Bankruptcies and influence of new minutes on foreign investors

By Xu Bangwei and Zhang Xiaotong, Jingtian & Gongcheng
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In the Minutes of the National Working Conference on the Trial of Civil and Commercial Cases by Courts (Minutes) issued by the Supreme People’s Court on 8 November 2019, part X summarizes the basic views of the Supreme Court regarding several difficult legal issues in the hearing of bankruptcy disputes. This will have significant and profound influence on the trial of bankruptcy cases in China, and this article looks at several key provisions that may directly affect the immediate interests of foreign investors in China.

creditor
Xu Bangwei
Partner
Jingtian & Gongcheng

First, article 107 of the minutes stresses that the court should in a timely manner put the bankruptcy application on docket, and should not reject the application on such non-statutory grounds as “affecting social stability”. In recent years, the number of enterprises applying for bankruptcy has surged. As a result, many courts actually raised the threshold for accepting and hearing the bankruptcy applications, and limited the number of cases to be tried under bankruptcy procedure.

For example, in cases where creditors apply for bankruptcy, some courts require that the creditors obtain valid legal documents through litigation or arbitration procedure before their bankruptcy applications are to be accepted.

The issuance of the minutes is expected to gradually solve such difficulties. It is good news for the more efficient exit of foreign equity investors who expect to exit by their subsidiaries (as the debtor) applying for bankruptcy, and who expect to obtain repayment and exit by applying for bankruptcy of their debtors.

creditor
Zhang Xiaotong
Paralegal
Jingtian & Gongcheng

Second, article 110 of the minutes specifies the ways to handle related lawsuits brought by creditors when the bankruptcy cases are placed on docket. According to this article, if there is a pending civil litigation to which the creditor is the plaintiff when the court accepts its bankruptcy application, the creditor may also declare the creditor’s right to the administrator at the same time.

As no decision has been made regarding the creditor’s right, the creditor, in principle, shall not exercise the voting right unless the people’s court temporarily decides on the amount of its claim. However, if the creditor withdraws the litigation and directly declares its creditor’s right to the administrator, it may exercise the voting right as soon as the administrator confirms the amount of the claim.

Therefore, the authors understand that the minutes are intended to encourage the creditor to withdraw its litigation by restricting the temporary voting right, and seek repayment by directly declaring creditor’s right to the administrator. In this way, the minutes may help save litigation resources and prevent pending litigations from slowing bankruptcy procedures.

In the future, when a foreign investor and its debtor are involved in a lawsuit, if the debtor is in the bankruptcy procedure, the foreign investor should fully weigh the pros and cons of “continuing the litigation until a valid judgment is granted”, or “withdrawing the litigation and directly declaring the creditor’s right to the administrator”.

If the investor believes that the creditor’s right is less controversial, and it is highly probable that it will be recognized by the administrator, and it expects to exert influence on the bankruptcy procedure by exercising its voting right as the creditor, the second means may better help it protect its legitimate rights and interests.

Third, article 111 of the minutes clarifies the conditions on application of the debtor self-management system in the bankruptcy reorganization procedure, and provides a termination mechanism for the debtor self-management system.

In reorganization cases, the debtor self-management system enables the debtor to give its advantage in familiarity with its own businesses to full play, and reduce operation costs. It has the risk, however, that the debtor may seize the opportunity to hide or transfer its properties, and damage the interests of the creditor.

The minutes, by specifying the application conditions of the system, provide courts with a clear and reasonable reference for their decision on whether the debtor obtains the power of self-management. In the meantime, the minutes grant stakeholders such as administrators and creditors the right to supervise and apply for termination against debtors.

In future, when a foreign investor is involved in a reorganization case as the creditor, if the debtor of self-management commits fraud or maliciously reduces its properties, there will be a legal basis for the investor’s attempt to seek remedies. The foreign investor may first report to the administrator and request it to apply to the court for termination of self-management by the debtor.

If the administrator fails to apply, the investor may apply to the court by itself for termination of self-management. Once the court decides to terminate self-management, the administrator will take over the properties and business affairs of the debtor.

Fourth, article 112 of the minutes provides resumption of the exercise of security interests during a reorganization procedure. It stresses protection of the legitimate rights and interests of the secured party while maintaining the reorganization value of the company.

The minutes request that the administrator (including the debtor of self-management) timely determine whether the debtor’s property subject to a security interest is necessary for reorganization after the application for reorganization is accepted. If the property is not necessary, it should be timely auctioned or sold so that the proceeds would first be used to satisfy the claims of the secured party.

For cases where the secured party applies to the court for resumption of exercise of its security interests, as it believes the security may be damaged or decreased in value, the minutes improve the operability for holders of security interests to seek remedies by specifying the procedures, burden of proof, time limit, and means of reconsideration.

Based on the above-mentioned provisions, if foreign investors participate in the reorganization procedure as secured creditors, they may first communicate with the administrator on whether the security is necessary for reorganization, and try to sell the unnecessary security as early as possible and timely get paid. If the security is necessary for reorganization but has the risk of damage or a decrease in value, there will be more specific procedural rules for the reference of foreign investors who intend to resort to the court for remedies.

Xu Bangwei is a partner and Zhang Xiaotong is a trainee associate at Jingtian & Gongcheng

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