Chapter 7 Enterprise bankruptcy law

1. Chapter 7 Enterprise bankruptcy law 1 Overview 2 Bankruptcy causes and application 3 Bankruptcy liquidation 4 Reconciliation 5 Reorganization

2. 1 Overview

3. 1.1 Concept Bankruptcy liquidation, reconciliation and reorganization

4. 1.2 Sources of bankruptcy law Sources of bankruptcy law

5. 2 Bankruptcy causes and application

6. 2.1 Bankruptcy causes Bankruptcy causes • SOE’s bankruptcy: • (1) It is incurred major losses • (2) Such losses are due to improper operation and management • (3) It is unable to discharge matured debts. • Obviously the EBL is to save the SOEs rather than get rid of • them.

7. Failure of repaying matured debts: (1) The period for performing the debts has expired (2) The debtor is evidently unable to repay such debts • Unless there is evidence to the contrary if the debtor ceases to matured debts continuously, it is presumed that such debtor is unable to discharge matured debts. • SOEs’ exemption: (1) public utility enterprises and enterprises having important relationship to national economy and people's livelihood, for which relevant government departments grant subsidies or adopt other measures to assist the repayment of debts (2) enterprises having obtained guarantees for the repayment of debt within 6 months from the date of the application for bankruptcy

8. 2.2 Bankruptcy application 2.2.1 Eligible applicant • Both creditor and debtor may apply for bankruptcy • Before SOE as debtor dong so, he shall seek approval from his competent government departments. 2.2.2 Submission of application Debtor’s application: (1) written bankruptcy application (2) evidence the enterprise itself (3) legal representative and major responsible persons (4) situation of the workers and staff and plans for their settlement (5) written statement on the enterprise’s losses attached with audit report (6) balance sheet including tangibles, intangibles and investments up to the bankruptcy submission

9. Creditor’s application: (7) detailed situation of the accounts in the financial institutions including account approval document, account number and funds (8) situation of the enterprise claims including the name and domicile of the debtors, amount and time of debts as well as their information of collection (9) situation of the debts including the name and domicile of the creditors, amount and time of claims (10) guarantees involving the enterprise (11) litigations occurred (12) other materials deemed necessary by the court. (1) facts and evidences of the claims (2) nature and amount of the claims, and their security status attached with evidences (3) evidences showing the debtor’s failure of repaying matured debts

10. 2.3 Acceptance • Within seven (7) days. • Causes for rejection: • (1) debtor conceals or transfers property so as to escape the debts • (2) creditor intends to defame the goodwill of the debtor and disrupt • fair competition through bankruptcy application • Appeal against rejection ruling is allowed 2.4 Declaration of claims • Within 10 days after receiving detailed list of debts submitted by • debtor, court notify known creditors • Creditors having received notice: 1 month from receipt to declare • Remaining creditors: 3 months after the public announcement to • declare • Else, regarded as automatic waiver

11. 3 Bankruptcy liquidation

12. 3.1 Creditor’s meeting Non-permanent organization consisting of all creditors having declared claims Chairman: court’s appointment • Powers and functions: • examine materials of proof relating to the claims, and to • confirm the amount of such claims and whether or not the claims are secured • (2) discuss and adopt the draft reconciliation agreement • (3) discuss and adopt the plan for the disposition and distribution of bankruptcy property

13. First creditor’s meeting: convene by court within 15 days after the expiration of the claims declaration period • Subsequent meetings convene by: • court or the chairman of the creditor’s meeting when • deeming necessary • (2) liquidation commission or creditors whose claims • comprise more than one fourth of the total unsecured • claims • Ordinary resolutions: 1/2 affirmative votes of creditors • with voting right + 1/2 of total unsecured claims Draft • reconciliation agreement: 2/3 total amount of • unsecured claims

14. 3.2 Bankruptcy declaration • Causes for declaring bankruptcy: • Once declared bankrupt, it is irreversible • debtor unable to repay the matured debts & fails to perform • the reconciliation agreement; • (2) in course of reorganization: creditor’s meeting has applied for the termination due to continued worsening in the debtor’s its financial condition • (3) in the course of reorganization: debtor engages in fraudulent bankruptcy acts seriously harming the creditor’s interests • (4) upon expiration of reorganization: debtor unable to repay its debts in accordance with the reorganization plan • Appeal against bankruptcy ruling is allowed

15. 3.3 Liquidation group • Permanent body to administer the bankruptcy affairs • Creation by court within 15 days from bankruptcy declaration • Members: competent government departments liquidation intermediary organizations accountants and lawyers

16. Responsibility: (1) take over the assets sheets and accounts of the tangible property, and all the property, accounts, documents and files, seals, licenses and relevant materials from the bankruptcy debtor’s legal representative and other personnel (2) put bankruptcy property in order, prepare balance sheet and claims and debts statement, and organize the their appraisal, auction and converting into cash (3) recover the property of the bankruptcy debtor and exercise property rights against the debtors and property holders (4) manage and dispose of the bankruptcy property, and decide whether to perform contracts and carry out operations within the scope of liquidation, and confirm the right of repossession (5) entrust eligible organizations to appraise and auction the property and other works so as to convert them into cash (6) draft and the execute the property disposition and distribution plans (7) submit liquidation reports (8) take part in the litigation and arbitration on behalf of the bankruptcy debtor (9) handle cancellation registration (10) other matters as designated by the court

17. 3.4 Bankruptcy and non- bankruptcy property 3.4.1 Scope of bankruptcy property • all property the bankrupt debtor operated and managed • at the time bankruptcy was declared • (2) property obtained by the bankrupt debtor from the bankruptcy declaration to the termination of the bankruptcy proceedings • (3) other property rights that bankrupt debtor should exercise

18. 3.4.2 Scope of non-bankruptcy property (1) property possessed or utilized by the bankruptcy debtor based on such legal relationships as storage, custody, processing, lease, consignation, borrowing, commissioned sale and entrusted sale; (2) mortgaged or pledged property except for the waiver of such preferential repayment or part in excess of the secured debts (3) substitutes for the extinguished collaterals (4) the property on which preemptive rights exist according to the law except for the waiver of such preferential repayment or part in excess of the preferred debts (5) the sale of specific things where the payment has been made in full but the possession has been transferred (6) the property title or property rights transfer have been completed but the property has been delivered to the buyer (7) in the conditional sale where the bankruptcy debtor has not obtained the title yet (8) exclusive State-owned property whose circulation is prohibited (9) property owned by the trade union (10) welfare facilities such as the kindergarten, schools and hospitals of the bankruptcy debtor

19. 3.5 Bankruptcy claims Only confirmed as bankruptcy claims can the creditors obtain repayment from the debtor. 3.5.1 Scope of bankruptcy claims (1) unsecured claims occurred before the bankruptcy declaration (2) secured claims occurred before the bankruptcy declaration whose preferential repayment have been abandoned (3) secured claims occurred before the bankruptcy declaration, the claims in excess of the value of the collaterals (4) upon bankruptcy of the drawer of the negotiable instruments, the claims occurred due to the drawee or acceptor make payment to the bearer without the knowledge of the facts (5) upon discharge of contract by the liquidation group, the claims of the counterpart according to the law or contractual provision which can be measured in cash

20. (6) claims occurred when the debtor’s agents handled entrusted matters in the interests of the debtor (7) claims arising from the guarantor’s recourse rights against the debtor after discharge the debts on the debtor’s behalf (8) claims arising from issuing bonds (9) claims of the debtor’s guarantor declared for the advance exercise of recourse rights according to Art.32 of the STL (10) in the case of debtor as guarantor, the guarantee liability confirmed by judicial documents effective prior to the bankruptcy declaration (11) compensation liability of the debtor for tort or breach of contract causing losses to others (12) other claims recognized by the court

21. 3.5.2 Scope of non-bankruptcy claims (1) fines and other fees imposed on the debtor by the administrative or judicial organs (2) late fee for the payable items after the court’s acceptance of the bankruptcy case (3) interests on the claims after the bankruptcy declaration (4) the expenses of creditors for participating in the bankruptcy proceeding (5) shareholder’s rights on the debtor’s stocks and capital contribution including that of the employees as shareholders (6) claims declared to the liquidation group after the commencement of property distribution (7) claims whose limitation of action has lapsed (8) the management fees and contracting operation fees charged by the debtor’s sponsors (9) the funds allocated to the debtor without compensation by the government

22. 3.6 Bankruptcy fraudulent acts 6 months prior to bankruptcy acceptance until bankruptcy declaration date • concealment, secret distributions or transfers of property • without compensation • (2) sale of property at abnormally depressed prices • (3) securing claims originally unsecured • (4) early repayment of immature claims • (5) abandonment of the enterprise's own claims

23. 3.7 Property distribution and sequence of payment Disposition of assets held by bankruptcy debtor

24. 3.7.1 Property distribution • expenses needed for management, sale and distribution of • bankruptcy property, including expenses of hiring work personnel • (2) litigation expenses of bankruptcy proceedings • (3) other expenses paid in the course of bankruptcy proceedings for common interest of creditors 3.7.2 Payment of bankruptcy expenses 3.7.3 Sequence of payment • wages of staff and workers and labor insurance expenses • owed by the bankrupt debtor • (2) taxes owed by the bankrupt debtor • (3) bankruptcy claims

25. Illustration : GITIC’s bankruptcy property distribution GITIC was created in the 1983 and once one of China's most prominent financial institutions. As the investment arm of Guangdong province, the fast-growing province bordering HK, GITIC obtained loans and issued bonds overseas to finance local projects. It also invested in stock and property deals that went bad. It was shut down by the central PBOC in October 1998 for failing to repay debts and declared bankrupt on 15 January 1999 by the GDHPC as the trial court, which became the first non-bank financial institution bankruptcy. There are 131 overseas creditors with a claim of RMB 15.9 billion. It involves more than 80000 shareholders and the resettlement of 629 employees, which are closely connected with social and political stability. GITIC’s property was very complicate. It had nine securities offices, among which three in Guangzhou, two in Shanghai, and one each in Shenzhen, Xian, Tianjin and Puning, which should be sold as a whole. Creditor claims accepted by liquidation group totaled RMB 26.14 billion, and the claims against GITIC totaled RMB 38.8 billion.

26. The liquidation group was composed of personnel from the provincial government, provincial audit bureau, personnel bureau and judicial administration. After putting GITIC’s property in order, there were enormous works involving the conversion of them into cash. The nine securities trading offices were sold as a whole. The sixty-three (63) floors building was auctioned for three times and eventually sold for RMB 1.13 billion on 11 November 2002. The Jiangwan New City was sold for RMB 350 million on 31 January 2002 and the Guangdong Trading Center was sold for RMB 389 million on 23 May 2001. The liquidation group adopted staged property distribution, which were three times until the conclusion of the proceedings. In the first distribution in October 2000 liquidators recovered RMB 755 million in cash and realized RMB 476 million by selling recovered assets, the creditors obtained an initial RMB 1.0027 billion, i.e. 3.84 percent of total approved claims. In the second distribution on 28 June 2002 the creditors obtained RMB 820 million, and repayment rate raised to 7.38 percent of the total approved bankruptcy claims. In the third distribution on 28 February 2003 the creditors obtained the final RMB 700 million. Putting the three distributions together the creditors obtained RMB 2.536 billion, and the repayment rate was 12.52 percent. That means if the GITIC owed you RMB100, you may get back RMB 12.52. After the third distribution the GDHPC ruled the termination of the bankruptcy proceedings lasting for four years, i.e. from January 1999 to February 2003. It is reported that the liquidation group would survive the termination so as to collect the un-recovered property and distribute it to the creditors in the future.

27. 3.8 Termination of bankruptcy proceedings

28. 4 Reconciliation 4.1 Comparison between reconciliation and reorganization 4.2 Reconciliation proceedings

29. EBL links reconciliation with reorganization • Reorganization is proposed and organized by the competent • government departments • Reconciliation is treated as the prerequisite of re-organization, • reorganization is natural outcome of reconciliation • Debtor may simultaneously apply for reconciliation when • filing for bankruptcy • After court’s bankruptcy acceptance, both debtor and • creditors may do so • Reconciliation agreement: submission to court for confirmation • If confirmed, termination of bankruptcy proceedings • Secured creditors may exercise their respective real rights over • the secured things after agreement • Agreement: binding upon debtor and all creditors • Undeclared claims may be repaid • If debtor fails to repay the debts, creditors may apply to court • for enforcement and for bankruptcy declaration.

30. 5 Reorganization

31. Since late 1990’s there are a number of informal restructuring activities mainly involving the SOEs • Debt restructuring plans usually comprise government injections of assets into the enterprise, asset sales, or one-off cash payments. (1) Asset injections: common component of debt restructuring plans (2) Asset sales: virtually all enterprises in distress undergoing the restructuring process have surplus assets not fundamental to the operations of the business (3) One-off payments • Reorganization plan: 2/3 affirmative votes of the ascertained claims • If approved, it shall be submitted to court for approval • If ratified by court, administrator is responsible for its execution • Upon complete execution of the reorganization plan the court rules • the termination of the bankruptcy proceedings at the administrator’s • request • If reorganized enterprise fails to perform the reorganization plan • without due causes, court may rules the termination of such plan at • request of interested parties. If reorganized enterprise meets the • bankruptcy cause, the court shall declare its bankruptcy

32. Illustration: GDE’s restructure GDE was Guangdong province's main investment arm based in HK. It was created in the early 1980’s to raise funds in the international markets for the development of hundreds of companies in Guangdong province. By late 1998, GDE faced an immediate need to restructure more than $5 billion in debt for international lenders and bondholders. Goldman Sachs was retained to advise the Guangdong provincial government on the restructuring under the supervision of the former deputy governor Wang Qishan. The GDE restructuring was no less monumental a task. The restructuring also involvd GDE's Hong Kong-listed units, i.e. Guangnan (Holdings) Ltd and Guangdong Investment Ltd (GDI). According to the restructure plan Guangnan creditors would receive HK$775 million cash from a rights issue, HK$650 million of new Guangnan debt and all the non-core assets of Guangnan. GDI would get an 81 percent stake in the Dongshen Water Supply business and HK$155 million cash from the Guangdong government in exchange for 2.3 billion new GDI shares and other assets. GDI's debt of HK$ 4.5 billion would be rescheduled with more than 40 percent to be repaid in five years and the remaining debt to be refinanced, and sell HK$1.6 billion assets over five years for debt repayment. Such restructuring would involve the creditor’s loss of at least 21 percent, i.e. around $ 2 billion and the Guangdong government as the debtor’s asset injection valued around $ 2 billion. That is to say, such restructuring involved equivalent compromise from both the debtor and the creditor. It turned out to be a very successful restructuring highly commended by the international financial community.

33. Illustration: Zhengbaiwen’s restructure Zhengbaiwen is the listing code of the Zhengzhou Baiwen Co. Ltd. in the Shanghai Securities Exchange. Its predecessor was founded on the bases of Zhengzhou Department Store and Zhengzhou Timepieces & Stationeries Company under the name of Zhengzhou Commodities & Stationeries Company. In December 1988, its predecessor was reorganized to CLS and adopted the name of Zhengzhou Commodities & Stationeries Company Limited and in December 1992 its name was changed to Zhengzhou Baiwen Co., Ltd. (Group). It operated the department store, retails and whole-sales commodities and stationeries and variety of other goods. It was once one of the 500 largest enterprises in service trades. In September 1994, it was granted the right of operation of import & export by the former MOFTEC. It also engaged in printing, transportation and tertiary industry.

34. It was listed on the Shanghai A share stock market in 1996. It has lost RMB 1.5 billion and owed RMB 2.5 billion in bank loans. It has just RMB 600 million worth of in assets. In order to avoid an embarrassing bankruptcy and also relieve small investors who would otherwise get nothing from the bankruptcy, the debt-ridden State-owned department store in the capital of Henan province, Zhengbaiwen tried to restructure its business and assets. Restructuring began when the Construction Bank of China, Zhengbaiwen's biggest creditor ordered its assets management subsidiary Cinda to negotiate the debts with the Zhengzhou municipal government, the store's biggest shareholder. Cinda also appealed twice to the CSRC to let Zhengbaiwen go bankrupt, but met with strong resistance from local authorities. The Zhengzhou based court also rejected Cinda's application requesting for Zhengbaiwen’s bankruptcy.

35. After lengthy negotiation it reached reorganization agreement with the Sanlian Group, a Jinan-based company with diverse interests. Sanlian would take over the store and up to 50 per cent of stake in the listed branch of the company. The local government's holdings would be phased out from the store, and loan liabilities would be divided three ways: the parent company of Zhengzhou Baiwen, Sanlian Group and Cinda. In return Sanlian would pump RMB 300 million into the Zhengbaiwen, and Cinda would waive part of the loan liabilities. On the 2001 Zhengbaiwen shareholder’s meeting such reorganization was passed by an overwhelming majority. Over 90% shareholders attending the meeting voted for the plan. Thus Zhengbaiwen’s shareholders including the shareholders of legal person shares and negotiable shares should transfer 1/2 of the shares they held to Sanlian. Over 90% shareholders attending the meeting voted for the plan. 111862 shares held by 39 dissident shareholders would be bought back at a fair price and written off later. Other shareholders did not show any objection to the restructuring would transfer 1/2 of their shares to Sanlian for nothing.