Cover Story: China Rewrites the Rules of Financial Failure

By Shan Yuxiao and Denise Jia

When China Huishan Dairy Holdings Co. Ltd. collapsed in 2017, it didn’t just bring down a once-celebrated milk brand — it exposed deep cracks in a system ill-prepared for corporate failure.

The company’s Hong Kong–listed shares plunged 90% in a single day, triggering a chain reaction across creditors, employees and suppliers throughout northeast China.

Behind the implosion was a web of debt and deception. A year earlier, short-seller Muddy Waters had accused the Liaoning-based conglomerate of fabricating its alfalfa farming business — an allegation that proved true. What followed was one of China’s most sprawling bankruptcies involving 83 affiliated companies, 8,000 employees and more than 30 billion yuan ($4.2 billion) in liabilities.

In 2020, after three years of legal wrangling, the Shenyang Intermediate Court approved a single restructuring plan that consolidated all 83 firms — a judicial leap that effectively merged their fates. It became China’s largest “substantive consolidation” bankruptcy on record, and a watershed in how courts manage corporate collapse.

That experiment — borrowing from the U.S. bankruptcy practice of treating intertwined affiliates as one — filled a gap in China’s 2007 bankruptcy law, which never formally provided for such consolidation.

Five years later, that improvisation is becoming law. On Sept. 8, 2025, China’s top legislature began reviewing the first full overhaul of the Enterprise Bankruptcy Law in nearly two decades. The draft, released days later for public comment, explicitly incorporates mechanisms pioneered in cases such as Huishan’s — from merged reorganizations to tighter coordination between courts and local governments.

The revision marks a milestone in China’s slow embrace of market-based exit rules. When the law first took effect in 2007, bankruptcy was a stigma; today, it is a policy tool.

Annual filings have topped 20,000 for years, and even state-owned and financial institutions have started to fail through court-supervised procedures. Yet policymakers admit the existing framework still lags behind reality. “Bankruptcy remains a clear institutional shortfall,” said Zhong Shan, head of the legislature’s finance committee, who introduced the draft.

For Beijing, this is about more than paperwork. As debt piles up and growth slows, China needs a functioning exit valve — one that can unwind failed firms without triggering social unrest or financial contagion. The Huishan experiment showed how ad hoc fixes can work in crisis. The new law aims to make them the norm.

Redefining the role of government

When a company goes bankrupt in China, it’s no longer just the courts that step in. Increasingly, the government does too. The latest draft revision bankruptcy law aims to formalize this role.

The proposed amendment introduces a “bankruptcy coordination mechanism.” Under Article 7, every local government above the county level would be required to establish a dedicated body to manage and coordinate bankruptcy-related administrative affairs. In effect, officials would no longer act on an ad hoc basis; they would have a clear mandate to help courts and administrators keep liquidation and restructuring cases on track.

The draft goes further by creating a new category of “public administrators.” These government departments — or their designated staff — would handle cases where a debtor’s assets are too depleted to cover even basic bankruptcy expenses. Although these public managers would not be paid, they could ensure that “no-asset” cases — often ignored by private firms — still proceed. To fund such cases, local governments could set up bankruptcy guarantee funds, financed through fiscal allocations, small levies from administrator fees, voluntary donations or interest income.

For legal scholars, this marks a notable recalibration of state power. “The 1986 trial bankruptcy law stressed government authority; the 2007 version empowered professional administrators. This time, the pendulum swings toward redesigning the government’s role,” said Chen Xiahong, a researcher from China University of Political Science and Law, who was involved in drafting the bill. In practice, he noted, many bankruptcy proceedings still depend on bureaucratic cooperation — from accessing financial records to restoring a company’s credit rating after restructuring. Without government support, administrators can easily hit dead ends.

That recognition has already shaped local experiments. In recent years, provinces such as Guangdong and Zhejiang have pioneered what’s known as “government-court coordination,” a mechanism first tested in environmental and intellectual property enforcement. Under this model, courts and local authorities establish standing liaison offices, jointly issue documents, and convene meetings to handle complex or politically sensitive bankruptcies.

The Supreme People’s Court endorsed the approach in 2017, calling for “enhanced coordination between governments and courts” — and it has since become routine across China’s judicial map.

“The redesign is a rational move,” Chen said. “Bankruptcy cannot be left to private parties alone. The government must intervene — especially in cases of zombie enterprises with no assets, where only public administrators can realistically close the books.”

Currently a visiting scholar at Oxford University, Chen compared China’s direction to the U.K.’s Insolvency Service. “In the U.K., it is a powerful agency that combines administrative, investigative and prosecutorial powers,” he said. “They’ve even released a five-year plan to strengthen oversight and crack down on bankruptcy-related crimes.”

Chinese scholars, however, are cautious with language. The term “government-court linkage,” once common, has quietly been replaced by “coordination.” The distinction matters. “Coordination means communication and adjustment within independent spheres of authority — not interference,” said Wang Xinxin, director of the Bankruptcy Law Research Center at Renmin University of China and another contributor to the draft.

Wang argued that China’s move from a planned to a market economy left a legal vacuum: most regulations were designed for normal business operations, not for failure. “That mismatch has created contradictions between existing laws and the Bankruptcy Law itself, forcing courts and governments to improvise through coordination.”

Still, both Chen and Wang stressed that coordination should not become a permanent patch. True reform, they said, will come only when supporting laws catch up — clarifying who does what when companies collapse.

During the September legislative review, some delegates urged clearer delineation of responsibilities between the State Council, financial regulators and local governments, as well as stricter safeguards for the use of guarantee funds. Others proposed that the funds cover unpaid wages and include provisions to prevent abuse.

Guarding against fake bankruptcies

For years, Chinese creditors have complained that bankruptcy proceedings too often serve as a shield for debtors — a way to walk away from obligations under the guise of “restructuring.” The drafters of the new Bankruptcy Law want to change that. The overhaul aims to make it harder for companies to exploit court protection to dodge debts, close loopholes and restore public confidence in the system.

At its core, the reform strengthens rules on “avoidance rights” — legal tools that allow administrators to unwind suspicious transactions made before a bankruptcy filing. Under current law, administrators can revoke deals completed within the year before a court accepts a case if they involve giveaways, irrational pricing, premature repayments or waivers of debt. The draft law expands that authority to cover new situations, such as relinquishing secured claims, extending repayment deadlines without compensation or assuming the debts of others.

Crucially, when the beneficiary of such a transaction is a related party — such as an affiliate or controlling shareholder — the look-back period doubles from one year to two. “This significantly raises the cost of evasion,” said Chen from the China University of Political Science and Law. “It means debtors can’t easily hide assets or forgive debts in the two years leading up to bankruptcy.”

Not everyone is convinced. Small-business owners and lenders worry the broader claw-back powers could backfire. One Guangdong entrepreneur told Caixin that under China’s current financing norms, borrowers and guarantors are often separate entities. “If every guarantee made in the year before bankruptcy can be revoked, banks will stop lending to struggling firms altogether,” he warned. “The fear of retroactive invalidation could cut off financing and push more companies into insolvency.”

Others argue the reforms don’t go far enough. Some legal experts said even a two-year window is too short, suggesting three years instead. “Debtors can still delay filing for bankruptcy to run down the clock,” one lawyer said. Wang from Renmin University of China noted that many jurisdictions allow longer claw-back periods — two to four years on average, and up to 10 years in personal insolvency cases involving fraud.

Wang stressed that the key isn’t just the length of the window but the speed of enforcement. “If courts don’t promptly accept filings and appoint administrators,” he said, “even a two-year period won’t protect creditors.” Timely rulings, he added, are essential to ensure administrators can act before fraudulent transfers are buried under bureaucracy.

The draft also increases penalties for non-cooperation. Debtors who hide, destroy or refuse to hand over assets, seals or accounting records can now be fined, detained or formally reprimanded. Those who evade inquiries or lie to the court face similar consequences. Lawmakers say these measures are intended to remind corporate officers that bankruptcy is not an escape hatch but a regulated process demanding transparency and accountability.

Transparency is, in fact, the reform’s other big theme. For the first time, the draft introduces explicit disclosure requirements. Administrators and debtors must publicly reveal details of restructuring plans, valuations, risks and financial forecasts, subject to court review. “This is about turning bankruptcy from a procedural box-ticking exercise into a system built on substantive transparency,” said Zheng Zhibin, a senior partner at Beijing Dacheng Law Offices LLP and vice president of the Beijing Bankruptcy Law Society.

Zheng urged lawmakers to go even further: establishing a comprehensive disclosure declaration system with independent legal standing, mandatory content standards and penalties for omissions or false statements. He also suggested lowering the threshold for forming creditors’ committees and allowing courts to appoint neutral financial advisers to review disclosures on behalf of small creditors. “Even if a restructuring plan is approved,” he said, “those who falsify or conceal key information must still face civil, administrative, or even criminal liability.”

Reviving the failing firm

When China first enacted its modern bankruptcy law in 2007, “reorganization” was hailed as a breakthrough — a legal lifeline to rescue struggling companies before collapse. Yet nearly two decades later, that promise remains largely unfulfilled.

In 2024, Chinese courts concluded more than 30,000 bankruptcy cases, but reorganizations and settlements made up less than 5% of the total. Most firms still exit the market through liquidation, leaving behind a landscape littered with “shell companies” and “zombie enterprises” that limp along without real operations.

The new draft seeks to correct that imbalance. It overhauls China’s reorganization framework to make corporate rescue not only possible, but practical.

According to lawyers Xu Shengfeng and Zhang Sheng of Zhong Lun Law Firm, the bill refines how creditors are classified and how plans are approved, simplifies equity transfers, resolves hidden liabilities and introduces tax relief for debt forgiveness. It also establishes a credit rehabilitation mechanism to help revived companies regain access to finance after restructuring — a crucial step toward restoring business confidence.

The reform also redistributes power within the process. Administrators’ duties are clarified, and distressed companies can now manage their own reorganizations under looser conditions, addressing what Xu called the “motivation gap” among debtors.

By curbing the dominance of existing shareholders and defining the rights of outside investors who inject new capital during restructuring, the draft aims to turn reorganization into a genuine opportunity rather than a last resort. Zhang added that procedural deadlines — including the time limit for a second creditors’ vote — have been tightened to reduce delays and lower the social cost of stalled cases.

Perhaps the most welcome change involves taxation. Under current rules, when creditors forgive part of a company’s debt, the written-off amount is treated as taxable income — even though the firm receives no actual cash. “The debtor doesn’t get a penny yet must pay 25% corporate income tax on paper gains,” said Renmin University’s Wang. “Many reorganizations fail for this reason alone.” The new draft classifies such forgiven debt as non-taxable income, removing one of the biggest barriers to successful corporate rescues.

Still, experts note that China’s reorganizations are overwhelmingly creditor-driven, with few debtors taking the initiative. Articles 100 to 102 of the draft law introduce provisions linking court-led and out-of-court workouts — what practitioners call “pre-reorganization.” The aim is to allow negotiations and draft plans before a case is formally filed, so that once it enters the court system, approval can move swiftly. “The in-court process should support the out-of-court one, not the other way around,” said Zheng from Dacheng.

Zheng pointed to international lessons. The United States relies on its “pre-packaged” bankruptcy model — supported by deep capital markets and a predictable legal system — to streamline restructurings. Japan, meanwhile, adopted a European Union-style “preventive reorganization” law in June 2025, creating a hybrid framework that lets debtors and creditors negotiate under court supervision without a full bankruptcy filing. “Japan’s model,” Zheng said, “offers a valuable reference: an early intervention system that saves viable companies before they fall too far.”

Clearing personal debt

Can personal bankruptcy finally find its place in China’s legal code? That question has hovered over the country’s reform agenda for years — and it has resurfaced with this new overhaul.

A decade ago, China’s consumer-lending boom opened credit to millions of people. Banks, fintech platforms, and consumer-finance firms flooded the market with easy money. But as borrowing soared, so did risk. Poor screening, reckless lending and the economic fallout of Covid-19 left many small investors, entrepreneurs and households trapped in debt they could never repay.

Since 2018, when bankruptcy reform entered the national legislative plan, scholars and policymakers have pushed for a system that will give the “honest but unfortunate” a second chance. Legal experts proposed expanding the Enterprise Bankruptcy Law into a comprehensive Bankruptcy Law, covering both individuals and firms. Some pioneering cities — including Shenzhen, Xiamen and Wenzhou — used their special legislative powers to pilot local personal-bankruptcy rules, allowing qualified residents to discharge debts under strict supervision. Even the Communist Party’s 20th Central Committee meeting in mid-2024 endorsed “exploring a personal bankruptcy system.”

Yet the draft now before the legislature stops short of that goal. Instead of creating a fully-fledged individual bankruptcy regime, it introduces a narrow framework for debt clearance by natural-person shareholders — those who personally guaranteed their companies’ debts and remain liable after corporate bankruptcy.

“Enterprises cannot truly be freed from debt if their owners remain shackled,” said Zhong, chair of the legislature’s Finance Committee, in his briefing. Article 2 of the draft allows such shareholders to apply for debt relief alongside their company’s bankruptcy case.

Under Articles 18 and 19, courts may restrict these guarantors’ high-end spending — banning luxury purchases and non-essential travel — and require full disclosure of personal and family assets. They must file monthly reports during a supervision period of up to five years and are barred from serving as executives or directors in listed or financial firms. Lawmakers said the goal is to balance leniency with accountability, preventing “fake bankruptcies” or asset concealment.

The draft also defines behaviors that prohibit eligibility for discharge: hiding or transferring property, fabricating debts, gambling or squandering funds, or committing fraud. Certain liabilities — including personal-injury compensation, unpaid wages, or consumer claims — remain non-dischargeable. Together, these provisions create what one scholar called a “narrow gate to redemption”: open only to those who act in good faith and suffer genuine financial collapse.

Is this personal bankruptcy in disguise? Not exactly. “It’s not a full personal bankruptcy system,” said Wang of Renmin University of China. “But it is a historic first step.” The distinction is more than semantics. By limiting eligibility to shareholder-guarantors, the law preserves its corporate focus while recognizing that entrepreneurs often blur the line between business and personal risk. The goal, Wang said, is to encourage owners to pursue corporate restructuring without fear of personal financial ruin.

For practitioners, the change could have real-world impact. In many reorganizations, companies survive while their founders collapse under personal debt, deterring others from seeking formal rescue.

The draft’s limited debt-clearance clause could help correct that imbalance. But experts such as He Dan of Beijing Normal University and Qi Lijie of Shenzhen University argue the scope should be broader — extending beyond shareholders to actual controllers, partners and sole proprietors. “After all,” Qi said, “entrepreneurs come in many legal forms. The spirit of second chances shouldn’t depend on what type of company they registered.”

Expanding the boundaries of bankruptcy

One of the most notable additions in China’s new bankruptcy overhaul is its focus on specialized regimes — tailored procedures for small businesses, financial institutions and even cross-border insolvencies. The aim is to make bankruptcy more adaptable to the realities of a diverse and globalized economy.

For small and micro-sized enterprises, the draft introduces a new chapter entitled “Special Procedures for Small-Scale Bankruptcies.” The six-article framework allows simplified hearings, single-judge trials and reduced procedural requirements for cases involving few creditors and straightforward debts. The aim is speed and affordability — ensuring that entrepreneurs who fail in the market don’t drown in legal complexity on their way out. By cutting costs and streamlining filings, lawmakers hope to normalize business exit as a natural part of the economic cycle, not a bureaucratic ordeal.

At the other end of the spectrum, the draft strengthens the bankruptcy framework for financial institutions, detailing jurisdiction, application procedures and claim-settlement orders. It also defines how regulatory interventions and court-led bankruptcies should align when banks or insurers face insolvency.

“Financial institutions are different — their assets are fluid, systemic, and interconnected,” said Qi of Shenzhen University. “They require a specialized, swift, and professionally guided emergency mechanism.” But others, like Yang Zhongxiao of East China University of Political Science and Law, warn that even with regulatory oversight, judicial independence must remain paramount. “At its core,” he said, “bankruptcy is a matter of law, not administration.”

The draft also reaches beyond China’s borders. Reflecting the country’s growing engagement in global commerce, a new chapter entitled “Judicial Cooperation in Cross-Border Bankruptcies” introduces six provisions covering jurisdiction, recognition and assistance between Chinese and foreign courts. It clarifies when overseas insolvency proceedings can be recognized in China, how domestic rulings apply abroad and how creditors can file cross-border claims.

“It builds the basic framework,” said Chen of the China University of Political Science and Law. “What’s still needed are the finer details — from claim procedures to coordination mechanisms — to make this cooperation genuinely workable.”

Contact reporter Denise Jia (huijuanjia@caixin.com)

caixinglobal.com is the English-language online news portal of Chinese financial and business news media group Caixin. Global Neighbours is authorized to reprint this article.

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