What were the effects of the old bankruptcy law in China?

The 1986 Enterprise Bankruptcy Law of the People’s Republic of China, promulgated on December 2, 1986 and effective on October 1, 1988 (the “1986 Enterprise Bankruptcy Law”, also known as the “Old” Bankruptcy Law), was the first significant attempt at bankruptcy reform in China since the Qing dynasty. However, the 1986 Enterprise Bankruptcy Law was not viewed as adequately effective in regulating bankruptcy issues and was to a general extent applicable only to State-owned enterprises. As a result, a large number of State-owned enterprises incurred significant losses, but had their debts and loans written off by State-controlled banks.

There were additional problems with the 1986 Enterprise Bankruptcy Law. It allowed significant discretion by the administrative authorities in the bankruptcy process. Under that law, State-owned enterprises required government approval before bankruptcy could occur. This was because employees and existing assets needed to be resettled before bankruptcy would be considered. As a result only “leftovers” were paid to creditors, which meant creditors had few rights and remedies in the bankruptcy process. The issue was further plagued by the long tradition of “identity” and “instability”, as State employees or the so-called government servants (to the outside world) were guaranteed an “iron rice bowl” or life-time employment.

Other insolvency laws were also enacted in China over this period supplementing the 1986 Enterprise Bankruptcy Law. In April 1991 (at the fourth Session of the Seventh National People’s Congress (“NPC”)), the NPC issued the amended 19th Chapter of the Code of Civil Procedure (the “Civil Procedure Law”), which enacted a procedure for bankruptcy repayment of enterprises as legal persons. Articles 199-206 discussed bankruptcy for non-state-owned enterprises, specified repayment procedures (Art. 199) and provided a three-month period for creditors to file claims in the People’s Courts (Art. 200). Art. 204 established priorities for repayments: (1) wages of employees
and labour insurances, (2) unpaid taxes, and (3) finally, bankruptcy claims.
Despite the grant of these legal rights to creditors in the Civil Procedure Law, heavy intervention from government departments impeded the effectiveness of the courts, and creditors rights were not upheld in equity. Even though the law provided for a 3-month time period for claims, a claim would be deemed abandoned if the creditor was unable to notify the courts in time.
There were also issues of interpretation. For example in the Civil Procedure Law the instrument used to identify rights between parties is the use of “judgment” or “panjue” and of “ruling” or “caiding”. These methods are often confused with bankruptcy law and deprive parties the right to challenge evidence and appeal. Other problems under that regime persisted. In some cases assets were distributed to local creditors but not creditors from other jurisdictions.8 In other instances major creditors such as commercial banks had a significant influence in court proceedings, while smaller trade creditors were ignored or not even notified at all. Some judges lacked capacity and experience, especially in smaller, undeveloped cities, in comparison to bigger and more advanced cities, where judges had more experience in handling bankruptcy proceedings.

The miscarriage of justice from even one incorrect judgment clearly damages the rule of law. However the problem cannot be solely based on incorrect judgments from the courts. Implementation of the poorly drafted old bankruptcy legislation was a major contributory factor for its failure.9 In Liquidation Group of Wenzhou Trust Company v. Xinfu Industrial Co. Ltd. (3/21/00), the Higher People’s Court of Hubei Province, and on appeal the Supreme People’s Court (7/18/02), demonstrated a need to protect creditors’ rights. However, a year later, in 2003, the Higher People’s Court of Guangdong Province, construed the 1986 Enterprise Bankruptcy Law strictly and placed the creditors’ group as the lowest priority, resulting in minimal recovery for the creditors. This inconsistent approach adopted by the courts at different levels demonstrated the need for further bankruptcy reform.

(01/01/07)

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