The legislation means workers' claims will no longer be regarded as secured assets in the event of insolvency
CHINA'S RECENT PASSING of the new Corporate Bankruptcy Law on August 27, a Sunday, marked a significant step forward in the country's protection of creditors. It was also unexpected.
'China always catches you by surprise when approving legislation,' said Jackie Muk, partner, restructuring, at accounting firm KPMG. 'We have been talking about this draft bankruptcy law for over two years and no one expected it to pass now. Certainly not on a Sunday.'
Existing legislation in China provides no easy way to liquidate a company or share the assets between creditors and workers. The new law gives creditors greater protection if a company is bankrupt, whereas in the past employees were paid off first. The move brings China more in line with international practices, where it is standard to pay creditors first. The bill will also permit firms struggling financially to request reorganisation and reconciliation with clients.
The Corporate Bankruptcy Law applies to state-owned enterprises (SOEs) and privately owned companies, foreign and domestic alike. The law has been several years in the making. The draft law, which passed its ninth reading in October 2004, was expected to be approved last year and come into effect early this year. But its passage into legislation was held up by two issues. First, the question of whether to give priority to secured creditors or employees of the bankrupt company. Second, the test for insolvency.
The first draft of the proposed bankruptcy law contained provisions for a balance sheet test and a cash flow test. To determine whether a debtor company was insolvent or not, the creditors had to show that it failed one or the other test. In the revised second draft, both tests had to be satisfied before a debtor company could be regarded as or proved to be insolvent, a requirement that critics argued would be difficult to satisfy in practice.