China Amended Company Law 2023 – from Bankruptcy Perspective

Practitioners engaged with bankruptcy laws in China always look eagerly forward to new laws and regulations that have an impact on when and how a company may go into bankruptcy liquidation and reorganization. With the amended Company Law of the People’s Republic of China (“New Company Law”) revised and adopted by the Seventh Session of the Standing Committee of the 14^th National People’s Congress of the People’s Republic of China (“PRC”) on December 29, 2023, and coming into effect on July 1, 2024, we propose to examine the New Company Law from a bankruptcy practice perspective.

In principle, when trialling enterprise bankruptcy cases, the people's courts shall respect the independence of corporate legal personality, making independent judgment on the cause of bankruptcy of affiliated companies and applying single bankruptcy procedure as the basic principle. There are exceptions, for instance, the courts may apply a so-called “substantive consolidation procedure” where there is a high degree of confusion in legal personality of affiliated companies, the cost of distinguishing the property of affiliated companies is too high, with serious prejudice to the interest of creditors in relation to fair settlement of interests. ¹Such substantive consolidation is applicable to consolidation of affiliated entities. The assets and debts of each enterprise will be combined as a whole bankruptcy restructuring property which will be arranged as a whole in the restructuring to achieve fair compensation to all creditors.

Article 23 of the New Company Law provides the legal basis for substantive consolidations. In practice, there exist a large number of cases where substantive consolidations and reorganisations are due to the fact that the affiliated companies have taken advantage of the inappropriate affiliation relationship to jeopardise the interests of creditors. The cost of correcting each of the inappropriate behaviour through revocation, invalidation and denial of the corporate personality is often too high, and in numerous cases practitioners have to deal with unclear facts and un-rectifiable issues. After the substantive consolidation and reorganization of affiliated companies, the assets and liabilities of the affiliated companies will be disposed of and settled in a unified manner, and the creditors of the affiliated companies will be paid in a fair manner in accordance with the statutory order in the same proceedings of bankruptcy. Therefore, substantial consolidation and reorganization increases the likelihood of a successful reorganisation.

Article 35 of the Enterprise Bankruptcy Law, which came into effect on 1 June, 2007, stipulates that where the investor of the bankrupt enterprise has not yet fulfilled his capital contribution obligation after the people's court accepts the application for bankruptcy, the administrator shall request the investor to pay his capital subscribed regardless of the time limit set out in the articles of association of the company. Similarly, the New Company Law breaks through the benefits of capital contribution terms of the shareholders under the registered capital subscription system, and explicitly stipulates that when a company is unable to meet its matured obligations, the shareholders’ outstanding capital contributions become due immediately.  

In the case of having clear evidence to prove that the company cannot pay its debts, Article 54 of the New Company Law provides a legal basis for creditors to directly bring a lawsuit against the shareholders of the debtor to require them to make capital contributions before the due date.  In addition, without having to wait until the company enters into bankruptcy proceedings or dissolution liquidation proceedings, this article formally establishes a system of accelerating the capital contributions subscribed by shareholders when a limited liability company is unable to fulfil its payment obligations. However, the law is not clear whether it refers to the company’s inability to pay its debts in general or failure to pay any single debt, we need to keep a close eye on this.

The introduction of non-ordinary shares in the New Company Law caters for the need to diversify shareholders' rights in practice. The New Company Law provides that a company may issue three types of non-ordinary shares with rights different from those of ordinary shares in accordance with the provisions of the company’s articles of association. From the perspective of bankruptcy reorganisations, if a company under reorganization has already issued non-ordinary shares, then the reorganisation plan should consider the adjustment of the rights and interests of the original investors and/or issuing non-ordinary shares to the reorganisation investors (financial investors or industrial investors).  And if the reorganisation plan contains a debt-to-equity conversion scheme, it should also consider the difference of type of shares between the debt-to-equity conversion shareholders and the original investors, i.e. whether or not to grant the debt-to-equity conversion shareholders the shares with priority to profits or residual property distribution.

The New Company Law specifies that shareholders of the parent company have the right to inspect the relevant materials, resolutions and financial and accounting reports of the parent company itself, but also those of its wholly-owned subsidiaries. In addition the New Company Law also clarifies that shareholders of the parent company have the right to take actions against the directors, supervisors and senior officers of their wholly-owned subsidiaries or others who infringe the legitimate rights and interests of the wholly-owned subsidiaries in their own name. This Article 189 of the New Company Law may improve the financial status of corporate groups, and it will enable the parent company to demonstrate better financial performance in the case of consolidation of the financial statements of wholly-owned subsidiaries and their parent company, hence reducing the possibility of bankruptcy liquidations or reorganizations.

Allowing a company to use its capital reserve to make up for the company's losses is one of the highlights of the amendment to the Company Law this time. From the perspective of bankruptcy reorganizations, the major consequences of this change are as follows:

• It will accelerate the speed of making up for losses, thus bringing forward the time period for the debtor’s shareholders to obtain profit distributions, and reorganization investors will be more motivated to invest in companies under bankruptcy reorganization when they can expect a shorter period of return on investment; and
• In practice, debt-to-equity conversions have been widely used in bankruptcy reorganizations.If the capital reserve is used to cover losses and accelerate the transformation of an enterprise’s undistributed profits from negative to positive so that the shareholders who convert their debts to shares can obtain returns on their investments as early as possible.As such, debt-to-equity conversions will also be more attractive in bankruptcy reorganizations.

Taking these (and other) changes to the corporate law regime in China together, the rules for corporate bankruptcies have once again become more comprehensive and concrete. As a general trend, the formation of professional bankruptcy courts has received more attention, the acceptance of bankruptcy as a concept of market economies has been improved by all stakeholder of the society, and investment opportunities brought by some high-quality assets in economic downturn triggered insolvencies have made bankruptcy liquidations and the reorganizations a more popular target. Bankruptcy practitioners can hence be satisfied upon their review of the New Company Law that the bankruptcy regime in China has again further moved towards a legal area driven by the rules-based market economy

[1] Article 32 of the Notice of the Supreme People's Court on Issuing the Minutes of the National Court Work Conference on Bankruptcy Trials