A Chinese enterprise may go bankrupt if both of the following conditions are met: first, it fails to pay its debts as they fall due; and second, its assets are inadequate to pay off all debts or it is clearly insolvent.
This post was first published in CJO GLOBAL, which is committed to providing consulting services in China-related cross-border trade risk management and debt collection. We will explain how debt collection works in China below.
1. What is failure to pay off debts as they become due?
For an enterprise to fail to pay off debt as it falls due, three conditions shall be satisfied:
(1) The debt exists;
(2) The debt has become due; and
(3) The debtor has not repaid the debt in full.
Whether the debt exists is sometimes disputed between the creditor and the debtor. In practice, courts accepting bankruptcy cases often require the creditor and the debtor to formally confirm the debt through a lawsuit.
2. What is insufficiency to pay off all debts?
The conditions for bankruptcy are met when a Chinese enterprise is unable to pay off the due debts and at the same time has insufficient assets to settle all its debts.
The court usually requires the debtor to provide financial statements such as its balance sheet to prove whether it is able to pay off all its debts.
If the debtor’s financial statements show that all of its assets are insufficient to pay off all its debts, the court shall determine that the debtor has insufficient assets to pay off all its debts.
In addition, in practice, if an enterprise has negative net assets on its balance sheet as a debtor, it is presumed to have insufficient assets to pay off all its debts.
3. How to determine apparent insolvency?
When a Chinese enterprise is unable to pay off its due debts, even if its balance sheet does not show negative net assets, it may still be found to be qualified for bankruptcy in one of the following circumstances in which it is clearly insolvent:
(1) It is unable to repay debts due to a serious lack of funds, impossibility to realize its assets, or any other reason;
(2)It is unable to repay debts because the whereabouts of its legal representative are unknown and there is no other person in charge of asset management;
(3) It is unable to repay debts even after enforcement by the court;
(4) It is unable to repay debts because of long-term losses and difficulty in recovering from them; or
(5) Other circumstances leading to the debtor’s insolvency.
When a Chinese enterprise falls into one of the five circumstances, the court can find that it is clearly insolvent.
The third circumstance deserves special attention. In practice, where an enterprise is unable to pay off its due debts and is clearly insolvent, and the debtor “is unable to repay debts even after enforcement by the court” in cases entering enforcement proceedings, the creditor may apply to the court to convert the enforcement case into a bankruptcy case.
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Contributors: Meng Yu 余萌