Insolvency Law in Emerging Markets

By Aurelio Gurrea-Martínez (Singapore Management University)

Aurelio Gurrea-Martínez

Corporate insolvency law can serve as a powerful mechanism to promote economic growth. Ex ante, a well-functioning insolvency framework can facilitate entrepreneurship, innovation and access to finance. Ex post, corporate insolvency law can perform several functions, including the reorganization of viable companies in financial distress, the liquidation of non-viable businesses in a fair and efficient manner, and the maximization of the returns to creditors. Therefore, if having an efficient corporate insolvency framework is essential for any country, it becomes even more important for emerging economies due to their potential for growth and their greater financial needs.

Unfortunately, the academic literature has generally paid more attention to the regulation of corporate insolvency in developed countries. Thus, it has largely omitted the debate about the optimal design of insolvency law in jurisdictions that, in addition to requiring a more active policy debate, amount to 85% of the world’s population and 59% of the global GDP, since they include some of the world’s largest economies such as China, India, Brazil, Russia and Indonesia.

In my new article, ‘Insolvency Law in Emerging Markets’, I seek to fill this gap in the academic literature by analyzing the problems and features of insolvency law in emerging economies and suggesting a new framework for financially distressed companies in these countries. My paper argues that, even though, in an ideal scenario, any improvement of the insolvency framework in these countries should start by enhancing the judicial system and the sophistication of the insolvency profession, these reforms usually take time, resources and political will. In fact, due to a variety of factors, including corruption, lack of awareness about the importance of the insolvency system for the real economy, or lack of political incentives to engage in such complex reforms whose benefits will only be shown in the long run, they might never occur. For this reason, my paper suggests an insolvency framework for emerging economies taking into account the current market and institutional features of these countries. If these conditions change over time, or they do not exist in some particular emerging economies, my proposal would need to be adjusted accordingly.

My proposed corporate insolvency framework for emerging markets is based on three fundamental pillars. First, pre-insolvency proceedings and out-of-court restructuring should be promoted as a way to avoid an insolvency system that is usually value-destroying for both debtors and creditors. Second, insolvency proceedings should be reformed to respond more effectively to the problems and features existing in emerging markets, which generally include the prevalence of small companies and large controlled firms, as well as the existence of inefficient courts and unsophisticated insolvency practitioners. Finally, emerging economies should adopt a more contractual approach to deal with a situation of cross-border insolvency. Thus, by facilitating the choice of insolvency forum, debtors, creditors and society as a whole will be able to enjoy the benefits associated with having access to more sophisticated insolvency frameworks. Besides, since many debtors and creditors would be using foreign insolvency proceedings, this value-creating forum shopping may incentivize many Governments in emerging economies to invest the resources needed to improve the market and institutional environment existing in these countries, hopefully making the insolvency framework suggested in this article no longer needed.

The full article is available here.

Another version of this post was previously published on the Oxford Business Law Blog and the Singapore Global Restructuring Initiative Blog.

For previous Roundtable posts on insolvency reforms in China and India, see Xiahong Chen, INSOL Europe/LexisNexis coronavirus (COVID-19) Tracker of Insolvency Reforms—China; Xiao Ma, China Continues to Issue New Rules Promoting Corporate Rescue Culture, Facilitation of Bankruptcy Proceedings; and Himani Singh, Pre-packaged Insolvency in India: Lessons from USA and UK.

INSOL Europe/LexisNexis coronavirus (COVID-19) Tracker of Insolvency Reforms—China

By Xiahong Chen (China University of Political Science and Law)

Xiahong Chen

The modification of Enterprise Bankruptcy Law of the People’s Republic of China in 2006 had been announced to be in legislative organ’s amendment procedure for years. As there is no further progress in 2020, the slow process must not catch the urgent needs of economic community for corporate rescue after breakout of coronavirus epidemic. Consequently, the Supreme People’s Court of P.R.China was playing an active role in policy-making from judicial perspective concerning civil disputes resolution. From April to June 2020, the Supreme People’s Court of P.R.China had issued 3 judicial guidance in series to direct judicial hearing of civil case in all level of courts during and after the epidemic, with purpose to guide judicial hearing of civil cases relating to disputes caused by coronavirus. Among them, the second one, published on 19 May 2020, contains 7 important guidelines for judicial hearing of bankruptcy cases relating to COVID-19, aiming to improve possibility of corporate rescue and enhance viability of those financial-distressed companies further.

Changes of bankruptcy policy in above-mentioned guidance include: (1) Court-supervised negotiation between the insolvent debtor and those creditors before the opening of bankruptcy proceeding; (2) Distinguishing real causes of insolvency when examining bankruptcy criteria; (3) Further promoting the link between civil execution proceedings and bankruptcy proceedings; (4) Extending the reorganization period from maximum of 9 months according to EBL 2006 by another 6 months; (5 ) Highlights of effective protection of creditors’ substantive rights and procedural rights in bankruptcy proceedings;(6) Maximizing the debtor’s ability to continue operations and the value of property disposal; (7) Promoting the efficient hearing of bankruptcy cases.

In this short note, the author Xiahong Chen, fellow of Bankruptcy Law and Enterprise Restructuring Research Center of CUPL, was invited by the INSOL Europe, introduces the main points of adjustments of bankruptcy policies relating to epidemic in detail. According to his observation, like the global legal and policy changing trends in bankruptcy area all over the world recently, the changes concerning judicial hearing of bankruptcy cases in China is expected to be helpful for survival of those financial struggling companies.

The full article is available here.

The Evolution of European Insolvency Law Part 3: The EU Parliament’s Report on the Amendment of the European Insolvency Regulation (EIR)

By Robert Arts and Dr. Björn Laukemann (Maîtr. en droit)

Robert Arts Laukemann PicAfter the external evaluation of European Insolvency Law (Part 1) and the European Commission’s proposal for the amendment of the EIR (Part 2), the report of the European Parliament (EP) on this proposal marked the latest stage of the reform process.

While the Parliament generally supports the changes proposed by the Commission and many of its amendments simply clarify wording or align the text with the existing legislation, the draft report made some noteworthy revisions:

  1. To prevent abusive venue-shopping, the draft requires the factual circumstances of the debtor’s centre of main interests to be established three months prior to the opening of insolvency proceedings.
  2. While welcoming the introduction of synthetic proceedings (i.e. the granting of special rights to groups of local creditors in order to avoid the opening of secondary insolvency proceedings) the EP strengthens the procedural standing of the local creditors by:

(i) granting them the power to challenge any decision to postpone or refuse the opening of secondary proceedings;

(ii) allowing them to petition the court conducting the main proceeding to take protective measures, e.g. by prohibiting the removal of assets or the distribution of proceeds, or by ordering the administrator to provide security; and

(iii) empowering the court to appoint a trustee to safeguard their interests.

  1. The coordination and cooperation between administrators appointed in different proceedings within a group of companies is further enhanced by the implementation of an independent coordinator who, for instance, is empowered to present a non-binding, court-approved group coordination plan, to mediate in disputes between insolvency representatives of group members, or to request a stay of proceedings with respect to any member of the group.

As a result, the Parliament report  aims to strengthen the role of main insolvency proceedings while still sufficiently considering interests of local creditors and to improve coordination within groups of companies. The draft is expected to pass the European Council by the end of this year.

See the full report here.

Emerging Economies and Cross-Border Insolvency Regimes: Missing BRICs in the International Insolvency Architecture

By Steven T. Kargman, President, Kargman Associates

SK-Roslyn (July '14) (1) Many of the world’s major advanced economies are subject to some form of cross-border insolvency regime, such as Chapter 15 in the United States. However, despite this clear and important progress in the adoption of cross-border insolvency regimes among many advanced economies, there appears to be a glaring gap in the international insolvency architecture. Specifically, very few of the major emerging economies – and, in particular, none of the BRIC countries (Brazil, Russia, India and China) – have adopted the UNCITRAL Model Law on Cross-Border Insolvency or otherwise enacted effective alternative regimes for handling cross-border insolvencies.

With their growing integration into the global economy, these emerging economies may face a rising number of cross-border insolvencies at some point in the coming years. Nonetheless, while the current absence of cross-border insolvency regimes in major emerging economies may not represent an immediate problem in the next few years, it may pose challenges for the international insolvency framework over the longer term given that these economies are playing an increasingly important role in the global economy.

This two-part article, originally published in 2012-2013 in Insolvency and Restructuring International, reviewed the status of the adoption among major emerging economies of comprehensive insolvency regimes along the lines of the UNCITRAL Model Law and outlined possible pathways that emerging economies might pursue that could lead to the adoption of such cross-border insolvency regimes in these jurisdictions. The article also explored intermediate steps that emerging economies might adopt as a means of growing more comfortable with the concepts that are central to any meaningful cross-border insolvency regime.  Such intermediate steps might serve to pave the way ultimately for the adoption by these emerging market jurisdictions of a more comprehensive cross-border insolvency regime.

Part I of the article (September 2012) can be found here and Part II (April 2013) can be found here.  (This article was first published in Insolvency and Restructuring International, Vol. 6 No. 2, September 2012 and Vol. 7 No. 1, April 2013, and is reproduced with the kind permission of the International Bar Association, London, UK © International Bar Association.)

Revisiting the Voting Prohibition in Bond Workouts

posted in: Workouts and Pre-Packs | 0

Author: Carlos Berdejó, Loyola Law School, Los Angeles

Economic theory suggests that corporate law should enable parties to contract freely in order to promote their best interests, leading to socially optimal arrangements.  This is particularly true for corporate bonds, which are governed by detailed indentures and held by large, sophisticated investors.  However, the Trust Indenture Act, which for 75 years has regulated the terms of U.S. public corporate debt, contains numerous mandatory rules, including a prohibition on collective action clauses (CACs).  A CAC allows a qualifying majority of bondholders to modify the interest rate, maturity and principal of an outstanding bond issue in a manner that binds all bondholders, including those who may prefer to hold-out to extract a larger payment.  This longstanding prohibition limits the ability of firms to restructure their debt via private workouts and can exacerbate the costs of financial distress by unnecessarily forcing issuers into bankruptcy.  Most countries other than the U.S. do not prohibit CACs and afford parties flexibility in choosing the qualifying majority that may amend the core terms of a bond issue.

My article, Revisiting the Voting Prohibition in Bond Workouts, examines contracting choices in Brazil, Chile and Germany, countries that have recently enacted reforms affecting their bond markets, including changes in restrictions on CACs.  I find that not only do market participants embrace increased flexibility with respect to CACs, but that interest rates decrease as a result, lowering the cost of capital for issuers.

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[Related Work Note: The work in Revisiting the Voting Prohibition in Bond Workouts provides evidence relating to the argument made in Mark Roe, The Voting Prohibition in Bond Workouts, 97 Yale L.J. 232 (1987), that the prohibition unwisely impeded out-of-bankruptcy recapitalizations and channeled some parties’ incentives towards coercive restructurings that would not have been needed if straight-forward votes were allowed.  That article can be found here.  More generally, academic bankruptcy theory has focused on the extent to which contract terms should be respected by law, inside and outside of bankruptcy.  See Alan Schwartz, Bankruptcy Workouts and Debt Contracts, 36 J. of L. & Econ. 595 (1993), available here.  –Stephen Adams, Editor]

The Evolution of European Insolvency Law Part 2: The EU Commission’s Proposal for the Amendment of the European Insolvency Regulation

Author: Dr. Björn Laukemann, Maître en droit (Aix-en-Provence), Senior Research Fellow at the Max Plack Institute Luxembourg for International, European and Regulatory Procedural Law

Laukemann PicFollowing the external evaluation (Part 1), the EU Commission released a proposal for the amendment of the European Insolvency Regulation in December 2012, aimed at enhancing the efficiency of cross border insolvency proceedings and thus ensuring a proper “functioning of the internal market and its resilience in economic crises”. The following main changes were proposed:

  1. The Regulation’s scope of application now includes hybrid proceedings (“debtor in possession”), pre-insolvency proceedings and debt discharge proceedings for natural persons. The Commission will scrutinize whether specific national proceedings fall within the revised scope.
  2. Retaining the jurisdictional criterion of the debtor’s centre of main interests, the proposal clarifies the criteria and improves the procedural framework for determining the competent court (examination ex officio, information of foreign creditors and creditors’ right to judicial review).
  3. The proposal empowers the court to refuse to open secondary proceedings (i.e. parallel territorial proceedings opened in the Member State of the debtor’s establishment) if they are unnecessary to protect the interests of local creditors, and thus to reduce detrimental effects on rescue efforts (abolishment of the winding-up-requirement; improved cooperation and communication between main and secondary proceedings, also on a court-to-court basis).
  4. Member States are required to establish publicly accessible and interconnected electronic registers in which the relevant court decisions are published.
  5. The implementation of standard forms will facilitate the lodging of claims for foreign creditors.
  6. A framework for the coordination of insolvency proceedings within groups of companies is set up (obligation of courts and liquidators to cooperate and communicate with each other; extending certain rights of administrators to proceedings of other group members, e.g. the right to be heard, to participate, to request a stay of proceedings and to propose a rescue plan).

Part 3 will address the reactions of the European Parliament and the Council and comment on ongoing and future developments.

 

The Evolution of European Insolvency Law: Part 1: The Heidelberg/Luxembourg/Vienna Report

Authors: Prof. Burkhard Hess (Luxembourg/Heidelberg), Univ.-Prof. Paul Oberhammer (Vienna/London/St. Gallen) and Prof. Thomas Pfeiffer (Heidelberg), summarized by team member Robert Arts

The first step towards the upcoming amendment of the European Insolvency Regulation was an evaluation of its application since its adoption in 2002. The Regulation itself required the evaluation to make sure that European Insolvency Law keeps up with the constant changes to the multitude of national insolvency regimes. A team from the Max Planck Institute Luxembourg (Hess), Heidelberg University (Pfeiffer), and the University of Vienna (Oberhammer) conducted the research and collected empirical data in all 26 concerned Member States.

The evaluation shows that the defining principle of the Regulation, that of universality (single proceeding and single insolvency statute with universal effect and recognition) has proven to be a great boon for the procedural handling of cross-border insolvencies in Europe. The report consequently proposes to further strengthen universality by reducing the possibility of separate, territorial proceedings.

Moreover, the report finds that widening the scope of application (by inclusion of pre-, hybrid and annex proceedings and by providing – for the first time ever – a framework for collaboration within group of company insolvencies), is necessary to keep the Regulation in line with the ongoing shift from liquidation towards the reorganization of companies.

The report also addresses technical difficulties arising from cross border insolvencies – e.g., the lodging of claims, the need for communication amongst judges and administrators and the information deficit of foreign creditors.

The entire report can be found here. Part 2 will cover the proposal for the amendment of the Regulation by the European Commission, which adopted many of the report’s suggestions.