Insufficient Information Summary

There is insufficient publicly available information as to China's compliance with the Principles and Guidelines for Effective Insolvency and Creditor Rights Systems developed by the World Bank. However, there is some largely descriptive information suggesting that China is making progress in the area of insolvency reform. Chief among China's efforts is the passage of China's new Enterprise Bankruptcy Law in 2006, which establishes a new insolvency regime that, according to KPMG and PricewaterhouseCoopers' (PWC) reports, is believed to be more orderly and structured, and to provide greater creditor protection. Nonetheless, China's key concern of maintaining social stability has led to the inclusion of a provision in the new law that prioritizes the payment of claims by laid-off employees if such claims were accrued prior to the passage of the law (claims accrued after the laws passage do not enjoy this priority). The PWC report adds that the new legislation brings China more closely into alignment with international practice on reorganization and other procedures, and includes provisions that respect foreign bankruptcy judgments. The legislation extends bankruptcy provisions to cover all enterprises. This is contrary to the previous regime, in which private enterprises were ineligible for bankruptcy protections and only state-owned enterprises had access to the system. However, a lack of consistency in the application of the law and the paucity of trained insolvency professionals has led to an uncertainty about outcomes.

General Overview

In October 2006, KPMG reported that China's National People's Congress had adopted a new Enterprise Bankruptcy Law on August 27, 2006. KPMG describes the new law as offering greater structure and order to the bankruptcy process. The provisions covering reorganization are consistent in principle with the methods employed in most modern insolvency regimes worldwide. There are also provisions dealing with cross-border insolvency, bringing China into closer alignment with international practice. The 2009 Country Commercial Guide produced by the U.S. Department of Commerce's (DoC) adds that the law extends access to the bankruptcy process to private enterprise, whereas the prior law restricted such access to state-owned firms. According to both KPMG and the DoC, the law improves creditor protection, and the DoC notes that payment to creditors is the first priority of the new regime. However, the DoC adds that credit guarantees are specifically earmarked for payment to laid-off workers. According to a 2007 publication issued by PricewaterhouseCoopers (PWC), the new law contains 12 chapters and 136 articles that, taken together, provide the bankruptcy regime a unified statutory framework for all enterprises, including state-owned enterprises, replacing what was previously an amalgamation of laws, rules, and procedures.

Writing prior to the passage of the new Act, Mitchell et al. reported in the Asia-Pacific Restructuring and Insolvency Guide of 2006, that the then-draft legislation represented a potential catalyst for change in China, "paving the way for true corporate and economic reform" (p. 11). The report opined that it might take years before use of the new law became widespread, in part because China lacked the necessary infrastructure to accommodate many cases. The paper notes that the People's Republic of China observes civil law, and that the court system is largely inexperienced with cases that involve creditors' rights concerns. Other problems noted in the Chinese legal system include a tendency towards local protectionism, inconsistency, and the questionable independence of the courts. This creates uncertainty with regard to outcomes. According to the paper, efforts at improving the system have been made in some areas, including through enhanced training of the judiciary. The PWC report notes that one way that the new legislation attempts to address the problem of independence is through the introduction of the office of "independent administrator." The administrator is charged with taking over the debtor firm, managing its assets through the liquidation process, conducting investigations as required, adjudicating claims, and distributing payments to creditors. This breaks from prior practice, in which government officials and related parties formed a liquidation committee to handle these tasks. The administrator is initially appointed by the court, but must call a creditors' meeting early in the process, where he or she can be challenged by creditors. The creditors have the option of replacing the original appointee or establishing a committee of creditors to supervise the administrator's activities. The PWC report also offers greater detail as to employee protections afforded by the new law, noting that Article 132 requires the payment of employee entitlements that were accrued prior to the law's passage must be honored over the entitlements of even secured creditors. Such benefits if they accrue after the law was passed, do not qualify for such preferential treatment. In addition, the new law introduces bankruptcy alternatives, such as conciliation and restructuring. PWC's report adds that this legislation attempts to bring China's insolvency regime into greater harmony with international best practices.

According to the "Doing Business 2010" snapshot of closing a business in China offered by the International Bank for Reconstruction and Development and the World Bank, China ranks 65th out of the 181 economies surveyed, worldwide for the factor “Closing a business.” The report tracks three aspects of the business-closing process to identify problem areas in insolvency regimes. These include the time it takes, on average, to complete the process, expressed in years; the average cost of the procedure, expressed as a percentage of the debtor estate; and the average recovery rate, expressed in cents on the dollar. The report also offers comparable figures for the region and for the member states of the Organization for Economic Cooperation and Development (OECD). In China it takes an average of 1.7 years to complete a bankruptcy proceeding, which is the same amount of time averaged within the OECD and less than the 2.7 years that is the regional average. It costs an average of 22 percent of the estate in China, compared to an average regional cost of 23.2 percent and an OECD average of 8.4 percent. The average recovery rate is 35.3 cents on the dollar in China, compared to an average of 28.4 cents in the region, and 68.6 cents in the OECD countries.