PRC courts increasingly willing to convert enforcement into bankruptcy proceedings

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Haifeng Li
Baker McKenzie FenXun, Beijing
haifeng.li@bakermckenziefenxun.com

In a demonstration of active participation in combating the economic fallout of Covid-19, on 31 March 2020, the Supreme People’s Court of China (SPC) published eight exemplary cases of bankruptcy proceedings. The cases showcase how PRC courts have contributed to the survival or revival of insolvent enterprises by administering or supervising debt restructuring and composition proceedings in a business-friendly and growth-oriented manner.

An interesting development which can be observed from the eight cases is that PRC courts seem to be increasingly willing to conduct bankruptcy proceedings. In one of the eight cases, the Guangdong Xingangxing Concrete Co Ltd ('Xingangxing') case, the Guangdong Foshan Shunde Court transferred the series of enforcement proceedings against Xingangxing to bankruptcy proceedings ex officio. In another case, the Sichuan Southeast Medical Equipment Co Ltd ('Southeast'), the Sichuan Chengdu High-tech Development Zone Court readily accepted the Southeast’s application to transfer the pending enforcement proceedings against it into bankruptcy proceedings.

Once converted into bankruptcy proceedings, a moratorium on payment of any and all debts by the insolvent enterprise will take effect. The moratorium can provide a certain degree of protection to the insolvent such that they will be able to retain some essential operational assets to sustain operations until a revival or composition programme has been approved and implemented. This will be helpful to both the creditors and the insolvent debtor when the distress of the insolvent is only temporary, such as that caused by the current Covid-19 pandemic.

Bankruptcy proceedings are especially beneficial to those unsecured creditors who are late in initiating enforcement proceedings as opposed to other prior creditors. Without bankruptcy proceedings, late creditors can only get paid out of any residual assets after the prior creditors have been discharged, and the odds of them getting paid at all are de minimus. Once the enforcement proceeding has been converted into bankruptcy proceedings, all unsecured creditors will be put on an equal footing regardless of the commencement timing of their enforcement proceedings.

Traditionally, PRC courts have been very reluctant to accept bankruptcy applications for various considerations. As China realises the benefits of freeing up the resources wasted in dysfunctional or inefficient enterprises, in recent years the Chinese central government has taken an encouraging attitude towards bankruptcy. Indeed, there has been a campaign by the Chinese government to expunge zombie enterprises, especially the state-owned. The two cases highlight PRC courts’ efforts to align with such a policy orientation. Indeed, we are increasingly hearing stories about PRC courts taking an easier approach towards accepting bankruptcy applications.

In the wake of Covid-19, there may be a surge in defaults and insolvencies. Considering the easing stance of PRC courts on bankruptcy, it’s advisable for those unsecured and late creditors to petition for the commencement of bankruptcy proceedings. However, one should also bear in mind that when the PRC courts ease up standards for accepting bankruptcy filings, they may push harder than before for debt restructurings and revival programmes whenever there is still a fighting chance. On balance, this is reasonable for those unsecured and late creditors.