Developing a pre-reorganization system in China

By Xu Bangwei and Zhang Xiaotong, Jingtian & Gongcheng

The pre-reorganization system originated in the US in the 1990s. Its core idea is to collect the creditors’ support for the reorganization plan before the debtor starts the formal bankruptcy procedure. Once this goal is achieved, the bankruptcy reorganization procedure will be started immediately and the reorganization plan supported by the creditors will be submitted at the same time.

Compared with the formal judicial reorganization procedure, pre-reorganization is more flexible in time and procedure, and also conducive to saving judicial resources. Moreover, pre-reorganization enables all parties to evaluate the operation expectation of the enterprise in a relatively free, equal and objective state, so as to avoid potential investors substantially reducing their valuation of the enterprise due to the enterprise’s entering into the formal bankruptcy procedure, and to preserve the business value of the enterprise as much as possible.

Xu Bangwei
Jingtian & Gongcheng

For enterprises with a large number of employees and creditors, and involving a large number of suppliers in upstream and downstream industrial chain, pre-reorganization can also avoid large-scale mass panic and social instability caused by the enterprises’ directly entering bankruptcy procedure. In the past decade, the pre-reorganization system began to take shape in China and experienced the development process, from individual local exploration to recognition and encouragement by the Supreme People’s Court (SPC), and then was gradually promoted to the regions.

In July 2013, Zhejiang High People’s Court first proposed the system of “pre-registration of enterprise bankruptcy application” by issuing meeting minutes, that is, allowing enterprises meeting certain conditions to apply to the court for “pre-registration of bankruptcy”, and then to begin to negotiate with creditors on a debt settlement plan or asset reorganization plan. The results of the negotiation remain binding on all parties after the debtor enters the formal bankruptcy procedure.

Zhang Xiaotong
Jingtian & Gongcheng

In March 2018, the SPC’s Minutes on the National Courts’ Bankruptcy Trial Work Meeting first proposed at the national level to “explore the connection between out-of-court reorganization and in-court reorganization systems”, which is understood to be a prelude to the establishment of a pre-reorganization system in China in the future.

Then, in July 2019, the Reform Plan for Accelerating and Improving the Exit System of Market Entities, jointly issued by the National Development and Reform Commission (NDRC) and other departments, also clearly proposed to “research the establishment of a pre-reorganization system” and “clarify the legal status and content of a pre-reorganization system”. On this basis, the Minutes on the National Court’s Civil and Commercial Trial Work Meeting, issued by the SPC in November 2019, formally confirmed that the out-of-court reorganization agreement concluded in the pre-reorganization stage was legally binding on relevant parties.

Up until now, in addition to the above-mentioned Zhejiang province, the bankruptcy courts in Beijing and Shenzhen have formulated working procedures for enterprise reorganization cases, and made specific provisions on the process of pre-reorganization system. According to the existing cases summarized, China’s pre-reorganization mainly includes the following three modes:

(1) Out-of-court pre-reorganization before the court accepts the bankruptcy application. Generally, the creditors, debtor, shareholders and other interested parties negotiate to form a reorganization plan, and then the debtor applies to the court for reorganization. After the court’s approval, the reorganization plan will be implemented and the pre-organization terminated.

Under this mode, the pre-reorganization procedure is independent of the judicial reorganization procedure and is often carried out under the guidance and co-ordination of government departments. For example, in the reorganization case of China National Erzhong Group Co and Erzhong Group (Deyang) Heavy Equipment Co in 2016, the two debtors and the financial creditor committee composed of more than 30 financial creditors negotiated and determined the framework financial debt reorganization plan, and then applied to the court for bankruptcy reorganization.

After the court accepted the application, the financial debt reorganization plan was included in the reorganization plan. It took only 70 days to complete the entire judicial reorganization procedure.

(2) Pre-reorganization in the pre-filing stage of the court. After receiving a reorganization application, the court will pre-file the case and will not formally decide to accept the reorganization application. At the same time, the court will designate an administrator to carry out negotiations with creditors, find investors, preliminarily sort out assets and debts under the guidance of the court, and guide shareholders to reach an agreement on a reorganization plan with major creditors.

The reorganization plan will become the reorganization scheme after the court accepts the bankruptcy reorganization case. According to statistics, nearly 30 enterprises have released pre-reorganization announcements on the National Enterprise Bankruptcy Information Disclosure website, 12 of which have publicly recruited investors into the procedure. Typical cases that have been completed under this mode include the reorganization case of Shenzhen Fuchang Electronic Technology, accepted by Shenzhen Intermediate People’s Court, and the reorganization case of Hangzhou Yifengcheng Real Estate Development, accepted by Yuhang District Court in Zhejiang province.

(3) Pre-reorganization after the court accepts the bankruptcy application. After the court accepts the debtor’s bankruptcy application, the creditors, debtor, shareholders and other interested parties should negotiate and complete the pre-reorganization plan before the court declares the debtor’s bankruptcy, and then apply for reorganization when the time is right. In that case, the liquidation procedure will be changed to a reorganization procedure.

Typical cases under this mode include the reorganization case of Nengtong Technology, accepted by Haidian District Court in Beijing, the reorganization case of Anhui Yangguang Bandao Culture Development, accepted by the Shouxian People’s Court in Anhui province, and the reorganization case of Yangzhou Dayang Shipbuilding, accepted by Yangzhou Guangling People’s Court in Jiangsu province.

It should be noted that the pre-reorganization system is just in its infancy in China, and lacks thorough and uniform legislative rules. In practice, the specifics of many cases will vary from place to place, even from judge to judge. Moreover, the out-of-court reorganization agreement concluded in the pre-reorganization stage also lacks legal binding force on other creditors who do not agree with the plan.

Therefore, when creditors or shareholders participate in the pre-reorganization procedure, they often need to carry out complex professional analysis from the commercial and legal aspects, in order to make decisions conducive to their own business purposes.

Xu Bangwei is a partner, and Zhang Xiaotong is a trainee at Jingtian & Gongcheng

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