Lecture 2, bankrupty laws around the world

Question 1

absolute priority rule

Answer 1

principle in bankruptcy proceedings that determines the order in which creditors and shareholders are paid from the lquidation or reoganization

Question 2

Distressed exchange

Answer 2

Exchange of existing debt for new debt or equity securities

Question 3

debtor in possession (DIP) financing

Answer 3

type of financing provided to companies that have filed for bankruptcy, financing is usually super senior

Question 4

out of court restructuring

Answer 4

restructuring out of court, most of the time done through an distressed exchange. a company renegotiates its debt and the terms with the creditors

Question 5

automatic stay

Answer 5

gives the debtor breathing room, as soon as the bankruptcy is filed, creditors must stop all collection activities immeidately.

Question 6

cram-down option

Answer 6

court is able to confirm a reoganizaion plan despite the objectinos of certain classes and creditors, this ensures that a feasible reorganization plan can proceed even if some creditors do not agree with it

Question 7

Chpater 11

Answer 7

liquidaton

Question 8

chapter 7

Answer 8

restructuring

Question 9

what are the four main events in the US bankruptcy laws

Answer 9

Bankrupty act of 1898
The chandler act of 1938
Bankruptcy reform act of 1978
bankruptcy abuse prevention and consumer protection act of 2005

Question 10

Bankrupty act of 1898

Answer 10

Focussed on liquidation established modern bankruptcy procedures, inefficient receivership replaced.

Question 11

Teh chandler act of 1938

Answer 11

Focused on restructuring, replaced equity receiverships, laid groundwork for better reorganization processes. New features were:
Cram downs
super senior distressed funding
Absolute priority doctrine for liquidations (so who has first rights)

Question 12

• Bankruptcy reform act of 1978

Answer 12

comprehensive overhaul, introduced exclusive right to file reorganization plan, formalized creditors’ committees.
- increased bargaining power of debtors (they are theone to propose a restructuring plan)
court allows bankrupty fillings even wihtout payments default, this is a strategic threat towards creditors
introduction of prepackaged chapter 11

Question 13

• Bankruptcy abuse prevention and consumer protection act of 2005

Answer 13

Aimed at preventing abuse, introduced the means test, changed dynamics for consumer bankruptcy filings.

Question 14

What is historically the main focus of bankruptcy laws?

Answer 14

Secured creditors, only the US and more modern laws start focussin on total enerprise value

Question 15

What is a main determinant for bankruptcy outcomes

Answer 15

the legal environment and bankruptcy laws

Question 16

Where is the US law focussed on in terms of bankruptcy?

Answer 16

restructuring

Question 17

What are the two major law systems?

Answer 17

Civil (roman) law
common (case) law

Question 18

What is common (case law) and what countries use this

Answer 18

Used by the UK, US and Australia. Judges make the law on a case by case basis, legal custom and tradition are becoming law
contracts: long and detailed
strong investor protection

Question 19

What is civil law (Roman law) and what countries use this

Answer 19

Germany France Scandinavia
detailed written code containing all rules and regulations
philosophical foundations tie the system together
judgjes find and apply the law
contracts are short
weak investor protection

Question 20

What are characteristics of the USA bankrupty laws

Answer 20

Preservation of enterpise value (debtor friendly)
Has DIP
has automatic stay

Question 21

what are the characteristics of the German bankruptcy laws

Answer 21

liquidation oriented
does have DIP
has three mont observation period for automatic stay

Question 22

what are the characteristics of the French bankruptcy laws

Answer 22

liquidation oriented (storngly in hand of the court)
practically no DIP
automatic stay, only on specific court order

Question 23

Characteristics of dutch bankrupty law

Answer 23

• French civil law regime
• Insolvency proceedings mainly governed by the bankrupty act of 1893
• Creditor friendly (debtor unfriendly)
  o Secured creditors have highly privileged position
  o No automatic stay without creditor consent
• Out of court settlement possible
• Dutch bankrupty law
  o Suspension of payment (forma restructuring) only applies to unsecured creditors, usually fails within days
  o Bankrupty in the Netherlands = liquidation
• However, we are very efficient in liquidation compared to other countries.

Question 24

Main findings out of acadamic research

Answer 24

o Great variation in investor protection (high for common law, low for civil law)
o Law enfor also varies greatly, Germany and scandinavian countries exhibit highest enforcement
o Countries with low investor protection have substitute mechanisms (statutory and non-statutory)
o On average 48% of firm value lost in bankrupty process (richer countries perform better)
o Efficient bankrupty procedures proxy for developed debt markets
o Bank significantly adjust their lending and reorganization practices in response to the country’s bankrupty code
o Real estate collateral is the most important source of banks’s recovery in Germany and the UK, it is far less valuable in France
o Banks median (undiscounted recovery rate) in default: 92% in UK, 67% in Germany and 56% in France.

key takeaways
- Countries differ greatly in their bankruptcy laws and levels of investor protection
- Substitute mechanisms (statutory and non-statutory) can alleviate lack of investor protection
- Differences in bankrupty law alter market practices and security prices

Question 24

What are the main take aways of the 2019 incentive for a general EU bankruptcy law

Answer 24

• Create preventive framework that enables a restructuring
• EU bankrupty laws move towards U.S. laws

Question 25

what are the main mechanisms and criticisms on the EU directive?

Answer 25

• Limits the rights of single creditors to block a reasonable restructuring plan if majority of creditors approves the plan
• Elements inspired by U.S. chapter 11: cram-down, debtor in possession financing, automatic stay

Criticisms of the EU directive
- Only applies to firms that are still solvent (to avoid comprehensive changes in national bankrupty laws)
- No specialized court

Question 26

What is the WHOA?

Answer 26

• Wet homologatie onderhands akkoord, also known as Dutsch Scheme
• Effective since January 2021
• Flexible and efficient framework for companies in financial distress to restructure their debts and avoid bankruptcy, seeks to prevent viable businesses from being liquidated due to temporary financial difficulties
• If the majority approves the restructuring is binding to all creditors, also those who voted against it. Requires a 2/3 majority.

Question 27

What are the effects of bankrtupty laws on capital markets?

Answer 27

• Greatly affect the outcome of a financially distressed situation
• These differences are anticipated as a consequence these alws and court systems affect:
  o Cost of capital of firms
  o Access to funding
  o Company ownership
  o Collateral requirements
  o Bad las greatly increases the costs for risky businesses, companies might refrain from projects if NPV turns negative, hindering innovation and economic growth

Question 28

Exercise
- We assume a bankrupt firm for which equity holders receive nothing in case of default
- The firm has only one zero bond with a maturity of one year
- The bond carries only idiosyncratic risk and the risk-free rate is 2%
Non risky firm
- 99% chance of getting 100, 1% of getting 50 for strong laws and 25 for average laws
- What is the difference in yield to maturity?

Answer 28

Step 1 calculate the bond prices
0.99* 100/1.02 + 0.01 * 50/1.02 = 97.54
0.99 * 100/1.02 + 0.01 *25/1.02 = 97.30
Step 2 calculate the YTM per price
100 – 97.54 / 97.54 = 0.0251
100 – 97.30 / 97.31 = 0.0277
Difference = 0.26% so a non risky firm has to pay a premium of 0.26% for the worse bankruptcy law

Question 29

Exercise
- We assume a bankrupt firm for which equity holders receive nothing in case of default
- The firm has only one zero bond with a maturity of one year
- The bond carries only idiosyncratic risk and the risk-free rate is 2%
Risky firm
- 90% chance of getting 100, 10% of getting 50 for strong laws and 25 for average laws
- What is the difference in yield to maturity?

Answer 29

Step 1 calculate the bond prices
0.90* 100/1.02 + 0.10 * 50/1.02 = 93.14
0.90 * 100/1.02 + 0.10 *25/1.02 = 90.69
Step 2 calculate the YTM per price
100 – 93.14 / 93.14 = 0.0737
100 – 90.69 / 90.69 = 0.1027
Difference = 2.9% so a risky firm has to pay a premium of 2.9% for the worse bankruptcy law