What can a lessor do when the lessee is in bankruptcy?

In a financial lease, if the lessee goes bankrupt or enters reorganisation due to insolvency, the lessor is certain to be adversely affected. To uphold its own interests, the lessor should carefully assess the status of the lessee and leasehold, and take the initiative if necessary

In recent years, due to macroeconomic trends, national policies and raised legal awareness, courts have been accepting a notably increasing number of corporate bankruptcy cases. Meanwhile, the likelihood of financing and financial leasing companies (the lessors) encountering bankruptcy reorganisation of lessees during the lease term has likewise multiplied. Based on the authors’ legal practice experience, we have summarised the following key advice for lessors when dealing with the bankruptcy reorganisation of lessees.

Where the lessee risks bankruptcy, strengthen post-lease management, keep abreast of the state of the lessee and the leasehold and, if necessary, resort to litigation without delay. If the lessee is found to have paid rent late, diverted assets, brought in a debt restructuring adviser, changed its place of registration without reasonable cause, been involved in a large number of litigations, or had negative public opinion on its creditworthiness, it would indicate that the legal risks of the lessee defaulting or even going bankrupt are accumulating rapidly.

The lessor is advised, first and foremost, to step up post-lease management, inspect the leasehold, ensure that its title is publicly disclosed, and that the lessee did not dispose of the leasehold on its own accord. The lessor should further check whether the information on the leasehold specified in the financial lease contract is consistent with its actual state, and for any defects in the specialisation of the leasehold. In case of any issues, the lessor should remedy them to the extent possible.

Additionally, the lessor should consider bringing legal action against the lessee and the guarantor, if litigation was the specified method of resolution. Pursuant to articles 20 and 21 of the Business Bankruptcy Law, if the lessor initiates litigation in the agreed competent court before the bankruptcy application of the lessee was accepted, to determine the legal relation, the amount of the claim and vesting of the leasehold, it would be able to avoid litigation at a later time in the local court of the lessee, thereby reducing uncertainty.

Timely and accurately declare creditors’ rights, monitor the use of the leasehold and consider exercising the right of recovery. If the lessee has been ordered to go through reorganisation, the lessor should promptly and accurately declare its creditors’ rights, submit requisite documents evidencing the claim, and actively communicate with the administrator in terms of the amount and nature of the claim, as well as disposal of the leasehold.

The lessor must continue monitoring the use of the leasehold. If the administrator decides to continue using the leasehold to sustain the basic production and operating activities of the lessee, in respect of the debts arising from such continued use, the lessor may consider claiming it as collective debts in accordance with the first or third paragraph of article 42 of the Business Bankruptcy Law, which is likely to advance the claim in terms of priority.

Pursuant to article 42 of the Business Bankruptcy Law, the following debts incurred after court acceptance of a bankruptcy application are deemed collective debts: (1) debts generated from a contract, the performance of which both parties concerned fail to fulfil on the request of performance raised by the bankruptcy administrator or debtor against the opposite party; (2) debts generated from the negotiorum gestio (management of business) of the debtor’s assets; (3) debts generated from ill-gotten gains; (4) the labour cost for the continuance of business operations, social insurance premiums, and other liabilities as incurred; (5) debts generated from the damage that occurs in the performance of functions and duties by a bankruptcy administrator or other relevant personnel; and (6) debts generated from any damage due to the debtor’s assets.

If the administrator decides to cease using the leasehold, although the lessor could consider entrusting the administrator to dispose of the leasehold in the course of the bankruptcy proceedings, such proceedings can be quite lengthy, and the leasehold may be at risk of depreciation and impairment if not promptly disposed of. The lessor should consider the feasibility of exercising its right of recovery as soon as possible, and appraise the leasehold to contain losses.

Furthermore, with respect to dismantling, transport, appraisal, auctioning and other expenses incurred in the retrieval and disposal of the leasehold, the lessor should consult the financial lease contract, and determine whether the lessee can be required to bear such expenses, and claim them as bankruptcy expenses or collective debts afterwards.

Apart from its own creditor rights, the lessor should examine the claims of other major creditors. Pursuant to articles 57 and 58 of the Business Bankruptcy Law, the administrator will register, bind and examine the claims declared by the creditors, prepare a form of the creditors’ rights, and submit it to the first creditors’ meeting for verification. In the course of verifying the claims, the lessor should pay attention to not only the administrator’s examination of its own claim, but also the inspection results of other creditors, including the amount, nature and security. The lessor should promptly raise any objection that they may have, or even institute legal action, to avoid impairing the solvency of its rights as creditors.

Maintain necessary contact with other creditors of the same class when formulating and voting on the reorganisation plan. In the course of the administrator’s formulation of the reorganisation plan, the lessor, as a financial institution with a relatively strong capacity to bear losses, may suffer certain impairment of its interests. Accordingly, it is imperative for the lessor to maintain necessary contact with the creditors of the same voting class for the draft reorganisation plan. The parties ought to strive for common interests and prevent the adoption of a reorganisation plan that materially harms their lawful rights and interests.

Chen Zhuo is a partner at Tian Yuan Law Firm. He can be contacted at +86 138 1041 7260 or by e-mail at chenzhuo@tylaw.com.cn

Wang Hao is an associate at Tian Yuan Law Firm. He can be contacted at +86 136 5118 1449 or by e-mail at wanghao@tylaw.com.cn