Vol 2 (2005) - Issue 1

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An Overview of China’s Insolvency Law

Background to and history of China’s existing insolvency law

The People’s Republic of China is an emerging market economy. In 1978 all enterprises were owned by the State and there was no private sector throughout the country. In 1978 China began a programme of economic reform. Since then, the government has gradually allowed the existence and development of private ownership in China. With the acceleration of economic reform in 1992, private enterprise has been encouraged and the traditional planned economy has been replaced by a market economy.
In the past (mainly before 1992), all state-owned enterprises (‘SOEs’) were 100% owned and controlled by the state (i.e. governments at different levels in China). Today only a small number of the biggest SOEs in key industrial sectors are 100% owned by the state or the government. Most SOEs are actually entities of mixed ownership - some have private ownership, some have listed shares and some have foreign shareholders. Generally if more than 50% of the shares or control or voting power of an enterprise is held by the state or an entity owned or controlled by the state, the entity is generally termed a state-owned entity (SOE). However there is no clear definition of a SOE in China. The exact meaning of the word has evolved as economic reform has developed in China.

Before 1978, when China began to carry out economic reform throughout the country, almost all enterprises in China were SOEs, whose operation were controlled by the state. The state was responsible for the enterprises’ losses. The State financed any losses by borrowing from the banks (which were all stateowned) or by fiscal allocations. Bankruptcy was not an option for the SOEs. Insolvency was not a feature of the Chinese economy. During that period China did not need any bankruptcy laws.
Individual bankruptcy is still not recognized in China and there is no regime for individuals to excuse themselves from liability for debts. However the recovery of unpaid debts from an individual is rare since, even if judgment can be obtained, enforcement of the judgment is unlikely to be a fruitful pursuit.
The banks, which were all owned by the State, were the principal creditors of SOEs. The banks had to obey the State’s order to provide loans to SOEs, notwithstanding the SOEs’ inability to repay these loans. In these cases the national treasury provided capital to these banks to compensate them for their losses.
The result was that SOEs in financial difficulties were either sustained by the State or, as happened in many cases where no such funding was in fact forthcoming, the SOEs remained in a ‘dying’ condition indefinitely. They could not go bankrupt, but neither could they operate normally. So they would just be ‘hanging around’. The employees would stay idle and live on whatever wages the SOEs managed to give them. Moreover the debts could not be written off: the SOEs continued to be subject to the obligations to pay the debts and would be required to do so if their operations became profitable.
China began to reform its economic system in 1978. One of the objectives of these reforms was to introduce competition into the market.
SOEs were permitted to compete against each other, to carry on independent business operations and to assume responsibility for their own profits or losses. The SOEs which suffered from poor operations and which made losses were unable to survive. The creditors of these loss-making SOEs, mainly the Stateowned banks and the government departments ultimately responsible for them, could not sustain these losses any more. The result was that in 1986 the first Enterprise Insolvency Law for Trial Implementation (‘Insolvency Law 1986’) was promulgated. Since then there have been various developments to the insolvency regime in China, the most recent being the Draft of New Insolvency Law (‘Draft Insolvency Law 2004’) which was submitted on 21st June 2004 to the Standing Committee of the 10th National People’s Congress, China’s top legislature, for review and deliberation.
In this article we consider the insolvency law in China from 1986 to the present and we discuss the reforms proposed in the Draft Insolvency Law 2004.