One of the most frequent complaints heard from foreign firms involved in arbitration or litigation against a Chinese company is the difficulty to collect after a judgment in their favor.
A typical situation goes like this: There is a dispute, for example a WFOE sells products to a Chinese company, yet the Chinese company fails to pay the purchase price as agreed. The WFOE takes the non-paying company to court, or arbitration, and because they have a clear and effective Chinese contract drafted by a China lawyer, and have a well preserved chain of evidence, the WFOE wins at court over the protestations and indignation of the Chinese company.
Typically, the Chinese company will have 10-15 days to comply with the ruling by paying the WFOE the ordered amount of damages. But often, the Chinese company refuses to pay, forcing the WFOE to bring a new enforcement proceeding at court. The Court in the enforcement proceeding has the power to freeze, access and distribute funds found in the bank account of the Chinese company… so long as the WFOE can provide evidence of the correct bank account number.
Sometimes this enforcement process is successful; often the court finds an empty bank account as the Chinese company has transferred and withdrawn as much funds as possible in anticipation of the Court’s enforcement action.
What is the WFOE to do? Is the court’s favorable judgment and award meaningless?
In this situation, the Chinese company has become a debtor to the WFOE, and as such the PRC
Enterprise Bankruptcy Law
offers a potential solution. According to the
Enterprise Bankruptcy Law
, a creditor has the right to apply for the bankruptcy of a debtor where that debtor is unable to pay debts owed. Relevant People’s Supreme Court of China interpretations have stated that the inability to pay debts at an enforcement proceeding before the court meets the criteria allowing the creditor to initiate bankruptcy.
The initiation of bankruptcy serves as a strong incentive for the debtor company and its principles to relent and pay the court judgment.
- In bankruptcy, as may be expected, the debtor company cannot continue normal operations. At the start of bankruptcy, the court will appoint an administrator to take over operations of the company. The administrator will assume control over the debtor’s property and assets and will be entitled to rescind or continue the performance of ongoing contracts per the administrator’s decisions on the benefit to the company.
- The court will further impose restrictions on the Legal Representative and management personnel of the debtor company. This may include a court order that these individuals may not leave their area of domicile without court approval. They will also likely be prohibited from undertaking any new management positions in any other companies (which they may seek to establish as part of efforts to avoid the bankruptcy proceeding). They will be obligated to maintain and report to the court regarding the status of the debtor company’s property, financial records, official documents, company seals and other official items and information of the properties. These persons would face fine or detention by the court if they refused to comply with these bankruptcy procedures.
Being forced to bring a bankruptcy proceeding against a company that owes you money is of course not ideal, but these restrictions put pressure on the debtor company which may allow for the ideal resolution of the Bankruptcy. When faced with the court assuming control of the company and reviewing its financial and accounting information; the attitude of those which have been resistant to payment after the initial judgment or the enforcement proceeding will likely change. If they do so, and the court is satisfied that there are no remaining unpaid creditors, the court has the authority to end the bankruptcy proceeding.
As is often the case in China, legal compliance is not found by simply presenting someone with the law. Compliance is often resisted until an actor feels the direct authority of the law and the impending threat of real consequences.