Prerequisites, exemptions for fledgling personal bankruptcy system

Localisation of the personal bankruptcy system is not new in China. As early as 2007, when the Enterprise Bankruptcy Law was being formulated, the natural person bankruptcy exemption system was written into a proposed draft of the legislation. But, given the lack of theoretical basis or mature complementary systems at the time, it was ultimately shelved.

In the past 15 or 16 years since then – with the gradual maturation of enterprise bankruptcy, overall lowering of household saving rates, and improved leverage ratio of the population – the time is ripe for personal bankruptcy to finally take root in China.

Accordingly, on 26 August 2020, the Standing Committee of the Shenzhen Municipal People’s Congress reviewed and passed the Regulations for a Personal Bankruptcy Pilot Project in the Shenzhen Special Economic Zone, establishing Shenzhen as a forerunner of the system.

BASIS FOR EMERGENCE

While personal bankruptcy lags far behind enterprise bankruptcy in China, it is historically at the root of the bankruptcy legal system globally, dating as far back as ancient Rome. It developed markedly during the Middle Ages in Italy and England, becoming one of the key economic drivers of Western markets.

Yet in China, a certain uneasiness exists between personal bankruptcy and the traditional concept of “paying back one’s dues”, with personal bankruptcy regarded by many as a means for “deadbeats” to legally evade their debts.

The truth, however, is that personal bankruptcy is not limited to benefitting debtors. As early as 1994, after studying relevant legal systems in the UK, Professor Zou Hailin, of the Institute of Law at the Chinese Academy of Social Sciences, introduced the theory of debtor co-operation – granting the debtor benefit of exemption from liability if he or she actively co-operates in the bankruptcy proceedings.

At its core, the theory still serves the interests of creditors. Exemption in bankruptcy may indeed impair some of the creditors’ rights, but from another angle, exchanging uncertain future claims for debtor co-operation and active turnover of properties serves, in fact, to maximise creditor interests under realistic circumstances.

THE PREREQUISITES

It has to be noted that a debtor cannot be granted bankruptcy exemption without good cause. The debtor has to prove himself/herself by way of action or non-action, while the law also sets certain limits on the scope of exemption.

In China’s first personal bankruptcy liquidation case, the bankrupt, going by the alias Hu Yong, was first required to state the reasons for her bankruptcy, and establish that her debts were not due to a “dishonest” act prohibited by any negative lists, but to commercial risks encountered during business operation.

According to the civil ruling of Shenzhen Intermediate People’s Court, her indebtedness resulted from the bankruptcy of her lessor, Xinyijia Supermarket, which in turn forced the closure of her own company, Huyan Culture, resulting in debts of RMB4.8 million (USD707,704). She sold her only house, repaying debts with all proceeds totalling RMB2.6 million, and continued making repayments, but ultimately still owed more than RMB1 million.

Furthermore, Hu was required to actively co-operate in the bankruptcy proceedings and court procedures, including submitting various materials requested by the court, and attending creditors’ meetings to actively respond to their questions. Only then did she satisfy the criteria for being an “honest but unfortunate” person, ushering her bankruptcy into the exemption examination period.

But this did not mean she was immediately exempt. Rather, she was still required to strictly comply with loss of right provisions and submit to scrutiny of the bankruptcy administrator and relevant stakeholders; failing which the debt exemption could still be rescinded.

Considering the relevant provisions of the above-mentioned Shenzhen regulations and the decision in Hu’s case, in practice, an examination of whether a debtor is “honest but unfortunate” can be conducted from the following perspectives:

1. Whether the debtor had submitted complete bankruptcy petition material to the court, such as a property report, before acceptance of the bankruptcy case, and whether the reason for bankruptcy was fully and truthfully stated;
2. When the business risks materialised, resulting in insolvency, whether the debtor sought to evade his/her debts;
3. Whether the debtor truthfully and fully reported his/her financial status to the court and administrator;
4. Whether the debtor actively co-operated in the launch and unfolding of the bankruptcy proceedings after the bankruptcy case was accepted by the court;
5. Whether the debtor complied with the restrictions on his/her employment and conduct; and
6. Whether the debtor consciously and actively submitted to administrator scrutiny after bankruptcy concluded.

SCOPE OF EXEMPTION

Satisfaction of the above-mentioned requirements does not necessarily mean exemption from all debts.

Pursuant to article 97 of the Shenzhen regulations, exemption is not possible for the following debts:

1. Damages arising from infringement of another person’s right to body or life due to intentional conduct or gross negligence;
2. Alimony or child support based on a statutory relationship;
3. Caims for remuneration or return of advances based on an employment relationship;
4. Debts known to the debtor but not recorded in the register of claims and debts, except where a creditor is well aware that a people’s court has declared the debtor bankrupt;
5. Property damages arising from malicious infringement;
6. Taxes owed by the debtor;
7. Fines owed in connection with illegal or criminal acts; or
8. Other debts specified in law that may not be exempted.

CONCLUSION

The Shenzhen regulations serve as a starting point for China’s personal bankruptcy system, laying down the general framework and operational mechanism for nationwide implementation.

With Hu’s bankruptcy case, and relevant provisions of the Shenzhen regulations, good insights have been gained into the prerequisites for application and scope of exemption for personal bankruptcy.

This corner of the legal system, when fully developed, will benefit not only debtors by granting them a new lease of life, but also creditors, by preventing the dishonest evasion of their debts in bad faith.

Qian Xin is a senior partner at Joint-Win Law Firm. He can be contacted at +86 180 1978 7906 and by email at qianxin@joint-win.com