PRC Court’s Acceptance of Insolvency/Bankruptcy Case – No Longer Difficult

The “PRC Bankruptcy Law ( 中華人民共和國企業破產法)” (the “Law“) has been in effect since 1 June 2007. However, PRC courts had been most reluctant to accept creditors’ applications for insolvency/bankruptcy of enterprises unable to pay their debts as they fell due. That was due chiefly to the absence of clarity and guidance on the proof of insolvency and the burden of proof.

With the issuance of definite guidelines by the PRC Supreme Court on the enforcement of the Law, referred to as the Judicial Interpretation below, it is generally believed that PRC courts are now able to, and indeed have to, deal with applications for bankruptcy in accordance with the stipulations in the Judicial Interpretation.

PRC Supreme Court’s stipulations applicable to the several issues in implementing the ‘Enterprise Bankruptcy Law’ (1) (最高人民法院關於適用《中華人民共和國企業破產法》若幹問題的規定 (一))(the “Judicial interpretation”)

The much needed Judicial Interpretation was issued by the PRC Supreme Court, for implementation as from 26 September 2011. It provides clarifications to primarily the following areas:

1. the circumstances under which the court is obliged to accept an application for bankruptcy; and
2. the burden of proof in petitioning for bankruptcy.

In essence, the court shall accept a petition for bankruptcy, if the following conditions are met, namely:

1. the debtor is unable to pay its debt as it falls due (i.e. debtor is insolvent); and
2. the debtor’s assets are insufficient to discharge its entire indebtedness; OR the debtor obviously lacks the ability to discharge its indebtedness (i.e. it obviously lacks liquidity).

The Judicial Interpretation further clarifies with regard to the above bankruptcy conditions, briefly as follows:

1. A debtor is insolvent if there exists a lawfully established creditor-debtor relationship and the debt is due for payment, but the debtor is unable to settle the debt fully.
2. The court shall regard a debtor’s assets as insufficient for payment of all its debts if the debtor’s financial statements and/or relevant audit report or asset appraisal report, etc., indicate that all its assets together are insufficient for full settlement of its indebtedness, unless there are evidentiary documents proving otherwise.
3. Even where the debtor’s total asset value exceeds that of its total indebtedness, the court shall regard the debtor as obviously lacking liquidity if, due to certain circumstances or reasons, the debtor is unable to discharge its indebtedness, such as when:

• it is in serious shortage of funds or otherwise unable to liquidate its assets to pay its debts;
• its legal representative cannot be located and there is no available personnel to take charge of management of its assets resulting in its inability to pay;
• it is under court enforcement proceedings and unable to discharge its indebtedness; or
• it has suffered losses over a long period of time and unable to improve the status, and hence unable to pay its debts.

The PRC Supreme Court appears to have taken note of the fact that it would be difficult, if not impossible, for the creditor to obtain internal financial information pertaining to the debtor, to prove the debtor’s asset to debt or liquidity status. Thus, per the Judicial Interpretation, the creditor is only required to provide evidence proving the debtor’s insolvency (being condition (a) mentioned above) in its petition for bankruptcy, and unless the debtor is able to prove otherwise within the time stipulated in the Law, the court shall accept such petition accordingly.

With the implementation of the Judicial Interpretation, courts are now obliged to accept applications for bankruptcy if the conditions of bankruptcy (as stipulated therein) are met. In fact, it is expressly set out in the Judicial Interpretation that the applicant for bankruptcy may submit its application to the next higher court if the relevant (lower) court should fail or refuse to attend to or accept its application for bankruptcy in accordance with the stipulations in the Judicial Interpretation.

While it remains to be seen how the Judicial Interpretation will be implemented and abided by the courts, it should nonetheless give much comfort to creditors faced with insolvent debtors. Petitions (for bankruptcy) will no longer be cast aside simply, and creditors can now expect the courts to deal with their petitions for bankruptcy in accordance with the stipulations in the Judicial Interpretation and the Law.