Comparative Corporate Insolvency Law
Interest in comparative corporate insolvency law has grown considerably in recent years, driven by various factors. It is increasingly recognized that (corporate) insolvency laws have a significant impact on entrepreneurship and economic growth. Hence, jurisdictions attempt to identify best practices that allow them to boost their domestic economies. At the same time, the number of transnational insolvencies is clearly on the rise. Given the growth in international commerce, today even the insolvency of small or medium-sized (closed) corporations usually will exhibit some transnational aspect such as foreign creditors, subsidiaries/branches/offices in other jurisdictions or assets that are located abroad. However, scholarly work in the field of comparative corporate insolvency law so far has been rather scarce.
My article ‘Comparative Corporate Insolvency Law’ deals with fundamental issues of corporate insolvency law in a comparative perspective. Particular attention is paid to the agency problems related to ‘bankruptcy governance’ and how these are addressed in various jurisdictions. Methodologically, the article is based on a functional approach that compares different legal regimes against the yardstick of economic efficiency. The structure of the article follows the issues as they arise in time in a corporate insolvency proceeding: objectives of insolvency laws, opening and governance of proceedings, ranking of claims, the position of secured creditors and shareholders, and rescue proceedings. The article also deals with the contractual resolution of financial distress. It concludes with reflections on the reasons for the identified jurisdictional divergences and an outlook on the worldwide efforts towards harmonization of (corporate) insolvency laws. In terms of jurisdictions, the article mainly draws on the corporate insolvency laws in the US, England, France and Germany. It does so because these jurisdictions are representative of diverse legal traditions and because they can rightfully be characterized as leading the international search for optimal insolvency and/or restructuring regimes with respect to corporate entities that find themselves in or near financial distress.
I find that jurisdictions worldwide differ markedly with respect to the ‘bankruptcy philosophies’ that they pursue. At the same time, an international trend emerges according to which restructuring proceedings gain in importance relative to liquidation proceedings. With the increasing importance of corporate restructurings and the need for legal regimes to facilitate these, especially pre-insolvency, some jurisdictions now offer not just one restructuring regime but a multifaceted set of restructuring laws. These are often debtor in possession-like proceedings that reward shareholders/managers for filing early by leaving the debtor in control – at least as far as bankruptcy law ‘on the books’ is concerned. Secured creditors also often have a lot of ‘governance leverage’: despite academic criticisms, they enjoy full priority in many jurisdictions. Their leverage will be even stronger if they act as debtor in possession financiers and are granted ‘super priority’ for fresh money.
By contrast, reforms in many jurisdictions have reduced the leverage of shareholders in restructuring proceedings. Shareholder loans are often subordinated to the claims of ordinary unsecured creditors. Further, shareholders’ interests may be affected by a restructuring plan. As has been the case in the US for a long time, the reformed German Insolvenzordnung, for example, provides that the incumbent shareholders of the corporation form one or more of the various classes whose interests can be dealt with in a restructuring plan. This makes sense conceptually, as a corporation’s shareholders, in a situation of financial distress, have the lowest ranking claim on the corporation’s assets, ie they are ‘sub-subordinated’. Integrating the shareholders into the structured bargaining and voting process allows debt to equity swaps to be part of a restructuring plan. Such swaps are an important element of modern restructuring practice. They reduce debt levels and interest payments, improving the balance sheet and liquidity position of a distressed firm.
Going concern sales are another important feature of modern restructuring practice, especially because they are speedier and less costly than full-blown restructuring proceedings with class-wise bargaining and voting. Such sales often raise intricate governance problems. More specifically, precautions must be taken to avoid sales to insiders at fire sale prices. Jurisdictions differ significantly in their approach to this problem.
Statutory insolvency proceedings trigger significant direct and indirect bankruptcy costs. Hence, stakeholders of a financially distressed firm have a strong incentive to avoid these costs and attempt a private resolution of financial distress: the ‘privatization of bankruptcy’ promises flexible, tailor-made and fast solutions that come with significantly reduced bankruptcy costs. Two forms of such a privatization must be distinguished: ex ante contracting about bankruptcy, and an ex post renegotiation of the firm’s debt structure (‘workouts’). While lending practice is characterized by an increasing sophistication also with respect to governance rights for creditors upon the financial distress of the debtor, full-blown ‘contracting for bankruptcy’ still very much is more an academic than a real-life issue. Workouts have always been plagued by the hold-out problem. They are further made more difficult by changing debt structures and financing techniques (bond financing also for SMEs, debt trading, activist investors, credit default swaps, etc). This reinforces the need to have well-functioning statutory restructuring proceedings in place that can be initiated pre-insolvency.
A lack of efficient local proceedings is not so much a problem for multinational corporations as these are usually able to forum shop for the best or most suitable restructuring regime. At the same time, last-minute forum shopping by firms – possibly initiated by dominant lenders – can create problems, especially for outside creditors whose interests might be compromised by the move. As a consequence, the international regulatory trend is to make forum shopping more difficult. Further, not all firms have the knowledge and money to engage in sophisticated regulatory arbitrage and, as a consequence, might not have access to an efficient restructuring regime. Hence, a case can be made for ‘minimum harmonization’ with respect to jurisdictions’ provisions of (pre-insolvency) restructuring regimes. Such harmonization efforts are currently being undertaken in the European Union, for example (see Eidenmüller/van Zwieten, 16 EBOR 625 (2015)). By and large, the substantive insolvency regimes of the Member States would be left intact, potentially reducing the political resistance that is to be expected.
Horst Eidenmüller is the Freshfields Professor of Commercial Law at the University of Oxford.
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