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
Who are german insolvency practitioners?
- A person ‘qualified’ for the respective cases, experienced in a particular area of business
- Must be independent of both creditors and debtors
- A number of unofficial insolvency organizations have developed, with their own codes of conduct
What are the two main insolvency proceeding in France?
Redressment judiciaire (reorganisation)
Liquidation judiciaire (liquidation
What are the objective of reorganisation in France?
The objectives of reorganisation are to allow the continuation of the business, the maintenance of employment and the settlement of liabilities.
What is the process of reorganisation in France?
- The debtor must apply to court within 45 days following its cessation of payment; creditors can also apply
- In either case, a ‘works council’ or employees delegates may inform the court of any information relating to the cessation of payment (e.g. if employees haven’t been paid)
- The court decides whether to open reorganization proceedings
- Reorganisation is broken into two periods:
- The observation stage (2 months)
- The decision and execution stage (if reorganisation is deemed viable, it is put into play)
- Within the observation period, the court decides whether to allow the continuation of the business
- If it does, then the court will also fix the duration of the reorganisation plan
- The implementation of the plan is strictly under the control of the court
- The court can appoint a ‘supervisory judge’ (has commercial/ business experience, they assess the reorganisation prospects)
- Supervises the progress of proceedings
- Protects all relevant parties’ interests
- The court will also appoint an administrator and trustee (insolvency practitioners and officers of the court)
- Administrator represents the debtor (i.e. the company) – objective is to ensure the preservation of business and to maintain production
- Trustee acts for the creditors
What are the benefits of the French system?
Provides a forum
Better compared to US as rather than a judge, it is a commercial person who is making the decision.
French system represents the different interests (of company and creditors)
- Professions of trustees and administrators are highly regulated (high entry requirements) and also incompatible (either one or the other – independent)
- High entry requirements
What are the issues with the French System?
French system has heavy court involvement.
May be biased towards employee concerns.
- General bias towards favouring employees
- Courts may sacrifice economic goals in favour of employee interests
What are the two types of insolvency proceeding in Spain?
• Two types of court proceedings:
• Ordinary concurso proceedings (liabilities >€1m)
Expedited concurso proceedings (liabilities < €1m)
What is the process of Spanish insolvency?
Handled by the court.
- Three “IPs” must be appointed (the receivers’ panel)
- IPs are either a lawyer with over 5 years’ practising experience
- An auditor or economist with over 5 years’ practising experience
- A creditor of the insolvent company, holding an unsecured claim sits on the panel
- In the case of the professional IPs, there are restrictions on the number of times they can be appointed (3 proceedings in last 2 years)
• A single liquidity test – debtor cannot pay debts regularly as they fall due
- Voluntary insolvency – directors file for insolvency
- Directors must do this within 2 months of the date when they become aware or should have become aware of the insolvency situation
• Necessary insolvency – any creditor may file for the debtor’s insolvency
- Common phase
- Judge appoints receivers’ panel at this stage
- The debtor may remain in possession of its management (in the case of voluntary insolvency) or the receivers will replace and take over management (in the case of necessary insolvency)
Common phase is then either followed by a composition agreement (needs creditors and court approval) or liquidation
Why is the difference is insolvency proceedings across the EU a problem?
- Might be seen as problematic, especially given the global nature of many organisations
- Insolvency proceedings are likely to invoke cross-border issues
- EC Regulation on Insolvency Proceedings is based on the Centre of Main Interests (COMI) principle – where most trade is carried out
