Debt Collection in China

• Based on China’s rebalancing policy, direct financing or bank loans are sharply shrinking and extending to more and more sectors. DSO thus remains high, and late payments are not adequately controlled.

• The arbitration system is complex and requires accountability, setbacks and high costs. When compliance reports are weak, the preferred option is to obtain amicable or non-litigation.

• The insolvency process is complex, with liquidation as the main procedure.

1. Summary

1.1. General financial information

1.1.1. As a general rule, financial information available to the public about Chinese companies is not satisfactory since, due to a lack of transparency, data rarely reflect real business situations. Only those listed companies are required to report their financial statements. The information for the rest is either not available or not reliable. Additionally, there are no restrictions on business owners starting new businesses without settling debts after shutting down another.

1.2. Key legal structures

1.2.1. Corporate debt responsibility is defined by legal structures listed as follows:

• Domestic companies frequently take the form of a Sole Proprietorship (a corporate entity formed through assets donated and held by one person) or Joint Stock Companies that instead possess stock and assets equally divided into negotiable securities (shareholders are not)

• Foreign investors also have exposure to complex market systems. Wholly Foreign-Owned Companies (WFOE) are limited-liability systems. These are owned by foreign investors and require income to be repatriated to the home country of the investor. Foreign-invested Partnership Enterprises (FIPE) has also been allowing foreign investors with limited capital to create partnership companies in China since 2010. Representative offices (RO) serve rather as the representative offices of international parent companies and may only be used for specific purposes (contact liaison, market research, marketing, quality control) because they do not produce any income.

• The aim of the joint ventures (JV) between Chinese companies and foreign investors is to share investments / controls, risks and revenues so that a foreign entity can enter a restricted market. Equity Joint Ventures are based on incorporated entities but it may also be possible to set up contractual joint ventures. Through reality, Hong Kong based companies also operate as Special Purpose Vehicles (SPV) to invest through mainland China.

1.3. Regulatory framework

1.3.1. The Chinese justice system is excessively complex. In various levels the courts are split into several tribunals. The Specific People's Courts (including County People's Courts, Regional People's Courts, People's Courts of Autonomous Counties, and People's Courts of Local Districts) receive in the first place civil, financial, and domestic cases under RMB 50 m. In the first place, intermediate People's Courts treat such lawsuits (including foreign-related cases and allegations approaching RMB 50 m), as well as challenge litigation brought against the judgments of the Specific People's Courts. The Higher People's Courts address classification problems at the central government level, but in the first place it can also rule on major cases.

2. Receiving payments

2.1. DSO - Days Sales Outstanding

2.1.1. Compensation periods in China fluctuate from 30 days (high-tech industry) to 120 days (commodity trading) but the average days of outstanding sales (DSO) are on a declining pattern of 89 days (compared to 78 days in 2012) given cultural standards that do not require promises to be made.

2.1.2. In most situations, delinquent payment results from financial difficulties (increased by poor banking support) encountered by debtor's clients. Therefore, increasing payment periods is a common form of cash management in action and Chinese firms frequently rely (heavily) on securing payment terms of 120 to 180 days. Agreement on those lines is not recommended.

2.2. Late interests

2.2.1. Late interest on payment may be paid, according to contract terms. The calculation is based on the loan rate of the People's Bank of China: 6 percent per annum (5.6 percent if the overdue is less than six months, 6.15 percent if the overdue is more than one year).

2.2.2. If the case goes to court, certain creditors/claimants can owe interest rate four times that of the Central Bank when late payment happens and there is no default included in the sales contract.

2.2.3. Debt usually acts as a negotiating tool which appears to be discarded when a settlement is achieved and the debt is amicably restored. Nevertheless, recovery expenses would be included in the lawsuit if no agreement is found.

2.3. Costs of debt collection

2.3.1. As a general rule, the law does not allow debt collection fees to be paid to the claimant because, culturally speaking, debt payment is deemed a cost write-off. Nonetheless, recovery expenses would be included in the lawsuit if no agreement is found.

2.4. Protecting ownership

2.4.1. As a general rule, Chinese contract law calls for the transfer of ownership to the consumer after sale, but it would be admissible and enforceable to preserve title (RoT) clauses aimed at retaining ownership until the products have been paid in full. Extended ways of RoT retaining property are not feasible, pending transfer or selling to a third party. Theoretically, RoT deals could be used to take back products during ordinary litigation but would not be used in insolvency proceedings (see Payments).

2.5. Payments

2.4.2. The most common methods of payment are as follows: Swift bank transfers are among the most prominent means of payment, as they are quick, safe and supported internationally and domestically by an increasingly integrated banking network. For companies based outside China and exporting to China, transactions are usually guaranteed through an Export Credit Insurance policy which helps to minimize the risk of sudden or unforeseen insolvency of customers.

2.4.3. Furthermore, Standby Letters of Credit (a bank guarantees the creditworthiness and redemption ability of the debtor) are valid assurances that can be interpreted as a sign of good faith as they can be enabled as a' payment of last resort' if the borrower fails to fulfill a contractual obligation. Also, it may be called the irrevocable and verified Documentary Letters of Credit (a debtor promises that a certain amount of money will be made available to a borrower through a bank once certain terms specifically agreed by the parties have been met).

2.4.4. Checks are common. However, since the 2010 import regulations, it is becoming increasingly difficult to obtain Standby Letters of Credit and Documentary Credits, while banks enabled to deal with foreign currencies must register guarantees with the Foreign Exchange State Administration. As a result, 20 to 25 percent of international transactions are now paid in advance in part (up to 10 percent by law). It should also be stressed that local banks tend to read Documentary Credit terms creatively, while domestic tribunals' interpretation differs significantly from the recommendations made by the International Chamber of Commerce.

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3. Collecting payments

3.1. Amicable action

3.1.1. The factor that might lead to an amicable collection in China is business experience and understanding what can be leveraged to drag the debtor back into negotiation because dunning letters are not very successful.

3.1.2. Until beginning legal proceedings against a debtor, asset appraisal is important because it allows clarification as to whether the business is still successful, whether the chances of recovery are at maximum, and increases compliance chances. Therefore, it is important to be mindful of the solvency position of the debtor: once insolvency proceedings have been started, payment of a loan will indeed become extremely difficult.

3.2. Legal proceedings

3.2.1. Ordinary proceedings. If the amicable process falls or if the debtor challenges the allegation, there is the right to begin legal proceedings. If the debt is undisputed, a pre-court case (PRC Civil Procedure Law No. 189) may be instituted to obtain a restitution order from the Basic People's Court, enforceable for 15 calendar days after serving the debtor if the latter refuses to comply and does not present a defense.

3.2.2. Nevertheless, if the claimant makes a counterclaim, the dispute must be resolved by ordinary court proceedings. The procedure would be as follows: once a lawsuit has been made, a formal investigation would be performed by the appropriate court to determine if the complaint should be admitted.

3.2.3. The court would then review the evidence and allow the parties to come to a compromise before making a verdict. Remedies ordered by the court will usually take the form of compensatory damages, instructions to remove harmful effects, termination of violations, etc. You may also request specific performance. Punitive injury is not admissible though.

3.2.4. Required documents. According to China's Civil Procedure Code, the required records for credit-related conflicts include: a detailed petition, a collection of proofs, each party's business license, contracts, distribution orders, invoices, related correspondence, letters of collateral / guarantee and all other relevant verification.

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3.2.5. Time limitations.

As a general rule, cases must be brought before the court within a specified time period beginning from the moment the complainant is (or should have been) aware of the facts to validate the lawsuit. Administrative conflicts must be taken to public authorities within three months. Legal charges must be made within two years (up to four years covering product transitions and international sales of goods). Claims related to the transportation of goods by ship must be made against 180 days for claims relating to the carriage of goods by rail within one year from the (effective or anticipated) date of the delivery. Civil-rights security claims must be filed within two years. Documents must be made within one year for situations concerned with understandard products, rent payment problems, physical injury etc. Legal action will not be granted beyond those time limitations.

3.2.6. Precautionary measures. Pending a final and enforceable verdict, precautionary measures that help to protect the rights of the borrower. In addition, the courts can order measures to avoid irreparable damage and preserve the status quo (preventive attachment to bank accounts and properties, plant locking, stock retention, prohibition of executing an act or contract) or to protect facts.

3.2.7. The applicant would be required to file a reasoned appeal explaining the immediate and utter need of issuing such an injunction, and the court would most certainly order protection on expenses to be given to shield the debtor against reckless behavior. Different demands should be made to the court to secure or obtain evidence but these would not come within the framework of precautionary measures being implemented.

3.2.8. Appeal lodging. The parties are entitled to bring to the Superior People's Court decisions rendered in the first instance within 15 days, but a petition must be filed for this purpose. The decision rendered in the second instance would deal with facts or law matters, and is considered final. For an unsatisfied group the only remedy would be to apply for a retrial on multiple grounds.

3.2.9. Enforcing court decisions. The losing party will accept a final decision in principle. Otherwise the claimant may apply with the People's Court or with an execution officer for execution. In this situation, the court can order keeping the debtor's properties or accounts frozen. In fact, it can be difficult to enforce a court judgment or an arbitral award throughout China.

3.2.10. The option is to seek enforceable rulings under the 2006 Reciprocal Recognition and Compliance Arrangement on Civil and Commercial Matters (REJA) through the Hong Kong courts. Hong Kong has an effective, independent legal structure from the Chinese courts and REJA allows Hong Kong Courts to impose rulings in mainland China. As a result, Hong Kong has long been the chosen territory for international and Chinese parties contracts and remains the best venue to execute judgments in China.

3.2.11. Throughout China, Garnishee Regulations are admissible and enforceable against a third party debtor. If a trustee refuses to conduct the verdict, then the borrower may order compliance promptly. To use the courts in Hong Kong, arrangements and terms and conditions will specify that all conflicts are to be settled solely by the courts in Hong Kong. Legal advice should be taken on board. The China Supreme Court issued a Notice from the Supreme People's Court on the application of law concerning the failure to comply with the court verdict (2015 No.16) successful after 22 July 2015 to improve the compliance process, in particular as regards personal guarantee. With this warning it is expected that the overall results of compliance will change and the borrower will benefit from a personal guarantee. One main prerequisite for compliance in China is a hint to properties that the Court or creditors may find. The urgent order for action should be submitted to the court if new properties are detected.

3.2.12. The duration of a judicial action. Under statute, judgments of the first instance should be taken within six months of the court's admission of the appeal, but litigation would be much longer if separate investors were concerned or if the dispute had a dishonest aspect. The appeal process must be drawn to a conclusion within three months of approval of the petition. Enforcement usually takes six months but in domestic disputes, it can take two years. When it comes to enforcement with a foreign dimension, see the points above. In fact, the courts are allowed to extend the time limits for complex cases, which may exceed two years before making a verdict, or much longer when including a foreign entity.

3.2.13. The costs of the procedure. As a general rule, the successful party may ask the court to compensate the losing party for court fees as well as processing, legal and compliance expenses (from 2% to 15% of the claim).Court fees will be paid after submitting the complaint, while the scale may vary from 2.5% (CNY10~100k part) to 0.5% (beyond CNY 20 m) based on the amounts involved, with a minimum RMB 50 thousand.

3.2.14. Conditional payments whereby lawyers are not paid in advance but instead obtain a fixed sum on performance and contingent payment whereby lawyers are entitled to receive a proportion of the final reward are authorized by law in business disputes.

3.3. Alternatives to legal action

3.3.1. Even though domestic courts remain unpredictable, negotiation is gradually helping to resolve disputes in a cooperative and discreet way, enforcement of mediation arrangements is sometimes inconsistent in reality.

3.3.2. Foreign forums. The absence of effectiveness of domestic courts appears to resolve disputes through a global venue. It is sometimes proposed that Swiss market law be enforced in Sino-Foreign contracts, as it is viewed as impartial. In practice, most contracts may be governed by the law selected by the parties except for joint venture contracts and transfer contracts to be governed by Chinese legislation. Having said that, domestic courts may have difficulty applying foreign law and the best way to seek compliance is to go through Hong Kong Courts under REJA (see below). Therefore it might seem better to apply the contract to Hong Kong rule. It should not be considered facultative to seek specialized legal advice on this point.

3.3.3. Awards enforcement. The compliance of foreign awards in China can be difficult but not impossible to tell. As with most nations, in order to become enforceable, China demands that international decisions be accepted by exequatur proceedings. Nonetheless, in fact, China has only mutual compliance arrangements with a few former communist countries, while domestic courts are protectionist and tend to make exequatur prosecutions exceedingly lengthy and costly. As a consequence, although it's always possible to sue Chinese debtors overseas, efforts to implement international rulings in China would most definitely be a waste of time (and money).

3.3.4. As mentioned earlier, the use of Hong Kong Courts under the 2006 REJA would be a successful way to obtain judgments for commercial cases, as these might seek compliance of international awards in mainland China. Throughout fact, and because the deal is subject to the exclusive jurisdiction of Hong Kong Courts, the Hong Kong High Court must make a ruling and grant summonses through the Shanghai High Court, which would then accept and execute the award under REJA (without being able to review the dispute in its merits).

3.3.5. China is a signatory to the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards, which means that Chinese courts should recognize and enforce international arbitration awards. As such, international arbitration could also be an important alternative to ordinary legal proceedings.

4. Managing insolvent debtors

4.1. Insolvency in China

4.1.1. Insolvency in China is both a matter of cash flow and balance sheet: a debtor is considered insolvent when it is illiquid, i.e. when it is permanently unable to pay its outstanding debts, but illiquidity can also be characterized when the liquidated assets of the debtor are unable to satisfy all the creditors. Before filing for bankruptcy both tests must be met.

4.1.2. Restructuring, liquidation and settlement are necessary for firms in financial difficulty according to the new Enterprise Bankruptcy Law of 2006 (inspired by international standards). In fact, the Supreme People's Court issued guidelines in June 2009, stating that businesses with viable future opportunities and in accordance with the national structural adjustment program should be actively supported by consolidation and consensus procedures. Additionally, local governments appear to be able to use stability stabilization assets or allow third parties to provide temporary funding. Having said that, it is not obvious whether these regulatory measures are successful, and in general they do not seem to be relied on in reality.

4.1.3. Proceedings will normally take place before the debtor's region's People's Courts (economic divisions), but in reality consensus never occurs and dissolution or liquidation is typically depended upon.

4.1.4. The years 1996 to 2003 saw a peak period during which the government let several state-owned businesses go bankrupt as a way to clear up bad assets. Nevertheless, at the moment this approach was successful, as companies rarely made efforts to go through insolvency proceedings and merely appeared to vanish. As a consequence, the average recovery potential from insolvency proceedings continues to be very low and it is essential to make any attempt to resolve the disagreement before insolvency is achieved.

4.1.5. However, due to complexities in labor issues and banking requirements, more companies are being put through the insolvency procedure by the local government. Whereas similar activities such as tracing movements of illicit funds and owner's liabilities do not apply. China courts are more concerned with social harmony (labor arrangement) and the pace of the case closing when compared justice to credit security.

4.2. Insolvency cases

4.2.1. Out-of-Court proceedings. The new law therefore authorizes the claimant to try a settlement to resolve claims with the creditors. Two-thirds of unsecured creditors will accept the Agreement. The court will rule on recognizing the conciliation agreement (which is therefore binding), but if no compromise is found, it may also declare the debtor bankrupt.

4.2.2. Restructuring the debt process. Reorganization allows a debtor to submit a debt restructuring plan to his creditors. Before being validated by the court, the plan has to be approved by each creditor class (employees, secured creditors, tax claims, common claims, etc.). The debtor is then liable, under the guidance of an attorney, for executing the program. The parties are committed and a suspension is formed to keep the prosecution proceedings in parallel. Nonetheless, if the proposal is considered non-viable, the court may order liquidation of the firm. Throughout fact, insolvency arbitration is seldom settled by debt-restructuring proceedings and liquidation is China's default protocol.

4.2.3. Winding up proceedings.  If the judge grants a motion for bankruptcy (initiated by the claimant or his creditors), the creditors are required to file their cases with the court during a specific period (up to three months) levied by the court. Any lawsuits against the debtor are then temporarily suspended until a trustee, under the oversight of the creditors ' committee, assumes control of the company and liquidates the properties. If the debtor is deemed untrustworthy, the court can impose a Conservation Impose of Assets.

4.2.4. Priority rules. As long as no insolvency proceedings have been initiated, unsecured creditors will claim their privileges. When insolvency proceedings begin, the law gives preference to the costs associated with bankruptcy proceedings, and to the secured creditors. The debtor's liquidation funds would then be used to fund administrative expenses in foreclosure, labor-related costs (wages, taxes), and fiscal obligations. Unsecured creditors would be the last to arrive. There is no formal protection priorities list (such as RoT clauses), but priority issues need to be addressed before the court if appropriate.

4.2.5. Cancelation of fraudulent transactions. The trustee will usually be able to resume or discharge any deal completed with investors after one year of receipt of the insolvency claim. In fact, unauthorized exchanges of properties will usually be invalid, improper transactions granting one borrower an unfair advantage over the others, etc.

4.2.6. In practice, parties to whom notice of acceptance of the bankruptcy application has not been given within two months may consider that their contract could be terminated.

4.2.7. The duration of insolvency proceedings. Insolvency proceedings will typically take between two to four years, but the judge would automatically dismiss the proceedings if the claimant lacks sufficient collateral.

4.2.8. Required documents. Record details of the creditor and the applicant, application form showing demands and purposes, credit evidence (VAT, lease, shipping instructions, correspondence etc.), financial balance and collateral if any.