(This paper won the First Prize for Outstanding Paper at the 2022 Annual Conference of the Bankruptcy Law Research Association of the Liaoning Provincial Law Society.)

The pre-reorganization system is receiving increasing attention from both legal theorists and practitioners, and scholars, judges, and lawyers have devoted considerable discussion to it. The author attempts here to explore the theory and practice of the pre-reorganization system from the perspective of a manager.

I. Legal Basis of the Pre-reorganization System

China’s Enterprise Bankruptcy Law provides for bankruptcy liquidation, conciliation, and reorganization systems, but does not explicitly establish a pre-reorganization system. Nevertheless, courts across the country are now actively exploring and piloting pre-reorganization practices. What is the legal basis for these efforts? In 2018, the Supreme People’s Court issued the “Minutes of the National Courts’ Conference on Bankruptcy Adjudication,” Article 22 of which stated: “Explore and promote the linkage between out-of-court restructuring and in-court reorganization. Before an enterprise enters reorganization proceedings, the debtor may first engage in out-of-court commercial negotiations with creditors, investors, and other stakeholders to formulate a restructuring plan. Once the reorganization procedure is initiated, the draft reorganization plan based on this restructuring plan can be submitted to the people’s court for legal review and approval.” This marked the first time that the Supreme People’s Court proposed exploring and promoting the linkage between out-of-court restructuring and bankruptcy reorganization procedures. On June 22, 2019, the National Development and Reform Commission, the Supreme People’s Court, the Ministry of Justice, and 13 other departments jointly issued the “Plan for Accelerating the Improvement of the Market Entity Exit System,” which noted: “Study the establishment of a pre-reorganization system, effectively link the out-of-court restructuring system, the pre-reorganization system, and the bankruptcy reorganization system, enhance the credibility and binding force of out-of-court restructuring, and clarify the legal status and institutional content of pre-reorganization.” On November 8, 2019, the Supreme People’s Court released the “Minutes of the National Courts’ Conference on Civil and Commercial Adjudication,” Article 115 of which provided an interpretation on the extension of the validity of out-of-court restructuring agreements into the reorganization procedure: “Continue to improve the linkage mechanism between out-of-court restructuring and in-court reorganization, reduce institutional costs, and enhance the efficiency of the bankruptcy system. If, prior to the people’s court accepting a reorganization application, the debtor and certain creditors have already reached an agreement whose contents are consistent with the draft reorganization plan prepared during the reorganization procedure, the consent of the relevant creditors to such agreement shall be deemed as their consent to vote on the draft reorganization plan. However, if the draft reorganization plan modifies the contents of the agreement in a way that adversely affects the relevant creditors or involves significant interests of those creditors, the affected creditors shall have the right, in accordance with the provisions of the Enterprise Bankruptcy Law, to re-vote on the draft reorganization plan.” Furthermore, Article (5) of the State Council’s “Opinions on Carrying Out Pilot Programs for Innovation in the Business Environment” (Guofa [2021] No. 24) stipulates: “Improve market entity entry and exit mechanisms that are more open, transparent, standardized, and efficient... Promote the pre-reorganization system for bankruptcy, establish and improve a credit restoration mechanism for corporate bankruptcy reorganization, and allow creditors and others to recommend and appoint bankruptcy administrators.” These provisions undoubtedly serve as the legal basis and driving force behind local people’s courts’ efforts to carry out and advance pre-reorganization practices.

II. Current Status and Trends in the Development of the Pre-reorganization System

Encouraged by the Supreme People's Court, the State Council, and various government departments, courts across the country have actively launched pilot programs for pre-reorganization efforts and have achieved remarkable results. For example, the bankruptcy and reorganization case of Beijing University of Technology Zhongxing Technology Co., Ltd., which was named one of the Top Ten Typical Reorganization Cases of 2018, adopted a pre-reorganization model by the Beijing No. 1 Intermediate People's Court to enhance reorganization efficiency. By effectively integrating the outcomes of the pre-reorganization work and accelerating the trial process, the court convened a creditors’ meeting within just over eighty days after accepting the case to vote on the draft reorganization plan. The creditors’ group approved the draft plan unanimously (all claimed claims were ordinary claims), and the approval rate among investors exceeded 87%. The Beijing No. 1 Intermediate People's Court subsequently ruled to approve the bankruptcy reorganization plan and terminate the reorganization proceedings.

Based on their summaries of practical experience in pre-restructuring, courts across various regions have gradually established relevant institutional norms for pre-restructuring. For instance, the Shenzhen Intermediate People's Court, the Beijing No. 1 Intermediate People's Court, the Chongqing No. 5 Intermediate People's Court, and the Nanjing Municipal Court have successively issued guidelines and other normative documents providing guidance on pre-restructuring. On August 16, 2021, the Shenyang Intermediate People's Court also released the “Operational Guidelines for Pre-Restructuring of Bankruptcy Cases by the Shenyang Intermediate People's Court” (hereinafter referred to as the “Shenyang Guidelines”).

Currently, China’s Enterprise Bankruptcy Law is undergoing revision. In the author’s view, based on the opinions and regulations issued by the Supreme People’s Court, the State Council, and relevant departments, as well as the practical explorations of pre-restructuring initiatives across various regions and overseas legislative experiences, the pre-restructuring system will undoubtedly be elevated to a legal framework and incorporated into the amended “Enterprise Bankruptcy Law of the People’s Republic of China.”

III. The Concept and Essence of the Pre-reorganization System

There has been considerable discussion on the concept of pre-reorganization, and two views have emerged as relatively consensus-based. The first is that pre-reorganization is a mechanism in which, prior to a debtor enterprise entering formal reorganization proceedings, creditors, debtors, investors, and other stakeholders engage in equal and voluntary negotiations to develop a plan—covering such aspects as debt repayment and equity adjustments—that is conducive to the debtor’s reorganization, thereby helping to rescue enterprises facing financial crises. The second view holds that pre-reorganization is an auxiliary corporate rescue model that emerges from the innovative integration of two existing mechanisms: out-of-court restructuring and bankruptcy reorganization. By organically linking and complementing these two mechanisms in sequence, pre-reorganization leverages their respective strengths while mitigating their weaknesses, thus enabling market-oriented and rule-of-law-based solutions for rescuing and reviving enterprises grappling with debt and operational difficulties.

From the perspective of a manager, the two aforementioned descriptions of the pre-reorganization system essentially capture its core essence, operational rules, and implementation pathways. However, these descriptions do not fully encompass the entire scope of the pre-reorganization system—particularly, they fail to clearly articulate the actual outcomes of pre-reorganization practices. Indeed, pre-reorganization is, at its heart, an out-of-court restructuring negotiation aimed at steering a company toward formal reorganization proceedings. It represents an innovative mechanism that emerges from the integration of both out-of-court restructuring and bankruptcy reorganization systems. Nevertheless, good intentions do not necessarily guarantee success. In other words, even when starting from the laudable goal of rescuing struggling enterprises and attempting to guide them toward formal reorganization through out-of-court restructuring negotiations, the outcome may not always lead to a formal judicial reorganization process. The reasons for this will be discussed later in this article.

• The Superiority and Value of the Pre-reorganization System

Regarding the advantages and value of the pre-reorganization system, it is generally believed that there are mainly the following aspects:

• Pre-reorganization can address the shortcomings of the existing bankruptcy mechanism, meet the diversified needs of enterprise rescue, and enhance the bankruptcy prevention system.
• Pre-reorganization can reduce the judicial and time costs of reorganization and increase the success rate of reorganization.
• Pre-reorganization can effectively address the “hold-up problem” posed by a small number of creditors encountered in out-of-court restructurings.
• Pre-reorganization can address the irreversibility inherent in existing bankruptcy reorganization procedures.

From the perspective of a practicing bankruptcy administrator, I agree with most scholars, judges, and lawyers in their assessment of the superiority and value of the pre-restructuring system. At the same time, I believe that our understanding of any legal system should not lead us to overlook its shortcomings simply because we overestimate its advantages. It is precisely because a system possesses certain advantages that it has room to exist and develop. We must clearly identify both its strengths and weaknesses, leverage its strengths, and avoid its pitfalls. To illustrate this point, take the example of how pre-restructuring can reduce the judicial and time costs associated with restructuring. Indeed, pre-restructuring can significantly lower these costs; however, this issue needs to be examined from two distinct angles. First, during the pre-restructuring phase, the debtor and major creditors engage in negotiations and reach an agreement on restructuring matters, draft a restructuring plan, and then put it to a vote. Once the case enters the formal restructuring procedure, if the agreements already reached between the debtor and certain creditors during the pre-restructuring phase are consistent with the contents of the draft restructuring plan prepared during the restructuring process, the consent of those creditors to the pre-restructuring agreement will be deemed as their approval of the draft restructuring plan. This substantially shortens the time required for creditor claim registration, claim review, and drafting of the restructuring plan itself, thereby effectively reducing judicial and time costs. Second, we should also recognize that the reduction in judicial and time costs of restructuring comes at the expense of the judicial and time resources consumed by the debtor and creditors during the pre-restructuring phase. Without the initial investment of judicial and time resources in the pre-restructuring stage, there would be no corresponding reduction in the judicial and time costs of the restructuring itself. Moreover, the time cost incurred during pre-restructuring is inherently uncertain: some courts set specific deadlines for pre-restructuring, while others do not. In cases where no deadline is set, it becomes difficult to accurately determine the total time cost—both pre-restructuring and restructuring combined—because, for both debtors and creditors, what they ultimately pay is the total time cost, not merely the restructuring time itself. Therefore, we should avoid overestimating the role of pre-restructuring in reducing judicial and time costs associated with restructuring. Another example is the claim that pre-restructuring can enhance the success rate of restructuring. For pre-restructuring cases that successfully transition into formal restructuring procedures, it is indeed quite common for most creditors to have already reached consensus on the restructuring plan, selected investors, and identified the enterprise’s restructurable value. Under such circumstances, it is entirely natural for the success rate of restructuring to increase. As administrators, however, we must acknowledge that not all pre-restructuring outcomes necessarily lead to successful entry into the formal restructuring process.

The author believes that the pre-restructuring system indeed plays an extraordinary role in reducing judicial and time costs associated with restructuring and enhancing the success rate of restructurings. However, the author contends that the pre-restructuring system’s more significant function lies in effectively addressing, in cases where restructuring proceedings are successfully initiated, the mandatory requirement stipulated in Article 79 of the Enterprise Bankruptcy Law—that the total period for submitting a draft restructuring plan, including the six-month period plus the three-month extension, must not exceed nine months—and thereby avoiding the outcome where the debtor or administrator fails to submit the draft restructuring plan on time, thus leading to the failure of the restructuring process. Moreover, this system provides a clear pathway for the people’s courts to supervise, in accordance with the law, both the debtor and the administrator’s timely submission of the restructuring plan. As a result, it prevents the awkward situation in which the people’s courts, administrators, debtors, and other parties might find themselves bearing responsibility for violating bankruptcy laws while striving for a successful restructuring. In cases where restructuring proceedings are not successfully initiated, the pre-restructuring process effectively identifies debtors who lack the potential for restructuring or whose circumstances prevent them from entering the restructuring procedure, thereby screening out debtors who do not meet the eligibility criteria for restructuring. This approach significantly conserves judicial resources and spares the people’s courts, creditors, debtors, and administrators from wasting manpower, material resources, and time on bankruptcy cases that are destined to fail.

• Several Issues in the Practice of the Pre-reorganization System

• The Status of the People's Court in the Pre-reorganization Procedure

In the reorganization procedure, the people’s court occupies a leading position from beginning to end. It serves not only as the adjudicator of reorganization cases but also as the promoter and supervisor of the reorganization process itself. From reviewing and filing reorganization cases, setting the deadline for creditors’ claims, issuing rulings confirming the list of claims, convening creditors’ meetings, approving the reorganization plan, to ruling on the termination of the reorganization procedure and declaring the debtor bankrupt due to the debtor’s failure to implement the reorganization plan—every step involves the people’s court playing a crucial role in directing, supervising, and coordinating the proceedings. Therefore, the people’s court occupies an irreplaceable, central position in the reorganization procedure. So, what is the status of the people’s court in pre-reorganization procedures, where the law does not provide explicit regulations? Based on judicial practice regarding pre-reorganization, the author believes that the people’s court still holds a central position of procedural control in the pre-reorganization process. The people’s court has the authority to decide whether a debtor should undergo pre-reorganization, appoint a provisional administrator, determine the remuneration of the provisional administrator, and, upon application by the provisional administrator, creditors, and debtor, may take preservation measures against part or all of the debtor’s assets. The administrator is required to submit a pre-reorganization work report to the people’s court. Furthermore, the people’s court is responsible for ensuring the alignment between the pre-reorganization plan and the draft reorganization plan. To illustrate this point, let’s take the “Shenyang Guidelines” as an example: The decision on whether to initiate a pre-reorganization procedure rests with the people’s court. Article 2 stipulates: “During the review period of a bankruptcy reorganization application, if the debtor, upon application by the applicant or with the applicant’s consent, submits a written commitment to accept supervision by a provisional administrator during the pre-reorganization procedure and to fulfill the obligations associated with pre-reorganization, the people’s court may decide to subject the debtor to pre-reorganization.” Article 5 sets the duration of the pre-reorganization period at three months; upon application by the provisional administrator and after review by the people’s court, if the reasons are deemed valid, the court may decide to extend the period, but the extension shall not exceed three months. Articles 6 and 7 specify the appointment of the provisional administrator and the duties of the provisional administrator. Article 12 outlines the circumstances under which the provisional administrator may apply to the people’s court to terminate the pre-reorganization procedure, as well as how the people’s court will rule on such applications. Article 13 requires the provisional administrator to submit a pre-reorganization work report to the people’s court. All of the above provisions clearly demonstrate the people’s court’s controlling role in the pre-reorganization procedure and its decisive influence on the direction of the pre-reorganization process.

• The outcome of pre-reorganization

As previously mentioned, the outcome of pre-reorganization does not always inevitably lead to a successful reorganization procedure. The original intention of pre-reorganization is indeed to steer the process toward reorganization and thereby rescue debtors who are in distress. However, given the diverse range of reasons why enterprises fall into difficulty, the large number of creditors with vastly different individual circumstances, and the influence of market changes, voluntary and equal negotiations between debtors and creditors can sometimes be extremely challenging, making it difficult for the negotiation outcomes to meet everyone’s expectations. Although pre-reorganization does not require unanimous consent from all creditors, meeting both the threshold criteria—both in terms of the number of creditors and the total amount of claims—for initiating a formal reorganization procedure remains highly difficult. This leads to two possible outcomes following pre-reorganization: First, upon completion of the pre-reorganization phase, the people’s court, based on the interim administrator’s application to terminate the pre-reorganization, rules to accept the reorganization application, thereby transitioning the case from the pre-reorganization procedure into the formal reorganization procedure. Second, after the pre-reorganization concludes, the people’s court, upon the interim administrator’s application to terminate the pre-reorganization, rules not to accept the reorganization application; however, if it finds that the debtor meets the legal requirements for bankruptcy, it may inform interested parties that they can file a bankruptcy liquidation application in accordance with the law. This is precisely why, as discussed earlier, the outcome of pre-reorganization does not always inevitably lead to a successful reorganization procedure.

• Preservation and Enforcement of the Debtor’s Property in Pre-reorganization Proceedings

The legal effect of bankruptcy proceedings is undoubtedly powerful, and all market entities, judicial authorities, administrative agencies, and other relevant parties must comply with the pertinent provisions of the Bankruptcy Law. In light of Article 19 of the Bankruptcy Law, which stipulates that “after a people’s court accepts a bankruptcy application, any preservation measures concerning the debtor’s property shall be lifted, and enforcement proceedings shall be suspended,” does the pre-restructuring procedure also produce the same legal effect? Clearly not, since there is no corresponding legal basis for this. However, to a certain extent and within a certain scope, pre-restructuring is not entirely without effect. Article 9, Paragraph 2 of the Shenyang Guidelines provides: “After entering the pre-restructuring phase, the enforcement courts (departments) within the jurisdiction of this city shall suspend any ongoing enforcement or preservation measures against the debtor.” Paragraph 3 further states: “After entering the pre-restructuring phase, strengthen communication and coordination with enforcement courts (departments) outside this city, requesting these courts (departments) and the applicants for enforcement to provide assistance and support for the debtor’s pre-restructuring efforts and to temporarily suspend enforcement actions against the debtor’s property.” Under the circumstances where courts across various regions have formulated operational guidelines for pre-restructuring, courts within this jurisdiction are bound by the provisions of these regional guidelines, thereby achieving—in a certain sense—the legal effect prescribed by Article 19 of the Enterprise Bankruptcy Law. Meanwhile, through coordinated communication among courts that have accepted pre-restructuring cases, enforcement courts (departments) outside this jurisdiction will also take into account the views of the courts that have accepted pre-restructuring cases, thus achieving—at least in part—the legal effect set forth in Article 19 of the Enterprise Bankruptcy Law.

• Issues That Temporary Managers Should Pay Attention to When Performing Their Duties

Diligence, responsibility, and faithful performance of duties are the fundamental requirements for a provisional administrator—and also the most basic moral bottom line that such an administrator must uphold. After the People’s Court decides to initiate pre-reorganization proceedings, the provisional administrator begins to step into the pre-reorganization process. At this stage, the provisional administrator must closely monitor the equal negotiation between the debtor and creditors, and if necessary, actively participate in the negotiation process. The administrator should assess the number of debtors and creditors who can reach an agreement, as well as the total amount of claims involved, and determine whether the proposed reorganization plan can meet the dual threshold requirements—both in terms of the number of creditors and the total amount of claims—that must be satisfied for the plan to be approved. At the same time, the provisional administrator must comprehensively evaluate the debtor’s financial condition, operational status, market prospects, technological level, industry standing, and other relevant factors to determine whether the debtor’s enterprise has the potential for reorganization. If, after a comprehensive assessment, it becomes clear that the debtor lacks the feasibility for reorganization, upon expiration of the pre-reorganization period set by the People’s Court, the provisional administrator should promptly apply to terminate the pre-reorganization proceedings. The People’s Court will then notify all relevant stakeholders, enabling them to file for bankruptcy liquidation with the court. This approach helps avoid wasting judicial resources, as well as time, manpower, and material resources on both the debtor and creditors during the pre-reorganization and reorganization processes, thereby preventing greater losses. It is precisely through this proactive identification of reorganization feasibility that the pre-reorganization procedure best fulfills its intended purpose.

Conclusion

Judicial practice of pre-reorganization has been widely adopted by courts across the country, and pre-reorganization has gained recognition from both academic and practical circles for its unique advantages. In the pre-reorganization process, people’s courts maintain control over the procedure and determine the direction of each case. Debtors and creditors engage in equal and cooperative negotiations, leveraging their initiative as market entities to autonomously decide the future of enterprises facing financial difficulties. The interim administrator acts diligently and responsibly, faithfully performing their duties and effectively facilitating the pre-reorganization procedure as well as executing specific tasks. The author believes that, building on the widespread adoption of pre-reorganization judicial practice by courts nationwide and driven by academic efforts, unified rules for the pre-reorganization system will undoubtedly become an integral part of the revised “Enterprise Bankruptcy Law.”

About the Author:

Attorney Li Haiyi

Senior Partner at Liaoning Tongfang Law Firm, Director of the Liquidation and Bankruptcy Specialized Committee of the Liaoning Provincial Lawyers Association, Vice President and Secretary-General of the Shenyang Bankruptcy Administrators Association.