Laws on bankruptcy prove a minefield for foreign creditors

The collapse and subsequent bankruptcy of Guangdong International Trust and Investment Corp (Gitic) has turned foreign creditors' attention to the mainland's bankruptcy laws. And they are in for some nasty surprises.

Mainland bankruptcy procedures are fragmented and many regulations are implemented on a trial basis, subject to changes. Importantly, in most cases, they tend to favour local creditors over foreign ones.

The 1986 Bankruptcy Law concerns state-owned enterprises (SOEs) and the 1991 Civil Procedure Law applies to non-SOEs - such as joint-stock limited companies and foreign-investment enterprises. However, the implementation of bankruptcy procedures is subject to two other sets of State Council notices, issued in 1994 and 1997, depending on the location of the bankrupt enterprises.

For example, an SOE in Shanghai filing for bankruptcy is governed by the 1986 Bankruptcy Law and the 1994 notice, while a joint-stock limited firm in Guangzhou will have to follow the bankruptcy-related provisions of the 1991 Civil Procedure Law and the 1997 notice.

The lack of uniformity and law enforcement are causing confusion and headaches among foreign creditors, Baker & McKenzie partner Winston Zee King-tak said.

Adding to the chaos, bankruptcy on the mainland is not a self-contained process and a number of approvals from the relevant authorities are required to enable the procedures to proceed.

If the bankrupt firm is a mainland joint-venture party to a Sino-foreign joint-venture company, the bankruptcy procedure will be subject to joint-venture rules governing foreign investment rather than to the relevant bankruptcy laws and State Council notices.

Approvals from the joint-venture party, the Ministry of Foreign Trade and the relevant local authorities are required in the sale of assets, such as the bankrupt enterprise's joint-venture interest.

If bankrupt companies own assets in restrictive (to foreign participation and ownership) sectors such as telecommunications, they can sell only to locals.

'The restriction could affect the valuations of the assets and the amount of proceeds realised,' Mr Zee said.

Valuation of assets in the mainland is also tedious because of the difficulty in verifying what assets companies own due to lack of transparency.

'Because ownership and documents of ownership are governed by different sets of laws. It is hard to track down the ownership structure of assets of bankrupt enterprises,' Mr Zee said.

In Hong Kong, things are much clearer. An accountancy firm is appointed by the court to liquidate a bankrupt company and it holds responsibility only to the court - no one else.

One of the tasks of the liquidator is to seek the highest possible price for assets of the bankrupt firm to pay off creditors.

In the mainland, the court appoints a liquidation committee to handle the liquidation, as in the case of Gitic.

Members of the liquidation committee comprise local and relevant authorities. It is their independence and transparency that is being questioned.

'As a creditor, you [are] like an outside spectator,' Mr Zee said.

The inclusion of local government bureaus in the liquidation committee may tend to promote local interests or industry-specific interests over the interests of other creditors, another Baker partner John Grobowski said.

While the State Council notices are meant to supplement the bankruptcy laws that are too obsolete to meet requirements for modern bankruptcies - involving larger enterprises and substantial foreign creditors - they 'have substantially modified the bankruptcy procedures for SOEs set out in the Bankruptcy Law'.

One of the modifications has been the greater emphasis on worker resettlement, Mr Grobowski said.

Creditors of a bankrupt SOE holding mortgages in land-use rights may find themselves worse off than unsecured creditors in mainland bankruptcy proceedings, since the proceeds of the land-use rights will be applied first to funding worker resettlement regardless of the existence of the mortgages.

In Hong Kong, secured assets do not form part of the bankruptcy assets. Secured creditors are repaid from the proceeds of the asset sale.

Creditors of bankrupt mainland enterprises will find it difficult to enforce their rights because of the priority given to resettlement and claims of workers of SOEs; as well there is the time-consuming nature of bankruptcy procedures and strong local interference.