China: A Brief Analysis Of The Application Of The Statute Of Limitations To Bankruptcy Claim Verification

[Abstract] In bankruptcy cases, an administrator needs to examine claims declared by creditors and verify that they are legal, authentic and valid after receiving supporting evidence from these creditors. To verify that a claim is "valid" means to verify whether or not the age of the claim is within the deadline imposed by the Statute of Limitations (the "SOL"). If the claim is within the SOL, it is considered valid in a bankruptcy proceeding. If not, it will not be considered a valid bankruptcy claim and will not be protected under bankruptcy law. Bankruptcy clams must be verified by an administrator subject to objections raised by the creditors and the bankrupt enterprise.

[Keywords] bankruptcy, creditor's claim declaration, statute of limitations

I. Application of the Statute of Limitations in Bankruptcy Cases

Once an enterprise enters into a bankruptcy procedure, all enterprise debts must be paid in proportion and order of priority mandated by the Enterprise Bankruptcy Law of the People's Republic of China. The nature of the enterprise's debts will not change just because the enterprise has entered bankruptcy: outstanding labor claims arising prior to bankruptcy remain valid, and unsecured loans owed by the enterprise prior to bankruptcy remain ordinary creditor's rights. Since the nature of the liabilities remain unchanged, the SOL as prescribed by the General Rules on P.R.C Civil Law and the Civil Procedure Law of the People's Republic of China apply to bankruptcy cases.

To avoid ambiguity in the application of the law, the Supreme People's Court further specifies in Article 61 of the Provisions on Issues Concerning the Hearing of Enterprise Bankruptcy Cases that claims exceeding the SOL shall not be considered bankruptcy claims.

Accordingly, in bankruptcy cases, an administrator must verify that the creditor's declared claims are still within the SOL. (likewise, the author believes that an administrator must also confirm that labor claims are still within the SOL for arbitration when he investigates claims asserted by laborers.)

II. Verification of Claims by Administrator Under the Statute of Limitations

Pursuant to provisions concerning the SOL under the General Rules on Civil Law and the Civil Procedure Law, SOL is a defense that a debtor may raise against a creditor. If a debtor does not raise an SOL defense in its Answer, the People's Court shall not educate the debtor about SOL or adjudicate by actively applying SOL-related provisions. In addition, if a creditor's claim falling outside the SOL has already been paid, the payment shall be protected by law and the debtor may not raise an SOL defense thereafter.

Moreover, according to Article 49 of the Enterprise Bankruptcy Law, when declaring a claim a creditor must explain in writing the amount of his claim, and must state whether there is any collateral. The creditor must also file relevant evidence of the claim. If a creditor declares a claim with an administrator, the creditor is required to submit evidence proving the amount of the claim, not further proof that the claim is still within the SOL.

In view of the foregoing, the author holds that an administrator should take the initiative to check whether or not the claim declared by a creditor is within the SOL, rather than simply relying on SOL-related documentation submitted by the creditor. In fact, according to the Enterprise Bankruptcy Law, an administrator should and is able to verify the SOL because

1. An administrator, after being established, is responsible for internal affairs such as managing the property of the bankrupt enterprise, along with external affairs such as representing the bankrupt enterprise in lawsuits. When it comes to claims declared by creditors, an administrator must prudently assert the SOL defense on behalf of the bankrupt enterprise.

2. Once the administrator has been established by a People's Court, he must fully administer the bankrupt enterprise by creating a detailed list of debts, financial materials, contracts and other important documents of the bankrupt enterprise, and must consult the relevant personnel of the bankrupt enterprise. For this reason, an administrator is able to verify the SOL's application to the debts of the enterprise, based on the materials available and its own investigation.

III. Creditor Objections to Administrator's Conclusion of SOL Verification

After examining claim declaration materials submitted by creditors, the administrator must prepare a Credit Form in accordance with the Enterprise Bankruptcy Law so that the creditor's meeting can review it. In practice, however, due to limited time for the creditor's meeting, it may not be practical for all creditors to verify every declared claim. Consequently, in most cases the administrator will notify creditors of the progress of claim verification (especially when a declared claim(s) is rejected or when the amount of the claim is adjusted or reduced by the administrator) and illustrate the facts relating to and the grounds for unrecognized claim(s) as well as any adjustments or reductions in the claim(s) amount.

Where the administrator refuses to recognize a declared claim on the ground that the SOL has expired, the creditor may raise a defense with documents evidencing the interruption or suspension (tolling) of the SOL. If the claim in question is found to have been tolled, and if it is still within the SOL, the administrator must approve the claim.

IV. Objections Filed by Bankrupt Enterprise or Other Creditors

According to the Enterprise Bankruptcy Law, the Claim Form generated by the administrator must be submitted to the creditors' meeting for review, and the bankrupt enterprise or creditors may object to claims on this form. Likewise, in bankruptcy procedures, the bankrupt enterprise and creditors are legally entitled to apply to the administrator for review of the claim declaration materials submitted by creditors, which means that the law supports bankrupt enterprises' and creditors' right to know and to object to claims declared by other bankruptcy creditors. If, after exercising its right to know, a bankrupt enterprise or creditor believes that the SOL applicable to any claim declared by any other creditor has expired under the SOL, it may file an objection to the administrator demanding reexamination.

V. Flexible Application of SOL Examination Rules in Bankruptcy Claim Verification

A number of statutes and regulations including the General Principles of Civil Law, the Civil Procedure Law and the Provisions of the Supreme People's Court on Certain Issues Concerning the Application of the Statute of Limitations to Civil Trials provide provisions regarding the SOL. According to these，a general rule for the examination of a creditor's claim to determine whether or not it is still within the SOL is that the creditor must assert its rights against the bankrupt enterprise within two years of the date that it knows or should have known that its rights have been infringed by the enterprise. We should pay particular attention to the application of certain general rules in bankruptcy cases. Generally speaking, when an enterprise has qualified for bankruptcy (or such a qualification gradually arises) prior to entering into bankruptcy procedures, the enterprise often suffers from loss of laborers and slack management. During this period, the enterprise tends to act passively in external affairs (the performance of contracts and the settlement of debts and creditor's claims); therefore, some contracts could be suddenly suspended during the course of their execution. Since contracts generally represent mutual agreements, the establishment of the specific amount of a creditor's claim or terms of payment depends on the fulfillment of the contract, and the abrupt suspension of performance of the contract will leave the amount of a creditor's claim or terms of payment undetermined. In this circumstance, the author holds that the examination of the SOL as applied to the creditor's claims should be conducted by considering the composition of such claims and the relevant parties' contractual payment terms.

1. For claims on which the terms of payment have been established under the contracts, the SOL should start running on the day immediately following the due date of the corresponding payment; and if the relevant SOL has expired, the corresponding claims should not be treated as bankruptcy claims.

2. If, under the provisions of the relevant contract, a creditor's claim arises after a creditor has partially performed his obligations but relevant payment terms have not yet been fulfilled, the author believes that as long as specific performance of such contract is not required, the creditor's claim should be declared and examined in accordance with applicable provisions governing the termination of mutual agreements under the Enterprise Bankruptcy Law. Correspondingly, such creditor's claim should not be burdened with SOL issues.

VI. Summary

The main goal of the trial and management of bankruptcy cases is to sort out and pay all bankruptcy claims. Since the establishment of a creditor's claim has a direct impact on other creditors' interests, administrators should carefully examine the claim and the corresponding SOL status to avoid the risk of being penalized or facing claims for recovery due to creditor's losses caused by faulty creditor claim examination and verification. Likewise, creditors should understand and use the law. They should not hesitate to assert their legal rights, and they should avoid forfeiting legal protection due to problems arising from the claim recovery process.