China’s corporate bankruptcy law comes into effect

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China’s corporate bankruptcy law took effect today. The law, which effects both foreign and domestic companies, allows creditors or financial supervision agencies to initiate bankruptcy proceedings against companies whose managements are unwilling to do so.

The law should streamline the process for declaring bankruptcy or securing defaulted payments, especially for foreign companies that before fell under various civil laws when performing insolvency liquidations. “This law will help redeem those organizations or enterprises which are in financial difficulties and still can be revived by reorganization,” said An Jian, deputy director of the standing committee’s legislative affairs commission.

China Economic Review’s Alfred Romann had this to say about it:

As usual with new laws, there are still a few questions. The law puts an inordinate amount of responsibility on the hands of local courts to manage the process of bankruptcy. It’s up to them to accept a case or stop the process cold in its tracks. Also, it’s up to the courts to appoint administrators who then manage whatever assets are available to be managed.

Putting such a big onus on single individuals who are often poorly trained and may put a priority on local interests above the spirit – if not the letter – of the law, may open the door to corruption and abuses.

We wrote about this back in our March issue of China Briefing. The bankruptcy law stipulates in Article 5, “(t)he validity of any bankruptcy proceedings commenced in accordance with this law shall extend to the properties of the debtor outside of the People’s Republic of China.” For the first time, a claim can be made over the assets of foreign investors in a bankruptcy case in an exterritorial jurisdiction outside of Chinese territory. The bankruptcy administrator is responsible for bringing actions against any debtors on behalf of the company during bankruptcy proceedings.

According to the new law, any foreign shareholder who had not fully paid up their registered capital shall be held liable for this inadequate capitalization. Some Chinese legal scholars also argue that in a cross-border bankruptcy, the foreign investor should be treated as a subordinate creditor compared with other creditors, if the investor claims creditor’s rights in an FIE that they control and they are guilty of poor management, improper dividend policy, breach of any relevant laws, or fraud. Some even say that the foreign investor shall be held liable for all of the debts of the FIE by applying the doctrine of “piercing the corporate veil,” and adopting just and equitable consideration if the foreign investor has abused its control over the subsidiary.