Bankruptcy & Insovency

OFFICIALLY, only a few thousand companies will declare bankruptcy this year in China. Unofficially, local manufacturing groups believe many more than that will go out of business in the southern province of Guangdong alone. And the underlying causes—falling demand for exports, higher material costs, stricter labour laws—are hardly unique to that province. But in contrast to Europe and America, where business failures are meticulously tracked, the only trace left by most of these firms will be rusting locks on their old front gates.

This is because Chinese business owners who wish to shut down their companies have three options: to reach informal agreements with employees, trading partners and the government; to file under the auspices of a court; or to walk away. Each has its drawbacks.

A Shenzhen manufacturer who recently tried to close by informal agreement describes the process as almost impossible. He had to negotiate separately with over a dozen government agencies, including tax, labour and even the fire department; each had demands that changed by the day. Then there were skittish suppliers, one of whom blockaded his firm’s entrance. “Everyone just wanted more money,” he says. “That is why most people just shut down overnight.” The only thing everyone agreed on was the need to avoid the local courts.

Last year a new bankruptcy law came into effect, but it is incomplete and poorly understood. Even firms that might recover by restructuring under court protection are reluctant to use it, says Helena Huang of Kirkland & Ellis, a law firm. In the past, bosses often preferred to run a business down to its last yuan before acknowledging problems, at which point there was little to reorganise. Even under the new law, it is unclear whether lenders who step in after a bankruptcy have priority over old claims, undermining any incentive for a would-be backer to give a firm a second chance.

As a result, any reorganisations that do take place often happen informally. One local municipal government, Ms Huang says, recently bailed out a big local firm because it feared that a collapse would harm local jobs and its own reputation—and this is hardly uncommon. There are quiet bail-outs, she adds, even among publicly listed companies.

More than 30 companies on the national stockmarkets have recently failed, says Alan Tang of Grant Thornton, a consultancy. But in many cases control has been acquired by other firms to engineer a “backdoor listing”, without the lobbying and delays common in China. Evidently some Chinese entrepreneurs continue to believe that a listed firm’s ability to raise public capital is worth having—if not now, then one day.

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