BASIC CONCEPTS OF INSOLVENCY LAWAN INTERNATIONAL PERSPECTIVE

University of Istanbul, November 2012

Prof. Dr. Ignacio Tirado, LLMUniversidad Autónoma de Madrid

Senior Legal Consultant

The World Bank

OUTLINE• INTRODUCTORY REMARKS

• INTERNATIONAL FINANCIAL INSTITUTIONS AND THE HOMOGENEIZATION OF PRIVATE LAW

• BASIC CONCEPTS OF INSOLVENCY LAW– A JUSTIFICATION – NEW CONCEPTIONS– BEST INTERNATIONAL PRACTICE

INTRODUCTION

• Basic concepts:– IFIs:

• What are they General• Which institutions • Cross relationships Regional

• What’s the World Bank?– Who does it belog to?– Aims

International Financial Arquitecture

• CONCEPT: economic, legal and institutional framework aimed at the prevention and management of financial crises as well as to the creation of an adequate, integrated international financial environment

• ACTIVE AT DIFFERENT LEVELS– Collective Action: measures at international level

– Actions at country level: international stability based on adequate operation of each local and regional market

• INSTITUCIONES:– WBG

– IMF

– FSF, BIS (Bank of Intern. Settlements/Basel Committee), IASB (Inter. Accounting Standards Board, etc.)

International Financial Arquitecture(II)

• WBG Mandate: Poverty Reduction

DEVELOPMENT INTERN. INSTITUTION

• ACTIVE ON TRIPLE LEVEL:– A) Assists countries identifying sources of social and economic

vulnerability and improving institutional deficiencies

– B) Defense of DC in international forae

– C) Assists countries in overcoming financial crisis

• CONCRETE ACTION FSAP

ROSC

THEORETICAL JUSTIFICATION OF INSOLVENCY LAW

• A WORLD WITHOUT INSOLVENCY?

• …FOR SOME THE ANSWER IS NO: INSOLVENCY LAW IS NECESSARY,

• BUT… WHY AND HOW?

INTRODUCTORY REMARKS

• WHAT IS INSOLVENCY LAW?• HEALTHY BUSINESS. INDIVIDUAL DEBT

COLLECTION MECHANISMS SUFFICE• INSOLVENT BUSINESS. NOT ENOUGH CAKE

FOR EVERYONE. LOSS DISTRIBUTION NECESSARY

• RACE TO THE SWIFTEST…WHO’S USUALLY THAT? …UNFAIR,

• A NEED TO MINIMIZE HARM TO COMMON MARKET: DOMINO EFFECT

THEORETICAL JUSTIFICATION: THOMAS H.JACKSON’S MODEL

but also INEFFICIENT…I

NSOLVENCY MATCHES THE “COMMON POOL” OR THE “TRAGEDY OF THE COMMONS” GAME

ONLY FISHERMAN. ERIC FISH

1 MILLION

THOMAS H.JACKSON’S MODEL II

• …COMMON POOL. ASSUMPTIONS

• BEHAVIOUR AS A SOLE OWNER

– YEAR 1: 1 MILLION IF ALL THE FISHING– YEAR 2: NOTHING– ALTERNATIVE: YEAR 1 500.000; YEAR 2: 500.000…

WORTH 5 MILLION– SOLE OWNER WILL ONLY FISH 500.000…but, if OTHER FISHERMEN…

THOMAS H.JACKSON’S MODEL

INSOLVENCY MATCHES THE “COMMON POOL” OR THE

“TRAGEDY OF THE COMMONS” GAME

- FSH 1 FSH 2 FSH 3 FSH 4 ….

1 MILLION

THOMAS H.JACKSON’S MODEL III

• THE OPTIMAL SOLUTION HASN’T CHANGED, BUT THERE IS AN OBSTACLE:

– YOU CANNOT BE SURE, BY LIMITING YOUR FISHING, THAT THERE WILL BE ANY MORE FISH NEXT YEAR, SINCE YOU CANNOT CONTROL THE OTHERS

– …they are FREE RIDERS: PRISONERS’ DILEMMA

JACKSON’S MODEL IV

PRISONERS’ DILEMMA

• Two criminals arrested. Both committed a serious crime, but they cannot be convicted for the crime without extracting at least one confession. However, they can be convicted for a lesser offence without cooperation.

• …if neither confesses, they will both be convicted by the lesser offence: 2 years in jail; if one confesses and the other doesn’t, the former will go free and the latter will be tried for the serious crime: 10 years; if both confess, they will both be prosecuted for the serious crime, but the district attorney will not ask for the highest penalty: only 6 years.

THOMAS H. JACKSON’S MODEL V

• RULES:

1. EACH PRISONERS HAS AS SOLE GOLE TO MINIMIZE HIS TIME IN PRISON

2. EACH PRISONER IS INDIFFERENT TO HOW MUCH TIME THE OTHER SPENDS IN JAIL

3. THEY HAVE NO WAY OF REACHING AN AGREEMENT

THOMAS H.JACKSON’S MODEL VI

• HOW WOULD YOU BEHAVE? …There is only one correct answer

PRISONER 2

SILENT CONFESS SILENT 2, 2 10,0

• PRISONER 1

CONFESS 0, 10 6,6

THOMAS H.JACKSON’S MODEL VII

• … NO MATTER WHAT THE OTHER PRISONER DOES, THE PRISONER IS ALWAYS BETTER OFF CONFESSING

• SOLUTIONS TO THOSE PROBLEMS: WHAT IS REQUIRED IS A SOME RULE THAT WILL MAKE ALL FISHERMEN ACT AS A SOLE OWNER WOULD: A MANDATORY COLLECTIVE ACTION

THOMAS H.JACKSON’S MODEL VIII

• EFFCIENCIES OF A “CORRECT” INSOLVENCY LAW:

– A) MOST IMPORTANT: SALE AS A GOING CONCERN

– B) BIG COST REDUCTION:• 1) COMMON PROCEDURAL COSTS (ONE PROCEDURE V.

HUNDREDS

• 2) REDUCTION OF LITIGATION

• 3) CENTRALISATION OF LEGAL INSTRUMENTS TO RECONSTRUCT THE ESTATE

THEORETICAL JUSTIFICATION OF INSOLVENCY LAW

• LETS GO BACK TO THE QUESTION WE FIRST MADE: A WORLD WITHOUT INSOLVENCY? …

• THE ANSWER IS YES FOR SOME: BEBCHUCK

• REASONS: …

A WORLD WITHOUT INSOLVENCY

• COSTS OF BANKRUPTCY ARE HIGH• SUGGESTED ALTERNATIVE: AUCTION • PROBLEMS: NEED FOR A PERFECT MARKET • PROBLEM OF THIS AND OTHER ALTERNATIVE

THEORIES IN INSOLVENCY: BASED ON BIG QUOTED COMPANIES. Ch 11

• SECOND ATERNATIVE: THE WORKOUT (OUTSIDE BANKRUPTCY)…UNREAL, SINCE MOST INSOLVENCY LAWS PUT HIGH RESTRICTIONS TO THEM. AN EFFICIENT EXCEPTION: THE LONDON APPROACH. COUNTEREXAMPLE: ADM RECEIVERSHIP

FURTHER REFLECTIONS ON THE GOALS OF INSO LAW

WE MUST GET RID OF PREJUDICES:

•INSOLVENCY IS NOT AN STIGMA.

•*“Tertiis nundinis partis secanto. Si plus minusve secuerunt, se fraude esto”… the thrid day of the market, creditors can slaughter and carve the debtor up. If they take more than entitled to, it will be considered a fraud…Tabula 3 numb 6 of the XII Tabulae in ROMAN LAW

Getting rid of prejudices

• MANUS INIECTO • PIGNORIS CAPIO• STATUTTI OF THE ITALIAN MEDIEVAL STATES:

PRISON• In FRENCH MEDIEVAL TOWNS, BANKRUPTS

were REQUIRED TO WEAR A GREEN CAP AT ALL TIMES, AND ANYONE COULD THROW STONES AT THEM

• STATUTE FOR SUCH PERSONS AS DO MAKE BANKRUPT: HENRY THE VIIITH, PIERCING OF AN EAR

Getting rid of prejudice

• …American perspective: bankruptcy culture: SILICONE VALLEY. FIGURES: AMERICA 55.000 corporate insolvencies a year; UK 40.000; SPAIN: 800 CASES (before the crisis); Mexico: 100 cases in 10 years…Kosovo: 0 cases

• AIM OF INSO LAW IS NEVER TO PUNISH BUT TO PROVIDE A SOLUTION TO THE CRISES.

• ONLY FRAUDULENT BEHAVIOUR MUST BE PUNISHED: CHANGE IN MODERN LEGISLATIONS

• FRAUDULENT DIRECTORS CAN BE MADE ACCOUNTABLE TO COMPENSATE CREDITORS: INCENTIVE FOR GOOD BEHAVIOUR IN THE MARKET

Who can be made insolvent?

• One insolvency procedure for all?– Business/professionals/others– Consumer/business– Special cases: banks and insurance companies

• General insolvency proceedings as wide-encompassing as possible– Trust/Funds– SOE?

ACCESS TO THE PROCEDURE

• MAIN GOALS IS TO ADVANCE THE MOMENT IN WHICH THE PROCEDURE IS OPEN

• INSOLVENCY LAW SHOULD BE ABOUT HEALING THE SICK, NOT ABOUT BURYING THE DEAD.

• 2 WAYS: …

ACCESS TO PROCEDURE II

– PROMOTING THE FILING BY THE DEBTOR:

• EASY ACCESS • SETTING UP A DUTY TO FILE BY COMPANY

DIRECTORS• SOFTENING MAJORITIES TO REACH A BINDING

AGREEMENT • LIMITING INVESTIGATION OF DIRECTORS’ BEHAVIOUR

IN CASE OF A GOOD PLAN

– MARKET’S CONTROL. PROMOTING CREDITOR’S PETITION:

• 1) INCREASING PUBLIC MANDATORY INFORMATION ABOUT THE COMPANY’S FINANCIAL SITUACION

• 2) PRIORITY TO THE PETITIONING CREDITOR…

ACCESS TO THE PROCEDURE III

• CRITERIA:– CASH FLOW TEST.- Debtor unable to pay its debts

as they fall due– BALANCE SHEET TEST: More liabilities than assets

• RELATIONSHIP BETWEEN BOTH TESTS

• QUESTIONS TO SOLVE:– ASSETLESS CASES?– PLURALITY OF DEBTORS?

Instruments and objectives of insolvency law

Estate, creditors and third parties

JACKSON=WORLD BANK

GOALS OF INSOLVENCY LAW (WORLD BANK=JACKSON)

• 1) TO MAXIMIZE THE ESTATE, IN ORDER TO OFFER THE HIGHEST RETURN POSSIBLE

• 2) TO RESCUE VIABLE BUSINESSES• 3) TO SOFTEN THE EFFECT OF BUSINESS

CRISES IN THE MARKET: KEEPING THE STABLE ORDER OF CLAIMS

• OTHER OBJECTIVES?

Enhancing the estate

• (Again) Main rule: to keep the business running as a general rule

• Management powers:– Reorganization vs liquidation– DIP. Is the fox guarding the hen house?– UK administrator

• Control mechanisms. How and Who– Creditors (committee vs assembly)– Judge/Agency/SRO

Swelling the assets

• The “initial picture” is misleading

• Separation of certain assets/rights is needed

• Swelling the assets:– Avoidance of transactions at undervalue– Avoidance of preferences– Avoidance of fraudulent operations– Some common examples: ex post security for FIs,

intra-group operations, etc.

Automatic Stay

• Stay of actions and executions. Protecting the business– The importance of the measure– The need to avoid procedural privileges (Mexico)

• Stay and secured creditors– General rule. Underlying rationale– Limitations. Some examples

Liability of Directors

• Trading in the eve of insolvency:– A change in fiduciary duties?– Duty to file. Effects of non-compliance– Wrongful trading

• Fraudulent trading

• Disqualification of directors

• Liability of shareholders: piercing the veil/de facto/shadow directors

EXITS TO THE BUSINESS CRISIS

THE PARTICIPATION AND TREATMENT OF CREDITORS

REORGANIZATION VS LIQUIDATION

Reorganization vs liquidation. The flawed debate?

• The PYRAMIDAL APPROACH. ABSOLUTE PRIORITY RULE

• HIERARCHICAL RULE: WHATEVER ALLOWS A HIGHER RETURN FOR CREDITORS (top of the pyramid)

The decission makers

• CREDITORS:– INDIVIDUAL PARTICIPATION– COLECTIVE PARTICIPATION

• ASSEMBLY OF CREDITORS• COMMITTEE OF CREDITORS

– DESIGN. MEMBERS– MAIN COMPETENCES

• CREDITORS AND IPS. THE DEBATE

PRIORITY RIGHTS

• THE PROBLEM OF PRIORITY

• THE PAR CONDITIO CREDITORUM RULE. GROUNDS

• EXCESS IN PRIORITY: IF EVERYONE IS SPECIAL, NONE IS SPECIAL

• TENDENCY SHOULD BE TO REDUCE THE NUMBER OF EXCEPTIONS, BUT…

PRIORITY RIGHTS II

• …NOT ALL OF THEM

• FOR THE WORLD BANK, A PROPER INSOLVENCY LAW MUST RESPECT THE PREFERENCES SET OUTSIDE INSOLVENCY

– THIS WAS “FORUM SHOPPING” IS AVOIDED– THOSE WHO HAVE PRIORITY OUTSIDE INSOLVENCY

ARE –TYPICALLY- THOSE WHO ENJOY COLLATERAL: MORGAGES, CHARGES, SET OFF, ETC. IT IS ESSENTIAL THAT THOSE RIGHTS ARE RESPECTED: OTHERWISE THE MARKET COULD COLLAPSE.

PRIORITY RIGHTS III

• IDEA: IF A BANK LOSES ITS PRIORITY IN THE PROCEDURE, THE RESULT WOULD BE THE RESTRICTION OF CREDIT (NO CREDIT OR INCREASE OF INTEREST RATES) WITH THE SUBSEQUENT COLLAPSE OF ECONOMY

• ANY COUNTERARGUMENT?

PRIORITY RIGHTS IV

TREATMENT OF PRORITY RIGHTS: DIFFERENT SYSTEMS TEND TO FAVOUR: 1) SECURED CREDITORS; 2) EMPLOYEES RIGHTS; 3) TAXES; 4) OTHERS

ALWAYS A PREPAYMENT OF THE COSTS OF THE PROCEDURE OR OF THE DEBTS INCURRED DURING THE PROCEEDINGS.

SOMETIMES THERE IS A SUBORDINATION OF CLAIMS

TRANK YOU!