Secured Creditor Recovery Rates from Management Buy‐outs in Distress

Buy‐out literature suggests that secured creditors will recoup substantial proportions of the funds they extend to finance the initial buy‐out. This paper uses a unique dataset of 42 failed MBOs to examine the extent of credit recovery by secured lenders under UK insolvency procedures and the factors that influence the extent of this recovery. On average, secured creditors recover 62 per cent of the amount owed. The percentage of secured credit recovered is increased where the distressed buy‐out is sold as a going concern and where the principal reason for failure concerns managerial factors. The presence of a going concern qualification in the audit report and the size of the buy‐out reduce the recovery rate by secured creditors.     

Investment Incentives: New Money, Debt Relief, and the Critical Role of Conditionality in the Debt Crisis

External debt depresses investment and lowers economic growthbelow its potential through its negative effect on liquidityand expected profitability. These effects can pull a countryinto a downward spiral in which both the debtor country andcreditors lose. This article considers the possibilities forrevising contracts between a debtor and its creditors once adebt crisis has erupted. The framework that we develop showshow various combinations of new money and cuts in debt and debtservice affect a debtor country's welfare, its debt repayments,and the earnings of its creditors. The analysis distinguishesbetween debtor countries that are willing and able to precommitcredibly to an adjustment program and those that are not. Thisdistinction provides the basis for a discussion of conditionallending by the international financial institutions to provideincentives and sanctions that make credible a debtor's promisesto invest.     

A case of constitutional apples and oranges: a functional comparison of pension priority and benefit guarantees in U.S., U.K. and Canadian insolvency and pension law regimes

Canada's insolvency law reform increased the priority granted to employer‐sponsored pension claims. The article compares the treatment of such claims in the U.S., the U.K. and Canada. A comparison of the legislative provisions concerning pension funding shortfalls from contribution arrears or economic underperformance in relation to the assumptions used for investment income or liability valuations finds that insolvency law has been used to address contribution arrears, but risks from economic underperformance have been addressed by pension benefit insurance. Post‐insolvency priority for contribution arrears provides appropriate incentives to discourage pre‐insolvency preferences for payments to other creditors, while shortfalls from economic underperformance do not involve issues of preference between creditors. The absence of any insolvency rationale for changing priority for shortfalls from economic underperformance and the likely disparity between the assets available to satisfy clams and the much larger amounts of such shortfalls makes the use of insolvency law to address this risk much less effective than insurance. Canada, however, has not adopted the insurance policy instrument used in the U.S. and U.K. to mitigate the impact of pension funding shortfalls. The constitutional inability of Canada to legislate in respect of matters of pension regulation that would allow it to control the well‐known insurance problems of moral hazard and adverse selection may explain why it has only chosen to adopt an insolvency policy instrument. However, a change in priorities in insolvency may generate incentives for secured creditors that either undermine or reinforce this policy choice. Secured creditors could attempt to circumvent the new priority scheme through private arrangements with the debtor or to increase their monitoring activities to ensure the debtor is current in its pension contributions. Secured creditors choices will be influenced by the bankruptcy courts' interpretation of the preference provisions in the insolvency legislation. Copyright © 2009 John Wiley & Sons, Ltd.     

Paradigm shift from a liquidation culture to a corporate rescue culture in Malaysia: A legal review

The company law landscape in Malaysia has witnessed a significant change in its insolvency law with the adoption of two new corporate rescue mechanisms, the corporate voluntary arrangement and judicial management under the Companies Act 2016 (CA 2016), which has repealed the Companies Act 1965 (CA 1965). Previously, the insolvency laws under the CA 1965 were based on the traditional pro‐creditor laws of winding up and receivership, which embodied the liquidation culture. This article examines the transition of the insolvency laws in Malaysia from a liquidation culture under the CA 1965 to a corporate rescue culture under the CA 2016. It also reviews the necessary changes to the pro‐creditor laws, which are preserved under the CA 2016 in order to accommodate the pro‐debtor laws with the introduction of the corporate rescue mechanisms, which came into force on March 1, 2018. Through comparative and critical analysis of similar laws in the United Kingdom and Singapore, this article argues that while the corporate rescue mechanisms are regarded as pro‐debtor however the review reveals that the position of secured creditors are impeding its application and reforms ought to be considered.     

Dutch corporate insolvency law: On the brink of a revolution?

The Dutch Bankruptcy Code (DBC) has not changed fundamentally over the more than 110 years of its existence, at least as far as corporate insolvency proceedings are concerned. On 1 November 2007, however, a committee of insolvency experts presented a draft for an entirely new code to the Ministry of Justice. Whether this new code will gain the force of law and whether this will happen within the near future remains uncertain but the proposals will in any event dominate discussions on insolvency law in the Netherlands for the foreseeable future. The main goal behind many of the proposals is improving the ability to successfully restructure companies that experience financial difficulties. To this end the proposals include various measures that would weaken the position of (secured) creditors. The proposals include widening the scope of the cooling-off period during which secured creditors are unable to enforce their security by granting the administrator a right of use of assets subject to security interests. The ability to rely on early termination clauses in contracts is also reduced during the cooling-off period. The position of secured creditors is further weakened by a proposal to grant the right to sell assets that are subject to security interests to the administrator if he continues the business. Under the current bankruptcy code, secured creditors can largely ignore insolvency proceedings, there is no general stay on enforcement and, early termination clauses in contracts are generally thought to be valid and enforceable during insolvency proceedings. Although banks have already argued that weakening the position of secured creditors will limit the ability to restructure companies, it seems safe to assume that the relatively comfortable position that secured creditors currently enjoy during insolvency proceedings in the Netherlands will be under fire due to the proposals for a new bankruptcy code. Copyright © 2008 John Wiley & Sons, Ltd.     

Secured and unsecured debt in creditor-friendly bankruptcy

This article develops a continuous-time asset pricing model for valuing corporate securities in the presence of both secured and unsecured debt. We consider a framework where creditors dominate the negotiation process. This is consistent with the increasing influence of creditors in bankruptcy. We show that the unsecured creditors are incentivized to liquidate the firm prematurely relative to the first-best threshold. However, if the firm’s liquidation value is very low, it should complement its secured debt with unsecured debt as a form of insurance to avoid early liquidations. Our results have important implications for the debt structure and the resolution of financial distress of modern firms with substantial intangible assets.     

The ancillary insolvency proceeding

The main legal acts on International Insolvency Law (the European Regulation, the UNCITRAL Model Act and the European Convention on Certain International Aspects of Bankruptcy) lay down several local proceedings with substantive effects as regards the debtor, the distribution of proceeds and the ranking of claims. These—full—proceedings are characterized by a high degree of unpredictability and prove to be inadequate for creditors. These are the reasons why, as an immediate solution, the existing insolvency rules should be reinterpreted according to a certain logic of the market. However, such revision would only partially and provisionally solve the inconveniences of the current model. The true and ‘unsolvable’ problem is that even though the full local proceeding is based on international assistance, it alters the substantive insolvency rules. Therefore, in future it would be necessary to create a truly ancillary proceeding. Such a proceeding would not have any substantive effect as regards the debtor, the creditors and third parties, nor would it require any kind of distribution of proceeds and ranking of claims. However, this proceeding would enable to provide procedural assistance to foreign courts and procedural protection to local creditors. Copyright © 2010 John Wiley & Sons, Ltd.     

The Decline of Secured Debt

The share of secured debt issued (as a fraction of total corporate debt) declined steadily in the United States over the twentieth century. This stems partly from financial development giving creditors greater confidence that high-quality borrowers will respect their claims even if creditors do not obtain security upfront. Consequently, such borrowers prefer retaining financial flexibility by not giving security up front. Instead, security is given contingently—when a firm approaches distress. This also explains why, superimposed on the secular decline, the share of secured debt issued is countercyclical.     

Closing the Ledger

Using a unique, hand‐collected final dataset of 57 management buy‐outs in distress, this paper analyses the determinants of bankruptcy costs under the UK's receivership regime. We show that the direct costs of receivership consume a significant percentage of the receivership proceeds, with mean receivership costs equal to 30% of receivership proceeds. Importantly we find that while the average length of receivership was 3.0 years, 95% of repayments are made on average within 1.9 years. Our findings do not support the argument that multiple lenders create inefficiencies resulting in significantly lower secured creditor recovery rates. However, when there are multiple secured lenders, the senior secured lender gains at the expense of other secured creditors. We find that receivership costs are positively related to the proportion of secured debt repaid and that, consistent with the presence of a scale effect, the relative significance of receivership costs declines as firm size grows. Receiverships last longer the larger the amount of debt owed to the secured lenders.     

Post‐IRCJ challenges: changing Japanese culture to enable early revitalization of troubled corporations

The Industrial Revitalization Corporation of Japan (IRCJ) was created in 2003 to restructure distressed debtor corporations with excessive debts before their bankruptcy with a view to deterring ever‐increasing non‐ and poor‐performing loans. The IRCJ successfully reorganized target debtor companies through the out‐of‐court workout with multiple financial institutions where unanimous consent of financial creditors is required. Since the lifetime of the IRCJ is limited, the IRCJ cannot rescue troubled corporations after the end of March 2005. From then onward, the out‐of‐court workout should be utilized more widely in Japan in order to revitalize distressed businesses at an early stage without impairing the rights of trade creditors and deteriorating the value of the businesses. To make the workout most effective, it is important to ensure that the statutory reorganization procedures, including the majority rule, are applied more flexibly and reliably. Copyright © 2005 John Wiley & Sons, Ltd.     

Stiffing the creditor: Asset verifiability and bankruptcy

Evidence suggests that asset pledgeability, debt complexity, and control rights of dispersed debt influence financial distress resolution. We model how courts’ imperfect verifiability of assets and valuable control of misaligned creditors shape firms’ debt structure and create coordination problems that determine distress outcomes and financing. A key result is that an increase in verifiability allows financially constrained firms to fund projects by pledging more assets to misaligned creditors, making contract renegotiation in distress times more difficult and increasing the probability of bankruptcy. Since equity receives less in the event of distress, constrained firms choose riskier projects with higher returns. Consistent with our model, bankruptcy filings increase after the U.S. Supreme Court decision imposing a “market test” to assess the value of stockholders’ interest in debtor proposals. The effect is stronger for firms with low asset verifiability. These firms also experienced an increase in recovery rates, debt capacity, and risk-taking. Our findings suggest that reforms improving the verifiability of assets substantially impact credit access. However, our results also point out that improving asset verifiability may be insufficient for constrained firms with aligned creditors. Therefore, complementary reforms that facilitate firms’ access to creditors from different market segments may be necessary.     

Tripping the Light Fantastic: A Comparative Analysis of the European Commission's Proposals for New and Interim Financing of Insolvent Businesses

The European Commission published a Draft Directive in November 2016, with the aim of ensuring that all Member States have in place an effective mechanism for dealing with viable, but financially distressed, businesses. The Draft Directive includes provisions designed to encourage financing for the debtor company, both interim financing to ‘keep the lights on’ for a brief period while the debtor negotiates with its creditors for a resolution to its financial distress, and, where possible, to finance implementation of a restructuring plan, called ‘new financing’ in the Draft Directive. Creating such a financing regime is a complex and difficult issue, as the law's intervention in this area often involves constraints on the rights of existing creditors, requiring that a careful balance is maintained between existing creditors' rights and the rights of the interim financier. This article examines the underlying policy rationale and benefits of having new and interim financing available to financially distressed debtor companies and discusses the risks involved. It examines the EU Commission's proposals in light of the experience of jurisdictions that have already tackled these issues, notably the USA and Canada, or have developed a market‐based solution to this problem, such as the UK. While the European Commission's wish to include such measures in its restructuring proposals is laudable, the measures as drafted raise concerns, particularly regarding risks associated with priority for the grantors of such finance. The authors suggest that there are four fundamental aspects of such financing on which the Directive could give guidance to Member States, namely, effective notice to pre‐filing creditors, thresholds for the debtor to qualify, a menu of relevant criteria to balance benefit and prejudice, and a role for the court in resolving disputes, ensuring fairness to stakeholders, and serving as an accountability check on interim financing arrangements, all aimed at maintaining the integrity of the insolvency process. Copyright © 2018 INSOL International and John Wiley & Sons, Ltd.     

Asset Sales and Secured Creditor Control in Restructuring: A Comparison of the UK,US and Canadian Models

The primary insolvency restructuring mechanism in the UK is administration under the Insolvency Act 1986, as amended by the Enterprise Act 2002. In an administration, an insolvency professional known as an administrator, who is accountable to the insolvent company's creditors as a whole, is appointed to oversee the restructuring. The administration process was designed to rehabilitate distressed but viable companies and businesses and to maximize creditors' recoveries. Increasingly, however, insolvent companies are using this process to sell substantially all of their assets through pre‐packaged administrations or ‘pre‐packs’. In a pre‐pack, the insolvent company and its senior creditors negotiate the terms of the sale prior to initiating administration proceedings and appointing an administrator. The administrator then implements the deal, often with little or no input from junior creditors or other stakeholders. Both the US Bankruptcy Code and the Companies' Creditors Arrangement Act in Canada permit insolvent companies to sell substantially all of their assets under the auspices of the restructuring legislation. This article compares pre‐packs with these US and Canadian processes, arguing that they are all functionally equivalent in that they facilitate quick realizations for secured creditors by bypassing traditional restructuring processes. This analysis suggests that pre‐packs may give too much control over the restructuring process to secured creditors, encouraging rent‐seeking and other value‐destructive behaviours that undermine the fundamental goals of insolvency law. Copyright © 2017 INSOL International and John Wiley & Sons, Ltd.     

Optimal bankruptcy laws across different economic systems

We model fundamental differences across economic systems andpropose optimal bankruptcy laws. We show that creditor-debtorrelationships in a given economy are affected by the abilityof creditors to obtain information about fundamentals and themanagers' ability to strategically use their private information.An optimal bankruptcy law utilizes creditors' information whileminimizing managers' use of strategic information. Our proposedlaws for a developed bank-based system like Germany includea creditor chapter only, for a developed market-based systemlike the United States include both a creditor chapter and adebtor chapter, and for an underdeveloped system include botha creditor chapter and a debtor chapter that gives the managermore protection than in a market-based system.     

The effect of unfunded pension liabilities on corporate bond ratings,default risk,and recovery rate

Unfunded pension liabilities lower ratings of non-senior secured bonds but do not affect ratings of senior secured bonds due to their higher seniority. Pension funding improvement (deterioration) is associated with bond rating upgrade (downgrade). Moreover, large unfunded liabilities increase bond default risk and reduce the recovery rate of bondholders after controlling for credit ratings, suggesting that bond ratings do not fully capture pension underfunding risk. Overall, our results highlight the important effects of unfunded pension obligations on bond ratings, default risk, and creditors’ payoff, and suggest that investors should look beyond bond ratings in making investment decisions.     

Forecasting recoveries in debt collection: Debt collectors and information production

Recent theoretical work suggests that debt collection agencies play an important role in gathering and processing debtor information. We study a comprehensive data set with information provided by original creditors and information gathered in third‐party debt collection. In line with the theoretical results, the initial information is sparse and the gathered information is essential for better‐informed predictions.     

The impact of delay: Evidence from formal out-of-court restructuring

Different types of bankruptcy restructuring procedures are used in most legal systems to decide the fate of businesses facing financial hardship. We study how bargaining failures in an under-researched type of restructuring procedure, a formal out-of-the court procedure impacts the economic performance of participating firms. Croatia introduced a “pre-bankruptcy settlement” (PBS) process in the wake of the Great Recession of 2007–2009. A novel dataset provides us with annual financial statements for both sides of more than 180,000 debtor–creditor pairs, enabling us to address selection into failed negotiations by matching a rich set of creditor and debtor characteristics. Failures to settle at the PBS stage due to idiosyncratic bargaining problems, which effectively delay entry into the standard bankruptcy procedure, lead to a lower rate of survival among debtors as well as reduced employment, revenue, and profits. We are the first study to track how bargaining failures diffuse through the network of creditors, finding a significant negative effect on small creditors, but not others. Our results highlight the impact of delay and the importance of structuring bankruptcy procedures, to rapidly resolve uncertainty about firms’ future prospects.     

The effect of relative performance evaluation on earnings management: a game-theoretic approach

Because investors and creditors often compare the financial statements of similar or competing firms when deciding how to allocate their funds, it is likely that a firm's financial well-being depends on how well it performs relative to its rivals. In this paper, we consider the problem of earnings management as a non-cooperative game among several firms, in which each firm seeks a comparison advantage through its financial statement numbers. Our model indicates that firms may exaggerate their earnings in a world driven by multi-firm-comparisons simply because they expect other firms to do so. Thus, very little may be needed for earnings management to emerge in the Nash equilibrium. Our results hold under the following conditions. First, investors and creditors are not able to unravel the earnings management, thus ensuring that some information asymmetry remains. Second, investors and creditors make inter-firm comparisons when assessing firm value. Third, firms care about their own fundamental value as well as the market's perception about firm value. We also show that the equilibrium amount of earnings management depends on the characteristics of the earnings management technique itself and on the proportion of stockholders who are long-term investors in the firm.     

Dynamic prediction of hedge fund survival in crisis-prone financial markets

This study focuses on dynamic changes in survival probabilities over the lifetimes of hedge funds. To model such probabilities, a mixed Cox proportional hazards (CPH) model-specifically, a survival/hazard model with time-varying covariates and fixed covariates- is employed. Resulting dynamic survival probabilities show that the mixed CPH model provides significantly higher accuracy in predicting hedge fund failure than other models in the literature, including fixed covariate CPH models and discrete logit models. Our results are useful to investors and regulators of hedge funds in crisis-prone financial markets.     

The value implications of restrictions on asset sales

This paper examines the effect of restrictions over asset disposition, measured by the ratio of secured debt to fixed assets, on firm value. We find evidence consistent with two non-mutually exclusive hypotheses. (1) Restrictions on the disposition of assets reduce firm value by limiting a firm's ability to restructure assets or to raise funds to finance higher NPV projects. (2) Restrictions on asset disposition increase firm value by limiting agency costs of managerial discretion over uncommitted assets. The net effect of restrictions over asset disposition on firm value is determined by potential agency problems and the need for operating flexibility.