The Philosophy Of Insolvency Rescues

The current financial crisis is likely to bring in its train a

re-examination of corporate rescue statutes as a way of protecting

the economy and it is worth reviewing where we have got to on this

topic internationally.

Insolvency does not mean insolvency proceedings. By far

the great majority of financial problems are resolved by a private

restructuring outside the courts, known as work-outs. Nobody

knows the proportion of work-outs to judicial rescues or

liquidations internationally, but there is no question that they

are the preferred course for both debtors and creditors if at all

possible.

Work-outs avoid the trauma of formal insolvency proceedings

which cause credit to dry up and which deter new business.

They avoid a loss of control by both management and creditors to a

court or administrator. They avoid the forcible stays on

creditor rights (which may include, depending on the jurisdiction,

stays on set-off, taking and enforcing security and contract

terminations). They keep the group together. They avoid

the examination of management, greater public scrutiny and the

delays, formality, cost and tactical litigation typical of court

proceedings. Security for old and new money to support the

company is easier to take.

Also, whatever you call the insolvency proceeding in most

countries, it inevitably sparks off termination clauses in leases

and contracts and any resulting close-outs and cancellations.

Formal proceedings are generally a last resort.

Liquidation is the stroke of midnight for everybody, the final

guillotine.

On the other hand, they might be unavoidable. This will be

the case if there are hold-out creditors who will not agree to a

work-out, or there are desperate junior creditors who do not

realise they have lost everything, or disgruntled shareholders who

have a veto, e.g. against a debt-equity conversion or a large

disposal, or the issues are too complex to be worked out before the

company runs out of money. There can be just too many

conflicts – between creditors in laddered tranches, or

creditors with credit protection, or labour unions or pension

trustees with blocking rights.

Of course the decision may be taken out of the hands of

creditors and management by reason of rules imposing personal

liability on directors if they deepen the insolvency by not

stopping early enough or by reason of rules imposing a duty on them

to file once the company is insolvent.

Liquidation is the stroke of midnight for everybody, the final

guillotine. It is very rare for liquidation to have

advantages over judicial rescues or work-outs.

Some jurisdictions have half-way houses between judicial rescues

and private work-outs. These include official umpires

(France), and "voluntary" codes of conduct for work-outs,

prompted by the authorities. These were based on the

"London Approach" initiated in the 1970s and are found in

Indonesia, Turkey, Hong Kong, Japan, Thailand and elsewhere.

They are official arm-twisting, soft law.

It was...