Payment of debts to individual creditors (hereinafter also referred to as “individual payoff”) refers to the debtor’s payment to individual creditors when the debtor is already subject to bankruptcy because of a certain reason. The P.R.C. Bankruptcy Law endows bankruptcy administrators the right to revoke such payment to individual creditors; in other words, after the bankruptcy proceedings begin, the bankruptcy administrator petitions with the people’s court to revoke the bankruptcy debtor’s acts committed within a statutory period prior to the bankruptcy proceedings that jeopardize the creditor’s interests, and return the property profits generated by such acts to rights over the bankruptcy properties. The right of revocation is to ensure that all creditors will be paid from the bankruptcy properties on a justified basis, and presents the irreplaceable role played by the bankruptcy system. The recently promulgated judicial interpretations add more restrictive conditions to individual payoff made by bankruptcy administrators through judicial proceedings, which will be covered in the following discussions:
- Provisions on Exercising the Right to Revoke Individual Payoff under the Bankruptcy Law
Article 32 of the P.R.C. Enterprise Bankruptcy Law provides as follows: Within six months before the People's Court accepts the application for bankruptcy, if the debtor is in any of the circumstances set forth in Article 2.1 of this Law but still pays off debts to individual creditors, the administrator is entitled to request the People's Court to revoke the payoff unless the debtor's property benefits from such payoff. Article 2 of the same law provides as follows: Where an enterprise legal person is unable to pay off its debts due, and its assets are not sufficient to pay off all its debts or such legal person is obviously insolvent, its debts shall be liquidated in accordance with this Law.
Based on the foregoing provisions, the administrator should meet the following four conditions before exercising the right of revocation: (1) Timing: within six months before the court accepts the application for bankruptcy; (2) Conditions for the behavior: payoff to individual creditors; (3) Property conditions: the debtor is subject to bankruptcy for a certain cause; and (4) An additional requirement: the payoff does not benefit the debtor’s property. Since these four conditions do not involve the debtor’s subjective conditions, i.e., legislation does not consider whether or not the debtor or the paid-off individual creditors have bad faith, but simply and objectively comment on whether or not the right of revocation in bankruptcy can be exercised. Meanwhile the bankruptcy law does not restrict the means through which the debts are paid off, i.e. it does not matter whether such payoff is made voluntarily or compelled through judicial proceedings; as long as payoff to individual creditors exists, the behavior condition under the foregoing provisions will be satisfied.
- Provisions of the Judicial Interpretations on Exercising the Right to Revoke Individual Payoff Caused by Judicial Proceedings
Article 15 of the Provisions of the Supreme People's Court on Several Issues Concerning the Application of the Enterprise Bankruptcy Law of the People's Republic of China (II) provides as follows: With regard to debtor's payoff to individual creditors through litigation, arbitration and enforcement procedures, if the administrator petitions for revocation of such payoff in accordance with Article 32 of the Enterprise Bankruptcy Law of the People's Republic of China, the people's court shall not support such petition, unless the debtor collaborates with relevant creditors in bad faith to jeopardize the interests of the other creditors. According to the Supreme Court’s explanations of the provisions, the payoff herein actually covers two aspects: (1) after the court’s civil judgment, civil mediation decision or arbitral award comes into effect but before the enforcement procedure is initiated, the debtor voluntarily performs the payment obligation under such effected judgment, decision or award and thereby forms the individual payoff; and (2) after the foregoing judgment, decision or award comes into effect, the creditor initiated the enforcement procedure in accordance with the law, and the debtor is therefore compelled to perform the payment obligation, which also forms the individual payoff.
According to the foregoing judicial interpretation provision, within the period allowing exercise of the right of revocation set forth in Article 32 of the Bankruptcy Law, if a creditor is paid off through the litigation, arbitration or enforcement procedure, the administrator will not be able to exercise the right of revocation in accordance with the same article, unless there is evidence to prove the parties have bad faith in the payoff.
This judicial interpretation provision restricts exercise of the right of revocation under the Bankruptcy Law: in the event of individual payoff through judicial proceedings, whether or not the parties had bad faith is an additional condition for determining whether the administrator can exercise the right to revoke the payoff. Accordingly, if no evidence of bad faith is available, neither the debtor’s voluntary payoff in accordance with the judgment, decision or award nor the compelled payoff by the enforcement procedure initiated by the creditor is revocable. In other words, it is likely that the ordinary creditors can receive full payment that they cannot obtain through the bankruptcy proceedings, which results in that creditors with equal amounts of debt and in equal positions are not equally paid in the end.
- Exactly Opposite Views in the Draft Version for Comments and the Formally Promulgated Version of the Judicial Interpretations
Article 14-1 of the Draft for Comments of the Provisions of the Supreme People's Court on Several Issues Concerning the Application of the Enterprise Bankruptcy Law of the People's Republic of China (II) provides as follows: where a debtor makes an individual payoff for the purpose of performing an effected judgment, a mediation decision or an arbitral award, if the administrator petitions to revoke such payoff, the people’s court shall support such petition. Article 14-2 of the Draft further provides as follows: where a debtor makes an individual payoff compelled by the relevant enforcement action, if the administrator petitions to revoke such payoff, the people’s court shall support such petition. Based on the Draft for Comment, the courts used to hold that in general circumstances individual payoff based on an effected judgment or an enforcement action can be revoked; however, the formally promulgated version sets forth provisions exactly opposite to the foregoing views, which was probably because a denial of revocability of effective judgments and enforcement actions finally prevailed. According to such a view, the right of revocation in bankruptcy applies to civil acts between civil subjects, while the enforcement action is an act out of public power, and consequently holding the enforcement action as the target of the right of revocation does not conform to the conditions for exercising such a right. Furthermore, if a civil act is confirmed in an effective judgment or decision and has already been performed, and if a petition is still made to revoke such an act, then the basic relationship on which the effective judgment or decision confirming the civil act relies will be changed and it will be difficult to determine the validity status of the effective judgment or decision. In conclusion, it will be inappropriate, whether the target of the revocation is a civil act or an enforcement action.
- The Author’s Views
- Since it is the act of payoff which is revoked, the confirmation effect of the debts is not denied; consequently, the validity of effective judgments will not be affected.
Both payoff voluntarily made by the debtor for the purpose of performing an effective judgment and payoff compelled in the enforcement procedure initiated by the creditor include two links: (1) confirmation of the debt; and (2) payment of the debt. The revocation prescribed in Article 32 of the Bankruptcy Law is targeted at payment of the debt; in other words, the administrator does not petition to revoke the effective judgment or decision, but instead the payoff to individual creditors. Consequently, such revocation will not affect the finality and authority of the effective judgment or decision, the rechtskraft and the binding power of which will remain unchanged after the revocation. The only change lies in the means that the enforcement power is exercised, i.e. the original individual enforcement will become enforcement through the collective bankruptcy proceedings ; the creditor can claim their rights through the debts declaration procedure, and include the individual enforcement into the bankruptcy proceedings for fair allocation.
- The judicial interpretations restrict the administrator’s exercise of the right of revocation, which conflicts the basic principle of fair repayment under the bankruptcy law.
The judicial interpretations impose restrictions on the administrator’s exercise of the right of revocation, i.e. only when the debtor and the creditor have malicious conspiracy to jeopardize the interests of the other creditors will the administrator be able to exercise the right to revoke the effective judgment or decision or the enforcement action. Nevertheless, the judicial interpretations do not provide a further definition for the term malicious conspiracy, for example, can malicious conspiracy be established as long as there is evidence to prove that the debtor is already aware of the cause of bankruptcy but still repays the debt to an individual creditor? Can malicious conspiracy be established if the creditor is an affiliated enterprise of the debtor or has a special relationship with the debtor? Should the evidence be produced by the debtor or the repaid creditor? Such a lack of explicit provisions will necessarily cause difficulties for the administrator’s exercise of the right of revocation. Furthermore, an enforcement action taken by the court based on local protectionism or a conspiracy between the creditor and the court can also lead to individual payoff and cause damages to the other creditors; however, since the debtor is obviously not involved in such malicious conspiracy, the administrator cannot exercise the right of revocation because the precondition for exercising the right to revoke effective judgment or decision or enforcement action under the judicial interpretations is not satisfied.
If the administrator cannot effectively exercise the right of revocation, it means that different proportions of repayment will be determined in different proceedings (i.e. litigation and bankruptcy), and consequently no impartiality can be reflected. One basic principle of the Bankruptcy Law is fair repayment for creditors, which means that creditor’s rights of the same nature and in the same amount should be repaid at the same proportion. Article 32 of the Bankruptcy Law was actually formulated to ensure the creditors’ right of fair repayment to a larger extent, and consequently there should be no exceptional circumstance because of intervention of any public power. The consequence caused by application of the judicial interpretations will be in conflict with the basic principle of the Bankruptcy Law.
- Application of the judicial interpretations will likely cause contesting lawsuits and “bankruptcy” of the bankruptcy mechanism.
Generally speaking, if the voluntary payoff based on an effective judgment or the enforcement action cannot be revoked, it will surely lead to that the creditors claim their rights by filing different lawsuits, which will in turn quickly divide up the debtor’s property and when actually entering the bankruptcy proceedings, no property will be available for allocation and the creditors will lose the opportunity to fair repayment and cannot recover the property by the right of revocation. For the creditors, now that they can obtain excessive repayment through the litigation proceedings, they surely will not initiate the bankruptcy proceedings, which will likely lead to “bankruptcy” of the bankruptcy mechanism.
The most important principle of the bankruptcy law is fair repayment, and such fairness should more be reflected in substantive rights, i.e. the repayment proportions of the creditors. If an individual creditor is excessively repaid through irrevocable judicial proceedings, it will be obviously unfair to the other creditors and will cause a massive impact on the bankruptcy mechanism. For these reasons, the author believes that the provisions on the right to revoke individual payoff through judicial proceedings in the judicial interpretations are inappropriate.