Threshold to Bankrupt Your Debtor in China

When your debtor defaults in your payment, one of the options, probably the most well known one, is to file a petition with court to bankrupt your debtor such that the court can stop all the operation of your debtor, seize whatever is left, turn them into cash and apply the same towards the amount owing to you.

However, this may not be easy in China. Although China has promulgated a western style Bankruptcy Law back to 1 June 2007, most PRC courts had been most reluctant to accept creditors’ applications for insolvency/bankruptcy of enterprises unable to pay their debts as they fell due. That was partially due to other economical, social or even cultural reasons, but technical set back, such as absence of clarity and guidance on the proof of insolvency and the burden of proof, certainly plays a role.

With the issuance of definite guidelines by the PRC Supreme Court on the enforcement of the Bankruptcy Law, referred to as the PRC Supreme Court’s stipulations applicable to the several issues in implementing the ‘Enterprise Bankruptcy Law’ (1) (“Judicial Interpretation”) below, it is generally believed that PRC courts should be able and have to deal with applications for bankruptcy in accordance with the stipulations in the Judicial Interpretation.

 

The much needed Judicial Interpretation was issued by the PRC Supreme Court, for implementation as from 26 September 2011. It provides clarifications to primarily the following areas:

 

(1)       the circumstances under which the court is obliged to accept an application for bankruptcy; and

 

(2)       the burden of proof in petitioning for bankruptcy.

 

In essence, the court shall accept a petition for bankruptcy, if the following conditions are met, namely:

 

(a)       the debtor is unable to pay its debt as it falls due (i.e. debtor is insolvent); and

 

(b)       the debtor’s assets are insufficient to discharge its entire indebtedness; OR the debtor obviously lacks the ability to discharge its indebtedness (i.e. it obviously lacks liquidity).

 

As it is infeasible, if not impossible, for the creditors to acquire internal financial documents of the debtors to prove the above item (b), the Judicial Interpretation further clarify that the creditors are imposed with the burden of proof of the above item (a) only. The burden of proof of the above item (b) shall be deemed to be satisfied upon the satisfaction of burden of proof of the above item (a), unless the debtors can prove otherwise within the prescribed period of time set forth in the Bankruptcy law.

 

The Judicial Interpretation further clarifies with regard to the above bankruptcy conditions, briefly as follows:

 

(i)         A debtor is insolvent if there exists a lawfully established creditor-debtor relationship and the debt is due for payment, but the debtor is unable to settle the debt fully.

 

(ii)        The court shall regard a debtor’s assets as insufficient for payment of all its debts if the debtor’s financial statements and/or relevant audit report or asset appraisal report, etc., indicate that all its assets together are insufficient for complete settlement of its indebtedness, unless there are evidentiary documents proving otherwise.

 

(iii)       Even where the debtor’s total asset value exceeds that of its total indebtedness, the court shall regard the debtor as obviously lacking liquidity if, due to certain circumstances or reasons, the debtor is unable to discharge its indebtedness, such as when:

 

  • it is in serious shortage of funds or otherwise unable to liquidate its assets to pay its debts;

 

  • its legal representative cannot be located and there is no available personnel to take charge of management of its assets resulting in its inability to pay;

 

  • it is under court enforcement proceedings and unable to discharge its indebtedness; or

 

  • it has suffered losses over a long period of time and unable to improve the status, and hence unable to pay its debts.

 

With the implementation of the Judicial Interpretation, courts are now obliged to accept applications for bankruptcy if the conditions of bankruptcy (as stipulated therein) are met. In fact, it is expressly set out in the Judicial Interpretation that the applicant for bankruptcy may submit its application to the next higher court if the relevant (lower) court should fail or refuse to attend to or accept its application for bankruptcy application documents in accordance with the stipulations in the Judicial Interpretation.

 

Theoretically, petitions (for bankruptcy) should no longer be cast aside simply, and creditors can now expect the courts to deal with their petitions for bankruptcy in accordance with the stipulations in the Judicial Interpretation and the Bankruptcy Law.

 

But guess what? The amount of bankruptcy cases accepted and heard by the PRC court continues to drop after the promulgation of the Judicial Interpretation. Due to the complexity of bankruptcy cases and the unreasonable performance review mechanism for bankruptcy judges, most judges still choose to turn a hard face on the bankruptcy petitions to the extent possible. Outside of the court, few governmental officers and entrepreneurs are big fans of the bankruptcy proceedings either.

 

In light of above, please bear in mind bankruptcy proceedings is not as handy as it appear on the black and white. It is thus advisable to seek professional advice when bankruptcy matters become relevant to your investment in China.

 

 

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Please note that this article is not contemplated to exhaustive or be relied upon as formal legal advice. Should you wish to know more about the details of this particular area of law, please send an email to info@pricecao.com and we would be more than happy to hear from you.

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