Restructuring and Insolvency in China
The PRC Enterprise Bankruptcy Law (EBL, which came into effect on 1 June 2007) offers a formal restructuring regime for a company in financial difficulties to work out a reorganisation plan to rehabilitate its business. The reorganisation procedure is a court-driven process that in some ways is akin to the English Law administration regime. During the process of reorganisation, any bankruptcy proceedings are suspended and secured creditors are not permitted to enforce their security rights against the debtor’s assets without leave of the People’s court. Alternatives to reorganisation are liquidation and compromise.
This informal arrangement is not defined by PRC law. Parties may, however, always negotiate and agree on certain alternative commercial arrangements without having recourse to court proceedings. However, such arrangements should not prejudice creditors who may challenge arrangements and seek to have them declared invalid in later bankruptcy proceedings.
Under the EBL, a company may apply for voluntary liquidation or compromise when both the ‘cash flow test’ (i.e. the debtor is unable to pay its debts as they fall due) and the ‘balance sheet test’ (i.e. the debtor’s liabilities exceed the value of the debtors’ assets or the debtor obviously lacks the capability of paying debits) are satisfied. To be eligible to petition for reorganisation, a company need only establish that it is about to become insolvent.
A creditor is still entitled to apply for bankruptcy or reorganisation against the debtor if only the ‘cash flow test’ is satisfied.
A shareholder contributing more than 10% of the registered capital of the company is also entitled to apply for reorganisation in creditor-initiated proceedings.
The EBL provides for the restructuring of insolvent enterprises upon the application of a debtor, creditor or investor holding at least 10% of the registered capital of the debtor. Once an application is approved by the court, ‘reorganisation’ begins.
During the reorganisation period, the administrator has responsibility for the management of the company. However, the EBL allows the company’s management team to continue its work under the administrator’s supervision with the court’s approval. The company or administrator is required to submit a draft business restructuring plan to the court. The plan should be drawn up with a view to improving the company’s financial status and business performance, including restructuring of debt. Unless the court grants an extension time, the reorganisation plan should be submitted to the court and the creditors’ meeting within six months from the commencement of the reorganisation period.
Upon receipt of the reorganisation plan, the court should convene a meeting of the creditors to vote on the plan. The creditors are divided into four classes:
The approval of each class is determined by an affirmative vote of a majority of the creditors in that class present and voting, and representing two-thirds in value of the debt held in that class.
If the creditors’ meeting rejects the plan, the company or the administrator may apply to the People’s court to have the plan approved, and approval will be granted provided it meets certain criteria. If the plan is rejected by the court, the restructuring will be terminated and the debtor declared bankrupt.
If the plan is accepted by both the creditors’ meeting and the court, the company will be able to implement it and it will do this under the supervision of the administrator.
The company is responsible for the implementation of the reorganisation plan. The administrator re-transfers the assets and business operations back to the company. The administrator supervises the implementation of the plan for its entire duration.
During reorganisation, the company is expected to report to the administrator on progress with implementation as well as on the company’s financial status, and he in turn should submit a supervision report to the court upon the expiry of the supervision term.
The concept of ‘administrator’ was introduced by the EBL. The EBL provides that the People’s court is required to appoint an administrator upon acceptance of a bankruptcy petition. The administrator is a person or organisation responsible for managing the debtor’s property and overseeing the reorganisation process during the court bankruptcy process. Law firms, accounting firms and bankruptcy liquidation firms or individuals from relevant departments or agencies, can act as administrator.
Under the EBL, the administrator’s main duty is to take over the management of the debtor’s property. He will also handle other related matters, such as participating in litigation and arbitration or other legal procedures on behalf of the company, making decisions on the operation of the company, and performing such other functions and duties as the court deems appropriate. The administrator will report to both the court and the creditors (at creditors’ meetings).
If a creditor’s meeting concludes that an administrator has failed to perform his duties properly, it may apply to the court to have him replaced.
An administrator may resign, but only for justifiable reasons, and must obtain the court’s prior approval.
Once the reorganisation plan is approved by the court, it should be implemented by the debtor, subject to the administrator’s supervision, within the prescribed supervision period.
A reorganisation plan, once approved by the court, binds the company and all creditors. If a creditor fails to present his claim in accordance with the provisions of the EBL, he is precluded from exercising any other rights during the implementation period.
The rights of a creditor against the guarantor of a debtor company, and the other obligors bearing joint and several liability with the debtor, will not be affected by the plan.
If the company fails to or refuses to implement a reorganisation plan, the court may, at the request of the administrator or an interested party, terminate the implementation of the plan and declare the debtor bankrupt.
Where the court decides to terminate the implementation of a plan, the commitment of creditors to the adjustment of their rights in the reorganisation plan is released. Any repayment received by creditors during this process remains effective however, and outstanding claims that have not been repaid treated as proven in bankruptcy.
A company, whether a domestic entity or a foreign invested enterprise, may initiate a voluntary winding-up if its assets are sufficient to settle all outstanding liabilities. A liquidation committee of the company is constituted (in the case of foreign invested enterprises, approval from the Ministry of Commerce or its authorised local department, must first be obtained), creditors notified and an assets distribution plan drawn up by the liquidation committee and submitted to shareholders and creditors for approval. All outstanding debts are then repaid, a liquidation report produced by the liquidation committee and approved by the shareholders, and the company wound up and deregistered.
If during the voluntary out of court winding-up procedure, the company is found unable to repay all its outstanding debts, a court bankrupt liquidation procedure should be initiated and the liquidation committee should hand over the liquidation to the court.
As mentioned above, a company may itself apply to the court for liquidation if both the ‘cash flow test’ and ‘balance sheet test’ are satisfied.
Under the EBL, a creditor may apply for a court-driven liquidation provided it can prove that the debtor is unable to pay its debts as they fall due. However, an application may not necessarily or immediately result in the liquidation of the debtor, as the company or a shareholder contributing more than 10% of the registered capital may apply for reorganisation instead.
Both compulsory liquidation and voluntary winding-up are regulated by the EBL and other laws and regulations. The major difference between the types of dissolution is that voluntary winding-up need not be undertaken with court supervision if the company remains solvent and able to pay its debts.
Under the EBL, an administrator takes charge of the business of the company in disposing of assets and paying debts.
In a non-court-driven voluntary winding-up, a liquidation committee is formed to perform the following functions:
The liquidation committee should apply to the court for a liquidation order if the company is found to be insolvent during the voluntary winding-up process. If the application is successful, the committee will hand over the liquidation affairs to the court.
The EBL applies PRC bankruptcy proceedings to the assets of a PRC debtor located outside China. However, the EBL does not enable a PRC court to issue a winding-up order against a foreign company.