Restructuring In Asia - A Brief Survey Of Asian Bankruptcy Law

Recessions are generally viewed as the plumbing of economics. They drain out of the system the inefficient and allow for the reallocation of capital and labor to the most efficient enterprises. When recessions do occur, the safety of investments and the speed of recovery will partly depend on how quickly the reallocation process takes place. The assessment of the potential risk for any investment or loan will depend on the same process. One aspect of this process, the bankruptcy system, has until recently received little attention in Asia. The remarkable success of the area has led many to ignore the consequences of potential failure.

Restructuring in Asia - A brief survey of Asian bankruptcy law

Like ports, roads, electricity and education, efficient and honest legal structure is an integral part of a country's infrastructure. The quality and procedure of the insolvency system vary widely between Asian jurisdictions. The competence of each system seems to have been generally ignored in quantifying a country's risk premium. As various countries recover, these distinctions should become more obvious. One generalization can be said for the entire area. With the unusually long expansion the judicial, legal and often cultural resources are simply not available. Even if the laws in place were consistent with the most recent and enlightened legal and economic thought, the personnel to administer the system is simply not available. This bottle neck will have a profound impact on the length of the recovery across the region. Growth will return, but legal systems are perhaps the most difficult parts of an infrastructure to construct.

There are basically three ways to deal with insolvency: liquidation, rescue, and work out. For purposes of this paper these terms will be defined as follows. A liquidation is a formal court administered sale of most or all of the assets usually in piecemeal fashion. At the end of the process, third parties would become owners of the assets. A rescue is a formal court administered rehabilitation, reorganization or restructuring in an attempt to preserve the concern as an on going income producing entity. The end result is that one or more creditors become in some way owners of the enterprise (e.g. debt/equity swap). I have used the term "work out" to describe an informal process that does not involve court proceedings. The debtors remain in possession of the assets. Creditors accept either a reduction or rescheduling of debts.

By way of contrast, both the United States and Western European countries have laws that allow both liquidation and rescue. United States is considered to be slightly more favorable to rescue than European systems. This is only a matter of degree and definition. For example, France favors complete liquidation but in the form of a sale of the business as an entity.

As a general rule, work outs are the norm throughout Asia. There are four main reasons for the preference. First, there are cultural reasons that vary in degree between the jurisdictions. Commentators often mention that the Confucian ethic of harmony in conjunction with the desire to "save face," requires that debtors and creditors avoid public proceedings. As in the west there is a social stigma attached to a bankruptcy filing. Although still, a major factor, the stigma and tradition of avoiding bankruptcy at all costs are declining especially among younger western educated business people.

A greater influence is the lack of a reliable legal infrastructure. For the most part laws are exceptionally antiquated. Most allow only for liquidation. When the creditors or lenders do resort to the local legal system, they often find that it is lengthy, costly and often corrupt. At the end of the process there is often nothing left for either creditor or debtor. Finally in those countries that have reformed their system or are in the process, the new system is often hobbled by the lack of legal resources. Judges and lawyers skilled in the process are nonexistent. The many years of growth in Asia have left a gap in the number of local professionals with experience in handling insolvency proceedings.


China follows the general rule that bankruptcies are treated by informal methods.

China follows the general rule that bankruptcies are treated by informal methods. Although modern laws exist, they are rarely used. Of the 20,000, 000 businesses in China, probably fewer than 2,000 cases of bankruptcy have been resolved by the courts in the past eight years. Bankruptcy law was last revised for state companies in 1986 and is currently under review. The procedure for non state enterprises went into effect in 1994.

The problem in China is more political than economic. The general perception is that the state companies cannot go bankrupt. If state companies can go bankrupt then communism can go bankrupt. Therefore, the government in order to encourage faith in the system and avoid social unrest has a strong motivation to avoid liquidation. Their usual method of dealing with insolvent companies is to fold them into healthy companies. This has become more than a necessity. Recently the government has been following a policy of creating large conglomerates on the Korean "Chaebol" model despite the obvious problems.

Two other problems hobble the Chinese system. The first is the triangular debt problem, which is typical in reforming socialist systems. The problem occurs because one state enterprise (a manufacturer) owes a second state enterprise (a supplier). The second state enterprise owes money to a third state enterprise (a bank). In this example the second enterprise cannot pay its debt to the third enterprise because it cannot collect from the first enterprise. The first enterprise cannot earn money because it makes goods that no one wants. Since all enterprises are owned by the same entity, the state, it appears that the state owes money to itself. The problem is that the inefficient first enterprise continues to function despite the fact that it is inefficiently using resources. The whole process has ruined the banking system, despite administrative attempts to isolate the problem.

The Chinese have a new draft Bankruptcy amendment to the 1986 act. It is hoped that the new law will address the problem. Unfortunately, the problem is the system itself. Until the Chinese government decides that it wants to go to a total market economy the problems will continue to get worse.

The other problem with the bankruptcy system is also at the root of the Chinese economic problems. One result of the increase of a market economy is the dispersion of economic power away from the central planning authorities.

With the economic power has gone the political power. As a result application of the bankruptcy laws can vary with the locality. In a market orient locality like Shenzhen, the bankruptcy of a state owned enterprise does not have to be approved by the department in charge. In Beijing it does. With such a variance in local conditions and the need to support the political system underlying the economic system, the Chinese process of reallocation resources will be exceptionally slow for the foreseeable future.


Indonesia is an excellent example of a system that relies on informal work out methods because it has failed to create any sort of legal infrastructure.

Indonesia is an excellent example of a system that relies on informal work out methods because it has failed to create any sort of legal infrastructure. Unfortunately, Indonesia has all of the problems. Its bankruptcy law dates back to the old Netherlands colonial ordinances first promulgated in 1906. The law is not only antiquated. It does not allow for a formal court-supervised rescue.

In addition there is a strong social stigma associated with bankruptcy. One commentator stated "insolvency is a complete no-no, a major loss of face. Thus adversaries may not enforce it because of the stigma. Even if there was a well-developed body of law, nobody would use it." (ALCJ) Since many of the merchants and traders in Indonesia there is also a reliance on traditional Confucian values of harmony and reliance on families helping each other in times of financial difficulties. Indonesia also has local customary Adat law, which stresses harmony.

There are other reasons for avoiding litigation or court proceedings. People wish to avoid courts because they are considered expensive, notoriously unpredictable and unreliable. In addition there is a pervasive culture of corruption at all levels. High profile persons are perceived as exempt from the process. The government may also step in at any point to rearrange the process to suit what it considers its interest. According to the "Corruption Perception Index" published by Transparency International and Gottingen University. Indonesia scored a 2.72 on a scale of 10 (the top was Denmark is 9.94, China was a 2.88). An Indonesian legal expert stated "it is not the (the Indonesian) culture that is the primary influence in people deciding not to go to court. If the legal system could provide a quick and painless way of winding up then many more creditors would go to the court or through the system."


Singapore stands in stark contrast to Indonesia. First, Singapore is one of the least corrupt jurisdictions in the world.

Singapore stands in stark contrast to Indonesia. First, Singapore is one of the least corrupt jurisdictions in the world. With a Corruption Perception Index score of 8.66, Singapore is ahead of many western jurisdictions including the U.S. Second, Singapore's law is also up to date. It was originally based on the Malaysian statue of 1965, which was based on the Australian law of 1961, which in turn was based on English law.

Singapore's law has also been recently amended. In 1987, Singapore amended the law to include a formal court supervised rescue scheme modeled on the UK Insolvency Act of 1985. The law was further amended in 1995. The western legal influence has not totally eclipsed the Asian values for harmony. Like their American counter parts, the Singapore courts have favored compromise and negotiation. Also Singapore creditors may be a bit more reluctant to force a debtor into bankruptcy, once the process has begun it follows the procedure without cultural bias.

Like other jurisdictions, Singapore's bias against bankruptcy has been changing. The resort to the law courts is seen to be more acceptable than in times past. In 1985 Singapore experience the high profile bankruptcy of a publically listed company. The result was a number of bankruptcies of brokers and some fundamentally sound companies that might have been saved. Singapore was fortunate enough to heed the warning and modernize its law. In the process the attitudes toward bankruptcy in the absence of fraud have been seen more as a normal risk in the entrepreneurial process rather than a moral failure.


Like Singapore, Malaysia's bankruptcy law is based on pre 1985 UK bankruptcy law.

Like Singapore, Malaysia's bankruptcy law is based on pre 1985 UK bankruptcy law. Unfortunately the 1965 act has not been updated to keep current with the growing economic sophistication of the marketplace. The problem with present Malaysian law is that it does not have sufficient emphasis on more modern concepts of formal court-supervised rescue. Although various governmental organizations including the central bank, the trade ministry and the attorney general's office have recently issued guidelines to protect debtors' rights, there is as yet no systematic revision of the law.

From a cultural standpoint, Malaysian is divided between the overseas Chinese communities and the Malay community. The Malaysian Chinese share with other Chinese communities throughout Asia a strong cultural bias against bankruptcy. A strong emphasis is placed on informal workouts, social and family support systems and avoidance of social stigma. Also, like other Chinese enclaves there are a split based on the size of the firm. Smaller businesses are far more likely to avoid liquidation than larger corporations.

The cultural values against liquidation are not as pronounced in the Malay community. The real detriment to use of the bankruptcy procedure has far more to do with the social and political connections of the debtor. Like Indonesia and China, political connections and influence will restrict the use of litigation and insolvency procedure far more that cultural inhibitions.

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