Identifier
Created
Classification
Origin
06BEIJING19482
2006-09-14 06:06:00
CONFIDENTIAL
Embassy Beijing
Cable title:  

CHINA ADOPTS NEW ENTERPRISE BANKRUPTCY LAW

Tags:  ECON EFIN EINV ELAB PGOV CH 
pdf how-to read a cable
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RUEHC/DEPT OF LABOR WASHDC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
INFO RUEHCN/AMCONSUL CHENGDU 7128
RUEHGZ/AMCONSUL GUANGZHOU 1451
RUEHHK/AMCONSUL HONG KONG 8147
RUEHGH/AMCONSUL SHANGHAI 5817
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RUEHGV/USMISSION GENEVA 1340
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)

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