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After the lessor enters bankruptcy proceedings, whether the right of the bankruptcy administrator to decide to continue performing or terminate the executory contracts specified in Article 18 of the Bankruptcy Law of China shall be restricted is a highly controversial issue in bankruptcy proceedings. Based on his own professional practice and focus on the theories and practices of China's bankruptcy law, the author discusses and exchanges views on the aforesaid issues from the perspective of real estate leasing in this article. Your comments and corrections are sincerely welcomed.

I. Scope of Executory Contracts

1. Constitutive Elements of an Executory Contract

Determination of the scope of executory contracts constitutes the prerequisite for the administrator to exercise the right to elect performance of contracts. The elements for an executory contract are specified as follows: 1. In terms of existence duration, the contract is concluded before the People's Court accepts the bankruptcy application, and has not been terminated after the bankruptcy proceedings are initiated; 2. The contract falls under the category of bilateral contracts, where both parties mutually assume reciprocal performance obligations which are primary contractual obligations; 3. With respect to performance status, there exists the circumstance that neither party has fully performed its obligations. It can be clearly ascertained from the wording of the second element that the "obligations that neither party has fully performed" as mentioned in the third element shall refer to primary contractual obligations rather than ancillary obligations.

2. Judicial Determination of Executory Contracts

In judicial practice, the general approach is as follows: Ascertain whether the parties to the contract owe mutual consideration to each other to classify the contract as a unilateral contract or a bilateral contract. Where the contract is determined as a bilateral contract, the performance status of the contract shall be examined to clarify whether one party has fully performed its obligations, or neither party has completed the performance of their respective obligations. In the "Case of Dispute over Sales Contract between a Huainan-based Real Estate Co., Ltd. and Xu", the People's Court held that a guarantee contract is a unilateral contract, to which Article 18 of the Enterprise Bankruptcy Law of the People's Republic of China does not apply. In the "Case of Dispute over Third-Party Revocation Action between a Ningbo-based Construction Group Co., Ltd. and Wo", the People's Court ruled that the bankruptcy administrator has no right to choose to rescind the contract if one party thereto has fully performed its obligations.

II. Disputes Concerning the Administrator's Termination of Executory Real Estate Lease Contracts

There are substantial disputes over whether the administrator's right to choose to terminate an executory real estate lease contract is subject to restrictions. Some opinions hold that, from the perspectives of ensuring lessees' effective utilization of real estate, encouraging long-term investment and stabilizing earnings expectations, reasonable restrictions shall be imposed on the administrator's exercise of the right to elect to perform or rescind executory contracts. Contrary opinions hold that the administrator is entitled to unilaterally terminate the real estate lease contract and demand the lessee to return the leased property, so as to guarantee the smooth recovery and disposal of the leased property and maximize the value of the bankruptcy property. Therefore, it is necessary to clarify the conflicting rules and their underlying value orientations.

1. Determination of the Nature of Immovable Property Lease Contracts

Whether a real estate lease contract concluded by and between the lessor and the lessee before the lessor commences bankruptcy proceedings shall be categorically deemed as the aforesaid executory contract after the lessor enters bankruptcy proceedings remains to be further discussed. Where the lessee has fully performed its primary obligations, that is, paid all rent under the contract, and the lessor is obliged to continue to perform the contract by providing a leasehold fit for leasing purposes, as such circumstance does not meet the aforesaid constituent element of "both parties have not fully performed their primary obligations under the master contract", the bankruptcy administrator certainly has no right to exercise the right to assume or reject executory contracts. A real estate lease contract under which the lessee is still obliged to pay rent and the lessor is still obliged to provide a leasehold fit for leasing purposes shall undoubtedly be deemed as an executory contract.

2. Special Protection System for Lessees of Immovable Property

For real estate lease contracts that fall under executory contracts, due to the inherent particularity of such contracts, namely the conversion of leasehold rights into rights in rem, under the current system of China, the special protection granted to lessees in real estate lease relationships has been extended from the Contract Law to the Civil Code. Article 725 of the Civil Code stipulates the "sale does not break lease" rule, and Article 726 stipulates the lessee's right of preemption. The aforesaid provisions that give priority to protecting the interests of lessees are in sharp conflict with the principle in insolvency proceedings that the administrator conducts expansive recognition of the debtor's property and realizes fair satisfaction of claims among all creditors. There are considerable controversies over whether the administrator's right of termination is restricted as a result. Accordingly, it is necessary to further clarify the value choices underlying the conflicting rights.

Both in jurisprudence and judicial practice, the "sale does not break lease" rule has been widely established and recognized. The mainstream view holds that the possession and use of the leased property by the lessee in a leasehold relationship generally falls within the scope of basic subsistence interests, which cover both the residential interests of residential lessees and the business maintenance interests of commercial real estate lessees. In the value hierarchy of civil law, subsistence interests rank higher and shall be given priority in protection. Secondly, the "sale does not break lease" rule, by way of granting in rem effect to leasehold rights, can achieve the purposes of stabilizing leasehold relationships and protecting transaction security, which is conducive to encouraging lessees to make medium- and long-term investment in and utilization of the leased property.

The lessee's right of first refusal is an extension of the "sale does not break the lease" rule. The establishment of the right of first refusal is primarily intended to protect the lessee's rights and interests from infringement, maintain the stability of lease relationships, and realize the residential or economic interests of the lessee.

3. Legitimacy of the Bankruptcy Administrator's Selective Performance of Contracts

From the perspective of the value objectives and value pursuit of the Bankruptcy Law, as a general collective enforcement procedure, the Bankruptcy Law prioritizes the overall maximization of the debtor's interests, and on that basis, guarantees the fair satisfaction of creditors' claims. Granting the bankruptcy administrator the right to assume or reject executory contracts is a specific institutional design for realizing the legislative purpose of the Bankruptcy Law. The claims held by creditors under executory contracts fall within the scope of bankruptcy property, which shall be acquired only against payment of certain consideration. Accordingly, it shall be examined whether the contractual benefits of the debtor, compared with the consideration paid for contract performance, will ultimately generate value increment to the debtor's property, which is the basis for the administrator to exercise the aforesaid right to assume or reject executory contracts.

From the perspective of the role orientation of the administrator, as a neutral organization appointed by the People's Court, the administrator adheres to the principles of maximizing the value of the debtor's property and ensuring the fair satisfaction of creditors' claims, performs its duties faithfully and diligently in accordance with the law, and submits work reports to the creditors and the People's Court. Whether the administrator terminates the executory real estate lease contract or not, it will objectively gain no benefits or suffer no losses therefrom. Theoretically, the administrator has no motive to prefer the interests of specific creditors, and it exercises the right to assume or reject executory contracts with the interests of all creditors as the starting point.

From the perspective of the regulatory system, creditors including lessees enjoy the right to information in bankruptcy proceedings. The bankruptcy administrator is obligated to report its work to the creditors and the creditors' committee, and shall also report its work to the people's court. Shareholders of the debtor shall exercise their shareholders' right to information before the debtor is deregistered. The aforesaid systems stipulate that the bankruptcy administrator shall not exercise its rights arbitrarily, but shall exercise the right of rescission reasonably in accordance with the law under the supervision of various interested parties to the bankruptcy case and the people's court.

Based on the foregoing, the administrator is vested with the right of rescission or right of election. It may either continue to perform contracts conducive to increasing the value of the debtor's property, or refuse to perform contracts that impose burdens or whose cost of continued performance outweighs the benefits. Rescinding contracts increases the debtor's property available for distribution to creditors in the bankruptcy liquidation procedure, so as to protect the interests of general creditors to the greatest extent possible.

III. Questions Concerning the Necessity of Restricting the Administrator's Right of Rescission

The view advocating restriction on the bankruptcy administrator's right of rescission holds that rescinding a real estate lease contract is not conducive to preserving or increasing the debtor's property. This is because the existence of a lease contract does not affect the transfer of the subject matter of the contract. The administrator may achieve the goal of maintaining and increasing the value of the debtor's property by transferring the ownership of the subject matter, while rescinding the lease contract will definitely lead to the loss of rental and other proceeds. A dissenting opinion holds that the continued existence of a housing lease contract often causes material devaluation of the debtor's real property or seriously impairs its disposal value. Moreover, according to the average rental yield of China's real estate industry, the value of the debtor's real property is far higher than the rent that shall be returned to the debtor, as the minor value fluctuation arising from the transfer of the real property subject to the existing lease may have far exceeded the rent payable to the debtor. For prospective investors in the reorganization procedure, their investment plans for the real property will be frustrated due to the existence of the established leasehold relationship, which will dampen their investment initiative. The view that undermines the realization of the debtor's assets or the introduction of investors for the purpose of protecting the interests of individual lessees, thus causing damage to the interests of all creditors, is open to question.

Some hold that the right of a bankruptcy administrator to terminate an executory contract shall be the product of balancing of interests. If there are mandatory provisions in the law for the protection of public interest, or the contract is special in nature, or the loss suffered by the other party to the contract due to the termination of the contract is far greater than the increase in the debtor's property brought by the termination, the administrator's right of termination shall be reasonably restricted. With regard to the view that "the administrator's right of termination shall be reasonably restricted where the loss suffered by the other party to the contract due to contract termination is far greater than the increase in the debtor's property brought by such termination", the loss incurred by the lessee as a result of contract termination constitutes a claim against the debtor. Where such claim is greater than the property gain obtained by the debtor from the termination, the overall property of the debtor will still decrease, and the administrator shall choose to continue the performance of the contract rather than terminate it. It remains questionable whether it is necessary to restrict the administrator's right of termination by formulating legal provisions. As mentioned above, the basic principles for the administrator's performance of duties, the supervision of all stakeholders, the duty of diligence and loyalty and the corresponding compensation liability will naturally prompt the administrator to continue to perform the contract. Otherwise, the administrator may even have to compensate out of his own pocket for the losses caused by the decrease of the debtor's property due to his improper performance of duties. With regard to the view that "the administrator terminates the contract in pursuit of the maximization of the debtor's property, thus endangering the stability and predictability of contractual relations and affecting the security of market transactions and economic order", the author holds that the choice between termination and performance of the contract involves a trade-off among the claims interests of all creditors, the effective circulation and utilization of social and economic resources, and the lessee's leasehold right. Employee claims in bankruptcy proceedings may also relate to the survival of a large number of employees. Most of the claims of general creditors are contractual claims, and the contracts they concluded with the debtor are mostly unperformed by the debtor. The contractual interests and transaction security of these creditors are also affected by the debtor's bankruptcy. It may be unfair to other creditors if only the interests of the lessee are emphasized. It is true that the administrator's termination of the contract when the lessee is not at fault violates the principle of pacta sunt servanda. However, after the debtor has entered into bankruptcy proceedings, the losses incurred to the debtor's property will ultimately be passed on as the reduction of the distributable property available to creditors. It may be unfair to secure the lessee's contractual interests at the expense of the interests of other creditors.

IV. Conclusion

Admittedly, the leasehold right of the lessee is worthy of protection. In bankruptcy proceedings, the administrator's decision to terminate a real estate lease contract shall be based on the consideration of the overall property value of the debtor, rather than merely the interests of the lessee. Even if the real estate lease contract is terminated, the decoration and fit-out costs invested by the lessee, as part of the ascertainable losses, shall be included in the common benefit debts of the debtor and repaid at any time, the same as prepaid rent. By contrast, the claims of ordinary creditors shall be repaid pro rata only after the completion of procedures such as the realization of bankruptcy property. The institutional arrangements of China's Bankruptcy Law on the priority and proportion of repayment for lessees also constitute special protection for lessees. As for the administrator's decision to continue performing or terminate a real estate lease contract, it shall be determined by the administrator at its own discretion in light of the circumstances of each specific case and in compliance with the principles of maximizing the value of the debtor's property and ensuring fair repayment for creditors under the Bankruptcy Law, rather than being subject to explicit statutory restrictions.