- Streamlining insolvency proceedings
- Establishing or clarifying rules for commencing insolvency proceedings
- Establishing effective reorganization proceedings
- Promoting creditor participation
- Improving provisions applicable to treatment of contracts and voidable transactions
- Introducing provisions on post-commencement financing
- Regulating the profession of insolvency administrators
Changes in insolvency regimes over the years—whether motivated by economic or financial crises or implemented as part of broader judicial or legal reforms—have led to the emergence of several trends and good practices. Among these is a unified international good-practice standard on creditor and debtor regimes and insolvency set forth by the World Bank and the United Nations Commission on International Trade Law (UNCITRAL). Good practices in many economies are aimed at improving both the efficiency and the outcome of insolvency proceedings. These include streamlining insolvency proceedings, establishing effective reorganization proceedings and promoting creditor participation in the proceedings.
STREAMLINING INSOLVENCY PROCEEDINGS
Establishing time limits for proceedings can enhance the efficiency of the insolvency process. Long proceedings reduce creditors’ chances of recovering outstanding debt and can create unnecessary uncertainty for all parties involved(1). Efficient insolvency proceedings increase debt recovery by creditors by making it more difficult for the shareholders of a company to sell its assets at an unreasonably low price to a second company they own.
Many economies focus their reform efforts on improving the efficiency of insolvency proceedings. For example, in an insolvency law adopted in 2016, India introduced time limits for the insolvency process Chile implemented a new Insolvency Law in 2014 with the goal of adopting a modern and efficient bankruptcy system. The new law simplified provisions governing liquidation and reorganization procedures. As a consequence of the reform, the time to resolve insolvency proceedings has become more efficient in Santiago. Doing Business 2018 recognized a time reduction in a liquidation procedure after an attempt at reorganization from of 3.2 to two years.
ESTABLISHING OR CLARIFYING RULES FOR COMMENCING INSOLVENCY PROCEEDINGS
The possibility for both the debtor and the creditors to initiate judicial liquidation or judicial reorganization together with a concrete mechanism which identifies parties who can apply for the procedure and establishes a formal process for submitting the application as well as the timing of the application should be clearly addressed by the law. Some commencement criteria (for example: a debtor which is unable to pay its debts as they become due may be made subject to formal insolvency proceedings) and presumptions about insolvency should be clearly defined in the law.
ESTABLISHING EFFECTIVE REORGANIZATION PROCEEDINGS
The highest recovery rates are recorded in economies where reorganization is the most common insolvency proceeding. Reorganization aims to restore the financial well-being and viability of a debtor's business so that the business can continue to operate through means that may include debt forgiveness, debt rescheduling, debt-equity conversions and sale of the business (or parts of it) as a going concern. The ultimate purpose is to allow the debtor to overcome its financial difficulties and resume or continue its business operations. The UNCITRAL’s Legislative Guide on Insolvency Law and the World Bank Principles on Effective Insolvency and Creditor/Debtor Regime, as well as other authoritative texts, recommend reorganization proceedings that are formally structured and have the following elements:
a. The possibility for both the debtor and the creditors to initiate reorganization procedures and a concrete mechanism to commence reorganization proceedings, identifying parties who can apply for reorganization, establishing a procedure for submitting the application as well as the timing of the application;
b. A mechanism to manage the property of the debtor while reorganization proceedings are on-going, this usually involves the appointment of an administrator or a manager to oversee the debtor’s assets and operation and a moratorium preventing creditors from enforcing their rights outside the reorganization process;
c. Minimum standards for a reorganization plan, including its content and treatment of creditors;
d. A mechanism for implementation of a reorganization plan and equity considerations for approval of a reorganization plan. In that sense, when voting reorganization plan, only creditors whose rights are affected by the plan should vote. The rights of certain secured creditors may be unaffected by a given reorganization plan. If that is the case, those creditors should not vote to approve the reorganization plan.
e. Enable creditors to vote reorganization plan in classes and establish that creditors of the same class receive the same treatment under the reorganization plan. Good international practice recommends dividing creditors into classes and having each class vote separately to approve a rehabilitation plan. This approach helps in preparation of the reorganization (rescue) plan and ensure fair voting procedures.
f. Based on the possibility that the majority of creditors can impose a plan on the dissenting minority, a generally accepted principle is that dissenting creditors must receive at least as much under the reorganization plan imposed on them as they would have received in liquidation proceedings.
g. An element of restructuring. The debtor’s business undergoes a change based on the approved reorganization plan, whereby some restrictions are imposed on the debtor as to how its assets and business should be managed or structured until the debts are repaid in accordance with the plan.
It is noteworthy that one-third of economies around the world have no formal judicial reorganization proceeding, and in only 18 economies is reorganization the most common proceeding as recorded by Doing Business. However, this number is rising—since 2013, 23 economies have introduced reorganization proceedings, including Cyprus, the Arab Republic of Egypt, Malaysia and the United Arab Emirates.
Pakistan provides a good example of successful reforms aimed at implementing reorganization proceedings. In line with international good practices, the government of Pakistan adopted the Corporate Rehabilitation Act in March 2018 under which the option of reorganization for commercial entities as an alternative to previously available liquidation procedure was introduced, allowing the debtor to commence the reorganization procedure. It also stipulated specific rules on how creditors vote on the reorganization plan—all creditors must vote on the plan, regardless of its impact on their interests. Finally, the Act specified that the anticipated cash return to dissenting creditors should be at least equal to the allowed amount of their claims.
PROMOTING CREDITOR PARTICIPATION
Research shows that if creditors are not protected or allowed to participate in insolvency proceedings, they will have less incentive to lend in the future, leading to less-developed credit markets(2).
Creditors are key participants in insolvency proceedings—the maximized value of the assets is closely tied to the recovery of creditors, whether financial lenders, employees or trade creditors. Thus, it is key that creditors play an important role in insolvency proceedings as well as the powers, liabilities and rights in the rescue process. Good practice suggests that legal frameworks establish specific and direct provisions allowing the following creditor’s rights:
· The right to select the insolvency representative. Because the insolvency practitioner’s fees are deducted from creditors’ returns, they are highly motivated to seek out a professional who is familiar with the nature of the debtor’s business, activities or type of assets, or who has special knowledge to handle the particular circumstances of the case. The risk that an insolvency practitioner might favor the creditor who nominated him or her can be mitigated by provisions that allow for other creditors to move to replace the insolvency practitioner, for example at the first creditor’s meeting. Moreover, once a strong framework for regulating insolvency practitioners is in place, an insolvency practitioner can be held accountable for his or her professional conduct.
· The right to approve the sale of substantial assets of the debtor. The law should incorporate a number of procedural safeguards to make sure that the procedures are fair, transparent, well publicized and that the manner of sale chosen maximizes the value for the estate. To that end, where assets of the insolvency estate are to be sold, the law should require that the creditors are notified and consulted on the sale of assets (outside of the ordinary course of business). Good practice suggests that creditors should be allowed to challenge the sale of the assets (either with the insolvency representative or the court, as appropriate) if they disapprove, to ensure that their interests are also protected. As such, the creditors will be able to require that neutral, independent professionals value the assets and that collusion between the debtor and prospective bidders is discouraged.
· The right to request information at any time from the insolvency representative on the debtor's business and financial affairs. Good practice suggests that individual creditors should have the right to request information about the financial state of the debtor on a continuous basis throughout the insolvency proceedings without significant impediments. The most common way to gain access to such information is through a request to the insolvency representative who manages the business affairs of the debtor.
· The right to object to the decision accepting or rejecting its own claims and claims of other creditors. The law should establish specific and direct provisions allowing the right of individual creditors to object to the decision of the insolvency representative regarding acceptance or rejection of its own claims, as well as object to the decision of the insolvency representative regarding the acceptance and value of claims of other creditors.
Several recent insolvency reforms have addressed this concern. In 2018, Morocco granted individual creditors the right to access information about insolvency proceedings relating to the debtor’s business and financial affairs and allowed individual creditors who have submitted their claims against the debtor to examine and object to the claims of other creditors. Djibouti granted creditors the right to approve the appointment of the insolvency representative and the right to approve the sale of substantial assets of the debtor in the course of insolvency proceedings.
IMPROVING PROVISIONS APPLICABLE TO THE TREATMENT OF CONTRACTS AND VOIDABLE TRANSACTIONS
Implementing efficient and transparent regulatory mechanisms for the management of the debtor’s assets during insolvency proceedings may improve the likelihood of high recovery. Such mechanisms prevent debtors from distributing assets that can otherwise be used to pay off the creditors or to preserve the business so that it can be sold as a going concern.(3) Good practice suggests including explicit and direct provisions authorizing continuation and rejection of contracts after the commencement of insolvency proceedings (by either the debtor or the insolvency representative) if such contracts are for goods and services essential to the debtor’s business operations. Equally important for the preservation of the insolvency estate is to ensure that the debtor’s assets are not dissipated in the period after the debtor first learns of financial difficulties but before formal commencement of insolvency proceedings by allowing the avoidance (invalidation) of undervalued transactions, which were made as a gift or in exchange for less than equivalent value and which occurred when the debtor was insolvent or resulted in the debtor becoming insolvent.(4)
For these two important reasons, the bulk of reforms have been aimed at improving the management of debtor’s assets during insolvency proceedings. Fiji adopted a new Companies Act in 2015 introducing new categories of obligations that can be avoided by a company during insolvency proceedings, such as insolvent transactions (unfair preferences and uncommercial transactions), unfair loans and unreasonable director-related transactions concluded before or on the day of filing for insolvency. New amendments to legal insolvency framework in Georgia enacted in 2017 incorporated a rule that contracts supplying essential goods and services to the debtor shall be continued despite the commencement of insolvency proceedings. The amendments also allowed courts in Georgia to invalidate undervalued transactions (resulting in the depreciation of trusted property) which were carried out within one year before the filing of the insolvency application. In 2018 Kenya amended its insolvency law to allow the administrator to continue or disclaim the contracts of the debtor, thereby allowing for the continuation of contracts supplying essential goods and services to the debtor when necessary.
INTRODUCING PROVISIONS ON POST-COMMENCEMENT FINANCING
Establishing the possibility for the insolvency representative to request new financing after the commencement of insolvency proceedings and granting creditors who provide post-commencement financing with priority over claims of existing creditors are vital for the continued operation of the debtor’s business during reorganization proceedings and also to maximize the value of the debtor’s assets. It can also be important in liquidation proceedings. New funding is especially important in the period between the commencement of proceedings and approval of the reorganization plan and should be specifically addressed by the insolvency law. The law should recognize the need for post-commencement financing, authorize its use and establish priority of repayment for lenders who agree to supply such financing. Additionally, post-commencement creditors should rank above ordinary unsecured creditors.
Several economies recently strengthened aspects of regulation governing the provision of post-commencement financing during insolvency proceedings. In 2016 India adopted the Insolvency and Bankruptcy Code establishing the possibility for the debtor to receive new financing after the commencement of insolvency proceedings and granted creditors who provide post-commencement financing priority over claims of existing creditors. In 2018 Turkey also introduced the possibility to obtain post-commencement financing in reorganization proceedings.
REGULATING THE PROFESSION OF INSOLVENCY ADMINISTRATORS
Professional insolvency practitioners play a key role in the operation of a swift and efficient insolvency system. Courts are of course needed to supervise the proceedings and make legal decisions, but they do not have the technical expertise to, for example, restructure a struggling enterprise or run a company with the aim of maximizing the liquidation value of its assets. Therefore, many countries—such as the United Kingdom, Canada, Australia, China, Japan, Korea, Brazil, Mexico and Russia—have facilitated the development of a professional insolvency practitioner profession whose members manage the economic and operational aspects of a proceeding.
1. Cirmizi, Elena, Leora Klapper and Mahesh Uttamchandani. 2010. “The Challenges of Bankruptcy Reform.” Policy Research Working Paper 5448, World Bank, Washington, DC.
2. Claessens, Stijn, and Leora Klapper. 2003. "Bankruptcy around the World: Explanations of Its Relative Use." Policy Research Working Paper 2865, World Bank, Washington, DC.
3. Robert-Tissot. 2010. “The Effects of a Reorganization on (Executory) Contracts: A Comparative Law and Policy Study.” [United States, France, Germany, Switzerland], in: 3 International Insolvency Law Review 2 (2012): 234.
4. UN. 2004. UNCITRAL Legislative Guide on Insolvency Law. New York, NY: UN.
World Bank. 2001. The World Bank principles and guidelines for effective insolvency and creditor rights systems. Washington, DC: World Bank.
World Bank. 2011. Principles for Effective Insolvency and Creditor/Debtor Regimes. Revised. Washington, DC: World Bank. Available from http://siteresources .worldbank.org/EXTGILD/Resources/5807554-1357753926066 /ICRPrinciples-Jan2011[FINAL].pdf.