Opening the Door for the Opportunistic Use of Interim Financing: A Critical Assessment of the EU Draft Directive on Preventive Restructuring Frameworks

The European Union Draft Directive on a Preventive Restructuring Framework and Second Chance (the ‘Draft Directive’) provides rules for adopting reorganisation plans in order to avoid insolvency. The Draft Directive also provides rules on the related problem of interim financing. According to the Draft Directive, interim financing should be encouraged and not be made subject to claw back unless parties have committed fraud or acted in bad faith. The Draft Directive thereby fails to recognise that finance transactions are too diverse in nature to provide the company and its financial creditors with a transaction avoidance free period. If the Draft Directive is adopted in its current form, it will open the door for opportunistic use of interim financing by both debtors and professional lenders. It will allow debtors to make final bets with other people's money and will also allow for conduit pipe financing reducing the exposure of existing shareholders. Lenders will also be able to make opportunistic use of the rules, most notably in the form of cross‐collateralisation and aggressive loan‐to‐own strategies under the guise of interim financing. There are several possible solutions to the potential for opportunistic use. The courts could be involved ex ante. This would, however, turn the Draft Directive into a fully fledged court supervised procedure instead of the currently intended preventive restructuring procedure which avoids such court procedures. An alternative would be to simply take out the provisions on interim financing. Another possibility would be to limit the protection offered in the Draft Directive to cases of new security against new money necessary and used for the continuation of the business. Copyright © 2018 The Authors International Insolvency Review published by INSOL International and John Wiley & Sons Ltd.     

功能主义视角下所有权担保的实现路径及价值冲突消解

所有权担保的实现有形式主义和功能主义两个路径,其中功能主义采用担保程序的实现路径,是双方当事人真实的意思表示,有利于债权人和债务人双方的利益,也有利于维护担保关系的稳定。实践中,首先应当遵循当事人选择的路径;协商不成,法院再判定采用担保程序;破产案件中,法官在面对原被告方不同诉求时,可以采纳《企业破产法》第109条进行裁判。登记技术的进步和登记制度的发展可以有效地弥补功能主义的效率缺陷。     

《新兴市场稳定资本流动和公平债务重组的原则》述评

《新兴市场稳定资本流动和公平债务重组的原则》(以下简称《原则》)是由一些新兴市场国家和以国际金融协会为首的国际私人债权人组织在2004年11月联合发布的。这一《原则》旨在促使发生债务危机的国家尽早恢复债务支付能力和确保国际资本向这些国家的稳定流动,其中主要涉及到透明度和信息流动、双方对话与合作、善意行动和债权人间公平待遇等基本原则。这些原则对于完善债务危机解决机制具有重要意义。     

Market discipline by bank creditors during the 2008–2010 crisis

We investigate whether uninsured depositors, insured depositors, and general creditors exhibit evidence of quantity market discipline during the recent financial crisis. To establish which types of creditors expect to incur loss, we evaluate the FDIC's expectations about losses to creditors at banks that failed between 2008 and 2010. Our results show that quantity market discipline tends to begin far enough in advance to signal to both banks and supervisors that corrective actions can and should be taken. Furthermore, creditors are able to distinguish between banks of different risk levels. Our findings support several policy implications for encouraging market discipline.     

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.     

Debt,Equity and Hybrid Decoupling: Governance and Systemic Risk Implications

We extend here our prior work, which focused on equity decoupling ( Hu and Black, 2006, 2007, 2008 ), by providing a systematic treatment of debt decoupling and an initial exploration of hybrid decoupling. Equity decoupling involves unbundling of economic, voting, and sometimes other rights customarily associated with shares, often in ways that may permit avoidance of disclosure and other obligations. We discuss a new U.S. court decision which will likely curtail the use of equity decoupling strategies to avoid large shareholder disclosure rules. Debt decoupling involving the unbundling of the economic rights, contractual control rights, and legal and other rights normally associated with debt, through credit derivatives and securitisation. Corporations can have empty and hidden creditors, just as they can have empty and hidden shareholders. ‘Hybrid decoupling’ across standard equity and debt categories is also possible. All forms of decoupling appear to be increasingly common. Debt decoupling can pose risks at the firm level for what can be termed ‘debt governance’? the overall relationship between creditor and debtor, including creditors' exercise of contractual and legal rights with respect to firms and other borrowers. Widespread debt decoupling can also involve externalities and therefore create systemic financial risks; we explore those risks.     

Valuation of the Firm's Liabilities When Equity Holders Are Also Creditors

Abstract:  This paper presents a tractable structural model whereby controlling equity holders are also among the creditors of the firm. As the firm approaches distress, equity holders can drain the assets of the firm and expropriate other creditors by repaying their credit before bankruptcy. The right of the bankruptcy court to revoke such repayment protects arm's length creditors, reduces the cost of borrowing and induces equity holders to anticipate repayment of their credit. Equity holders decide repayment neither too early nor too late, so as to reduce the risk of repayment revocation by the bankruptcy court. Similar conclusions apply to the preferential repayment of bank loans personally guaranteed by equity holders. The analysis also suggests that callable bearer bonds may be more valuable to equity holders than to other creditors.     

Price Stability with Imperfect Financial Integration

This paper studies whether the international monetary system can be affected by asymmetries in the cross-country positions in the international financial markets, i.e., the fact that some countries are large debtors while others are creditors. An important channel that is explored is the interaction between international risk sharing and the stabilization role of monetary policy in each country. The main finding is that the welfare costs of incomplete markets and the gains of deviating from a policy of price stability are increasing with the cross-country asymmetries in the initial net international positions and in particular they become nonnegligible when the persistence of the shocks increases (1% of a permanent shift in steady-state consumption, for the welfare costs of incomplete markets, and 0.2%, for the gains of deviating from a policy of price stability). When global imbalances become larger, optimal monetary policy requires an increase in the volatilities of the real returns on assets and in particular of the nominal interest rates, which should happen to be more correlated across countries.     

Administration of recoveries in individual insolvency: case studies of two UK banks

Against a background of greater competition, market saturation and falling margins over the past decade UK banks have sought greater efficiencies in credit and risk assessment procedures, especially with personal lending products. In the same way they have attempted to reduce costs associated with the monitoring and collection of bad debts. Failure to monitor debt recoveries adequately, however, can lead to further pressure on profits. This paper uses a case study approach to outline key strategies adopted by two major banks in respect of formal insolvency, the ‘tip’ of a considerable debt recovery ‘iceberg’. The paper illustrates the reactions and changing administrative practices of banks, as unsecured creditors, and draws on empirical research that has charted the effect of the Insolvency Act 1986 as regards individual debtors. The collection of bad debts presents banks with risks, heightened by adverse selection and moral hazard problems greater than those applicable to credit risk assessment. However, while the ‘downside risk’ equates with the debt write-off plus transaction costs the ‘upside potential’ has elements of both tangible and intangible benefit. The paper goes on to review specific centralization and outsourcing policies against the critical risks in insolvency. It also suggests that the bargaining power of major creditors, including banks, is increased through these activities, to the possible detriment of smaller creditors and of debtors.     

Lender Liability and Large Investors

We explore the optimal financial contract for a large investor with potential control over a firm's investment decisions. An optimal menu of claims resembles a U.S. version of lender liability doctrine—equitable subordination. This doctrine permits the court to subordinate a controlling investor's claim in bankruptcy, but only under well-specified conditions. It allows a firm to strike an efficient balance between: (i) inducing the large investor to monitor, and (ii) limiting the influence costs that arise when claimants can challenge existing contracts. We provide a partial rationale for a financial system in which powerful creditors do not hold blended debt and equity claims. Journal of Economic Literature Classification Numbers: G20, G33, K22.     

自然人破产制度的建立

从法政策角度考量,自然人破产制度可以使债权人获得公平受偿,使债务人获得重生,这是自然人破产制度确立的最重要原因;而信贷消费的迅速发展,是我国确立自然人破产制度的社会基础。我国面临的城乡二元结构、信用体系的不健全只是建立自然人破产时必须予以考虑的法技术问题。在建立自然人破产制度时必须正视城乡二元结构、信用体制缺失等问题,并逐步建立自然人财产申报登记制度,完善信用制度。     

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.     

Hurdles to debt relief for “no income no assets” debtors in Germany: A case study of failed consumer bankruptcy law reforms

Given that many overindebted households have low or no assets and income, governments have increasingly tried to adapt their consumer bankruptcy regimes to the needs and capacities of these NINA (“no income, no assets”) debtors. Most notably, since the mid‐2000s, some countries from the Anglosphere have created low‐cost, means‐tested, and administrative (i.e., nonjudicial) debt relief procedures as alternative to traditional bankruptcy for NINA debtors. By contrast, in some European countries such as Germany, legislators have tried—but until today failed—to create efficient debt relief measures for NINA debtors. This contribution aims to make English‐speaking readers familiar with the history of consumer insolvency law in Germany, with a focus on legislative developments regarding NINA debtors, and to identify actors, institutions, and ideas that have contributed—especially during the 2000s—to the failure of consumer bankruptcy reforms addressing the main problems of NINA cases in Germany (i.e., high hurdles to relief for debtors, high administrative efforts for trustees and courts, high costs for the public purse, and yet very few payments to creditors). The German case is relevant not only because it is a striking case of failure to adapt a debt relief regime to NINA debtors but also because German consumer bankruptcy law—despite its shortcomings—continues to serve as a template for insolvency law reforms in European and other countries.     

Control Rights and Capital Structure: An Empirical Investigation

We show that incentive conflicts between firms and their creditors have a large impact on corporate debt policy. Net debt issuing activity experiences a sharp and persistent decline following debt covenant violations, when creditors use their acceleration and termination rights to increase interest rates and reduce the availability of credit. The effect of creditor actions on debt policy is strongest when the borrower's alternative sources of finance are costly. In addition, despite the less favorable terms offered by existing creditors, borrowers rarely switch lenders following a violation.     

Individual voluntary arrangements: A ‘fresh start’ for salaried consumer debtors in England and Wales

Since the mid‐1990s the number of consumer insolvencies in England and Wales has grown exponentially. The UK's Insolvency Act 1986 offers two formal responses to personal insolvency: bankruptcy and individual voluntary arrangements (‘IVAs’). While consumers have used both these debt relief mechanisms in increasing numbers in recent years, IVAs—regulated agreements between debtors and creditors facilitated by a licensed insolvency practitioner, usually taking the form of a 5‐year payment plan—grew faster than bankruptcies between 2003 and 2006. However, the level of new IVA approvals fell back in 2007 and the first half of 2008. This article charts the transformation of the IVA from a bankruptcy alternative originally designed for insolvent traders and professionals into a tool of consumer debt relief. It then seeks to explain both the stellar rise in IVA usage among consumer debtors and the subsequent stalling of IVA growth. The rise of consumer IVAs can be attributed largely to supply side changes in the market for debt resolution—in particular the emergence of volume providers commonly referred to as ‘IVA factories’—while a sustained backlash against the procedure and the providers instigated by institutional creditors demanding higher recoveries accounts for the subsequent decline in approvals. The article concludes by considering the near‐term prospects for consumer IVAs within the context of the increasingly complex UK debt resolution market. Copyright © 2009 John Wiley & Sons, Ltd.     

Minimal Settlement Assets in Economies with Interconnected Financial Obligations

A model is developed where firms belonging to a group are obliged to make payments to one another by using a liquid asset. The paper studies the exogenous endowments of this asset that are necessary to assure that all obligations are met. Conditions are presented under which the degree to which firms are interconnected (so that each creditor has more debtors and each debtor has more creditors) increases the number of firms that must be endowed with the liquid asset. Interconnectedness then makes payment defaults more likely. By acquiring too many payment obligations, firms may also become too interconnected.     

Twenty‐five years of consumer bankruptcy in continental Europe: internalizing negative externalities and humanizing justice in Denmark

This paper explores the problems and processes that led to the birth of consumer bankruptcy in continental Europe, a process that began in Denmark in January 1972 and culminated with the adoption of the Danish consumer debt adjustment act, Gældssaneringslov, on 9 May 1984. While this law is often described in primarily humanitarian terms, in the sense of offering a respite to “hopelessly indebted” individuals, both the motivation for the law and its intended scope were not simply accretions on an already multi‐layered welfare system. Instead, the law was designed primarily as a pragmatic response to economically wasteful collections activities that imposed negative externalities on debtors, creditors, and especially Danish society and state coffers; the law was intended to force creditors to internalize (or eliminate) these externalities with respect to all debtors unable to pay their debts within a reasonable period of 5 years. The paper also examines the growing pains of this new system. The law originally left significant administrative discretion to judges, which produced vast disparities in treatment of cases in different regions of the country. Ultimately, a reform implemented in October 2005 made the system more accessible, more unitary throughout the country, and more humane. The effects of this reform are already visible in statistical observations of the system, though significant regional variations persist. Given the striking coincidence in timing, this paper also offers brief comparative comments on the parallel design—but very different effect—of the most significant reform of the US consumer bankruptcy law, also effective in October 2005. Copyright © 2009 John Wiley & Sons, Ltd.     

The formative decade of Israel's reorganization law: 1995–2004

The article analyses closely the major developments that took place between 1995 and 2002, both as a result of legislation and judicial law making. In 1995, the Knesset, the Israeli legislature, enacted a moratorium statute. This statute stays all pending proceedings against a financially distressed corporation which has applied to the court requesting its reorganization through a compromise or arrangement scheme. The moratorium statute influenced significantly this scheme and effectively reshaped it in a reorganization‐friendly manner. The article submits that the moratorium statute has effectively transformed the nature of secured creditors' rights from rights‐in‐kind to rights‐in‐value. In addition, the article will demonstrate the relative contribution of both the Supreme Court and the district courts to reorganization law's development. The Supreme Court established the grand premises for judicial law making in corporate reorganization by holding that the statutory substantive norms which apply in corporate liquidation apply in reorganization as well mutatis mutandis. For their part, the district courts contributed to the law making in two primary aspects of corporate reorganizations: First, by requiring that in reorganization cases a court‐appointed trustee shall manage the corporation and negotiate on its behalf with the creditors. Secondly, the courts developed the practice of auctioning the firms undergoing reorganizations as a means for maximizing the return to the creditors. Copyright © 2005 John Wiley & Sons, Ltd.     

Bankruptcy: What is left for the creditors? A Belgian exploratory study

It is sometimes alleged that in cases of bankruptcy, there is often not much left for the creditors, especially for the ordinary unsecured creditors. This article examines, in an exploratory way, what the different classes of creditors, depending on their priority position, recover in cases of bankruptcy in Belgium, by investigating a sample of 286 bankruptcy files from the Commercial Court of Ghent (Belgium's second largest city). This article also explores what impact some existing proposals to improve the position of ordinary unsecured creditors in the event of bankruptcy would have had on the bankruptcy cases studied.     

The Bankruptcy System's Chapter 22 Recidivism Problem: How Serious is It?

This paper is adapted from the keynote address from the Eastern Finance Association's 2014 meeting in Pittsburg, Pennsylvania. We highlight a recidivism problem: about 15% of debtors who emerge as continuing entities under Chapter 11, or are acquired as part of the bankruptcy process, ultimately file for bankruptcy protection again (18.25% when considering only those firms which emerge as a continuing, independent entity). We argue that the “Chapter 22” issue should not be dismissed by the bankruptcy community just because no interested party objects during the confirmation hearing. Applying the Z”‐Score model to a large sample of Chapter 11 cases reveals highly different and significant expected survival profiles at emergence. Credible distress prediction techniques can effectively predict the future success of firms emerging from bankruptcy and be used by the bankruptcy court to assess the feasibility of the reorganization plan, a requirement mandated by the Bankruptcy Code. Branch reviews, discusses, and critiques in this follow‐up article to Altman's original thesis.