The Political Economy of the Implementation of the Bankruptcy Law of. China. Wang Zuofa

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1 The Political Economy of the Implementation of the Bankruptcy Law of China Wang Zuofa Abstract: The implementation of the bankruptcy law of China deviates much from the legislature. This article draws on political economy analysis, especially the interest group approach, to give an explanation of the causes of the deviation and predict what the future of the modification and reform of the law might be. This article also describes the China context in using public choice theory to explain legal issues. Keywords: Bankruptcy law of China, Legislature, Implementation, Interest Group, Bargaining. Introduction: The existing bankruptcy law of China, the Enterprise Bankruptcy Law of the People s Republic of China, which was promulgated on Aug.27, 2006 and took effect in June.1, 2007 is often referred to as the new bankruptcy law in China. This is because this law is sharply contrast to the 1986 Bankruptcy Law of China, which was the first bankruptcy law of China which was made in 1986 and became effective in The 1986 bankruptcy law was made for regulating state-owned enterprises with strong orientation of planned economy while this law is a market economy-oriented modern bankruptcy law formulated on the basis of drawing from the bankruptcy laws of developed market economies such The author is an associate professor of Law School of Shan Dong University of Technology. billwang@aliyun.com 1

2 as the U.S bankruptcy law while taking account of the particular context of China s ongoing economic transition. However, the new bankruptcy law (hereinafter referred to as the Law ) has encountered some problems in its implementation. There is a big gap between the expectation of the Law and the effect of its implementation. In public choice studies it is standard to describe the optimal version of the law in question and use interest group theory to explain the observed deviations. A satisfactory explanation of the Bankruptcy Code must take into account the interests of all relevant parties and the extent of their political power. 1 This article will describe what the Law is expected to achieve, observe the deviations of the implementation of the Law from the expectation of the legislature and provide a tentative explanation by taking into account of the incentives of the interest groups relevant to the Law and the extent of their political power. There are several factors contributing to the problems in the implementation of the Law. The interaction among the interest groups participating in the implementation of the Law is a good perspective through which we can understand the problems in the implementation of the Law and its future. This article will provide a contour of how different interest groups influence the current implementation of the Law and its future. This article is composed of five parts. Part one discusses the general approach of interest group analysis in legal academy based on the context of judicial independence and market economy and the characteristics of 1 See Eric A. Posner, The Political Economy of Bankruptcy Reform Act of 1978, 96 Mich. L. Rev. 47,47-50(1997). 2

3 interest group analysis based on China context. Part two describes the difficulties the Law encounters in its implementation. Part three describes the interactions of different interest groups contributing to the conditions of the implementation of the Law. Part four describes the incentives, interests and responses of different groups toward the current conditions of the implementation of the Law. Part five concludes with a tentative prediction of the future development of the Law. I. The Interest Group Analysis of Judicial Process in General and Its Application in China Context A. The Interest Group Analysis of Judicial Process in General The interest group literature principally focuses on the legislative process. The logic can be derived from the economic theory of regulation. This theory assumes that legal rules are demanded and supplied like any other commodity. Regulation is supplied to those groups that successfully bid for it with compensation in the form of political support, campaign contributions, lobbying expenditures, and the like. The contours of a given law will therefore reflect a competitive equilibrium among the rival interest groups affected by the law. A further prediction of the economic theory of regulation is that laws will tend to benefit small, cohesive special interest groups at the expense of the general public. Although 3

4 individual members of the public lack sufficient incentives to promote laws that benefit the public directly, interest groups have strong incentives to lobby for laws that transfer wealth from the public to themselves. 2 Thus the central insight of interest group analysis is that concentrated interest groups often benefit at the expense of more widely scattered groups, even if the diffuse group has much more at stake overall. 3 This analysis, and in particular its self-interest assumption, also has generated important insights into related areas such as the incentives of agency bureaucrats and the nature of the judicial process. 4 One perspective of interest group insights into judicial progress is judicial review. The general logic of this perspective is that since interest groups are better informed than ordinary voters and serve as an important source of political funding, legislators have a tremendous incentive to be responsive to interest group perspectives. 5 Thus diffuse groups tend to fare poorly in the legislative process. The legislative dysfunction leads to different comments and suggestions of judicial review. For instance, one opinion argues that court should refuse to apply statutes to issues not addressed by the terms of the statute, 6 while another argues that courts should defer to interest group influence other than find a constitutional 2 See Jonathan R. Macey and Geoffrey P. Miller, Toward an Interest Group Theory of Delaware Corporate Law, 65 Tex. L. Rev. 469, David A. Skeel, Public Choice and the Future of the Public-Choice-Influenced Legal Scholarship, 50 Vand. L. Rev. 647, Id, at page Id, at page Frank H. Easterbrook, The Supreme Court 1983 Term-Foreword: The Court and the Economic System, 98 Harv.L.Rev.4, 14-18(1984). 4

5 right where constitutionality is unclear. 7 However, the interest group analyses of legislative and judicial process as discussed above are based on two assumptions. On the one hand, the legislative process is assumed to be a free bargaining of different interest groups or their representatives. Take the legislative evolution of U.S. bankruptcy law as an example, the bargaining among interest groups or their representatives such as lawyers, judges, investment banks and SEC permeate the evolution of U.S. bankruptcy law. 8 On the other hand, the judges are assumed to be somewhat above the fray and can be wholly objective in interpreting the statutes that come before them. 9 The precondition for judges to act like this is judicial independence. The author believes that interest group analysis must have strong implications on the legislature and judicial process of the bankruptcy law of China. However, these two assumptions of analysis do not hold exactly in China context. What are the pictures of legislative process and judicial process in China context? B. The Legislative Process of the Bankruptcy Law of China in General 1. The Only Issue under Hot Debate between Two Interest Groups 7 Richard A. Posner, Economics, Politics, and the Reading of Statutes and the Constitution, 49 U.Chi.L.Rev. 263,284-85(1982). 8 See David A. Skeel, Jr., Debt s Dominion: A History of Bankruptcy Law in America, Princeton University Press, Princeton and Oxford, See also Aric A. Posner, The Political Economy of The Bankruptcy Reform Act of 1978, 96 Mich. L. Rev Supra note 1, at page

6 During the legislative process of the Law, the only issue under hot debate is the priority between employee claim and secured claim. Employee claim include the salaries and social insurance as well as the compensation owed to the employees by the debtor. 10 The major interest groups arguing for the priority of employee claims are All China Federation of Trade Unions and Ministry of Human Resources and Social Security of People s Republic of China. The secured creditors are generally banks, and the major interest groups protecting the priority of secured claim are China Banking Association and The People s Bank of China, which is the Central Bank of China. According to the general practice of China s lawmaking, a draft law may be reviewed three times by the National People s Congress (NPC). If it is passed in any session of review, it will become law; if it fails for the third review, it has to wait a long time for the next session of the NPC or shall be put on the shelf and left in the cold. The Law was passed at the third review. The priority of employee claim and secured claim had experienced changes during the three sessions of review. The first draft to be reviewed for the first time stipulated that security claim was prior to employee claim, while in the second review the priority was reversed. 10 Li Shuguang, The Drafted Bankruptcy Law in the Third Review Faces Key Debate: The Priority Between Employee Claim and Secured Claim (Po Chan Fa Jin Ru San Shen Guan Jian Zhi Zheng: Dan Bao Zhai Quan Yu Zhi Gong Zhai Quan Shu You Xian), 21 Century Economic Report(21 Shi Ji Jing Ji Bao Dao),

7 11 In the third review the priority was reversed again. Although the bargaining seemed quite fierce, the two players can hardly influence the real voters directly. They impose their influence by expressing their opinions on the media or holding seminars. For example, when the second draft which put employee claim prior to secured claim was pending for review, the vice chairman of the All China Federation of Trade Unions expressed his welcome to this draft by praising it may protect employee rights and help safeguard social security 12 while the China Banking Association held a special seminar criticizing the treatment of secured claim of the second draft The Debates among Bankruptcy Scholars on Technical Issues Despite the quasi-bargaining of interest groups concerning the priority between employee claim and secured claim in the legislative process of the Law, we can not see any bargaining about technical issues among interest groups. However, the technical issues of the Law are to a large extent shaped through the debate and compromise among several bankruptcy scholars who participated in the drafting of the Law. Among these technical issues, the bankruptcy administrator system affects the 11 Chen Huan, The New Bankruptcy Law Is Expected To Be Passed With Employee Salary Claim Prior to Secured Claim (Xin Po Chan Fa Chu Tai You Wang Gong Zi Zhai Quan You Xian ), 21 Century Economic Report(21 Shi Ji Jing Ji Bao Dao), Id. 13 Fu Ping, Employee Claim Should Not Be Prior to Secured Claim The China Banking Association Held A Seminar Discussing Related Issues in the Enterprise Bankruptcy Law (Zhi Gong Zhai Quan Bu Yi You Xian Yu Dan Bao Zhai Quan Shou Chang Zhong Guo Yin Hang Ye Xie Hui Ju Ban Qi Ge Po Chan Fa You Guan Wen Ti Yan Tao Zuo Tan Hui), Financial Times( Jin Rong Shi Bao),

8 implementation of the Law the most. 14 The bankruptcy administrator system was resulted from the bargaining and compromise of two schools of bankruptcy scholars. 15 One school preferred the U.S. bankruptcy law system and proposed to completely introduce the DIP system into the Law. Their idea about bankruptcy administrator is that there should be a clear distinction between liquidation administrator and reorganization administrator; the former is compulsory rule while the latter is default rule. The other school with strong preference to European bankruptcy laws insisted that bankruptcy administrator should control bankruptcy proceeding and proposed to impose bankruptcy administrator as a compulsory rule without distinction of liquidation or reorganization. They insisted that there should be a bankruptcy administrator for every bankruptcy case, be it a liquidation or reorganization case. The subsequent debate is how to appoint the administrator. The former proposed to let the creditors appoint administrator. Their argument was that the purpose of bankruptcy law is to protect creditors and creditors has the incentive to find the best administrator to protect their interest. The latter insisted that the court should appoint the administrator in order to safeguard justice. There argument was that since the current market credit 14 How it affects the implementation of the Law will be discussed in detail later. 15 This information is from the author s interview from professor Li Shuguang, one of the major drafters of the Law. 8

9 condition in China is rather poor, a disinterested body with strong sense of justice should be authorized to appoint administrator in order to avoid fraud. They regard the court as the perfect disinterested body. 16 As a result, the Law establishes the basic framework of administrator system like this: Article 13 of the Law establishes the foundation of administrator system. It stipulates that when the people s court accepts a filing for bankruptcy, it shall designate a bankruptcy administrator in the meanwhile. It sets up the general tune of the Law, that is, as long as a bankruptcy case is filed, the court must assume its authority to appoint a bankruptcy administrator to control the case no matter if it s a liquidation or reorganization application. The courts rigidly follow this mandatory rule in practice which will be discussed in detail later. Following article 13, the Law uses several other articles to construct the powers of administrator to manage bankruptcy assets and supervise the debtor. For instance, article 17 stipulates that after the people s court accepts a filing for bankruptcy, the debtor or the holder of the debtor s assets shall pay off the debts or deliver the relevant assets to the bankruptcy administrator. Although article 73 of chapter 8 of the Law, which is the chapter specifically stipulating reorganization like the Chapter 11 of the U.S. 16 There might be a possibility that some scholars have self-interest in making the court happy since in China the scholars can not be completely independent from the government sectors in order to realize their self-interests as scholars. Closer relations with court system may generate some academic profit as well as some economic profit. 9

10 bankruptcy law, does opens a door for DIP by providing that during reorganization, a debtor may, upon filing an application and obtaining an approval from the people s court, manage its assets and business operation under the supervision of its bankruptcy administrator. Under the circumstances as prescribed in the preceding paragraph, a bankruptcy administrator that has taken over the assets and business operation of the debtor shall deliver the assets and business operation back to the DIP according to the provisions of the Law and the bankruptcy administrator s functions and duties as prescribed herein shall be exercised by the DIP. That is, the DIP of the Law assumes the bankruptcy administrator takes the control power first. This kind of provision makes the administrator control as presumption while DIP as exception and subject to the supervision of the bankruptcy administrator. Another important aspect of the administrator system under the Law is liquidating group (Qing Suanzu). Article 24 of the Law stipulates that liquidating group composed of persons from relevant government sectors, institutions, law firms, accounting firms and bankruptcy liquidating firms can act as administrator. Liquidating group is a term emerging under China s economic transition context. In China s economic transition period, many state-owned enterprises going through policy bankruptcy 17 must solve some difficult historical problems such as 17 Policy bankruptcy refers to the fact that during the transition from planned economy to market economy, the bankruptcy of many state-owned enterprises must solve some problems left from the planned economy, such as the 10

11 the settlement of laid-off workers. These problems can not be solved without the participation of government sectors. So, liquidating groups are established when state-owned enterprises are under bankruptcy liquidation. When the Law was enacted, the policy bankruptcy was still on the way. In order to compromise with the policy bankruptcy practice, the Law grants liquidating group the status as administrator. But the problem is that the Law does not specify the scope of power of liquidating group and it may control a bankruptcy under the status of administrator. Moreover, the government sectors may control the bankruptcy through dominating the liquidating group. And it does in practice! The last but not the least part of administrator system is the appointment of administrator. Article 22 stipulates that the administrator is appointed by the court and the specific appointing mechanism is entrusted to the Supreme Court. 18 The above is a brief description of how the administrator system came settlement of laid-off workers. In order to solve these historical problems, the State Council issued some policies to support the bankruptcy of these enterprises. Policy bankruptcy requires the support of government sectors. So liquidating group was formed to handle policy bankruptcy. The members of the liquidating group are from relevant government sectors. When the Law became effective, there were still many enterprises under policy bankruptcy. So the Law allows liquidating group to act as administrator as a compromise of the Law to the reality of China s economy. For a detailed survey of the bankruptcy of these state-owned enterprises, see The Research Group of the Department of Enterprise Reform and Restructure of the State-Owned Assets Supervision and Administration Committee of the State Council, Research of the Problems in the Bankruptcy Restructure of Central Enterprise Left Over from the Past (Zhong Yang Qi Ye Po Chan Chong Zu Zhong You Guan Li Shi Wen TI Yan Jiu), Law Review of Corporate Reorganization & Restructuring (Gong Si Chong Zheng Fa Lv Ping Lun), Volume 2, 2012, pp This kind of legislation mechanism is quite common in China. The laws which are formulated by the National People s Congress (NPC) tend to be general and they leave the details to the Supreme Court or related government sectors under the State Council. One reason of this kind of legislation mechanism is to avoid too much debate and hold out during the legislation process in the level of NPC. 11

12 up as the result of the bargaining and compromise initiated by a few scholars during the bankruptcy legislation. 19 The effect of the legislative bargaining is that the administrator controls bankruptcy procedure and the court is assumed to play a dominant role in bankruptcy procedure since it is the court who has the authority of appointing the administrator. The debtor s control of business is undermined as long as bankruptcy petition is filed, even if the debtor applies for DIP. This control mechanism of bankruptcy procedure directly affects the judicial process of the Law. C. The Judicial Process of the Bankruptcy Law of China in General 1. The Court Independence Is Undermined Despite the passage of hundreds of laws and the expansion of the judiciary since the late 1970s, a dominant theme in the literature is that Chinese courts have enjoyed little judicial independence. Scholars and observers find that the party-state has direct or indirect control of the courts: judges are still on the payroll of local governments, their professionalism is limited, and the influence of local protectionism on the court is strong. The courts are thus little more than a loyal-subordinate of the party-state that carefully carries out assigned tasks; they have no will 19 A vivid description of bankruptcy law legislation bargaining among scholars is like this. One scholar states his opinion, others present their arguments, and legislative officials observe the discussion and make the final decision according to which opinion gets more support from scholars. It might sound interesting, but it s quite true. 12

13 or capacity to resist the party-state s interference. 20 Court independence becomes deteriorate in recent years. What the two high officials in Chinese court system acted in recent years present strong evidences. The former president of the Supreme People s Court as well as the Chief Judge Wang Shengjun failed to mention judicial independence in his annual report before the NPC both in 2011 and He only mentioned impartial justice while avoiding expressing independence of judiciary. 21 Professor Jiang Ping, the most prestigious law professor in China, respectful for his unsparing efforts in promoting democracy and rule of law in China, interpreted this phenomenon as a signal of retrogression of judicial independence. 22 Zhang Wenxian, the president as well as the Grand Justice of the High Court of Jilin Province before 2013, showed his disrespect of judicial independence by promoting the idea of coordinated judicial process (Lian Dong Si Fa). He argued that if more than 10% of the people in a society are involved in law suit, this society can be categorized as a litigation society. According to his data China has entered a state of 20 See Xin He, Why Did Dhey Not Take on the Dispute? Law, Power and Politics In the Decision-making of Chinese Courts, International Journal of Law in Context, p The working report of the Supreme People s Court is available at Last visited on Mar An interesting but profound information is that this guy, as the Chief Justice and the president of the Supreme Court in China from , had no legal background. People often joked him as the Chief Layman of Law in China. 22 Jiang Ping argues that the precondition of impartial justice is the independence of justice, so only mentioning impartial justice while avoiding independence of justice is a big flaw. See Duan Hongqing, The Core of Rule of Law is to Protect Private Right An Interview with Professor Jiang Ping (Fa Zhi De He Xin Shi Bao Hu Si Quan), available at Last visited on Mar.27,

14 litigation society. 23 He further argues that under the context of litigation society, China should promote the idea and practice of coordinated judicial process instead of sticking to the stereotype idea of judicial independence. He describes coordinated judicial process as When the people s court exercises its authority of trial and decision and performs her function as judicial organ, it should always subject to the leadership of the Chinese Communist Party and relies on the political advantage of the party committee in coordinating different interested parties; It should subject to the supervision of the People s Congress and relies on the support of the People s Congress to overcome illegal intervention and maintain judicial authority; It should also actively strive for the support and cooperation from the government in order to realize the harmonious coordination between judicial power and administrative power The Interactions of Interest Groups Are Active However, the lack of judicial independence, reinforced by the popular idea of so called coordinated judicial process, makes the interactions of interest groups in judicial process quite active. The interest groups involved in the judicial process are generally the local court, the local government, the litigants, the higher court and/or the supreme people s court. 23 Zhang Wenxian, Coordinated Judicial Process: The Judicial Mode under the Litigation Society Context (Lian Dong Si Fa: Su Song She Hui Jing Kuang Xia De Si Fa Mo Shi), Journal of Law Application (Fa Lv Shi Yong), 2011(1).p Id., at page 4. His argument sounds not coherent. The more ironical thing is that he is considered a prestigious scholar in jurisprudence in China. 14

15 The interactions among interest groups in the judicial process of bankruptcy are generally more intense than other cases. On the one hand, there are more interest groups involved in bankruptcy cases. Since bankruptcy, especially the bankruptcy of large companies, affects the local economy, employment and social stability, local government actively intervenes in bankruptcy process. Under the current practice, the bankruptcy of listed companies requires the approval of the China Securities Regulatory Commission (CSRC) and the Supreme People s Court in certain issues, the CSRC and the Supreme People s Court are important players in the judicial process of bankruptcy. Besides, according to China s legislation system, the Supreme People s Court actively makes judicial interpretations in the name of filling the gaps of laws made by the NPC. Since judicial interpretations of bankruptcy law is more responsive to judicial practice and has more influence on future interactions among the interest groups than the bankruptcy law itself, the Supreme People s Court has more voice in the judicial process as an important interest group. The debtors, the creditors, the law firms and the financial management firms are also important players in the judicial process of bankruptcy. They may also influence the drafting of judicial interpretations of the Supreme People s Court through Chinese approach. Again, bankruptcy scholars also play a part in the game of judicial process of bankruptcy. 15

16 On the other hand, the incentive of the interest froup of participating in the game of judicial process of bankruptcy is generally stronger than in other cases. This is mainly because there are more stakes in bankruptcy cases. For local government, since bankruptcy cases affect the political and economic performance of the local government officials, the government officials have strong incentives to interfere in bankruptcy cases. Lawyers, financial consultants, creditors and debtors all have different stakes in corporate bankruptcy and have incentives to make bankruptcy law and its judicial interpretations be made to their preference. The general legislative and judicial process of the Law as described above is with strong Chinese characteristics. What is the current situation of the implementation of the Law under this legislative and judicial process? How do the interest groups interact in the implementation of the Law and how this interaction will shape the future of the Law? The following of this article will discuss these problems in detail. II. The Implementation of the Bankruptcy Law A. The Bankruptcy Regime and Its Implementation in General The bankruptcy regime of China is composed of two parts: the Law and its judicial interpretations. The former is formulated by the NPC and the latter are formulated by the Supreme Court. In order to facilitate the 16

17 implementation of the Law, the Supreme Court has released several judicial interpretations. They are: Supreme People s Court Regulation on Law Application of Cases Still Pending upon the Enterprise Bankruptcy Law of People s Republic of China Coming into Effect 25 ; Supreme People s Court Regulation on the Appointment of Administrators 26 ;Supreme People s Court Regulation on Compensations of Administrators 27 ;Supreme People s Court Regulation on Bankruptcy Cases in Which the Whereabouts of the Debtor or Its Assets Are Unclear 28 ;Supreme People s Court Regulation on Time Limits for Hearing Civil Cases 29, Several Issues in the Application of the Enterprise Bankruptcy Law of PRC(No.1) 30, Several Issues in the Application of the Enterprise Bankruptcy Law of PRC(No.1) 31 etc. Compared to the 1986 Bankruptcy Law, the scope of application of the Law extends to all enterprise legal persons. 32 Drawing upon the Chapter 11 of U.S. bankruptcy law, the Law provides for reorganization system. The Law introduces independent administrator system in contrast to the liquidating group system of the 1986 bankruptcy law. 33 The Law also enhances the protection of creditors in its stipulations on creditors 25 Fashi (2007)10, Apr.23, Fashi (2007)8, Apr.4, Fashi (2007)9, Apr.4, Fashi (2008)10, Aug.4, Fashi (2008)11, Aug.11, Fashi (2011)22,Sep.9, Fashi (2013)22.Sep.16, The 1986 bankruptcy law only applied to state-owned enterprises. Although the Law does not clearly stipulate the application of other economic organizations, the bankruptcy of other economic organizations other than enterprise legal persons can refer to the Law in practice. 33 Under the 1986 bankruptcy law, the bankruptcy case is handled by a liquidation group composed of administrative staff. 17

18 meeting and creditors committee. These sweeping changes and innovations bring the Law up to the level of market economy oriented bankruptcy law. 34 However, the Law has not brought about an apparent increase of bankruptcy cases as expected. The chart below depicts the annual bankruptcy cases settled by the court in China from 1998 to Figure 1: Annual Bankruptcy Cases Settled in China annual bankruptcy cases case amount year amount year year amount (Data Resources: the Supreme Court of China and the Bankruptcy Law & Restructuring Center, China University of Politics and Law) According to figure 1, from 1998 to 2001, annual bankruptcy cases witnessed a sharp increase. The year 2001 witnessed an annual bankruptcy case of near 9000, and the year 2002 witnessed a slight increase. From 2002 to 2005, the amount of annual bankruptcy cases 34 A senior attorney in Hong Kong comments the Law as more advanced in form than the bankruptcy law in Hong Kong where there are more developed law of market economy. See Rraham Ridler, Restructuring in the PRC The Outsider Looking In, INSOL World Fourth Quarter 2009, p The author checked the 2013 Supreme Court report in order to find the bankruptcy filing data of 2012 but failed because this report was a five year report without mentioning the specific figures of bankruptcy filing. 18

19 dropped sharply from 9000 to And then the year 2006 witnessed a considerable increase from 3800 to However, the annual amount of cases adopted by courts since the implementation of the Law generally drops from 3817 in 2007 to 3567 in The amount of bankruptcy cases have been decreasing since the Law came into effect. There were only 2531 cases settled in 2011, which drops onto the floor. Another source of data might provide a more direct view of the situation the Law faces in China s economic context and reinforces our puzzlement towards the low annual bankruptcy cases since the implementation of the Law. Figure 2 reflects the annual amount of enterprises withdrawing from the market from 2005 to Figure 2: Annual Amount of Enterprises Withdrawing from the Market annual amount of enterprises withdrawing from the market year deregistration license revoking total year deregistration license revoking total (Data Resources: the Supreme Court and the Bankruptcy Law& 19

20 Restructuring Research Centre of China University of Politics and Law) Figure 2 reflects that the annual amount of enterprises withdrawing from the market from 2005 to 2009 fluctuates around the average of 800,000. The year 2006 witnessed the lowest point, that is, 672,000 cases. The year 2008 witnessed the peak point, that is, 871,400 cases. The peak in 2008 is in accord with the situation that China was affected by the global financial crisis in 2008 and the economy experienced a depression, resulting in many enterprises caught in distress. But the fact that the bankruptcy filings from 2007 to 2009 continued to drop while the amount of enterprises withdrawing from the market was drastically rising compared with 2006 reflects a sharp contrast. To focus on the data comparison during 2008 may further highlights the awkward condition the Law faces in its implementation. In 2008, the bankruptcy cases filed in China amounted to 3139 while there were 780 thousand business entities exited the market in the same year. Among these 780 thousand business entities, 380 thousand exited the market in the form of deregistration (Zhuxiao) and 400 thousand in the form of revoking of license (Diaoxiao). 36 According to China s company law, bankruptcy law and relevant administrative regulations, a business entity may terminate its business (Zhongzhi) either voluntarily based on its articles of association or involuntarily by the Administration for Industry 36 The data is collected by Bankruptcy Law and Restructuring Research Center, China University of Politics and Law, based on relevant media reports and information disclosure of the Supreme Court. 20

21 and Commerce (AIC). A business entity whose business is terminated (Zhongzhi) still has legal personality; It should undertake the wind up process before filing with the AIC for deregistration (Zhuxiao). In case there remain residual assets after the wind up process, the residual assets are to be distributed to shareholders before filing with the AIC for deregistration (Zhuxiao); In case the existing assets of the business entity are not enough to pay out all of its debts, the wind up process under company law is transferred into bankruptcy liquidation process and the creditors are reimbursed under rules of bankruptcy law. But the problem is that a lot of business entities exit the market without going through the wind up process in order to evade debts or for other reasons. Take China s Zhejiang province, one of the most economically advanced provinces in eastern China, as example. In 2008, there were only 60 bankruptcy cases filed in this province, while there were numerous reports that many company owners or top executives mysteriously disappeared, leaving the troubled business entities together with miserable employees discarded behind. 37 We don t see any improvement for the living condition of enterprises in China from 2010 to We take Wen Zhou, one of the most 37 See Wu Xiaofeng: The Bankruptcy Filing Drops since the New Bankruptcy Law Implemented (Xin Fa Shi Shi Yi Lai Po Chan An Jian Bu Sheng Fan Jiang), available at Last visited on Dec.11,

22 advanced market place in China, as an example. Wen Zhou is a costal city in eastern China which earns its reputation for robust private economy. But since 2010 when the chains of folk finance (Min Jian Jin Rong) broke down in this city, 38 many enterprise owners chose to run away instead of filing for bankruptcy. It was recorded that from Jan.2010 to Oct.2010, there were more than 90 enterprise owners run away to escape debt. 39 But Wen Zhou is not a special case, there are also many other reports about enterprise owners running way to escape debt around China. If we further consider the influence of world economy on China s enterprises, the financial and economic situations of Chinese enterprises in 2011 are no better than before. Thus, we may well doubt about the record of the poor bankruptcy case settlement in B. Reorganization Regime and Its Implementation in General Despite the poor implementation of the Law in general, reorganization sounds rather hot, especially the reorganization of listed companies. Reorganization involves more bargaining among more interest groups 38 There are two sets of finance systems in China. One is official finance, which is the financing through the formal banks. The other is folk finance, which is the financing through private financial companies, underground financial institutions or through individual loaning. Since the official financing can not meet the demand of financing of private enterprises and private transactions, the folk finance is quite active in China, especially in such places where private economy is brisk like Wen Zhou. But the risk of folk finance is that, since private borrowing always parallels with guarantees from other private parties, if a debtor fails to repay his debt, there will be a domino effect, rendering the whole market break down. This is why in Wen Zhou a chain of defaults occurred within a concentrated short period of time. 39 Yan Ge, Gu Qizheng, Zhao Xiaoyan, Run Away or File Bankruptcy: How Do the Enterprises Deal With the Debt Crisis in Wen Zhou (Pao Lu Hai Shi Po Chan? Wen Zhou Qi Ye Ru He Ying Dui Jin Rong Wei Ji.)? last visited on Mar.30,

23 since there are more stakes in it, so reorganization, at least now, reflects more Chinese style political economy of law and deserves more observation. 1. The Regime of Reorganization in China The Law provides for low thresholds for filing reorganization. The court shall accept the filing of reorganization as long as one of the three conditions is met:(1)when the debtor fails to settle its debt as due, and its assets are not enough to pay off all the debts;( 2)the debtor is obviously incapable of clearing off its debts;( 3)it is obvious that the debtor is unable to pay off its debts. 40 A debtor or creditor may, according to the provisions of the Law, apply directly with the people's court for reorganization against the debtor. Where any creditor applies for bankrupt liquidation against its debtor, after the court accepts the application for bankruptcy and before the debtor is announced bankrupt, the debtor or its capital contributor whose capital contribution makes up 1/10 or more of the debtor s registered capital may apply with the court for reorganization. 41 The reorganized corporation can be managed by the Debtor-in-Possession (DIP) under the supervision of the administrator or directly by the administrator. But the plan of reorganization shall be carried out by the debtor under the supervision of the administrator Article 2 of the Law. 41 Article70 of the Law. 42 Article 73,74,89,90 of the Law. 23

24 The Law provides for market-oriented administrator system to replace the liquidating group under the 1986 bankruptcy law. In order to coordinate with the provision of the Law, the Supreme Court has formulated two judicial interpretations regulating administrator as a supplementary of the Law in March Under the judicial interpretation, qualified social intermediaries and individuals can apply to register as administrator candidates on the registration list formulated by the court under whose jurisdiction they are subject to. The court generally designates the administrator from the list by casting lot in a specific bankruptcy case. The administrator may come out by competitive bid among different jurisdictions in influential cases. And in some cases the liquidating group may transform into administrator. In addition, the compensation of administrators is also covered by the judicial interpretation. It should be clarified that the Law allows the liquidating group to transform into administrator only for the purpose of compromise to the current practice in real life. Since there are still many state-owned enterprises undergoing liquidation or restructure at the time the Law became effective, 43 it is intended to be a supplementary and temporary 43 Until the end of 2008, the application for bankruptcy of 300 central state-owned enterprises was approved within the time limit specified by the state council; at the end of 2009, 90 percent of the qualified bankruptcy application of central state-owned enterprises either finished judicial process or entered judicial process. See The Task Force of the State Owned Enterprise Restructure Group under the State Council, The Report of Some Historical Issues Remained in the Bankruptcy and Restructure of Central State-Owned Enterprises, The Law Review of Corporate Reorganization, 2012 edition. This figure reflects that there are still a lot of state-owned enterprises facing bankruptcy and restructure when the Law becomes effective. 24

25 transition from the current practice to market-oriented practice. But the transitional arrangement becomes dominant in practice, especially in the bankruptcy reorganization of large corporations. 2. Reorganization in Practice a. Reorganization of Listed Companies The reorganization regime which was introduced by the Law brings much impact on China s securities market. Until Oct.15, 2012, there are 38 listed companies filing for bankruptcy reorganization and their plans have been approved by court. All these listed companies undergoing bankruptcy reorganization are called ST companies. There are many insolvent listed companies in China s securities market labeled as ST companies. 44 Since the listing cost in China s securities market is very high, the ST companies still remain considerable shell value even if their assets are far less than their debts. ST companies become attractive targets of acquisition for outside investors. But since the out-of-court restructure negotiation involves much costs and uncertainty, there has been very few successful cases of out-of-court restructure. Some ST companies were dragged long on the road of restructure and ended with failure and being delisted. The 44 ST means special treatment. It s a special warning system formulated by the securities exchanges in China against listed companies suffering severe losses for the protection of investors. According to the rules of Shenzhen and Shanghai stock exchanges, listed companies suffering losses for two continuous years shall be marked ST before the name of the company to warn the investors the potential risk that the company may be delisted. If the ST company remains losing money for the third year. It will be suspended for trading in the stock market. If it cannot recover at the following year, it shall be delisted from the stock market of China. 25

26 reorganization system under the Law provides the ST companies with a low cost alternative of preserving the shell. This is also a good business opportunity for investors. Another political force which has strong incentive of reorganizing the ST companies is local government. Since reserving a license of listed company indicates good administrative performance, more job rates and good image for the local governments, the local government officials have strong incentives to exert influences on the local courts, the debtors, and the creditors to reorganize those ST companies instead of allowing them to fail and be delisted. These factors lead to a comparative brisk market for reorganization of ST companies. In order to provide a general picture of how a ST company is reorganized, the case of ST Huayuan, which is the first reorganization case of listed company in Shanghai, is presented here as an example. The debtor was suspended to trade on the stock market by Shanghai Stock Exchange due to its three-year continuous loss from 2005 to In August 2008, a creditor of ST Huayuan, Shanghai Taishengfu Enterprise Development Corporation applied the second intermediate court of Shanghai to reorganize the debtor. The court ruled to accept the case on September. What s noteworthy is that Shanghai Taishengfu Enterprise Development Corporation is a subsidiary of ST Huayuan and they are both subject to the same controlling party China Resource 26

27 Group of Hong Kong. So it is the debtor who actually applied for reorganization. Considering that the debtor is the first listed company filing for reorganization in Shanghai and the debt relations were rather complicated, the court designated the liquidating group as administrator and ordered the administrator to manage the business of the debtor during the reorganization process. The parties of the liquidating group include: China Banking Regulatory Commission (CBRC) Shanghai Bureau, China Securities Regulatory Commission (CSRC) Shanghai Bureau, Shanghai Financial Office, State-owned Assets Supervision and Administration Commission of the State Council (SASAC) Shanghai Branch, China Resource Medical Group, King & Wood Law Firm of Beijing. The plan of reorganization was approved by all the voting classes on Dec.1, The plan was composed of two basic parts:(1)all the existing shareholders transfer about 186,504,000 shares to creditors as compensation and to the restructure party as consideration;( 2)To undertake a direct issuance of stocks to investors and the investors inject sound net assets with certain profitability valued no less than 1 billion CNY, enabling ST Huayuan to restore sustained operation and become economically viable. On April 24, 2009, the administrator submitted its supervision report on the carrying out of the plan of reorganization to the court, stating that 27

28 the plan was consummated. From the items of the supervision report, we may find what transactions have been done in the carrying out of the plan of reorganization. The items are as follows: (1) Sale of assets; (2) Settlement of employees; (3) Reduction and transfer of stocks; (4) Selection and confirmation of restructurer; (5) Reimbursement of creditors; (6) Annual auditing of the reorganized corporation. 45 b. The Reorganization of Close Companies Because close companies lack shell value, their reorganization is more difficult than that of listed companies. But despite the difficulties compared with that of listed companies, the general filing of reorganization in China is still robust in China since the Law was enacted. Until the end of 2012, there were 287 reorganization cases of close companies. 46 The following case is presented to reflect a general picture of how a close company is reorganized. Yaxin Electronics and Yaxin Circuit Board (hereinafter referred to as Suzhou Yaxin) are two companies located in Wuzhong District of Suzhou city. Their business was pretty good. But their parent company, Taiwan Yaxin Corporation was ruled by Taiwan Shilin Court to be reorganized. The bankruptcy reorganization of parent company brought a heavy blow to Suzhou Yaxin. The cash receivables can t be collected, cash flow failed, 45 See 46 Since this data is collected based on published newspapers, it might not be accurate. But the real figure should be higher than the data collected if there are some cases omitted. 28

29 and the business plunged into plight. At that time, there were nine domestic banks and six foreign banks having credit loans exposed to Suzhou Yaxin, totaling 1.46 billion CNY. These bank creditors were divided toward the future of the debtor. Some banks demanded winding up the debtor, while others were confident with the debtor s market potential and called on reorganization. The local government negotiated with the fifteen bank creditors to reorganize the debtor. The government s intervention led to the final consensus to reorganize the debtor. On Apr.25, 2008, a banking group composed of the fifteen bank creditors filed reorganization petition to the local court. The administrator controlled the management the reorganized corporation. The local court didn t have a list of administrators at that time. So the bank creditors proposed Ernst & Young Huaming Accounting Firm as administrator 47 and the court examined and approved the proposal. The administrator invited investors across the world to bid. Tiger Builder Consultant Ltd. (hereinafter referred to as Tiger Builder) won the bidding competition. Tiger Builder promised to pay out the debtor s confirmed debts at the rate of 100% on the condition of obtaining 100% 47 Ernst & Young Huaming is a joint venture of Ernst & Young in China established in It is noteworthy that sino-foreign joint venture accounting firms registered in China are allowed to act as administrator in bankruptcy cases in China under the judicial interpretation of Supreme Court in

30 of the old equity of the reorganized company as consideration. Thus the old equity holders were wiped out of their equity interests completely under the judgment confirmation of the court. Tiger Builder contributed 35 million CNY and got 100% equity interests and control right of the debtor, Suzhou Yaxin. The legal entity of Suzhou Yaxin remained unchanged and the claims confirmed by the court will be repaid at the rate of 100%. The plan of claims compensation will be carried out within eight years. Now the reorganized debtor has already restored business operation. III. The Interest Groups and Their Incentives in the Implementation of the Bankruptcy Law As mentioned above, the legislative process of the Law did not involve much bargaining among interest groups. The only hot bargaining concerning the priority of employee claim and security claim does not generate much effect on the judicial process. However, the bargaining among bankruptcy scholars on the administrator system and the compromise of the bargaining have greatly affected the implementation of the Law. This part will discuss the interest groups and their incentives in the implementation of the Law in the context of the operation of administrator system because it is the administrator system of the Law that provides the major platform of bargaining for the interest groups in the judicial process. 30