THE PROMISE OF bankruptcy reform in the mainland still hangs in the air but is as yet unfulfilled. A year ago the draft bankruptcy law, which passed its ninth reading in October 2004, was expected to be approved in the second half of 2005 and to come into effect this year. Unfortunately, there has been little progress in the past 12 months. The proposed law is to give more protection to creditors and improve China's image by having bankruptcy protection laws that foreign investors can depend on. But practising accountants in Hong Kong say the passage of the reform into legislation is being held up by two issues. The first is the rather delicate matter of whether to give priority to secured creditors or employees of the bankrupt company. 'The authorities have come to a complete deadlock about this issue,' said Rainier Lam, a partner at PricewaterhouseCoopers. 'On the one hand, some people say that if China wants a modern insolvency regime then secured creditors should have priority over employees. 'On the other hand, some people say never forget that China is a communist country. Accordingly, the welfare of employees must come first.' The second sticking point concerns the test for insolvency. The first draft of the proposed bankruptcy law contained the provisions for a balance sheet test and a cash flow test. In order to determine whether a debtor company was insolvent or not, the creditors needed to show that it failed either the balance sheet or the cash flow test. In the revised second draft of the law, both tests must be satisfied before the debtor company can be regarded or proved to be insolvent. Those who oppose the idea of having both tests satisfied argue that in practice it is actually difficult to satisfy both tests. While the Chinese authorities are understood by Hong Kong accountants and their mainland counterparts to be 'generally happy' with the second revised draft, no one will offer any prediction as to when the draft law will be passed. 'Most of us remain hopeful,' Mr Lam said. 'China's accession to the World Trade Organisation (WTO) plus pressure from the WTO, other countries and foreign investors means that it is in desperate need of a new equity regime. The passing of the bankruptcy law would be a very first step towards achieving that.' According to reports, there is a faint chance that the Chinese government may pass the law later this year. Beijing-based lawyers said the authorities were resigned to the fact that they may not be able to get the law right and make everything perfect the first time around. In which case they may go ahead and pass the law as soon as is practicable without further amendments. Or they may continue to postpone it. Mr Lam said another reason the law was being postponed may be the concern that its passage into legislation would open up the floodgates to people rushing to wind up companies. However, he said he did not think this would happen. 'The law will be a new chapter in the bankruptcy regime of China. On paper it should bring China more in line with best practices in countries with well established bankruptcy regimes like the UK and Australia,' he said. 'But because it is new to China, I believe that investors and creditors are likely to adopt a cautious approach towards it.' Mr Lam said people may wait to see how successful the new law would be once it was implemented before using it themselves. 'Even after it is passed I don't expect it to bring about any big changes.'
