1 ALB CHINA INSOLVENCY & RESTRUCTURING GUIDE 2023 ALB CHINA INSOLVENCY & RESTRUCTURING GUIDE ALB 中国破产重组指南 ASIAN LEGAL BUSINESS 双语 – 中英文 IN CHINESE & ENGLISH NOVEMBER 2023 SPECIAL SUPPLEMENT 2023
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3 ALB CHINA INSOLVENCY & RESTRUCTURING GUIDE 2023 LIST OF CONTRIBUTORS
4 ALB CHINA INSOLVENCY & RESTRUCTURING GUIDE 2023 TABLE OF CONTENTS Senior Director, Media & Events, Asia & Emerging Markets Amantha Chia amantha.chia@thomsonreuters.com Managing Editor Ranajit Dam ranajit.dam@thomsonreuters.com Rankings and Special Projects Editor Wang Bingqing bingqing.wang@thomsonreuters.com Traffic/Circulation Manager Rozldah Jambari rozidah.jambari@thomsonreuters.com PUBLISHING TEAM Steffi Yang South and West China (86) 010 5669 2041 qifan.yang@thomsonreuters.com Steven Zhao China Key Accounts (86) 10 66271360 s.zhao@thomsonreuters.com Yvonne Cheung China Key Accounts, Hong Kong and Korea (852) 2847 2003 yvonne.cheung@thomsonreuters.com Introduction 5 ABOUT ASIAN LEGAL BUSINESS Asian Legal Business (ALB) is owned by Thomson Reuters, the world’s leading source of intelligent information for businesses and professionals. With its portfolio of leading titles, online services, law awards and in-house legal summits, ALB provides authoritative and unbiased insights and unmatched networking and business development opportunities to legal professionals throughout the Asia-Pacific and the Middle East regions. ALB combines news and analysis from its team of professional legal journalists and the expert opinions of senior industry professionals with Reuters news and insights that power business across the globe. All rights reserved. No part of this publication may be reproduced, transmitted, stored in a retrieval system, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise without the prior written permission of the publishers. Asian Legal Business, Thomson Reuters, the Asian Legal Business logo and the Thomson Reuters logo are trademarks of Thomson Reuters. ©2023 Thomson Reuters
5 ALB CHINA INSOLVENCY & RESTRUCTURING GUIDE 2023 INTRODUCTION China's insolvency and restructuring landscape has experienced profound transformations in recent years, driven by a confluence of factors including legislative changes, shifts in judicial practices, and evolving law enforcement. The momentum of these transformations gained significant acceleration in 2022, marking a pivotal juncture in the country's economic and legal history. These developments have been spurred by multiple influences, including the ongoing macroeconomic environment, China's pandemic containment policies, and the government's heightened emphasis on optimizing the business environment. China's mounting debt crisis, particularly in critical sectors such as real estate and household consumption, has galvanized policymakers to recognize the urgency of revising and enhancing the country's bankruptcy regime. This response is not only about addressing immediate economic challenges but also about shaping the long-term economic and social fabric of the nation. The changes that unfolded in 2022 are expected to have far-reaching implications, setting the stage for a transformational journey that goes beyond that year. The impact of these changes can be best understood by examining the key drivers and consequences within the Chinese insolvency and restructuring landscape. One crucial driver is the continuous growth in judicial practice, particularly the increased efficiency and informatization of the bankruptcy judiciary. As of the end of 2022, China had established 17 specialized bankruptcy courts and expanded the number of judges, resulting in substantial time and cost savings in case trials. The nation has also witnessed a surge in corporate bankruptcy cases, with the Supreme People's Court of China reporting a nearly 292 percent increase in cases over the past five years, exemplified by an eight-fold increase in bankruptcy cases in Shanghai. The mounting debt crisis in large corporations has led to high-profile cases, often involving debts in the billions or trillions of dollars, and a significant role played by government agencies in expediting the filing and trial of cases. To address these complex debt issues, diverse debt repayment tools such as debt-to-equity swaps, debt extensions, and interest rate reductions have been employed. These factors underscore the growing prominence of market and economic factors in restructuring cases, in addition to the influence of national policies. Furthermore, the Chinese government's commitment to improving the business environment, particularly in the bankruptcy sector, has been a driving force behind these changes. In recent years, the government has issued regulations and directives aimed at enhancing the bankruptcy regime, facilitating the rescue-and-exit mechanism for business entities, and strengthening the role of bankruptcy administrators. The World Bank's restructuring of the Business Enabling Environment assessment system in May 2023 is expected to further incentivize the Chinese government to provide comprehensive and secure policy guarantees for corporate bankruptcy and encourage judicial authorities to handle such cases more fairly and efficiently. As we delve into the ALB Guide to Insolvency & Restructuring in China for 2023, we will explore these transformative developments in-depth and examine their implications for businesses, creditors, and the legal and financial landscape in China. These changes are reshaping the insolvency and restructuring framework in the country, with profound implications for the future. Ranajit Dam Managing Editor, Legal Media Group Thomson Reuters
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7 ALB CHINA INSOLVENCY & RESTRUCTURING GUIDE 2023 I. Prepackaged reorganization and related systems Prepackaged reorganization system refers to a rescue system for enterprises in distress whereby creditors, debtors, contributors and other stakeholders negotiate and reach a proposal on debt and other matters in a market-oriented manner before the enterprise enters into judicial restructuring procedures. The prepackaged reorganization system grew spontaneously in the United States in the late 1980s and early 1990s. In the U.S., companies in financial crisis have four viable options to continue to operate independently: traditional Chapter 11 bankruptcy, outof-court restructuring, prenegotiated or prearranged bankruptcy, and prepackaged reorganization. Prepackaged reorganization has now become an important legal system in the commercial field worldwide. For example, in order to promote the Capital Markets Union (CMU), the European Union has proposed a legislative package to comprehensively improve the legal system including the insolvency law from the perspective of the capital market, which involves the prepackaged reorganization directive. When the Netherlands and Belgium overhauled their insolvency laws, they added the prepackaged reorganization and its related rules. There is currently no prepackaged reorganization system in China's Enterprise Bankruptcy Law, but the Supreme People's Court has constantly emphasized the connection between out-of-court restructuring and in-court reorganization in various judicial documents, and local courts have been exploring the prepackaged reorganization and issuing local rules or guidelines STUDY ON PREPACKAGED REORGANIZATION RELATED SYSTEMS one after another. It can be said that the prepackaged reorganization system in China has achieved a topdown "top-level design" and bottom-up "grass-roots needs" model. It can be seen that the prepackaged reorganization system is a kind of out-of-court restructuring and in-court reorganization system which has been gradually formed and developed in China's judicial practice with reference to foreign experience. In practice, the prepackaged reorganization system applies mainly to enterprises in distress with reasons for insolvency, in line with national policies, with better industry prospects and with restructuring value and salvage possibilities. The purpose of the prepackaged reorganization system is to reach a consensus through voluntary reorganization negotiations among the parties concerned and to make the draft reorganization plan effective with the help of the reorganization procedure, so as to avoid some of the costs, delays and procedural and legal requirements usually brought about by formal reorganization procedures. The prepackaged reorganization system applies before the court accepts an application for enterprise reorganization, and there is no more prepackaged reorganization after the court accepts an application for enterprise reorganization or after reorganization proceedings have commenced. II. Relationship between prepackaged reorganization, out-of-court restructuring and incourt reorganization Prepackaged reorganization is a link between, rather than a mixture of, out-of-court restructuring and incourt reorganization. Prepackaged reorganization is an 1 CHAPTER
8 ALB CHINA INSOLVENCY & RESTRUCTURING GUIDE 2023 out-of-court procedure that cannot be confused with in-court procedures. As a special form of out-of-court restructuring, the relationship between prepackaged reorganization and in-court reorganization is one of chronical connection rather than one of substantive functional complement. 1. Differences between prepackaged reorganization and out-of-court restructuring 1.1. Out-of-court restructuring is not bound by a legal framework, and consultations between creditors and debtors are voluntary and not judicially mandatory, with the agreements reached having the effect of civil contracts and binding on the parties to the agreements to a certain extent, but not binding on other creditors who have not reached a consensus; Agreements reached through prepackaged reorganization, in particular the content of a prepackaged reorganization plan that becomes part of a reorganization plan in a subsequent reorganization proceeding and is approved by a court decision, are binding on the debtor, all creditors and contributors. In addition, similar to most debt instruments, out-of-court restructuring requires the consent of all creditors, whereas the prepackaged reorganization system, by linking up with judicial restructuring at a later stage, allows the majority to bind the minority by the terms of the restructuring plan, thus allieviating to a certain extent the problem of “veto power”. 1.2. Out-of-court restructuring is completely the independent behavior of the parties outside the court, without the participation of public authorities; The prepackaged reorganization system is more conducive to the rebirth of troubled enterprises through the participation of judicial organs, government organs and relevant functional departments. Therefore, prepackaged reorganization is the further development of out-of-court reorganization procedure, which enables it to connect more smoothly with bankruptcy reorganization procedure. 1.3. Out-of-court restructuring is a voluntary negotiation process of debtors, which is flexible and convenient in procedure, and in which the parties can fully negotiate without time limit; In practice, prepackaged reorganization generally has a time limit and requires the debtor to assume certain obligations. 2. Differences between prepackaged reorganization and bankruptcy reorganization 2.1. Prepackaged reorganization can save the cost and time of reorganization and improve the efficiency of reorganization. Prepackaged reorganization has reversible procedures and does not produce bankruptcy liquidation consequences. Bankruptcy reorganization often takes a long time from application to acceptance, from submission of the draft reorganization plan to implementation of the reorganization plan. As a legal procedure, the reorganization procedure should be carried out in strict accordance with the provisions of the Enterprise Bankruptcy Law. If the draft reorganization plan cannot be submitted as scheduled, the reorganization procedure should be transferred to bankruptcy liquidation procedure. 2.2. Prepackaged reorganization can respect the autonomy of debtors and creditors more than bankruptcy reorganization, and give full play to the initiative of all parties in reorganization; Bankruptcy reorganization is dominated by the court, is by nature the reorganization in the court and must therefore be bound by the legal framework. 2.3. In the prepackaged reorganization proceeding, the debtor retains control over its own management, and since it is not a judicial reorganization proceeding, it can effectively reduce the negative impact on the enterprise's own goodwill and creditworthiness brought about by the enterprise's bankruptcy reorganization; bankruptcy reorganization has clear provisions on the takeover of the debtor's property and business affairs, the exercise of creditors' rights, the assumption of obligations by the debtor, and disclosure of the debtor's negative information, and so on. 2.4. The content of the prepackaged reorganization plan reached in the prepackaged reorganization proceedings is effective only if it becomes the content of the reorganization plan in the subsequent reorganization proceedings and is approved by the court; bankruptcy reorganization is a statutory procedure, and once the reorganization plan has been approved by the court, it must be strictly implemented by all creditors, debtors, contributors and investors. III. Advantages and significances of the prepackaged reorganization system 1. Advantages of prepackaged reorganization system The advantages of the prepackaged reorganization system lie in improving the mechanism for hearing bankruptcy restructuring cases, accurately identifying the restructuring value of enterprises in distress, judging whether the enterprises have the feasibility of restructuring, and saving judicial resources, reducing the institutional costs of enterprise restructuring and effectively improving the success rate of enterprise restructuring by promoting the effective connection
9 ALB CHINA INSOLVENCY & RESTRUCTURING GUIDE 2023 [1] Minutes of the National Court Bankruptcy Trial Work Conference in 2018 and Minutes of the National Court Civil and Commercial Trial Work Conference in 2019. [2] As of July 2023, according to the author's statistics, there have been 6 provinces (including municipalities directly under the Central Government), 30 cities, and 8 districts in which the relevant courts have issued prepackaged reorganization normative guidelines. between out-of-court restructuring and in-court reorganization procedures. In practice, the advantages of the prepackaged reorganization system are also reflected in the strong dominance of the debtor in the prepackaged reorganization case, and the debtor's risk can be reduced to a reasonably controllable level; if the debtor and the creditors fail to reach a consensus, the debtor can also withdraw the application for prepackaged reorganization, which makes the procedure reversible with fewer negative effects. 2. Significances of the prepackaged reorganization system 2.1. Under the prepackaged reorganization system, the work of clearing claims and debts and voting on the draft reorganization plan precede the bankruptcy reorganization procedure, thereby greatly shortening the time of bankruptcy reorganization procedure and improving the efficiency of reorganization. 2.2. Prepackaged reorganization is condusive to presenting and protecting the value of enterprise reorganization. In practice, it often happens that when troubled enterprises directly enter the in-court reorganization, the outsiders will greatly reduce their business expectations and value judgments based on concerns about the bankruptcy trend of enterprises, so as to minimize acquisition price. As a result, the actual value of enterprises may be seriously underestimated. If the distressed enterprises choose prepackaged reorganization to get out of trouble, all parties will make a more rational judgment on the current and future potential commercial value of the debtor, and all parties can negotiate in a peaceful manner, so that the distressed enterprises have the opportunities to take more initiative at this stage, with a view to preserving more business interests. 2.3. Prepackaged reorganization can improve the quality of reorganization procedure. In many cases, when troubled enterprises enter the reorganization, their primary goal is to prevent the reorganization from failing and leading to bankruptcy liquidation, , and to a large extent, the reorganization has become a "Success only, not failure." battle. In the prepackaged reorganization, while the enterprise has no realistic liquidation pressure, there is the possibility of bankruptcy in the future. That gives all parties enough motivation to carry out many rounds of negotiation and bargains, thereby forming a benign interactive scenario for finally discovering the scheme that best meets Pareto optimal standards. 2.4. Prepackaged reorganization has become an important path that helps enterprises to solve and recover from difficulties For an enterprise in deep financial crisis, if the enterprise or its operator can timely apply to enter the prepackaged reorganization procedure and carry out enterprise rescue as early as possible, quick solutions may be found to curb the crisis and avoid expansion of the debt and business risks. IV. Existing problems of the prepackaged reorganization system and proposals for improving the prepackaged reorganization system 1. The existing problems of the prepackaged reorganization system. At present, the prepackaged reorganization system in China is in the exploratory development stage, there is no legislative provision for the prepackaged reorganization system in China, so there is no legal basis in practice, and it is basically explored without universally applicable rules. Although some local courts have issued relevant rules and guidelines, however, in view of the inconsistent understanding of the nature of prepackaged reorganization, improper operation mode and inconsistent and nonstandard implementation standards are prone to appear in practice, making the practice of prepackaged reorganization in various regions ineffective, affecting the protection of the basic rights of creditors and other stakeholders, and even adversely interfereing with and impacting the reorganization procedure. 2. The proposals for improving the prepackaged reorganization system Although all regions are actively exploring the prepackaged reorganization system in practice, and have continued to issue relevant guidelines applicable to the implementation of the prepackaged reorganization system, there are no clear provisions on the prepackaged reorganization system at the national legislative level. Due to the lack of legal norms, some major problems cannot be solved, such as how procedures are to be initiated and how prepackaged reorganization and reorganization procedures are to be connected. Therefore, the establishment of a prepackaged reorganization system
10 ALB CHINA INSOLVENCY & RESTRUCTURING GUIDE 2023 should be expedited, and the relevant legislation on the prepackaged reorganization system should be improved by drawing on foreign legal systems while taking into account China's national conditions and practice, so as to achieve the establishment of a prepackaged reorganization system and the effective connection between prepackaged reorganization and restructuring procedures. V. Conclusion In conclusion, China's prepackaged reorganization system is gradually developing under the joint promotion of market and policy. Under the protection of national legislation, the prepackaged reorganization system makes it possible for creditors, debtors, contributors and other stakeholders to reach consensus through voluntary restructuring negotiations, and makes the draft restructuring plan effective with the help of restructuring procedures to improve the quality and efficiency of enterprise restructuring. As a result, the objectives of effective allocation of resources, rescue of enterprises in distress, protection of the interests of all parties and optimisation of the business environment can be achieved.
11 ALB CHINA INSOLVENCY & RESTRUCTURING GUIDE 2023 Jianyi Zhou Partner of DeHeng Law Offices zhoujy@dehenglaw.com (+86) 186 1111 8723 Lawyer Jianyi Zhou, who has been deeply engaged in bankruptcy and non-performing assets practice for nearly 10 years. Apart from acting as a bankruptcy administrator, he has also participated in many restructuring and prepackaged reorganization counseling for distressed enterprises, has a wealth of debt restructuring work experience. Ling Jiang Lawyer of DeHeng Law Offices jianglingsc@foxmail.com (+86) 138 8020 9920 Lawyer Ling Jiang has worked in the management of large state-owned financial institutions and the parent companies of private listed enterprises for a long time, and is familiar with financial business, project investment and financing and related legal business. Her expertise areas are enterprise bankruptcy and restructuring, investment and M&A, non-performing asset management, etc. Chunlei Zhang Partner of DeHeng Law Offices zhangcl@dehenglaw.com (+86) 139 1081 8111 Lawyer Chunlei Zhang is a member of the Bankruptcy and Liquidation Committee of the All-China Lawyers Association, and has been listed as a recommended lawyer in the field of "bankruptcy reorganisation" in the Asia-Pacific region by international authoritative legal rating agencies for a number of times. His team is mainly engaged in corporate crisis management, corporate reorganisation, mergers and acquisitions restructuring business. Xinwei Zhao Lawyer of DeHeng Law Offices zhaoxw@dehenglaw.com (+86) 139 5328 8696 Lawyer Zhao Xinwei, with experience of 17 years of legal practice, is mainly engaged in civil and commercial litigation, corporate legal counsel, corporate bankruptcy reorganization and other fields of related legal business. Especially in the civil and commercial dispute settlement and corporate bankruptcy restructuring, he has rich practical expertise. THE AUTHORS
12 ALB CHINA INSOLVENCY & RESTRUCTURING GUIDE 2023 Kang Ma Lawyer of DeHeng Law Offices makang@dehenglaw.com (+86) 185 1696 0913 Lawyer Kang Ma, a member of the International Bankruptcy Association, has more than 5 years' legal practice experience. She is mainly engaged in crisis management and rescue of enterprises in distress, bankruptcy reorganization and prepackaged reorganization counselling services. Her articles have been included in national insolvency law symposiums for many times. Jialin Li Lawyer Associate of DeHeng Law Offices lijl @dehenglaw.com (+86) 183 8220 5248 Jialin Li, a Master of Southwest University of Political Science and Law, is now a lawyer assistant of DeHeng Law Offices. Her practice areas are debt restructuring, bankruptcy reorganization and liquidation. ABOUT DEHENG LAW OFFICES DeHeng Law Offices is one of the largest comprehensive law firms in China. It was founded in Beijing in January 1993 with the approval of the Ministry of Justice of the People's Republic of China. It was formerly known as China Lawyer Service Centre and was renamed in 1995 as Deheng Law Offices. Since its establishment, DeHeng abides by the tenet of diligence and responsibility, dedicated service and pursuit of justice, and is committed to providing high-quality and high-efficiency legal services for clients at home and abroad, and has now formed a global service network covering more than 160 major cities in China and the world. The firm has made outstanding contributions to the economy's reform and opening-up, national development, and the prevalence of rule of law. Deheng has created a number of firsts in the field of legal services in China, which has won recognition and praise from all walks of life. As one of the earliest Chinese law firms ventured into bankruptcy liquidation and reorganization, DeHeng has undertaken a mass of enterprise bankruptcy prepackaged reorganization and reorganization cases, and in the process has accumulated rich practical experience and achieved good social effects.
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14 ALB CHINA INSOLVENCY & RESTRUCTURING GUIDE 2023 Protection of creditors’ rights and interests has always been a focus in bankruptcy proceedings. The discharge sequence of claims of different types and the source of debt-paying funding, once determined, will directly affect the level of assurance of a creditor’s rights and interests. Rules on discharge of bankruptcy expenses, debts of common interest and claims secured by property are provided in current Chinese laws. As people understand such rules in different ways, however, combined with the complexity of bankruptcy proceedings, the discharge rules effectively adopted in some cases are not compliant with laws and regulations and may damage the creditors’ legitimate rights and interests. In view of the foregoing, this article attempts to summarize the aforesaid discharge rules based on the laws and regulations governing bankruptcy expenses, debts of common interest and claims secured by property, and to list typical examples of noncompliant practices that may damage creditors’ legal rights and interests for their reference when effectively safeguarding such rights and interests. I. General Rules of Discharge of Bankruptcy Expenses, Debts of Common Interest and Claims Secured by Property (I) Identification of Bankruptcy Expenses and Debts of Common Interest The types of bankruptcy expenses and debts of common interests are defined in Articles 41, 42 of the Enterprise Bankruptcy Law (the “Bankruptcy Law” hereinafter). According to Article 41, “The following expenses that may occur after a people’s court accepts an application for bankruptcy shall constitute bankruptcy expenses: (I) court costs of the bankruptcy proceedings; (II) expenses incurred for management, sale and distribution of the debtor’s property; (III) expenses incurred by the administrator for performance of his duties, remuneration to the administrator, and costs of staff he may recruit.” According to Article 42, “The following debts that may occur after a people’s court accepts the bankruptcy application shall be debts of common interest: (I) debts arising when the administrator or the debtor requests the counterpart of a contract to continue performance of the contract which the parties thereto have yet to perform in full; (II) debts arising from negotiorum gestio on the debtor’s property; (III) debts arising from the debtor’s unjust enrichment; (IV) salaries and social security contributions payable in order to enable the debtor’s continuity of business, plus other obligations that may arise therefrom; (V) obligations arising from damages that any person may suffer because of performance of duty by the administrator or otherwise; (VI) obligations arising from damages that any person may suffer because of the debtor’s property.” The above-cited provisions of the Bankruptcy Law enable clear identification of bankruptcy expenses and debts of common interest. Besides, the Supreme People’s Court, by publishing judicial interpretations of the Bankruptcy Law, further set forth the circumstances where the rules on discharge of bankruptcy expenses and debts of common interest may be considered for reference. According to Article 1 of the Regulations of the Supreme People’s Court on Applicability of the Law of PRC on Enterprise Bankruptcy (III) (“Interpretation No. 3” hereinafter), “where the people’s APPLICABILITY OF RULES ON DISCHARGE OF BANKRUPTCY EXPENSES, DEBTS OF COMMON INTEREST AND CLAIMS SECURED BY PROPERTY 2 CHAPTER
15 ALB CHINA INSOLVENCY & RESTRUCTURING GUIDE 2023 court decides to accept the bankruptcy application, all costs of compulsory liquidation and the appraisal, announcement, custody fees and charges incurred in pending enforcement procedures, as may be payable but unpaid by the debtor, may be paid off out of the debtor’s property from time to time with reference to the provisions of the Enterprise Bankruptcy Law regarding bankruptcy expenses. All court costs and enforcement application fees payable but unpaid by the debtor may be treated as bankruptcy claims and paid off as such.” It is essentially an addition to the bankruptcy expenses-related part of Article 41 of the Bankruptcy Law. (II) Identification of Claims Secured by Property A claim secured by property refers to a claim holding security interest in a specific property of the debtor. According to Article 109 of the Bankruptcy Law, “The rights holder with security interest in a specific property of the bankrupt shall enjoy priority of payment from the property.” It is defined in Article 389 of the Civil Code, “The security scope of the security interest shall include the principal obligation and the interest thereon, penalties, damages, and expenses incurred in the custody of the securing property and realization of the security interest. If the parties have otherwise agreed thereupon, such other agreement shall apply.” Accordingly, the creditor of a debt secured by a property may demand prioritized payment of its expenses for realizing the security interest out of the property. It is noteworthy that the payee of the “expenses incurred in the custody of the secured property and realization of the security interest” shall be identified depending on the cause of the expenses and the payer. It is likely that such expenses may be paid by the creditor directly, or, in bankruptcy cases, by the administrator. In bankruptcy proceedings, the expenses incurred by the administrator for managing, selling and distributing the securing property fall in the category of bankruptcy expenses. In addition, the securing property may incur debts of common interest, such as those arising from negotiorum gestio, unjust enrichment or infringement, which, if construed broadly, may also be included in “expenses incurred in the custody of the securing property and realization of the security interest”. Therefore, “expenses incurred in the custody of the securing property and realization of the security interest” occurring during bankruptcy proceedings may in some cases constitute bankruptcy expenses and debts of common interest. (III) Discharge of Bankruptcy Expenses, Debts of Common Interest and Claims Secured by Property The following general rules may be drawn from Article 43 of the Bankruptcy Law over the discharge of bankruptcy expenses and debts of common interest. First, bankruptcy expenses and debts of common interest shall be paid from time to time out of the debtor’s property. Second, when the debtor’s property is insufficient to satisfy the bankruptcy expenses and debts of common interest in full, the bankruptcy expenses shall be settled first. Third, if the debtor’s property is inadequate to discharge the bankruptcy expenses in full, payment shall be made pro rata; if the debtor’s property remaining after the discharge of bankruptcy expenses is not enough to cover the debts of common interest, the debts shall be satisfied on proportionate basis. Fourth, when the debtor’s property is insufficient to support payment of the bankruptcy expenses, the administrator shall file a request to the people’s court for terminating the bankruptcy proceedings. Where a claim is secured by property, the creditor may demand prioritized payment of the secured amounts from the securing property according to Article 109 of the Bankruptcy Law and Article 389 of the Civil Code. Discharge Sequence of Bankruptcy Expenses, Debts of Common Interest and Claims Secured by Property & Sources of Funding: According to Article 3 of the Regulations of the Supreme People’s Court on Applicability of the Law of PRC on Enterprise Bankruptcy (II) (“Interpretation No. 2” hereinafter), “Where security interest has been established on any specific property of the debtor under law, the people’s court shall identify it as the debtor’s property. During bankruptcy proceedings, the portion of such property remaining after extinction or exercise of the security interest may be used to satisfy bankruptcy expenses, debts of common interest and other bankruptcy obligations”. It means that, where any security interest has been set upon a specific property (the “security” hereinafter), the obligation secured thereunder shall enjoy priority of payment, and the portion of the property remaining thereafter, if any, shall be used to satisfy bankruptcy expenses, debts of common interest and other bankruptcy obligations. Given that, as defined in Article 41 of the Bankruptcy Law, the expenses incurred by the administrator for managing and selling the collateral shall also be treated as part of bankruptcy expenses, may we conclude such part of bankruptcy expenses shall be inferior to claims secured by property in terms of payment sequence? Our answer is no because: First, according to Interpretation No. 1 and Interpretation No. 2 of the Bankruptcy Law in the interpretations of the Supreme People’s Court regarding understanding and applicability of the Enterprise Bankruptcy Law, “The debtor’s property (or bankruptcy property) is managed by the administrator. Once the property posted as security is incorporated into the debtor’s property, there will come the administrator’s expenses for managing the property and the remuneration payable for such management. Expenses for managing the property posted as security include all costs and amounts that may be incurred directly or indirectly for the purpose of realizing the
16 ALB CHINA INSOLVENCY & RESTRUCTURING GUIDE 2023 secured obligation, including the expenses for selling the collateral, all of which shall, unquestionably, be paid with priority from the proceeds from sale of the property.” Second, the security scope of security interest, according to Article 389 of the Civil Code, includes the expenses incurred for custody of the property and realization of security interest. Pending bankruptcy of a debtor, the said expenses for realization of security interest are conventionally advanced by the security interest holder, who will then receive prioritized reimbursement of the same out of the proceeds from sale of the property. In ongoing bankruptcy proceedings, however, such expenses are advanced by the administrator. In that context, if the expenses were held inferior to claims secured by property, it would be highly likely that, after satisfaction of claims secured by property, nothing would remain to pay the expenses, which would have to be paid using some other property of the debtor, a practice apparently unfair to other creditors and likely to affect disposal of the collateral. In consideration of the foregoing, we are inclined to support the following sequence of satisfaction of bankruptcy expenses, debts of common interest and claims secured by property: the proceeds from sale of the collateral shall be used first to pay the administrator’s expenses for managing the property and realizing the security interest, then discharge the claims secured by property, and finally, all other bankruptcy expenses and the debts of common interest. II. Problems Existing in Application of Rules on Discharge of Bankruptcy Expenses, Debts of Common Interest and Claims Secured by Property In practice, rules governing satisfaction of bankruptcy expenses, debts of common interest and claims secured by property in some bankruptcy cases are not always fully compliant with laws and regulations as the result of people’s different ways of understanding and complexity of bankruptcy proceedings. Followed are several typical examples: First, in some bankruptcy cases, the administrators disclose only the sum of bankruptcy expenses and debts of common interest without giving any expense details or causes, preventing the creditors from knowing the different causes of such expenses and debts, and in turn from accurately judging the payment sequence and the sources of funding. For instance, some bankruptcy expenses and debts of common interest might have arisen from the property posted as security but are paid off using unsecured property, which practice is unfair to ordinary creditors. Second, there are bankruptcy cases where all bankruptcy expenses and debts of common interest are straightly made prioritized over claims secured by property without disclosure of the details or causes of the expenses and debts, which is unfair to the creditors of the obligations secured by property. Third, according to the Regulations of the Supreme People’s Court on Determination of Administrator’s Remuneration in Enterprise Bankruptcy Cases (the “Administrator’s Remuneration Regulations” hereinafter), the value of the collateral that the security interest holder may receive with priority shall not be included in the total property value in administrator’s remuneration calculation, while the administrator shall have the right to receive an appropriate pay from the security interest holder for the reasonable work he has done for maintenance, sale, delivery and otherwise management of the collateral. However, the collateral’s value remains not deducted from the administrator’s base remuneration calculation in some bankruptcy proceedings, which may lead to an exorbitant pay to the administrator, leaving less property for other claims. Despite the laws and regulations providing rules on satisfaction of bankruptcy expenses, debts of common interest and claims secured by property, courts also support party autonomy in practice. Therefore, creditors in bankruptcy proceedings shall carefully check all relevant documents to determine whether the satisfaction rules are reasonable in order to avoid impairment of their legal rights and interests. III. Advice to Creditors Fair and reasonable rules shall be developed to govern discharge of bankruptcy expenses, debts of common interest and claims secured by property depending on the circumstances of the specific bankruptcy proceedings in order to achieve a balance of all parties’ interests and realize efficient liquidation of debts and claims. To safeguard their rights and interests, creditors shall promptly examine the rules to see if they are compliant with laws and regulations. Specifically, First, on occurrence of any expense for management, maintenance or sale of the property posted as security, the administrator shall immediately notify the security interest holder, fully guarantee his right of knowledge, and listen to his opinion. The administrator shall disclose details of all bankruptcy expenses and debts of common interest, categorize them by cause, and determine the discharge rules for each category separately. The first category shall be bankruptcy expenses and debts of common interest arising from the property posted as security, which ought to be paid from that property. In practice, the administrator, when taking possession of the property posted as security, often advances, out of unsecured property, the bankruptcy expenses and debts of common interest that have arisen from the property
17 ALB CHINA INSOLVENCY & RESTRUCTURING GUIDE 2023 posted as security. Therefore, proceeds from disposal of the property posted as security shall be used to satisfy claims secured by property only after deduction of the advanced expenses and debts of common interest. The second category shall be bankruptcy expenses and debts of common interest arising from unsecured property, which shall be paid off from the unsecured property, or may be covered by the balance, if any, of the property posted as security that may remain after satisfaction of claims secured by property. The third category includes all expenses other than those in the first and the second category, for instance, court costs of bankruptcy cases, which under current laws may only be paid from unsecured property or from the remaining part of the property posted as security. Second, the creditor shall determine whether the payment sequence and the sources of funding are compliant with laws through considering the causes of bankruptcy expenses and debts of common interest, and shall promptly seek remedies if discovering any practice that damages its rights and interests. Third, if the administrator has paid reasonable efforts for maintenance, sale, delivery and otherwise management of the property posted as security, it shall, through consultation with the security interest holder, determine to receive a reasonable amount of remuneration. The creditor shall examine the administrator’s remuneration calculation and consult with the administrator on the issue. It needs to be noted that, given that reality is far more complex than what is discussed herein, there might be difficult situations that cannot be addressed using the above rules, and creditors shall make comprehensive judgment depending on the circumstances to protect their legitimate rights and interests.
18 ALB CHINA INSOLVENCY & RESTRUCTURING GUIDE 2023 ABOUT BEIJING HAN TAO LAW FIRM Since founding in March 2004, Han Tao Law Firm (referred to as “H&T” hereinafter) has dedicated itself to offering professional legal services to the sector of special assets, with major clients including (without limitation to) the top five state-owned asset management companies (AMCs), namely CINDA, COAMC, HUARONG, GREAT WALL and GALAXY, Huida Assets, a number of local AMCs, commercial banks, trust companies, finance leasing companies, domestic and overseas fund companies and related industry-specific funds (including security funds in the trust industry), among others. H & T has been recognized as one of “Top Ranked Law Firms in China 2023” by LEGALBAND in Banking and Financing, Bankruptcy Reorganization and Liquidation, and won the “China Business Law Awards” in Asset Management, Real Estate Investment & REIT Fund Industry; Address: 2805A-2807, Beijing Silver Tower, No. 2 Dongsanhuan Beilu, Chaoyang District, Beijing Tel: 86-10-6410 6061 Email: liling@hantao.cn Website: http://www.hantao.cn Ling Li Founding Partner liling@hantao.cn (138) 0111 7329 A graduate from China University of Political Science and Law, Li Ling, as a lawyer, is the founding partner of Han Tao Law Firm. Since establishing the firm in 2004, she has led its dedication in areas including bankruptcy reorganization and liquidation, finance and asset management, disposal of non-performing assets, investment and financing, and real property and construction. LI has been recognized in “LEGALBAND Ranking 2023: Top 15 Litigators”, “Top 15 Specially Recommended Chinese Lawyers of 2023: Finance and Asset Management”, “Top Preferred Lawyers of 2022: Top 15 Female Lawyers in China”, among other rankings. THE AUTHOR
19 ALB CHINA INSOLVENCY & RESTRUCTURING GUIDE 2023 德禾翰通办公室 : 上海|郑州|海口|无锡|泰州|成都|宁波|常州|昆明|芜湖 Shanghai|Zhengzhou|Haikou|Wuxi|Taizhou|Chengdu|Ningbo|Changzhou|Kunming|Wuhu about us 德禾翰通律师事务所成立于2006年，总部位于上海市徐汇区宜山路425号光启城 大厦18层、24层。作为在商业领域和争议解决领域被广泛认可的中国律师事务所，致 力于为客户提供高效优质和切实可行的法律服务解决方案。 德禾翰通重视与司法部门、政府机关、法学研究机构和专业协会的联络，同时 保持独立性和对客户的忠诚。德禾翰通能够准确和及时地把握中国的最新立法动态 ，并能够充分理解客户在中国商业环境中的特殊需求，从而为客户制定专门的法律 服务方案。 Dehehantong Law Offices found on June 2006，Address：18F & 24F, Pole Tower, 425 Yishan Road, Shanghai 200235, P. R. China.As a widely recognized Chinese law firm in the field of business and dispute resolution, Dehehantong is committed to providing customers with efficient, high-quality and practical legal service solutions. Dehehantong attaches great importance to liaison with the judiciary, government agencies, law research institutions and professional associations, while maintains independence and loyalty to customers. Dehehantong can accurately and timely grasp the latest legislative trends in China, and fully understand the special needs of customers in China's business environment, so as to develop a special legal service plan for customers. 勤勉 | 匠心 | 极致 DILIGENCE PERFECTION INGENUITY
20 ALB CHINA INSOLVENCY & RESTRUCTURING GUIDE 2023 INITIATION AND IMPLEMENTATION OF THE REORGANIZATION PROCEDURE 3 CHAPTER [1] Refer to civil ruling documents No. (2019) Hu 7101 Po 62 and No. (2019) Hu 7101 Po 62-1. [2] Refer to Article 7 of the Beijing Bankruptcy Court Standards for Handling Bankruptcy Reorganization Cases (Trial), Part 9, Article 2 of the Jiangsu Provincial High People's Court Guidelines for the Trial of Bankruptcy Cases (Su Gao Fa [2017] No. 794), Section 2(1) Article 4 of the Hainan Provincial High People's Court Procedural Guidelines for Enterprise Bankruptcy Cases (Qiong Gao Fa [2019] No. 257), and Part 8, Article 3 of the Shanghai Municipal High People's Court Guidelines for Bankruptcy Trial Work (Trial) (Hu Gao Fa Min Er [2018] No. 9). 1. Initiation of the Reorganization Procedure 1.1 Applicant for Reorganization 1.1.1 Applicants for the Revival against General Debtors According to Article 70 of the Enterprise Bankruptcy Law of the People's Republic of China (hereinafter referred to as the Enterprise Bankruptcy Law), a debtor or creditor may directly apply with the people's court for revival against the debtor, known as the initial reorganization application. Where any creditor applies for bankruptcy liquidation, after the people’s court accepts the application and before the debtor is announced bankrupt, the debtor or its capital contributors whose capital contribution makes up one-tenth or more of the debtor’s registered capital (hereinafter referred to as "competent capital contributor") may, apply for revival, known as the subsequent reorganization application. A competent capital contributor could be a single capital contributor with more than one-tenth of the registered capital or multiple capital contributors collectively holding more than one-tenth of the registered capital. The reorganization case of Shanghai Nanyang Electric Motor Co., Ltd. (hereinafter referred to as "Nanyang Electric") is a prime example of a transition from bankruptcy liquidation to revival[1]. Shanghai Electric (Group) Corporation (hereinafter referred to as "Electric Group"), which holds 60% of Nanyang Electric's shares, applied for its bankruptcy liquidation as a creditor. In the bankruptcy liquidation procedure, considering Nanyang Electric's value for reorganization, the Electric Group, in the capacity of a capital contributor with more than one-tenth stake, applied for the revival against Nanyang Electric. According to Article 70 of the Enterprise Bankruptcy Law, subsequent reorganization applications apply only to cases where creditors apply for bankruptcy liquidation; capital contributors are not permitted to make initial reorganization applications, and creditors are not allowed to submit subsequent reorganization applications. However, in practice, local courts' working guidelines on bankruptcy reorganization have variously expanded their applicability. In regions like Beijing, Jiangsu, Hainan, and Shanghai, subsequent reorganization applications are applicable to cases of bankruptcy liquidation filed by creditors and debtors. In Jiangsu and Shanghai, if a resolution at the creditors' meeting is passed, creditors can make subsequent reorganization applications. Furthermore, Beijing has made it explicit that creditors may directly submit subsequent reorganization applications[2]. According to the Summary of the Symposium on the Work of Bankruptcy Reorganization Cases of Listed Companies by the Supreme People's Court (Fa [2012] No. 261,
21 ALB CHINA INSOLVENCY & RESTRUCTURING GUIDE 2023 [3] Refer to Part 2, Article 8 of the Shanghai Municipal High People's Court Guidelines for Bankruptcy Trial Work (Trial). [4] Refer to Article 22 of the Guidelines on Several Issues Concerning the Trial of Enterprise Bankruptcy Cases by the Guangdong Provincial Higher People's Court (Yue Gao Fa Fa [2019] No. 6) and Article 3 of the Guidelines for Regulating the Trial of Bankruptcy Cases of Real Estate Enterprises by Courts throughout Kunming City (Trial) by the Kunming Intermediate People's Court. hereinafter referred to as the Summary on Bankruptcy Reorganization of Listed Companies), when a listed company qualifies for revival, shareholders holding more than one-tenth of the company’s shares may apply with the people’s court for its revival. This is a breakthrough in Article 70 of the Enterprise Bankruptcy Law, which states that competent capital contributors can only submit subsequent reorganization applications, it establishes that competent shareholders of listed companies have the right to initiate reorganization applications. 1.1.3 Applicants for the Revival against Financial Institutions According to Article 134 of the Enterprise Bankruptcy Law, if the debtor is a financial institution such as a commercial bank, securities company, or insurance company, the financial regulatory agency under the State Council shall apply for its revival. Meanwhile, Article 90 of the Insurance Law stipulates that, with the consent of the State Council's insurance regulatory authority, an insurance company or its creditors may apply for revival. It should be noted that although only the Insurance Law stipulates that creditors and debtors can initiate reorganization applications with the consent of the State Council's regulatory body, the State Council's regulatory agencies for financial institutions such as banks and insurance companies have been unified under the National Financial Supervision and Administration Bureau. The application of Article 70 of the Enterprise Bankruptcy Law, once approved, shall not be limited to reorganization applications for insurance companies. In practice, local courts have already clarified in their working guidelines that, with the consent of the State Council's regulatory body, financial institutions or their creditors can initiate reorganization applications[3]. 1.2 Examination of Reorganization Applications 1.2.1 Reorganization Application Materials The reorganization petition shall elucidate the debtor's business operations, financial status, and the necessity of revival, accompanied by relevant materials. Article 8 of the Enterprise Bankruptcy Law prescribes the general documentation that a debtor must submit when applying for revival. When creditors initiate a reorganization procedure, they usually must provide evidence concerning their claims, as well as evidence indicating the debtor's inability to clear off its debt as due. In addition, according to the Summary on Bankruptcy Reorganization of Listed Companies, applications for the bankruptcy reorganization of listed companies shall submit a report on the feasibility of revival for the listed company, materials regarding notifications from the provincial people’s government of the company’s domicile to the securities regulatory department, opinions from the securities regulatory department, and a stability maintenance plan issued by the people’s government of the listed company’s domicile. 1.2.2 Review by the People's Court According to Article 14 of the Minutes of the National Court Bankruptcy Trial Work Conference (Fa [2018] No. 53, hereinafter referred to as the Bankruptcy Conference Minutes) issued by the Supreme People's Court, when reviewing reorganization applications, the People's Court shall comprehensively assess the actual situation of the debtor to determine whether there is value and the possibility of rescue in reorganization. When different entities initially apply for revival, compromise, or bankruptcy liquidation against the same debtor, based on the principle of giving priority to the reorganization procedure, the court shall prioritize the acceptance of reorganization applications for debtors who have reasons for reorganization and possess reorganization value and feasibility[4]. According to Article 15 of the Bankruptcy Conference Minutes, for cases involving complex creditor-debtor relationships, a large scale of debt, or the reorganization of listed companies, the People's Court can organize hearings for the applicant and the respondent during the review of the reorganization application. According to the Summary of Listed Companies' Bankruptcy Reorganization, if the creditor applies for reorganization and the listed company objects within the legally prescribed time, or if creditors, listed companies, or capital contributors separately submit bankruptcy liquidation and reorganization applications to the People’s Court, a hearing shall be convened. It is
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