Lecture 2, bankrupty laws around the world Flashcards
absolute priority rule
principle in bankruptcy proceedings that determines the order in which creditors and shareholders are paid from the lquidation or reoganization
Distressed exchange
Exchange of existing debt for new debt or equity securities
debtor in possession (DIP) financing
type of financing provided to companies that have filed for bankruptcy, financing is usually super senior
out of court restructuring
restructuring out of court, most of the time done through an distressed exchange. a company renegotiates its debt and the terms with the creditors
automatic stay
gives the debtor breathing room, as soon as the bankruptcy is filed, creditors must stop all collection activities immeidately.
cram-down option
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
Chpater 11
liquidaton
chapter 7
restructuring
what are the four main events in the US bankruptcy laws
Bankrupty act of 1898
The chandler act of 1938
Bankruptcy reform act of 1978
bankruptcy abuse prevention and consumer protection act of 2005
Bankrupty act of 1898
Focussed on liquidation established modern bankruptcy procedures, inefficient receivership replaced.
Teh chandler act of 1938
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)
- Bankruptcy reform act of 1978
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
- Bankruptcy abuse prevention and consumer protection act of 2005
Aimed at preventing abuse, introduced the means test, changed dynamics for consumer bankruptcy filings.
What is historically the main focus of bankruptcy laws?
Secured creditors, only the US and more modern laws start focussin on total enerprise value
What is a main determinant for bankruptcy outcomes
the legal environment and bankruptcy laws
Where is the US law focussed on in terms of bankruptcy?
restructuring
What are the two major law systems?
Civil (roman) law
common (case) law
What is common (case law) and what countries use this
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
What is civil law (Roman law) and what countries use this
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
What are characteristics of the USA bankrupty laws
Preservation of enterpise value (debtor friendly)
Has DIP
has automatic stay
what are the characteristics of the German bankruptcy laws
liquidation oriented
does have DIP
has three mont observation period for automatic stay
what are the characteristics of the French bankruptcy laws
liquidation oriented (storngly in hand of the court)
practically no DIP
automatic stay, only on specific court order
Characteristics of dutch bankrupty law
- 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.
Main findings out of acadamic research
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
What are the main take aways of the 2019 incentive for a general EU bankruptcy law
- Create preventive framework that enables a restructuring
- EU bankrupty laws move towards U.S. laws
what are the main mechanisms and criticisms on the EU directive?
- 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
What is the WHOA?
- 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.
What are the effects of bankrtupty laws on capital markets?
- 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
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?
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
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?
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
