An insolvent enterprise incorporated in Mainland China (“PRC”) or its creditors (“Applicant”) may institute a bankruptcy proceeding against the insolvent enterprise under the PRC Enterprise Bankruptcy Law (“Bankruptcy Law”) by the filing of a bankruptcy petition. There have long been complaints by industry practitioners that PRC courts are reluctant to register bankruptcy petitions. Against that background, the Supreme People’s Court (“SPC”) issued a guidance notice[1] (“2016 SPC Notice”) in July 2016 to streamline and standardise the administrative procedures for the registration of bankruptcy petitions.

SPC Notice: Enhanced administrative procedures

Under a series of regulations and opinions issued by the SPC in 2015 (“2015 SPC Notices”) [2], the SPC sought to streamline the court filing and registration system by requiring PRC courts to register a petition after conducting a “formality examination” of the petition. We understand the 2015 SPC Notices were intended to cover civil, criminal and administrative proceedings in general (without a specific mention to bankruptcy proceedings), which caused different implementation approaches across the PRC[3].

For the purpose of clarification and to deal with the backlog of bankruptcy cases, the SPC issued the 2016 SPC Notice which prescribes the procedures for the registration of bankruptcy petitions.

Under the 2016 SPC Notice, with effect from 1 August 2016, the registry unit of a PRC court is expressly required to:

  1. upon the filing of a bankruptcy petition by an Applicant, issue a written acknowledgement of receipt;
  2. conduct a formality examination of the bankruptcy petition pursuant to Article 8 of the Bankruptcy Law; and
  3. following such formality examination, if the court is of the view that the materials submitted by the Applicant (“Application Materials”) conform to the relevant legal requirements, register the bankruptcy petition immediately and then pass the case to the bankruptcy tribunal unit of the court in a timely manner.

Article 8 of the Bankruptcy Law provides that a bankruptcy petition filed by a third party Applicant shall set out the following information items (“Necessary Items”):

  1. the basic information about the Applicant and the debtor;
  2. the purpose of the bankruptcy petition;
  3. the facts and reasons of such petition; and
  4. other matters considered necessary by the court.

The Necessary Items, and their application in the context of bankruptcy proceedings have applied for years across the PRC. The filing procedure is intended to be an administrative and formal assessment of the forms that are lodged, but does not involve a review of the merits of the petition by the relevant court registry unit (the function of court registry units is described below).

The proposed registration system prescribed in the 2016 SPC Notice is not an isolated initiative by the SPC, but rather an embellishment and integral part of the SPC’s on-going initiative since 2015 to streamline the filing system for judicial petitions.

The 2016 SPC Notice – Context

A proper interpretation of the 2016 SPC Notice requires context in order to assess its implications.

Based on the experience of our PRC bankruptcy practitioners, the 2016 SPC Notice is generally regarded by onshore legal practitioners (including judicial officials) as the SPC’s intention to streamline the registration procedure for bankruptcy petitions. Court registry units (which conduct the formality examination of petitions) is an administrative department whose function does not involve a substantive case assessment. The substantive assessment of the merits of a bankruptcy petition sits with a separate court department, being the bankruptcy tribunal unit. The formality examination undertaken by a court registry unit is a purely administrative step to ensure that the Application Materials contain the Necessary Items (without assessing the merits thereof).

Bearing in mind this background, and its practical impact on judicial cases generally, the formality examination of a bankruptcy petition is unlikely to involve any substantive screening of a case as part of the registration of a petition. The policy intent is set out in Article 1 of the 2016 SPC Notice which provides that the courts “shall not impose any additional conditions other than the legal conditions, restrict a party’s right to make a bankruptcy petition, obstruct the registration and acceptance of a bankruptcy petition, or influence the normal commencement of a bankruptcy proceeding”.

Is the 2016 SPC Notice designed or intended to reject frivolous petitions?

Frivolous bankruptcy petitions have long been a cause of concern for financial institutions which have elected to apply automatic early termination (“AET”) against PRC enterprises (“PRC Counterparties”) under a master agreement for derivatives transactions (such as the ISDA Master Agreement) (for example, when a PRC Counterparty becomes insolvent).[4] There have been concerns that AET could be triggered easily if a third party creditor files a frivolous petition against a PRC Counterparty.

Following the publication of the 2016 SPC Notice, there are suggestions that the implementation of the 2016 SPC Notice will cause frivolous petitions to be rejected. We don't think the 2016 SPC Notice is intended to provide that comfort.

Should parties to an ISDA Master Agreement adopt the registration of bankruptcy petition as the trigger for AET?

It is possible that some market participants may prefer to adopt court registration (as opposed to a filing of bankruptcy petition) as the trigger for AET. But parties need to bear in mind that:

  1. The 2016 SPC Notice has not been strictly implemented at all court levels across the PRC. In particular, the enhanced administrative procedures may only be implemented by higher level courts in major cities (such as Shanghai and Beijing) but not necessarily in other parts of the PRC.

    Accordingly, deeming court registration as the trigger for AET may expose the non-defaulting party to additional risks if the court does not register a bankruptcy petition but rather accepts the petition without registration.

  2. The 2016 SPC Notice requires a PRC court to immediately register a petition upon the on-site submission of a petition following an (administrative) "formality examination" (which does not involve any substantive assessment of the merits of the relevant petition but rather checking of the Necessary Items). There is generally no substantive time lag between the timing for the filing of a petition and a court’s registration of the petition, nor is there any examination in that period of the merits of the petition. Therefore, linking an AET with court registration does not reduce the risk of a frivolous bankruptcy petition.

Closing remarks

We recommend that market participants read the 2016 SPC Notice in the context in which it has been issued in order to assess whether to adopt the filing, or registration, of a bankruptcy petition as the trigger for AET.

We encourage derivatives market participants to continue monitoring closely the onshore regulatory and judicial developments and other on-going industry-led initiatives with respect to close-out netting issues under PRC law.