Q&A: Top Court Adviser Suggests Better Use of Bankruptcy

As more Chinese companies struggle with debt in a cooling economy, discussion is heating up on how bankruptcy reorganization should be used to protect troubled business borrowers as well as creditors.

China enacted the Enterprise Bankruptcy Law in 2007, laying the legal groundwork for bankruptcy liquidation and reorganization. In practice, however, many companies, creditors and government officials have hesitated to use bankruptcy reorganization to manage business debt crises.

Du Wanhua, deputy director of an advisory committee to the Supreme People’s Court, attributed the low acceptance of bankruptcy reorganization to wide misunderstanding of the process, a lack of professional insolvency administrators and inadequate supportive policies.

In an interview with Caixin, Du said most market players in China haven’t realized that bankruptcy reorganization is a better way to protect all parties’ interests in a bankruptcy case compared with liquidation.

Bankruptcy reorganization is a tool to reallocate resources and protect creditors’ legal rights in a market economy, Du said. It allows unqualified players to exit the market while reducing the loss of productivity and resources, he said.

As China experienced a record number of corporate debt defaults in recent years, a handful of bankruptcy reorganization cases have drawn attention. They include the country’s largest bond defaulter, Dongbei Special Steel Group Co., and its major unit, Fushun Special Steel, as well as the one-time pioneering smartphone maker Gionee Communication Equipment Co.

“One of the major reasons for the slow progress of bankruptcy reorganization in China is the lack of affiliated policy arrangements,” Du said. There are not enough qualified institutions that can act as administrators in a bankruptcy procedure to manage, assess and dispose of assets, and there are is a lack of enterprises capable of rescuing troubled companies, he said.

Du specializes in bankruptcy cases at the Supreme Court and has led the drafting of several major policy documents regarding bankruptcy procedures. In a recent interview with Caixin, he discussed the plight facing Chinese enterprises and investors in bankruptcy. Excerpts of the interview follow.

Caixin: Many people see bankruptcy reorganization as a way of allowing debtors to evade their obligations. What are the differences? 　

Du Wanhua: The modern legal arrangement for bankruptcy originated in Britain, which laid down some basic principles for debt payment in bankruptcy cases. It also proposed the idea that debtors that are not intentionally trying to escape their obligations should be protected.

As economies developed and modern enterprises emerged in the West, the bankruptcy system has evolved to regulate the obligations of shareholders when a company needs to be liquidated for bankruptcy.

The system of bankruptcy reorganization was set up even later to deal with assets that are difficult to dispose of. Reorganization targets a company’s business rather than assets. It invites a strategic investor to revive the business and then repay the debts.

But unlike Western countries where bankruptcy law evolved from dealing with individual debtors to corporations, China created the corporate bankruptcy law first. There is still no legal bankruptcy arrangement designed for individuals in China.

You have proposed a joint effort between local government and courts in dealing with company bankruptcy cases. But there are also concerns over excess government intervention. How do you see governments’ role in bankruptcy?

In China, cooperation between local governments and courts is the most efficient way to push forward a bankruptcy procedure. We are working to set up a standard mechanism to coordinate government and court efforts and make that an important part of the bankruptcy procedure.

In most of China’s bankruptcy cases, it is difficult for courts to rule on a bankruptcy reorganization or have court orders implemented without the involvement of local governments. That is because the bankruptcy procedure involves lots of issues that fall under government supervision, such as tax collection, land transfer, business registration and employee settlements. These all require government support and coordination.

Companies are often hesitant to apply for restructuring because many entrepreneurs see it as a shameful thing. Local governments’ concerns over social stability also hinder companies from entering a restructuring process. Local governments are more inclined to intervene in state-owned companies rather than private ones.

How should the responsibility of bankruptcy administrator be defined?

Bankruptcy administrator is the key player in the bankruptcy procedure. But China still lacks professional organizations to play the role and standardized rules for them to follow.

Bankruptcy administrators should first be responsible for protecting asset security and prevent further loss after the procedure starts. The administrator should organize asset auctions and distribute the revenue among creditors in a bankruptcy liquidation.

Secondly, administrators should have the ability to manage and evaluate assets. They need to push companies to implement restructuring plans.

Therefore, bankruptcy administrators should have expertise in law, accounting, corporate management and asset management. But in China, most administrators are simply lawyers or accountants.

Who will supervise bankruptcy administrators?

Bankruptcy administrators should be an assistant to the judge and lead the negotiations with all parties, including debtors, creditors and new investors.

Bankruptcy administrators should take a neutral stance in a bankruptcy case and balance the interests of all parties. But they should work under the guidance of the court and based on court orders.

All parties can oversee the work of bankruptcy administrators, including creditors, courts and industry associations. They are also subject to public scrutiny.

Contact reporter Han Wei (weihan@caixin.com)