Microlender decline raises bankruptcy route dilemma

Like mushrooms after rain, China’s microloan companies sprouted and expanded exponentially after the 2008 publication of the Guiding Opinions of the China Banking Regulatory Commission and the People’s Bank of China on the Pilot Operation of Small-sum Loan Companies. But after 2015, the sector appeared to hit a bottleneck.

Between that peak and the end of June 2021, the number of China’s microloan companies shrank from 8,951 to 6,686, and the loan balance decreased from RMB959 billion (USD150 billion) to RMB887 billion.

What caused the sudden shift in momentum? For one thing, banks that were facing trouble with their financing channels and a tightening-up economic environment, defined microlending as a high-risk industry and limited its credit. For another, there is the interest rate cap. On 20 August 2020, the Supreme People’s Court (SPC) revised the upper limit of judicial protection for private lending interest rates to four times the loan prime rate, or 15.4%, significantly lower than the previous benchmarks of 24% and 36%. In addition, competition within the industry gradually ate away the market share of microloan companies. Finally, small and micro-sized enterprises and individual businesses, the primary client base of microloan companies, are often less resilient to risks and have low incomes. This means microlenders face an additional burden in recovering outstanding loans, just as their own credit position has become harder – even if they are extending more new loans. Obviously, the industry cannot revive until outgoings are balanced with incomes.

To make matters worse, many debtors have reported microloan companies to the authorities for issuing “trap loans” since the joint release in October 2019 of the Opinions on Several Issues Concerning Handling Illegal Lending Criminal Cases by the SPC, the Supreme People’s Procuratorate, the Ministry of Public Security and the Ministry of Justice.

The question is, if a microloan company is in financial turmoil, is it possible for creditors to protect their own lawful interests by applying for “enforcement to bankruptcy”, forcing an asset reallocation after liquidation of the microloan company, in accordance with the relevant provisions under the Guiding Opinions on Several Issues Concerning the Transfer of Enforcement Cases for Bankruptcy Examination and the Enforcement Procedures in the Application of the Civil Procedure Law issued by the SPC?

CASE ILLUSTRATION

Starting from 2011, company A, a microlender and the respondent, received a series of loans amounting to RMB35 million from Zhang, the applicant. Wang, the general manager of company A, bore joint and several liability for the principle and interest. On maturity in one year and after multiple attempts to recover the loan, Zhang filed a lawsuit.

The court, after two rounds of hearings, supported Zhang’s claim for approximately RMB45 million in principle plus interest, borne jointly and severally by Wang. During the lawsuit, company A recorded a heavy fiscal deficit due to certain management members and financial staff embezzling company property.

As if that wasn’t enough, due to unsound risk control with the microloan business, a significant amount of company A’s outstanding receivables could not be recovered in a timely fashion, completely disrupting its operations. In view of the situation, Zhang requested a court enforcement. However, with barely any cash assets or other realisable fixed assets other than its vast amount of outstanding receivables, company A was simply unable to pay Zhang back in time. In response, Zhang applied for the bankruptcy of company A to cover its debt.

Focus of dispute: Company A suffered from massive debts but had little in the way of tangible assets at hand to enforce a repayment, although it did have a great amount of receivables. Does it fulfill the conditions for bankruptcy and liquidation? And can the court cease the enforcement process and go into bankruptcy instead?

Ruling: The court decided not to accept Zhang’s application for company A to enter bankruptcy and liquidation, holding that the relevant conditions were not fulfilled in this case according to the Enterprise Bankruptcy Law (EBL) and other laws and regulations.

Enforcement update: Company A honoured its commitment, requested by the court, to prioritise repayment to Zhang with its receivables and gradually paid him back with its own recovered loans. At present, the majority of Zhang’s creditor’s rights have been satisfied.

Case analysis: When Zhang applied for company A to enter bankruptcy, the struggling company did ostensibly match the characteristics and circumstances described under article 2 of the EBL. However, when analysing the situation, the court did not apply the EBL and its judicial interpretations of bankruptcy by rigidly following the literal provisions.

Instead, by assessing company A’s financial dynamic, it recognised that the company had a vast amount of receivables, and it stood a reasonably good chance of eventually overcoming its liabilities with total assets in hand. Furthermore, since company A’s receivables were partially secured by collateral, the recovery of such debts was considered likely and expectable. For these reasons, the court rejected Zhang’s application.

By analysing this case, the author reached the conclusion that, when handling “enforcement to bankruptcy” cases, courts are advised not to instinctively accept bankruptcy applications without comprehensively considering the company’s financial status. It is through sound analysis, not inflexible observance of provisions, that a favourable decision could be reached to protect the interests of all parties involved. Likewise, when dealing with such cases, lawyers must properly strategise after surveying all aspects of the parties, in order to minimise professional risks and effectively safeguard clients’ lawful interests.

Liu Shanqiao is a senior partner at ETR Law Firm