Restructuring and insolvency law in China

The PRC Enterprise Insolvency Law (“Insolvency Law”, promulgated by the Standing Committee of the PRC National Congress on 27 August 2006) is the primary legislation governing insolvency and (insolvency-related) restructuring proceedings in the PRC. 

In addition, the PRC Supreme People’s Court (“SPC”) has so far released several interpretations on trial of enterprise insolvency cases and application of the Insolvency Law (“SPC Interpretations”). Judicial interpretations of the SPC are not “law” in a technical sense. However, they have legally binding effect in practice for all levels of the People’s Courts in the PRC. Therefore, the SPC Interpretations are an important supplement to the primary legislation governing insolvency proceedings in the PRC.

No PRC law exists yet on personal insolvency. Only in June 2020, a draft of the Regulations on Personal Insolvency was published by the legislative body of the Shenzhen Special Economic Zone. The legislative procedures of these local regulations have not yet been completed. Further, even if they are enacted, they only apply to individuals residing in the Shenzhen Special Economic Zone. 

Insolvency/restructuring proceedings in the PRC are initiated upon application or according to law:

Upon application 

• if a company (debtor) is unable to repay due debts and its assets are insufficient to repay all debts or it is obviously illiquid, the debtor may file an application to the competent People’s Court to initiate the respective type of insolvency/restructuring proceedings, i.e. reorganisation, reconciliation or  insolvency liquidation (jointly referred to as “Insolvency Proceedings”)
• if a company is unable to repay due debts, any creditor may file an application to the competent People’s Court to initiate reorganisation or insolvency liquidation.

According to law

• if it turns out during the dissolution and liquidation of a company that the assets of the company are insufficient to repay all debts, the liquidation group of the company shall apply to the People’s Court for announcement of insolvency   
• if a company has been dissolved but not yet been liquidated or its liquidation has not yet been completed, and it turns out that the assets of the company are insufficient to repay all debts, the party responsible for the liquidation according to law (which is normally the liquidation group) shall apply to the People’s Court for insolvency liquidation of the company.   

Please note that in the current practice of the People’s Courts, if a foreign-invested enterprise applies for insolvency, the courts will only accept the application after the employees of the company have been terminated and duly received statutory settlement compensation.

According to the Insolvency Law and the related SPC Interpretations, the People’s Court shall determine that the debtor is insolvent if the debtor is unable to repay due debts and:

• its assets are insufficient to repay all debts, or  
• it is obviously illiquid. 

Further, the likelihood that the debtor has obviously lost its solvency can also be a reason for the debtor or the creditor to apply for reorganisation to the People’s Court. 

Due debts

The People’s Court shall determine that “the debtor is unable to repay due debts” if the following circumstances exist concurrently:

• the claim-debt relationship is legally established
• the debt has become due, and
• the debtor has failed to pay off all of the debts.

All debts

The People’s Court shall determine that “the assets of the debtor are insufficient to repay all debts” if the balance sheets or audit reports, asset evaluation reports, etc. of the debtor indicate that all assets of the debtor are insufficient to pay off all the debts, unless there is contrary evidence which can sufficiently prove that the assets of the debtor are sufficient to pay off all debts. 

Illiquid

If the book value of the debtor is more than its debts, the People’s Court shall still determine that “the debtor is obviously illiquid” if the debtor is unable to repay the debts:

• because it is in severe lack of funds or has failed to realise any properties
• because the whereabouts of the legal representative of the debtor is unknown and there is no one else responsible for managing the assets
• upon enforcement by the People’s Court
• because it has made losses for a long time and has difficulties in making profits, or
• due to other circumstances which have resulted in the insolvency of the debtor.

The Insolvency Law provides for three types of Insolvency Proceedings: reorganisation, reconciliation and insolvency liquidation.

Reorganisation

The reorganisation proceeding aims at “saving” the debtor from insolvency by recovering its operation so that the debts can be repaid. PRC law does not stipulate any measures that can be adopted to reorganise the debtor. Therefore, as long as approvable by the creditors’ meeting and the People’s Court, reorganisation measures may be, for instance:

• reduction or cancellation of the debts
• prolongation of the payment deadlines
• capital increase or decrease
• conversion of debts into equities, etc. 

The debtor or a creditor may directly file an application to the competent People’s Court for reorganisation of the debtor. Such application may also be filed by the shareholder(s) of the debtor who hold(s) more than 10% of the debtor’s shares after the People’s Court has accepted an application filed by a creditor for insolvency liquidation, but before the People’s Court has declared the debtor insolvent. The debtor or the administrator designated by the People’s Court shall draft a reorganisation plan for approval by the creditors’ meeting and the court. The draft reorganisation plan shall include:

• debtor’s operation plan
• classification of the debts
• adjustment scheme of the debts
• repayment scheme of the debts
• period for execution of the reorganisation plan, etc.

If the reorganisation cannot be approved by the creditors’ meeting or the People’s Court, or the debtor is unable to or refuses to execute an approved reorganisation plan, the People’s Court shall declare the debtor insolvent.

Reconciliation

The reconciliation proceeding focuses on a settlement to be agreed between the debtor and the creditors on the reduction or cancellation of debts and/or on prolongation of the repayment deadlines so that the debtor can be relieved of its financial crisis. Only the debtor may file an application to the People’s Court for reconciliation. The debtor can either file the application directly, or it may do so after the People’s Court has accepted an application for insolvency proceedings, but before the People’s Court has declared the debtor insolvent. The reconciliation proceeding is in general similar to a reorganisation proceeding, except that the debtor shall prepare a draft reconciliation agreement for approval by the creditors’ meeting and the People’s Court.

Insolvency liquidation

Insolvency liquidation has the purpose of liquidating the assets of the debtor and repaying the debts under the management and supervision of an insolvency administrator, after the debtor has been declared insolvent by the People’s Court. As stated above, an insolvency liquidation may be initiated by the debtor or a creditor upon application, or by the liquidation group as required by statutory PRC law.  

The differentiation of several types of creditors is mainly caused by the statutory sequence of their repayment. According to PRC law, creditors shall be repaid in the following order of priority:

• creditors of insolvency expenses (e.g. litigation fees for the insolvency proceedings, expenses for management, sale and distribution of the assets of the debtor, expenses and remuneration of the administrator) and debts of common benefits (e.g. debts caused by management of the debtor’s assets without authority (gestio negotiorum) or by unjust enrichment of the debtor, labour costs and social insurance premiums required to resume the debtor’s operation, etc.)
• creditors of salaries, medical expenses, disability subsidies, pension expenses, basic pension and medical insurance premiums owed to the individual account of employees, severance payments (i.e. to employees of the debtor)
• social insurance premiums other than those specified in the preceding item and taxes (i.e. to employees, relevant tax authorities)
• creditors whose rights are secured by specific properties of the debtors
• common creditors.

Generally, PRC law does not stipulate an obligation to initiate Insolvency Proceedings except for the two cases mentioned above:

• if it turns out during the dissolution and liquidation of a company that the assets of the company are insufficient to repay all debts, the liquidation group of the company shall apply to the People’s Court for announcement of insolvency   
• if a company has been dissolved but not yet liquidated or its liquidation has not yet been completed, and it turns out that the assets of the company are insufficient to repay all debts, the party responsible for the liquidation according to law (which is normally the liquidation group) shall apply to the People’s Court for insolvency liquidation of the company.

However, also in the two above-mentioned cases, the law does not impose any sanctions or penalties if the liquidation group does not apply for insolvency proceedings. 

Under PRC law, the registered legal representative of a company by law is the representative organ of that company. However, since the board of directors and general manager of a company carry out the management and operation of the company, they also function as representative bodies of the company with a respective scope of representation power as stipulated by law, articles of association (“Articles of Association”) or internal rules of the company. 

In general, the representative bodies of the debtor have the duty of loyalty and diligence in order not to cause the insolvency of the debtor. If they have violated such duty and caused the insolvency, they shall assume respective civil liability which may include e.g.  compensation of the debtor for its losses caused by the above-mentioned violation.

According to the Insolvency Law, “relevant personnel” of the debtor shall have the following main duties during/in connection with the Insolvency Proceedings:

• properly keeping (and/or handing over) all properties, seals, books, documents, etc. of the company which they possess and manage
• conducting work according to the requirements of the People’s Court and the administrator and answering their inquiries truthfully
• attending the creditors’ meeting as non-voting party and answering the creditors’ inquiries truthfully
• not leaving their place of residence without the permission of the People’s Court 
• not serving as a new director, supervisor or senior manager of other enterprises.  

The law defines the term “relevant personnel” as the legal representative of the company and, upon a decision of the People’s Court, the finance manager and “other operation and management personnel” of the debtor. However, the law does not further define the term “other operation and management personnel”. Normally such personnel in a company typically include members of the board of directors (or the executive director in lieu of a board), general manager and deputy managers (if any). Therefore, it cannot be excluded that a People’s Court interprets the term “other operation and management personnel” in a board way, so that the above-mentioned duties shall apply not only to the representative bodies (i.e. the legal representative, directors (or executive director) and general manager) and the finance manager, but also to other senior management personnel in a company.  

The legal representative and other directly responsible representative bodies shall be liable towards the company for compensation if any one of them has committed a fault or gross negligence in causing the debtor to illegally dispose of its assets and, thus, has damaged the interests of the creditors. 

The representative bodies of the debtor are not normally directly involved in the proceedings of insolvency liquidation because upon acceptance of the application by the People’s Court, an insolvency administrator shall be appointed by the court to manage and supervise the proceedings and shall take over the assets, books, seals, documents and other materials of the debtor. However, the representative bodies should provide full cooperation and support to the administrator in order for the latter to manage the insolvency proceedings according to law.

In the case of a reorganisation, the Insolvency Law provides for the alternative that the assets and business of the debtor may, upon approval by the People’s Court, be managed by the debtor itself instead of by the administrator, but under the latter’s supervision. In such a case, the representative bodies, i.e. the legal representative, directors and general manager, will need to be involved in the reorganisation process for operation and management of the debtor. 

In the case of a reconciliation, although there shall still be an insolvency administrator appointed to be in charge of the proceedings, the Insolvency Law requires the debtor rather than the insolvency administrator to put forth a draft of the reconciliation agreement. Therefore, the involvement of the representative bodies is necessary.  

Under PRC law, the shareholder(s) are the highest authority organ of limited liability companies and companies limited by shares. Therefore, the shareholders of a company basically are entitled to determine all matters of the company including applying for Insolvency Proceedings. Accordingly, the shareholders shall cause the company to provide full cooperation and support to the administrator in order for the latter to manage the Insolvency Proceedings according to law.

PRC law requires that the shareholders shall make capital contribution to the company according to the schedule stipulated in the Articles of Association of the company. If the company is under Insolvency Proceedings and a shareholder has not yet fully contributed all registered capital it has subscribed, the People’s Court shall support the claims filed by the administrator requiring the shareholder to pay the outstanding capital to the company, even if such outstanding capital has not yet become due according to the Articles of Association of the company. Please further note that to the extent that a shareholder has subscribed for, but not yet contributed, registered capital of a limited liability company and a company limited by shares, the shareholder is jointly liable with the company towards creditors of the company for debts of the company up to the amount of the unpaid capital contribution.

As mentioned above, due to the function of the insolvency administrator, the shareholders of a company are not normally directly involved in the proceedings of insolvency liquidation. However, they will be involved if the company needs any internal instructions or approvals from the shareholders in relation to the Insolvency Proceedings (e.g. for the preparation of a reorganisation plan draft in the case of a reorganisation carried out by the debtor, or a reconciliation agreement draft in the case of a reconciliation) if such instructions or approvals are required according to the company’s Articles of Association.  

Yes, according to law, a company may be dissolved in any of the following cases:

• the business term of the company has expired or another reason for dissolution has occurred as stipulated in the Articles of Association of the company
• the shareholders of the company have resolved to dissolve the company
• the business licence of the company has been revoked or the company has been ordered to shut down
• a People’s Court has determined the dissolution upon application by shareholders holding more than 10% of the voting rights in the company because the company’s operation is in serious difficulties, and to continue the company would significantly damage the interests of the shareholders and there is no other solution.

However, if during a solvent liquidation the conditions for insolvency are met, as mentioned above, the liquidation group shall apply to the People’s Court for announcement of insolvency (please see point 6 above).

PRC law does not generally oblige a debtor to file for Insolvency Proceedings or to restructure effectively at an early stage to avoid a potential insolvency. Therefore currently no legal framework exists for preventive restructuring under PRC law. Restructuring under the Insolvency Law, i.e. the above-mentioned Reorganisation, can only be applied for under the conditions mentioned under point 4.

The recovery rate varies a lot from case to case, and also depends on whether it has been a direct insolvency liquidation or after (unsuccessful) reorganisation or reconciliation.

According to unofficial statistics conducted by scholars, the recovery rates of claims with securities are much higher than ones without securities. The average recovery rate of claims without securities is reported to be approximately: 

• 30.02% in cases of reorganisation
• 24.25% in cases of reconciliation
• 14.01% in cases of insolvency liquidation. 

These statistics are unofficial information which cannot be verified by us and should be used only for general reference.