new personal bankruptcy scheme has been welcomed by Chinese economists and the legal sector, the first time the government has proposed allowing individuals to declare bankruptcy. Wang Xinxin, a law professor from the Renmin University of China, told NewsChina that the scheme will plug a major loophole in the nation’s economic system.
In a recent reform plan released on July 16 by 13 agencies, including China’s top economic planner, the National Development and Reform Commission (NDRC), the central government said it would promote the establishment of a comprehensive personal bankruptcy system.
According to the plan, China will gradually promote reasonable liability exemptions for individuals when their consumer debt meets requirements. The reform will serve as part of a grander plan that focuses on the market entity withdrawal mechanism in order to root out zombie companies from the market and foster a more efficient economy, said the NDRC.
China’s current bankruptcy system was based on the Enterprise Bankruptcy Law, which became effective in 2007. From its name, one can tell that the law limits the scope of application of the bankruptcy system to enterprises considered to be legal entities. This excludes individuals. According to Wang, who also participated in the drafting of the law, there were heated debates among officials and experts at the time on whether the law should cover personal bankruptcy.
When the initial draft of the law, which did cover individuals, was submitted to the National People’s Congress (NPC), China’s legislative body, many lawmakers voiced objections, and the bill eventually took a very conservative approach which excluded personal bankruptcy, Wang said.
For Wang, much of the objection against a personal bankruptcy system lies in the concern that such a system would provide a way for debtors to evade their debts, especially when there was no established national credit system or transparent property registration system.
Other analysts also pointed to a mindset originating from the era of a planned economy that considers bankruptcy as a product of the capitalist world that can erode social ethics and is subject to fraud. Such a mindset was so deep-rooted that even enterprise bankruptcy was rather rare in the early years after the enterprise bankruptcy law was passed. For example, in 2012, barely 1,000 bankruptcies were filed to courts throughout China, a tiny figure considering some 800,000 firms were insolvent in the Chinese mainland that year.
But lately authorities have started to push forward the implementation of enterprise bankruptcy. In the three years between 2016 and 2018, the number of bankruptcy filings experienced an annual increase of 53.8 percent, 68.4 percent and 97.3 percent, reaching about 19,000 in 2018, but still a small figure in comparison to the 1.8 million companies that exited the market in 2018.
By the end of 2018, the People’s Supreme Court had set up 98 courts to deal with insolvency and bankruptcy cases. According to Wang, a major reason behind the authorities’ newfound enthusiasm for the bankruptcy law is the “implementation difficulty” courts have encountered in the past years.
According to official data, between 2016 and 2018, the court made rulings on some six million debt-related civilian cases each year, among which 43 percent could not be effectively implemented, mostly due to insolvency. The problem is so serious that the court released a separate report on the issue during the annual National People’s Congress session in each of the past three years.
A major approach taken by courts to solve the problem is promoting implementation of the bankruptcy law. According to the annual report of the People’s Supreme Court released in April, about 630,000 cases involving over 20,000 enterprises were transferred to bankruptcy courts in 2018. In the meantime, the government also set up a committee on amending the enterprise bankruptcy law in June, the primary focus of which was to specify bankruptcy procedures so courts can deal with bankruptcies more effectively and efficiently.
It is against this background that a personal bankruptcy system was put on the government’s legislative agenda. Wang said that the rationale is that enterprise bankruptcy alone cannot solve the implementation program. Wang estimated that about 70 percent of all cases that cannot go forward involved individual insolvency.
“Without a personal bankruptcy law, a company can go bankrupt or restructure, but the owner of the company will still be forever in debt due to collateral liability,” Wang said. “In many cases, they will just abandon the company and flee, and in some cases, resort to extreme measures including suicide, which could create social problems.”
Stressing that a personal bankruptcy system is a necessary part of a market economy, Wang said that for honest but unfortunate debtors, such a system can protect their basic rights and allow them a new start, and it will help their creditors by allowing seizures and distribution of the debtor’s assets.
“For the overall economy, it can improve the business environment that encourages innovation and promotes a sustainable economic order,” he said.
Following the NDRC’s announcement, there have been reports that pilot programs will be launched in selected areas in the second half of the year. But Wang, who was entrusted by the NDRC in June to lead a research team on the issue, said given that markets across different regions are connected, it would be very difficult to pilot the mechanism in just selected areas. It is not the first time pilot programs have been mooted. In 2014, authorities in Shenzhen, Guangdong Province, put the establishment of the personal bankruptcy system on its local law-making agenda. Considered a pioneer in institutional reform and policy experiments with a robust financial sector, the city was considered the best one to introduce a personal bankruptcy system. But no legislation was ever forthcoming.
According to Lu Lin, a Shenzhen lawyer specializing in insolvency and bankruptcy, the major obstacle lies in concerns over the discrepancy between the national market and regional bankruptcy laws. For example, authorities are concerned that a local personal bankruptcy law may attract unwanted incomers from other areas who only seek to go bankrupt in the city. Other issues, such as whether a bankruptcy ruling made by a court in Shenzhen can be recognized by other cities, contributed to the reluctance of city officials to push forward the initiative.
But for Lu, who is a leading advocate for the bankruptcy system, these problems can only be identified and solved after a personal bankruptcy system is in position. “It’s a chicken and egg situation. Without experimenting with the system first, you can never find the solution.”
Wang argued that the government should take a holistic approach toward the issue as it needs a multiagency and multidisciplinary approach. “A solid personal bankruptcy system will require more than just a bankruptcy law. It has to be supported by taxation policies, financial institutions, the credit management system, social security system and law enforcement agencies,” he said.
With or without pilot programs, Wang estimated that given the personal bankruptcy system is still in the feasibility study phase, it will be several years at least before people in China will be allowed to go bankrupt.