Understanding your rights as a creditor while navigating under China’s bankruptcy laws is becoming a must these days, especially for foreign creditors. As many foreign companies engage in business with Chinese companies, chances are likely that you will encounter a failing Chinese company that will file for bankruptcy in China. A China bankruptcy filing can have a tremendous impact upon foreign creditors.  If you are doing business with Chinese companies or have investments in Chinese companies, you should be aware of your rights as a creditor under Chinese bankruptcy laws. Knowledge about your rights as a creditor – whether it be filing a claim, recovering your property, compelling a bankruptcy administrator to continue performance of a contract or seeking its rescission, having the bankruptcy administrator examine and revoke fraudulent transfers and preferences or exercising set off rights – are all important legal rights which can help you to minimize your business risks.

China’s current bankruptcy law, the Enterprise Bankruptcy Law (“2007 Bankruptcy Law”), came into effect on June 1, 2007.  The 2007 Bankruptcy Law is still developing, and frequently the Supreme Court issues an interpretation to clarify certain unclear and developing areas of the bankruptcy law.  Recently, China’s People Supreme Court issued its second interpretation of the Bankruptcy Law, the Interpretation II of the Supreme People’s Court on Several Issues Concerning the Application of the Enterprise Bankruptcy Law of the People’s Republic of China (the “2013 Interpretation”). While the 2013 Interpretation clarifies many ambiguous areas of the 2007 Bankruptcy Law, this discussion focuses upon its relevance to important creditors’ rights.

Identifying Property of the Debtor

In a bankruptcy proceeding, knowing what is property of the debtor is important as it allows creditors to evaluate what will be distributed on their claims. Under the 2007 Bankruptcy Law, the debtor’s property is identified as all of the property before the bankruptcy application is accepted as well as obtained during the period from the acceptance to the date when the case is concluded.  The 2007 Bankruptcy Law was ambiguous, leaving courts without guidance as to whether intangible property which have measurable value can be assets of the debtor available for distribution to creditors.

The 2013 Interpretation defines more clearly the scope of debtor’s property.  In addition to currency and tangible property, the Interpretation also provides that certain intangible property that can be measured by currency and transferred according to law are property of the debtor, and includes the following:

1. creditor’s rights
2.  equities
3. intellectual properties
4. usufructuary rights
5. security interests in debtor’s property (remaining after extinguishment of security interest)
6. debtor’s rights in jointly owned or co-owned property or debtor’s divisible income

However, the following property is identified as not property of the debtor:

1. assets occupied or used by the debtor under a contract (warehousing contract, safekeeping contract, lease contract, commission contract )
2. property in which debtor has not  yet acquired title under a transaction;
3. state-owned assets
4. other assets not belonging to the debtor in accordance with the law or administrative rules

Rights of Revocation

Revocation rights of the bankruptcy administrator are important to creditors. Transactions that are revoked can be brought back into the bankruptcy estate as property of the debtor that will be available for distribution to all creditors.  Creditors should be aware that transactions that are fraudulent or create unfair preferential treatment can be revoked.

Under the 2007 Bankruptcy Law, the bankruptcy administrator can investigate and apply to the court to revoke certain actions done relating to the debtor’s assets.  The bankruptcy administrator can petition the court to revoke the following transactions, if within one year before the bankruptcy application is accepted, debtor’s property was -

1. transferred for an unreasonable price
2. transferred without payment
3. provided as a guaranty on an unsecured debt
4. used to pay off debts not due, or
5. abandoned or waived (claims)

Where the asset transaction was based on an unreasonable price, the 2013 Interpretation provides that upon revocation of the transaction the contracting parties should return the assets or payments.

A second kind of transaction that a bankruptcy administrator can apply the court to revoke involves preferential payments made to certain individual creditors.  Within six months before the bankruptcy application is accepted, payment made to individual creditors while the debtor was insolvent can be revoked.

A third kind of transaction that a bankruptcy administrator can revoke regards the debtor’s granting of a security interest against its property six months before the bankruptcy application was accepted while the debtor was insolvent.

The 2013 Interpretation recognizes that these revocation provisions are significant rights to creditors.  If the bankruptcy administrator is negligent at exercising its rights of revocation, creditors can seek damages against the administrator.  Also, if the bankruptcy administrator fails to seek revocation of acts in which the debtor’s assets are transferred for an unreasonable price or without payment, a creditor has the right to file an independent action against the debtor in the bankruptcy court under similar provisions of the PRC Contract Law.

Reclaiming Property not Belonging to the Debtor

After the court accepts the bankruptcy application, a creditor has the right to recover property from the debtor that does not belong to it but remains in its possession. Also, the recovery must be made through the bankruptcy trustee.   The 2007 Bankruptcy Law is silent as to when the creditor can recover its property. However, the 2013 Interpretation now clarifies the time for recovery, as it provides that a proposal should be made before the realization plan or reconciliation agreement or plan of reorganization are submitted to the creditors’ meeting.

Creditors must timely exercise this right.

Set Off Rights

Do you owe any debt to the debtor company?  Does the debtor company owe any debt to you? A creditor who owes a debt to the debtor company can set off such debt against the debt that the debtor owes the creditor.

The 2013 Interpretation provides that a creditor can assert set-off against the bankruptcy administrator, with set-off effective upon the administrator’s receipt of the creditor’s set-off notice.  The 2013 Interpretation also does not allow the administrator from challenging the set-off on the grounds that (a) the debt owing by the debtor has not become due when the bankruptcy application was accepted, (b) the debt owed by the creditor has not become due when the bankruptcy application was accepted, or (c) that the debts owed by the debtor and creditor are of different quality or types.

The 2013 Interpretation significantly advances the rights of creditors.  It is significant that unmatured debts as well as debts of different quality or types qualify for set-off.  Also, it clarifies the 2007 Bankruptcy Law where it provides that a creditor can assert a right of set-off, but had failed to specify whether prior approval of the bankruptcy administrator is required.

Conclusion

The 2013 Interpretation, while it clarifies many ambiguous provisions of the 2007 Bankruptcy Law, sets forth key provisions relating to creditors’ rights.  Given the increasing amount of cross-border transactions and investments made between the U.S. and China, an understanding of these provisions and the underlying basic principles is a good start at planning on minimizing your business risks- especially when your Chinese counterpart begins defaulting upon its obligations and mentions bankruptcy.

Xinlan Liu coauthored this article.