In 2017, the reorganization of Chongqing Iron and Steel Company sensationalized the steel industry as well as the reorganization market in China. This steel titan, listed on both the mainland and Hong Kong stock exchanges, managed to emerge from bankruptcy only six months after the court accepted its reorganization application. During this period, the sophisticated reorganization plan, which provided more than CNY 10 billion cash in debt payment to the company’s creditors, was formulated, accepted, approved, and fully implemented. Such reorganization is a microcosm of the thriving reorganization market in China. Since reorganization was introduced by the current Enterprise Bankruptcy Law in 2006, the emerging reorganization market has grown rapidly, especially after 2015 when the central government formulated the policy to deleverage, reduce inventory, and address overcapacity. Professionals and investors are pouring into this promising, developing, and challenging market. And China’s market for non-performing assets disposal is undergoing a transition from enforcement-focused to reorganization-oriented.
Unfortunately, the Enterprise Bankruptcy Law (EBL) is unable to meet the needs of the reorganization market, due to its ambiguities with regard to certain important issues, such as the criteria for approving the reorganization plan, the conditions for consolidating bankruptcy proceedings, etc. As a result, the practice of different local courts may be inconsistent, causing a “regionalization” of reorganization markets to some extent. In view of this, the Supreme People’s Court (SPC) promulgated the Minutes of the National Court Work Conference on Bankruptcy Trials (the “Minutes”) in March 2018. The Minutes draws experience from local courts and becomes a new landmark for China’s reorganization procedure.
Recent Development of Reorganization: Main Contents of the Minutes
Under the EBL, reorganization is a type of bankruptcy proceeding in which a debtor is protected from collection actions by individual creditors so that a reorganization plan dividing creditors into different classes based on the nature and priority of their claims can be formulated and accepted. Once the plan is approved by the court and fully implemented, the debtor can emerge from bankruptcy in much healthier financial condition.
Judicial oversight of the reorganization process and the plan is critical. However, the EBL is silent as to the approval criteria of the reorganization plan after its acceptance by the creditors, making it unclear whether the judicial review should be substantive or procedural. Further, rules on “cram-down,” which empowers a court to approve a plan that it is voted down by the creditors (in the process “cramming it down” the creditors’ throats), is believed to be over-used by local courts.
On one hand, the Minutes fills the gap in the EBL regarding the criteria for judicial review of reorganization plans after their acceptance by creditors. The Minutes stipulates that in principle courts should review both the legality and feasibility of the reorganization plan, to ensure that the rights and interests of creditors who voted against the plan are being protected. However, many challenge the court’s competence to take the place of market players, especially creditors, in making a “business judgment” on the feasibility of a reorganization plan. So far, most courts have been reluctant to exercise discretion and veto a plan that has been accepted by creditors. One of the reasons is that the revival of the reorganized debtor is often associated with the employment of workers, the local economy and other social issues, making the court extremely reluctant to deny a reorganization plan based on its own judgment.
On the other hand, the Minutes adds two more conditions to those already stipulated in the EBL before the court can exercise “cram-down” power: (1) consensus from at least one group of creditors; and (2) ensuring that the rights and interests of the creditors who voted against the reorganization plan are protected.
In addition, the Minutes for the first time sets out a series of rules regarding the consolidation of bankruptcy proceedings, in response to a few controversial cases of consolidation ordered by local courts. The Minutes also emphasizes that courts should help the reorganized debtor recover its credit standing, which is important for the debtor to obtain any post-reorganization financing. The Minutes also encourages the combination of reorganization and out-of-court restructuring, a new trend adopted by local courts.
Challenges Still Faced by Reorganization: Unsolved Issues by the Minutes
It seems that the Minutes fails to respond to certain important issues which may still affect the vitality of the reorganization market, including: (1) the absence of a clear priority right for interim financing during the reorganization proceedings; (2) the absence of rules for the relevant authority to change the business registration of shareholders pursuant to the reorganization plan; and (3) the absence of enterprise income tax incentives for the exempted claims in reorganization. However, the resolution of such problems may be beyond the SPC’s jurisdiction and require joint efforts from other legislative and governmental organs.
In our view, the Minutes represent a substantial step towards reducing the uncertainty of reorganization proceedings and the balancing of the influence of different stakeholders on the process. More importantly, with better clarity on the aforementioned issues, reorganization proceedings have been made more predictable. And we hope that, from now on, market players will gradually become the key driving party behind reorganization proceedings, leading to a more dynamic reorganization market.
By Nuo Ji, Partner, and Lingqi Wang, Counsel, Fangda Partners (Shanghai)
This Article was originally published in Issue 5.10 of the CEE Legal Matters Magazine. If you would like to receive a hard copy of the magazine, you can subscribe here.
