIRC may also petition the court to reorganize or liquidate such insurance company. 
 
Article 91 of the Insurance Law provides the discharge sequence in case of the liquidation of an insurance company. Such discharge sequence is as follows:
 
  1. Bankruptcy expenses and debts of common interests;
  2. Wages, medical and disability subsidies and support owed to staff, basic pension insurance premium and basic medical insurance premium which shall be remitted into personal accounts of staff and compensation payable to staff;
  3. Insurance compensation or insurance payment;
  4. Social insurance premium other than those as specified in item (2) above and taxes owed by the insurance company; and
  5. Unsecured bankruptcy claims.
 
Due to insurance compensation and insurance payment relates to public interests, the law gives such claims priority over the social insurance premium other than basic pension/medical insurance premium which shall be remitted into personal accounts of staff, taxes and unsecured claims.
 
As to life insurance business of the insurance company, since the insured are all individuals, Article 92 of the Insurance Law has special provisions to protect such individuals due to public policy reason. According to Article 92 of the Insurance Law, where an insurance company with life insurance business is revoked or is declared bankrupt, its life insurance contracts and liability reserve fund shall be transferred to another insurance company with life insurance business; if no agreement can be reached with any other insurance company with life insurance business, CIRC shall designate an insurance company to accept the transfer of the life insurance business. 
 

Zhong Lun Law Firm

 

For further information, please contact:

 

Wantao Yang, Partner, Zhong Lun

[email protected]

 

Carol Dongping Cao, Zhong Lun

[email protected] 

 

 

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