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Saturday, November 17, 2018

The new Law on Bankruptcy at a glance

Updated: 15:20’ - 23/10/2014

Bui Duc Giang[1]

Key points:

l    The new law on bankruptcy is much better drafted than the existing one and rather favours the winding up of insolvent companies than the rescue culture.

l    Bankruptcy proceedings include two major procedures, being business rescue procedure and bankruptcy declaration procedure.

l    Lessees of property of the insolvent enterprise become more vulnerable while secured creditors preserve their first rank priority.

On June 19, 2014, long-awaited Law on Bankruptcy No. 51/2014/QH13 was passed by the National Assembly and will take effect on January 1, 2015 (the “2014 Law on Bankruptcy”)[2]. This law contains various substantive changes compared to the 2004 Law on Bankruptcy. Notably, the asset management and liquidation team has been replaced by the administrator and the asset liquidation and management enterprise; there are provisions on summary bankruptcy procedures, bankruptcy proceedings of financial institutions and the obligation on the company’s managers to submit the petition for initiating bankruptcy procedures; the provisions on suspect transactions have been improved; and there is also a clear division of rights and obligations of the parties involved in the bankruptcy procedures. Other procedural aspects have been amended, becoming more feasible compared to the previous rules. This article focuses on the main points of the new law.

Bankruptcy procedures

Unlike the approach of the 2004 Law on Bankruptcy, bankruptcy procedures provided in the 2014 Law on Bankruptcy consist of only two major procedures, being business rescue procedure and bankruptcy declaration procedure. Asset liquidation shall be conducted after the issuance of the enterprise bankruptcy declaration decision, and no longer as a separate procedure preceding the issuance of the bankruptcy declaration decision as previously provided. It is not necessary for the insolvent company to successively undergo such two procedures to be bankrupt. The procedure of commencing a bankruptcy procedure (Article 42 and seq.) is a launching pad for those procedures[3].

Insolvency test

It is noted that Article 4 of the 2014 Law on Bankruptcy clearly distinguishes the two concepts of “insolvency” and “bankruptcy”. Indeed, an enterprise will be deemed insolvent if it “fails to fulfil its obligation to pay a debt within three months from the due date of this debt”. Meanwhile, bankruptcy means “the state of an enterprise which is insolvent and is subject to a bankruptcy declaration decision issued by the relevant court”. As such, only when a court issues a decision declaring the bankruptcy, the insolvent enterprise is considered bankrupt. Moreover, lawmakers have provided a waiting period of three months from the due date for the payment of the relevant debt, during which the enterprise shall be given opportunity to pay the debt and thus alleviate the pressure of “threat” of bankruptcy procedure initiation from the creditors. It is noteworthy that the new law still adopts the cash flow test[4] as the sole means of assessing whether companies can pay their debts.

The insolvency condition will serve as a basis for the creditors, employees, trade union, legal representative, enterprise’s managers or shareholders to submit a request to the court regarding the initiation of the bankruptcy procedures with respect to the enterprise (Article 5) and will be a basis for the judge to initiate bankruptcy procedures (Article 42.2). However, it should be noted that the insolvency status is not necessarily leading to the initiation of bankruptcy procedures. Actually, within the time period from the submission of the petition for initiating bankruptcy procedures until the court issues a decision on initiating or not initiating bankruptcy procedures, the enterprise can overcome its state of insolvency (for example, it may gain significant income from the performance of a contract or obtain a new facility from one of its creditors). Even when the enterprise is in insolvency condition and its creditor has submitted the petition for initiating bankruptcy procedures, such enterprise still can achieve an agreement with such creditor regarding the withdrawal of the petition for initiating bankruptcy procedures (Article 37).

Upon becoming aware of the enterprise’s insolvency, certain persons (unsecured creditors and partially secured creditors, employees and trade union, shareholders or groups of shareholders holding at least 20 percent (or a lower percentage stated in the company’s charter) of ordinary shares for a minimum time of six months) have the right to petition while others (legal representative of the insolvent company, owner of a private enterprise or of a single-member limited liability company, chairman of the board of directors of a shareholding company or of the Members’ Council of a limited liability company with two members or more or partner of a partnership) are obliged to apply for the commencement of bankruptcy procedures with the court (Article 5).

Procedures of business rescue and bankruptcy declaration

The creditors’ meeting may issue a resolution requesting the implementation of business rescue measures with respect to the insolvent enterprise (Article 83.1 (b)). Afterwards, the enterprise will have to prepare the business rescue plan together with the creditors and the administrator or the asset management and liquidation enterprise, which will be served as a basis for the judge to consider and convene a meeting of creditors. If the meeting of creditors issues a resolution approving the business rescue plan, the judge will issue a decision recognizing such resolution (Article 87 and seq.). The measures for business operation rescue are diversified and provided in Article 88.2, including: capital mobilization; debt reduction, debt clearance, extension of debt payment term; change of goods to be traded or manufactured; renewal of production technology; reorganization of the management personnel, production division merger or splitting; sale of shares to the creditors and third parties; sale or lease of assets and other measures not in contrary to law. It is easy to see that this is an open list, the parties may then consider applying other measures beyond the list which may help the enterprise to recover its business. The resolution of the meeting of creditors approving the business rescue plan may determine the term for implementing the business rescue plan of the enterprise. If such term is not specified, it will be three years from the date when the meeting of creditors approved the business rescue plan (Article 89).

A company will be declared bankrupt when:

(i)     it has no asset to pay the fees for submission of the petition for initiating bankruptcy proceedings or bankruptcy fees (Article 105),

(ii)    the meeting of creditors has been delayed but when being re-convened, the conditions for it to become valid are still not met (Articles 80.3 and 106),

(iii)   the first meeting of creditors fails to approve a resolution on the rescue of the company (Article 83.4 and Article 106) or was unable to be reorganized to approve the business rescue plan or fails to approve the resolution regarding such plan (Article 91.7) or

(iv)   the enterprise fails to finalize the business rescue plan within the provided time period (Article 107.2 (a)), fails to implement the business rescue plan or remains insolvent upon the expiry of the term for implementation of the business rescue plan (Articles 95.1(b), 95.1.(c) and Article 96.2).

As such, the 2014 Law on Bankruptcy opens more doors for enterprises to step out of the market in a lawful manner.

Bankruptcy and lease contracts

The current law remains unclear on the status of lessees in bankruptcy proceedings against lessors. Unfortunately, the new law on bankruptcy does not deal specifically with this issue.

However, the 2014 Law on Bankruptcy makes it easier to enforce security in bankruptcy proceedings. Indeed, if a building has been mortgaged before the commencement of bankruptcy proceedings, the mortgagee may enforce its security after the commencement of the bankruptcy proceedings even if the company is involved in a business rescue proceeding (Articles 53 and 91.5). In such case, the lessee would become more vulnerable.

Furthermore, as the lessee is not mentioned in the list of preferential creditors, it appears that the new law treats it as an unsecured creditor. Therefore, the lessee’s claims will rank lower than all secured debts, bankruptcy expenses, employees’ wages and social insurance, new financing (e.g. new loans by a bank to finance the business rescue plan) and the State’s claims (e.g. taxes) (Article 54.1).

As analyzed above, the new law provides more grounds in favor of the winding up of insolvent enterprises and less grounds in favor of the rescue of the company. As such the lessee encounters a higher risk of the lessor being declared bankrupt.

Priority of secured creditors

Secured creditors enjoy the first rank priority before preferential creditors and unsecured creditors (Articles 53 and 54). In principle, the secured creditor may enforce its security even in the course of implementation of a business rescue plan (Articles 53 and 91.5).

Nevertheless, the 2014 Law on Bankruptcy remains unclear about how the secured creditors may enforce their security upon declaration of bankruptcy of the company. Indeed under Articles 53.1 (b) and 53.2 (a), before the declaration of bankruptcy of the company, all secured debts arising before the commencement of bankruptcy procedures will “be settled by the secured assets concerned”. Does this mean that the secured creditors may enforce their security in accordance with the security agreements or that the court may enforce the security (e.g. by allowing the administrator, the asset liquidation and management enterprise or the judgement execution agent to proceed with the sale of the secured assets and then to the distribution of the proceeds to the secured creditors)? The first solution appears to be more appropriate and is of common practice in many other jurisdictions.

Other uncertain areas

It is easy to note that there is still inconsistency regarding the provisions on cases in which the state of bankruptcy is declared by the court with regard to the implementation of the business rescue plan. Indeed, Article 107.2 only provides a single case in which the enterprise fails to implement the business operation rescue plan while Article 96.2 provides another assumption that at the expiry of the term of the business rescue plan, the enterprise remains insolvent.

Moreover, Article 37 of the 2014 Law on Bankruptcy provides for a possibility of negotiation between the creditor who requests the initiation of bankruptcy procedures with respect to the insolvent enterprise and the latter regarding the withdrawal of the petition. However, the text does not specify the schemes that would be reached with that negotiation such as the conversion of debt into equity, subordination of secured or unsecured debt, conversion of secured into unsecured claims and vice versa, increase or reduction of share capital, etc.

On the other hand, the 2014 Law on Bankruptcy only mentions the case where the insolvent enterprise early terminates executorial contracts (Articles 61 and 62), but it provides nothing on the enforceability of the provisions of a contract signed with the enterprise which enable its counterpart to unilaterally terminate the contract upon becoming aware that the enterprise becomes insolvent, such clause being of common use in practice. In addition, there are too few provisions on legal duties of the company’s managers before and during the implementation of bankruptcy procedures.

The 2014 Law on Bankruptcy is much better drafted than the existing one although there are still rooms for clarification. Around 10 documents guiding the law are expected to be passed in the near future. One can hope that those documents will further clarify the law to ease market exit.-

[1] PhD in law and associate in the secured lending and insolvency team at Audier and Partners Vietnam LLC.

[2] On the draft law, see Nguyen Minh Hang and Bui Duc Giang, “The 3rd draft law on bankruptcy at a glance”,  Vietnam Law & Legal Forum, Vol.20, No. 237, May 2014. For a more detailed presentation of the new law, see (in Vietnamese), Bui Duc Giang, “Some new points of the 2014 Law on Bankruptcy: a view from practice”, Banking Review, issue 15, August 2014.

[3] See (in Vietnamese), Bui Duc Giang, “Bankruptcy proceedings under new rules”, The Saigon Times, issue No.29-2014 (1.231), July 17, 2014.

[4] For a distinction between the cash flow test and the balance sheet test and their relevance, see Ben Jones and Eva Wilhelm, “Past the point of no return”, Corporate Rescue and Insolvency Journal, Volume 4, Issue 2, April 2011.


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