CHINA ADOPTS NEW ENTERPRISE BANKRUPTCY LAW

C O N F I D E N T I A L SECTION 01 OF 03 BEIJING 019482 SIPDIS SIPDIS DEPT PASS USTR LABOR FOR ILAB-CARTER, OWENS, HELM, ZHAO, SCHOEPFLE TREAS FOR OASIA/ISA-CUSHMAN USDOC FOR 4420/ITA/MAC/MCQUEEN, IA/LORENTZEN, HSU USTR FOR STRATFORD, WINTER, ALTBACH, KARESH, ROSENBERG GENEVA FOR CHAMBERLIN E.O. 12958: DECL: 09/11/2026 TAGS: ECON EFIN EINV ELAB PGOV CH SUBJECT: CHINA ADOPTS NEW ENTERPRISE BANKRUPTCY LAW REF: BEIJING 13027 Classified By: Acting Econmincouns Christopher Beede, reason 1.4(b/d) ¶1. (SBU) Summary. On August 27, China passed a new Law on Enterprise Bankruptcy which provides a vastly improved legal framework for corporate bankruptcy in both private and state-owned enterprises (SOEs). The law will go into effect on June 1, 2007, and will enable the government to further extract itself from the process of reorganizing and liquidating insolvent SOEs. The new law settles a long-standing debate regarding liquidation of bankrupt enterprise assets by making claims by secured creditors senior to other claims, except in certain cases regarding wage, pension and health insurance arrears that accrued prior to August 2006. The new law gives the government a freer hand should it decide to break precedent and start allowing banks and other financial institutions to go bankrupt. The new law provides for administration of bankruptcy proceedings by disinterested professionals, although one prominent expert is calling for the creation of a "Bankruptcy Administration Bureau." The new law also allows for international cooperation on cross-border bankruptcy claims. End Summary. ¶2. (SBU) On August 27, the National People's Congress (NPC) passed a new "Law on Enterprise Bankruptcy." The new law will go into effect on June 1, 2007, and replaces the current bankruptcy regime, which consists of a 1986 interim law covering only state-owned enterprises (SOEs) and a number of administrative regulations. The new law extends legal standards for bankruptcy cases to all enterprises, except sole-proprietorships and about 2,000 specific SOEs already in the process of reorganization or liquidation. The new law improves on the existing bankruptcy regime by: -- providing a clearer insolvency test, -- reducing government interference and improving creditor powers in bankruptcy proceedings, -- increasing the look-back period under which the courts can nullify certain transactions used to shield assets, and -- by providing for the first time an option for corporate reorganization. Passage of the new law puts an end to two years of intense debate, and its proponents hail it as a historic breakthrough in laying the foundation for a market economy. No accurate or official English translation of the law is available yet. ¶3. (C) Laboff met on September 5 with Li Shuguang (protect throughout),a professor at the China University of Politics and Law who also serves on the NPC's "Bankruptcy Law Drafting Group." (Ref reports Embassy's previous meeting with Li.) Li said the new law has long been on the NPC's reform agenda and is part of China's Eleventh Five-Year plan, but added that pressure from foreign governments and companies also provided impetus for its passage at this time. The press has linked the law's passage to demands by the EU and others that China pass a comprehensive bankruptcy law in order to be treated as a market economy under relevant trade laws. COMPROMISE BETWEEN EMPLOYEES AND SECURED CREDITORS ¶4. (SBU) The main issue of contention during the past two years' debate was whether the law should give priority in liquidating bankrupt enterprises to the wage and benefit payments owed to employees or to claims from secured creditors. Although the 198 interim law followed international practice by excluding secured assets from the "bankrupt assets" against which claims could be made, the vast majority of bankruptcies have been handled administratively, with government bodies giving priority to settling claims by employees. The All China Federation of Trade Unions (ACFTU) and others argued strenuously that BEIJING 00019482 002 OF 003 workers should come first under the new law. However, Article 109 of the new law gives secured creditors first priority in claims against their specific secured assets. Arrears in wages and pension and health care insurance contributions receive first priority in claims against non-secured assets. ¶5. (SBU) The new law does give employees important recognition. Most significantly, Article 132 gives employees' wage and benefit arrears claims priority over secured creditors' claims if the wage and benefit arrears accrued prior to promulgation of the new law (August 27, 2006). There is no time limit regarding how far back such employee claims can go. The new law also gives employee representatives a place on "creditors meetings" and "creditors committees" that supervise the liquidation process. How the courts will select employees representatives will be the subject of forthcoming implementing regulations. Finally, unlike other creditors, employees do not need to file claims in order to be treated as creditors. ¶6. (C) Guo Jun (protect),Deputy Director of the ACFTU Legal Affairs Department, told Laboff on August 31 that the new bankruptcy law is the ACFTU's biggest lobbying failure ever. Li Shuguang agreed that the new law is a set-back for employee interests compared to existing administrative practices in bankruptcy cases, but told Laboff that employee claims are primarily social problems and should be dealt with through other means, such as through an improved social security system, or through creation of a "bankruptcy fund" similar to the U.S. Pension Guarantee Trust Corporation. Li has argued publicly, and also within the NPC drafting group, for quick action on both fronts, and said there is growing interest within the Chinese Government in establishing a bankruptcy fund. (Social security reform is already under way.) Li does not believe employees will make unreasonable claims under article 132, or that the article creates significant risk to lenders. Article 132, he said, is directed mainly at SOEs, and should send a signal to new investors and lenders that secured assets will not be encumbered by employee claims in bankruptcy cases. FINANCIAL INSTITUTIONS CAN NOW GO BANKRUPT, IN PRINCIPLE ¶7. (C) Li told Laboff that up to now, the Chinese Government would bail out banks or financial institutions rather than allow them to go bankrupt. The fact that the new law makes no exceptions for them is significant. However, financial institutions will not be treated exactly like other enterprises. Li said that as-yet-unwritten implementing regulations will give bank and securities regulators an advisory role in court decisions on whether to accept applications for bankruptcy, effectively giving the government a chance to decide whether to bail out the financial institution or let the bankruptcy proceed. IMPROVED ADMINISTRATION OF LIQUIDATION ¶8. (C) Li said a major improvement in the new law is in the administration of bankruptcies. Under the old law, the court handled the debtor's business and legal affairs directly until liquidation, at which point it named a "liquidation committee" composed of officials from relevant government agencies. In the case of bankruptcies that did not fall under the old law, government agencies directed the entire process. Li said under the prior bankruptcy regime, the various government representatives looked after their own agencies' particular interests. However, the new law (Articles 22-29) requires the court to name a "bankruptcy administrator" immediately after accepting the bankruptcy filing to manage the debtor's assets and expenses, decide whether the debtor must suspend business, handle legal procedures on behalf of the debtor, and perform other relevant duties the court requires. The new law lays out qualifications for bankruptcy administrators. Li said the BEIJING 00019482 003 OF 003 law may still not go far enough to assure that administrators have the required experience, and has called privately and publicly for the creation of an independent "bankruptcy administration bureau," so far to no effect. CROSS-BORDER BANKRUPTCIES ¶9. (SBU) The new law also breaks new ground on cross-border bankruptcies. Article 5 provides that procedures initiated under the law shall have binding force over the debtor's assets outside China, and that China can give effect to foreign bankruptcy judgments or rulings against assets held in China, as long as the foreign country in question has signed the necessary agreements with China. COMMENT ¶10. (C) The new Law on Enterprise Bankruptcy is an important step forward in bringing China's bankruptcy regime closer to international standards. Among other things, this should help ease the anxieties of creditors should the economy turn soft and corporate finances deteriorate. The law also sends two important signals about the government's future relationship with SOEs. First, the government will play a reduced role advocating for employees' interests, instead giving them a new, legal means to assert their own rights. Second, the government is extracting itself from the reorganization and liquidation of insolvent SOEs. Although 2,000 specific SOEs will be exempt from the terms of the new law, this is fewer than over 10,000 exempted under the old law, and Li Shuguang added that the government has decided it will not continue protecting these 2,000 insolvent SOEs indefinitely. If their cases are not resolved by the end of 2008, he said, the government will deal with them under the new bankruptcy law. End comment. RANDT