Lecture 10: Corporate Insolvency procedures: an international perspective Flashcards
What did the US Bankruptcy Reform Act 1978 implement?
Chapter 7 - Liquidation
Chapter 11 - reorganisation
Chp 11 - Described as a debtor friendly system.
The debtor retains control of the property of the bankruptcy estate. Aim is to preserve the company’s going concern value.
Managers have legal rights to prepare a reorganisation plan.
This will usually involve: a standalone plan between creditors, company and shareholders; a sale of the assets as a going concern; a capital injection from a third party; a debt for equity swap.
What does the US Bankruptcy code prescribe for managers?
• So managers retain control over the company – sometimes referred to as ‘debtor in possession’.
Management powers are circumscribed however:
- Need approval from bankruptcy court for some decisions.
- Ideally should have active creditors’ committees (approving the professional fees/appointment of a restructuring officer)
- Although management remain in control, the process is supervised by a bankruptcy court
- Are bankruptcy judges the best people to make commercial decisions
What does the US Bankruptcy Code stop creditors from doing?
- As soon as filing takes place, automatic “stay” on creditors’ claims
- Idea is that secured creditors must be stopped from prematurely liquidating the firm
What is the purpose of Chapter 11?
- Chapter 11 is designed to keep firms as going concerns
* Issues of unfair competition
What is the process of a chapter 11 proceeding?
- Managers file for chapter 11
- As soon as filing takes place, there is an automatic stay on creditors’ claims.
- Process is supervised by the bankruptcy court.
- Creditors have to vote on the plan (prepared by management) - Management must be fairly confident that those classes will vote in their favour before they submit the plan, each class of creditor must vote, need majority in number and 2/3 of value
- Court can still “cram down”, providing the ‘best interests’ test is satisfied and the plan is ‘fair and equitable’.
- Chapter 11 reorganisations should satisfy senior claimants ahead of junior claimants (absolute priority)
- Where this does not happen, we say there has been a ‘violation of absolute priority’
- Shareholders get involved and prepare their own plan - takes co-ordination and is difficult to implement.
Solvent firms can enter Chapter 11.
What is the best interest test used to determine if the court can cram down a restructuring plan on creditors?
Best interest test - creditors will be no worse off under the reorganisation than they would be in liquidation.
What is absolute priority rights and when are they violated?
• Ch 11 reorganizations should satisfy senior claimants ahead of junior claimants (absolute priority)
Where this does not happen, we say there has been a ‘violation of absolute priority’ - whereby you see shareholders getting something back out of the reorganisation when creditors have not received full value of their claims.
Why does violation of absolute priority occur?
- Due to managers powers (have the ability to prepare this plan).
- Managers chose strategies which benefit them the most rather than outcomes which maximise firm value.
- Also consensual voting structure (shareholders get a vote) (managers and shareholders have similar priorities).
What is the role of bankruptcy judges in the US?
In the US administration is driven by bankruptcy judges’ opinions - what gives the best outcome for the company? So they are happier to violate secured creditors rights.
May not be commercially minded. It could be argued that the purpose of administration is to get the best value from the market.
Newer literature suggests that Chp 11 proceedings are being driven slightly more by the market - seeing more of auction process - auctioning packages of assets.
What is debtor in possession financing?
Any finance that is provided after the Chp 11 commences has priority over other pre-petition claims.
- All post-petition unsecured credit automatically has priority over pre-petition claims.
- Often claimed as an advantage of the US system as finance is provided to help with the reorganization.
- However might result in inefficient investment or over-investment. Companies think they can make a healthy return on loans but may be dealing with a zombie company that may have been better if it had been liquidated.
- Pre-petition claims shouldn’t be affected by DIP financing.
- Effect is that post-petition credit should be paid in full because to trade a company that is insolvent you need funding - only going to fund this business if you are guaranteed your money back.
What is the safeguard for solvent restructurings under chapter 11?
One safeguard against abuse is the requirement that all filing applications are made in ‘good faith’ - need to have a genuine restructuring motive
Bad faith filing - to get out of contracts and obligations.
What were the findings of Bris et al, 2006)?
- Firms are more likely to file for Ch 11 than Ch 7 when:
- They are larger (based on assets) - have more to play with
- Have a large number of secured creditors - difficult to coordinate so may be easier under Chp 11.
An unsecured creditor committee was formed in 45 out of a sample of 225 Ch11 cases (not that common)
• Tend to be more common in larger firms (based on assets), firms without a bank among unsecured debt and for very underwater firms.
- Some evidence to suggest that Ch 11 retains more value than Ch 7
- Secured creditors recovery is between 32% and 51% in Ch 7 and about 90% in Ch 11.
- Unsecured creditors recovery is about 1% in Ch 7 and 52% in Ch 11.
- APR (absolute priority rights) is always followed in Ch 7 and in 88% of their Ch 11 cases, APR was followed
- The identity of the judge seems to matter.
What changes were brought to the German insolvency Code in 2012?
The Act for Further Facilitating the Restructuring of Companies.
Prior to this, it was felt that the German code did not facilitate the possibility of restructuring viable companies (sense that there was too much court involvement).
Shift away from court supervision to greater creditor control
• Upon filing for insolvency, the court must appoint a preliminary creditors’ committee
• Preliminary creditors’ committee get to choose the insolvency administrator (court must approve their choice, unless the person is clearly inappropriate for the role)
• Administrator must be independent
But also enhanced rights for debtors through ‘self-administration’
• Management remain in charge
• Must accept self-administration if the preliminary creditors’ committee unanimously supports it
• Essentially a debtor in possession system, comparable with US Ch 11
Introduction of “protective shield proceedings”
What is the main restructuring tool in Germany?
- Main restructuring tool is the Insolvency Plan
- Used to rescue and reorganise
- 2012 reforms have made it easier to approve the Plan
- Permits debt-for-equity swaps – similar to CVA agreement – easier to preserve the actual legal company.
- Also shareholders can now be ‘crammed down’ – if they disagree, the judge can enforce it on them
What are protective shield proceedings?
- Used in cases of imminent insolvency – not cash flow insolvent and restructuring has a good chance of working
- Debtor filing must be endorsed by an insolvency law expert
- Company is granted a protection period of up to 3 months
- Debtor must then submit a draft insolvency plan
- A preliminary advisor (insolvency trustee) must be appointed by the Insolvency Court
