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Prc China Law Bankruptcy


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A Legal Analysis and Practical
Application of the PRC
Enterprise Bankruptcy Law
John J Rapisardi and Binghao Zhao*

When China enacted its landmark bankruptcy law in June 2006, it did so with
the anticipation that a legal infrastructure was needed to soften and control
the impact of a sudden economic downturn or crisis. The worldwide economic
events of the last 18 months have seen the United States and European
countries suffer one of the most severe recessions in the last 70 years. The
impact of the economic slowdown in the West has been felt in the East.
   Indeed, China’s economic breakneck growth has been slowed under the
weight of the global economic recession. Thousands of profitable enterprises,
particularly in the export sector, have been hit hard by crisis, and millions
of workers have reportedly been laid off.
   The good news is that China’s Enterprise Bankruptcy Law (EBL) is coping
with business failures as the recession progresses. In the case of very large
companies, China’s EBL has begun to have some impact and prevented
complete chaos from taking hold. This article offers a case study and a
critique of the law itself that illustrate how the EBL is being tested initially
under the current global recession.

General principles of the PRC Enterprise Bankruptcy Law
The EBL recognises two well-developed principles of bankruptcy law: equality
of treatment of creditors and providing a ‘fresh start’ to a beleaguered
debtor, which are shared by the US Bankruptcy Code. However, the process
to recognise and establish these principles is controversial. Not long ago,

*   John J Rapisardi is the Co-Head of Cadwalader’s Financial Restructuring Department and
    co-author of The PRC Enterprise Bankruptcy Law: The People’s Work in Progress. Binghao Zhao
    is an associate of the firm.
50                       Business Law internationaL Vol 11 No 1 January 2010

notwithstanding certain statutes, labour claims took priority over secured
claims in practice.1 Such an arrangement, if tolerated and accepted by the
EBL, would have negated the fundamental principle of equality of treatment
among similarly situated creditors. Moreover, the Enterprise Bankruptcy Law
of the People’s Republic of China (Trial Implementation) (which was in
existence prior to enactment of the EBL) failed to afford the honest debtor
a fresh start through bankruptcy relief by not offering the reorganisation
option available to the debtor. After more than two decades of debate,
Chinese law-makers eventually realised that bankruptcy law which embodied
the principles of equality of treatment and fresh start was required in the
public interest of the country at large and for its welfare.

Equality of treatment of creditors
In contrast, outside bankruptcy law, creditor remedies can be characterised
as a first-come, first-served exercise. Chinese law-makers intended to include
a broad range of interests within the bankrupt estate and the ambit of
the avoidance powers to effectuate a central policy of the EBL: equality
of distribution among a debtor’s creditors.2 However, Article 132 of the
EBL declared that labour claims that were incurred before 27 August 2006
could be satisfied with proceeds from the sales of encumbered assets, with
priority over secured creditors, to the extent they cannot be satisfied from
unencumbered sources. In practice, most of the labour claims at issue arose
before 27 August 2006. Prior to enactment of the EBL, it was not unusual for
the People’s Court to strip secured creditors’ claims of their secured status
and structural priority and grant that priority to employee claims.

Providing a ‘fresh start’ to a beleaguered debtor
The purpose of the US Bankruptcy Code is to provide the honest but
unfortunate debtor with a fresh start.3 Similarly, Article 1 of the EBL provides,
among other things, that the EBL is formulated in order to protect the
lawful rights and interests of creditors and debtors. Specifically, Chapter
11, like reorganisation, was adopted in the EBL. Both the debtor and its
creditors are allowed to file reorganisation petitions to the People’s Court.
Moreover, the EBL discharges the debtor’s obligation with regard to claims

1    However, under Article 132 of the EBL, labour claims will be repaid with the proceeds of
     secured creditors’ collateral ahead of secured claims, but only if such labour claims were
     incurred before 27 August 2006.
2    See Articles 17, 30, 31, 32, 33, 34, 35 and 36 of the EBL.
3    Marrama v Citizens Bank, 549 US 365, 367 (US 2007).
the prc enterprise Bankruptcy Law                                                           51

that are treated under the approved plan.4 Reorganisation was introduced
as a means of attempting to rescue potentially viable businesses. Hence, the
China bankruptcy regime is actively fostering a ‘rescue culture’.
   On the other hand, the US courts have declared that the US Bankruptcy
Code was crafted to ‘protect those in financial, not moral, difficulty. The
bankruptcy courts were not created as a haven for criminals’.5 It is not
surprising that the EBL takes the same initiative to make efforts against
those who commit crimes in the context of bankruptcy.6 To take a step
further, Chinese law-makers have made bankruptcy fraud and crime a
high priority by awarding the People’s Court ample power to scrutinise
the bankruptcy proceeding.

Challenges for the EBL and the PRC bankruptcy professionals
Ambiguities of the EBL itself
Many provisions of the EBL do embrace some ambiguities and flaws. Actually,
there are many situations in which China’s law-makers appear to leave
ambiguities in order to facilitate the passage of the statute.
   However, bankruptcy practitioners have found unintended flaws in
the EBL. For example, the EBL broadens the scope of debtors that may
apply reorganisation and also makes the reorganisation petitions available
for debtor and creditors to file.7 Moreover, if an involuntary petition for
bankruptcy liquidation is filed by creditors, then the debtor or equity holders
representing more than one-tenth of the debtor’s ‘registered capital’ may
apply to the People’s Court to covert a case to a reorganisation proceeding
after the People’s Court accepts the bankruptcy proceeding and before the
debtor is declared bankrupt.8 Nevertheless, it is unclear whether and how
the creditor may convert the case from liquidation to reorganisation, if the
case was commenced by the filing of an involuntary liquidation petition
after the People’s Court accepts the bankruptcy proceeding and before the
debtor is declared bankrupt.
   In addition, the language of the EBL presents ambiguities that are new
to the court and that must be resolved by statutory interpretation, which
helps give full effect to the legislative intent behind the initial legislation. For
example, a secured claim is secured to the extent of the creditor’s interest

4   See Articles 92 and 94 of the EBL.
5   Barnette v Evans, 673 F 2d 1250, 1251 (11th Cir 1982); In re French, 139 BR 485, 489 (Bankr
    DSD 1992).
6   See Articles 131 of the EBL.
7   Articles 2, 7 and 70 of the EBL.
8   Article 70 of the EBL.
52                       Business Law internationaL Vol 11 No 1 January 2010

in the debtor’s interest in the property, and it is unsecured to the extent
that the creditor’s collateral is worth less than the amount of the creditor’s
claim. However, it is unclear whether the secured creditor is entitled to assert
a deficiency claim if such a deficiency exists.
   Nevertheless, we believe that the perceived flaws in the EBL should not be
overstated. It would not be surprising to see the split of authority result from
ambiguities in the EBL like what has happened to the US bankruptcy regime.
The legal community has learned to accept the ambiguities inherent in the
rules’ articulation as unavoidable characteristics of the statutory law.9 In fact,
the People’s Court is making efforts to resolve various ambiguities in the EBL,
undertaking the difficult and often confusing task of deciphering China’s law-
makers’ intent regarding the various provisions of the law, and determining
whether these provisions affect different parties’ substantive rights under the
law. Moreover, the Supreme People’s Court is conducting investigations and
studies on a comprehensive and detailed judicial interpretation to the EBL.10
According to Hon Xiaoming Xi, an associate justice of the Supreme People’s
Court, this judicial interpretation will be introduced in the near future.11

Lack of transparency in the PRC bankruptcy regime
Under previous bankruptcy laws, the assets of a debtor were subject to the
control of a court-appointed liquidation committee that typically consisted
of government officials and the former management of the debtor itself.
Creditors were rarely appointed or represented, and concerns had been raised
about transparency and the adequate protection of creditors’ interests. To
address this issue, the EBL introduced a bankruptcy administrator with broad
powers to manage the debtor’s assets and exercise administrative authority over
the entire bankruptcy procedure. Moreover, the EBL empowers the creditors’
committee with the supervision of the administrator.12 The introduction of
a creditors’ committee increases the creditors’ involvement and provides a
counterbalance to the administrator.13 However, China’s bankruptcy regime

9    David A Schulman, ‘The Effectiveness of the Federal Fair Debt Collection Practices Act
     (FDCPA)’ (1985) 2 Bankr Dev J 171 at 183.
10   The Supreme People’s Court issued two important judicial interpretations on 12 April 2007,
     ie, the Supreme People’s Court Regulation on Appointing Administrators in Enterprise
     Bankruptcy Proceedings; and the Supreme People’s Court Regulation on Defining
     Compensation for Administrators in Enterprise Bankruptcy Proceedings, respectively.
     Moreover, the Supreme People’s Court issued an Opinion on Hearing Enterprise
     Bankruptcy Cases Correctly and Preserving the Order of the Market Economy by Offering
     Judicial Guarantee on 12 June 2009.
11   Hon Xiaoming Xi, speech at China Bankruptcy Law Summit in Beijing, 20 June 2009.
12   Articles 67, 68 and 69 of the EBL.
13   Ibid.
the prc enterprise Bankruptcy Law                                                           53

still lacks transparency because different parties have only limited access to
relevant bankruptcy information, let alone the general public.
    Alternatively, section 107 of the US Bankruptcy Code indicates Congress’
intent to maintain open access to judicial records in cases of bankruptcy.14
The US courts have repeatedly emphasised the importance of transparency
in bankruptcy proceedings, the presumption of public access mandated by
section 107 of the Bankruptcy Code and the constitutional right of access
to judicial proceedings and court documents.15 Most of the key decisions
in bankruptcy reorganisations, such as the selling of assets, cannot occur
without a court filing and bankruptcy court approval. Access to such filings
necessarily facilitates the exchange of information among different parties
in a bankruptcy case.
    In contrast, there is a long tradition in China’s courts that judicial
proceedings are inaccessible to the public, including the case files and
records of what transpires before the court. Moreover, a comprehensive
and searchable system for reporting judicial decisions is unavailable in
China.16 As such, the public and even the creditors have difficulty in gaining
access to judicial records to bankruptcy proceedings. This inability to gain
access to core bankruptcy information complicates the creditors’ efforts
to protect their basic rights and interests. In fact, China’s courts have used
new technology and the commercialisation of the media to spread positive
reports about their own work.17 In this regard, the People’s Court should
facilitate all parties as well as public access to bankruptcy information, which
can eliminate corruption, reduce conflicts and result in a more efficient and
less expensive bankruptcy process.

Absence of debtor-in-possession financing mechanism
‘Debtor-in-possession (DIP) financing’, also known as ‘post-petition
lending’, is one of the most important (and revolutionary) innovations
introduced in the 1978 Bankruptcy Code. Specifically, sections 364(a)
and 364(b) authorise a debtor to obtain unsecured post-petition credit

14 Section 107(a) of the Bankruptcy Code provides: ‘Except as provided in subsections (b)
   and (c) of this section and subject to Section 112, a paper filed in a case under this title
   and the dockets of a bankruptcy court are public records and open to examination by an
   entity at reasonable times without charge.’ 11 USC § 107(a).
15 See Nixon v Warner Communications, Inc, 435 US 589 (1978); In re Bell & Beckwith, 44 BR 661
   (Bankr ND Ohio 1984); and In re Northwest Airlines Corp, 363 BR 704 (Bankr SDNY 2007).
16 Thomas E Volper, ‘TRIPS Enforcement in China: A Case for Judicial Transparency’ (1991)
   33 Brook J Int’l L 309 at 329.
17 Benjamin Liebman, ‘China’s Network Justice’ (2007) 8 Chi J Int’L L 257 at 315.
54                      Business Law internationaL Vol 11 No 1 January 2010

and incur unsecured debt as a first priority administrative expense. 18
Section 364(c)(2) enables a debtor who is unable to procure unsecured
post-petition credit to obtain funding by giving the lender a first lien on
unencumbered pre-petition assets. Section 364(c)(3) enables a debtor
to give the lender a junior lien on pre-petition assets that are already
secured. The crux of the DIP financing mechanism is that section 364(d)
allows a debtor to give a ‘superpriority’ lien on pre-petition assets that
are already secured if the debtor can show that the originally secured
party is adequately protected and that no alternative financing exists.
Indeed, the entire US bankruptcy industry has grown up around the rules
authorising post-petition finance, and many chapter 11 cases would have
been impossible without it.19
   The secured DIP is recognised under the EBL, but a lien is only permitted
to be placed on the debtor’s unencumbered property or property with
equity exceeding existing liens that can be pledged.20 In other words, the
EBL is silent as to whether the lender is allowed to leapfrog over the existing
creditors when the debtor seeks post-petition financing. Although the
existing creditors may enter into a forbearance agreement with DIP lenders
voluntarily under the PRC Civil Law, it is unlikely that any creditor would
assume all of the risks without receiving any protection under the EBL. As
such, typical DIP financing is almost unavailable in China. As a result, the sale
of a company as a whole would currently be the only effective reorganisation
approach under the EBL.

Roles and motivations of key participants in the PRC bankruptcy cases
Role of the People’s Court and the Bankruptcy Judge21
court possessing extensive powers in the Bankruptcy regime

The US Bankruptcy Code methodically tries to balance the countervailing
interests between debtors and creditors. The US Supreme Court also
pointed out that ‘Chapter 11 strikes a balance between a debtor’s interest
in reorganizing and restructuring its debts and the creditors’ interest in

18 See also 11 USC 503(b)(1).
19 Chapter 11 – ‘101’: Obtaining DIP Financing and Using Cash Collateral, 23-7 ABIJ 16 (1
   September 2004).
20 Article 75 of the EBL.
21 China is not equipped with specialised bankruptcy courts and bankruptcy judges as in the
   United States. Therefore, for clarity and uniformity, Chinese ‘bankruptcy judge’ refers to
   the judge who presides over bankruptcy cases. Also, Chinese ‘bankruptcy court’ refers to
   the forum over which the ‘bankruptcy judge’ presides.
the prc enterprise Bankruptcy Law                                                      55

maximizing the value of the bankruptcy estate’. 22 Both the debtor and
creditors are awarded equal access and the chance to protect their rights
and interests under the US Bankruptcy Code. Actually, the US bankruptcy
statutory scheme is to centralise disputes regarding a debtor’s assets and
liabilities in the bankruptcy courts. The US bankruptcy courts require
the creditor to take a proactive role in the bankruptcy and monitor the
treatment of their claim. Moreover, the US Bankruptcy Code, which was
enacted in 1978, transformed the bankruptcy court ‘from active participant
to passive arbiter’.23
   In contrast, the People’s Court takes a very active role in the control
and oversight of bankruptcy cases. Specifically, all the key participants of
the bankruptcy proceedings, including the administrator, chairman of the
creditors’ meeting, creditors’ committee members and the DIP, must be
approved by the court.24 Moreover, significant bankruptcy documents and
motions, such as the bankruptcy application, draft reorganisation plan,
conciliation agreement and bankruptcy estate distribution proposal, should
be submitted to the court for approval. Furthermore, the court has the
authority to modify and amend proposals at issue in the case of disagreement
in order to avoid deadlock.25
   The US Congress also found that ‘bankruptcy is an area where there exists
a significant potential for fraud, self-dealing and for diversion of funds’,26
and thus ‘active supervision is essential. Bankruptcy affects too many people
to allow it to proceed untended by an impartial supervisor’.27 To fill this
role as protecting the public interest, Congress established the Office of
the US Trustee. ‘The concept of the US Trustee system [was to] provide
decentralized, semi-autonomous officials to administer the bankruptcy
laws.’28 The legislative history of the Bankruptcy Reform Act of 1978
indicates that Congress expected US trustees to oversee the administration

22 Fla Dep’t of Revenue v Piccadilly Cafeterias, Inc, 128 S Ct 2326, 2339 (US 2008).
23 Walter W Miller, Jr, ‘Bankruptcy Code Cramdown Under Chapter 11: New Threat to
   Shareholder Interests’ (1982) 62 BUL Rev 1059 at 1066.
24 Articles 13, 22, 60, 67 and 73 of the EBL.
25 See Shi Jingxia, ‘Twelve Years to Sharpen One Sword: The 2006 Enterprise Bankruptcy
   Law and China’s Transition to a Market Economy’ (2007) 16 J Bankr L & Prac 5 Article 2.
   For instance, if the creditors’ meeting cannot approve the debtor’s property management
   proposal or bankruptcy estate valuation proposal, the court may issue a ruling on its
   own. The same power is vested in the court if the creditors’ meeting cannot adopt the
   estate distribution proposal after two meetings. Moreover, even if some creditors vote
   to reject the plan, the court may confirm the plan under the cramdown provisions of
   Article 87 of the EBL.
26 1978 USCCAN at 6050.
27 Ibid.
28 1978 USCCAN at 6062.
56                      Business Law internationaL Vol 11 No 1 January 2010

of bankruptcy cases and ‘to serve as bankruptcy watchdogs to prevent fraud,
dishonesty and overreaching in the bankruptcy arena’.29
   During substantial discussion in the hearings on the drafts of the EBL,
the Supreme People’s Procuratorate30 submitted a proposal to establish an
agency to supervise the bankruptcy procedure that is similar to the Office
of the US Trustee. However, the law-makers did not accept this proposal.
Legislative history and the current EBL explain that this does not mean that
the Chinese law-makers believe bankruptcy is a ‘holy place’, without any
fraud, false representations or knowing concealment of material facts. On
the contrary, Chinese law-makers are aware that bankruptcy fraud was a new
and significant area of concern to the EBL, which loathes any kind of fraud.
As a result, China’s bankruptcy judge and the administrator assume the US
Trustee’s administrative and supervisory roles, which had been removed from
the responsibility of bankruptcy judges under the 1978 US Bankruptcy Code.

The myth of the Chinese bankruptcy judge
In the eyes of many commentators, China lacks sophisticated, experienced
and well-trained judges in trying bankruptcy cases. Although it is undisputed
that Chinese bankruptcy judges should receive more training to acquire
the necessary expertise in order to hear bankruptcy cases efficiently and
properly, the authors find the above statement to be factually inaccurate
or exaggerated.
   Indeed, the ability of judges to handle bankruptcy cases varies greatly from
place to place owing to the imbalance of economic development in China’s
various regions. However, the situation in the United States is no different.
A substantial portion of the largest bankruptcy cases have been filed in the
Southern District of New York or Delaware, on the theory that debtors seek
out these districts when their cases are complex and will benefit from the
experienced bankruptcy judges in these jurisdictions.31 Interestingly, after
Delaware district judges, none of whom was experienced in bankruptcy, were

29 HRRep No 95-595, 95th Cong 1st Sess at 88, 1978 US Code Cong & Admin News, pp 5963, 6049.
30 The Supreme People’s Procuratorate is the highest procuratorial organ of China and
   the legal supervisory organ of the state. It is mainly responsible for supervising regional
   procuratorates and special procuratorates to perform legal supervision by law and
   protecting the unified and proper enforcement of state laws.
31 Stephen J Lubben, ‘Choosing Corporate Bankruptcy Counsel’ (2006) 14 Am Bankr Inst
   L Rev 404. Also, according to, of the 105 large cases listed for 1995
   to 2001 (15 for each year), 56 were filed in Delaware. The Southern District of New York
   accounted for 18 of the large cases, and no other judicial district had more than three
   of the large cases. A total of 44 Chapter 11 and Chapter 7 bankruptcy cases were filed by
   public companies between 1 January and 22 May 2008 and, of those cases, 12 went to New
   York, ten to Delaware and the other 22 were filed throughout the country.
the prc enterprise Bankruptcy Law                                               57

assigned to hear bankruptcy cases in Delaware in 1997, ‘for five months, not
a single large public company filed a bankruptcy petition in Delaware’.32
   The truth is that there are many competent and highly educated judges in
China. Moreover, in the economically developed regions, such as Shanghai,
Beijing and Guangzhou, the judges’ heavy dockets and workload equip
them with extensive experience in all aspects of commercial and business
disputes. In fact, these Chinese judges may very well be more versed and
experienced in substantive commercial issues when compared to some of
their counterparts in the United States.
   The crux of the problem is the absence of judicial autonomy and
independence, which is an overriding concern in enforcing the EBL. Unlike
in the United States, where courts, practitioners and creditors have a more
lucid understanding of the bankruptcy court’s role in the bankruptcy process,
China’s courts and judges are struggling with conflicts and tensions between
the courts and the administrative authorities. For example, the Supreme
People’s Court issued an Opinion on Hearing Enterprise Bankruptcy
Cases Correctly and Preserving the Order of the Market Economy by
Offering Judicial Guarantee on 12 June 2009. One of the important points
in this opinion is to encourage the People’s Court to cooperate with local
government authorities in order to resolve the challenging issues that arise
in the context of bankruptcy proceedings. However, local protectionism is
among the fundamental obstacles to enforcement of the EBL. As a result,
China’s courts have to accommodate conflicting values between assisting
local governments and curbing local protectionism.
   Hence, in contrast to the EBL where there exists the potential for debtors
to be mired in court-controlled bankruptcy proceedings for years, out-of-
court reorganisation may provide a speedy and cost-effective alternative
strategy. As such, Chinese bankruptcy professionals may view out-of-court
reorganisations as the best way to gain creditors’ confidence and for a quick
restructuring without resort to a formal bankruptcy proceeding.

The EBL introduces the role of an independent administrator (which
can be a law firm, accounting firm, bankruptcy liquidation firm, relevant
government official or similar) appointed by, and accountable to, the
People’s Court. This administrator will manage the debtor’s assets during
the bankruptcy and report to the court on the status of the company. The
introduction of an independent administrator in bankruptcy proceedings is

32 William Jarblum, ‘Incorporation Issues: Why Delaware?’ (1999) 18-8 ABIJ 6.
58                     Business Law internationaL Vol 11 No 1 January 2010

intended to create a proper balance of power between the bankruptcy court
and the parties in interest.
   There are specific duties and restrictions placed on the administrator.
Specifically, the administrator shall be diligent and dutiful and shall
faithfully perform its duties.33 However, there is an obvious lack of clarity
in the minds of the law-makers of the EBL about what and whose interests
the administrator actually represents. Thus, the administrator is faced with
the struggle to balance the inherent tension between the debtor’s need to
conduct its business affairs as it sees fit and the creditors’ right to monitor
the debtor’s course of conduct. Moreover, it remains to be seen under the
EBL how the administrator works with the bankruptcy court and whether
the administrator becomes an ipso facto branch of the bankruptcy court.

The US Bankruptcy Code contemplates that a post-petition Chapter 11
debtor will continue to operate its business and manage its affairs as a DIP. 34
It is well accepted that the DIP is usually familiar with the business it had been
managing pre-petition, often making it the best party to conduct operations
during the reorganisation.
    However, under the EBL, the People’s Court is required to appoint an
administrator at the same time as it has decided to hear the case, whether it
is a liquidation case or a reorganisation one. Thus, an administrator must be
appointed even for a debtor who voluntarily seeks reorganisation – there is
no DIP as under US law. In fact, the reality is that the filing of a petition for
reorganisation in China does automatically replace pre-petition management
with a disinterested administrator.
    Alternatively, the EBL provides that the debtor’s management may
recapture its estate under two situations. First of all, during the reorganisation
period, the incumbent management is allowed to continue to operate the
debtor’s business under the supervision of the administrator, after the
People’s Court approves its application.35 Where the debtor’s application is
approved, the administrator shall return control of the debtor’s property
and business to the debtor ‘and the power of the administrator provided
for herein shall be exercised by the debtor’.36 Secondly, once a plan of
reorganisation has been successfully adopted by creditors and approved

33 Article 27 of the EBL.
34 See 11 USC §§ 1107 and 1108. See also Nathalie Martin, ‘Common Law Bankruptcy Systems:
   Similarities and Differences’ (2003) 11 Am Banker Inst L Rev 367 at 391.
35 Article 73 of the EBL.
36 Ibid.
the prc enterprise Bankruptcy Law                                                 59

by the court, ‘[t]he administrator who has received the debtor’s property
and business affairs shall transfer the property and business affairs to the
debtor’, and the debtor ‘shall be responsible for the implementation of
the reorganization plan’.37 Providing the debtor with a choice between
having an administrator and retaining control might well prove to be one
of the EBL’s strengths. However, in most cases, the creditors would prefer
an administrator over the incumbent management to manage the debtor’s
daily business operations.
   In sum, the power to run the company is taken from the debtor and
given to the administrator when the administrator is appointed under
the EBL. Moreover, it is unlikely that the incumbent management may
regain control of their day-to-day businesses, which is in marked contrast
to the US DIP approach. In China, creditors, shareholders and other
stakeholders usually blame the incumbent management for steering
the company into bankruptcy, because they believe that the firm’s
managers are operating the firm incompetently or fraudulently and
the directors are not monitoring these managers. Therefore, under the
first scenario, the incumbent management will not regain control of the
debtor’s property, because the creditors and shareholders will throw out
incumbent managers who are accused of either committing fraudulent
acts or of being incompetent. This second scenario illustrates the same
result. As we have explained in the previous section, because it is very
difficult to negotiate and obtain DIP financing in China, most troubled
Chinese companies are ultimately sold as going concerns, which again
means that management, as well as ownership, will change. Thus, it
would be reasonable to conclude that the debtor has no motivation to
file voluntary bankruptcy if it intends to continue operating the company
under the EBL.

Case studies
The financial crisis and global recession have produced a wave of bankruptcy
filings in China over the past year and a half. Specifically, the number of
bankruptcy cases accepted by the people’s courts at various levels for the
first quarter of 2009 is 28 per cent higher than during the same period in
2008.38 Among those potential or pending cases, the following three cases
deserve closer study.

37 Article 89 of the EBL.
38 Hon Xiaoming Xi, speech at China Bankruptcy Law Summit in Beijing, 20 June 2009.
60                  Business Law internationaL Vol 11 No 1 January 2010

Steel maker FerroChina has become one of the highest-profile Chinese
victims yet of the global economic crisis. The case reveals many features of
the practical application of EBL. FerroChina is a Bermudan company and
is listed on the Singapore stock exchange. FerroChina’s principal activities
are producing and selling galvanised steel coils and other related products.
Its products include antisepticised and cold-rolled steel coils, thin gauge
galvanised steel coils, heavy gauge galvanised steel coils and pre-painted
galvanised steel coils. FerroChina also provides a post-galvanisation service
and product customisation for clients by cutting and slitting steel coils
into required sizes. FerroChina’s operations are carried out in Dongbang
Industrial Park, Changshu, Jiangsu, China.
    In October 2008, FerroChina disclosed that it could not pay RMB706
million (US$103.83 million) in working capital loans. Thereafter,
FerroChina reported that a further RMB2.03 billion (US$298.5 million)
worth of loan facilities and notes as well as working capital loans of
RMB2.49 billion (US$366.18 million) may also become due and payable.
FerroChina’s stock was suspended from trading on 8 October 2009, at 54.5
Singapore cents, valuing FerroChina at S$436 million (US$293 million).
Its shares have slumped 80 per cent over the past year. In November
2008, FerroChina disclosed that 206 creditors had filed suits against
its subsidiaries for unpaid debts totalling RMB4.82 billion (US$708.8
million). According to the administrator, the amount of outstanding
debt totalled approximately RMB12 billion (US$1.7 billion) by the end
of April 2009.
    Thereafter, involuntary petitions for bankruptcy against FerroChina’s
five Chinese mainland subsidiaries, Changsu Xinghai Advanced Building
Material, Changsu Xingyu Advanced Building Material, Changsu Xingdao
Advanced Building Material, Changsu Everbright Material Technology
and Changsu Changgang Steel Plate, were filed by six bank creditors. On
18 November 2008, Changshu Municipal People’s Court issued an order
permitting FerroChina’s subsidiaries to undergo the reorganisation process.
Under Article 79 of the EBL, the debtors must submit a reorganisation plan
by 18 May 2009. However, the deadline has been extended for three months
to 18 August 2009, because strategic investors failed to reach agreements
with the parties in interest.
    Finally, FerroChina’s creditors accepted a reorganisation plan. Under
the plan, China Minmetals Corp and Zhejiang Materials Industry Group
Corp jointly acquired the five operating subsidiaries of FerroChina. China
Minmetals Corp invested RMB3.2 billion (approximately US$468.5 million)
the prc enterprise Bankruptcy Law                                                       61

in FerroChina. Specifically, the amount of the proposed distribution to
creditors depended on whether their claims were secured by specific onshore
or offshore assets or collateral of FerroChina. Thus, secured creditors have
had much higher recovery rates than unsecured creditors. Moreover, the
reorganisation plan treated similarly situated creditors, whether domestic or
foreign, equitably. On 31 August 2009, the reorganisation plan was approved
by Changshu Municipal People’s Court. The FerroChina case is instructive as
another example of reorganising a failed business by selling its assets through
a reorganisation plan.

Asia Aluminum
Asia Aluminum is the largest aluminium extrusion group in Asia, and is
based in China. Its annual designed capacity is 350,000 metric tonnes.
According to the company’s unaudited financial reports, its revenue in the
fourth quarter of 2008 was HK$1.4 billion (US$180.6 million), with a net
loss of HK$105 million (US$13.5 million). At the end of 2008, the company
had cash and bank deposits totalling HK$702 million (US$90.6 million). Its
total assets were HK$18.9 billion (US$2.5 billion) with liabilities of HK$11.8
(US$1.5 billion).
    Facing severe financial challenges, Asia Aluminum offered to buy back
its foreign bonds at less than one-third of their face value in February 2009.
Specifically, the plan includes an offer to buy back US$450 million in high-
yield bonds for 27.5 cents in the dollar and to repurchase US$727 million
payment-in-kind notes for 13.5 per cent of face value. Foreign bondholders
strongly opposed this offer, arguing that it is unrealistic, with a lack of
financial disclosure. Thereafter, Asia Aluminum withdrew its buyback offer
and entered provisional liquidation proceedings in Hong Kong.
    Although Norsk Hydro, a Norwegian aluminium firm, had approached
the Zhaoqing municipal government and Asia Aluminum to explore a
possible acquisition, the firm withdrew from the bidding after its overtures
were met with a cool response and fierce resistance from Asia Aluminum’s
largest shareholder – its chairman. The local government claimed it needed
a quick rescue deal for Asia Aluminum to ensure social stability and to
preserve jobs.
    Finally, the Hong Kong court approved the sale of the principal assets
of Asia Aluminum to a management-backed group called Golden Concord
Pacific, for US$475 million including debt on 25 June 2009. 39 Asia Aluminum

39 The bankruptcy law and judicial system in Hong Kong are different from those in Mainland
   China. Moreover, the EBL does not apply to Hong Kong under the Basic Law of the Hong
   Kong Special Administrative Region of the People’s Republic of China.
62                  Business Law internationaL Vol 11 No 1 January 2010

will repurchase high-yield bonds for 20 per cent of face value and the
payment-in-kind notes for 0.09 per cent of face value under the terms of
the management buyout plan. The current repurchase price is much less
than its buyback offer that was proposed in February. In contrast, Chinese
lenders would get repaid almost in full.

Neo-China Real Estate Company
Neo-China Group (Holding) Co, Ltd is a Hong Kong-listed mainland real
estate developer. The company had RMB2.5 billion (approximately US$366
million) cash and equivalent as of 30 June 2008, according to its 2008 interim
report. Long-term loans were RMB6.3 billion (approximately US$923
million) and short-term loans maturing within one year were RMB2.8 billion
(approximately US$410.4 million). The net debt–equity ratio was 86 per cent.
The company defaulted on a payment of HK$152 million (approximately
US$19.7 million) interest for the US$400 million bonds payable on 23
January 2009. Then the amount of cash and equivalent fell to about RMB2.3
billion (approximately US$336.5 million).
   Moreover, Neo-China, which has been suspended from H-share trading
since 22 January 2008, must buy back HK$1.1 billion (approximately US$142
million) convertible bonds due to mature in 2011. Thereafter, the company
made a tender offer which proposed to cut the buy-back price to HK$6,300
for every HK$10,000 principal from an originally agreed HK$12,010,
representing about 40 per cent discount. Finally, the bondholders voted to
accept Neo-China’s offer on 13 May 2009.
   However, Neo-China still faces a number of challenges. For instance, it
disclosed that on 10 January 2008, the Hong Kong Independent Commission
Against Corruption (ICAC) executed a search warrant at the company’s
offices in Hong Kong and seized certain documents and articles from the
company’s premises. The ICAC is investigating suspected offences under
sections 9(1), 9(2) and 9(3) of the Prevention of Bribery Ordinance, and
asserted that it had reasonable cause to believe that there were documents
and articles that are or contain evidence of the suspected offences at the
company’s premises.
   Neo-China may lead another wave of bankruptcy in all industries.
Moreover, the other two major Chinese real estate companies – Poly Real
Estate Group Co Ltd and Greentown China Holdings Limited Co – also face
serious financial challenges at this time.
the prc enterprise Bankruptcy Law                                         63

Conclusion: no gains without growing pains
Tracing back to the early years of the Bankruptcy Act of 1898, we find that
it has taken more than 100 years for the US bankruptcy jurisprudence to
evolve to its present state. The legislative history to the US bankruptcy law
illustrates that the US Bankruptcy Code has survived many constitutional
and technical challenges.
   China is experiencing the years of trial and error that has characterised
the US bankruptcy law adventure. Although China bankruptcy law is far
more highly developed than it was in 1980, it will not remain static. The
EBL will continue its evolution, within its own unique setting, of whatever
US-based principles it chooses to adopt for the present. For example, one of
the overriding purposes of the EBL is to promote the rescue of companies
and their businesses. We have seen that the importance of the rescue culture
has been recognised in relation to the new-style bankruptcy regime by the
Chinese legal and business community.
   Although it is unrealistic to expect that China will have an identical
experience to the United States, the fundamental, well-founded principles of
bankruptcy law have been recognised and adopted by the EBL in any event.
The evolution of the EBL is inevitable because the economic forces that
shaped, and continue to shape, the development of the EBL in the Chinese
business community are ever-changing. All of us wish for China and its legal
and business community to succeed in this endeavour.
64   Business Law internationaL Vol 11 No 1 January 2010

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