New regulations try to plug the gaps in China's bankruptcy law

The bankruptcy process in China is deeply flawed. A new law is needed, but going by the latest tinkerings, it could be years.

A few years ago, I was cycling in Yunan province, down by the Vietnamese border. As night set in, I was gliding down a mountain road when I came across a huge, derelict compound. Rust-eaten corrugated roofs covered portions of the crumbling buildings. Everything looked deserted until I saw a couple of security guards tending a stove in their little office. They told me the compound had been a factory, under the supervision of the local county government, but that mismanagement and huge losses had forced the locality to close its doors. But the company hadn't gone bankrupt, said the guards. No, it was still hoped that at some stage it would reopen and contribute to the local economy.

Looking at the weeds sprouting the concrete, the wrecked dormitory blocks and the empty hangars, that seemed a bit dubious. On the plus side, it was at least not functioning instead of chewing up capital.

I never found out how much money the factory owed before it closed down, but speaking to local bankers in Beijing and Shanghai, it's clear that getting money back from an SOE is tough.

That's where the debate in China about the bankruptcy law comes in. The primary objective of the bankruptcy law is to find a way to force loss making state-owned factories to close their doors in an orderly manner and to repay their creditors by liquidating their assets.

Although a valid aim, it does not even begin address the problem of how to deal with the possibility of bankruptcy amongst the tens of thousands of privately owned companies - for the time being, coping with the SOEs is enough.

It's easy to think of China's SOEs as a monolithic block, run out of a handful of ministries in Beijing. Nothing could be further from the truth. A complex hierarchy starting at the village level, and going up via county, city and provincial levels to the ministerial level involves many different levels of ownership, all of which enjoy the power and resources which their sphere of responsibility provides.

So it's not easy for a Beijing bureaucrat to declare a company in a far flung county bankrupt, despite his intention to help say, the local branch of one of the state banks gets its loans back. The local government will point out that workers need to be given other jobs, further education and a stipend.

In the meantime, as the cogs in Beijing grind on, sending a steady flow of directives down to the township, and possibly a special liquidation team, factory managers and officials could well be concealing the company's assets, handing simply the shell and a few empty bank accounts over to the trustees.

In September, the supreme peoples' court issues some new directives to help flesh out the first set of amendments to the bankruptcy laws in 1991. The directives are badly needed. The original law is still classified as "experimental", even though it was passed over 16 years ago, and many discrepancies have arisen with the old law and a Chinese economy that has a much greater market orientation. You only to have pick up the documentation in your hand to get physical evidence of how the new regulations are scrambling to cope on the one hand with a more complex economy and on the other, with the restraints imposed by the original law. The latest amendments are 12,000 characters long, compared to the original bankruptcy law's scant 4000 characters, while the 1991 amendments come in at 7000.

In fact, the supreme court has reportedly been working on the latest set of amendments since 1995, but the process was held up by the problem of wanting to lay out more relevant regulations which might conflict with the original. By definition, the amendments can't exceed the often erroneous scope of the actual law. The process has taken so long that many of the framers of the original law have already passed into retirement.

The latest amendments have incorporated the directives referring to SOEs passed by the state council in 1995 as well as some directives passed in areas where an experimental bankruptcy programme has begun. These include bringing the bankruptcy case of enterprises relevant to the country's national programme under the jurisdiction of the intermediate people's court and in ensuring that companies applying for bankruptcy present notarized documents showing the agreement of their administrative superiors.

In addition, the amendments strengthen the supervision over the bankruptcy process, including the hearing of the case, to protect creditors' rights. They also stipulate that SOEs directly under the control of major cities, provinces or autonomous regions must receive approval for bankruptcy from the highest court - a reassertion of central control and suspicion of the provincial bases which is reflected in other clauses.

That's because one favourite tactic of insolvent SOEs has been the opposite of delaying bankruptcy. It involves hastening the bankruptcy process and diverting cash and other assets into the pockets of the officials responsible for the disposal, to the detriment of the legitimate creditors.

To prevent this, the amendments forbid the local courts from ruling on the "disapearance" of assets and mandates the transfer of information relating to such wrongdoings to the "clean up" teams who will have the authority to sue those directly responsible and to pass on the materials to state level organs.

Arguably, this is too weak, say some observers.

"Although some measure have been adopted to stop abuses within the bankruptcy process, it's not strong enough. A bankruptcy should be a process of calling the management to account and the courts should use the bankruptcy process to find out exactly what has been going on," commented Li Shuguang, professor at the Policy and Law University of China at a recent press conference.

"You could say the courts are reneging on their responsibility," he concludes.

Li also points out that the amendments make no alteration to the principle of treating SOEs as a special - in other words, protected - category.

Although the amendments are steps in the right direction, they keep running up against the problem of the limitations imposed by the original. This does not just have implications for the amendments, it also means that the urgently needed new and more comprehensive bankruptcy law about which much has been spoken, will be hamstrung by trying to take previous rulings into account. This could have the damaging consequence of delaying a new law for a very long time.

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