Current practice and financial impact of personal bankruptcy

By Wang Zhenxiang, Jingtian & Gongcheng
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In its Outline for the Enforcement Work of People’s Courts (2019-2023), the Supreme People’s Court proposed the launching of pilot work for functions equivalent to a personal bankruptcy system so as to lay the foundation for establishing such a system. Subsequently, pilot projects for personal bankruptcy, or alternatively a quasi-personal bankruptcy procedure (QPB), were gradually launched in Shenzhen city, Zhejiang province and other areas.

The legislative purpose of personal bankruptcy is to improve the business environment, resolve the difficulties in enforcement, and provide an opportunity for economic renewal to honest but unfortunate debtors while ensuring fair repayment to creditors. Once implemented, such a system will also have a profound impact on the investment and financing sector. This article looks at the QPB system in light of the experiences of Shenzhen and Zhejiang.

Current practice and financial impact of personal bankruptcy Wang Zhenxiang
Wang Zhenxiang
Partner
Jingtian & Gongcheng

(1) Debtor’s obligations. First, the debtor is required to co-operate in the bankruptcy adjudication or in the administrator’s performance of its duties and obligations during the bankruptcy procedure, which includes: The safekeeping and timely handover of relevant materials; submitting to inquiries and investigation by the administrator, as well as questioning by the creditors; proactively reporting changes in personal particulars; reporting any departure from the place of residence and complying with restrictions on going abroad; reporting details of personal property, income and debts, sometimes those of family members; refraining from repaying individual creditors; and other obligations deemed necessary in regulatory documents, bankruptcy adjudication or by the administrator.

Second, a debtor has the obligation of restricting consumption. A survey of the QPB system documents of Shenzhen and Zhejiang shows that the consumption restrictions on debtors involved in personal bankruptcy are more lenient than those on discredited judgment debtors, permitting them to travel economy class on flights or second class on high-speed rail.

(2) Exempt property. Certain property may be retained to ensure the debtor’s basic livelihood rights, which generally includes: (i) essential living expenses and necessities limited to the local minimum necessary to ensure livelihood and that of the dependent family; (ii) clothing, furniture and other life necessities; (iii) protective insurance and personal damages exclusively belonging to the debtor; (iv) and items of particular significance that have commemorative significance, such as medals earned by the debtor, but little economic value. Taizhou city in Zhejiang and several other areas specify a maximum total value of exempt property, such as RMB20,000.

After review and adoption by a vote of the creditors’ committee, the list of exempt property enters into effect following a ruling or judgment by the court. The debtor’s property other than the exempt property is taken over and sold off by the administrator in accordance with regulations, and used to discharge the debts.

(3) Behaviour observation period. Also known as an exemption observation period, is usually set at three to five years by the court according to local provisions, and is mainly determined based on the creditors’ repayment ratio, the indulgence by creditors, etc.

During this period, the debtor is required to continue performing the income reporting and consumption restriction obligations specified in the court-rendered act restriction decision. The court may extend the observation period in case of a breach.

(4) Effect of completion. If the observation period expires and the specified requirements are complied with, the court will decide to forgive the undischarged debts or terminate the enforcement and lift the restrictions on the debtor’s acts. The effect of the debt forgiveness applies to all creditors, including those that have and have not declared their claims, but excepts damages arising due to a wilful act or a gross negligence tort, support or maintenance expenses arising based on a statutory personal relationship, claims for remuneration arising based on employment relationships, taxes owed, fines imposed for violations of laws or criminal offences, bankruptcy claims intentionally omitted by the debtor, etc.

Impact on investment, financing

QPB practice is still hampered at the systemic and social awareness levels, which is evident in a report issued by the Taizhou Intermediate Court in March 2021. Since 2019, the court has accepted 146 QPB cases and concluded 119, of which 25 cases (21% of concluded cases) were able to end with the debtor declared “honest” and a settlement reached.

In other cases, personal debt clearing could not be achieved due to breach of trust or the debtor’s failure to co-operate, failure to normally clear the debts due to inability to contact the debtor, or poor social ramifications of the case. Nonetheless, the impact of personal bankruptcy on investment and financing is worthy of note.

It is necessary to understand personal bankruptcy and brace for its impact on the investment and financing sector.

(1) Equity investment sector. Currently, value adjustment mechanism (VAM) clauses are applied liberally in the equity investment sector, tying the personal wealth of the actual controller of an investee enterprise to its business performance and results. Investment institutions lack systematic post-investment management and relatively few assist the investee enterprises in establishing sound governance structures, contorting the equity income that should be realised through joint participation in corporate governance into a demand that the actual controller of the investee enterprise bear a guaranteed minimum fixed income corresponding to the investment.

Personal bankruptcy allows the debts borne by entrepreneurs who participate in VAM financing in good faith, but unfortunately fail to achieve the VAM targets, to be subsequently forgiven.

(2) Non-performing personal loan assets. The valuation of non-performing personal loan assets will also be affected by the personal bankruptcy system. The previous valuation model used the debtor’s lifetime income as the basis for valuation, but this will be limited by the behaviour observation period if personal bankruptcy is implemented.

(3) Financial loan. Under societal and cultural influences creditors may, after implementation of personal bankruptcy for a certain time, be more willing to accept a one-time debt repayment plan and reject a plan that will treat the debtor’s uncertain future income as the repayment source.

In such a situation, a financial institution may explore providing repayment financing loan services to debtors, granting a line of credit based on their earning power during the observation period and paying off creditors in one lump sum in exchange for their vote of indulgence and consent. Certain commercial banks are exploring such opportunities.

Wang Zhenxiang is a partner at Jingtian & Gongcheng

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