MNI INTERVIEW: China Bankruptcy Overhaul Would Tackle Zombies

China needs to overhaul its bankruptcy law to give lenders and borrowers a bigger say in restructuring debts, helping to extract more value from distressed assets and allowing unviable state-owned companies to be closed down, a former senior official at the predecessor body to the National Development and Reform Committee told MNI.

In a document in March 2019, the People's Supreme Court reaffirmed the rights of debtors to propose restructuring plans, but in practice they are, together with creditors, sidelined by the court-appointed trustees, usually lawyers and sometimes local government associates, who are appointed to oversee restructurings under current law. Often the trustees are unfamiliar with the companies to which they are assigned, and do little more than write off debts, said Xu Meizheng, who has founded Integrity Financial Counsulting since leaving the State Commission for Restructuring the Economic System, now know as the NDRC,, and has appeared at events on bankruptcy law sponsored by the People's Bank of China and the banking regulator.

"We need to restructure the economy, closing many zombie companies, but the current restructuring system saves them," Xu said in an interview, referring to the firms, usually state-owned, which only survive thanks to their debts continually being rolled over, usually at the behest of the local governments which control them.

"A good bankruptcy law should provide a fair platform for creditors and debtors for quarrels. The result then would be that debtors give up something and creditors and shareholders do the same and in the end the company may survive," said Xu, who noted that in the U.S. trustees are only appointed in bankruptcy proceedings resulting from fraud.

"In China, most of the banks are state-owned and certainly they can write off debts for distressed state-owned firms, just as an elder brother gives something to younger siblings. But the efficiency of state-owned assets doesn't improve that way," Xu said.

DEBTOR-IN-POSSESSION

Instead, she argues for debtor-in-possession rules such as those under Chapter 11 proceedings in the U.S., which allow companies undergoing bankruptcy to continue to operate and to raise capital, and which permitted the survival of General Motors in the aftermath of the 2008 financial crisis.

The rights of debtors are often ignored by Chinese courts and trustees, according to Xu, to the benefit of local governments with stakes in zombie companies. Some legal officials regard the debtor-in-possession approach as a foreign concept not applicable in China, she added.

"Most of the bad loans on banks' books are to state-owned enterprises," said Xu.

A rare example of an efficient restructuring of a state-owned enterprise came in 2019 in the case of Bohai Steel, which owed CNY287 billion to 105 financial institutions, when a strategic investor took over some assets and transformed most of the debts into equity, she said. However, the case did not go through the courts, and was instead handled by China International Capital Corporation, a leading state-owned investment bank, she noted.

Chinese banks may have to write off CNY3.4 trillion in non-performing loans by 2020, up nearly 48% from 2019, and the figure is likely to continue to grow next year, the chairman of the China Banking and Insurance Regulatory Commission, Guo Shuqing, told state-run Xinhua News Agency earlier in August.