Debt Restructuring: When Do Loan and Bond Prepayments Pay Off?

By Edwin Fischer and Ines Wöckl (University of Graz)

Many debtholders, whether private households, companies, or states, are caught up in high-interest long-term loans. At the same time, economic developments in the Eurozone over the past few years have created a low-interest environment in which prepaying an existing loan and simultaneously refinancing into a new loan can be advantageous from the borrower’s point of view. By redeeming an existing loan before maturity and refinancing into a loan with a lower interest rate, the amount of interest owed to the lender can be reduced significantly. Intuitively debt restructuring seems advantageous whenever the nominal interest rate of the new loan is lower than that of the old loan. However, prepayment considerations are more complex since debt restructuring entails transaction costs. These include a possible penalty for the early redemption of the existing loan, called a prepayment penalty, as well as credit charges and a possible loan disbursement fee for taking out a new loan. We use the method of differential investment to analyze under which circumstances loan and bond prepayments make sense for debtholders. We provide an exact solution concept as well as an easy-to-use approximation for calculating the critical upper limits for the nominal interest rate of the new loan up to which prepayment and subsequent refinancing is optimal. The calculations address both fixed and variable rate loans and consider whether the debt agreement is repaid at maturity or in annuities.

The full article is available here.

Insider Trading: Are Insolvent Firms Different?

By Andrew Verstein (Wake Forest University School of Law)

Are insolvent firms different from solvent firms with respect to insider trading law and policy? One difference is the level of regulation of trading in the residual claims of the firm. In solvent firms, the residual claims are equity securities, and equity securities are subject to the full ambit of trading restrictions. In insolvent firms, non-equity claims are typically residual claims that are subject to less stringent regulation precisely because they are not equity and they may not even be securities. As a result, insider trading regulations apply with lesser force to the most economically significant and informationally-sensitive interests in an insolvent company. Insolvency is therefore deregulatory.

While insolvency deregulates, it also expands the reach of other aspects of federal insider trading law. That is because bankruptcy law creates new roles and new duties. Since insider trading law hinges on duties, these new relationships expand the coverage of insider trading restrictions.

I consider these tradeoffs in a forthcoming article, and I offer two tentative conclusions.  

First, we should not rush to close the “loopholes” in insider trading law that open with regards to the residual claims. Deregulating insider trading is a Faustian bargain—greater price accuracy at the risk of lesser liquidity, fairness, and managerial integrity—but we should be more willing to accept the bargain with respect to insolvent firms than solvent ones.

Second, we should be solicitous of efforts to shield members of creditors’ committees from extensive insider trading regulation because these creditors occupy a position without analogue in the solvent firm: they both receive and contribute material, nonpublic information. Traditional insider trading law theory may not have the resources to manage a two-way flow of information, requiring new and accommodating thought.

The full article is available here.

Transplanting Chapter 11 of the US Bankruptcy Code into Singapore’s Restructuring and Insolvency Laws: Opportunities and Challenges

By Gerard McCormack (University of Leeds) and Wai Yee Wan (Singapore Management University – School of Law)

In 2017, Singapore introduced wide-ranging reforms to its insolvency and restructuring laws with a view to enhancing its attractiveness as an international centre for debt restructuring. A key theme of the reforms is the transplantation (with modification) of certain provisions from Chapter 11 of the US Bankruptcy Code including the automatic moratorium, cross-creditor cram-down, rescue financing and pre-packs. These provisions are engrafted into the existing scheme of arrangement framework, which in turn has its roots in the United Kingdom (UK).

In our paper, relying on the US experience and the reactions to similar reform proposals in the European Union (including the UK), we critically evaluate the effectiveness of the legal transplantation and discuss the possible unintended consequences of such transplantation.

We raise three issues. First, the new cross-class cram-down provisions could lead to valuation disputes and satellite litigation, such as whether the directors and scheme managers have properly discharged their duties. Second, the 2017 reforms shift power from the creditors to the management of the debtor company. This may prove to be disadvantageous to creditors in Singapore (and many other Asian countries) where the majority of the companies, including publicly listed companies, have concentrated shareholdings, and managers owe their existence to those who are in control. Finally, there remains the question whether the Singapore schemes will be recognised overseas, which will be important if the scheme proposes to modify debt obligations that are governed by non-Singapore law.

The full article is available here. The article is recently published in Journal of Corporate Law Studies.

 

How Specialized Courts Changed the Chinese Bankruptcy System

By Bo Li (Tsinghua University – PBC School of Finance) and Jacopo Ponticelli (Kellogg School of Management – Department of Finance)

In the last decade, China experienced a massive increase in corporate debt and, more recently, in corporate bankruptcies. Despite the mounting pressure on its insolvency resolution system, little is known about how bankruptcy works in China and the role played by the government.

China’s bankruptcy system experienced two recent changes: the reform of the bankruptcy code in 2007, and the introduction of specialized courts between 2007 and 2017. Before the introduction of specialized courts, bankruptcy cases were filed in local civil courts. Characterized by limited expertise and long delays, local courts tend to operate under the influence of local politicians, who have strong incentives to keep financially distressed state-owned companies alive to reduce unemployment and boost their political career. Thus, even though  the 2007 reform aligned Chinese bankruptcy law with those in the US and Europe, timely resolution of state-owned firms in financial distress remains a problem due to the influence of local governments.

Recently, China’s central government promoted the introduction of courts specialized in bankruptcy, which are modeled on US courts and run by insolvency professionals. In this paper, we study the impact of the introduction of specialized courts across Chinese provinces a on bankruptcy resolution and credit markets. The introduction of specialized courts led to an increase in the share of liquidations of state-owned firms and a faster speed of processing in court. In addition, state-owned firms operating in jurisdictions with specialized courts experienced a decrease in the size of new bank loans, lower access to new loans, and lower investment in physical capital relative to privately-owned firms.

The full article is available here.