China's revised Enterprise Bankruptcy Law ("EBL") only recently, on 1st June 2007, came into effect. As the ink dries on its 136 articles, the EBL is yet to be tested.1One of the key drivers behind the implementation of the new bankruptcy laws was the need to continue to attract and maintain foreign investors into China following China's move to a market economy in the 1990s. Lenders and investors need to be able to assess the credit risk of their investment. As foreign investors are not permitted to hold assets or operate a business directly in China, but are required instead to do so through a foreign investment enterprise, a fundamental concern will be how the EBL operates domestically. Investors will wish to ensure that they can actively participate in restructurings of entities in which they hold investments. They will also look for a degree of predictability and greater certainty of outcome where they exit from their investments following business failure, where rescue is not feasible. The EBL provides a framework which, if politically and culturally embraced, will go some way towards dealing with the concerns of the foreign investor. A number of the key provisions of the EBL which represent important advances, from the point of view of the foreign investor in particular, are highlighted in the initial section of this article.
The focus of the remaining section of the article is on cross-border issues as such issues are likely to come increasingly to the fore, because of marketplace developments. In China's case, these developments include its now significant role as a key player in the international capital markets, illustrated by its listings on the London, New York and Hong Kong Stock Exchanges. Consequently, it is not difficult to envisage complex cross-border restructuring issues arising in circumstances where "ChinaInc." has listed or has assets overseas. This is particularly likely where, economically, a cross-border solution for the whole of the enterprise will provide the best restructuring outcome for the various stakeholders. The key here will be the extent to which Chinese bankruptcy procedures will be recognised overseas, and vice versa.
Key Highlights Of The EBR Of Particular Significance To Foreign Investors
• The EBL is not intended to apply to any company incorporated outside PRC, but will apply to a foreign enterprise investment through which a foreign investor is permitted to operate a business or hold assets in China. The EBL will not apply in cases where foreign investors have merely a branch office.
• The EBL includes provisions which for the first time will allow the debtor voluntarily to file for bankruptcy. Alternatively, creditors can file. The court has 15 days in which to decide whether or not to accept a filing, and if accepted a moratorium on enforcement action comes into play. This will prevent secured creditors from enforcing their rights unless they can show that their assets are in jeopardy.
• The EBL introduces a reorganisation procedure, modelled broadly on U.S. Bankruptcy Code Chapter 11, in which the debtor can request the court's permission to carry on its business subject to the supervision of an administrator. The alternative available procedures are liquidation and conciliation. As well as a moratorium, the reorganisation procedure includes provisions enabling "DIP style" finance to be raised.
• The restructuring plan is required to be approved by a majority in number of creditors in each class representing at least 2/3 in value of the liabilities for that class. As under U.S. Chapter 11, however, the court has power to impose the plan on dissenting creditors through a cram-down procedure.
• The EBL includes provisions for the appointment of a creditors' committee with wide supervisory powers over the administrator. Creditors' committee sanction is required, for example, on the decision whether or not to carry on in business, for decisions relating to asset disposals and on the restructuring plan.
• Once a bankruptcy filing has been made, holders of 10 percent or more of the debtor's shares can apply to court for a reorganisation.
• If the proposed reorganisation plan impairs shareholders' interests, Article 85 permits shareholders to vote on the plan, (although they may be subject to cram-down.)
• Creditors with security over the entity's assets enjoy a priority status in repayment to the extent of the secured collateral. This is a significant advance as under the old law, employees' claims enjoyed priority even over secured claims. Under the EBL, employees' claims are payable after the expenses of the bankruptcy, but ahead of certain taxation and state claims and the claims of unsecured creditors which then follow.
The Cross-Border Framework
Before the implementation of the EBL, China had no specific statutory provisions addressing aspects of cross-border insolvency. Previously, the success of an incoming request for recognition of a foreign bankruptcy proceeding would depend upon whether a treaty or arrangement was in place between China and the requesting jurisdiction permitting mutual recognition of court orders. Alternatively, the Chinese courts could exercise their discretion to adapt powers under the Chinese Civil Procedure Laws to permit recognition. There are few reported cases, but in 2002, the Chinese courts recognised Italian bankruptcy orders in the case of B&T2 , concluding that they were permitted to do so, based on a combination of the provisions of a bilateral treaty between Italy and China and the Chinese Civil Procedure Laws. However, whilst the Italian proceedings were recognised by China in B&T, the Chinese courts did not go on to determine any requests to assist the Italian insolvency office holders to enforce over B&T's assets located in China. It is understood that this latter aspect was dealt with through diplomatic channels. Importantly, the new law deals not just with recognition, but also enforcement.
Inbound And Outbound Recognition Requests
On the face of it, the EBL represents an important advance. Although the provisions relating to cross-border insolvency are confined to a single article (Article 5), this ambitiously not only sets out a framework for the approach to be taken by Chinese courts in dealing with foreign requests for recognition of bankruptcy proceedings (i.e. in-bound proceedings), but also asserts how Chinese bankruptcy proceedings are to be recognised abroad (i.e. out-bound proceedings.). In practice, the two aspects go hand in hand, given that the power to recognise a foreign proceeding is subject to a number of important conditions, including, perhaps most critically, a requirement of reciprocity. For those jurisdictions able to satisfy the reciprocity requirement, the Chinese courts are open for the business of dealing with requests for recognition and enforcement of overseas bankruptcies.
Whether a Chinese bankruptcy proceeding will be recognised in a foreign jurisdiction will depend in practice on the view taken by the relevant foreign jurisdiction to whom the request is made. For countries implementing the UNCITRAL Model Law on Cross-border Insolvency ("The Model Law") (including the U.S. and the UK), provided that the Chinese proceeding seeking recognition has been commenced over an entity which qualifies as a "main proceeding" or "non-main proceeding,"3then those Chinese bankruptcy proceedings, absent public policy grounds, are required to be recognised.4Although the point has yet to be tested, it would appear then that the U.S. and Great Britain, at least, ought presumably to be able to satisfy the Article 5 reciprocity requirement, as neither jurisdiction has sought to limit their application of the Model Law recognition regime to those jurisdictions which have likewise enacted the Model Law. It should here be noted that China has not enacted the Model Law.
Other key trading partners of China, notably Hong Kong, have not enacted the Model Law. Neither is there a separate bi-lateral agreement between China and Hong Kong, whether relating to bankruptcy proceedings or civil proceedings more generally, which could satisfy the reciprocity requirement. So jurisdictions like Hong Kong will presumably have to prove reciprocity on a case by case basis before the Chinese courts. Few outbound requests for recognition of Chinese insolvency office holders are understood to have been made, but in 2001, in a headline case, the Hong Kong recognised the liquidation of Guandong International Trust Investment Corp, ("GITIC" 2005 2 HKC 589). Any Hong Kong insolvency office holder seeking recognition in China under the EBL will doubtless point to the GITIC case as evidence of Hong Kong's compliance with the reciprocity requirement. For other jurisdictions, proving reciprocity may be more of an uphill task, as it will be based on legal theory, rather than empirical evidence.
As well as the requirement of reciprocity, before agreeing to recognise a foreign bankruptcy proceeding and enforcing it in China, the Chinese courts will also have to be satisfied that recognition will not "violate the basic laws of the People's Republic of China" or "damage sovereignty, safety or social public interests of the state" or "damage the legitimate rights and interests of the creditors within China." These conditions leave the Chinese courts with a great deal of flexibility and discretion as to how they will apply the provisions. From the point of view of the foreign insolvency office holder, this unfortunately means that it is likely to be uncertain and unpredictable whether a recognition request will be granted. For jurisdictions satisfying the reciprocity requirement and not falling foul of the other conditions, Article 5 opens up the opportunity not merely for bare recognition, but also for the assistance of the Chinese courts in enforcing against assets in China.
The cross-border provisions of the EBL look set to provide a useful building block which will facilitate the structuring of effective mechanisms to allow for the restructuring of cross-border groups. These structures might include, for example, combining a Chinese restructuring of a foreign owned enterprise with a Hong Kong Scheme of Arrangement of group entities centred in Hong Kong. This might be the best manner in which effectively to bind in creditors who will likely be subject to Hong Kong governed financing packages whilst at the same time ensuring assets located in China are not isolated from the rescue plan. Investors will watch with interest to see how the EBL is applied in practice and the extent to which it facilitates cross-border restructurings.
1 Details of the number and types of filings are not readily available, moreover, China has no official reporting mechanism for its decisions and there is no system of precedent applying in China.
2 Not officially reported in China.
3 Within the meaning of the respective applicable foreign implementing laws.
4 To date there are no reported decisions of any recognition applications made by China to (1) the U.S. under chapter 15 of the U.S. Bankruptcy Code (implementing the Model Law in the U.S.), or (2) the UK Courts pursuant to the Cross Border Insolvency Regulations 2006 SI 2006/1030.
Dominic McCahill is a Partner in the London office of Weil Gotshal & Manges LLP, where his practice focuses on restructuring and includes cross-border insolvencies. Sally Willcock is a professional support lawyer in the firm's London office.