This article was first published in the Global Restructuring Review, 14 Jan 2020.
King & Wood Mallesons’ Dispute Resolution Partner Sam Kinsey shares her key takeaways from recent insolvency seminars in Beijing and Shanghai. There are positive signs, but considerable uncertainty remains, she says.
Foreign concepts less than 15 years ago, bankruptcy and reorganisation in China are evolving rapidly, with new courts emerging and case numbers surging. But the most exciting development may have come from the United States, where a court has recognised a Chinese bankruptcy proceeding. It’s a significant moment in the current tense political climate and it may just pave the way for China to reciprocate – potentially drawing a new map for navigating insolvencies across the PRC’s borders.
A glimmer of hope on the cross-border horizon
In a significant recent decision, the US Bankruptcy Court for the Southern District of New York formally recognised the bankruptcy of Reward Science and Technology Industry Group, currently taking place in Beijing under the laws of the PRC. The effect of that recognition is that the US assets of Reward Science and Technology Industry Group have been entrusted to the Chinese bankruptcy process and US creditors are now prevented from exercising any rights in respect of those assets rather than submitting claims as part of the Chinese bankruptcy process.
The decision is interesting for several reasons. It is highly unusual – only the second time a US court has formally recognised a Chinese bankruptcy process – and the moment in which it comes is undoubtedly heated. The US and China are mired in a protracted trade war, set against a backdrop of ideological differences and amplified by domestic politics. This charged atmosphere explains why the New York court’s decision to entrust US assets to a Chinese bankruptcy process, to the potential detriment of US creditors, is attracting considerable interest. To PRC practitioners the decision is a welcome endorsement of the PRC bankruptcy regime. It has also ignited discussion over whether a PRC bankruptcy court would now be similarly prepared to recognise and facilitate a foreign insolvency process. Several practitioners now consider such recognition may be granted in an appropriate case.
Chinese law is evolving rapidly
The past year has seen a dramatic increase in the number of bankruptcy and reorganisation cases in the PRC, which are up almost tenfold on previous years. Among them are high profile entities including six companies listed on the Main Board that are subject to reorganisation proceedings. These companies span flagship industries including steelmaking and manufacturing. To handle the emerging volume, bankruptcy courts have now been established in Shenzhen, Beijing, Shanghai and Tianjin.
Improving creditor protections and potential bankruptcy protection for individuals
Courts and legislators are taking key steps to further develop bankruptcy processes.
Last March, the Supreme People’s Court issued Judicial Interpretation III, partly as a response to issues raised in the World Bank’s contentious report on the ease of doing business in China.
The judicial interpretation sought to clarify parts of the PRC’s Enterprise Bankruptcy law and has strengthened creditor protections and rights.
China’s bankruptcy regime has traditionally favoured debtors, but Judicial Interpretation III makes several critical changes. It clarifies the priority of debtor-in-possession financing and increases creditors’ rights to information. The judicial interpretation also clarifies the rights of shareholders to vote on a draft restructuring plan, and otherwise increases the protection of creditors’ interests.
In another major development, personal bankruptcy protection is also being trialled, which could also make it much easier for companies to restructure.
Chinese lenders have traditionally required guarantees from company owners and their families. The absence of personal bankruptcy protection in China has made it difficult for owners to place their insolvent corporations into bankruptcy, potentially resulting in ‘zombie’ companies that are neither living nor dead.
However, a new pilot program appears highly promising. In the recent Wengjo and Taijo cases, creditors have for the first time agreed to compromise debts owed by a Chinese individual. This is an important development and has the potential to encourage insolvent companies’ managers to proactively engage in seeking restructuring solutions.
Where China innovates – a note on tech
PRC bankruptcy practitioners are leading the world in their innovative use of technology to increase efficiency and reduce the costs of liquidation processes. Online auctions are now commonly utilised, on transparent platforms such as Alibaba, to sell assets in liquidation processes.
The year ahead
High-level will to make restructuring more accessible is very encouraging. The importance of this cannot be understated given the current economic conditions.
The same goes for formally recognising cross-border cases. The Reward Science case creates optimism that the PRC courts will reciprocate. But there remain some significant challenges in the cross-border recognition space. Notably, there is still no clear mechanism for cross border insolvency recognition between Hong Kong and mainland China. Though agreements have recently been signed between the two jurisdictions to recognise and enforce civil and commercial judgments, insolvency matters are still excluded.
Insolvency and restructuring in the PRC are undoubtedly at an interesting intersection. There are positive signs, but considerable uncertainty remains.