In 1986, the standing committee of the National People's Congress (NPC) promulgated and implemented, on a tentative basis, the Enterprise Bankruptcy Law (Trial Implementation), which is only applicable to State-owned Enterprises (SOEs). And it has been in use until now. For private enterprises, a Civil Procedure Law has been used since 1991 to govern bankruptcy-related matters. In 2002, the Supreme Court of the People's Republic of China (PRC) promulgated the "Provisions Concerning Certain Issues Relating to the Proceedings of Corporate Bankruptcy Cases".

It can be said that there is basically no complete bankruptcy law in the PRC that covers all types of enterprises. This situation would be very unsatisfactory in terms of protecting the creditors' interests.

Following China's entry into the World Trade Organization, foreign investors have been playing an important role in market economy development and their rights and interests cannot be ignored. While the market is more deregulated and the investment environment is friendlier than before, most foreign investors are still worried about starting businesses on the mainland. The reason is the lack of a comprehensive legal framework that can protect the interests of foreign investors if debtors fail to repay debts. The implementation of a bankruptcy system with global standards can strengthen investor confidence when they are having or plan to invest on the mainland.

In view of the above, it is necessary that a unified bankruptcy law that applies to bankruptcy of all enterprises be established as soon as possible.

In June 2004, the eighth draft of the proposed bankruptcy law was submitted to the NPC for consideration and approval. The Legal Committee of the NPC has made comments on the draft and the revised draft was submitted to the NPC for its second reading in October 2004. The third reading is expected to take place within the year.

Three limitations of the existing Bankruptcy Law

The existing Bankruptcy Law is only applicable to SOEs. Due to the transition of the Chinese economic system from the "socialist planned economy" to "socialist market economy" and deepening reforms of SOEs, many business entities other than SOEs have been formed. In addition, the promulgation of the Company Law and the continued reform of SOEs also facilitated the emerging of new types of enterprises. It follows that the existing Bankruptcy Law is no longer in line with the reality of PRC enterprises today. It fails to extend its regulatory controls over limited liability companies and joint stock limited companies. Given the limited scope of the application of the existing Bankruptcy Law, foreign enterprises simply do not know the rules of the game when going into bankruptcy or going for divestment.

Besides, the existing Bankruptcy Law is more a law of principle and is not detailed enough to make it a comprehensive and operational framework. There also exist some provisions that go against the rule of law. It also fails to offer sufficient protection to the parties concerned. For example, Clause 2 of Section 9 of the Bankruptcy Law provides that "Creditors who fail to lodge their claims during the respective periods shall be deemed to have abandoned their rights" is an unjustified deprivation of creditors' rights. Although the Civil Procedure Law, promulgated in 1991, has made additional provisions for the proceedings of bankruptcy cases, the system is still too simplistic. There are no operative provisions specifying the circumstances under which an enterprise shall apply for liquidation and bankruptcy, and the procedures regarding registration and settlement of claims and debts.

In addition, the existing Bankruptcy Law also provides no procedure for protection of enterprises from bankruptcy nor for the preservation of the legitimate rights/interests of employees. While the Company Law has been introduced, the provisions only set out how an enterprise can be established without specifying how an enterprise in financial difficulties can pursue restructuring or how to let certain incurable enterprises rest in peace sooner than later.

As China has entered the World Trade Organization, its ties with global economies are becoming closer and closer and the presence of foreign investors in the PRC is also growing. In order to speed up the development of the market economy, and ease the concern of foreign investors and enhance investor confidence, the need to introduce a new Bankruptcy Law on the mainland is becoming more pressing than ever.

After China joined the World Trade Organization, the mainland government has taken a more active role to bring the new Bankruptcy Law into operation. The bills for the eighth and ninth amendments of the Bankruptcy Law were reviewed and passed by the NPC in June and October 2004 respectively. It is generally expected that the third reading will take place this year but whether or not the review will proceed as expected is uncertain. Besides, the final passage of the new law depends on whether or not agreement can be reached in respect of disputed issues such as the rights and protection of secured creditors and the appointment of administrators in bankruptcy by judges or creditors.

The New Bankruptcy Law should be introduced as soon as possible

Every law must be improved and enhanced towards perfection with the help of professionals as areas of insufficiency often reveal when a law is enforced by the judicial authority.

In order to strengthen the confidence of foreign investors in the PRC, the new Bankruptcy Law should be enacted as soon as possible in order to let the PRC's judicial officers get themselves familiar with the spirit of the bankruptcy law. The introduction of the new Bankruptcy Law will ensure the effective allocation of resources on the mainland and help establish a fair, equitable and open legal environment and a free economy where "survival of the fittest" is the rule.

The new bill has made significant improvement in different areas compared with the existing Bankruptcy Law. Beside its provisions are stated, in detail, the new Law also supplements the law in respect of reorganization/restructuring and cross-border insolvency as well as extends its application to SOEs and private enterprises.

In conclusion, the new Bankruptcy Law is not only a thorough manifestation of a system of bankruptcy law and practice advocated by the Western world but also embodies the Chinese tradition.

Derek Lai is Deputy Managing Partner for Reorganization Services, Deloitte Touche Tohmatsu.

(HK Edition 09/21/2005 page4)