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China: solving the zombie problem

Earlier this year the Supreme Court of China announced the PRC’s vision for a modern bankruptcy regime to rid the nation of zombie businesses while resuscitating healthier ones, which may affect winding-down of businesses in the PRC and impact non-PRC creditors.

A “zombie company” generates funds but after covering running costs only yields enough profits to cover the interest due on their debts, and not service the debts themselves. They rely on their creditors being satisfied to refrain from bringing insolvency proceedings, effectively postponing the recovery of the principal sums due. The creditors in question are often banks that are prepared to keep the companies on life support indefinitely.

Chinese officials have previously been less willing to take steps such as cutting cheap credit and subsidised utilities to state-owned companies, supervising proper dividends, and dissolving companies incapable of rehabilitation as these zombie companies continue to provide revenue and essential employment.

However, the new regime will require Chinese courts to recognise the judgments of foreign courts in insolvency or bankruptcy cases pursuant to the various international treaties to which China is a party, or under the principle of reciprocity. Though it represents a step in the right direction for cross-border cooperation in the PRC, there is still little detail as to how individual cases should be decided. The decision in Sino-Environment Technology Group Limited v Thumb Env-Tech Group (Fujian) Co Ltd helps draw a clear line in the sand when taken with the new regime: the Chinese courts will not permit companies that are not financially viable to continue, and will not erect barriers to the recognition and enforcement of foreign insolvency proceedings.

For external investors in businesses with assets in China (particularly state-owned enterprises, as these make up the bulk of the zombie companies), there is a significantly lower risk of finding assets of the debtor squirreled away by unscrupulous shareholders or managers, or that Chinese creditors of the same status will be able to recover more than them. This should promote greater confidence when investing into the PRC.

Find full article HERE.

 

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