What should a creditor do if the debtor goes bankrupt? (1)

When an enterprise enters bankruptcy proceedings due to insolvency, the bankruptcy administrator will be responsible for distributing the remaining assets. As a creditor, normally, it could only declare its claim and wait for distribution, and the results of distribution are often unsatisfactory.  

In fact, in regarding the type of a debt, the litigation status of related debt, etc., creditors may take more measures to recover more debts. (Note: This article will not mention the situation of bankruptcy of real estate development enterprises, as there are special regulations for this industry.)

Firstly, to check whether the debt related property shall not be available in the bankruptcy. Article 71 of the “Supreme People’s Court, Several Issues on Trial of Enterprise Bankruptcy Cases Provisions” has listed 9 categories of property which shall not be available in the bankruptcy. Those 9 categories include: (1) third party property in the possession of, or used by, the debtor based on a warehousing, custodial, processing contract, consignment trade, commissioned sale, loan, deposit, lease or other such legal relationship; (2) things encumbered by a mortgage, lien or pledge, except where the rights holder has waived his right of priority repayment and except for any portion thereof remaining after priority payment of the claim secured thereby; (3) such substitute as insurance benefits, compensation, indemnity, etc. arising from the destruction or loss of the property used as security; (4) property that, in accordance with the law, is encumbered by a priority right, except where the rights holder has waived his right of priority repayment and except for any portion thereof remaining from priority payment of the specific claim; (5) specific things being sold and purchased, where possession thereof has not yet passed to, but the price therefor has been paid in full by, the other party; (6) property that has been delivered to the buyer but for which the procedures for a certificate of title or registration of the passage of title have not yet been carried out; (7) property that is the subject of a sales and purchase transaction in which ownership is retained, where the debtor has not yet obtained ownership thereof; (8) property the ownership of which vests exclusively in the State and which may not be assigned; or (9) property owned by the bankrupt enterprise’s labor union. In view of this, it is recommended to require the debtor to provide real estate mortgage or movable property pledge to ensure the recovery of the creditor’s rights, if the creditor has doubts about the creditworthiness of the debtor, or finds the debtor’s business situation has deteriorated.

Secondly, the litigation status of a debt matters. There are 3 phases.

The first phase is that the debtor has entered bankruptcy proceedings before the creditor files a lawsuit. According to Article 23 of the “Provisions of the Supreme People’s Court on Several Issues Relating to Application of the Enterprise Bankruptcy Law (II)” (hereinafter referred to as the “Provisions (II)”) and Article 110 of the “Notice of the Supreme People’s Court on Issuing the Minutes of the National Court Work Conference for Civil and Commercial Trials”, upon acceptance of a bankruptcy application of the debtor, where a creditor has sued the debtor, the court shall not accept the lawsuit. Therefore, if a debtor’s business situation deteriorates, and it is not possible to recover debt by negotiation, it is recommended to sue the debtor as soon as possible.

The second phase is that the creditor has sued the debtor, the debtor enters bankruptcy proceedings before the case is concluded. According to Article 20 of the “Enterprise Bankruptcy Law” and Article 21 of the “Provisions (II)”, the court should suspend the trial of such case and resume the trial after the bankruptcy administrator takes over the debtor’s property and litigation affairs. In addition, considering that the suspension of the case and the participation of the bankruptcy administrator take time, according to Article 110 of the “Notice of the Supreme People’s Court on Issuing the Minutes of the National Court Work Conference for Civil and Commercial Trials”, the creditor could contact the bankruptcy administrator and declare its claims. In order to exercise its voting rights at the creditors’ meeting, the creditor can apply to the court for a temporary determination of the amount of its claims. If the claim is confirmed in the bankruptcy proceedings, the lawsuit can be withdrawn. If not confirmed, the creditor may continue with the litigation process.

The third phase is that the creditor wins the lawsuit, but the debtor enters bankruptcy proceedings during the execution proceeding. According to Article 19 of the “Enterprise Bankruptcy Law” and Article 22 of the “Provisions (II)”, the court should suspend the execution proceeding, and the creditor should declare its claims to the bankruptcy administrator. During this proceeding, there two situations which are tricky. The court has frozen the debtor’s bank account but the funds have not yet been transferred to the court account, or the funds have already been transferred to the court account. The relevant judicial interpretations have not mentioned whether such funds belong to the bankruptcy property or not. However, from the perspective of ownership, if the funds are still in the debtor’s bank account and ownership has not yet been transferred, they should belong to the bankruptcy property; or if the funds have already been transferred to the court account, due to the transfer of ownership, they should not belong to the bankruptcy property, and the creditor should be able to receive such funds.

Due to space limitations, we will introduce the measures could be taken in various special circumstances during bankruptcy proceedings in the next issue.