| It all starts by defaulting on an obligation: Money | | | | The Interim Trustee is empowered to do the |
| owed to creditors or to suppliers is not paid on | | | | following: |
| time, interest payments due on bank loans or on | | | | - liquidate property and make distribution of |
| corporate bonds issued to the public are withheld. | | | | liquidating dividends to creditors |
| It may be a temporary problem - or a | | | | - make management changes |
| permanent one. | | | | - arrange unsecured financing for the firm |
| As time goes by, the creditors gear up and | | | | - operate the debtor business to prevent further |
| litigate in a court of law or in a court of arbitration. | | | | losses |
| This is a technical or equity insolvency status. | | | | By filing a bond, the debtor (really, the owners of |
| But this is not the only way that a company can | | | | the debtor) is able to regain possession of the |
| be rendered insolvent. It could also run liabilities | | | | business from the trustee. |
| which will outweigh its assets. This is bankruptcy | | | | Chapter 11 - reorganization |
| insolvency. True, there is a debate raging as to | | | | Unless the court rules otherwise, the debtor |
| what is the best method to appraise the assets | | | | remains in possession and in control of the |
| and the liabilities. Should these appraisals be based | | | | business and the debtor and the creditors allowed |
| on market prices - or on book value? | | | | to work together flexibly. They are encouraged |
| There is not one decisive answer. In most cases, | | | | to reach a settlement by compromise and |
| there is strong reliance on the figures in the | | | | agreement rather than by court adjudication. |
| balance sheet. | | | | Maybe the biggest legal revolution embedded in |
| If the negotiations with the creditors of the | | | | chapter 11 is the relaxation of the ages old |
| company (as to how to settle the dispute arising | | | | ABSOLUTE PRIORITY rule, that says that the |
| from the company's default) fails, the company | | | | claims of creditors have categorical precedence |
| itself can file (=ask the court) for bankruptcy in a | | | | over ownership claims. From now on, the |
| "voluntary bankruptcy filing". | | | | interests of the creditors have to be balanced |
| Enter the court. It is only one player (albeit, the | | | | with the interests of the owners and even with |
| most important one) in this unfolding, complex | | | | the larger good of the community and society at |
| drama. The court does not participate directly in | | | | large. |
| the script. To say its lines - court officials are | | | | And so, chapter 11 allows the debtor and |
| appointed. They work hand in hand with the | | | | creditors to be in direct touch, to negotiate |
| representatives of the creditors (mostly lawyers) | | | | payment schedules, the restructuring of old debts, |
| and with the management and the owners of the | | | | even the granting of new loans by the same |
| defunct company. | | | | disaffected creditors to the same irresponsible |
| They face a tough decision: should they liquidate | | | | debtor. |
| the company? In other words, should they | | | | Chapter 10 |
| terminate its business life by (among other things) | | | | Is sort of a legal hybrid, the offspring of chapters |
| selling its assets? | | | | 7 and 11: |
| The proceeds of the sale of the assets is divided | | | | It allows for reorganization under court appointed |
| (as "bankruptcy dividend") among the creditors. It | | | | independent manager (trustee) who is responsible |
| makes sense to choose this route only if the | | | | mainly for the filing of reorganization plans with |
| (money) value generated by liquidation exceeds | | | | the court - and for verifying strict adherence to |
| the (money) the company as a going concern, as | | | | them by both debtor and creditors. |
| a living, functioning, entity. | | | | Despite its clarity and business orientation, many |
| The company can, thus, go into "straight | | | | countries found it difficult to adopt to the |
| bankruptcy". The secured creditors will receive | | | | pragmatic, no sentiments approach which led to |
| the value of the property which was used to | | | | the virtual elimination of the absolute priority rule. |
| secure their debt (the "collateral", or the | | | | In England, for instance, the court appoints an |
| "mortgage, lien"). Sometimes, they will receive the | | | | official "receiver" to manage the business and to |
| property itself - if it not easy to liquidate (=sell) it. | | | | realize the debtor's assets on behalf of the |
| Once the assets of the company are sold, the | | | | creditors (and also of the owners). His main task |
| first to be fully paid off will be the secured | | | | is to maximize the proceeds of the liquidation and |
| creditors. Only then will the priority creditors be | | | | he continues to function until a court settlement is |
| paid (wholly or partially). | | | | decreed (or a creditor settlement is reached, prior |
| The priority creditors include administrative debts, | | | | to adjudication). When this happens, the |
| unpaid wages (up to a given limit per worker), | | | | receivership ends and the receiver loses his |
| uninsured pension claims, taxes, rents, etc. | | | | status. |
| And only if there is any money left after all these | | | | The receiver takes possession (but not title) of |
| payments, it will be proportionally doled out to the | | | | the assets and the affairs of a business in |
| unsecured creditors. | | | | receivership. He collects rents and other income |
| The USA had many versions of its bankruptcy | | | | on behalf of the firm. |
| laws. There was the 1938 Bankruptcy Act, which | | | | So, British Law is much more in favour of the |
| was followed by amended versions in 1978, 1984 | | | | creditors. It recognizes the supremacy of their |
| and, lately, in 1994. | | | | claims over the property claims of the owners. |
| Each state has modified the Federal Law to fit its | | | | Honouring obligations - in the eyes of the British |
| special, local conditions. | | | | legislator and their courts - is the cornerstone of |
| Still, a few things - the spirit of the Law and its | | | | efficient, thriving markets. The courts are |
| philosophy are common to all the versions. | | | | entrusted with the protection of this moral pillar of |
| Arguably, the most famous procedure is named | | | | the economy. |
| after the chapter in the law in which it is | | | | Economies in transition were in transition not only |
| described, Chapter 11. Following is a small | | | | economically - but also legally. Thus, each one |
| discussion of chapter 11 intended to demonstrate | | | | adopted its own version of the bankruptcy laws. |
| this spirit and this philosophy. | | | | In Hungary - Bankruptcy is automatically triggered. |
| This chapter allows for a mechanism called | | | | It is not allowed to swap debt for equity. |
| "reorganization". It must be approved by two | | | | Moreover, the law provides for a very short time |
| thirds of all classes of creditors and then, again, it | | | | to reach agreement with creditors about |
| could be voluntary (initiated by the company) or | | | | reorganization of the debtor. These features led |
| involuntary (initiated by one to three of its | | | | to 4000 bankruptcies in the wake of the new law |
| creditors). | | | | - a number which mushroomed to 30,000 by 5 |
| The American legislator set the following goals, in | | | | 97. |
| writing the bankruptcy laws: | | | | In the Czech Republic- the insolvency law |
| - To provide a fair and equitable treatment to the | | | | comprises special cases (over indebtedness, for |
| holders of various classes of securities of the firm | | | | instance ...). It delineates two rescue programs: |
| (shares of different kinds and bonds of different | | | | - A Debt to Equity Swap (an alternative to |
| types) | | | | bankruptcy) supervised by the Ministry of |
| - To eliminate burdensome debt obligations, which | | | | Privatization. |
| obstruct the proper functioning of the firm and | | | | - The Consolidation Bank (founded by the State) |
| hinder its chances to recover and ever repay its | | | | can buy a firm's obligations if it went bankrupt at |
| debts to its creditors. | | | | 60% of par. |
| - To make sure that new claims received by the | | | | But the law itself is toothless and lackadaisically |
| creditors (instead of the old, discredited, ones) | | | | applied by the incestuous web of institutions in the |
| equal, at least, to what they would have received | | | | country. Between 3/93 - 9/93 there were 1000 |
| in liquidation. | | | | filings for insolvency, which resulted in only 30 |
| Examples of such new claims: owners of | | | | commenced bankruptcy procedures. There hasn't |
| debentures of the firm can receive, instead, new, | | | | been a single major bankruptcy in the Czech |
| long term bonds (known as reorganization bonds, | | | | Republic since then - and not for lack of |
| whose interest is payable only from profits). | | | | candidates. |
| Owners of subordinated debentures will, probably, | | | | Poland is a special case, always pitting horses |
| become stockholders and stockholders in the | | | | against tanks, always losing the war, as a result. |
| insolvent firm will receive no new claims. | | | | The pre-war (1934) law declares bankruptcy |
| The chapter dealing with reorganization (the | | | | when confronted with a state of lasting illiquidity |
| famous "Chapter 11") allows for "Arrangements" | | | | and excessive indebtedness. Each creditor can |
| to be made between debtor and creditors: an | | | | apply to declare a company bankrupt. An |
| extension or reduction of the debts. | | | | insolvent company is obliged to file a maximum of |
| If the company is traded in a stock exchange, | | | | 2 weeks following cessation of debt payment. |
| the Securities and Exchange Commission (SEC) of | | | | There is, indeed, a separate liquidation law which |
| the USA advises the court as to the best | | | | Allows for voluntary procedures. |
| procedure to adopt in case of reorganization. | | | | Bad debts are transferred to base portfolios and |
| What chapter 11 teaches us is that: | | | | have one of three fates: |
| The American Law leans in favour of maintaining | | | | - Reorganization, debt-consolidation (a reduction of |
| the company as a going concern. A whole is | | | | the debts, new terms, debt for equity swaps) |
| larger than the sum of its parts - and a living | | | | and a program of rehabilitation. |
| business is worth more than the sum of its | | | | - Sale of the corporate liabilities in auctions |
| assets, sold separately. | | | | - Classic bankruptcy (happens in 23% of the |
| A more in-depth study of the bankruptcy laws | | | | cases of insolvency). |
| shows that they allow for three ways to tackle a | | | | No one is certain what is the best model. The |
| state of malignant insolvency which threatens the | | | | reason is that someone has yet to come with |
| well being and the continued functioning of the | | | | answers to the questions: are the rights of the |
| firm: | | | | creditors superior to the rights of the owners? Is |
| Chapter 7 (1978 Act) - liquidation | | | | it better to rehabilitate than to liquidate? |
| A District court appoints an "interim trustee" with | | | | Until such time as these questions are answered |
| broad powers. Such a trustee can also be | | | | and as long as the microeconomic debt crisis |
| appointed at the request of the creditors and by | | | | deepens -we will witness a flowering of versions |
| them. | | | | of bankruptcy laws all over the world. |