Insolvency And Corparate Bankruptcy In China
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Insolvency and Corporate Bankruptcy in China
Overview
China's insolvency framework is evolving. The issue of insolvency is particularly sensitive due to the existence of many technically insolvent state-owned enterprises and financial institutions. This situation poses a dilemma between maintaining economic inefficiency and enacting mass layoffs, which could threaten social stability.
Initiating Insolvency Proceedings
In China, both voluntary and involuntary insolvency actions are possible, initiated by the debtor or a creditor, respectively. Proceedings begin with an application to the People’s Court to declare insolvency. The applicant must demonstrate the debtor’s inability to repay debts as they mature. Upon a declaration of insolvency, all proceedings against the debtor are paused, and the company generally must suspend operations.
Creditor Notification
The People’s Court informs creditors of the insolvency proceedings either by written notice or public announcement. Creditors receiving a written notice have 30 days to claim their rights, while those responding to a public announcement have three months. Missing these deadlines extinguishes the creditors’ claims.
Asset Distribution
All assets owned by the company at the time of the insolvency declaration, or acquired afterward, are available for distribution. These include intellectual property, real estate, equity investments, and assets recovered from voidable transactions, typically liquidated via auction.
Voidable Transactions
Certain transactions made by State-Owned Enterprises (SOEs) are void if conducted within six months prior to the court’s acceptance of the insolvency petition or within 180 days for Foreign-Invested Enterprises (FIEs). These transactions include:
- Selling property significantly below market value
- Concealing or secretly distributing assets
- Surrendering creditor claims
- Securing previously unsecured debt
- Repaying debts before maturity
Priority of Claims
Generally, claims must be settled in this order:
1. Secured creditors
2. Insolvency expenses
3. Employee wages and unpaid social security
4. Outstanding taxes
5. Unsecured creditors
In some areas, employee claims may supersede those of secured creditors.
Corporate Bankruptcy Law
China's new Corporate Bankruptcy Law, effective June 1, 2007, replaces the provisional law from 1986 and represents a significant advancement. It aims to address bankruptcy issues in financial organizations and balance the rights and interests of labor and creditors, while redefining the liquidation order.
The law encompasses all corporate entities, including state-owned, private, and foreign-invested enterprises. It features a reorganization system to help struggling enterprises avoid bankruptcy and effectively addresses cross-border bankruptcy issues. The law offers enhanced protection for mortgage holders over staff creditors, a provision that will apply to state-owned enterprises after 2008. Moreover, it establishes professional management for the liquidation process, moving away from reliance on local government officials.
This new law supports the growing market economy in China, which has led to an increase in bankruptcies, especially in the state-owned sector.
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