As home to some U.S.-listed companies, such as Alibaba and Sina, China has been enjoying constant and sound growth in its emerging socialist market economy past decades. It has also been offering a steadily improving regulatory regime. However, China has been slow to offer a mature market-exit solution to failing businesses at home and abroad. Nor has it enacted the UNCITRAL Model Law on Cross-Border Insolvency. Article 5 of China's Enterprise Bankruptcy Law, which went into effect in 2007, is the only provision addressing the extraterritorial effect of Chinese court decisions that wind up companies situated in China and the inbound petitions seeding recognition of foreign bankruptcy orders.
While article 5 provides a welcome start toward achieving greater cooperation in cross-border insolvencies, Chinese law must go further still. Under article 5, Chinese courts are only willing to recognize a foreign bankruptcy proceeding as a static fact, and are not prepared to participate in the dynamic process to optimize creditor protection and corporate rescues across borders. Moreover, article 5 uses vaguely formulated concepts of "reciprocity" and "public policy," which give Chinese courts considerable leeway to decline recognition of foreign bankruptcy proceedings.
This article highlights the present limitations in Chinese law and practice. Ultimately, China needs to replace article 5 with the Model Law. However, it is more lively to achieve that final step if it first takes baby steps toward expanding article 5. This article suggests changes of a more moderate nature to foster the evolution of Chinese law in addressing Cross-border insolvencies.
In 2006, China introduced its new Enterprise Bankruptcy Law ("EBL 2006"). (1) The new law represents a major breakthrough, as it expands eligibility for bankruptcy to all corporate debtors, (2) and recognizes the cross-border effect of some bankruptcy cases. (3) Article 5 of EBL 2006, which governs cross-border insolvency cases, is a tentative attempt to honor China's commitment to the World Trade Organization ("WTO") (4) and to transition from command to market economy. (5) Article 5(1) accords Chinese courts' bankruptcy proceeding with extraterritorial effect, and article 5(2) sets out the basic criteria to be met for foreign bankruptcies to be recognized:
(1) Bankruptcy proceedings initiated in accordance with this Law shall have effect upon the debtor's assets outside of China.
(2) Where a legally effective judgment or ruling made on a bankruptcy case by a court of another country involves a debtor's assets within the territory of China, and a petition or request is filed with the people's court to recognize and enforce the said judgment or ruling, the people's court shall conduct examination thereof, in accordance with the relevant international treaties that China has concluded or acceded to, or on the basis of the principle of reciprocity, and shall make the ruling to recognize and enforce the said judgment or ruling upon finding that the said judgment or ruling does not violate the basic principles of the laws of China, does not jeopardize state sovereignty, national security, or public interests, and does not undermine the legitimate rights and interests of the creditors within the territory of China. (6)
Unfortunately, the long-awaited EBL 2006 has had far less application than previously expected. As a country heavily influenced by Confucianism and historically emerged in natural economy, (7) China has a relatively short history of dealing with bankruptcies. Its courts have limited experience, despite the passing of EBL 2006; (8) but the need exists to gain this experience and expand its laws governing bankruptcies. China's economy has greatly expanded. (9) Companies conducting substantial business in China also increasingly used offshore structures. These offshore companies are often incorporated in tax havens and listed on major stock markets. (10) In recent years, bankruptcy proceedings initiated against these companies have increased. Examples include the liquidation of the formerly NASDAQ-listed Ambow Education by the Caymans court (11) and the delisting litigation initiated by the U.S. Securities and Exchange Commission against Global Education. (12)
In theory, a debtor has many options as to where it may initiate bankruptcy proceedings. These include: (1) its state of incorporation, (2) the location of its headquarter, (3) the jurisdiction where the company holds substantially all of its employees and day-to-day operations, and (4) the locale in which the debtor's primary assets are located. (13) Many of these possible venues would suggest filing in China, but few debtors so far have opted to do so. (14) This can be attributed partly to the debtors' distrust for China's bankruptcy regime, (15) and partly to the uncertainty created by the structure of variable interest entities ("VIEs"). Many of the offshore companies and listed companies utilize the VIE structure to circumvent regulatory and market-access restrictions in sensitive investment fields in China. (16) With fewer bankruptcy filings or recognition petitions, Chinese courts have little opportunity to clarify existing legal uncertainties, thereby creating a vicious circle.
Although it serves as a positive step towards cross-border cooperation in bankruptcy cases, article 5 of EBL 2006 does not go far enough to address all the problems involved in the initiation and recognition of bankruptcy cases with foreign elements. Even if China enacted the UNCITRAL Model Law on Cross-Border Insolvency ("Model Law") as its domestic legal regime, it would still be some time before the international community trusted China's new system. Under these circumstances, it is ill-advised to complain about either Chinese courts' conservative stance in handling inbound recognition petitions, or the underlying legal flaws and loopholes. Rather, international practitioners and Chinese legal framers should step out of the purely theoretical debates between territorialism and universalism, and unveil the most pragmatic interim solution for practical problems in China's cross-border insolvency regimes.
This article begins by examining China's current cross-border insolvency rules and ends with suggestions for necessary changes to provide a more consistent and enforceable bankruptcy legal system in China. Part I conducts a textual comparison of several drafts for China's rules on cross-border insolvencies, tracing the progressive path towards international cooperation and coordination. Parts II through IV address the three main issues in the existing cross-border insolvency regime. Part II analyzes the distinction between recognizing foreign bankruptcy proceedings under the Model Law, and recognizing foreign bankruptcy judgments (as envisaged in the current version in article 5), and emphasizes the negative implication stemming from this distinction. Part III inquires whether it is a politic choice to include the reciprocity requirement in handling cross-border insolvencies. Part IV investigates the public policy concerns, with special attention given to the legal risks involved in offshore listings and the VIE structure. Part V examines the success rate for outbound and inbound recognition petitions, briefly discussing U.S. and English case law, and identifies the Chinese equivalent of the center of main interest ("COMI"). Part VI concludes with proposed changes to China's bankruptcy rules.
EVOLUTION OF ARTICLE 5 OF EBL 2006: A PROGRESSIVE PATH
The drafting of EBL 2006 began as early as 1995. Its final adoption represents a hard-won result. (17) Notwithstanding, article 5 is far from being unanimously accepted. (18) In the initial 1995 version, the drafters clearly took a territorial stance. "No procedure of liquidation, composition, or reorganization initiated outside the territory of China shall have any effect upon the debtor's assets located within China's territory." (19) At the turn of the century, China was willing to offer a more cooperative and open stance. (20) Among the various suggested versions, the one that the Chinese legislature finally adopted is the most favorable for foreign bankruptcy proceedings. The difference in possible approaches can be seen through a comparison of article 5 in a draft proposed by Professor Shi Jingxia in 2000 ("Professor Shi's Draft") (21) and the provision in the Draft Enterprise Bankruptcy Law ("Draft EBL 2004"). (22) In relevant part, Professor Shi's Draft read:
The liquidation, reorganization, composition and similar proceedings commenced outside Mainland China (including Hong Kong, Macao and Taiwan) shall not in principle have effect upon the debtor's assets located within Mainland China. But the [p]eople's [c]ourt may recognize the effect of foreign proceeding commenced by the debtor's domiciliary court upon the assets located within Mainland China should this proceeding satisfy the following conditions:
(a) Chinese creditors will be given fair and equitable treatment if they participate in this proceeding;
(b) There are no significant differences among the substantive provisions embodied in the insolvency law of the relevant jurisdiction and this law;
(c) The recognition of this foreign proceeding will not violate the public interest of China; and
(d) Other considerations deemed necessary by the People's Court ...
Its counterpart in the Draft EBL 2004 proposed:
The bankruptcy proceeding commenced outside of the territory of People's republic of China, after people's court's ruling thereof, shall have effect upon the debtor's property within China's territory. People's court, however, shall rule that the said bankruptcy proceeding will not be accorded effect within China's territory if any one of the following situations exists:
(a) the foreign country or territory in which the said bankruptcy proceeding was commenced has neither treaty nor...