New China Chapter 11, but not so much Chapter 10

Via WSJ:

In the trenches of China’s debt-addled economy, the government has made a startling decision: Let companies fail. That has left creditors angry, debtors fighting to save their businesses and judges on a mission to promote the benefits of bankruptcy.

After years of pumping out financial support to keep the economy humming and workers happy, China has embarked on a debt reckoning. Beijing is building a bankruptcy system to take on a significant pickup in corporate defaults. The country now has more than 90 U.S.-style specialized bankruptcy courts to help sort through a morass of corporate debt that, until recently, would have been swallowed by state banks and other creditors.

It is a sign that Beijing is worried about the number of failing companies and trying to find a fix. The system is helping, many lawyers, foreign investors and lenders say, as it takes some pressure off local governments that lack the resources for so many bailouts.

The bankruptcy system in China, drawing on U.S. chapter 11 provisions, aims to allow companies to restructure under court protection to keep businesses alive and pay creditors over time.

China’s system differs significantly in at least one respect: Bankruptcy courts here sometimes are inclined to protect shareholders over debtholders — with the aim of averting social unrest.

Reorganizing or liquidating companies is proving to be a messy process in many cases, marred by disagreements, protests and disarray in a country with a steep learning curve in the bankruptcy process.

Last year more than a thousand people, including judges, bankers, home buyers and employees packed into a university auditorium here in China’s northwest to hear how a court-appointed law firm would sort through more than 7.5 billion yuan ($1.07 billion) in claims against a failed real-estate company.

Failure Is an Option Chinese courts are processing more bankruptcies at a faster pace. Number of bankruptcy cases, by year Source: Supreme People’s Court of China
Accepted/Completed: 2008 ’10 ’12 14’ 16 ’18 — 5,000 – 10,000 – 15,000 20 – 20,000

Hundreds of police officers and security personnel stood watch because of fears that grievances would turn to violence. About 7 miles away, a 21-building complex had stood unfinished since late 2014 after the company sold thousands of apartments and storefronts and then defaulted on its debts.

Liu Changyun, now 50 years old, paid roughly 600,000 yuan ($84,700) in 2013 for a storefront in the hopes of opening a small restaurant in the complex. She is still waiting, selling food from a cart nearby. “I own nothing in my whole life but this,” she said recently.

China introduced formal bankruptcy laws in 2007. But courts routinely rejected applications from struggling businesses and their creditors because of concerns over potential social unrest and large-scale layoffs.

Many insolvent companies chugged along with state subsidies and loans from state-owned banks. Some simply walked away from their debts, leaving creditors hanging.

Beijing is trying a new tactic. Most of the country’s bankruptcy tribunals have opened since 2015. New courts were added this year in Beijing, Shanghai and Shenzhen. Court-appointed administrators—law firms and accounting firms that help verify claims, organize creditors’ meetings, list and sell assets—increasingly make use of China’s online culture, as authorities look to handle more cases and process them faster.

After a decade of rapid expansion and heavy borrowing, China’s growth is slowing. Courts nationwide accepted close to 19,000 corporate bankruptcy filings in 2018, more than triple the number two years earlier.

They included the reorganization of steelmaker Bohai Steel Group Co., which buckled under more than 200 billion yuan ($28 billion) in debt—the largest failure of a state-owned Chinese enterprise in years. Some of Bohai’s assets will be taken over by another steel company and creditors are in the process of being repaid partially or in full.

Authorities “sensed the economic slowdown and that weaker companies would not survive, and needed a mechanism to deal with that,” said Ron Thompson, a managing director of restructuring and advisory firm Alvarez & Marsal who has worked in China for close to three decades.

Concerns grew last year amid the U.S.-China trade conflict. In an opinion piece published in a state-run media outlet, Du Wanhua, a high-ranking official at the Supreme People’s Court of China, said higher trade tariffs could lead to more bankruptcies. The courts should start “repairing the house before it rains,” he wrote, using a traditional Chinese phrase.

We’ll follow this pretty closely and have more to report shortly. Non-relevant updates: (1) Xi and Lam get together. (2) fentanyl equals jail, which is excellent, though we don’t know what that drug really does. (Hey man, put on those Grateful Dead and Pink Floyd albums again.)

2 Responses to “New China Chapter 11, but not so much Chapter 10”

  1. Neil Says:

    Steps like real bankruptcy law are absolutely necessary for China to ignite real economic growth. But there are still two questions: Will such mechanisms be more-or-less impartially administered, and can the central government retain the Mandate of Heaven through the declining side of a debt cycle?

    I think events in Hong Kong are giving us a hint that the answer to the latter may be negative. Beijing would have crushed the HK protests long ago, if they could do without HK financial firms. Crashes in a command economy don’t look the same as crashes in a free market economy, but crashes they are nonetheless.

  2. feeblemind Says:

    yeah. The bankruptcies are a good thing, though one wonders about cultural blowback and whether or not they are coming too little and too late?

    It will be interesting to watch.

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