According to a bulletin released by KPMG in October 2006, the Standing Committee of the National People's Congress adopted a new Enterprise Bankruptcy Law of the People's Republic of China (PRC) on August 27, 2006, which will take effect on June 1, 2007. It will supersede the existing bankruptcy law, which was adopted in 1986 and ran on a trial basis for more than two decades. The new law provides for a more orderly and structured approach to deal with failing companies and seeks to provide better protection for creditors. The method of reorganization to be applied conforms to most modern global restructuring and insolvency regimes and can offer creditors a better recovery than in a liquidation scenario. The new law applies to all legal persons, including state-owned enterprises (SOEs), private companies, foreign-invested companies and joint-stock companies. By contrast, the old bankruptcy law (enacted December 2, 1986, and effective November 1, 1988) merely applied to the SOEs. Inclusion of provisions for cross-border insolvency is another step taken to align China with the growing international practice of respecting foreign bankruptcy judgments. However, there is insufficient publicly available information regarding China's compliance with the World Bank's Principles and Guidelines for Effective Insolvency and Creditor Rights Systems.

General Overview

According to a bulletin released by KPMG in October 2006, the Standing Committee of the National People's Congress adopted a new People's Republic of China Enterprise Bankruptcy Law on August 27, 2006, which will take effect on June 1, 2007. It will supersede the existing bankruptcy law, which was adopted in 1986 and ran on a trial basis for more than two decades. The new law provides for a more orderly and structured approach to deal with failing companies and seeks to provide better protection for creditors. The method of reorganization to be applied conforms to most modern global restructuring and insolvency regimes and can offer creditors a better recovery than in a liquidation scenario. Inclusion of provisions for cross-border insolvency is another step taken to align China with the growing international practice of respecting foreign bankruptcy judgments. (KPMG 2006)

A news flash released by PricewaterhouseCoopers (PwC) in September 2006 explains that, comprised of 12 chapters and containing 136 articles, the new law establishes a unified statutory framework for bankruptcy for all types of enterprises in China, whether state or privately owned, and provides much clearer procedures for insolvent enterprises to restructure or exit the market by means of restructuring, conciliation or bankruptcy. (PwC 2006)

In another legal update released by Holland and Knight in October 2006, Yang states that the new Bankruptcy Law applies to all legal persons including state-owned enterprises (SOEs), private companies, foreign-invested companies and joint-stock companies. By contrast, the Old Bankruptcy Law (enacted December 2, 1986, and effective November 1, 1988) merely applied to the SOEs. The old Bankruptcy Law did not provide workable guidelines for companies and courts, therefore failing its goals of protecting the rights and interests of creditors, debtors, investors and employees of bankrupt companies. (Yang 2006, p.1)

Yang does note, however, that the applicability of the new Bankruptcy Law is limited. It does not apply to natural persons, sole proprietorships, partnerships and other non-legal-person entities. It has been clarified that the new Bankruptcy Law applies to financial institutions, but the bankruptcy of financial institutions is subject to special provisions. In addition, the State Council is delegated with the authority to promulgate the implementation rules on the bankruptcy of financial institutions. The Policy System will continue to apply to the bankruptcy proceedings of the SOEs commenced prior to the effective date of the new Bankruptcy Law. (Yang 2006, p.1)

To effectively resolve a bankruptcy case, the court must also refer to another set of rules, the bankruptcy provisions contained in the Civil Procedure Law of the Peoples Republic of China (enacted April 9, 1991, and effective as of the enactment date), the interpretations on the Implementation of the Law of Civil Procedures (issued by the U.S. Supreme Court on July 14, 1992), and other interpretations issued by the Supreme Court on bankruptcy proceeding (collectively, the Bankruptcy Procedural Rules). Moreover, since 1994, the State Council has promulgated a set of policies and administrative rules to effectively establish a policy bankruptcy system for the SOEs. Under such a system, the welfare interests of employees, including unpaid wages, pension contribution, medical insurance premium and workers' compensation, were given preference over secured debts in the distribution of the bankruptcy estate, despite the requirement under the old Bankruptcy Law and Bankruptcy Procedural Rules that secured creditors be given the first priority. (Yang 2006)

The PwC news flash also states that the law introduces the concept of an independent administrator, i.e. a professional organization or individual charged with managing the subject enterprise's affairs and overseeing the administration. The duties of the administrator includes taking over, managing and disposing of the assets of the subject insolvent enterprise, managing its daily affairs, reviewing and adjudicating claims, investigating affairs of the enterprise and making distributions. Having a professional, independent organization such as an accounting firm as an administrator in bankruptcy proceedings is very different from current practice in China where the bankruptcy process is under the control of a liquidation committee comprising mainly government officials and related parties. (PwC 2006)

According to the PwC news flash, it is generally believed that the new law will be well received by creditors as it broadens significantly their role and power in a bankruptcy. Other than the rights to apply to the People's Court to change the initially appointed administrator and appoint a creditors' committee to supervise the work of the administrator in the first creditors' meeting, the new law stipulates that a number of important matters, e.g. the plans as to how the debtor's properties will be realized and distributed, will need to be discussed with and approved by creditors at creditors' meetings. (PwC 2006)

The new law also upholds the rights of secured creditors over assets pledged to them in priority to that of other creditors, including employees. Article 109 of the new law clearly provides that secured creditors shall have priority over the assets pledged to them by the bankrupt enterprise. The only exception to this rule is provided in Article 132 which states that after the implementation of the new law, any entitlements of employees (e.g. salaries, pension funds, medical expenses) accrued before the promulgation of this law that remain outstanding shall be settled out of the secured assets referred to in Article 109 in priority to the entitlements of secured creditors. (PwC 2006)

Another important feature of the new law is that it provides alternatives to bankruptcy, namely options of restructuring and conciliation. After the People's Court makes a ruling to accept the bankruptcy but before the debtor is declared bankrupt, the debtor and/or creditors can apply for restructuring (where the debtor will have the opportunity to submit a plan for rehabilitation of its business) or conciliation (where the debtor can propose a compromise and settlement of its debts with its creditors). (PwC 2006)