Photographer: Johannes Eisele/AFP via Getty Images

Chinese Leaders Back Bankruptcies for Unwanted Zombie Firms

  • Courts accepted 5,665 bankruptcy cases in 2016, up 54%
  • Concerns remain about government influence on cases: Deloitte

China is getting serious about dealing with so-called zombie companies through court-led bankruptcies as it seeks to cut overcapacity in industries and boost economic growth.

The country’s Chief Justice Zhou Qiang said at the National People’s Congress Sunday that authorities will improve the country’s judicial system for dealing with bankruptcies in 2017 to support those goals. Chinese authorities are devoting more resources to tackle corporate restructurings and bankruptcies as bad debts at banks soared to an 11-year high in 2016 and bond defaults more than quadrupled in the period.

China is targeting growth of about 6.5 percent this year, and dealing with zombie companies is pivotal to the nation’s efforts to reduce excess capacity, President Xi Jinping told party leaders in February, according to a Xinhua report. Courts will tend to liquidate firms that clearly have no future, though restructurings will remain the preferred outcome for stressed companies in China, Gong Jiali, president of Guangdong Higher People’s Court, said in an interview last week.

“There is greater professionalism of the judiciary, greater specialism of judges in China’s bankruptcy courts,” Edward Middleton, head of restructuring for Asia Pacific at KPMG who has about 30 years of experience in the restructuring field. Still, neither company owners nor creditors are used to the idea of taking advantage of bankruptcy processes, according to Middleton.

Chinese courts accepted a record of 5,665 bankruptcy filings in 2016, up 54 percent from 2015, according to official data. The potential size of China’s distressed debt and non-performing loan market may be worth as much as $3 trillion, according to distressed fund operator ShoreVest Partners in a note this month.

China has set up bankruptcy and liquidation divisions at 73 courts so far to help work on insolvencies. Commercial bankruptcies in China are still small compared with the U.S., where there was a 26 percent increase in filings to 37,771 last year, according to the American Bankruptcy Institute.

China’s Supreme People’s Court set up a website in August for courts to release information on bankruptcy cases they are working on and for creditors to register bankruptcy applications. In the province of Jiangsu, north of Shanghai, the judiciary is changing its appraisal system to encourage judges to take up bankruptcy cases, according to Xu Qianfei, president of Jiangsu Higher People’s Court, in a written reply to questions.

Read: China’s Bankruptcy Law in Spotlight as Bond Issuers Test System

Concerns still exist, however, about government’s involvement in major restructuring cases, and banks reluctance to pursue court-supervised workouts.

“Judges’ decisions may not be purely market-driven as they would also consider the chain effect on other companies and some other social factors,” said Derek Lai, southern region managing partner for Deloitte China, who has 28 years of experience in restructuring.

Financial creditors such as banks are not keen to pursue court-supervised restructurings because they don’t want to bear losses, said Liu Yanling, head of restructuring and insolvency at King & Wood Mallesons in Beijing.

— With assistance by Lianting Tu, and Yuling Yang

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