Chinese Bankruptcy Law in an Emerging Market Economy: The Shenzhen Experience

In 1986, the People’s Republic of China (“China”) enacted its first national bankruptcy law, the Law of the People’s Republic of China on Enterprise Bankruptcy (Trial Implementation) (the “Chinese Bankruptcy Law”), as part of an emerging legal framework for the country’s transition from a planned economy to a market economy. At the time of its enactment the bankruptcy law was considered a significant political and economic breakthrough that was necessary to apply some market pressure on China’s State-Owned Enterprises (“SOEs”) to force them to become more efficient. However, the rapid development of economic reforms in China soon exposed serious limitations in the Chinese Bankruptcy Law. First of all, the law applies only to SOEs and not to Chinese economic organizations generally. Secondly, since the law was enacted before China pursued further economic reforms beginning in 1993, many of the bankruptcy law provisions guaranteeing government involvement and control began to conflict with the introduction of market-centered rules. Thirdly, relatively few bankruptcy cases have been brought under the 1986 law. At first glance, this low number appears surprising given the weak financial position of SOEs generally. For example, a national survey in 1997 of 14,923 large and mid-sized SOEs revealed that 40.5% were in the red with total losses of RMB 58.9 billion; and the situation in 1998 was even worse. Although SOE performance improved throughout 2000, the non- performing loans owed by SOEs to state-owned banks are still estimated to be 25-50% of their total lending. These figures demonstrate that before the Chinese Bankruptcy Law can be “strictly” applied to all insolvent SOEs, the Chinese government must first address two other related problems: (1) the massive level of unemployment that would result and its potentially destabilizing effect on social stability,7 and (2) the possible collapse of China’s state-owned banks.