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Editorial: The Upside to Bankruptcy

Ten years after China’s Enterprise Bankruptcy Law was put in place, it is clear that the system, which was designed to allow insolvent companies to gracefully bow out of the market, has not been widely accepted.

The former solar panel giant LDK Solar was a star company when it went public on the New York Stock Exchange 10 years ago in one of the biggest IPOs ever for a Chinese energy company. However, the company has struggled with its reorganization plan in the years since it went bankrupt.

Dongbei Special Steel Group, another troubled large Chinese company with tens of billions of yuan of debt, has become the center of controversy since the Liaoning province government stepped in and forced a restructuring process that many creditors took issue with.

At a time when the central government is calling for a cut in excessive production capacity and urging faster phasing out of “zombie enterprises,” it has become an urgent matter to find a way to have enterprises that have been hopelessly losing money for years withdraw from the market while protecting everyone’s rights and interests.

According to Chinese law, when a company’s assets aren’t worth enough to cover its debts or the company’s has clearly become insolvent, it or its creditors can petition a court for bankruptcy in the form of reorganization, settlement or liquidation.

Although more bankruptcy cases have been filed in recent years, the overall number remains relatively small. Only a tiny number of companies have quit the market through bankruptcy.

The stigma of the term bankruptcy, and the competing interests of the parties involved are the main reasons why there are so few cases. If the authorities cannot effectively clear these hurdles and build systems to facilitate the process, bankruptcy will not be able to play its proper role in a market economy.

If authorities soon start revising the Enterprise Bankruptcy Law, as some experts expect, they should try to fix problems encountered by Dongbei Special Steel or LDK Solar.

The fear of bankruptcy continues to be a problem. Some investors believe bankruptcy is the worst option available. Some banks are reluctant to see a company that owes it money go bankrupt, for fear of damaging their own performance.

Local governments also often resist the idea of corporate bankruptcy, as it can be seen as their own failure to cultivate a healthy business environment. Officials often interfere and mobilize resources to pump more money into dying companies. Although it may work for a while, this tactic only allows debts to grow larger, until the company’s finances buckle under the weight.

The local governments only see the benefit of keeping a company alive, while ignoring the huge costs to ensure a zombie company stays on its feet. A poorly handled bankruptcy case can do tremendous damage to a local business environment. And it is damage that is difficult to repair.

There is an urgent need to change the perception of bankruptcy. Bankruptcy law is not a law governing the death of companies. Bankruptcy reorganization can often save a company by allowing it to navigate difficult financial straits. By filing for bankruptcy, both debtors and creditors can relieve themselves of financial burdens via a process that treats both sides equally. As to what kind of bankruptcy protection should be chosen, debtors and creditors can decide that through negotiations.

China’s local governments are often involved in the creation, investment and operations of major companies. When these companies run into financial trouble, local governments often have to step in to deal with the laid-off workers. However, it doesn’t mean local government officials must lead the bankruptcy process because they often put their own will ahead of the interests of the creditors.

The Dongbei Special Steel and LDK Solar bankruptcy cases drew widespread criticism because of local governments’ overactive roles. Bankruptcy must respect both the market and the law based on competition. Local governments must be clear about what they can do and what they cannot do. Sometimes it is more important to ensure what they cannot do.

Improving the administration of justice under bankruptcy law and building systems to facilitate the process are the keys to solving the problems with bankruptcy. It will also ease concerns of companies, creditors and local governments.

In recent years, authorities have created clearer standards for how courts handle bankruptcy cases. In May 2016, the Supreme People’s Court issued a notice urging local courts to establish special bankruptcy courts to “prudently speed up” the resolution of bankruptcy cases. As of the end of June, the number of local liquidation and bankruptcy courts had grown from five in 2015 to 90, covering two-thirds of the country’s provincial regions. But the number of judges has continued to lag.

The bankruptcy trustee system must be improved to enhance the transparency of the process and strengthen its execution. The current bankruptcy law stipulates that a trustee is assigned by the court. But the stipulation lacks clear guidelines for how to choose a trustee or administrator, which could hurt the bankruptcy process.

Some experts call for the establishment of a bankruptcy trustee association to strengthen industry self-discipline. It’s worth a try. The authorities also need to coordinate different government bodies to deal with the relocation of affected workers.

Bankrupt companies that emerge from bankruptcy reorganization may still face questions about tax calculations, debt clearance and credit recovery. So far, there is no special tax policy for bankruptcy reorganization. As a result, different local authorities may have different practices. Some companies that have survived bankruptcy remained burdened by heavy taxes because they are unable to benefit from tax breaks. Also, some companies have seen their credit ratings take a hit, making it difficult for them to obtain new loans after reorganization. These problems need to be fixed.

Orderly bankruptcy, property protection, contract recognition and fair competition form the legal foundation for a market economy. Developed economies have a mature bankruptcy system.

A healthy market economy must maintain a balance between what comes in and what goes out, so that the flow of market elements will never rot. If China wants to upgrade its economic model, a healthy bankruptcy system is indispensable.

Hu Shuli is the editor-in-chief of Caixin Media.

 

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