A Global View of Business Insolvency Systems
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68423
A Global View of Business Insolvency Systems
A Global View of Business
Insolvency Systems
Jay Lawrence Westbrook
(Editor and Senior Author)
Charles D. Booth
Christoph G. Paulus
Harry Rajak
With a foreword by Anne-Marie Leroy, Senior Vice President
and General Counsel of the World Bank Group
A co-publication of The World Bank and Brill
LEIDEN • BOSTON
2010
This book is printed on acid-free paper.
Library of Congress Cataloging-in-Publication Data
A global view of business insolvency systems / edited by Jay Lawrence Westbrook.
p. cm.
ISBN 978-0-8213-8103-8 (pbk. : alk. paper)
1. Bankruptcy. 2. Corporate reorganizations. 3. Debtor and creditor. I. Westbrook, Jay
Lawrence.
K1375.G58 2009
346.07'8–dc22
2009039585
ISBN 978-90-04-18025-3 (Hardback)
ISBN 978-0-8213-8103-8 (Paperback)
© 2010 The International Bank for Reconstruction and Development / The World Bank
1818 H Street, NW Washington, DC 20433 Telephone: 202-473-1000 Internet:
www.worldbank.org E-mail: [email protected]
All rights reserved. The findings, interpretations, and conclusions expressed in this volume do
not necessarily reflect the views of the Executive Directors of The World Bank or the
governments they represent.
The World Bank does not guarantee the accuracy of the data included in this work. The
boundaries, colors, denominations, and other information shown on any map in this work do
not imply any judgement on the part of The World Bank concerning the legal status of any
territory or the endorsement or acceptance of such boundaries.
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printed in the netherlands
CONTENTS
About the Authors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xiii
Foreword . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xv
Chapter One: Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Chapter Two: Systems for the Enforcement of Debt . . . . . . . . . . . . . . . . . . 7
.. Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
.. Enforcement of Unsecured Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
... Enforcement of Unsecured Debt in General . . . . . . . . . 10
... Types of Property Seizable . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
... Exempt Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
... Enforcement Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
... Third Parties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
... Priorities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
... Provisional Remedies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
... Cross-Border Enforcement of Judgments. . . . . . . . . . . . 15
.. Secured Credit Systems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
... Personal Guarantees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
... Security Interests Generally . . . . . . . . . . . . . . . . . . . . . . . . . . 22
... Title Retention . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
.... Generally . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
.... Ambiguity of Interests . . . . . . . . . . . . . . . . . . . . . . 29
... Obtaining a Valid Security Interest . . . . . . . . . . . . . . . . . . 31
... Types of Liens Permitted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
... Constraints on Secured Transactions . . . . . . . . . . . . . . . . 33
... Enforcement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
... Priority . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
.... Publicity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
.... Exemptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
.... Registration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
.... Other Methods of Publicity . . . . . . . . . . . . . . . . . 41
.... Extent of Priority . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
.... Proceeds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
... Setoff (Offset) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46
... Cross-Border. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46
... Consolidation of Laws . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47
vi contents
... International Initiatives. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48
... Immovables (Real Estate) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48
... Theoretical Debates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49
Chapter Three: Corporate Insolvency Legislation . . . . . . . . . . . . . . . . . . . . 51
.. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51
.. The Liquidation/Rehabilitation Dynamic . . . . . . . . . . . . . . . . . . . . 51
.. Valuation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52
.. Director and Officer Liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53
... Comparative Legislative Survey . . . . . . . . . . . . . . . . . . . . . . 53
.... Background: Common Law/Case Law
Approach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53
.... Specific Insolvency Law Statutory
Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54
..... Fraudulent Trading . . . . . . . . . . . . . . 54
..... Wrongful/Insolvent Trading . . . . 55
..... Directors’ Disqualification and
Overall Risk of Liability of
Directors . . . . . . . . . . . . . . . . . . . . . . . . . 56
... Relationship Between Director and Officer
Liability and Corporate Governance . . . . . . . . . . . . . . . . . 58
.. Scope and Commencement of Insolvency Cases . . . . . . . . . . . . 60
... Scope of Application . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60
.... Financial Institutions, Insurance
Companies, Regulated Industries, and
Other Groups . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61
.... State-Owned Enterprises . . . . . . . . . . . . . . . . . . . 63
... Defining Insolvency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65
... Commencement Criteria . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66
... Assets Administered in Insolvency . . . . . . . . . . . . . . . . . . 68
.. Moratorium and Suspension of Actions . . . . . . . . . . . . . . . . . . . . . . 69
... Lawsuits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69
... State Regulatory Actions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70
... Other Exceptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70
... Secured Creditors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70
.... Protection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71
.... Receivership Regimes . . . . . . . . . . . . . . . . . . . . . . . 72
... “Gap” Moratorium . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73
.. Governance: Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74
... Administrator/Debtor in Possession . . . . . . . . . . . . . . . . . 74
contents vii
.... Liquidation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74
.... Rehabilitation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76
.... Administrator’s Financial Responsibility . . . 78
... Governance: Creditors and Creditors’ Committees . 79
.... Organization of Creditors . . . . . . . . . . . . . . . . . . 79
.... Creditors’ Committee Functions . . . . . . . . . . . 79
.... Transparency and Approval Rights . . . . . . . . . 80
.... Organization of Creditors’ Committees . . . . 81
.. Administration: Collection, Preservation, and Disposition
of Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83
... Rights of Secured Creditors . . . . . . . . . . . . . . . . . . . . . . . . . . 85
... Retention of Title Claimants . . . . . . . . . . . . . . . . . . . . . . . . . 86
... Other Priorities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86
... Procedure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89
.. Disposing of the Debtor’s Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90
.. Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91
... Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91
... Decision to Terminate the Contract . . . . . . . . . . . . . . . . . 93
... Decision to Continue the Contract . . . . . . . . . . . . . . . . . . 94
... Risks to Counterparties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97
... Assignment of Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99
... Procedure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100
... Special Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101
... Leases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103
... Setoff, Netting, and Derivatives . . . . . . . . . . . . . . . . . . . . . . 104
.. Avoiding Pre-Proceeding Transfers . . . . . . . . . . . . . . . . . . . . . . . . . . 105
... Generally . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106
... Intentional Fraud . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 109
... Transactions at an Undervalue . . . . . . . . . . . . . . . . . . . . . . . 109
... Preferential Transfers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111
... Defenses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113
.... Defenses to Avoidance Other Than
Preferential . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113
.... Defenses to Preferential Transfer
Avoidance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114
... Suspect Periods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114
... Security Interests . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115
... Procedure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 116
.. Avoiding Post-Insolvency Transfers . . . . . . . . . . . . . . . . . . . . . . . . . . 116
.. Special Treatment of Partnerships . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117
viii contents
Chapter Four: Corporate Rehabilitation Proceedings . . . . . . . . . . . . . . . . 121
.. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 121
.. History and Key Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 122
... Formal and Informal Rescue and Rehabilitation
Regimes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 124
... Survival of the Business and Liquidation . . . . . . . . . . . . 126
... A Single or a Dual Gateway? . . . . . . . . . . . . . . . . . . . . . . . . . 127
.. Structural Features of Rehabilitation Statutes . . . . . . . . . . . . . . . . 129
... Access . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129
... Timely and Efficient Administration of the
Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 135
... Protection of Secured Parties. . . . . . . . . . . . . . . . . . . . . . . . . 137
... Providing a Structure to Facilitate Fair Negotiation
of a Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 139
... Judicial or Other Supervision . . . . . . . . . . . . . . . . . . . . . . . . 141
... Shareholders’ Interests . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 142
.. Stabilizing and Sustaining Business Operations. . . . . . . . . . . . . . 143
... Financing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 143
.. Disclosure of Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 146
... Who Gathers the Information? . . . . . . . . . . . . . . . . . . . . . . 146
... What Information and How Obtained? . . . . . . . . . . . . . . 148
.. Plan: Formulation, Consideration, and Voting . . . . . . . . . . . . . . . 151
... Formulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 151
... Sponsorship and Negotiation . . . . . . . . . . . . . . . . . . . . . . . . 152
... Voting and Classes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 153
... Pre-packaged Plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 157
... Plan Approval . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 158
... Plan: Implementation and Amendment . . . . . . . . . . . . . 159
... Plan: Discharge and Binding Effects . . . . . . . . . . . . . . . . . 160
.. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 161
Chapter Five: Informal Workouts and Restructuring . . . . . . . . . . . . . . . . 165
.. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 165
.. What is an Informal Rescue? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167
.. Key Elements of a Rescue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 168
.. Preventive Action . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 170
.. The Main Aspects of an Informal Workout . . . . . . . . . . . . . . . . . . 171
... Commencing the Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . 172
... Engaging Advisers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 173
... Coordinating the Participants . . . . . . . . . . . . . . . . . . . . . . . . 173
contents ix
... Stabilizing the Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 173
... Ensuring Adequate Cash Flow . . . . . . . . . . . . . . . . . . . . . . . 173
... Securing Access to Complete and Accurate
Information on the Business . . . . . . . . . . . . . . . . . . . . . . . . . 174
... Negotiating, Agreeing to, and Implementing the
Restructuring Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 174
... Dealing with Outside and Dissenting Creditors . . . . . 174
... The Restructuring Agreement must be Legally
Binding on all Creditors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 175
.. Some Well-Known Informal Rescue and Restructuring
Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 175
... Receivership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 175
... The London Approach. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 177
... The Post- Adaptation for Asia . . . . . . . . . . . . . . . . . . 179
... The Pre-Packaged Insolvency Procedure . . . . . . . . . . . . 180
.. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 180
Chapter Six: Employee Rights in Insolvency . . . . . . . . . . . . . . . . . . . . . . . . . . 183
.. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 183
.. Special Status of Employees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 184
.. Protecting Employees as Creditors . . . . . . . . . . . . . . . . . . . . . . . . . . . 187
... Wages and Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 187
... Pensions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 194
.. Personal Liability of Officers and Directors . . . . . . . . . . . . . . . . . . 196
.. Employees, Consultation, Participation, and Business
Rescue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 196
... Employee Participation in Large Corporations . . . . . . 197
... Employees in the Management of the Insolvency
Proceeding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 199
Chapter Seven: Judicial and Administrative Institutions . . . . . . . . . . . . . 203
.. Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 203
.. Judiciary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 205
.. Administrators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 207
.. Comparative Approaches . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 208
... General Remarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 208
... Australia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 212
... Canada . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 213
... Finland . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 213
... United Kingdom . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 214
x contents
... United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 216
... Slovakia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 217
... China . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 217
.. Competence of Insolvency Administrators . . . . . . . . . . . . . . . . . . 218
.. Integrity of Administrators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 220
.. Rules of Compensation of Professionals. . . . . . . . . . . . . . . . . . . . . . 223
.. Periodic Reports. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 225
Chapter Eight: Cross-Border Considerations . . . . . . . . . . . . . . . . . . . . . . . . . 227
.. Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 227
.. Fundamental Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 228
... Basic Terminology and Concepts . . . . . . . . . . . . . . . . . . . . 229
.... Territoriality vs. Universality . . . . . . . . . . . . . . . 229
.... Unitary vs. Multiple Proceedings . . . . . . . . . . . 232
... Jurisdiction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 235
.... Determination of the Main Proceeding . . . . 236
.... Minimum Requirements for a Non-Main
Proceeding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 237
... Choice of Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 238
... Recognition of Foreign Proceedings . . . . . . . . . . . . . . . . . 240
.... Meaning of Recognition . . . . . . . . . . . . . . . . . . . . 240
.... Forms of Recognition . . . . . . . . . . . . . . . . . . . . . . . 240
..... No Trust, No Recognition . . . . . . . 240
..... General Trust . . . . . . . . . . . . . . . . . . . . 240
..... Mid-Ground Modifications . . . . . 241
..... Speed and Efficiency of
Recognition . . . . . . . . . . . . . . . . . . . . . . 241
..... Access and Assistance (Effects
of Recognition) . . . . . . . . . . . . . . . . . . 242
..... International Cooperation . . . . . . 243
...... General Meaning . . . 243
...... Modern Meaning . . . 243
.. International Initiatives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 246
... UNCITRAL Model Law on Cross-Border
Insolvency. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 247
.... A Global Impact . . . . . . . . . . . . . . . . . . . . . . . . . . . . 247
.... The Basic Ideas . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 248
.... Universality Principle . . . . . . . . . . . . . . . . . . . . . . . 249
.... Incompleteness of the Model Law . . . . . . . . . . 250
contents xi
... Latin American States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 251
.... Contents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 251
.... Deficiencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 253
... Nordic European States. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 253
.... Contents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 253
.... Achievements and Deficiencies. . . . . . . . . . . . . 254
... European Union Regulation on Cross-Border
Insolvency. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 255
.... Basic Elements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 255
.... Universality Principle . . . . . . . . . . . . . . . . . . . . . . . 256
.... Restrictions of the Universality Principle . . 257
.... Deficiencies of the Regulation . . . . . . . . . . . . . . 258
... American Law Institute’s Transnational Insolvency
Project . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 259
.... The Approach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 259
.... Basic Considerations . . . . . . . . . . . . . . . . . . . . . . . . 260
.... Universality Principle . . . . . . . . . . . . . . . . . . . . . . . 260
... OHADA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 262
.... The Project . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 262
.... Coordination of Several Proceedings . . . . . . 262
.... Recognition and its Consequences . . . . . . . . . 262
.... Incompleteness of the Act . . . . . . . . . . . . . . . . . . 263
.. Possible Future Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 264
Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 267
. Articles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 267
. Books . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 273
. Institutional Authors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 275
Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 277
ABOUT THE AUTHORS
Charles D. Booth is a Professor of Law and the Director of the Institute
of Asian-Pacific Business Law at the Richardson School of Law at the
University of Hawaii. He taught law for 1/2 years at the University of
Hong Kong, where he also headed the Asian Institute of International
Financial Law. He has served as a consultant for the World Bank, the
ADB, the OECD, the International Republican Institute, and the ABA-
UNDP International Legal Resource Center on many Asian insolvency
and commercial law reform projects. He is also a co-director of the Hong
Kong Institute of Certified Public Accountants Diploma in Insolvency
Course and heads the insolvency portion of an ADB law reform project
for Vanuatu.
Christoph G. Paulus is Professor of Law at the Humboldt University
at Berlin, Germany—teaching i.a. national and international insolvency
law. As an expert in this area, he has published several books and numer-
ous articles. He has worked extensively as a Consultant to the World Bank
and the International Monetary Fund in Washington D.C.
Professor Harry Rajak, formerly Dean of the Sussex Law School,
has been a visiting law professor at the Hebrew University, University
of Connecticut and Bonn University. He was a member of a Thyssen
Foundation funded study on Groups of Companies in Europe, a study
by the Wirtschaftsuniversität, Vienna of the Insolvency Laws of central
and eastern European countries, and has advised on reform of insolvency
law in South Africa.
Jay L. Westbrook is Benno C. Schmidt Chair of Business Law at The
University of Texas School of Law. He teaches bankruptcy, secured fi-
nance, and international business law and litigation. He served as the
United States Reporter, American Law Institute Transnational Insol-
vency Project and as Co-chair, U.S. Delegation to the UNCITRAL con-
ference that produced the Model Law on Cross-Border Insolvency. He is
President of the International Academy of Commercial and Consumer
Law and a director of the International Insolvency Institute. He also
serves as a consultant to the International Monetary Fund and the World
xiv about the authors
Bank. Publications include The Fragile Middle Class: Americans in Debt
(Yale University Press ) (co-author); The Law of Debtors and Credi-
tors (Aspen th ed. ) (co-author); and A Global Solution to Multina-
tional Default, Mich. L. Rev. ().
FOREWORD
As General Counsel of the World Bank Group, it is both a pleasure and
an honor to write a short introduction to “A Global View of Business
Insolvency Systems”.
Credit is one of the major driving forces of the world economy,
and particularly in an adverse economic climate, its ready availability
enhances predictability and commercial confidence. Properly designed
insolvency and creditor rights laws play an important role in economic
development, by facilitating the provision of credit in the first place, by
encouraging the preservation of distressed but viable enterprises, and by
ensuring that the assets of irremediably failing businesses are redeployed
to more promising uses.
In the aftermath of the Asian financial crisis, the international commu-
nity in mandated the World Bank to identify internationally recog-
nized best practices in the design of insolvency laws and the due protec-
tion of creditor rights. The Bank was also entrusted with the responsibil-
ity of assessing the effectiveness of domestic systems through the compi-
lation of Reports on the Observance of Standards and Codes. This is the
origin of the Bank’s Principles for Effective Insolvency and Creditor Rights
Systems, approved in and revised in , developed in conjunction
with partner organizations, international experts, and the international
community. These Principles, together with the Recommendations of the
UNCITRAL Legislative Guide on Insolvency Law, form the basis of the
Bank's work in this area.
The current global financial crisis infuses this work with particular
urgency, as the Bank contributes efforts to stabilize and develop financial
systems. Alongside the formulation of standards of international best
practice and the assessment of municipal insolvency regimes, the Bank
renders technical assistance to client countries, helps build capacity, and
disseminates knowledge.
The present work by Professors Westbrook, Booth, Paulus and Rajak
fits perfectly within this broad strategy, and forms an integral part of
the Bank’s insolvency and creditor rights initiative. The book takes a
systematic approach to a variety of topics related to credit and insol-
vency regulation. The functional analysis starts with the study of debt
enforcement, continues with an examination of general corporate insol-
xvi foreword
vency legislation, corporate rehabilitation proceedings, informal work-
outs, employee rights, judicial and administrative institutions, and the
considerations key to cross-border insolvency proceedings. In relation to
each of these topics, the authors’ primary objective is to illustrate policy
options with examples taken from a variety of jurisdictions. The authors
draw on a diverse range of legal systems to uncover the principles under-
lying bankruptcy policy. They regard insolvency and creditor rights as a
particularly complex area, in which legislative choices must be peculiarly
sensitive to local legal traditions and the social and economic environ-
ment of the jurisdiction.
The synergetic efforts of this premier team of international bankruptcy
scholars lift this exercise to the level of an academic tour de force. It goes
without saying that not all of the views they express would be universally
accepted. The views are, however, always well structured and clearly
articulated, and they constitute a valuable and weighty contribution to
the scholarly and policy debates in this arena.
While the views expressed in the book are the authors’ and not nec-
essarily those of the World Bank, it is important to highlight the affin-
ity in broad terms of the authors’ approach to the Bank’s own efforts in
this arena. The Bank is, and must be, guided by a deep understanding
of the fact that a “one-size-fits-all” approach would be particularly unde-
sirable here. The Bank has carried out assessments of creditor rights and
insolvency systems in almost fifty jurisdictions across four continents. Its
approach emphasizes, not the prescription that all system adopt particu-
lar doctrines or policy choices, but rather the overall functionality of the
system. An effective system can function with a variety of legal institu-
tions and techniques, provided that the legislative, regulatory and institu-
tional choices are internally coherent, mutually supportive, and appropri-
ate to the country’s economic and social situation. Attempts to transplant
rules drawn from one or a family of legal systems without due assessment
of the broad features of the intended recipient’s general system or with-
out an adequate understanding of its social, cultural and economic envi-
ronment are liable to prove inefficacious, or worse, counterproductive.
Real reforms are preceded by appropriate diagnostic efforts and consci-
entious research, and are driven by a conscious intent to find the appro-
priate solutions in the specific context of the jurisdiction to the specific
problems there.
The Bank’s support for this book, which started under the leadership
of Gordon Johnson at the early stages of its insolvency and creditor rights
initiative, is an indication of the Bank’s commitment to scholarly research
as the basis for ground-breaking legal work. The same commitment is
also demonstrated by the fact that two leading insolvency academics, José
Garrido and Riz Mokal, have just assumed the responsibility to lead and
reinforce the Bank’s insolvency and creditor rights initiative.
It is apt to recall that in ancient Greek, the word “crisis” means “deci-
sion”. In a time of global financial crisis, policymakers need to take par-
ticularly complex critical decisions in the field of insolvency and creditor
rights. I hope that this work will assist and offer guidance to those seek-
ing to assess the appropriateness and impact of legislative reforms, and
will stimulate academic debate on insolvency regulation.
Anne-Marie Leroy
General Counsel and Legal Vice-President
The World Bank Group
chapter one
INTRODUCTION
We live in a time in which insolvency laws are being rewritten all over
the world for the first time in a century. As investment and employment
have become more global, there has been a sharp rise in interest in the
application of insolvency procedures as part of the overall scheme of
commercial and corporate law. There is also a growing need for lawyers
and judges to gain an understanding of the insolvency procedures to be
found in other jurisdictions where a multinational company may have
assets and operations.
The purpose of this book is to provide a coherent overview of the insol-
vency systems found around the world. Its intended audience includes
academics, judges, lawyers, and policymakers. Its focus is on businesses
rather than natural persons.1 We hope to give the reader a sense of some
of the principal approaches to managing the general default of a busi-
ness debtor. We will discuss the nature of the costs and benefits arising
from the various policy choices legislators have made. In the process, we
will emphasize the close interrelationship among various elements of an
insolvency regime so that these elements can be viewed as part of an
overall system and not just as a series of policy decisions about partic-
ular rules, such as the method of initiation of an insolvency case or the
balance struck in setting the boundaries of an avoidance power. As we
identify these points, we want to avoid either generalizations too abstract
to be useful or a mass of confusing detail.
We will also avoid the easy labels so often used in this field, like
describing a system as “pro-debtor” or “pro-creditor.” There are some
useful generalizations to make, but the reality of insolvency systems is
that they have multiple policy goals and those goals are often in tension
with each other. We identify both the policies and the tensions, discussing
the various compromises that have been adopted under various legal
1 We do not exclude natural persons in business from this study, but we focus
primarily upon businesses that are corporations or other types of legal entities.
chapter one
regimes. We pay somewhat less attention to traditional bromides such
as “equality of distribution” as goals of insolvency and more to the costs
and benefits that seem to us to reflect the judgments that legislators have
actually made. In that connection, we often refer to three fundamen-
tal goals of any insolvency law—transparency, predictability, and effi-
ciency:
a. Transparency in the enforcement process is important. Transpar-
ency typically includes a system of indexing judgments and judg-
ment liens (for example, by recording judgments in land records),
an accessible and inexpensive method of registering security inter-
ests, and effective notice of insolvency proceedings. These elements
are important for the credit-granting process as well as for enforce-
ment and management of a general default of a business.
b. Closely related to transparency is predictability. Lack of predictabil-
ity in the legal system when enforcing the rights of creditors inevita-
bly leads to inflation of credit costs to compensate for the resulting
uncertainty. Predictability lowers those costs, so we will be con-
cerned with its presence or absence. Generally, a system will be
more predictable and fair if it is simple and clear.
c. Efficiency is easily understood as a concept while hard to measure
in reality. We will be interested to understand it with regard to the
needs and rights of both debtors and creditors.
Although these desiderata are universally applicable, each jurisdiction
must also address issues of fairness and social justice as they are under-
stood in that society. The insolvency laws of a country are closely linked
with its other laws and will inevitably reflect its fundamental values.
While this book will be useful to law reformers, we would refer the
reader to the UNCITRAL Guide, the World Bank Principles, and the
American Law Institute Principles for suggested reforms. Our task is
to provide a large-scale map of the insolvency field worldwide so that
lawyers, judges, and academics can understand the traditional patterns
and the emerging ones. They can then slot into the conceptual array the
particular systems of interest to them.
The organization of the book reflects our view of insolvency laws as
complete systems, including not only the “insolvency” or “bankruptcy”
code of a jurisdiction but also closely related laws and the institutional
framework in which those laws are applied. Thus we begin with an
overview of the collection of particular debts outside of insolvency
through enforcement of judgments or security interests against debtor
introduction
assets. Then we proceed to the core of the work—business insolvency
law—a collective response to a debtor’s general default.2
We first address traditional liquidation provisions, proceeding more
or less chronologically through the stages of a liquidation case, from eli-
gibility for filing through distribution. The next subject is the process var-
iously called in English reorganization, rehabilitation, or rescue. Such a
process always involves an attempt to preserve the going-concern value of
the assets of a business and at least some of its job opportunities and often
includes an attempt to rehabilitate the company itself. Closely related is
the emerging phenomenon of out-of-court workouts, with or without a
visit to the insolvency court after the deal is struck. We also devote a chap-
ter to employee rights because of their unique and important impact on
insolvency systems. We then consider the institutions—typically courts
assisted by official administrators and court-appointed private trustees—
within which the insolvency laws operate. In that connection, we also
consider the important role of regulation of those professionals (lawyers,
accountants, and others) who perform key roles in the administration of
insolvency laws in many countries. Finally, we survey cross-border insol-
vency, an increasingly important facet of globalization.
In our discussions, we mention some theoretical works, but our focus
for the most part is descriptive and analytical rather than theoretical.
Having said that, it will be helpful to state some fundamental proposi-
tions about insolvency that reflect our views and, we believe, the views of
most experts and policymakers around the world. We start with the fact
that insolvency is a collective proceeding, by contrast with the enforce-
ment of individual creditor rights in the judgment enforcement process.
In some rough sense, the individual enforcement system deals with recal-
citrant debtors and the insolvency system deals with incapable debtors.
However, the individual enforcement system also serves the function
of identifying incapable debtors by forcing them into insolvency pro-
ceedings. The security system straddles the enforcement and insolvency
systems. It is a super enforcement system for the individual creditor,
superior in many countries to the judgment enforcement system, but
it also represents the highest and best priority within an insolvency
2 We do not address certain aspects of remedies. For example, we do not consider
imprisonment or other physically coercive measures of enforcement nor methods of
“shaming” debtors into payment. See, e.g., James Q. Whitman, The Moral Menace of
Roman Law and the Making of Commerce: Some Dutch Evidence, Yale L.J.
().
chapter one
proceeding in most jurisdictions. The secured party’s special status fol-
lowing a debtor’s insolvency arises either as a result of special treatment
within the insolvency proceeding or, better still from the secured cred-
itor’s viewpoint, by freedom to enforce its rights without restraint by
the collective system. These characteristics emphasize that these three
elements—individual enforcement, security, and insolvency—are inti-
mately intertwined yet quite distinct in form and function.
We begin each chapter with an overview of the various systems or
approaches used around the world so that the discussion of each specific
problem and solution can be understood in the system’s context. While
we are not in the business of advising the reader as to what approaches
are better than others, we do try to note costs and benefits in various
approaches, leaving it to reform institutions and policymakers to weigh
them in the balance.
We try to avoid the United States pattern of massive footnoting in favor
of an English-language bibliography. For practitioners and judges, the
odd citation to a Dutch provision here and a Mexican provision there is
not likely to be of much help in a concrete case. We do not claim to have
done a global survey of laws or to report anything close to the full range of
variations found in insolvency laws around the world, but we have drawn
deeply on sources that describe the laws of many different jurisdictions
and have included many of those sources in the bibliography. It goes
without saying that we do not hold ourselves out as experts in laws
outside of the jurisdictions where we teach, but we frequently mention a
rule from a particular jurisdiction that exemplifies the point being made.
Readers of course must go to national sources and local legal experts as
to any specific legal question.
The terminology of insolvency law varies even within a single lan-
guage. For example, most of the world uses in English the term “insol-
vency proceeding” to refer to a legal proceeding related to the finan-
cial distress of a business. The usage sometimes refers only to a liqui-
dation proceeding but increasingly seems to include reorganization or
rescue as well. In North America and a few other jurisdictions, the term
“bankruptcy proceeding” is often used for a proceeding involving a dis-
tressed business and it too is used both narrowly and broadly. We gener-
ally use “insolvency” rather than “bankruptcy.”
The four authors bring to the subject different perspectives formed
by nationality and academic focus. One of the two American authors
has worked intensively with Latin American and Canadian experts in
insolvency law and extensively with experts from all over the world. The
introduction
other taught for many years in Hong Kong and writes frequently about
Asian insolvency laws and trends. The English author writes about British
and Commonwealth insolvency laws and has edited commentaries in
which a number of European authors analyze the insolvency systems in
their home countries. The German author is a leading expert in civil
law insolvency systems and has served as a consultant on insolvency
matters for the International Monetary Fund and the World Bank. We
hope that these varying perspectives come together to provide a well-
rounded summation of the principal systems found around the world.
Insolvency law is often misunderstood as a sort of legal mortuary when
in fact it is a hospital where the assets and the expertise of a business
injured by management mistakes or the vagaries of the free market are
recapitalized or rechanneled to renewed productivity and social benefit.
The insolvency process is uniquely intertwined with many other aspects
of a country’s laws. It is also the ultimate scale in that the rights of
entrepreneurs, workers, and creditors must be properly balanced if an
economy is to reach its maximum potential. Those characteristics make
its study both important and intellectually rewarding.
Charles Booth
University of Hawaii
Christoph Paulus
Humboldt Universität-Berlin
Harry Rajak
University of Sussex
Jay Lawrence Westbrook
University of Texas-Austin
chapter two
SYSTEMS FOR THE ENFORCEMENT OF DEBT
.. Overview
In general, the most important method of enforcing monetary obliga-
tions in most countries is through the seizure and sale of the debtor’s
property. A secured creditor obtains an interest in the debtor’s property at
the start of the transaction by getting a security interest to secure payment
of the debt. Upon default, that interest can be enforced either through pri-
vate, self-help action (in some jurisdictions) or through a public official,
such as a policeman or sheriff, often under court order. Unlike a secured
creditor, an unsecured creditor must first obtain a judgment in court and
then obtain enforcement of that order by an official under court order or
through an official administrative debt-collection procedure. Both meth-
ods generally permit a debtor an opportunity to show that the procedure
should be prevented or undone for a valid legal reason (for example, that
the debt has already been paid).
Although the emphasis in this work is upon insolvency systems, en-
forcement of debt outside of insolvency is also highly important. Indeed,
a debt-enforcement system and an insolvency system should be under-
stood as part of one overall system. They should be designed to work
smoothly and effectively together. An example is the close relationship
between individual debt enforcement and the initiation of an insolvency
proceeding. In an efficient system of enforcement of security interests
and judgments obtained by unsecured creditors, a creditor’s decision to
enforce its1 interest is fully credible. A debtor who is able to pay will do
so because the debtor must either pay or lose its property. A debtor who
cannot pay will be forced into an insolvency proceeding with the result
that the debtor’s affairs will be placed before the court for the protection
of all creditors.
1 Debtors and creditors may, of course, be men or women or legal entities. We use
the neuter form of the pronoun here because this discussion is largely concerned with
commercial debtors, a high proportion of which are entities.
chapter two
The inability of a creditor to enforce a security interest against a debtor
in a timely fashion—or at all—can skew the insolvency remedy. For
example, where a debtor can withstand a creditor’s attempts at security
enforcement, the debtor has increased leverage. This often leaves little
reason for a debtor to enter into negotiations with a creditor to restruc-
ture or reorganize. Eventually, the creditor might have no other option
but to file a liquidation petition against the debtor to force the debtor
to the table. But by that time the going concern value of the enterprise
might well have been lost, leaving no more than the liquidation value of
the assets. The debt enforcement system—both judgment enforcement
and the enforcement of security—should reinforce itself. A lack of syn-
ergy between debt collection laws and insolvency laws is exampled in
the various insolvency systems of Asia, wherein reform of the insolvency
laws came well before reform in secured credit laws, thus failing to ensure
that the two systems properly meshed.2
These examples also illustrate the process of balancing the rights of
debtors and creditors—entrepreneurs, investors, suppliers, customers,
and lenders. An efficient enforcement mechanism can produce one of
two good results, either the collection of the debt or the filing of an insol-
vency proceeding by the debtor, the party with the best information about
its financial condition and the need for such a proceeding. Forcing the
debtor to the choice puts that decision in the hands of the party with the
relevant information and provides strong incentives to make the correct
decision. On the other side of the coin, the availability of a reorganiza-
tion procedure to help a debtor who is unable to pay immediately but is
arguably viable in the long term reduces the risks that might otherwise
exist in giving the creditor an enforcement mechanism that operates with
summary procedures and with minimum delay.
Secured and unsecured credit each play important roles in most devel-
oped economies, although a few systems (for example, the British and
2 Secured transaction law reform and insolvency law reform are most effective if
they go hand in hand and if changes are promulgated according to a time schedule.
Nevertheless, it is not uncommon for calls for insolvency law reform to arise only after
the onset of financial crisis and for the reform of secured transaction laws to follow years
later, if at all. Unfortunately, this has been the trend in Asia after the onset of the
Asian Financial Crisis. The initial waves of law reform focused primarily on insolvency
law independently of secured transactions. Only in the last few years have some of these
countries commenced the reform of secured transactions laws that will enable them to
gain the benefits of the combined law reform synergy.
systems for the enforcement of debt
German systems) depend much more upon secured credit law as the
lynch pin of their systems than do others. The balance drawn between
secured and unsecured credit is a defining characteristic of a commercial-
law system.
While debt enforcement has a strong and necessary relationship to
insolvency proceedings, it has its own important and independent role
to play in an economic system. Insolvency proceedings are not effective
tools for debt collection as such. A collective proceeding is too cumber-
some and expensive, and too dangerous to the survival of a debtor’s busi-
ness, to be useful for the purpose of forcing payment of a particular debt.
Thus this chapter begins by examining systems for the collection of unse-
cured debt. It should be noted that in every jurisdiction there are inter-
sections between the enforcement of debt and the criminal law. In some
jurisdictions, nonpayment of debt is treated directly as a criminal matter,
while in others criminal charges, or contempt of court, may arise from
related events, such as violation of a court order to turn over certain assets
to creditors. For the most part, this book does not address these criminal-
law consequences.3
In this chapter the discussion of secured credit focuses upon its use
as a mechanism for enforcement of a particular debt. It also serves
as a powerful priority position in an insolvency proceeding in many
insolvency systems. We will discuss that aspect of secured credit in the
insolvency chapters.
.. Enforcement of Unsecured Rights
There are numerous questions of court or administrative procedure that
are closely related to the processes discussed below. Obviously, the pro-
cedures that must be followed in seizing and selling the debtor’s property,
including the method for initiating action by the appropriate official, the
notice required to be given to the debtor and others, and similar ques-
tions, are a function of local procedural law and vary greatly from one
country to the next. The discussion therefore presents approaches to the
process that vary as a function of the details of local procedures.
3 Certain other methods of debt collection are also not discussed.
chapter two
... Enforcement of Unsecured Debt in General
The process for an unsecured creditor necessarily begins with obtaining
a judgment of a court (or similar authority) determining that the creditor
is owed a fixed sum of money.4 In many jurisdictions, the process of
enforcing a judgment is carried out by a bailiff or other official attached to
the judicial system and under its supervision. The official is given a court
order that directs seizure and sale of property to pay the judgment and is
required to follow specified steps in carrying out that order. (For example,
the official may be required to attempt to satisfy the judgment by seizing
and selling the debtor’s movables before proceeding against the debtor’s
immovables.) In other countries, there is a government office devoted to
debt collection and its officials carry out the necessary steps.5
Once a creditor has obtained a judgment of a court against a debtor
(and thus has become a “judgment creditor”), some systems provide a
time of “grace” (i.e., delay) in enforcement. This grace period may permit
the debtor to appeal the judgment to a higher authority or to pay the
creditor the amount the court has found owing. In the case of an appeal
by the debtor, the time for enforcement may be extended until the appeal
is heard, although in many systems such a further delay requires the
posting of a bond or guarantee of a specified sort in favor of the judgment
creditor. The effect of such a requirement is to ensure that the creditor will
be paid quickly and in full if the appeal is unsuccessful.
Most systems require that a judgment be served on the debtor at
the start of the grace period. There may be special rules for “default”
judgments, where the debtor fails to defend against the creditor’s suit,
especially in consumer cases. The enforcement of a default judgment may
require giving the debtor a separate grace period to appear and provide an
excuse for the failure to appear originally before the judgment is entered.
After that opportunity, however, the judgment is fully enforceable.
4 Of course, court judgments may involve many others forms of relief, but those are
not within the scope of this book.
5 Switzerland is an excellent example of a country with an established debt collec-
tion office (Betreibungsamt). See Christoph Stäubli and Nicole Battistini-Kohler, Swiss
Insolvency and Restructuring Law—A Short Overview and Some Issues of Debate in Cor-
porate Restructurings in Switzerland, J. Bankr. L. & Prac. , at Art. , III(B) (Oct.
). See generally, Stephen V. Berti, Swiss Debt Enforcement and Bankruptcy Law
().
systems for the enforcement of debt
... Types of Property Seizable
Unless the grace period has been extended or the judgment paid by the
debtor, the judgment becomes enforceable against the debtor’s property.
In most modern systems, procedures exist for the enforcement of judg-
ments against every form of property known to the economy in ques-
tion. Thus a creditor can enforce against both immovables and mov-
ables. Amongst movables, the creditor can enforce against tangible prop-
erty, securities, debts owed to the debtor (for example, bank accounts,
accounts owed by customers, or wages owed by an employer), patents
and other intellectual property, and so on. In general, the methods of
enforcement are by seizure and sale of the property by a public offi-
cial, by transfer of title of the property to the creditor by a court, and
by recordation of the judgment in a registry. When the property is held
by a third party, or consists of a debt owed to the debtor by a third party,
enforcement may be by an order directed to the third party, as discussed
below.
There are some limitations in every system. For example, few systems
have devices for present enforcement against property the debtor will
come to own in the future. In some systems, however, it is possible
by recording a judgment in a public office to acquire an interest in
immovables or even movables in which the debtor acquires an interest
in the future.6 An order to an employer to pay over certain amounts
from the debtor’s wages may be enforceable in the future on each day
of payment of wages. In general, however, enforcement must be against
interests the debtor holds at the time of enforcement.
... Exempt Property
When the debtor is a natural person, there are often a variety of spe-
cial protections, including the exemption of certain property from the
judgment-enforcement process. Such property may include the debtor’s
residence or patrimony and certain necessary movables, such as tools
of the debtor’s trade or a method of transportation like an automobile
6 See, e.g., In re Hilde, F.d (th Cir. ). California and Florida are two
jurisdictions in the United States that permit recording of a judgment against all a debtor’s
movable property. See Elizabeth Warren and Jay Lawrence Westbrook, The Law of
Debtors and Creditors – (th ed., ).
chapter two
or horse. Typically, such exempted property is defined with reference to
both a category (e.g., tools of the trade) and a limitation of value per
category or item (up to a value of so many currency units). There may
be a total combined value limitation for all exempted property as well.
Because of value limitations, such systems typically have procedures by
which a debtor can designate which property is to be exempt within an
exempt category of property, either before or during the enforcement
process.
... Enforcement Process
The enforcement of the judgment is usually done by a non-judicial
official, often one connected with the court that gave the judgment. Most
systems rely on the judgment creditor, formally or informally, to locate
the debtor’s property and advise the official where to seize it. However, a
number of jurisdictions, including Germany, have procedures designed
to require the debtor to appear in court and provide information about
assets. In the United States, for example, such procedures go further to
require the debtor to turn over certain assets or suffer imprisonment for
failure to do so. (Note that the imprisonment is not for failure to pay the
debt but for failure to turn over an identified, specific asset.)
There are a host of varying rules about the official’s entitlement to seize
property of the debtor and the official’s liability if the wrong property is
seized (e.g., property really belonging to another person). Some jurisdic-
tions, like France, permit the court to transfer the title to the property to
the creditor, giving the creditor the right to dispose of the property as its
owner. Others require the official to offer the property in a public sale and
then to pay the proceeds of the sale to those entitled to them, including
the creditor. There are various rules governing such sales. These rules are
designed to avoid collusive bidding and to obtain the maximum value
for the asset sold.7 They include requirements for advertising the sale,
requirements for assuring that the winning bidder can and will pay the
amount bid, and legal rules assuring that a buyer will obtain title com-
pletely free and clear of competing claims. This last point is of special
importance. If a buyer takes the property subject to the debtor’s oppor-
7 A good example can be seen in a United Kingdom decision, American Express
Banking Corporation v. Hurley [] All E.R. , [] B.C.L.C. .
systems for the enforcement of debt
tunity to buy back the property within some period of time or subject
to lawsuits from various claimants for the property, then the assets will
bring much lower prices because of the perceived risk of loss to the buyer.
The modern trend is to give the debtor a reasonable opportunity to buy
prior to or at the time of the sale, but not later. As to disputes from rival
claimants to the property, they are left to be settled in the determination
of the proper distribution of the proceeds of sale, without tainting the
good title of the buyer at the sale.
... Third Parties
If the property is under the control of a third party—as with wages, a
bank account, a securities account with a stockbroker, and so on—there
are generally special procedures required that “freeze” the property but
give the debtor and the third party an opportunity to resist enforcement
before it is finally ordered. Thus the third party may be ordered to hold
the property pending further court order while the parties resolve any
disputes about it. Often a similar procedure is used where intangible
property is represented by a registry as, for example, a patent right or
a share ownership not represented by a physical certificate. In that case,
the third party would be the administrator of the registry, such as the
patent office or the corporate office maintaining the share register. A
typical procedure would serve the third party and the debtor with the
judgment and require the third party to disclose any property of the
debtor it holds or any amount it owes to the debtor. The order would
also forbid any disposition of the property. Once the debtor and the third
party have responded, the court would rule on any disputes and then
order the property turned over to a public official for sale or directly to
the creditor. Ordinarily, if the property is cash or the equivalent (as with
seizure of a bank account), the cash would be paid directly to the creditor
in partial or complete satisfaction of the debt.
... Priorities
It goes without saying that a debtor that is the subject of an enforcement
action is highly likely to have other unpaid creditors, so that there may
be a creditor race to seize the debtor’s assets. That fact gives rise to a need
for legal rules to determine priorities in the property or its proceeds as
among judgment creditors. Priority rules will also be needed vis à vis
other persons with interests in the property, notably secured creditors
chapter two
and tax authorities. Concerns that exist in this area are similar to those
involving priorities of secured creditors, where they are discussed.8
In establishing a system of priorities among judgment creditors, it
is also important to integrate that system with the secured credit pri-
orities. This point is often overlooked, even in sophisticated legal sys-
tems, because the two laws—judgment enforcement and secured credit
enforcement—are often located in different parts of the statute books.
For example, the judgment enforcement statute may say that the priority
of a creditor in a movable “relates back” to the creditor’s filing with the
court for enforcement, regardless of the actual date of seizure of the prop-
erty. A secured credit law may say that a secured creditor’s priority arises
upon registration of its interest, regardless of the actual date of the loan.
One law or both should say which of these priorities overrides the other
in case of a conflict between a judgment creditor and a secured creditor,
but this is not always done.
Once such a system of priorities has been established, it becomes more
important to establish a registry of judgments and judgment liens, with
indices, so that creditors can learn about rights already accrued against
debtors. Such a registry should be part of the registry that includes secu-
rity interests or the two should be linked. Given modern capabilities, it
may be more practical and useful to simply link various registries so that
one search will encompass them all. The United States is, unfortunately,
an example of a jurisdiction that does not have such a capability in official
form. Private credit services in effect provide the cross-registry searches
but necessarily without the priority effects that could be established in an
official system.
It should be noted that the question of priority between secured cred-
itors and employees has been particularly contentious in many jurisdic-
tions, especially upon the commencement of insolvency proceedings.
... Provisional Remedies
Virtually all modern systems of judgment enforcement provide provi-
sional remedies designed to protect a creditor against the risk that assets
will no longer be available by the time a judgment is obtained. Their
mechanisms are generally mirror images of the post-judgment meth-
8 See infra ...
systems for the enforcement of debt
ods described above, with the added problem of protecting defendants
whose liability has not yet been established in court. Obviously, seizing
someone’s property before a court has ruled risks a denial of due process
and natural justice. The most common safeguard is the requirement that
the creditor provide a sufficient guarantee from which the defendant can
be compensated if the creditor is unsuccessful in the lawsuit. In some
systems it is possible for the defendant to respond to a seizure of property
in the same way, substituting a guarantee for the property seized and
thus obtaining its release. Another important safeguard that is sometimes
found is the requirement that the creditor provide some evidence that
there is an unusual risk of debtor flight or concealment of assets along
with some evidence that the creditor has a valid claim on the merits of
the lawsuit. The defendant may have an opportunity for a rapid hearing
before the court, even after seizure, to rebut the creditor’s evidence in
either respect.
Many systems also provide for a provisional remedy of public recor-
dation when there is a dispute involving real estate. A party may be per-
mitted to make an entry in a public land record that will put all potential
buyers and lenders on notice of the party’s asserted interest in the real
estate.
The procedural remedies for successful parties may include orders
requiring the defendant to perform some specific obligations, but those
types of provisions are beyond the scope of this book.
... Cross-Border Enforcement of Judgments
There are many different approaches to the recognition and enforce-
ment of foreign judgments around the world. Some countries, such as
the United States, are very friendly to the enforcement of judgments from
other countries. Others, such as China, are said to present many difficul-
ties to such enforcement.9 Because the topic is too large for treatment
here, we refer the reader to other works focusing on those issues.10
9 See Arthur Anyuan Yuan, Enforcing and Collecting Money Judgments in China from
a U.S. Judgment Creditor’s Perspective, Geo. Wash. Int. L. Rev. ().
10 See, e.g., Gary B. Born, International Civil Litigation in United States
Courts – (d ed. ); Eberhard Braun, Commentary on the German Insol-
vency Code ().
chapter two
.. Secured Credit Systems11
Secured credit serves an important role in every developed economy, but
its importance and the legal rules governing it vary greatly among juris-
dictions.12 Our discussion is only introductory.13 Therefore this section
does not provide a full description of various systems but discusses their
principal features and their relationship to insolvency systems.
This section of this chapter is limited in two other ways. Most of
this section is devoted to systems of secured credit in movables. It is
so limited for reasons discussed at the end of the section. The second
limitation arises from the fact that the focus of this book is insolvency law
per se. Security interests in movables are of central importance in many
insolvency systems but are often studied as if they were a separate subject.
In large part, the reason is that they straddle two worlds: individual
debt collection that works side by side with the execution procedures
just discussed; and the collective default management system that is an
insolvency regime.14 In this section, we focus primarily on their role
in individual debt collection. We will refer to their role in collective
proceedings in the text devoted to that subject.15
Countries have made and will continue to make different decisions
about where to draw the balance between secured and unsecured credit.
Some, for example, may conclude that giving considerable power to a
secured creditor is essential to produce a sufficient flow of credit to
start-up companies. Others may differ, believing that too-strong secured
11 For an extraordinary summary, see Ulrich Drobnig, Present and Future of Real and
Personal Security, European Rev. Priv. Law . See generally, Symposium, Har-
monised Modernization of the Law Governing Secured Transactions, Unif. L. Rev.
(). Eva-Maria Kieninger offers a set of “cases,” fact situations with commentary
applying to each set of facts the laws of various European countries, a useful compara-
tive device. Security Rights in Movable Property in European Private Law (Eva-
Maria Kieninger ed., ).
12 For one example of the importance of security in movables in enhancing the
availability of commercial credit, see Nuria de la Peña & Heywood W. Fleisig, Romania:
Law on Security Interests in Personal Property and Commentaries, Rev. of Central
and East European Law, ().
13 For a truly extraordinary comparative study of security interests in many jurisdic-
tions, see Philip R. Wood, Comparative Law of Securities and Guarantees (London ).
Another important source is the UNCITRAL, Legislative Guide on Insolvency Law
(). Other excellent sources are listed in the Bibliography.
14 Jay Lawrence Westbrook, The Control of Wealth in Bankruptcy, Tex. L. Rev. ,
– ().
15 See infra .., ...
systems for the enforcement of debt
creditors stifle entrepreneurship. To some limited extent, the discussion
that follows may implicate those questions. For example, a country like
England that favors strong secured creditors may permit very broad
general liens and creditor management of many defaults, while a country
like France with a less favorable view of secured credit may disfavor
general liens and insist upon more court involvement in enforcement.16
Other jurisdictions, like the United States, may be in between, permitting
broad liens and self-help enforcement but requiring substantial court
involvement once an insolvency case has been opened.
The discussion in this section is limited to security interests in mov-
ables granted by a debtor by contract, along with the property right aris-
ing from a retention of title to goods by a seller, a lessor, or any other
person who gives possession to a debtor but retains title to the goods.
All these types of interests arise from contractual relationships wherein
one party has an interest in property whose possession or title is held
by another party. This section does not include any priorities (“privi-
leges”), special or general, that arise by operation of law without contrac-
tual agreement, except insofar as it discusses the relationship between
legal priorities of that sort and contractual creditor interests.
With all the risks attendant upon generalization, one might say that
there are four principal categories among modern systems of secured
credit: those derived from the systems in Germany, England, North
America,17 and France.18 Overall, these systems run roughly in order
from the German, the most favorable to secured creditors, to the French,
the least favorable. Most of these systems permit security interests over
most types of property and most transactions, although the French sys-
tem is more constrained. Most of them require publicity concerning
security interests, with Germany a notable exception. Many countries,
including Spain and the United States, cover vendor’s liens while permit-
ting leases to partly escape the secured credit system; others, including
France, include leases but exempt vendor’s liens. The English and North
16 Note that the United Kingdom has recently adopted some major changes in its
system of secured credit. See infra ...
17 “North America” here refers only to the common secured-credit law systems in
Canada and the United States, which are similar but which are quite different from the
Mexican system. The Personal Property Security Acts found in the Canadian provinces
are similar to, although not identical with, Article of the Uniform Commercial Code as
adopted in all of the states of the United States.
18 The Islamic approach is sui generis and is discussed at ...
chapter two
American systems give broad play to private enforcement of security
interests, while most other systems do not. A valuable example of recent
reform is Mexico.
Because the modern systems share so many common characteristics,
a summary description of any of them must amount to: (i) identification
of its difference in key respects from general trends; and (ii) its choice
as to the features that divide principal systems. Note once again that
the discussion that follows is devoted to the secured-credit systems in
exemplary countries as such, rather than their relationship to insolvency.
Thus, for example, the discussion ignores the fact that the United States
is very secured-creditor friendly under Article but more balanced
among the various interests involved when the insolvency system is also
taken into account, while the British system is very favorable to secured
creditors with or without consideration of insolvency proceedings.
The German system is dominated by security interests that for the
most part do not have to be disclosed.19 The result is that practically all
commercial actors must assume that any property of the debtor may be
subject to a security interest. To be more precise, the courts have imposed
a duty to investigate the existence of a security interest.20 Most German
secured credit law is based on case law rather than statute. Security over
tangibles derives in significant part from the concept of a vendor’s lien
on property sold. A “security transfer” gives ownership in trust to a
lender, with the lien “extended” and “enhanced” to cover much of the
debtor’s tangible property.21 “Extension” and “expansion” can be obtained
as to vendor’s transactions as well. Secured parties generally prevail
over competitors for collateral, but an insolvency administrator may be
entitled to liquidate the collateral and to receive from the proceeds a
substantial fee for its administration and liquidation. Enforcement is
solely through court action.22
British security law distinguishes between fixed and floating charges,
although both have to be filed in a public registry to be effective.23 Fixed
19 See generally, Burkhard Jakel, Outlines of Security Interests Under German Law,
in Bridge & Stevens, Cross-Border Security and Insolvency (); Tibor Tajti,
comparative Secured transactions Law ().
20 Bundergerichtshof (Supreme Court), Juristenzeitung ().
21 Tajti, supra note , at –.
22 Tajti, supra note , at –.
23 See generally, Roy Goode, Principles of Corporate Insolvency Law (d ed.,
).
systems for the enforcement of debt
charges are liens on specific assets while floating charges are potential
liens on most, if not all, of the debtor’s property. The key differences are:
(a) those who deal with the debtor in the ordinary course of business
take free of the interest created by a floating charge; (b) the floating
charge is subject to a “carve out” in favor of unsecured creditors; and (c)
the floating charge holder has a very favorable enforcement mechanism
in the form of an administrative receiver. The receiver, generally an
accountant and always a qualified insolvency practitioner, is appointed
by the secured party. The receiver generally acts in the interests of the
secured party, although formally the receiver is the company’s agent.
In the United States, secured credit law is found in the Uniform
Commercial Code, Article , revised with effect from in all the
American states. The Personal Property Securities Acts (“PPSAs”) in
Canada (and now in New Zealand as well) were based upon Article
but represent a substantial modernization in comparison with the
and versions of the United States statute. They are now in effect in
all of the Canadian provinces in one form or another. Article and the
PPSAs are often joined in discussion as the North American approach,
even now when the approach has spread to the South Pacific. The most
important characteristic of the North American system is unity. It brings
together to a unique extent all of the types of collateral and transactions
likely to be important in a modern secured credit regime.
The characteristic differences of the North American system are in
coverage and enforcement. In its near universality of coverage, it is like
the British system but may go even further under the revised Article
in covering a huge range of transactions. On the other hand, the North
American system does not contemplate management of a business and
sale of the collateral by a receiver appointed by the secured party, even
where the creditor has a general lien, so its enforcement system varies
greatly from the British approach. The North American secured creditor
is benefited by a system of self-help repossession and sale, avoiding the
need for judicial enforcement, unlike many other systems.
The French system is much less favorable to secured creditors and
much more complex. There are special rules for various forms of prop-
erty, such as intellectual property and inventory. There is a general busi-
ness lien—the nantissement du fonds de commerce, or enterprise mort-
gage—but it specifically excludes inventory and immovables. A security
interest must be perfected by registration or possession, except in the
case of a vendor’s lien. On the other hand, leases must be registered. The
French system includes a large number of privileges imposed by law and
chapter two
some of them are superior in priority to security interests. Enforcement
for both possessory and non-possessory security interests is by sale after
notification to the debtor.
Finally, Mexico presents an instance of a new reformed regime that
combines traditional and foreign elements.24 It has retained possessory
security interests similar to the Spanish (and French) systems, but has
added a nonpossessory security device similar to the security interests
created under the North American system. It must be registered to be
effective. Vendor’s liens, however, remain free of a registration require-
ment. Mexico also retains a “guaranty trust” device that substitutes an
Anglo-American-style trust for a security interest device, although the
reform has made this method closer to the new nonpossessory security
interest in effect. It also permits a modified form of self-help in enforce-
ment.
These five examples present a cross-section of the principal systems
found around the world. It is probably correct to say that the North
American system is currently the most influential in the reform of older
regimes, but it is not uncommon for reform efforts to include elements
of more than one existing system. Some aspects of international reform
efforts are mentioned below.25
One last general observation should be made: we do not discuss “struc-
tural security,” which we may define as organizational arrangements that
use legal entities, especially the corporate form, to isolate pools of assets
in favor of certain creditors with much the same economic consequences
as arise from security interests. For example, a lender might insist that
a debtor corporation create a finance subsidiary and place the debtor’s
principal financial assets (such as accounts) in that subsidiary. The lender
then lends to the subsidiary that “upstreams” the loan proceeds to the
debtor parent. The lender is the only creditor of the subsidiary (which
has promised not to incur any other debts) and thus has sole access to
the pool of the debtor’s financial assets held by the subsidiary, much the
same result as if the lender had taken a security interest in those assets. Of
course, the lender might take a security interest as well. Structural secu-
24 See generally, Am. Law Inst., International Statement of Mexican Bank-
ruptcy Law () [hereinafter “Mexican Statement”]. Another post-Cold War example
of reform is Hungary, which has a system that includes elements of the United States and
the United Kingdom systems along with some unique local features. Tajti, supra note ,
at .
25 See infra ..
systems for the enforcement of debt
rity is generally much less important than secured credit and we do not
attempt to include it in this brief survey of secured credit.
... Personal Guarantees26
In many civil law countries, guarantees are treated as a form of security
(“personal” security rather than “real” security), while in common law
countries guarantees are treated as a distinct form of personal obligation.
The reason for thinking of them as security is that they make all of the
nonexempt assets of the guarantor (the person giving the guarantee)
potentially available to satisfy the guaranteed obligation. However, the
guarantee by itself does not necessarily create any priority for the creditor
in any of the guarantor’s property as a real security right would.
In outline, there are five types of personal security: . Suretyship; .
Independent Guarantee; . Standby Letter of Credit; . Comfort Letter;
. Codebtorship with Security Function.
With traditional Suretyship, the guarantor can be sued (that is, can be
the subject of a legal action to collect the debt) only after demand against
the “original” or “primary” debtor and in some systems only after legal
judgment has been obtained against the primary debtor and enforcement
has failed. In other words, the guarantor’s liability is contingent on a prior
demand having first been made on the primary debtor. The guarantor
would be entitled to assert in defense any defenses the primary debtor
would have had on the primary obligation27 and also certain “suretyship”
defenses, such as the creditor’s failure to pursue all remedies against the
primary debtor. A new form is “suretyship on first demand” that may
mean the creditor may take action against the guarantor without first
seeking payment against the primary debtor and the guarantor must pay
regardless of defenses, but the guarantor may then sue the creditor for
return of its money and in that legal action may assert the defenses of a
surety.
An Independent Guarantee differs from Suretyship in that the creditor
may take action against the guarantor without first seeking payment
against the primary debtor and the guarantor has none of the suretyship
26 This subject is succinctly but comprehensively discussed in Drobnig, supra at
note .
27 Akzessorietät is the term for this parallelism of the defenses of the primary debtor
and the surety in Germany, where it has considerable importance.
chapter two
defenses except fraud. Some jurisdictions find it difficult to recognize
this form of guarantee because of a lack of legal “causa” to support the
guarantee obligation.
A Standby Letter of Credit serves many of the functions of an Inde-
pendent Guarantee. The condition of collection is often presentation of a
document showing a failure of performance by the primary debtor under
another contract. The bank, as issuer of the letter, is similar to a guarantor,
but the transaction is treated as largely separate from the obligation guar-
anteed, subject to the wording of the condition that triggers the credit and
subject to possible exceptions in case of fraud. These letters often state
that they are governed by the Uniform Customs and Practices .
A Comfort Letter is often used by a parent company to give assurance
of a subsidiary’s performance. It may amount to a guarantee of some kind,
depending on the interpretation of its language.
In the case of a Codebtorship with Security Function, the guarantor
is in the same legal position as the primary debtor in every respect as
against the creditor, so that the creditor has two primary debtors. The
guarantor may have some rights of reimbursement as against the other
debtor.
In any of these relationships:
a. The guarantor may or may not grant to the creditor security rights
in its assets to secure its obligation to the creditor.
b. The guarantor may or may not be a professional in the business of
assuming such obligations, like an insurance company, and may or
may not be compensated for giving the guarantee.
c. Especially where the guarantor is not a professional guarantor and
is not compensated for its guarantee, there may be special require-
ments to make the guarantee enforceable, including required warn-
ings or required execution before a notary.
d. Guarantees in a consumer context may be heavily regulated or
forbidden altogether.28
... Security Interests Generally
Because most systems of debt enforcement depend upon seizing and
selling the debtor’s property, the key difference between unsecured and
secured credit is that the secured creditor gets an enforceable interest in
28 See, e.g., Ulrich Drobnig, Recent Legislative Trends in the Field of Personal Security,
Eur. Bus. Organ. L. Rev. ().
systems for the enforcement of debt
the debtor’s property at the beginning of the transaction, rather than by
a legal action after default. Because the secured party wants to be able
to seize and sell the property securing its debt (“the collateral”), it must
have rights superior to those of the debtor once a default by the debtor
has occurred. Because it wants to be entitled to the proceeds of that
sale, it must have a priority (or privilege) over third persons who may
claim some right in that property, including other secured or privileged
creditors, buyers of the property, and an insolvency administrator.29 Thus
the secured party requires three enforceable rights: to seize, to sell, and
to obtain priority in the proceeds of sale. It must obtain those rights first
against the debtor and then against third parties. Enforceability against
the debtor may be called “attachment” and enforceability against third
parties may be called “perfection.”30
It should be noted that the availability of the collateral is only assured
if the secured creditor is protected against those who have acquired
interests prior to default. Examples would be other secured parties or
buyers of the collateral. For a secured credit law to be effective, it must
ensure that a secured party can obtain a priority superior to that of these
competitors or its rights may be of little value following default. A system
that gives that priority in turn effectively restrains the debtor’s capacity to
transfer property without the secured party’s approval, a result that may
be called “asset constraint.”31 Where the collateral consists of most of the
debtor’s assets, or of the key assets necessary to its business, the result of
the secured party’s priority and default rights may be effective control of
the business by the secured party.32
On the other hand, two types of debtor protection are often considered
necessary. Debtors need protection against improper seizure of their
property and against fraud or manipulation in the process of sale.
Equally important, third parties need notice of the secured party’s
interest in the collateral. That notice is crucial to provide stability and
certainty in the marketplace, ensuring: (i) that purchasers can take own-
ership of property, confident that they are not subject to a secured party’s
29 Note that in the German system priority arises less frequently as an issue because
there is not generally permitted a second assignment of a movable. Tajti, supra note ,
at .
30 These are United States terms found in Article but they have gained widespread
use in English-language commentaries generally.
31 Westbrook, supra note , at .
32 Id.
chapter two
priority; and (ii) that other creditors, secured or unsecured, know of the
existence of any security interest and can price their credits accordingly.
Thus the required notice accomplishes the general purposes of trans-
parency in any market but is especially important here because it relates
to specific legal rights in specific property.
The goals of a modern system of secured credit are to satisfy the needs
set forth in the prior two paragraphs as efficiently and inexpensively as
possible.33 Each of these goals is addressed in different ways in various
legal systems around the world. One of the reasons for the variation is
the tension or conflict among these goals.34 Because of the great variety
of secured credit systems, it is difficult to generalize about them. How-
ever, certain patterns are discernible. Two are especially important: the
requirement of publicity and the control of assets after default.
Most countries, both common law and civil law, have some form of
publicity for at least some security interests in movables, but there is enor-
mous variation in the extent of such systems and the approaches used to
provide public notice. By way of example, most security interests in the
United Kingdom must be registered to be enforceable, while in Germany
most security interests are not registered but are fully enforceable. The
consequences of the two approaches ripple throughout the secured credit
and insolvency systems of each country. Thus there is actually a judi-
cial presumption in Germany that a debtor’s assets are subject to security
interests, illustrating that the system of unregistered interests requires a
prudent creditor to assume that a business’s assets will be subject to pri-
ority claims by others.
A second pattern relates to control of assets, especially after default.
Most legal regimes put post-default control in the hands of courts or
administrative agencies that use public officers to enforce security rights.
However, private enforcement is found in a number of countries, most
of them common law jurisdictions. In the common law countries other
than the United States there has been a longstanding use of the “floating
33 See, for example, the European Bank for Reconstruction and Development’s “Ten
Core Principles,” which accompanied its Model Law on Secured Transactions,
discussed in Security Rights in Movable Property in European Private Law,
supra note , at –.
See also Jacob S. Ziegel, The EBRD Model Law on Secured Transactions—Some Cana-
dian Observations, in Festschrift für Ulrich Drobnig zum siebzigsten Geburt-
stag (Jürgen Basedow ed., ).
34 For example, in some countries, like Germany, where the bank lenders are especially
strong, there is a concern that strong forms of security might create an imbalance between
lenders and borrowers.
systems for the enforcement of debt
charge” that has unique characteristics. Without attempting to describe
them in detail, the key points are two. First, the floating charge permits
the secured party to obtain a blanket security interest covering all of the
debtor’s assets, although it permits free use of those assets prior to default.
Second, default gives the secured party the power to appoint a private
receiver to operate and then sell the assets for the benefit of the secured
party, but under a legal doctrine that largely insulates the secured party
from liability for any misstep by the receiver. The result is a system that
operates largely outside of court supervision and outside the insolvency
laws. Recent amendments to those laws in the United Kingdom have,
however, greatly reduced the power of the secured creditor to make
such appointments,35 a point discussed below.36 It should be noted that
these systems also permit a creditor to obtain a “fixed” charge or lien on
specific assets. That charge has certain advantages over a floating charge.
In particular, the fixed charge is not subject to the claims of preferential
creditors. Yet only a floating charge gives control of the enterprise to a
receiver after default. As a result, a secured creditor may often choose to
obtain both fixed and floating charges. Thus the English banker’s saying,
“The fixed charge for priority; the floating charge for control.”
The intensity of the competition between preferential and secured
creditors over certain assets, coupled with acute and opportunistic draft-
ing of security instruments by lawyers acting for secured creditors, led
to an attempt by secured creditors to have the bankrupt’s book debts or
receivables classified as an asset that could be included within the prop-
erty that constituted a fixed security. Receivables are often the most valu-
able of a debtor’s movable assets, and by shifting this category of asset
from a floating to a fixed security, this device permitted secured cred-
itors to leapfrog above preferential creditors. It was upheld in in
Siebe Gorman & Co Ltd. v. Barclays Bank Ltd., but in it was deci-
sively rejected by the House of Lords in National Westminster Bank plc.v
Spectrum Plus Ltd., so that this important category of security remains
subject to preferential claims.37
The receivership system is one approach to the problem of control of
assets following default, but the use of private enforcement is not lim-
ited to the receivership method. In some countries—notably the United
35 Section , Enterprise Act —applicable to Great Britain (i.e. England, Scot-
land, and Wales but not Northern Ireland, § () Enterprise Act ).
36 See infra ...
37 See infra ...
chapter two
States—“self-help” repossession and sale is permitted after default as long
as there is no risk of a “breach of the peace.” Thus the whole process of
taking possession of collateral, selling it, and applying the proceeds may
be accomplished without court intervention or supervision.
One of the reasons that characterization of legal regimes as “pro-
debtor” or “pro-creditor” is often misleading is that such characteriza-
tions often focus only on the secured credit law or only on the insolvency
law of a jurisdiction, whereas the actual position of creditors requires
viewing both of them as part of a single system, along with the debt-
enforcement law. Thus the Bankruptcy Code of the United States, which
governs insolvency cases, is often called “pro-debtor” with some justi-
fication. But Article of the American Uniform Commercial Code is
strongly protective of secured creditors, providing a balance not obvious
if only one or the other is observed.
... Title Retention
.... Generally
The largest difference among systems of secured credit is the extent to
which title-retention systems are included or excluded from the system.
Most countries have the legal concept of title retention, where the owner
of goods contracts to give to another (the debtor) the right to possess
and use the goods but with the understanding that the owner retains
title (ownership) to the goods. The two most common examples of title
retention are found in the sale of goods and the lease of goods. The seller
of goods often retains title until the full price of the goods has been paid.
Similarly, the owner-lessor of goods retains title to goods and will have
the right to reclaim them at the earlier of (i) default under the lease by
the debtor or (ii) the end of the lease. Both arrangements have much
in common with a security interest, including the fact that the party
extending credit is entitled upon default under the contract to obtain the
return of the specific goods, not merely to sue for monetary damages.
That difference is, of course, crucial in insolvency cases, where unsecured
creditors often get little or nothing.
The broader concept, which includes title retention, is title finance. It
includes devices that are like title retention in the use of title to the prop-
erty as a way of gaining many of the advantages associated with secu-
rity interests, but often with fewer of the detriments. In title finance the
financier has title or ownership of the asset as opposed to a mortgage
systems for the enforcement of debt
or security interest. Apart from hire, purchase, and finance leases, other
examples are trade finance forms, including retention of title; discount-
ing, factoring, or forfeiting of commercial receivables; sale and leaseback;
sale and repurchase (“repo agreements”—commonly used for investment
securities and important in financial markets); and stock borrowings.
Perhaps one might include in this bracket securitizations of receivables
and repackagings of debt securities, of which there are many variations.
In essence, title finance often has the commercial effect of security.
Indeed, many of the techniques are designed to avoid the obstacles of
pledge laws. The attitude of jurisdictions toward title finance has ranged
from enthusiasm to hostility. Some jurisdictions encourage the escape
from the cage of mortgages and hence support form over substance.
Others, like the United States and German systems, seek to rebolt the
gate: they recharacterize a title transaction as security with the result that
it often fails for noncompliance with a pledge rule or is reintroduced into
the regime covering security interests (such as Article of the United
States Uniform Commercial Code). Some legal systems protect one form
(such as seller’s retention of title to goods) but not others.
Reservations of title have longstanding importance in continental
Europe. A reservation or retention of title clause is generally found in
an agreement between a buyer and seller and provides that the seller
transferring property thereunder retains ownership of such property
until satisfaction of the conditions in the agreement, such as payment
in full. By agreement, the reservation may extend to the proceeds of the
goods if sold, to the extent traceable. On the other hand, some civil law
systems are hostile to this device.38
Retention of title devices are not confined to sellers but also may be
used by lenders or other providers of financing for the sale of property.
Retention of title effectively provides a security for payment of the pur-
chase price. The well-recognized effect of such clauses is to confer upon
the holder of the reservation of title a prior right or security interest in the
goods in question. These clauses protect sellers against the rights of other
secured creditors holding security interests, as well as against preferential
rights granted as a matter of law. Retention of title devices often do not
require registration or notice and hence may operate as a hidden interest
when such clauses may be enforced without notice or registration to any
38 Boris Kozolchyk, La Contratación Comercial en el Derecho Comparado
(); Boris Kozolchyk, Law and the Credit Structure in Latin America, Va.
J. Int’l L. , , n. (Apr. ).
chapter two
other party. However, some jurisdictions (for example, Portugal, Spain,
and Switzerland) require registration for the title retention to be effective.
Indonesia uses a fiduciary transfer under which the creditor receives title
in trust until the debt is paid.
There are various consequences of maintaining a separate legal regime
for title retention, but the most important is that such interests are often
free of the requirement for registration or some other form of publicity.
As a result, these devices create serious potential problems in the market
place, although those problems may be mitigated in some instances by
transparency in practice. Another major difference is the strength of the
device, with variation in rules as to when the right is lost (when the
transferee buyer or lessee takes possession of the property, when the
transferee resells, or at a still later point) and whether it extends to the
proceeds of the sale of the property.39
The central point of interest is not whether title finance is similar
to security—it often is—but the role of this safety valve. If a device is
established and widely used to escape incompatible pledge and mort-
gage restrictions, it should probably be governed by rules that address
the problems discussed in this chapter with respect to security inter-
ests. If devices of this sort are permitted, a title retention system that
requires some form of public registration, at least for collateral values
over a stated amount, avoids most of the serious cost disadvantages men-
tioned in the discussion.40 Those costs may also be minimized in systems
where retention is narrowly confined to include only purchase-money
situations rather than the grant of security interests over property already
owned.
Although the concept of title retention is found in many countries,
there is great variation in the extent that title-retention interests are
treated as security interests. In North America and Germany, for exam-
ple, all title retention by sellers is governed by the rules that govern secu-
rity interests, while in France title retention by sellers is kept almost
entirely separate from the secured credit system and governed by very
different rules. On the other hand, in North America title retention by
lessors is kept separate, while in France lease title retention is subject to
registration requirements similar to those for security interests.41
39 See infra ....
40 See infra ...
41 It is possible in France to register a title retention as a lease. This is done to gain
some procedural advantages in insolvency.
systems for the enforcement of debt
In some countries, notably Germany, the title-retention concept has
been carried well beyond the simple model of a “conditional” sale or
lease of goods and permits by agreement a number of financing devices.
In North America and elsewhere, the lease form of title retention has
similarly been expanded to be a general-purpose financing arrangement.
.... Ambiguity of Interests
In legal systems where title-finance systems are not integrated into a
secured-transactions law, the title-finance approach may provide a cred-
itor with legal advantages over the secured-transaction approach. For
example, the title-finance transaction may give the creditor an even
greater power to reclaim goods in an insolvency proceeding (as in
France) or permit the debtor and creditor to avoid registering the trans-
action under circumstances where registration would be required for a
secured transaction. Where there are such advantages, parties will nat-
urally attempt to obtain them by structuring their transactions as title
retentions. If they do so without changing the economics of the trans-
action, it may be that the transaction is economically a secured transac-
tion that merely bears the form of a title-finance. For example, the sale-
leaseback, where a debtor “sells” an existing asset to a creditor and then
leases it back is usually a secured transaction restructured as a lease to
gain various advantages given to lease transactions over secured trans-
actions. Especially if the advantages include avoiding publicity by regis-
tration, their widespread use can greatly reduce the efficiency-enhancing
effects of transparency in a registry system because creditors do not know
whether hidden interests have been granted to others.
This situation is also a problem with intangibles. If an assignment of
intangibles for security differs in its legal effects, including a registration
requirement, from an outright sale of intangibles, parties will naturally
try to give transactions the form that provides the most legal advantage,
even if the economic substance of the transaction is of the other type.
It is important to note that this problem does not arise merely because
parties try to disguise transactions. It also arises because often the parties
do not clearly state the nature of their bargain. For example, those who
deal in accounts receivable routinely lend against the security of accounts
and also buy accounts from their customers. Their contracts may not
make clear which of the two is being done in a particular case. The
variation in terms from contract to contract (for example, as to any
obligation of the assignor/borrower to repurchase doubtful debts) may
chapter two
make it difficult to determine the nature of the transaction. Finally, this
problem can arise where the parties are genuinely trying to achieve an
economic result that provides some of the characteristics of a security
interest and some of the characteristics of another sort of transaction.
The law does not generally recognize this “in-between” state but will see
the transaction as being either a security interest or not.
One approach to this problem is to authorize judges to review carefully
such transactions and to “recharacterize” them if they appear to adopt a
form different from their real economic basis. Thus in the United States,
for example, Article of the Uniform Commercial Code authorizes
judges to determine if a transaction called a lease (that does not require
registration under Article ) is really a secured transaction economically.
If it is, and has not been registered, then it is likely to be unenforceable
in insolvency. However, that system also permits lessors to register leases
in order to protect against the risk of such a recharacterization.
Other systems have other approaches. The German civil law code, for
example, gives lawyers and judges the right to characterize any transac-
tions on the basis of the parties’ bona fide intentions.42 Moreover, the
BGB prescribes that judges must recharacterize a void transaction into
a valid one if the void transaction fulfills all the requirements of a valid
one; thus, a void suretyship might be interpreted as a valid guarantee.
Conversely, some jurisdictions in the United States have adopted “true
sale” statutes that require the courts to recognize a transaction as a sale,
not the grant of a security interest, if the parties call it that, regardless of
its economic realities. It is not clear if the federal bankruptcy courts in the
United States will accept these state statutes in the context of insolvency.
Recharacterization without protection for the creditor (such as per-
missive registration) has the disadvantage of increasing to some degree
the risk of otherwise useful transactions (for example, leases). However,
mere acceptance of the form followed by the parties may greatly reduce
efficiency and increase the cost of credit, as indicated above, because of
uncertainty created by a lack of transparency. For these reasons, some
prefer a different approach: imposing certain secured-transactions rules
—especially the requirement of publicity—on all transactions that are
similar to secured transactions. The Canadian requirement for the regis-
tration of leases is an example.
42 See Bürgerliches Gesetzbuch [BGB] [Civil Code] §§ , , .
systems for the enforcement of debt
... Obtaining a Valid Security Interest
Turning to the specific goals of a secured credit system, the first—ob-
taining an enforceable interest against the debtor—is achieved, by defi-
nition, through a contract between debtor and creditor. What is permit-
ted and what is required in this contract may vary. Some of the prob-
lems presented by this first goal have been resolved similarly in most
systems, while there are substantial differences as to others. To begin
with the commonly agreed points, three types of liens that were often not
permitted in the past are included in virtually all modern systems: non-
possessory security interests, security for future (after-incurred) credits,
and security in future (after-acquired) collateral. Naturally, there remain
differences in detail.43
... Types of Liens Permitted
Possessory security interests are the traditional sort. Possession of col-
lateral solves a number of potential problems in a secured credit system.
It provides evidence of the agreement to grant the possessing creditor
an interest, it eliminates the need to seize the collateral to sell it after
default, and it provides effective notice to third parties that the debtor-
owner no longer owns the collateral free of other interests. The difficulty
is that the creditor’s possession denies the debtor the use of the collat-
eral. Especially in a business context, the creditor’s possession of the col-
lateral that the debtor needs to run its business and generate the funds
for payment would be self-defeating. Further, most systems permit secu-
rity interests in intangible property—like accounts receivable, intellectual
property, and investment securities in electronic form—all of which are
impossible to “possess.” Thus every system has found some way to per-
mit the enforcement of non-possessory security interests. Some systems
have moved fully and openly to a system not dependent on possession,
while others have used various fictitious or constructive concepts to try
to bring non-possessory interests within the framework of a possessory
system.
When a system departs from a requirement of possession, whether
completely or partially, it must then solve the problems that possession
43 See generally, Kieninger, Evaluation: A common core? Convergences, subsisting differ-
ences and possible ways for harmonization, in Security Rights in Movable Property
in European Private Law, supra note , at .
chapter two
previously solved. To achieve the goals of a modern system, it must
specify the formality necessary to create and evidence the granting of the
interest to the creditor (such as a writing), it must provide a mechanism
for gaining control of the collateral and realizing its value, and it must
provide a method for notice to the commercial community that the
debtor holds the collateral subject to the creditor’s interest. While there
is wide variation in the extent to which modern systems have solved
these problems and the methods they have used, the non-possessory
security interest is commonplace today. At a conceptual level, systems
vary depending on the extent to which they continue to rely on analogies
to possessory systems in order to formulate non-possessory security
interests, as opposed to adopting a new conceptual framework in which
possession is simply another method by which a security interest may be
made enforceable against third parties.
Most modern systems also permit coverage of future credits and future
collateral.44 The first refers to a method for making the arrangements for
security only once, at the start of a credit relationship, while providing
that the collateral will secure both credit extended at that time and credit
extended in the future. It is especially important for modern “revolv-
ing” loans or lines of credit, where the credit rises and falls as credit
is extended, the debtor makes some payment, and then new credit is
granted. Similarly, modern systems facilitate security interests in prop-
erty acquired by the debtor after the initial grant of security. These are
essential as to inventory, where goods are being sold and new goods are
being bought constantly, but they are also very helpful as to other types
of collateral. In one way or another, these devices permit any outstanding
credit to be secured by all the property of a specified type (or all property)
owned by the debtor at any given time, including property acquired after
the initial grant of security.
It should also be noted that one of the major advantages of a security
interest is that in some jurisdictions such an interest can be granted
in property that is exempt or otherwise protected from seizure in the
debt enforcement process. Thus the secured creditor may have access to
property that is unavailable to an unsecured creditor even after default.
44 Where a system does not do so, there is pressure on lawyers and judges to develop
alternative measures that in turn weaken the existing registration system. See, e.g., J.O.
Fabunmi, Contract Registration and Perfection, Lesotho L.J. , (–)
(Nigeria).
systems for the enforcement of debt
... Constraints on Secured Transactions
On the other hand, modern systems vary considerably as to other aspects
of this first goal, obtaining an interest enforceable against the debtor. The
three largest variations among legal systems are the formal requirements
for such a contract, the extent of the lien that may be obtained, and
the exclusion of certain types of or transactions from the secured credit
system.
Some systems impose fairly extensive formal requirements. For exam-
ple, some jurisdictions (e.g., France) require that the contract be signed
before a public official, a notary, and set forth a specific description of the
collateral. Other systems, such as the North American system, have min-
imal formalities, requiring only a writing signed by both parties contain-
ing a general description of the collateral and waiving even the writing
requirement where the creditor takes possession.
There is also considerable variation in the coverage that a security
interest may have and the ease with which a broad coverage may be ob-
tained. In the United Kingdom and in some other common-law coun-
tries, the “floating charge” routinely covers all or substantially all of the
debtor’s assets. In the United States, the “blanket” lien or “dominant secu-
rity interest” may be equally broad, although in practice it is less com-
mon. By contrast, a number of civil law systems have no single lien so
broad. Even the so-called “enterprise mortgage” in France specifically
excludes the inventory of the enterprise. (For differences between the
“floating charge” and other general liens as to management of default,
see Section ...)
The third area of substantial variation is in the exclusion from some
systems of some types of collateral. It goes without saying that things
excluded from commercial transactions (for example, sale of parts of
the human body) are excluded from secured financing as well. Many
systems provide for specialized methods of security for certain types
of collateral, such as ships. Beyond that, however, many exclusions are
merely historical accidents. That is, certain legal systems have simply
failed to adopt the necessary rules to permit the grant of security interests
in certain kinds of collateral. In other instances, exclusion may represent
a policy decision. One very modern example of deliberate exclusion is
the repurchase agreement, whereby a party buys a security at a certain
price and the other party promises to buy it back within a certain time
at a certain, higher price. Often the economic purpose and effect of the
agreement is the same as secured financing, but because these agreements
chapter two
are common in international finance, most modern systems exempt them
from the secured credit regime. In some countries, religious or cultural
constraints may be important. For example, in Saudi Arabia and some
other Muslim countries obtaining financial protection akin to a security
interest must be through mechanisms that are Sharia-compliant.45
A closely related point is the problem of anti-assignment clauses in
debt contracts. If a potential borrower and its customer sign a contract
with such a clause, then the debt to the borrower arising from that
contract may not be assignable for security, thus reducing the assets
available for secured financing. Some jurisdictions have rendered such
clauses unenforceable as they relate to debts46 while enforcing them as to
other types of performance.
One other form of attempted constraint on the grant of security inter-
ests is the “negative pledge” clause. The clause is often found in credit
agreements, whether secured or unsecured. The debtor: (a) promises to
refrain from granting security to any other creditor; or (b) promises that
if it grants security to another creditor, it will grant a pro rata (“equal and
ratable”) security interest to the other party to the credit agreement con-
taining the clause. In at least some countries, including the United States,
such agreements are of limited practical value because they are difficult
to enforce.47 For example, in some Commonwealth jurisdictions where
negative pledge clauses or other restrictive clauses are included in floating
charges, issues may arise as to whether subsequent fixed charge holders
had actual knowledge of the restrictive clauses.48
... Enforcement
All modern systems provide for the achievement of the second goal of
secured credit, a mechanism for enforcement of a security interest by
seizure and sale. One of the most persistent defects in security systems is
45 Michael J.T. McMillan, et al., Shari"ah-Compliant Equivalents to Western Mortgage-
Based Financings: Structures and Primary and Secondary Markets, The Common Core
of European Law: Laws of Mortgage (forthcoming).
46 That is, debts may be assignable despite a contractual agreement that the creditor
may not assign the debt. For example, this is the case in the United States. UCC §§ – –
–.
47 See Grant Gilmore, Security Interests in Personal Property ().
(United States); Tajti, supra note , at (Germany).
48 Gerard McCormack, Reforming the Law of Security Interests: National and Interna-
tional Perspectives, Sing. J.L.S. , (July ).
systems for the enforcement of debt
the difficulty and expense of enforcement through judicial methods.49
This factor often results in creditors using only those security devices
that permit non-judicial enforcement and a lack of available credit where
such devices are not applicable.50 Denying secured creditors self-help
remedies can lead to substantial delays in the recovery of debts. For
example, in Thailand where secured creditors are required either to reach
agreement with the debtor or to commence judicial action, recovery can
typically take as long as two years.51 Indeed, it was estimated in that
the backlog of , claims by secured creditors would take at least
years to process.52 Delays of this magnitude can embolden debtors and
make them feel recovery proof.
Many systems provide summary methods for judicial assistance in
this process, so that the debtor by granting the security interest has, in
effect, agreed to waive some or all of the formalities and protections of
the litigation process as to the seizure of the collateral.
Some systems go further and permit private enforcement of vari-
ous sorts. The two most notable are self-help repossession and receiver-
ship. Self-help repossession is seizure of the collateral by the creditor or
its agents without judicial intervention. In North America, for exam-
ple, creditors are allowed to repossess collateral in this way as long as
no “breach of the peace” (violence or the threat of violence) occurs.
Recent regulations in India permit banks and other institutional lenders
to exercise this power with no court involvement except through debtor
recourse to special Debt Recovery Tribunals.53 Many jurisdictions will
not permit this form of seizure, reserving that function to the state
through the courts or an administrative debt-collection office. The new
Mexican law represents an apparent attempt to take a first step toward
private enforcement, although there will be disagreement as to its likely
results. Regardless of the method, most modern systems permit rela-
tively inexpensive and swift seizure, balanced by rights given the debtor
to regain the property and even collect damages if the creditor acted
49 On the other hand, countries like Switzerland seem to have efficient public enforce-
ment. See Peter Straub, Remedies under Security Interests (Switzerland) at , in Ian
Fletcher & Odd Swarting, Remedies Under Security Interests ().
50 See, e.g., id.
51 Lampros Vassiliou, Legal Issues: Thailand, Siam Premier Guide to Restructuring
in Asia, at () at http://www.adb.org/Documents/Reports/Restructuring_Asia/
Thailand.pdf.
52 Thailand Economic Monitor, p. (May ).
53 Aparna Viswanathan, Banking and Financial Law Reform in India: Will It Improve
Lenders’ Rights and Recovery? [] J. Int. B. L. Rev. .
chapter two
wrongfully in initiating the seizure. Some systems represent a middle
ground, permitting enforcement by professional bailiffs without court
involvement under some circumstances, such as enforcement of security
documents satisfying a high level of formalities, including notarization.54
All modern systems have rules governing the sale of seized collateral.
Some require sale under judicial supervision, while others permit a
secured party to conduct auctions or even privately negotiated sales,
subject to rules designed to ensure that procedures are followed that are
likely to attract the most buyers and the highest price. Thus rules may
permit private sales as well as auctions but often with a requirement of
adequate notice to the debtor and adequate attempts to advertise the
sale and attract buyers, a requirement called under the United States
provisions “commercial reasonableness.” Using such methods assumes
appropriate and workable sanctions when the sale rules are violated,
thus providing incentives for conformity. In the United States system, for
example, the creditor risks losing its right to sue for any part of the debt
that is not recovered from the sale.55
Receiverships are found in the United Kingdom and some other com-
mon law jurisdictions that permit a secured creditor upon default by
the debtor to appoint a private receiver under a floating charge to take
possession of the debtor’s business and its assets for the purpose of sell-
ing the business as a going concern or selling the assets individually. In
effect, many of the functions performed by insolvency administrators in
other jurisdictions are instead carried out by the receiver appointed by
the secured party.56 Here, too, a commercial reasonableness doctrine may
be said to apply. While the receiver’s primary duty is to the secured cred-
itor at whose instance the appointment was made, the receiver also has
duties to others who might have an interest in the estate. Thus a receiver
will be liable to make good any loss to the estate where he fails to observe
appropriate commercial standards when disposing of the debtor’s assets
or otherwise in acting negligently causes a loss to the estate.57
54 The Slovak Republic is an example. These methods, however, are often limited to
circumstances in that the debtor cooperates. In Indonesia, sale is by the State Auction
office.
55 See White & Summers, Uniform Commercial Code (th ed.) at § –.
56 See infra ...
57 Standard Chartered Bank v. Walker [] WLR ; American Express Inter-
national Banking Corporation v. Hurley [] BCLC ; Knight v. Lawrence []
BCLC .
systems for the enforcement of debt
... Priority
The third goal of the secured creditor, to obtain priority in the proceeds
of sale over others who have claims to the debtor’s assets, creates three
categories of issues: publicity (registration), the primacy of the secured
creditor’s priority (whether subject to subordination in favor of other
priorities or privileges), and the rule for establishing priority (by date or
category).
.... Publicity
The existence of any priority in a debtor’s assets or a specific asset of
a debtor necessarily creates a problem of publicity. The credit market,
like all markets, operates most efficiently when it is the most transparent.
Information about a debtor’s finances is central to the pricing of credits
for that debtor. No datum is more important than the existence of pri-
orities for certain creditors in the assets of the debtor because in case of
default the value of those assets will be lost to creditors not enjoying an
equal or superior priority in them. Therefore, in principle there should
be public disclosure of any such priority. (The fact of having taken the
correct steps for publicizing the secured party’s interest in particular col-
lateral is often called in English “perfection” and the secured party who
has completed those steps is often said to be “perfected.”) The most com-
mon method of publicity is registration in a public office.
Nonetheless, no legal system is perfectly successful in requiring pub-
licity concerning all priorities (privileges) in a debtor’s assets. Even those
systems that maximize such publicity and impose significant sanctions
for failure to publicize have some exceptions for some priorities. Yet there
are great differences of degree in various systems as to the amount of pub-
licity concerning security interests, title retention, and other priorities.
Some require most such interests to be disclosed to the market, while
others produce very little disclosure.
The usefulness of a registration system depends greatly on the sanction
for failure to register or otherwise publicize the existence of a security
interest. Many systems make proper registration a condition of priority
over third parties, but some do not.58
58 For example, the new perfection law in Japan imposes this sanction for security
interests (actually assignment of title as security) in claims but not for security interests
in other movables.
chapter two
.... Exemptions
The most important single reason for incomplete disclosure is the exemp-
tion of title-finance interests. Thus, for example, the North American
system requires registration of most security interests under pain of
forfeiture or subordination of the interest for non-compliance, yet an
increasingly important category of financing, lease title-retention, does
not require registration in the United States and Ontario.59 A similar rule
for title retention is found in Spain. In the United States, the effects of
this exclusion are mitigated in practice by precautionary filings by many
lessors. Conversely, the French system exempts vendor’s liens from reg-
istration but requires registration of many leases. In Germany, there is a
greater effect than in the other countries mentioned because the avail-
ability of the title-retention device for various types of modern financ-
ing means non-disclosure is so widespread as to leave the market with
little meaningful information about priority interests in a debtor’s assets.
And in the United Kingdom, at least three institutions—setoff, the unpaid
vendor’s lien, and the resulting trust—that emerge from the general prin-
ciples of equity enable a position akin to that of secured creditor to be
established, despite the absence of registration or any other form of pub-
licity.60
.... Registration
Aside from the extent of a registration requirement, there are three
main variations among registration systems: detailed or general; officially
reviewed or merely filed as submitted; and multiple registries or central-
ized registries.
Some systems (for example, the French) require detailed informa-
tion to be filed with a public official, often including the security con-
tract itself. These systems typically insist upon a fairly detailed and spe-
cific description of the collateral and the credit being extended. They
may require refiling for future extensions of credit. Other systems (for
59 The other Canadian provinces with PPSAs have adopted the rule that all commercial
leases over one year in length must be registered under the PPSA.
60 London & Cheshire Insurance Co Ltd v. Laplagrene Property Co Ltd [] Ch. ;
National Westminster Bank Ltd. v. Halesowen Presswork and Assemblies Ltd. []
AC ; Barclays Bank Ltd. Quistclose Investments Ltd [] AC .
systems for the enforcement of debt
example, the Spanish and the North American) require only a brief
notice, including items like the debtor’s name and address, the creditor’s
name and address, and a general description of the collateral, often by
category or type. The assumption underlying the second approach is that
the third party searching the public record for this information needs
only to be alerted to a possible problem so the debtor or creditor can
be contacted for fuller information. The second system provides less
information, at least initially, but is inexpensive to administer. The first
system is more likely to lead to invalidation of security interests for
technical and formal reasons, making their value less predictable.61 On
the other hand, the second system presumes a commercial culture in
which accurate information will be readily provided by the secured party
in response to a third-party inquiry.
To some extent, the two approaches just outlined for the content
of a registration overlap with the adoption of two different roles for
the registering public agency. In some systems, the agency conducts a
content review of each filing by a secured party and refuses to accept the
filing unless it provides properly the information required. This approach
is supported by the view that third parties should be able to rely on
a degree of control exercised by the responsible public agencies and
that commerce will function more smoothly with that confidence. This
“content review” approach may be more common where detailed content
is required.
The other approach is to accept any filing that appears conforming,
with little review by the agency. In this sort of system, the sanction for
failure to provide proper information is post hoc, in that the filing may
later be considered wholly or partially invalid because of the defect,
with a consequent loss of priority. This second approach has the great
advantage that the registry does not require a large number of employees
and elaborate rules, so that its functioning is cheap and fast. The secured
party has a substantial incentive to make the filing accurate, lest it be held
later to be invalid, while any problem as to the content of the registration
will have to be reviewed only in the small minority of cases where the
debtor defaults. Such an inexpensive system may be especially attractive
to countries in the development process that might otherwise find it
difficult to support a comprehensive registry. The second approach also
lends itself to an electronic registration system, which is much cheaper
61 Substantive review by the filing office may lead to refusals to file and therefore delays
and backlogs, rendering sales difficult.
chapter two
and faster than paper records and easier to set up and maintain. On the
other hand, a system with substantive review may be thought desirable
where parties do not have ready access to legal advice and therefore the
official review in effect assists them in filing forms that are legally correct
and enforceable.
The third question about registries is the degree of centralization. Ide-
ally, there would be one registry covering all possible contractual interests
(security interests and title retention interests) and legal privileges (pri-
orities by operation of law). The OHADA treaty is an example of one cen-
tralized registry, although admittedly in the context of exclusion of vari-
ous types of property and transactions from the coverage of the treaty.62
With one registry, a party dealing with a debtor (purchaser or creditor)
could easily and cheaply determine all interests other persons might have
in the debtor’s property. Unfortunately, no country has yet achieved this
ideal. There remain considerable differences of degree among countries,
with some having unified the registration process much more than oth-
ers.
The most important division is between movables and immovables
(personal and real property). Even modern systems generally have sepa-
rate registries for security in land, although with a variety of rules about
movables that are associated with land, such as machinery installed in a
building (“fixtures”). Hawaii is the only state in the United States with a
single statewide recording office for immovables and movable property
(i.e., real estate and Uniform Commercial Code Article ). Within the
category of movables, few countries have reached the ideal of a single reg-
istry, but some countries still have many separate registries (or other sys-
tems of publicity), while others have reduced the number of registries to a
few. Multiple registries may arise from having different registries for dif-
ferent types of collateral, different types of transactions, or different types
of industries (for example, farm products or commercial inventory). It is
not uncommon for legal privileges (priorities as a matter of law) to be
unregistered or to use a different registry. Multiple registries may also
arise, especially in federal states, from having registries administered at
the local or provincial level of government rather than at the national
level. Such is the situation in the United States where the Uniform Com-
mercial Code registries are administered at the state level but the transfer
of copyrights are the administered at the federal level in the United States
62 L’Organisation pour l’Harmonisation en Afrique du Droit des Affaires (OHADA Trea-
ty), Oct. , , available at http://www.ohada.com/traite.php. See infra ...
systems for the enforcement of debt
Copyright Office. This, in turn, has led to debate as to whether the federal
filing is exclusive or whether a filing may be made in either the United
States Copyright Office or by a U.C.C. filing.63
It seems clear that developed economies will move in the direction of
electronic registries that tend to favor less detailed notice and minimal
agency review, although an electronic registry does not require those
attributes. The key point is that electronic registration solves most of the
problems of multiple registries because it permits on-line searches of all
registries and the use of internet links among registries.
The search logic of the electronic system is also of great significance.
As the search logic of computers improves, the need to search under a
permutation of names (that is especially problematic for individuals) will
likely ease. For countries setting up new systems, a possible improvement
in the process to lead to greater accuracy in searches could be to search
by identification number and not by name.64
.... Other Methods of Publicity
Although registries are the most common solution to the problem of
publicity for priorities for non-possessory interests and privileges, three
other approaches are employed. A common approach is title registra-
tion. In many countries, some kinds of assets are considered so uniquely
valuable and vulnerable to misappropriation or fraud that a separate title
certificate is assigned to each such asset, and transfers in such assets are
recorded in a public file.65 Ships, airplanes, and motor vehicles are com-
mon examples. Where such a system exists and is intended to cover com-
prehensively all the possible interests in an asset, it is common that reg-
istration of security interests and other interests would be accomplished
through the title system.
In the case of security assignments of debts, some legal systems require
that formal notice of the security assignment be given to the person obli-
gated to the debtor on the debt. For example, if a store offered its accounts
63 See, e.g., National Peregrine, Inc. v. Capitol Federal Savings and Loan Association of
Denver (In re Peregrine Entertainment, Limited), B.R. (C.D. Cal. ) (finding
that receivables generated by a copyright must be filed in the federal system).
64 On the other hand, the revisions to Article of the Uniform Commercial Code in
the United States had unintended consequences, because computers are so literal minded.
Meghan M. Sercombe, Good Technology And Bad Law: How Computerization Threatens
Notice Filing Under Revised Article , Tex. L. Rev. ().
65 Tajti, supra note , at .
chapter two
receivable as security, the persons obligated on the account would have
to be notified before the assignment would be effective against them
or other third parties, such as subsequent assignees. The customers are
sometimes called the “account debtors” to distinguish them from the
debtor-borrower, the store in our example.66 In some systems, the notice
must be given by an official in a prescribed form. Obviously, notice to the
account debtor is necessary before the account debtor is legally responsi-
ble to pay the assignee (secured party) rather than the original party with
whom the account debtor contracted. However, in some systems failure
to give this notice has more serious consequences than the risk of a pay-
ment to the wrong party. At the most extreme, the notice is a condition
of validity of the assignment. In other words, the notice is a constitu-
tive element in the creation of the security; without notice to the account
debtor, the assignment has no effect, although there is no reason that the
secured party’s debtor should escape its contract because its customer
was not notified.
In other systems, the notice is necessary to provide publicity concern-
ing the assignment in addition to, or even in substitution for, public reg-
istration. However, notice to an account debtor does not fulfill any effec-
tive public notice function. Furthermore, such notice is impractical in
the case of bulk assignments and security over ongoing streams of receiv-
ables. The notice requirement is incompatible with the concept of secu-
rity over classes of assets and security over future property that do not
lend themselves to individual specification.
For these reasons, there is a definite trend toward elimination of notice
to the account debtor, except for the limited purpose of directing the
account debtor to pay to the assignee (secured party) when appropri-
ate under the assignment/security contract with the debtor. Notice to
the account debtor does not feature as a constitutive element of a secu-
rity assignment in the UNCITRAL Draft Convention on Assignment of
Receivables Financing or in the draft chapter on assignment in the forth-
coming part III of the Principles of European Contract Law prepared by
66 The UN Secured Credit Guide includes this discussion at ¶ :
“Finally, the debtors of the receivables may be notified that their receivables have been
the subject of factoring (notification factoring), or they may not be so notified (non-
notification factoring). When notice is given to the customers, it is often accomplished
by requiring the assignor to make a note on the invoices that the assignor sends to its
customers.”
systems for the enforcement of debt
the Commission on European Contract Law.67 A number of civil law
systems likewise have begun to adapt their laws in this regard.
Finally, some countries have a rule of publicity based on notice in
newspapers or official publications. On the whole, this approach has been
viewed as seriously flawed and it is not used in modern legal systems. It
requires a constant monitoring of the publications that are used. Often
those publications are not well-indexed, given their serial nature, so that
a person seeking financial information at a given time as to a transaction
with a new seller or potential borrower has no efficient or reliable way
of determining what interests may exist in the other party’s assets. This
approach also does not lend itself to transactions on a national scale and
may well become more of a “legal fiction” of notice than an effective
notice mechanism. On the other hand, posting on an official website may
be the wave of the future, at least where the relevant technology is widely
available.
.... Extent of Priority
The second major issue as to priority for secured parties is the extent of
that priority. That is, do security interests receive an unqualified prefer-
ence in the proceeds of the sale of the collateral over all other parties?
Some systems come close to giving such a complete priority, while oth-
ers permit a number of other interests and privileges to come ahead of
a secured party’s priority. In the North American system for movables,
for example, only the costs of sale of the collateral and certain taxes come
ahead of a secured party’s priority. On the other hand, in the English sys-
tem, despite its favoring of secured credit, some privileges come before a
secured party’s “floating charge” priority, including insolvency expenses,
although holders of “fixed charges” (security interests on particular items
of collateral) receive a more absolute priority.68 Hence, the attempts by
67 The Principles are available in English at http://frontpage.cbs.dk/law/commission_
on_european_contract_law/Skabelon/pecl_engelsk.htm; See also United Nations Con-
vention on the Assignment of Receivables in International Trade, Sales No. E..V.
, http://www.uncitral.org / uncitral / en / uncitral_texts / payments/Convention_
receivables.html.
68 The amendments to the British system have abolished the “Crown priority” in favor
of setting aside a certain portion of the proceeds of sale for unsecured creditors. See,
e.g., Andrew McKnight, The Reform of Corporate Insolvency Law in Great Britain, []
J.I.B.L. . There is a similar “carve out” in German law but it supports administrative
costs. Braun, supra note , at , at § . A number of civil code regimes give a priority
to administrative costs to some extent.
chapter two
creditors in Commonwealth systems over the past few decades to have
their charges construed as fixed charges and thereby come ahead of the
preferential creditors.69 In France and Mexico, and in many countries that
have similar legal traditions, employees have a “super-priority” that over-
rides security interests.70
The subordination of the priority of a security interest to privileges like
taxes or employee claims in many jurisdictions exemplifies a “categorical”
priority, that is, one that is given to a certain category of debt regardless
of the date it arose or was registered. The other major method of deter-
mining priority among security interests and between security interests
and other priorities is by date, with the oldest priority ordinarily being
given first place. Within a rule of priority-by-date, there is variation as to
what date is crucial for priority purposes. For some priorities, the crucial
date is the date when the debt arose or became secured, while as to oth-
ers it is the date on which it was registered or otherwise publicized. In
some systems, there is an interaction between the two events—creation
and registration of the priority—so that registration is essential to prior-
ity, but once registration is achieved, the priority-granting date “relates
back” to the date the debt arose or became secured. There is sometimes
an interaction between the categorical approach and the chronological.
For example, priority might go to the debt first registered, but in case of
registration on the same day, a debt in one category (for example, taxes)
might have priority over other debts.71 Conversely, priority within a cat-
egory might be determined by date. Finally, some systems (for example,
the Spanish) traditionally gave a priority to interests publicly created in
a particular form.72
69 See infra .. and n. .
70 See infra ..., referencing the debate in China on this issue.
71 In many systems, certain privileges or liens, sometimes called “conservative privi-
leges,” that arise from transactions that enhance the property in question, take priority
over security interests and other priorities that arose earlier in time. These liens them-
selves may rank in reverse chronological order, last in time first in priority. For exam-
ple, France and the United States provide a “retention right” (not to be confused with
title retention), or “possessory lien,” that is given to certain providers of services such as
lawyers, accountants, or mechanics.
72 Another right of secured creditors, one that is both more and less than a priority, is
the right of separation from an insolvency proceeding See, e.g., Stacey Steele, Insolvency
Law in Japan, in Insolvency Law in East Asia – (Roman Tomasic ed., );
Braun, supra note , at –.
systems for the enforcement of debt
.... Proceeds
In a modern economy, collateral of one type is constantly transformed
into another. In an ordinary sale of goods, for example, inventory be-
comes accounts receivable or instruments, then cash, then the cash goes
to the purchase of the next batch of inventory. It is characteristic of highly
developed systems of secured credit that they extend the secured party’s
interest to the new type of collateral arising from the original collateral.
That process can be viewed as value-tracing through the transformations
of collateral.73 Thus the security interest in inventory becomes a secu-
rity interest in the resulting accounts receivable, and so on. Systems vary
greatly in the extent to which they extend the security interest to “pro-
ceeds” and whether the extension is automatic. The German and North
American systems are perhaps the most expansive in this regard.
The extension of security interests in proceeds makes security interests
much more effective, but it also raises a number of legal problems. One
legal problem is publicity. The new type of collateral that represents
proceeds of the original collateral may be subject to different publicity
rules. If, for example, the original collateral was an airplane subject to
a certificate of title system and the proceeds of its sale is a promissory
note, the method of publicity for the first (notation on the certificate)
will be different than the method for the second (probably possession or
registration). If the secured party is required to re-publicize (re-perfect),
then it must closely watch the debtor’s business. If not, then a later party
will not be alerted by the publicity represented by the title notation.
A second major problem is conflict in priorities between the secured
party with the priority interest in the original collateral and the one with
the priority interest in the new collateral. A typical example is a bank
account, in that both the bank (as lender) and the debtor’s inventory
supplier (on the basis of a proceeds claim) may have an interest. The
solutions to these and many other proceeds problems are complex.
To explore these solutions is beyond the scope of this chapter. Because,
as noted earlier, the German system creates a general commercial expec-
tation that there will be unpublicized security interests, the addition of
proceeds interests without publicity is not necessarily a serious burden.
Parties have made commercial adjustments to the system, although there
may be different views as to the efficiency of the required adjustments.
73 Lynn M. LoPucki & Elizabeth Warren, Secured Credit: A Systems Approach
(th ed., ), p. .
chapter two
By contrast, the North American systems have elaborate rules governing
publicity and priority in proceeds. Using the example introduced in the
last paragraph, under the Revised Article in the United States the bank
would ordinarily prevail as to the money in the account, unless the sup-
plier had taken steps to get a disclosed interest in the account itself. A
price paid for this sophistication, however, is the complexity that it pro-
duces.
... Setoff (Offset)
In many legal systems there is a right to set off mutual debts. That is, if A
owes to B and B owes to A, A may satisfy its debt to B by paying
the net amount, , to B. In English this right is called indifferently
“setoff ” or “offset,” with no difference in meaning. The economic effect of
a right of setoff is much the same as a security interest.74 In the foregoing
example, the debt that B owes to A is “paid” by the offset just as if A had
a security interest in an asset of B worth . Instead of A receiving, say,
of its debt in a insolvency distribution, A is allowed to cancel
of a debt that A would otherwise have to pay to B, a customer account
that is ordinarily an asset of B in an insolvency proceeding. Therefore the
right of setoff is often treated in insolvency as if it were a security interest,
although registration is not required. It is not uncommon for the right of
setoff to enjoy priority over a security interest in the debt held by the
debtor. The setoff right is most valuable in insolvency and is discussed
further in that part of this book.75
... Cross-Border
Internationally, there have been a few initiatives to develop cross-border
systems of secured credit, although these efforts are in the early stages.76
74 See, e.g., Afredo L. Rovira, Alehandro I. Lubinski, & Gonzalo Rovira, Security
Interests Under Argentine Law at (derecho de retención). This article makes the point
that property other than a debt can be retained if it relates to a claim against the debtor.
75 See infra ...
76 See, e.g., Nicola Yeomans, UNCITRAL Convention on Assignment of Receivables:
Toward a Uniform International Law of Bulk Assignments? [] J. Int. Bus. L. Rev. ;
Christel Bourbon-Seclet, Cross-Border Security Interests in Movable Property: An Attempt
at Rationalising the International Patchwork: Part , [] J. Int. Bus. L. Rev. ; Roy
Goode, The Protection of Interests in Movables in Transnational Commercial Law, Unif.
L. Rev. (). See generally UNCITRAL, Legislative Guide ().
systems for the enforcement of debt
Aside from these efforts, courts are required to apply choice-of-law rules
to determine which laws control as to transnational security interests
when the collateral is in more than one country. The traditional rule is
that the place of location of the collateral (“situs”) is controlling and that
is the rule in most countries.77 However, Article in the United States
has adopted a rule of the debtor’s state of incorporation as a substitute in
most domestic transactions involving intangible collateral like accounts.
In part, this change was a response to the difficulty of “locating” modern
intangible collateral like accounts and intellectual property. Most legal
systems have fictional “locations” for such collateral (for example, the
place where an account is to be paid) as a method of applying the
traditional situs rule. These questions are underdeveloped and in the
process of reexamination in many countries, so it is not possible to state
very much detail about their resolution. Some legal systems permit the
parties to choose the applicable law.78
Perhaps the most odd choice-of-law rule is found in the revision of
Article of the Uniform Commercial Code in the United States. For
debtor corporations organized under the laws of a country other than the
United States, perfection for non-possessory security interests requires
registration in the jurisdiction of the debtor’s place of business or chief
executive office, subject to an ex post determination by a United States
judge that the jurisdiction of registration has a system that has roughly
the same consequences that would apply under United States law.79
... Consolidation of Laws
In many jurisdictions, there are a number of different laws governing
secured transactions and related transactions like title retention, leasing,
and legal privileges. In others, the laws have been consolidated to some
extent. One of the greatest intellectual and practical accomplishments
of Article in the United States was the integration of most types of
secured transactions into one law, with variations in methods of publicity
(perfection) and other details, but with a single set of concepts and
priority rules. The latest revision has gone even further in bringing
more types of collateral and transactions into the coverage of Article ,
77 For example, see the EU Insolvency Regulation, Article .
78 Nigel J. Howcroft and Hugh Gillespie, Remedies under Security Interests (Bermuda),
in Fletcher & Swarting.
79 UCC –(b)–(c).
chapter two
although important categories of economically similar transactions (like
leases) remain outside its operation. Cutting against the approach of
Article are the problems that arise when laws are made exceedingly
detailed and complex, a problem that has been especially serious in
common law countries.
Going against the consolidation trend is the emergence of special laws
concerning certain types of financial collateral. A leading example is the
European Union Directive on Collateral.80
... International Initiatives
There are several international initiatives relating to secured credit. Par-
ticularly noteworthy are those of the European Bank for Reconstruction
and Development, which offers a Model Law based substantially on Arti-
cle ,81 and UNCITRAL, which has proposed a Model Law on the assign-
ment of receivables internationally.
... Immovables (Real Estate)
Mortgages on immovables are an important potential source of commer-
cial credit, although as an economy develops they tend to become less
important as compared with security interests in movables. These liens
will not receive extended discussion in this work for two reasons. First,
in a number of countries the entire system of land ownership and reg-
istration has serious defects, making impossible an effective system for
notice and enforcement of liens on immovables.82 The second reason is
that countries with workable systems of land ownership have systems that
are highly variable from country to country and are closely tied to local
real property laws and their particular histories. In most of those coun-
80 EU Directives: Directive //EC (financial collateral arrangements) and Direc-
tive //EC amending Directive //EC (settlement finality). Cf. France Eases
Restrictions on Collateral and Netting, Int’l Fin. L. Rev. (June ).
See, e.g., Nuria de la Peña & Heywood W. Fleisig, Romania: Law on Security Interests
in Personal Property and Commentaries, Rev. Centr. & E. Eur. Law ().
81 See Tajti, supra note , at . See generally Frederique Dahan and John Simpson,
The European Bank for Reconstruction and Development’s Secured Transaction Project: A
Model Law and Ten Core Principles for a Modern Secured Transaction Law in Countries of
Central and Eastern Europe (and elsewhere), in Kieninger.
82 See, e.g., Tajti, supra note , at n. (Serbia). See generally, Hernando de Soto,
The Mystery of Capital ().
systems for the enforcement of debt
tries the systems of security in immovables work reasonably well, subject
to broader institutional problems of judicial or administrative expense,
delay, or influence.83
Two points that should be considered nonetheless are non-judicial
enforcement and the modernization of procedures generally. There are
systems that use trusts or separate corporate entities to permit creditors
to take ownership of an immovable, or to sell it, upon a debtor’s default,
without incurring the expense and delay of a judicial proceeding. One
example is found in the “Deed of Trust” system in a number of jurisdic-
tions within the United States;84 another example is the procedure for
enforcement of mortgages in Turkey when there is acknowledgement of
default by the debtor.85 Mexico also has a trust system often used for
liens on immovables.86 On the other hand, enforcement procedures in
some countries are burdened with old-fashioned, inefficient procedures,
especially with regard to the mechanics of sales and the debtor’s right
to reclaim the property. Time and money can often be saved with more
modern procedures that still provide ample protection for debtor’s rights.
... Theoretical Debates
Although in this book we avoid purely theoretical discussions for the
most part, we should offer at least a glance at the longstanding and
extensive debates concerning secured credit in the academic literature
in the United States.87 The debate seems to have been sustained by a
sense, not often articulated, that there should be some justification for
giving certain creditors enormous advantages over others. For more than
a decade the debate centered on the efficiency vel non of permitting
secured credit. It began with a question: if interest rates were lowered
(good) by secured creditors because of their lowered risks, why would
not that benefit be canceled by interest rate increases by unsecured
creditors whose risk was increased by the grant of security? Various
83 Philip R. Wood, Comparative Law of Security Interests and Title Finance,
–, – ().
84 Restatement of the Law—Property Restatement (Third) of Property: Mortgages
§ .. See Bender et al., Modern Real Estate Finance and Land Transfer –
(d ed. ).
85 Id. at .
86 See ALI Mexican Statement App. E, .
87 For a sampling, see the authorities collected in Westbrook, supra note , at n. .
chapter two
reasons were advanced, including claims that unseured creditors relied
upon the “monitoring” of the debtor by the secured creditor, that the
grant of secured credit was a “signal” that the debtor was financially
sound, and that secured creditors (especially banks) would give the
debtor good advice and could make sure the debtor took it. None of the
justifications has won general acceptance.
More recently, the focus has been on the control that secured credi-
tors exercise over a debtor in financial distress, partly or wholly replac-
ing the role of the insolvency administrator. It is generally agreed that
control by secured creditors has increased, at least in the case of large
companies where management has been separated from ownership, but
there remains a fierce contention as to whether this development is to be
cheered or deplored.
chapter three
CORPORATE INSOLVENCY LEGISLATION
.. Introduction
This chapter introduces insolvency legislation and policy generally, but
with an emphasis on liquidation. Rehabilitation is discussed more fully
in Chapter . The choice between the two types of proceedings is one
of the issues that often must be considered prior to the commencement
of a formal proceeding. The other two are valuation of the business and
the liability of directors. We start with those three and then turn to the
procedure.
.. The Liquidation/Rehabilitation Dynamic
The choice between liquidation and rehabilitation is complex and dy-
namic, changing with evolving circumstances as a proceeding continues.
For that reason, it is important that there be readily usable procedures
for choosing liquidation or rehabilitation and for converting from one to
the other.
Some countries adopt a unitary approach (e.g., France, Germany,
Mexico) that establishes an interim period for review of the business
prospects before deciding on whether to liquidate or rehabilitate the
business. In countries that do not adopt the unitary approach, it is
particularly important that the court and participants have the ability
to request a conversion of the proceeding where, in retrospect or based
on a change in the financial circumstances of the enterprise, it becomes
apparent that rehabilitation can or cannot be achieved. As discussed
under the provisions on rehabilitation below, conversion to liquidation
might be appropriate even after a restructuring plan has been approved
if approval for the plan has been procured by fraud or the enterprise is
unable to perform its restructured obligations under the plan. Typically,
proponents of conversion will be those with a financial stake in the
outcome of the proceeding (e.g., creditors, management, unions, etc.).
chapter three
.. Valuation
Valuation issues are fundamental in insolvency cases. They are especially
important in reorganizations because a central point of the proceeding is
to avoid selling the property of the business, which means its value must
be estimated for various purposes. Prior to commencement of a formal
proceeding, valuation may be important to determine insolvency on a
balance-sheet basis, inter alia, to determine possible liability of directors
and officers and to permit a formal proceeding to be opened. It may also
be important to permit sale of the business as a going concern as part of
an out-of-court workout. In the Western countries valuation is generally
done by independent experts hired by individual creditors, by creditors
committees, or by management.
Once a case has been commenced, valuation is often immediately
important to determine the position of secured creditors pending pro-
posal of a reorganization plan and for evaluation of a plan when one
is proposed. In the United States, until the mid-s it was common
for creditor committees in larger cases to hire accountants to assess
the value of a distribution proposed in a plan of reorganization. In
the mid-s investment bankers started to get involved in the pro-
cess, and once one official committee hired one, it was only a short
time before almost all did in the larger cases. It is also common for
the debtor in possession in large cases to hire an investment banker
of its own. The upshot of this hiring of experts is that in the United
States creditors have come as close as they can get to full assessment
of the risks and values involved in a proposed plan of reorganization.
(Of course, this better assessment often comes at a high cost, includ-
ing delay.) On the other hand, in a typical reorganization, a full-blown
valuation of the company usually will not be necessary unless a cram-
down1 is proposed. In smaller cases, where less expensive approaches are
necessary, accountants and uninvolved bankers are often employed. In
real estate cases, the relevant expert is typically a specialist in real estate
appraisal.
1 See infra ...
corporate insolvency legislation
.. Director and Officer Liability
... Comparative Legislative Survey
.... Background: Common Law/Case Law Approach
Over the years, various case law approaches have developed in many
common law systems regarding when directors may be held liable for
actions that lead a company into insolvency. In a recent paper, one
commentator discusses the development of the following common law
principles in England:2
. The imposition on directors of duties of good faith and the practice
of care and skill;
. The assurance that a limited liability company’s capital would be
available to creditors by requiring that dividends be payable out of
profits and by prohibiting companies from purchasing their own
shares or issuing shares at a discount; and
. The development of the ultra vires doctrine, by which a court could
declare actions outside a company’s object clause to be void (includ-
ing misfeasance, breach of fiduciary duty, or unlawful conduct).
Similar principles have developed in other common law jurisdictions.
Other principles include holding directors personally liable under argu-
ments based on the “piercing of the corporate veil” and imposing a duty
to creditors when a company is insolvent or in “the zone of insolvency.”3
Over the years some of these common law principles have been cod-
ified in the companies or corporate law of common law jurisdictions.
For example, in Canada creditors and shareholders rely on corporate law
oppression remedy provisions in attempts to pierce the corporate veil.4 In
some jurisdictions, directors can also be held personally liable for unpaid
wages owed to workers.
2 Harry Rajak, Director and Officer Liability in the Zone of Insolvency: A Comparative
Analysis, II Potchefstroom Elec. L. J. ().
3 This duty has been expanding in a number of jurisdictions despite academic criti-
cism. See generally, Henry Hu & Jay Lawrence Westbrook, Abolition of the Corporate Duty
to Creditors, Colum. L. Rev. ().
4 Janis Sarra, The Oppression Remedy: The Peoples’ Choice, in Annual Review of
Insolvency Law (Janis P. Sarra, ed., ).
chapter three
However, it must be noted that, although these principles will often be
applicable in insolvency situations, the principles themselves are broader
than that and also apply to non-insolvency situations. The primary diffi-
culties with the common law approach are that it requires litigation, it is
expensive, and many of the principles require burdens of proof that are
difficult to meet, with the result that cases are infrequently commenced.
.... Specific Insolvency Law Statutory Provisions
In many jurisdictions in which the company law has English origins,
the legislator has supplemented the case law approaches described above
with corporate insolvency law provisions prohibiting fraudulent trading
and, to an increasing extent, wrongful/insolvent trading. Examples can
be found in the United Kingdom, Australia, Hong Kong, New Zealand,
Singapore, and South Africa. These provisions are triggered by the wind-
ing up of a company.
..... Fraudulent Trading
This provision provides for both civil and criminal liability against any
person who was knowingly party to the carrying on of business where it
appears that any business of the company has been carried on with intent
to defraud creditors of the company or creditors of any other person or
for any fraudulent purpose. Of course, in particular jurisdictions there
are differences in application. For example, in England and Australia,
the provision may be used only by the liquidator; in Hong Kong, the
official receiver or any contributor or creditor may also bring suit. In
South Africa, creditors may also bring suit.
The scope of the potential target of the provision is broad. Of course,
directors will be the main target but other potential targets might include
shadow directors, creditors, or holding companies. As the standard of
proof is very high (requiring proof of dishonesty), the provision is rarely
used. Moreover, in those cases in which civil recovery is sought, the
potential defendants may have little or no resources. Forcing them into an
insolvency proceeding will be of little benefit to the insolvent company’s
creditors.
The South African provision extends the scope of this provision to
also cover persons who carried on the business of the company “reck-
lessly,” which has been interpreted by the courts to mean with gross neg-
ligence.
corporate insolvency legislation
..... Wrongful/Insolvent Trading
Because fraudulent trading is notoriously difficult and expensive to
prove, several countries (e.g., the United Kingdom, Australia, New Zea-
land) have enacted wrongful or insolvent trading provisions that apply
where a company incurs a debt at a time when it is unable to pay its debts
as they fall due. In some jurisdictions, the provision applies only against
directors (e.g., Australia); in others, to other specified individuals (e.g., as
proposed in Hong Kong, to directors, shadow directors, and senior man-
agement). Unlike fraudulent trading provisions, these provisions provide
only for civil liability and do not require proving the dishonesty of a direc-
tor. Where a company has gone into insolvent liquidation and the liq-
uidator believes that it has engaged in insolvent trading, the liquidator
may apply to the court for an order declaring that a responsible person
or former responsible person is liable for insolvent trading.
There are subtle and sometimes quite significant distinctions in the
legislation of different countries,5 but there is sufficient similarity in
the underlying principles to enable certain useful generalizations to be
drawn. The conduct of the responsible person or persons—that is to
say, directors and other officers of the company—must be such as to
fall below that of a reasonable person. It must also—under the United
Kingdom regime—have contributed to the insolvent liquidation of the
company and—under the Australian regime—have caused the incurring
of a debt at a time when the company was either already insolvent or
would become insolvent as a result of that further debt. The insolvent
liquidation of the company is not a necessary condition for the invoking
of this provision in all jurisdictions, but given the circumstances, it is
highly unlikely that this provision would be invoked except where the
company has, in fact, gone into insolvent liquidation.
The conduct of the defendants will be judged by reference to a par-
ticular point in time identified by the court in its post hoc analysis of
the circumstances. Under the United Kingdom provisions, that point is
the time a reasonable person in the position of the defendant directors
or officers would or ought to have known that the company could not
avoid insolvent liquidation and would, therefore, have taken all possible
steps to minimize the loss to creditors. Under the Australian legislation,
5 See Andrew Keay & Michael Murray, Making Company Directors Liable: A Com-
parative Analysis of Wrongful Trading in the United Kingdom and Insolvent Trading in
Australia (), International Insolvency Review –.
chapter three
that point is the time when reasonable grounds exist for suspecting that
the company is insolvent or would become insolvent if a further debt
were incurred. A strict rule prevails in Germany, where the director of a
GmbH has the duty to check constantly whether or not the company is
insolvent. If so, the director has the duty to seek a company filing within
three weeks.
These provisions also include some defenses for a responsible person:
for example, that he took every step that ought to have been taken to
minimize the potential loss to the company’s creditors after the time he
became aware (or ought to have become aware) of the unavoidability
of insolvency. An additional defense recently proposed in Hong Kong
(the provision has not yet been enacted), that only applies to senior
managers, provides that a senior manager will not be liable if, before
the company incurred debt whilst trading in insolvent circumstances, he
issued a “warning notice” in the proper form to the company’s board of
directors.
..... Directors’ Disqualification and Overall Risk of Liability of
Directors
Here a sample of statutory provisions may be helpful:
() Several jurisdictions (e.g., the United Kingdom, Hong Kong) have
enacted statutory directors’ disqualification regimes, pursuant to which,
when companies are wound up, directors may be disqualified from serv-
ing as corporate directors if they are found to be unfit. These regimes
are as effective as the overall corporate and regulatory culture of which
they are part. For example, although the provisions in the United King-
dom and Hong Kong are almost identical, the United Kingdom provi-
sions have been far more frequently applied than those in Hong Kong.
The relevant law in the United Kingdom is the Company Directors
Disqualification Act . It provides that where the court has made a
disqualification order against a director or the director has given a dis-
qualification undertaking to the Secretary of State that has been accepted,
the director risks going to prison or exposing himself to personal liability
if he contravenes the order or undertaking. The order or undertaking is
interpreted substantively—the director cannot simply act as if he is no
longer a director, such as by changing his job description. He also cannot
give instructions for others to manage the company. In addition to being
prevented from acting as a director, an individual subject to an order or
corporate insolvency legislation
undertaking may also not act as a receiver of a company’s property
or be concerned with, or take part in, the promotion, formation or
management of a company.6
Part of the law’s success in the United Kingdom is tied to the adverse
consequences that result from being disqualified, including the public
shaming of a director, especially when a former director’s name is posted
on a website of disqualified directors, the Disqualified Directors Register,
that is maintained by the Companies House.7 To date, over , direc-
tors have been disqualified.
The INSOL International “Directors in the Twilight Zone” project cat-
egorizes countries by how they treat a director acting in the “Twilight
Zone” period when a company is in financial difficulty but it is not clear
whether an insolvency case or workout will occur. The initial INSOL sur-
vey in covered jurisdictions and the survey was expanded to
jurisdictions. The Overview to the INSOL study ranks common
law jurisdictions that adopt the “knowingly negligent” liability standard
(e.g., England, Australia, New Zealand) as medium risk jurisdictions for
directors.8
() United States—The United States has not enacted fraudulent trad-
ing or wrongful/insolvent trading provisions. It relies on common law
doctrines and state corporate laws.9 In the United States directors are
not infrequently forced to accept disqualification from public companies
through enforcement actions by the Securities and Exchange Commis-
sion. Directors in the United States are rarely held personally liable for
continuing to trade while a company is insolvent, and the application of
the “business judgment rule” works to the directors’ advantage. However,
class actions against directors are becoming increasingly common. The
“Directors in the Twilight Zone” project categorizes the United States as
a low risk jurisdiction for directors.
6 These issues and others are set out in a pamphlet issued by The Insolvency Service.
The Insolvency Service, Company Directors Disqualification Act and Disqualified
Directors: Effect of disqualification orders and disqualification undertakings, that may be
found at http://www.insolvency.gov.uk/pdfs/guidanceleafletspdf/cddadd.pdf.
7 See http://www.companieshouse.gov.uk/ddir/.
8 Philip Wood, “Overview,” Directors in the Twilight Zone II (INSOL ).
9 See generally, Hu & Westbrook, supra note .
chapter three
() Civil law jurisdictions
Germany—Contrary to the “vague” wrongful trading approach of
many Commonwealth jurisdictions, Germany instead opts for more ex-
plicit triggers. For example, directors in Germany are subject to criminal
and civil liability if they violate any “protection status” that provides
for the protection of others. They are also subject to criminal and civil
liability if they fail to petition for the commencement of insolvency
proceedings in a timely fashion. They are also liable to the company for
any payments made after a company has become illiquid or the discovery
of overindebtedness.
France—Directors in France are subject to “draconian personal lia-
bility” for their serious business mistakes that lead to the insolvency of
their company.10 Engaging in risky ventures, borrowing imprudently, or
engaging in similar actions leads to the personal liability of directors, and
it is not uncommon for the insolvency of a company to lead to the per-
sonal bankruptcy of the directors. Article L.– of the French Com-
mercial Code sets forth a list of actions by a director that may lead to the
personal liability or personal bankruptcy of a director. The “Directors in
the Twilight Zone” project categorizes France as a high risk jurisdiction
for directors.
... Relationship Between Director and Officer Liability and Corporate
Governance
It is clear that addressing directors’ wrongful behavior solely at the insol-
vency stage is almost always too late to help creditors. This point has
clearly been proved by the massive corporate failures in the United States
of Enron and Worldcom. In both cases, poor corporate governance pro-
cedures were at the heart of the problem. Such procedures lie outside
the scope of this book, but it is clear that when such procedures are
not followed, the risk of insolvency dramatically increases. By the time
fraudulent or wrongful trading provisions or directors’ disqualification
regimes are applied against directors of insolvent companies, the wrong-
ful behavior has already been committed. Although some of these provi-
sions will provide for the application of criminal and/or civil penalties, it
is the exception rather than the rule that the offending directors and offi-
cers are able to compensate creditors in full for the harm caused them.
10 Wood, supra note , at .
corporate insolvency legislation
Rather, the effect of fraudulent and wrongful trading (or directors’ dis-
qualification) provisions is the fact that rational directors will attempt to
avoid the application of such provisions by seeking assistance or filing for
bankruptcy protection rather than by engaging in the offending behavior.
To prevent such wrongful behavior (and, in turn, to prevent many
bankruptcies from occurring), the best safeguards are strong corpo-
rate governance and the efficient and effective enforcement of creditors’
rights.11 However, it must be borne in mind that effective corporate gov-
ernance procedures are more effective when they are part and parcel of a
strong corporate governance culture. In countries with such a strong cul-
ture, such as the United States, related factors include the active partic-
ipation of shareholders on corporate boards, the requirement that com-
panies publicize adverse corporate news in a timely and efficient fashion,
and the publication by leading magazines and newspapers of the atten-
dance record of directors and of the correlation of directors’ pay to cor-
porate performance. Class actions can also have a beneficial effect on cor-
porate governance.
A strong corporate governance culture is often less likely to take hold
in jurisdictions in which most companies are closely held—i.e., family
controlled—and less responsive to outside, public pressure. Closely held
companies are often reluctant to disclose adverse corporate news. In such
jurisdictions, it is necessary for the government and banks to jointly push
for effective corporate governance. At present, the global flow of capital is
another factor that leads to increased awareness of corporate governance
by such companies, because international capital is more likely to flow to
companies dedicated to effective corporate governance.
Overall, throughout Asia historically there has been less transparency
and less willingness by banks and financial institutions to disclose bad
news to the market than in the West. Consider, for example, the reac-
tion to Russia’s default on its international bond obligations in .
While United States banks and investment banks were quick to disclose
their expected losses from the default, such disclosure was quite rare in
Asia, a result of less comprehensive disclosure laws and a more secre-
tive Asian approach to disclosure. For example, it has been reported that
Japan’s banks apparently have objected to the promulgation of regulations
requiring banks to disclose the extent of their losses on derivatives.
11 See infra ..
chapter three
In the aftermath of the Asian financial crisis many called for
the reform of corporate governance procedures in Asia. Although some
changes have been made over the last decade, for the most part the
changes have not been dramatic. For example, after the collapse of Enron
an article in the Asian Wall Street Journal compared the situation in
the United States with that in Asia and concluded that “Enronitis” is a
problem in the United States because Americans had wrongly thought
that there was transparency; in contrast, in Asia, Enronitis was not much
of a problem because people already assumed that there was little or no
transparency.12
However, at least in relation to disclosure, the gap has been narrow-
ing, as is evidenced by the responses to the recent sub-prime crisis in
the United States. Global capital now demands more, and quicker, dis-
closure. More recently, it has not only been banks in the United States
that have disclosed (and later revised upwards) their expected losses on
investments related to the sub-prime crisis; banks in Europe and Asia
have also been disclosing (and revising) their expected losses on invest-
ments related to the sub-prime crisis.
This discussion is necessarily limited to those aspects of special impor-
tance in and near insolvency but effective corporate governance
throughout the life of a corporation is of great importance to any com-
mercial law system. Notably, the World Bank has been active in assess-
ing the effectiveness of domestic corporate governance systems around
the world and is furthering its efforts in collaboration with the OECD
through the Global Corporate Governance Forum.13
.. Scope and Commencement of Insolvency Cases
... Scope of Application
Reform legislation increasingly adopts the consensus that formal insol-
vency legislation should apply broadly to as many types of enterprises
and corporate enterprises as possible, with a few narrow exceptions for
certain entities.
12 See Sarah McBride & Phillip Day, Asia Looks Immune to “Enronitis”—Region’s
Investors Long Ago Learned not to Expect Transparency, Asian Wall St. J., Feb. , .
13 See http://www.worldbank.org/ifa and http://www.worldbank.org/gcgf.
corporate insolvency legislation
.... Financial Institutions, Insurance Companies, Regulated
Industries, and Other Groups
There is an ongoing debate among law reformers as to how best to
handle the insolvency of financial institutions and insurance companies.
However, at the outset it should be noted that it would be better to
refer to “regulated” industries and sectors rather than only to financial
entities and insurance companies. Other groups that might need special
treatment include stockbrokers, commodity brokers, companies wound
up by securities or market regulators, railroads, and utilities (e.g., electric
power and water companies). The special problem of foreign regulated-
industry debtors is not addressed here.
The first approach is to handle the insolvencies under separate legisla-
tion. The United States adopts this approach for the liquidation and reor-
ganization of banks and insurance companies. This is a sensible approach
for the United States given that: () the United States Bankruptcy Code
is a federal piece of legislation that permits commencement by creditors
for insolvency-related reasons and not by regulators for non-insolvency
reasons; () there are more banks and financial services companies (as
well as insurance companies, stockbrokers, and commodity brokers) in
the United States than in most other countries; and () the regulation
of financial services and insurance operations in the United States is
quite complicated and involves an overlap between state and federal law.
Given these factors, it would arguably be more complicated and, perhaps,
even unworkable for banks and insurance companies to be subject to the
United States Bankruptcy Code.
Other jurisdictions have separate legislation for reorganization and
liquidation and exempt regulated industries from one but not the other.
Hong Kong is a case in point, with certain defined regulated industries
(that are not exempt from the liquidation provisions in the Companies
Ordinance) exempted from the proposed Provisional Supervision legis-
lation. It is anticipated that the regulatory authorities for those industries
will amend the relevant non-insolvency legislation to cover the reorga-
nization of entities subject to the regulators’ control.
A second approach is to handle the insolvency of the regulated indus-
try under the generally applicable insolvency law as supplemented by
special rules within the insolvency law. The United States adopts this
approach, with special rules applicable to the reorganization of rail-
roads (handled pursuant to a special subchapter IV of Chapter of the
United States Bankruptcy Code) and to the liquidation of stockbrokers
chapter three
and commodity brokers (governed by a special subchapter IV of Chap-
ter of the United States Bankruptcy Code).
A third approach is to allow ordinary insolvency law provisions to
apply to regulated industries, as supplemented by additional provisions
in separate legislation applying to the regulated industry. Aspects of
this approach can be found in those jurisdictions that have adopted
the original English approach of incorporating corporate insolvency law
into company law. Although England has hived off its insolvency law
from its company law, many other jurisdictions have not yet done so.
Hong Kong is a case in point. In such jurisdictions, since there is not
a separate piece of insolvency legislation, statutory provisions that set
out the grounds for commencing the liquidation of a company include
insolvency-related grounds upon which creditors may rely, along with
the regulatory grounds that the government may rely on for winding up
a company that have nothing at all to do with insolvency. Other pieces of
legislation set out more detailed commencement procedures and other
criteria for liquidations commenced by the State against companies in
such regulated areas as banking, insurance, and stock broking. Such
petitions are called “public interest” petitions.
In such jurisdictions, “public interest” petitions are handled under the
usual insolvency provisions, as amended or supplemented by the relevant
provisions in other legislation that pertains to the relevant industry.
However, for the most part, the normal winding-up provisions in the
company law will apply to the companies that are the subject of the public
interest petition. Problems can occur under this approach, as is the case
in Hong Kong, in that the Companies Ordinance fails to cross-reference
the additional provisions that supplement or replace the provisions in the
Companies Ordinance in the case of a winding up on a public interest
petition.14 In other jurisdictions, all of the relevant provisions are either
included in a separate ordinance for the regulated sector or are grouped
in one chapter in the insolvency part of the Companies Ordinance setting
forth special rules for these types of cases (as in the United States in its
treatment of the reorganizations of railroads).
As noted above, England has enacted a separate piece of insolvency
legislation. Section of the Insolvency Act provides that the Secretary
of State may make an order setting forth that provisions relating to
14 See Charles D. Booth, When Government Intervenes: Winding Up Fraudulent Com-
panies in Hong Kong, Hong Kong L.J. ().
corporate insolvency legislation
liquidation and corporate rescue that are contained in the Insolvency
Act are to apply to banks. The Secretary of State did so in and
the Banks Administration Proceedings Order () provides that the
administration procedures in the Insolvency Act are applicable to banks.
A fourth approach for addressing the restructuring of regulated indus-
tries is to establish a separate administrative institution to liquidate or
otherwise dispose of non-performing assets. This approach was followed
by the United States in the establishment of the Resolution Trust Corpo-
ration in the aftermath of the Savings & Loan crisis in . This has also
served as the model in the aftermath of the Asian financial crisis in
many jurisdictions in that the financial sectors were reeling from the high
levels of non-performing loans (“NPLs”). Asset management companies
(“AMCs”) were established to assist with restructuring and the disposal of
NPLs in an orderly process. For example, the Indonesian Bank Restruc-
turing Agency (“IBRA”) was established in Indonesia, the Pengurusan
Danaharta Nasional Bhd (“Danaharta”) in Malaysia, and the Thai Asset
Management Company (“TAMC”) in Thailand. For the most part, these
entities were created as part of emergency measures and have been or
are now in the process of being wound down.15 More recently, China has
also adopted this model—but rather than establishing a single, central-
ized AMC, China instead set up four AMCs that were each linked to one
of the four largest state-owned banks.16
Which of these approaches is followed depends on the interaction
between the insolvency law and the regulated industry, the regulatory
framework for the regulated industry, and the history of the regulation
and administration of such regulated industries in the given jurisdiction.
.... State-Owned Enterprises
As a general rule, it is best for State-Owned Enterprises (“SOEs”) to
also be subject to the applicable insolvency law. Exceptions are some-
times necessary, however, in those jurisdictions in the midst of transition
from centralized, government-run economies to more market-oriented
economies. Of course, the debate in such countries often focuses on the
point in time when the SOEs should be made subject to the insolvency
15 Douglas W. Arner, Charles D. Booth, Berry F.C. Hsu, Paul Lejot, Qiao Liu &
Frederick Pretorius, Property Rights, Collateral and Creditor Rights in East Asia, in East
Asian Finance: Selected Issues Part III.B, – (Ismail Dalla ed., World Bank, ).
16 Id. at –.
chapter three
law. Making SOEs comply with insolvency prematurely can lead to dra-
matic increases in the unemployment rate as well as a significant knock-
on or domino effect on the financial sector that will, in turn, be forced to
write off high levels of NPLs.
It is not surprising that difficulties arise in these periods of transition
from the many conflicts of interest inherent in dealing with the admin-
istration of SOEs. Power struggles often arise. An insolvency law that
attempts to assert jurisdiction over all SOEs will often be opposed by gov-
ernment authorities that have been responsible for supervising particu-
lar SOEs, often for many years. In countries with SOEs it is not unusual
for the relevant state authority to have to give permission for an SOE to
file an insolvency proceeding. Thus, such authorities will try to retain
their influence over the SOEs subject to their control by lobbying for
the exemption of SOEs from the new insolvency law. Of course, as the
number of exemptions increases, the effect of the new insolvency law will
diminish for it is often the case that the entities most in need of the new
insolvency law are the oldest or largest and, in many cases, the most inef-
ficient SOEs. Whether or not the exemptions can be kept to a minimum
is a political issue far removed from insolvency law.
China, for example, has been dealing with this very issue. One of the
most significant areas of debate regarding the new Chinese insolvency
law was whether to apply the new law to SOEs. At an early stage it was
clear that there was a split in the drafting committee about how best to
proceed. However, during the years that the debate was ongoing, the Chi-
nese government commenced an ambitious scheme to close or otherwise
deal with those SOEs in most need of assistance. In essence, during this
period China established a bifurcated insolvency system with many of
the SOE insolvencies being handled under government policy decrees
and regulations and all other insolvencies being commenced under the
applicable insolvency laws.17 The new PRC Enterprise Insolvency Law
came into operation on June , . The goal of the Chinese govern-
ment is eventually to subject all SOEs to the new law, which will no longer
be administered subject to State Council regulations. However, it might
well be premature to proclaim the end of policy bankruptcies in China.
Article of the new law provides that the insolvency of SOEs shall be
handled within the time limit and to the extent stipulated in regulations
17 See Charles D. Booth, Drafting Bankruptcy Laws in Socialist Market Economies:
Recent Developments in China and Vietnam, () Colum. J. Asian L. , –
().
corporate insolvency legislation
issued by the State Council. In January , the State Council issued
opinions exempting roughly , SOEs from the new law through .
Only time will tell whether China’s dual track system will come to an end
in or whether further extensions will continue to be made.
... Defining Insolvency
The test for defining insolvency is a crucial aspect of an effective insol-
vency system because that concept serves a number of important func-
tions. Perhaps most important is determining a debtor’s eligibility for
an insolvency proceeding, which in most systems requires a showing of
insolvency. The problems with definitions based on balance-sheet tests
(“overindebtedness”) are legion: in countries with strict balance-sheet
tests, it is at times impossible to force a debtor company into an insol-
vency proceeding over the company’s opposition. Given the subjectiv-
ity and myriad difficulties involved in determining balance-sheet values
and the fact that this information is under the control of the debtor, this
should not be surprising. Thailand is an excellent case in point. It his-
torically has adopted the balance-sheet test. The Thai judicial decision in
Thai Petrochemicals (TPI) after the onset of the Asian financial crisis—in
which the court relied on a novel interpretation of the balance-sheet test
and ordered the debtor company to be wound up—was proclaimed at
the time as the most important commercial case in Thai history because
it was the first time that a court had ordered a company in Thailand to be
wound up over the company’s opposition.18
A cash flow, or liquidity, test is much easier to administer and fairer
to creditors because it puts the definitional factors within the control of
creditors—every creditor is able to seek repayment and if repayment is
not forthcoming (with a few exceptions, such as bona fide dispute), there
may exist a presumption that the debtor is insolvent. A debtor is obligated
to pay its debts when they become due and the failure to do so should
trigger an insolvency proceeding. Under this approach, the creditors will
not have to fight with the debtor over access to “confidential” data and
valuation experts will not have to be called to testify on whether or not
an enterprise’s assets exceed its debts. Common liquidity tests include a
finding that the debtor is “generally not paying” its debts (United States)
18 Of course, in retrospect it is clear that the debate over the propriety of winding up
the company was but the first stage of the battle waged by TPI’s management to retain
control over the company.
chapter three
or is “unable to pay its debts as they become due” (the traditional “equity”
test in common law countries). Several civil law countries use cessation
of payments as the test.19
... Commencement Criteria
Ideally, the commencement criteria for insolvencies should make access
to the laws convenient, inexpensive, and quick. Unfortunately, criteria are
too often ambiguous or include requirements that restrict access or are
cumbersome. These sorts of requirements will often lead to litigation at
the outset of insolvency cases and make for an inefficient system.
Insofar as a system depends on voluntary filings by debtors, insolvency
tests may be questioned as a necessary criterion for access. If debtors
are prepared to concede that they need legal protection because of their
financial condition, or imminent financial failure, it is not clear that the
delay and expense associated with an insolvency test produces a corre-
sponding benefit. The United States is a notable example of a system that
imposes no requirement of insolvency in voluntary cases, where the fil-
ing of a voluntary petition is equivalent to the opening of an insolvency
proceeding that might be either a liquidation or a reorganization.20 That
system relies on dismissal for “bad faith” filing as a protection against
abuse of the system. However, most systems require a showing of insol-
vency for both voluntary and involuntary filings, Mexico’s new law being
a recent example.21
For either voluntary or involuntary filings, delays often destroy value
for the debtor and its creditors and make it more likely that a proposed
rescue will result in a liquidation. Similarly, inconvenient and expensive
procedures will also deter creditors from filing for an insolvency proceed-
ing. The fewer hurdles there are, the greater the likelihood of a case going
forward in a timely fashion.
A factor that increases access to an insolvency proceeding is the adop-
tion of bright-line tests (for example, whether the debtor paid a debt
when due) rather than inquiries into a debtor’s intention or desire or
alleged misconduct (for example, whether the debtor committed an “act
19 European Principles § .. Tests often vary for voluntary and involuntary petitions.
20 Because the United States Chapter regime may be used to save value for equity
owners as well as creditors, an insolvency requirement would obviously be at cross-
purposes with one important function of its insolvency law.
21 ALI Mexican Statement at –. See also UNCITRAL, Legislative Guide on In-
solvency Law – ().
corporate insolvency legislation
of bankruptcy”). Although factors that set out subjective elements may
arguably lead to greater exactitude in determining which debtors should
be made bankrupt, this exactitude comes at a great cost because the
determination of such issues will inevitability lead to contested proceed-
ings and result in delay, uncertainty, and greater expense. In contrast,
although bright-line tests may lead to over- or under-inclusiveness in a
given case, this may be compensated for by the ease of administration
that flows from the adoption of such tests.
It is in this area that the criteria for access overlap with the definition of
insolvency. An insolvency test based on liquidity or cash flow provides for
much more efficient access than does a test based on balance-sheet con-
siderations even though it risks bankrupting a debtor with assets exceed-
ing liabilities. But too loose a standard for permitting an insolvency pro-
ceeding presents a countervailing risk. For example, a system that per-
mits a single creditor to force an insolvency proceeding (as in the United
Kingdom) may give too much leverage to creditors and permit initiation
of proceedings without sufficient information suggesting the existence
of a general default that requires collective action. Thus an important
aspect of every insolvency system is the extent to which it draws accurate
and precise lines for sorting out cases where the filing of a petition is the
result of a single creditor action and not an instance of real insolvency. Of
course, an attempt to seize the debtor’s property in an individual action
may lead to a needed insolvency filing by the debtor, a filing that might
not have been made but for the pressure of the individual action. The
same is true of an enforcement action or repossession by a secured cred-
itor.22 These actions may serve as informal creditor triggers for the filing
of an insolvency proceeding.
The power to initiate corporate rescue proceedings may be given to
creditors. However, it should be noted that it is usually true in Com-
monwealth countries (and other jurisdictions adopting English insol-
vency law principles) that only the debtor is able to commence formal
rescue procedures.23 It is likely that involuntary rehabilitation proceed-
ings, permitted in the United States and a few other countries, are not
common and are perhaps not likely to be successful. With regard to
the methods for attracting or forcing debtors into filing rehabilitation
22 See supra ...
23 However, it would be rare in such jurisdictions for debtors to resort to corporate
rescue without first consulting with its major secured creditors.
chapter three
procedures while there is still time to save the business, see Section
... below. Note also that in many jurisdictions (for example, France)
proceedings may be initiated by public authorities.
At the same time, it is important to remember that a number of systems
are unitary, in that they contemplate a proceeding being initiated without
an initial choice between liquidation and rehabilitation, with that choice
made following an observation period (e.g., France, Germany, Mexico).
Those systems have some important advantages,24 but one cost of such a
system is the complication of the choice of initiation standards because
both liquidation and rehabilitation situations have to be envisioned.
In systems that are not unitary, so that the original application repre-
sents a choice of liquidation or rehabilitation, there may be a mechanism
for conversion from one to another. Such a system permits the debtor
or a stakeholder to ask that the proceeding be converted from the initial
type of proceeding to one thought to be more appropriate.
... Assets Administered in Insolvency
At the outset, the administrator needs to identify all of the property
belonging to the debtor, including property obtained after the com-
mencement of the case. All systems dispossess the corporate debtor of all
or most of its property. The administrator must determine what property
is “the property of the insolvency estate or mass” or in general under the
administrator’s control regardless of the theory of dispossession used in a
particular legal system. Closely related is resolution of the problems that
can arise in relation to other rights in such assets. These problems increas-
ingly arise in relation to intangible property rights, the retention of which
might well be crucial to the ability of an enterprise to be restructured or
purchased by a third party and begin with a fundamental question: what
rights are to be treated as property? For example, is a government license
property of the estate?
In general, any interest the debtor had at the moment of filing that
can be sold or exchanged may be considered part of the property to be
administered and sold by the administrator. There may also be interests
that cannot ordinarily be sold (for example, an unassignable contract)
that should nonetheless be part of the administrator’s property.25 How-
24 See infra ...
25 See infra ...
corporate insolvency legislation
ever, some types of property raise conflicting policy issues. What about
lists of customers and their shopping and personal preferences that (in
some countries) conflict with the customers’ rights to privacy? While
their use by a rehabilitating debtor may be unobjectionable, should they
be sold to an unrelated company with whom the customer did not intend
to deal?26
.. Moratorium and Suspension of Actions
There is a consensus among experts that the moratorium on debtor and
creditor actions, and the consequent control by the court, ought to be
a broad as possible. The broad stay provided by article of the Model
Law on Cross-Border Insolvency promulgated by UNCITRAL illustrates
that consensus.27 It is clear, nonetheless, that some exceptions have to be
made and it is there that policymakers must consider certain alternatives.
... Lawsuits
All modern systems forbid enforcement of judgments, but some might
allow pending actions by or against the debtor to continue as far as judg-
ment without special court approval. Generally, that exception creates
some risks for stakeholders because debtors in the midst of financial cri-
sis may not be devoting the attention or the resources to defending or
prosecuting actions as they would under other circumstances. Thus, for
example, a default judgment for an inflated amount might be entered
against a debtor and taken as conclusive in the insolvency proceeding
whereas, on a proper adjudication, the action might have been dismissed
or judgment entered for a smaller amount. Such a result prejudices all
other creditors. One of the virtues of an insolvency proceeding is that it
usually permits all claims to be resolved in one court.
The Model Law itself excepts pending litigation under some circum-
stances. One concern is the running of a statute of limitations if suit
cannot be brought, thus barring a claim from being made. Suits can be
26 United States Bankruptcy Code §§ , (b)() (consumer privacy ombudsman).
27 U.N. Model Law on Cross-Border Insolvency (). See also UNCITRAL, Leg-
islative Guide on Insolvency Law – () (discussing the scope of application
of stays).
chapter three
exempted for that limited purpose or the statute of limitations on claims
can be suspended for a certain time or until the insolvency proceeding
has been resolved.28
... State Regulatory Actions
Regulatory actions that are not designed to collect money for the state
but to protect vital and urgent public interests may be exempted from
the stay. For example, if a debtor’s operations violate general health and
safety regulations, creating a present danger to others, then the state must
be permitted to take necessary enforcement actions.
... Other Exceptions
Other common exceptions include setoffs (discussed at Section ..),
closure of certain financial contracts (such as derivatives), and payment
to critical vendors in reorganization cases.
... Secured Creditors
Aside from timing, perhaps the most controversial aspect of the mora-
torium is its application to secured creditors. It is not uncommon for
the moratorium in European business rescue jurisdictions to exclude
secured creditors (e.g., Belgium, Denmark, Netherlands) who would thus
be free to pursue enforcement actions against the debtor. Some Com-
monwealth jurisdictions exempt only major secured creditors, that is,
creditors holding a charge over substantially all of the debtor’s assets.
The secured creditors are not exempt in rescue cases in France, Italy, Ger-
many, and the United Kingdom, among other countries. Making secured
creditors subject to the stay may be seen as more justifiable in rehabilita-
tion proceedings than in liquidations because an argument can be made
that, by subjecting the secured creditor to the stay, a reorganization is
more likely to be achieved that will benefit creditors generally.
A paradigm case would be one in which a secured creditor has a secu-
rity interest (or charge) in a piece of manufacturing equipment that is
being used to produce widgets. This piece of machinery is central to
any possible reorganization of the corporate debtor. If the secured cred-
28 E.g., in the United States Bankruptcy Code § .
corporate insolvency legislation
itor were allowed to take this asset and sell it to reduce its own liability,
the other creditors would be likely to receive nothing in the corporate
insolvency. However, if the secured creditor were subject to a morato-
rium, this would perhaps increase the likelihood that the bank holding
the security interest in the machinery could be protected at the same
time that the unsecured creditors could benefit from the cash flow gen-
erated from the sale of widgets produced by the manufacturing equip-
ment. Of course, to justify this intrusion into the secured creditor’s rights,
the insolvency law might ensure that the secured creditor is adequately
protected for any diminution in value of the secured asset that occurs
during the period that the creditor is prevented from asserting its pre-
existing rights against the machinery. This simple example demonstrates
the importance of understanding the place of the moratorium, or stay, in
a reorganization structure as well as the policy justification for delaying
the secured creditor’s assertion of its rights.
.... Protection
The protection for secured creditors restrained by a moratorium can
take a variety of forms. Clearly the adversarial process of discretionary
access regimes provides the opportunity for those who are opposed to the
debtor’s entry into the protective regime to state their case and to provide
evidence in support. Where the regime is automatic at the instance of
the debtor, there will invariably be a right for those who believe that the
regime is inappropriate to apply to court to have the protection set aside.
For example, in Australia, where the regime is automatic, protection of
other interests is provided by the requirement for the appointment of an
administrator, who is almost always a qualified accountant.
In the United States, the creditor may apply early, and often, for “relief
from the automatic stay” unless it is granted “adequate protection” of its
security interest. That protection is typically given by periodic payments
from the debtor or by an additional lien on other property of the debtor,
along with insurance coverage and similar protections. In addition, un-
der the United States system, if the protection given to the secured credi-
tor turns out to have been inadequate, it becomes a “super-priority” cred-
itor, ahead of almost all others, in the remaining assets of the debtor. In
other systems, secured creditors may have additional protections.29
29 See infra .... See also UNCITRAL, Legislative Guide on Insolvency Law
().
chapter three
Germany is an example of a civil law jurisdiction that bars lawsuits
while giving the administrator the right to dispose of assets subject to
liens (with some exceptions), but with protections for creditors, includ-
ing a right to suggest more favorable dispositions and a right to inter-
est.30
.... Receivership Regimes
Inevitably, the moratorium will have limited effect in the more than
common law countries that have fixed and floating charges.31 However,
this is beginning to change. One of the driving forces for this change has
been the promulgation of the London Approach and its adoption world-
wide in an effort to increase the effectiveness of out-of-court restruc-
turing. The London Approach32 has been adopted by many Asian coun-
tries in the aftermath of the Asian financial crisis. For example, in Hong
Kong the Hong Kong Monetary Authority (HKMA) and the Hong Kong
Association of Banks (HKAB) jointly issued guidelines for multi-bank
workouts that adopt as a central tenet the need for a standstill. Simi-
lar guidelines were adopted elsewhere in Asia, including the Jakarta Ini-
tiative in Indonesia, the Bangkok Approach in Thailand, the Corporate
Debt Restructuring Committee (“CDRC”) in Malaysia, the Hong Kong
Approach, and the Workout Accord in Korea.
Once banks start adopting standstills in out-of-court restructurings,
the notion of being bound by a moratorium in a formal insolvency pro-
ceeding is not as onerous as it might have seemed prior to the promulga-
tion of the London Approach. Hong Kong is a case in point because the
new proposed corporate rescue procedure provides for a moratorium.
If enacted, this will be the first statutory ban on the actions of secured
creditors in corporate insolvencies in Hong Kong. However, to gain the
support of the banking community, it was necessary to ensure that the
moratorium would be in place for as short a period of time as neces-
sary to achieve its purpose. In Hong Kong it has been proposed that the
moratorium should initially be in place for one month, with the possi-
30 Eberhard Braun, Commentary on The German Insolvency Code §§ –
().
31 Id, text at n. .
32 See infra ...
corporate insolvency legislation
bility of extension by the court for up to six months. Beyond six months,
the agreement of creditors will be necessary. Further protection has
been incorporated into the proposed Hong Kong legislation through
special treatment being provided for “major secured creditors,” which
are defined as creditors with a charge (fixed and/or floating) over sub-
stantially all of the assets of a company. Where a provisional supervi-
sion is commenced, within three days of commencement the provisional
supervisor must notify in writing any major secured creditor. The major
secured creditor has three days to respond to the provisional supervisor
as to whether or not it will support the provisional supervisor’s efforts to
draft a proposal for voluntary arrangement. If the major secured credi-
tor agrees, it too will be bound by the moratorium. If it does not agree,
then the provisional supervision will immediately cease and the major
secured creditor will be able to assert its pre-existing rights and appoint
a receiver (or receiver and manager) to protect its interests. In contrast,
all non-major secured creditors will be bound by the moratorium subject
to a right to seek exemption where the facts so justify.
The other large element of change was noted earlier—the fact that
the country of origin of the receivership system, the United Kingdom,
has adopted new legislation that greatly restricts its use, opting in favor
of a rehabilitation system governed by an administrator charged with
observing the interests of all creditors. It is fair to say that in all such
systems, the trend is strongly in favor of subjecting secured creditors to
the moratorium, although with often elaborate provisions for protection
of the value of its collateral as discussed herein.
... “Gap” Moratorium
When a “gap” arises between an initial filing and the opening of an insol-
vency proceeding, either: (i) the general moratorium must be imposed
immediately upon the filing of the application, voluntary or involuntary;
or (ii) provisional measures must be made available immediately, on an
emergency basis if necessary. In the first case, if there is an abuse of the
process, procedures may (and should) provide for an emergency hearing,
if necessary, to release the stay in whole or part. If there is instead a delay
in imposing the moratorium, then creditors will often find that key assets
have simply disappeared. It must be emphasized that these concerns are
even greater in a world in which enormous amounts of money (and even
property) can be moved very quickly around the world. Once control is
achieved, then the debtor can be permitted to operate in the ordinary
chapter three
course of business, with or without a monitoring system, until the court
decides to open or to decline to open a proceeding.33
.. Governance: Management
... Administrator/Debtor in Possession
This section discusses the appointment and operating functions of an
administrator, while Section . focuses on the qualification and regu-
lation of that official. When addressing the issues involved in the man-
agement of a bankrupt enterprise, a distinction must be drawn between
liquidation and corporate rescue.
.... Liquidation
In regard to the liquidation or winding up of an insolvent company,
there is a broad consensus that the pre-commencement management
should be replaced by qualified independent officials (administrators)
with authority to administer the estate for the benefit of creditors. Such
an official is generally entitled to take control of the property of the
company upon his appointment, and the company and third parties
should surrender property to him at that time. The official would have
the authority to delegate certain powers back to the company directors
and officials who would be required to report back to the administrator.
Although there is general agreement as to this principle, there are several
issues that are less likely to find such broad support.
The usual procedure would be for an independent official to be ap-
pointed by the court upon the commencement or declaration of the liqui-
dation. In an involuntary case, to appoint an official before a winding-up
order or order for relief is made, the court must balance certain factors.
To enable an independent official to be appointed prior to the making
of an order could create great hardship for a company if a winding-up
order or an order for relief was not eventually made. On the other hand,
if an official cannot be appointed as of the date of the filing of a petition,
this might lead to the dissipation of the company’s assets and thereby dis-
33 Cf. UNCITRAL, Legislative Guide on Insolvency Law (¶ ) () (dis-
cussing the use of provisional measures to protect the debtor’s assets where a preliminary
moratorium is unavailable).
corporate insolvency legislation
advantage the company’s unsecured creditors. In addition, where there is
no doubt that the company is bankrupt and will have to be wound up, the
company itself may be anxious for an interim appointment to be made
so that preparations for the winding up can begin as early as possible.
Therefore, most jurisdictions ensure a reasonable resolution to this
issue by providing that an administrator shall generally be appointed
upon the making of the winding-up order or the order for relief; however,
upon the filing of a creditor’s petition, where cause is shown, the court
may appoint an interim administrator (often with more limited duties)
until the time arises for the appointment of a permanent administrator.
In those jurisdictions where the legislation fails to set out the powers of
the interim administrator, a court order may do so.
Most jurisdictions provide that the official should be appointed by
a court. However, Commonwealth jurisdictions usually provide for an
out-of-court insolvent liquidation procedure called a creditors’ volun-
tary winding up. Such procedures are often more efficient and cheaper
than the court supervised alternative and provide for the appointment of
an administrator, initially by the company, with the creditors retaining
a right to choose their own administrator (liquidator) if they so choose.
Such procedures are only appropriate where the official chosen is suit-
ably qualified and independent.34 It should also be pointed out that in
such cases, provision is also usually made for the conversion of a vol-
untary winding up into a compulsory winding up where, for example,
the complexity of the winding up or the suspicion of bias warrants close,
direct court involvement.
Many jurisdictions prefer the formality of a court-appointed offi-
cial, often a government official (such as an Official Receiver or Official
Assignee).35 In some jurisdictions a government official may initially be
appointed. He might be given the authority to determine whether or not
to carry on in that capacity or he may be subject to later replacement
by an official chosen by the creditors. Increasingly, the individuals so
chosen must be registered insolvency practitioners who have qualified
as such through the obtaining of relevant insolvency experience and/or
the satisfactory completion of a formal course of instruction. One model
is for a roster system in which once an insolvency practitioner becomes a
34 See infra ..
35 Many of these officials belong to a worldwide association, the International Associ-
ation of Insolvency Regulators. http://www.insolvencyreg.org/index_main.php (last vis-
ited April ).
chapter three
member of the “administrators” panel, the practitioner is then appointed
in rotation with the other members (again, sometimes subject to replace-
ment at the discretion of the creditors). In some jurisdictions (e.g., the
United States) the administrator is usually legally trained; elsewhere (e.g.,
Commonwealth jurisdictions) the official is usually an accountant. Over-
all, the worldwide trend is for more and more insolvency work to be del-
egated to the private sector, subject to court supervision. Thus, in the
United Kingdom, for example, even in the case of a compulsory wind-
ing up, which has the most direct court involvement and supervision,
the liquidator will frequently be a member of the insolvency practitioner
profession.36
It is important to mention again one of the important differences
between American and English liquidation law: the effect of insolvency
law on the rights of secured creditors. In the United States, secured cred-
itors are bound by the stay and must go to court to seek adequate pro-
tection of their collateral but it is the administrator who has legal control
of the property throughout the reorganization. In contrast, in England
and Commonwealth jurisdictions that adopt the English approach, for
the most part the rights of secured creditors (whose security consists of
a fixed charge) operate independently of liquidation procedures. Where
the security is a floating charge, the matter is more complicated.37
.... Rehabilitation
In rehabilitation a number of jurisdictions appoint an administrator as in
liquidation but a number of others permit prior corporate management
to remain in control, an approach often called the “Debtor in Possession.”
One reason for the difference might be to take into account the fact that in
a rehabilitation scenario a company may well have spent weeks or months
negotiating with its creditors before any court process has taken place as
to the terms of a possible rescue. Thus, when a petition is filed it may
well be in a pre-packaged form or well along the way to the resolution of
many of the issues. The presumed expertise of business people to run the
company, rather than an accountant or lawyer appointed by the court,
is another reason. Moreover, in some jurisdictions only the company is
36 See infra ..
37 See supra ..
corporate insolvency legislation
able to petition for rescue, not the creditors, and retention of manage-
ment control is therefore an incentive for timely filing.38 Although the
different approaches to control of rehabilitation are discussed more fully
in Section ., it should be noted here that there are commonly these
options:
i. exclusive control of the proceeding by an independent administra-
tor or supervision of management by an independent administrator
or supervisor; or
ii. exclusive control of the proceeding shifting to an independent ad-
ministrator only if existing management proves incompetent or
negligent or has engaged in fraud or other misbehavior.
The first option has two alternatives:
a. exclusive control of the proceeding by an independent administra-
tor; or
b. supervision of management by an independent administrator or
supervisor.
The norm in Commonwealth jurisdictions and other jurisdictions fol-
lowing English company law is the (i)(a) approach in that once a com-
pany is ordered wound up the management’s powers cease and an inde-
pendent administrator, a member of the independent insolvency practi-
tioner profession (usually initially trained as an accountant), is appoint-
ed. At the other extreme, adopting the second option, is the United States
with a strong debtor-in-possession culture. Two countries adopting the
middle ground—the (i)(b) approach—are Canada and Mexico.
The new Chinese insolvency law offers another permutation—it pro-
vides for the appointment of an administrator to manage the debtor’s
property and business affairs but also permits the debtor to apply to the
court for permission to manage its property under the supervision of the
administrator.
A DIP, or modified DIP approach, may prove particularly useful for
closely held, family run companies whose management might be reluc-
tant to petition for corporate rescue if it automatically leads to their
replacement by an outside administrator.
38 That limitation may be de jure or, as in the United States, de facto because of the
risks and costs of involuntary proceedings.
chapter three
.... Administrator’s Financial Responsibility
A very important factor in any insolvency system is the extent to which an
administrator, in either liquidation or rehabilitation, is personally liable
for his or her activities as such. In virtually all systems, the administra-
tor will be liable in a civil action for damages from the administrator’s
misfeasance or malfeasance, although the standards (for example, negli-
gence versus gross negligence) may vary. It is common for that reason to
require that the administrator (if not a government official) post a bond
or other guarantee that an injured party can recover for the administra-
tor’s wrongdoing.
More difficult is the decision whether to make the administrator liable
personally for obligations incurred in the ordinary course of the insol-
vency proceeding. The benefits from doing so include the fact that sup-
pliers to the insolvency can feel more sure they will be paid even if the
assets of the insolvency are inadequate to do so and therefore will be more
willing to supply on credit. It is also true that the administrator will be
more careful about incurring debts if any shortfall, after application of
the debtor’s assets, will come from the administrator’s pocket. Yet, the
risk is that the administrator will grow too cautious, unwilling even in
liquidation to take steps that might maximize value (such as preparing
goods for sale or advertising extensively) because of the risk of personal
liability far in excess of the fees that might be earned in the proceeding. In
rehabilitation, the risk is much greater because the substantial expenses
of running the business could fall on the administrator and the adminis-
trator’s family if the attempt is unsuccessful, and it is even more likely that
the amounts at risk in that case would dwarf the amounts reasonably to
be earned as fees. Thus a system that is serious about rehabilitation must
probably decide to make only the assets of the debtor or the estate liable,
not the personal assets of the administrator.
As has already been pointed out, in the United Kingdom the receiver,
despite owing his or her appointment to the exclusive initiative of the
secured creditor, can be held liable for negligence where this causes loss
to others who have interests in the insolvency, for example a guaran-
tor of the company’s debt or, indeed, other creditors. In this respect,
the role and liabilities of the receiver are not without their compli-
cations and originally were virtually free from liability except at the
instance of the secured creditor by whom the appointment was made.39
39 See Harry Rajak, Can A Receiver Be Negligent?, in The Corporate Dimension,
(Barry AK Rider ed., ).
corporate insolvency legislation
In due course, however, as pointed out elsewhere,40 English judges
chipped away at the receiver’s erstwhile invulnerability.
... Governance: Creditors and Creditors’ Committees
.... Organization of Creditors
A number of systems, including those in many common law countries,
contemplate decisions being made by full meetings of creditors at crucial
junctures in a proceeding. Other systems provide for creditor participa-
tion primarily through creditors’ committees elected by mail or by proxy.
In general, the former approach is most useful with smaller companies or
where creditors are located in the same geographical region while the lat-
ter is more useful when there are many creditors or they are widely scat-
tered. Many creditors will be unable or unwilling to “throw good money
after bad” by devoting time and resources to participation in insolvency
proceedings. Thus all systems try to encourage creditor participation or
even control of proceedings, but it is also necessary to provide for guid-
ance of the proceeding by professionals alone where creditors are not
active.41 Some systems, as in Germany, use a full assembly of creditors
for ultimate decisions but may employ an interim representative creditor
council prior to the convening of the assembly.42
In a number of systems there may be appointed a single person to
represent creditors or a certain group of creditors.43
.... Creditors’ Committee Functions
A creditors’ committee or other creditor representatives can play a valu-
able role in insolvency cases and provide “double protection.” They may
be consulted on non-routine matters and have a right to be heard on key
decisions. The creditors’ committee may also play an important role in
disseminating information to creditors and in organizing creditors.
The scope of a creditors’ committee in a liquidation is much narrower
than in a rehabilitation. In a liquidation, the committee’s main functions
40 See supra .., ...
41 Some systems also provide for special procedural protections for employees as
creditors. This subject is dealt with below. See infra Chapter .
42 Braun, supra note at §§ –.
43 One example is the new Mexican law. See ALI Mexican Statement at .
chapter three
are to supervise the administrator and to provide the necessary approvals
where required. In a rehabilitation, in addition to providing these func-
tions, the committee also plays an integral role in approving (and perhaps
negotiating) the reorganization plan or proposal.
In general, a committee can serve a useful function as a sounding
board and in monitoring activities of the administrator, in processing
and distributing information to its constituents and in organizing cred-
itors for decisions on critical issues. Efficiency should be tempered with
accountability and transparency. Greater transparency and creditor par-
ticipation are generally required when regulations or institutions are
weak.
The court should take into account the views of creditors’ committees.
They should be consulted by the administrator or the judge and should be
given an opportunity to oppose major actions that will affect their inter-
ests. Having an ability to veto actions outright is less significant where
secured creditors have already been given the right to take their collat-
eral. In general, creditors tend to act rationally if they have full access
to information to make decisions and have a financial stake involved. A
creditors’ committee may also serve as a restraint on unreasonable cred-
itor expectations.
.... Transparency and Approval Rights
It is important to distinguish between issues of transparency and man-
agement. Transparency is designed to protect creditors by giving them
notice of issues that affect their interests and affording them an opportu-
nity to be heard. Notice does not in itself imply the right to approve or
make management decisions, as discussed above. Nonetheless, creditors
and a creditors’ committee can serve as an effective check and balance
on the activities of an administrator or liquidator with regard to major
decisions. A system will permit creditors to monitor effectively where
they are given an opportunity to obtain relevant, accurate, and current
information on the debtor’s enterprise, trading activities, and financial
affairs so that administrators can be held accountable for their conduct.
However, it often is true that, before the enterprise will agree to disclose
confidential information, it will require the creditors’ committee to sign a
confidentiality agreement to not disclose the information to competitors
or others without prior approval. While notice to the entire creditor body
may not be required, notice for the committee, major creditors (including
secured creditors), and fiscal creditors may be obligatory.
corporate insolvency legislation
Significant events might be published in an appropriate public jour-
nal to provide additional notice to creditors at large. For some major
decisions, the dissemination of notice often must go beyond the lists of
known creditors. For a sale of property of the estate to realize as high
a price as possible, parties outside the insolvency process must also be
notified. It is often in regard to the sale of significant assets that problems
arise and assertions are made that an insider or associate is benefiting
from its inside information at the expense of other parties. It is here that
judicial hearings can serve an important role in reassuring other creditors
that their concerns are being considered and that fairness will be done.
Notice is too often ignored in understanding and evaluating insolvency
systems. It is not a routine formality but central to an effective process.
.... Organization of Creditors’ Committees
The primary problem is that insolvency law in practice often creates dis-
incentives for active involvement. For a creditors’ committee to func-
tion properly and effectively, creditors must commit the time and energy
to make the committee a success. However, this can often be a time-
consuming, if not costly, endeavor. When creditors realize that they are
unlikely to receive a substantial recovery in a liquidation or a reasonable
payout in a restructuring, they frequently will make the rational decision
that their time and energy could be better spent elsewhere. Thus, it is not
unusual for the first few meetings of creditors to be well-attended but for
participation to drop off as a case carries on. In smaller cases, there may
be no committee at all.
Because of this natural tendency for creditors to lack interest in the
process, one should not underestimate the relevance of other aspects of
the insolvency process—such as the enactment of effective avoidance
and investigatory powers—in increasing participation rates. However,
rather than paying greater attention to this connection, law reform efforts
sometimes focus on streamlining the existing procedures—such as by
lowering the numbers necessary for quorums for creditors meetings (as
occurred in personal bankruptcy law reform in Hong Kong in the s).
Of course, different insolvency systems take on varying levels of credi-
tor participation. The United States system is unusual both in the levels of
participation and in the amount of time dedicated to the insolvency pro-
cess by creditors. It is not unusual in large cases in the United States for
there to be several unsecured creditors’ committees including separate
committees for unsecured debenture holder or for employee claimants.
chapter three
Arguably, part of the explanation for these occurrences is the fact that all
official committees can hire legal and other professional advisors (to be
paid for by the estate) and once one committee is armed in this way oth-
ers will follow. Another factor is the United States proclivity for debating
matters in open court.
The traditions and practices in other jurisdictions are quite different.
However, it is unfair to conclude (as have some United States courts)44
that other systems are less fair than American procedures because they
rely primarily on the skills of an experienced insolvency practitioner
serving as administrator rather than on the active involvement of cred-
itors in the process and the holding of more judicial hearings. A bal-
ance must be struck. Each approach has its merits and when evaluating
each system one must balance the increases in time and costs that result
from holding more frequent judicial hearings and involving more profes-
sionals in the committee process against the benefits resulting from the
increased transparency of the process.
For example, in jurisdictions where there are fewer well-trained insol-
vency professionals, the civil law approach of the appointment of an
interventor or inspector (or another creditor representative) has its mer-
its. The reliance on such an individual is also tied to the overall insol-
vency culture and the level of participation sought by creditors. There is
a tradeoff—there is no doubt that the use of an interventor or inspector
is more efficient than a full-blown creditor committee approach; on the
other hand, it is not as democratic and transparent.
Another difficult area is the composition of the committee. At one
extreme is the committee of inspection (British in origin) in which a vari-
ety of parties with an interest in the proceedings, including both creditors
and shareholders, may serve on the committee;45 at the other extreme is
the United States plethora of committees with not only separate com-
mittees of secured creditors but also the possibility of separate creditors’
committees for trade creditors, bondholders, and employees.
Rules and procedures are required to deal with such things as the call-
ing of meetings of creditors, the eligibility of persons to attend and par-
44 See, e.g., criticisms of Australian corporate insolvency procedures in Interpool, Ltd
v Certain Freights of M/V Venture Star, BR (DNJ ), appeal dismissed,
Fd (d Cir. ).
45 Only recently in did the Hong Kong courts rule that shareholders need not
necessarily be represented on a committee of inspection in a compulsory winding up of
an insolvent company. See Re Hung Fung Holdings Ltd [] HKCFI ( October
).
corporate insolvency legislation
ticipate in meetings (including voting rights and establishing a quorum),
and the chairing and general conduct of meetings. The committee itself
should operate according to by-laws, or another governing document,
adopted by the committee to normalize and define the parameters of its
operations and deliberations, but practices in this regard vary widely.
One point often overlooked is the procedure for voting. Because it is
often the case that creditors lose interest as the proceedings carry on, it
may make a real difference whether voting is only extended to creditors
who appear in person at meetings or by proxy or whether it should be
extended to creditors generally and allow for voting by mail or fax. In
this regard, the use of creditor representatives can prove of assistance.
Jurisdictions are beginning to take into account the potential benefits
of the Internet in organizing creditors.46 Internet websites and email
mailing lists could be created to disseminate information or even for
voting. Going forward, the web might well offer a cost-effective method
for increasing the involvement of creditors in the process.
.. Administration: Collection,
Preservation and Disposition of Property
Once the debtor’s interests in property have been ascertained, the prop-
erty must be collected. To assist the administrator in collecting the prop-
erty of the debtor, the insolvency legislation and rules need to include a
combination of sticks and carrots to ensure that company directors com-
ply. One such stick is to make the failure to comply with the require-
ments a ground for the disqualification of the director.47 In Hong Kong,
although these sections are not used as frequently as they are in England,
they do address common problems such as the non-submission of books
of account and the submission of incomplete books. A recurring prob-
lem in Hong Kong is that a Hong Kong company goes into liquidation but
most of its assets are in mainland China. When the directors either fail
to submit proper books of account or submit incomplete books, it makes
it difficult, if not impossible, for the liquidator to locate the assets. These
problems also demonstrate the cross-border difficulties that can occur.
Attention must also be paid to the ability of administrators to force
third parties to turn over property belonging to the estate. To what
46 See, e.g., http://www.enron.com/corp/ (website last visited April ).
47 See supra .....
chapter three
extent may the administrator exercise such powers, with or without
court coercion, and to what extent may such third parties raise defenses
such as professional liens?48 More modern systems adopt the principle
that all such property should come under the physical or legal control
of the court or the administrator, with the court then in a position to
adjudicate conflicting claims to the property. Strong legislation backed up
by strong decisions in the United Kingdom and South Africa have served
to favor the insolvency administrator as against claims by third parties,
for example, to retain documents relevant to the insolvency, or to resist
providing information as to events prior to the onset of the insolvent
liquidation, for fear of self-incrimination.49
The administrator must also make a series of quick decisions, includ-
ing whether to continue the business, with its salaries and other costs, in
the hope of getting a going-concern price. If not, then employees need to
be laid off, utilities shut down, and so on as soon as possible. It will also be
important to ensure the preservation of estate assets, which may require
insurance, for example, but may also require the fast sale of perishable
assets or assets declining rapidly in market value. Notice provisions may
be limited in this last instance.
Problems in the collecting of assets are exacerbated when the assets are
located in foreign countries. Of course, when the directors themselves file
an insolvency petition, they can take steps to minimize this occurrence—
for example, when an airline files for an insolvency proceeding, it is
sensible to do so when as many planes as possible are in the air heading
back to the jurisdiction in which the insolvency is occurring. But in
regard to those planes that are still on the ground when the petition is
filed, it is likely that the administrator will have difficulty in convincing
many foreign jurisdictions that his claims should take priority over the
various local mechanics’ liens against the planes.50
When an administrator tries to collect the debtor’s property, conflicts
might well arise with other parties asserting rights to those same assets.
There are two areas that need to be addressed specially: secured creditors
and retention of title creditors.
48 Professional liens may include liens of accountants and lawyers securing payment
for their services.
49 Sections –, United Kingdom Insolvency Act ; British & Commonwealth
Holding plc (Joint Administrators) v. Spicer & Oppenheim (Re British & Commonwealth
Holdings plc (No )) [] AC ; De Lange v Smuts NO and others, South African
Constitutional Court— () SA (CC); () BCLR (CC).
50 See infra ..
corporate insolvency legislation
... Rights of Secured Creditors
The earlier discussions have noted the very different positions of secured
parties in various jurisdictions, especially with respect to control of their
collateral.51 There are also differences in rights to the proceeds of the
sale of collateral. In some jurisdictions like the United States, the secured
party has first priority in those proceeds ahead of all claims except the
costs of sale. In other jurisdictions, certain preferred creditors (especially
employees)52 or even the unsecured creditor body may sometimes come
ahead of the secured party.53 In Germany, the costs of administration and
sale come first and are percentages fixed by statute.54
Potential conflicts in jurisdictions whose law is based on English
company law precedents might arise between the administrator and
creditors holding a charge over book debts. In such jurisdictions, it is
not uncommon for a secured creditor to take a fixed charge over book
debts and their proceeds, with a proviso that if the fixed charge is not
effective, then the book debts will be subject to a floating charge. The
distinction is an important one: first, because a floating charge is more
easily avoided than a fixed charge and, second, because a floating charge
has a lower priority of payment than a fixed charge.55 The issues regarding
the distinction between fixed charges and floating charges have been
among the most contentious in English security law. Cases have debated
whether it is sufficient for the categorization of a charge as a fixed charge
that the parties had intended that proceeds from book debts be deposited
into a blocked account. The alternative position was that a charge over
book debts could only be regarded as a fixed charge if the debtor was
unable to access the money paid into that blocked account, without the
permission of the chargeholder. A recent House of Lords case adopted
the latter view, that is to say the case was less concerned with what the
51 See supra ..
52 See, e.g., Sec. of the recently enacted PRC Enterprise Insolvency Law (adopt-
ed at the rd Session of the Standing Committee of the th National People’s Congress
on August , , and effective on June , ), which included a special priority for
various types of worker claims (wages, medical fees, and more) provided that the labor
claims occurred prior to the promulgation of the new bankruptcy law and existed until
the date the law came into operation.
53 The new law in the United Kingdom has such a provisions vis à vis the floating
charge. See § A, UK Insolvency Act .
54 Braun, supra note , at §§ –.
55 See supra ..
chapter three
charge said than with what the parties’ actual rights were.56 This decision
has been seen as concluding this debate—at least for the present.
... Retention of Title Claimants
Another possible class of claimants involves retention of title holders (for
example, sellers who retain title in goods sold until the purchaser pays for
the goods in full).57 In these disputes, as with conflicts over book debts
as discussed above, the resolution of the issue involves reviewing the
documentation that sets out the rights (in this case providing a seller of
goods with a retention of title, requiring the separate storage of the goods,
and giving the seller a right of re-entry upon default by the purchaser)
and ensuring that the procedures followed by the purchaser complied
with the requirements. One of the problems for holders of retention of
title interests is that even if the documentation is properly drafted, the
holder will lose if the company failed to store the goods in a way that
makes them easily identifiable. Part of the difficulty in jurisdictions that
follow this approach is that these interests may not be registrable.
... Other Priorities
Nearly all systems give priority to administration costs, including the
compensation of the administrator and various professionals and the
obligations of contracts adopted or created by the administrator. Obvi-
ously, without such priority no one would provide goods or services dur-
ing the proceeding.58 It is commonplace for insolvency systems to pro-
vide priorities among unsecured creditors as well, although some recent
reforms suggest a trend toward reducing or eliminating priorities (e.g.,
Austria, Germany, United Kingdom). The favored creditors will ordinar-
ily be paid in full or up to some stated limit before the other unsecured
creditors receive any payment. Although priority systems vary greatly in
whom they favor, a big three dominate: secured creditors (including title
claimants, as above), employees, and taxing authorities. In some jurisdic-
tions certain priority (or “preferential”) creditors will enjoy a measure of
priority even over secured creditors. One instance is discussed above.
56 National Westminster Bank plc v Spectrum Plus Ltd [] United Kingdom HL .
57 See supra ...
58 Some systems put these charges ahead of secured creditors as well.
corporate insolvency legislation
Recently, the issue of the competing priorities between employees and
secured creditors has emerged as one of the most contentious issues in
insolvency law reform.59 This is the very issue that held up Chinese law
reform efforts for several years and continues to delay an enactment in
Hong Kong. Under the old mainland Chinese laws—both the Trial
Insolvency Law for SOEs and the Civil Procedure Law for non-SOE
legal person enterprises—in bankruptcies, workers enjoyed statutory pri-
ority for their claims over unsecured creditors but were paid after secured
creditors. However, various State insolvency policy decrees provided for
special treatment for workers of some insolvent SOEs, pursuant to which
workers’ resettlement rights (and certain medical and pension benefits)
took priority over the rights of secured creditors. In drafting the new Chi-
nese insolvency law, a key issue was determining which approach to fol-
low. The draft adopted the approach in the and the laws
in which workers were given a more traditional priority. However, the
draft moved in the other direction and even exceeded the scope
of the PRC insolvency policy decrees, first by giving all workers prior-
ity over secured creditors and, second, by extending this protection to
a broader scope of employee claims. This issue continued to be debated
until the summer of when a compromise was finally reached regard-
ing the rights of employees vis á vis secured creditors: under the PRC
Enterprise Insolvency Law, secured creditors will have priority over all
workers’ claims arising after August , (the traditional approach
as contained in the earlier Chinese insolvency laws); however, certain
wage, medical, and insurance claims of workers arising before August
, (and continuing to existing as of June , ), shall have prior-
ity over the claims of secured creditors. (This was one of the few areas in
the new law where a policy disagreement was settled by a compromise).
In most jurisdictions the amount of such old claims would not be signif-
icant. However, given that some SOEs have not paid workers wages for
significant periods of time (many months and, in some cases, years), in
some instances these might well be substantial sums.60
Meanwhile, in Hong Kong the issue has not been able to be resolved.
Over a decade ago, the Hong Kong government proposed the Provisional
Supervision regime, whereby a company in financial distress would be
59See infra Chapter .
60Charles D. Booth, The Race of Two Tortoises: Insolvency Law Reform in Hong Kong
and China, () ABA China Law Reporter – (Nov. ); republished in INSOL
Electronic Newsletter (Jan. ).
chapter three
permitted to appoint a qualified professional to take over the manage-
ment of the company and develop a rescue plan. The Hong Kong Law
Reform Commission proposed that workers for companies using this
new procedure would be able to rely on the Protection of Wages on Insol-
vency Fund (“PWIF”), which provides financial assistance to workers of
companies that enter compulsory liquidation. However, the Hong Kong
government, fearful that the PWIF would become a corporate bailout
fund, rejected the use of the PWIF and instead inserted an unusual
requirement into the commencement criteria included in the Compa-
nies (Amendment) Bill : to utilize the Provisional Supervision pro-
cedure, a company would first have to either pay, in full, all the wages
and other entitlements owing to the company’s workers or set up a trust
account with sufficient funds to make such payments.
Of course, the obvious question raised by these proposals was how
a company in financial distress was supposed to find sufficient funds
to pay all workers their full entitlements. Rather than addressing this
concern, the government inserted the same proposal in the Companies
(Corporate Rescue) Bill . A government consultation paper issued in
September proposed a cap on such payments to bring the amounts
payable to workers in a Provisional Supervision in line with the amounts
that workers would receive in compulsory liquidations. However, this
cap would still require the company to pay individual workers up to
HK, (roughly US,),61 and little legislative progress has
been made since the conclusion of the consultation process in November
.62
Beyond the big three beneficiaries, the variation is remarkable. For
example, the United States for some reason favors grain farmers and
fishermen over other worthy claimants. Canada is like other jurisdictions
in favoring landlords, while the United States disfavors them.
One other major variation among systems relates to shareholder
claims of fraud in the sale of securities. The issue is whether those claims
should be treated as general unsecured claims (like most fraud claims)
or should have the lower position associated with the securities to which
the fraud related (for example, the purchase of common stock, with com-
61 See Philip Smart & Charles D. Booth, Provisional Supervision and Workers’ Wages:
An Alternative Proposal, Hong Kong L.J. – ().
62 Id.
corporate insolvency legislation
mon shareholders ranking below all creditors). In the United States, for
example, such claims are “subordinated,” while in Belgium they are not.63
The international trend is to cut back on the categories of protected
creditors in an effort to increase the distribution to unsecured creditors
generally. In the case of workers’ claims, this is easier in those jurisdic-
tions where the government is able to provide sufficient protection of
workers’ claims outside an insolvency proceeding.
Tax claims are another target. Australia has abolished the priority for
tax claims; interestingly, tax collection has actually increased as it appears
that the Australian tax authorities are more vigilant in policing their
debtors now that they can no longer rely on a priority in an insolvency
proceeding. On the other hand, critics argue that these changes merely
shift the burdens of insolvency onto other shoulders, mostly the taxpay-
ers’.
... Procedure
Procedures for resolving disputes over claims made against the debtor’s
assets will reflect the procedures generally following in litigation in each
country. Peculiar to an insolvency proceeding, however, is the role of
the administrator, who generally has the job of objecting to claims that
appear invalid or overblown, although creditors usually have the right to
object as well. This centralization reduces costs and is more efficient than
expecting each creditor to object for the common benefit.
Systems vary in their emphasis on thoroughness versus speed in the
claims process. The United States, for example, makes a claim “allowable”
in the amount claimed, unless an objection is made. Germany has a
similar system. A variety of rules can be found concerning deadlines for
filing claims and whether a debtor’s listing of a creditor is sufficient to
constitute a claim.
In looking at systems as a whole, the most important factor is whether
the claims process delays the proceeding as a whole, whether liquidation
or rehabilitation. A system that permits disposal of assets or approval
of reorganization to go forward while resolving claims later is likely
to produce larger dividends for creditors. However, that approach also
creates some difficulties as to voting.64
63 Lernout & Hauspie Speech Products N.V. v. Stonington Partners, Inc., F.d
(d Cir. ).
64 See infra ...
chapter three
.. Disposing of the Debtor’s Assets
The insolvency law should provide a mechanism by which sale of assets
subject to conflicting claims—ownership, leasehold, or lien—can go for-
ward without waiting for a final resolution of those claims. The assets can
be sold “subject to” a later determination of the rights of the claimants. If
absolutely necessary, they can be sold with those rights still attached, but
the prices obtained will obviously be very low. Some jurisdictions offer a
far better approach, which is to sell a debtor’s assets “free and clear” of all
other liens or interests, leaving the claimants to dispute over the proceeds
obtained in the sale. Because the law strips all conflicting interests from
the property being sold, it will bring the best possible price from buyers
glad to have judicial confirmation of their clear ownership.
It is very important to ensure, in the case of liquidations or of liqui-
dating reorganization plans, that the assets are sold for a reasonable sum.
The sale of assets is a major source of potential corruption or insider deal-
ing in an insolvency system. It is the norm, of course, that assets disposed
of in a liquidation will fetch a lower sales price than similar assets sold
under normal market conditions. Nevertheless, various procedural pro-
tections can be put in place to ensure that the process is fair and that it
maximizes the purchase price. The sort of protections found in modern
systems include the following:
– having valuations prepared by neutral, independent professionals
(especially important when dealing with real estate and specialized
industrial property);65
– providing proper notice to creditors and prospective purchasers and
permitting disgruntled creditors to seek legal redress if they have
concerns or objections in regards to the process;
– in some cases, requiring pre-bidder qualification and minimum
prices; and
– preventing and punishing bid rigging (that is, collusion among
bidders).
Of course, this is another area of the law where there often is a large gap
between the theory and the practice. It is important that the mechanisms
be both flexible and transparent. Even in jurisdictions where the laws are
clear and there are procedures in place to prevent insiders or associates
from buying back corporate assets at “sweetheart” rates, it is usually the
65 See supra ..
corporate insolvency legislation
case that the proceeds from such procedures are on the low side. This
result is further exacerbated in jurisdictions with poorly functioning
market economies or in insolvencies of state-owned enterprises where
the government wears many hats in the proceedings and might well serve
(or have a close relationship with the party that is serving) as seller, buyer,
and auctioneer, all in one.
One device increasingly used, especially in the sale of whole busi-
nesses as going concerns, is the “stalking horse” bidder. The administrator
arranges a contingent sale to an interested party at a set price, but the con-
tract states it may be cancelled (broken up) if a higher bid is received in a
stated time. To give the first bidder an incentive to enter into such a con-
tract, it will be paid a “breakup” fee of a substantial amount if its contract
is displaced by a higher bid. This device is sophisticated and sometimes
controversial but has become important in recent years.
Another problem is presented when a jurisdiction’s non-insolvency
laws prohibit or restrict foreign ownership in certain industries or sec-
tors. In an insolvency, such national policies are likely to lead to a lower
realization for assets and thus smaller distributions to creditors.
Overall, there are no factors more important in the disposal of assets
than maximum transparency and maximum publicity. Publicity attracts
buyers and transparency defeats fraud and collusion.
Finally, in keeping with the goal of maximizing the estate for the bene-
fit of creditors, the administrator may be entitled to abandon assets with
negative or insignificant value, providing the abandonment does not vio-
late compelling public policies (for example, abandonment of an envi-
ronmentally dangerous property). Notice to creditors of abandonment
should be required, however, as a check against carelessness or abuse.
.. Contracts
... Introduction66
Most insolvency laws allow the administrator to elect to continue or
repudiate (“accept or reject”)67 contracts based on a cost-benefit analysis
66 See generally, UNCITRAL Legislative Guide, ; Roy Goode, Principles of Cor-
porate Insolvency Law §§ ––, – (d ed. ). (United Kingdom); Eur
Prin. –, § ; Ian F. Fletcher, Insolvency in Private International Law –
().
67 Many different terms are used for the same actions. “Assume” is used here for
chapter three
of what is in the best interest of the creditors, accepting good bargains the
debtor had made and rejecting bad ones.68 In particular, rehabilitation
may depend on the ability to enforce contracts notwithstanding a right
of cancellation in the event of insolvency, to cancel contracts (including
labor contracts) to enable the enterprise to downsize its workforce to a
reasonable level, or to avoid burdensome contracts. The principle encour-
ages policy makers to take account of other policies that may provide a
compelling case for altering the commercial expectations and bargains
of the parties.
The calculus of costs and benefit of performing a contract is somewhat
different in insolvency than in a normal business context. If the contract
is accepted, in most countries it must be performed or damages paid in
full as a cost of the case.69 If the contract is rejected, the damage claim of
the counterparty is usually treated as a pre-insolvency unsecured claim,
which receives only a small percentage payment in most cases.70 Thus
acceptance can only be justified where the benefit to creditors is greater
than the full cost of performance, while rejection is appropriate when the
cost of performance by the debtor would be greater than the sum of:
a. the benefit of reciprocal performance still due from the counter-
party; and
b. the expense of paying a low-percentage damage claim for breach of
contract.
The decision is made almost entirely on the basis of the creditors’ inter-
ests, not those of the counterparty, but many insolvency systems provide
certain protections for the counterparty as well, especially in the case of
acceptance and continued performance.
Many contracts contain clauses forbidding assignment of the contract,
which would prevent the debtor’s rights from passing to the adminis-
trator. Many contracts also contain “insolvency clauses” (also known as
“ipso facto” clauses) that cancel the contract or permit its cancellation in
“adopt,” “accept,” “perform,” or “opt to perform.” “Reject” is used for “disclaim,” “disas-
sume,” or “refuse to perform.” “Assume” means to agree to perform a contract and “reject”
means to breach it.
68 For example, see the Mexican law, LCM article .
69 For example, in France such costs become “Article ” expenses and debts of the
estate. Anker Sorenson and Paul J. Omar, Corporate Rescue Procedures in France
() at , –. Germany, see Braun, supra note , at –.
70 Apparently, rejection damages are given a higher priority in Japan. See Council of
Europe () at .
corporate insolvency legislation
case of the insolvency of one of the parties (see below). If these clauses
are enforced in an insolvency proceeding, they will lessen or eliminate
the power of the administrator to maximize the value of the estate by
accepting good bargains and rejecting or disclaiming bad ones.
Discussions of contracts in insolvency often refer to “executory” con-
tracts. Obviously, nothing can or should be done about a contract that
is fully performed on both sides. Thus an executory contract is one in
which performance remains to some extent undone. Yet if the only per-
formance left is payment by the debtor to the counterparty or payment by
the counterparty to debtor, little thought is required about any contract
issue, because there is nothing left but a debt. It is the mutual dependence
of obligations that makes adoption or rejection of a contract an important
and often difficult business decision. Unfortunately, this state of mutual
dependence has sometimes been elevated from a business difficulty to
a legal one with the claim that only a contract with performance due on
both sides is executory enough (has a quality of “executoriness”) such that
it is permitted to be adopted or rejected.71 This mistake—a supposed legal
rule that only a contract with executoriness can be adopted or rejected—
in turn can give rise to a great conceptual tangle. The key point is that
mutuality is not a legal condition but an occasion for business judgment
as to whether the performance to be received by the debtor by adoption
is worth more than the cost of the debtor’s performance.
There are detailed rules governing different types of contracts, includ-
ing employee contracts72 and leases of real estate.73
... Decision to Terminate the Contract
Confusion can be avoided by a clear understanding of the fundamentals
of the problem. If the administrator determines to reject (not perform
and therefore breach) a contract, the estate is merely doing what any party
to a contract might do. The counterparty will be entitled to a damage
claim, as with breach by a solvent party, except that its claim will be
paid in tiny insolvency currency (perhaps the infamous cents on the
dollar) rather than in full currency units. The counterparty’s harm comes
from breach of contract, a risk with any contract, greatly worsened by
71 See Jay Lawrence Westbrook, A Functional Analysis of Executory Contracts,
Minn. L. Rev. ().
72 See infra Chapter .
73 See, e.g., Braun, supra note , at .
chapter three
insolvency. The harm is just the same, in most cases, as the harm suffered
by other creditors whose contracts happened to have been finished by
the time the insolvency proceeding began, so that the debts to them were
already fixed. (Excluded from this section are rights in rem or other rights
to obtain specific property, which are discussed elsewhere.) As such, the
counterparty has no more entitlement to percent payment or
percent performance than any other unfortunate general creditor. To give
it full payment or performance is to violate the equality principle, unless
creditors generally will benefit from doing so.
In many systems, the counterparty may not receive non-damage reme-
dies even if it would have been entitled to such remedies outside of insol-
vency. The reason is that other remedies—for example, delivery of goods
the debtor had manufactured but not shipped prior to the start of the
insolvency proceeding—would represent the equivalent of percent
payment to the counterparty, while other creditors of the same class—
almost always general, unsecured creditors without priority—would be
receiving far less. Therefore other remedies would violate the equality
principle. On the other hand, this view is not always followed. Some sys-
tems, for example, will permit a buyer of goods to demand shipment even
though the effect is to prefer the buyer over other unsecured contract
creditors. The policy reason for this result is not clear but it is consistent
with the rule in many civil law countries outside of insolvency that buy-
ers may demand delivery of goods from defaulting sellers.74 Similarly, in
common law countries, performance in kind may be required where the
contract is for the sale of real estate (immovable).75
... Decision to Continue the Contract
Where an administrator decides a contract should be accepted, the coun-
terparty is merely being held to its bargain with the debtor. Outside of an
insolvency proceeding, if it made a bad bargain, it would nonetheless be
required to perform. In principle, continuation of the contract in insol-
vency asks no more. Thus if the contract provides for the counterparty to
sell the debtor goods for , currency units and those goods are now
worth , units in the market place, the administrator will adopt the
contract, pay , units for the goods, and sell them for , units, thus
benefiting all the creditors by increasing the distribution to them. The
74For the situation of sellers, see supra, ...
75For example, this is true in the United Kingdom. Roy Goode, Principles of
Corporate Insolvency Law (d ed. ) at .
corporate insolvency legislation
good bargain has been preserved for their benefit and the counterparty,
having been paid as provided by the contract, has no legitimate com-
plaint. Any insolvency system should permit such results and most do.
The counterparty might have what amounts to an option to get out of
the contract if the contract contains an “insolvency termination” clause,
permitting termination of the contract if either party enters an insolvency
proceeding. Because on the facts of the example just discussed there is no
risk to the counterparty, its reason for termination might be merely that it
wants to get out of a bad bargain and make the , units profit for itself.
To avoid that result, some countries override such clauses, making them
unenforceable in insolvency while others permit them to be effective.76
This policy decision is an important one, especially in the context of
rehabilitation, where the power to accept good bargains may be essential
to rescue.77 It represents another instance of the balancing of the interests
of other creditors and other stakeholders generally against the interests of
a creditor counterparty to an incompletely performed contract. Much the
same situation may arise from an “anti-assignment” clause that forbids
the debtor from transferring its rights under the contract to a third
party. As discussed below, if such a clause is enforced in an insolvency
proceeding, it might prevent the estate or administrator from acquiring
the debtor’s rights in the contract.78 Again, some systems render such
a clause ineffective against an administrator so as to preserve the value
of the debtor’s bargain for the benefit of creditors. If such clauses are
permitted, the counterparty may get a windfall by virtue of escaping from
its bad bargain.
Nonetheless, some policymakers favor limiting an administrator’s
power by full or partial enforcement of an insolvency-termination clause.
Reasons supporting the right of a counterparty to cancel contracts under
such clauses are in reality arguments against the administrator’s power to
accept or breach contracts. These arguments include the following:
76 For example, see the LCM, art. ; Braun, supra note , at , § ; Eur. Prin.
–, § .
77 See generally Goode, supra note , at , –, (criticism of rule enforcing
such clauses, especially in rehabilitation proceedings).
78 Conceptually, such a clause has that effect in systems that conceive of the debtor’s
property being “conveyed” by operation of law to a legal entity, the insolvency estate, at
the moment the proceeding is opened. In those systems, an anti-assignment clause might
be claimed to prevent the property from passing into insolvency at all. Those insolvency
systems that conceive of the debtor’s property as remaining in the debtor, but taken from
his possession and control by the administrator, may not have the same difficulty with an
anti-assignment clause.
chapter three
– Where the parties have made several contracts between them, the
insolvent can “cherry pick”—that is, claim selective performance of
contracts profitable to the insolvent but cancel others. It is unrea-
sonable for a defaulter to have an advantage denied to the innocent
counterparty. One response would be a rule permitting a court to
aggregate apparently separate contracts where the parties intended
mutual dependence. For example, the debtor may have entered into
a franchise contract with a franchisor while also getting from the
franchisor a lease of the real estate where the debtor would operate
the franchise. The parties may have intended that the two apparently
separate contracts depend upon each other but may not have used
specific language to make this clear. In that case, the administrator
might be required to accept both or reject both, as if they were one
contract.79 On the other hand, if the debtor has two separate con-
tracts to buy two different types of goods from the same counter-
party and there is no contract language linking them together, the
law may conclude that they are truly separate and the debtor may
accept or reject either of them in the interests of creditors.
– If the administrator accepts some contracts and rejects others, the
result may be to prevent netting.80 One response is to permit netting
of some contracts and not others, leaving to the courts the some-
times difficult task of isolating contracts that should be eligible for
netting from those that are not. Alternatively, a finance ministry
could maintain a list of contracts exempted for netting purposes.
If a selective approach is not adopted, then all netting must be per-
mitted or none at all, and either of those choices will produce inef-
ficiencies.
– The insolvent estate is often unable to perform so there is no point
in forcing the other party to await a largely theoretical choice by the
administrator. If, however, the law permits a counterparty to ter-
minate unilaterally under an insolvency or non-assignment clause,
two serious problems are created. The first is that rehabilitation
will often become impossible because the business cannot main-
tain crucial contracts in the early stages of recovery. The second
problem, which arises even in liquidation, is that the possible ben-
efit of assigning a profitable contract to an eligible transferee is lost.
A response to this difficulty is to adopt a procedure that forces an
79 See infra .. regarding the “cum onere” rule.
80 Netting is discussed below under setoff and netting. See infra ...
corporate insolvency legislation
early decision on continuance of a contract and to deem the contract
ended if the decision is not made within the prescribed period.81
– It is inappropriate to compel a transfer of contracts to a different
unknown transferee. This point is clearly correct. As discussed
below, countries may provide that no approval of an assignment of
the contract by the administrator unless the assignee is identified
and determined to be ready and able to perform the contract.
... Risks to Counterparties
The most common risk to a counterparty is through continuation of a
contract. Although the counterparty is being held to its agreed bargain,
continuation of a contract with a party in an insolvency proceeding
presents risks not ordinarily present. The most important risk to the
counterparty is the risk of non-payment. For example, if the terms of
a contract provided for an extension of credit, in which the debtor
was not required to pay until days after delivery of the goods, then
enforcement of the contract by its terms would require the counterparty
to assume the risk of non-payment by the administrator for a period of
days. Even if the contract provided for payment on delivery and the
administrator promised to make such payment, the counterparty who
had to expend substantial sums to prepare the goods for delivery would
run a risk of harm if by the time of delivery the administrator was no
longer able to pay for the goods.
Some systems react to these risks by requiring the administrator to
provide some sort of guarantee of payment or performance to the other
party, perhaps by a bank guarantee or a letter of credit, even though
the original contract made no such provision.82 In other systems, the
administrator assumes personal liability for such contracts, so the coun-
terparty has a solvent defendant in case of breach.83 In still other systems,
81 For example, in a liquidation case in the United States a contract is deemed rejected
(breached) unless the administrator adopts it within days of the opening of the
proceeding. U.S.C. § (d)(). In Mexico, the LCM sets a -day period in article ,
third paragraph. See ALI Mexican Statement , sec. I, . Germany, Braun, supra note
, at .
82 For example, the Mexican law provides that the contract continues unless the
conciliator (administrator) objects. If it continues, the debtor must perform or secure
performance by a guarantee of some kind. ALI Mexican Statement , sec. I, .
83 For example, see Ian F. Fletcher, The Law of Insolvency (d ed. ) at –
, and Goode, supra note , () at , (in United Kingdom system, an
administrative receiver is personally liable for adopted contracts but an administrator
is not, although a new contract takes priority over administrator’s fees).
chapter three
however, the counterparty is forced to bear the non-payment risk on the
theory that it assumed the risk of the debtor’s insolvency by entering into
a contract with the debtor. That result is supported by the argument that
the risk is no greater by accident of timing. If, for example, there were
two creditors, A and B, with contracts allowing for payment days after
delivery, and A delivered the day before the proceeding began while B’s
contract was still unperformed on that date, a defender of the assumed-
risk theory would say there is no obvious reason B should be better
treated than A just because of the difference in timing of performance.
This policy decision—the allocation of the risk between perhaps blocking
rehabilitation by requiring assurance of payment or, on the other hand,
forcing the counterparty to take the risk of non-payment—is a highly
important one as a practical matter.
The most common increase in contractual power granted to the ad-
ministrator is the power to cure a default that may not have been curable
under the ordinary law of contracts. Thus a debtor might have fallen sev-
eral months behind on its land-lease rental payments before the insol-
vency proceeding began. If the administrator wishes to continue the
lease, the law may permit cure of the default by payment of the arrears
even if such cure would not ordinarily be permitted without the consent
of the landlord. In a rehabilitation case, for example, such a result may be
justified by a desire to ensure that a landlord who will be paid in full is
not permitted to frustrate a rehabilitation favored by the great majority of
creditors. The landlord, on the other hand, may feel that renewed defaults
are likely and it would strongly prefer in light of the earlier defaults to re-
lease the property to another party.
One rule protecting counterparties that may be universal is that the
administrator must elect to breach or continue a contract as a whole (cum
onere). It would be obviously unjust and productive of much mischief if
the administrator could elect some parts of a contract to continue while
breaching others.
Other rules designed to protect counterparties, in addition to the pro-
cedural rules discussed below, include flat prohibition of continuation of
certain kinds of contracts without the agreement of the counterparty. For
example, some jurisdictions impose such a rule with regard to contracts
with the government. Some of these are discussed below.84
84 See infra ...
corporate insolvency legislation
Of great practical importance is the rule with respect to the existence
or absence of personal liability of the administrator for performance of
assumed contracts.85 In some systems—for example the United King-
dom administration procedure—the administrator becomes personally
liable for the performance of “adopted” (continued) contracts, while a
liquidator is not so liable. Especially with regard to employees, that per-
sonal liability might operate as a significant disincentive to continuing
the business of the debtor because there will always be a risk of failure
and consequent liability for the professional who serves as administra-
tor. More commonly, as noted above, the counterparty is protected either
by a third-party guarantee (for example, a bond from an insurance com-
pany) or to a more limited extent by a right to priority payment from the
debtor’s assets.
... Assignment of Contracts
In more sophisticated systems, there is also the possibility of assignment
of a contract by the administrator to a third party for performance.
Obviously, this second stage may involve an even more complex set of
benefits and risks for both the estate and the counterparty. A common
example would be a debtor lessee who has a below-market lease for retail
space. The landlord would like to terminate the lease and re-lease to
another party at the higher market rate. The administrator would like to
continue the lease and sell its rights under the lease (often called a “sub-
lease”) to a third party, thus realizing the debtor’s good bargain for the
benefit of creditors. If the lease is freely transferable, then the only legal
question is the one just discussed: under what, if any, circumstances may
the administrator continue the contract and thus exercise the debtor’s
rights, including the right to transfer?
However, it is often the case that the contract has an “anti-assignment”
clause. As noted above, that clause may prevent the administrator from
acquiring any rights in the contract. In those systems where the adminis-
trator has the right to continue the contract despite such a clause,86 there
remains a further question as to the administrator’s right to take the sec-
ond step of transferring the contract to a third party.
One obvious point is that the counterparty never agreed to contract
with the third party and may not wish to do so. In some systems, the
85 Cf. ....
86 E.g., the United States. U.S.C. § .
chapter three
contract will not be transferable. In the systems that override the anti-
assignment clause so the administrator may transfer the contract to a
third party, the counterparty is generally entitled to some protection. For
example, the court may be required to determine that the third party
is a solvent and capable party to such a contract. Or the administrator
may be required to make some guarantee of the performance of the
third party (such as a bond) in a way that insulates the counterparty
from unreasonable additional risk. On the other hand, once assignment
is approved, the law may provide immunity from further liability under
the contract for the estate or administrator.
... Procedure
While avoiding the details of procedure, which necessarily vary from one
system to another, it is important to focus on some procedural points of
special importance in the area of contracts. The first is timing. Most sys-
tems have some time limit within which the administrator must decide
to continue or not continue each pre-insolvency contract of the debtor.87
Some have specific limits in the statute while others require the coun-
terparty to make a demand for a decision, after which the administra-
tor has a certain time to decide.88 Most systems anchor this procedure
with a default rule: if the administrator does not declare continuance or
non-continuance within the specified time, then the contract continues
or does not continue. Systems that adopt non-continuance as the default
rule89 sometimes have a different rule or no rule in a rehabilitation pro-
ceeding as opposed to a liquidation.
Two other procedural points often arise in the contract field. One is
that some systems require judicial approval of the administrator’s deci-
87 For example, in the United Kingdom the counterparty can demand a decision with-
in days. Fletcher, supra note , at –. In France, the time is one month. Soren-
son-Omar, supra note , at . In Indonesia, the period is set by the court if the parties
cannot agree on a time. Benny S. Tabalujan, Indonesian Insolvency law () at –
.
88 It is sometimes provided that certain types of contracts are subject to special timing
rules. For example, in France a lessor can demand surrender of the lease if rent is not paid
for two months. Sorenson-Omar, supra note , at . In the United States, a commercial
lease of an immovable or a movable must be adopted or rejected within days. U.S.C.
§ (d)(), ().
89 For example, this rule prevails in Indonesia. Tabalujan, supra note , at . The
Mexican system is one that adopts continuance as the default rule. See LCM art. XX. The
same is true in Belgium and, for the most part, in Italy. Harry Rajak, Peter Horrocks &
Joe Bannister, European Insolvency: A Practical Guide ().
corporate insolvency legislation
sion while others leave it entirely to that official (for example, the United
States and the United Kingdom, respectively). The second is the question
of continuation of a contract by conduct. That is, if the administrator
acts in a way consistent with continuation of a contract (as by encourag-
ing employees to continue to work), even though no formal continuation
is declared, will the administrator and the insolvency estate be bound?
This question is quite sophisticated and often not addressed in the insol-
vency statute. For example, the law in the United States on this point is
quite unclear. On the other hand, in the United Kingdom the possibility
of adoption by conduct is so clear that the statute expressly protects the
administrator from adoption of employment contracts by conduct dur-
ing the first days of an administration (rescue) procedure.90
There is a third question even less often addressed: what are the
obligations between the administrator and the counterparty during the
period within that the administrator is allowed to consider whether to
continue the contract or not? Must the counterparty perform as required
by the contract during that time? Must it prepare to perform where such
preparation cannot await the administrator’s decision? In either case,
if the contract is not continued, the counterparty may have incurred
damages after the opening of the insolvency proceeding while waiting
for the administrator’s decision. The law may have to determine to what
extent the resulting claim should be paid pro-rata as a pre-proceeding
claim or in full as a claim incurred by the administrator for the benefit of
creditors.
... Special Contracts
Because contracts are of so many different sorts in so many different
parts of a society, the general rules dealing with a debtor’s contracts are
often subject to exceptions for special contracts. To some extent, these
exceptions are inevitable because of the unusual social and economic
90 Section (), sch. B, United Kingdom Insolvency Act . In relation to employ-
ment contracts, an administrator will be liable (subject to the protection that any such
liability will be charged on and payable out of property of that the administrator had
custody) where he or she has “adopted” the contract of employment, and subject to the
provision that “action taken within the period of days after an administrator’s appoint-
ment shall not be taken to amount or contribute to the adoption of a contract.” See also
Goode, supra note , at –, ; ––, –.
chapter three
problems inherent in certain contracts. On the other hand, that fact
makes a perfect disguise for the desire of various creditor groups to evade
the collective rules of insolvency proceedings so they may benefit dispro-
portionately from special treatment. The policymaker will be constantly
presented with pleas for special treatment in this area. The key question
will be whether the pleader is genuinely in a position importantly differ-
ent from many other contractual parties.
To take the classic example of a contract that may not be adopted: if the
debtor was a portrait painter, the counterparty is not required to permit
the administrator to adopt the contract and paint the counterparty’s
portrait. Indeed, the administrator probably cannot assign the contract
to another good portrait painter because the nature of the contract is
so personal. This principle is much expanded in some systems to forbid
continuance of contracts that specifically contemplated performance by
the debtor uniquely, even though the debtor is a corporation and might
change its management and employees at will. An example is a court
decision in the United States making a patent license such a “personal”
contract where the licensee goes into an insolvency proceeding, so that
the administrator cannot accept and assign the license.91 While the result
is controversial in the United States, it illustrates how far the principle is
sometimes taken. Another common exemption is for contracts with the
government.92
Most systems will not permit the administrator to force the extension
of credit by continuance of a contract to make a loan. This rule, however
intuitively appealing, actually requires some difficult distinctions in those
systems that do not have a general rule requiring complete protection
for a counterparty. For example, if a contract for the purchase of goods
by the debtor can be continued without cash payment before delivery
or a third-party guarantee, as it can be in some systems, then how can
that forced extension of credit by the seller be distinguished from a
loan?
91 Some cases in the United States have gone so far as to deny acceptance even
in rehabilitation cases, where the debtor is in fact the same person with whom the
counterparty original contracted. See, e.g., In re Catapult Entertainment, Inc., F.d
(th Cir. ). Norway is another country where licensing agreements may not be
adoptable. Rajak, Horrocks & Bannister, supra note , at .
92 Yet another example: Under the recent Mexican law, no contract for services may
be rescinded, on whatever side the debtor may be—provider or purchaser. ALI Mexican
Statement , Sec. I,.
corporate insolvency legislation
Insurance contracts are also in a special category in many systems,
with a great variety of results,93 as are contracts with utilities, which are
often required to continue services.94
Employment contracts are given unique treatment in most insolvency
systems. Employment contracts are of two main types: the collective
rights won through a union and individual contracts with employees.
Both types of contracts are heavily protected in most systems, but only
in systems with extensive experience with rehabilitation has it been nec-
essary to go much beyond the priority of employee claims. In a rehabili-
tation, questions include the possibility of changing wage rates and work
rules to permit the business to continue. In this area, the insolvency rules
intertwine with labor laws in ways that make it very hard to generalize.
On the other hand, it must be candidly stated that rehabilitation is very
often not workable unless employees are prepared to sacrifice wage rates
and traditional work rules in the interest of preserving the business and
therefore their jobs. Ultimately, these questions are less matters of con-
tract than of labor policy versus rehabilitation policy.95
Contracts for the sale of goods are not “special contracts;” indeed, they
are almost the central example of treatment of contracts in most systems.
Nonetheless, it should be noted that these contracts are often subject to
special rules that have evolved over centuries of trading.96
... Leases
Leases in many legal systems may be regarded as a hybrid form, lying
between contract law and property law. Thus it is not surprising that
many systems have special rules for leases,97 although most treat them
under the general conceptual and legal structure associated with con-
tracts. Real property (immovable) leases may have different rules than
personal property (movable) leases. Within the category of immovables,
there are often distinctions between residential leases and commercial
93 For example, in Mexico see ALI Mexican Statement , sec. I,; in the United
Kingdom, see Fletcher, supra note , at ; Goode, supra note , at –.
94 For example, the United States provision (United States Code § ) and the United
Kingdom provision (IA § ).
95 See infra Chapter .
96 See supra ...
97 E.g., Germany. ff. IO; UNCITRAL, Legislative Guide on Insolvency Law
(§§ –) ().
chapter three
leases. The special social questions associated with a habitation may
protect the residential lessee more thoroughly than a commercial lessee.
Commercial leases are often of very great importance in rehabilitation
cases. On the one hand, below-market leases represent an asset that can
be sold, for example, where the debtor wants to close a certain retail
store but has a good price on the lease. On the other hand, the ability
to escape leases for money-losing locations by payment of only a part
of the remaining rent may be an important advantage of an insolvency
proceeding for a retailer whose survival depends on contraction of its
business.
A common problem with leases, especially of immovable property, is
a sub-lease, where the original lessee has assigned a lease granting all or
part of the leased premises to another party and later the original lessee
files in insolvency. The question is whether or not the sub-lessee’s rights
are dependent upon performance of the original lease by the original
lessee, now in an insolvency proceeding. Generally, the answer depends
upon non-insolvency law: what is the effect on the sub-lessee of a breach
of the original lease by the original lessee? Ordinarily, the parties will have
negotiated a clause in the sub-lease dealing with this very question. Much
the same problem arises where there is no sub-lease but the original lessee
has granted a security interest in its lease to secure repayment of a loan.
Much the same answer should apply.
Increasingly, the form of a lease transaction is being used to provide
finance, creating an economic relationship very similar to a secured loan.
The treatment of this sort of “financial” or “financing” lease is discussed
in Section ..
... Setoff, Netting, and Derivatives
In some common law countries setoff is permitted between solvent par-
ties but becomes compulsory on insolvency. In others, setoff is not re-
quired but is almost always in the interest of the counterparty. Gener-
ally, setoff is permitted only between two pre-petition debts or two post-
petition debts, but not between a pre-petition and a post-petition debt,
because the difference in value between the two types of debts (that is,
their different rights to priority in distribution) is usually so substantial
that setoff would lead to injustice.
Where setoff is compulsory—that is, where it takes place as a matter
of law without an election by either the debtor or the counterparty—it is
not subject to court control and may be governed by different choice-of-
corporate insolvency legislation
law rules.98 On the other hand, in some countries, including the United
States, setoff is an election by the counterparty and is restrained by the
automatic stay, so it may not be exercised without court approval once a
proceeding has begun.99
However, many countries provide an exception for certain financial
contracts.100 Policymakers have been persuaded that a number of these
financial contracts should enjoy virtually complete exemption from the
insolvency process (including the moratorium, the contract rules, and
the distribution rules), giving the counterparties to these sorts of con-
tracts far more favorable treatment than most creditors.
Netting is a more controversial subject.101 Nonetheless, some jurisdic-
tions (e.g., Belgium, France, Luxembourg) have granted exceptions to
the general insolvency rules for certain types of netting, again primarily
in the area of financial contracts, but its acceptance is significantly less
widespread than for setoff. The policymaker has similar policy consider-
ations to weigh in considering exemptions for netting.
The United Kingdom has a heady mix of principles. Netting is pro-
vided for by legislation in the financial services sector in domestic
cases.102 Yet, the netting arrangements of an international agreement
were specifically rejected by the House of Lords as incompatible with
United Kingdom insolvency principles. Finally, it might be mentioned
that the United Kingdom falls into the category of jurisdictions in which
insolvency setoff is compulsory.103
.. Avoiding Pre-Proceeding Transfers
Typically, insolvency systems permit recapture actions for as many as
four common types of pre-proceeding transactions. These transactions
may be subject to being treated as legally void, so that property the debtor
98 Goode, supra note , §§ – – –; pp. –. Some countries prohibit setoff
post-proceeding.
99 See U.S.C. § . See also UNCITRAL, Legislative Guide on Insolvency Law
().
100 In general, these are contracts that include “repurchase agreements” or “repos,”
“swaps,” and, more generally, “derivatives.”
101 “Netting” for present purposes means offsetting all amounts due under various
contracts between the two parties.
102 Sections –, United Kingdom Companies Act .
103 National Westminster Bank Ltd. v. Halesowen Presswork and Assemblies Ltd.
[] AC .
chapter three
has transferred, or its value, may be recovered by an insolvency repre-
sentative from the person receiving the transfer. (Some systems also per-
mit avoidance or cancellation of an obligation arising from a disfavored
transaction; references herein to “recapture” are meant to include such
actions unless the context suggests otherwise.) The four types are: trans-
fers in intentional fraud of creditors; transfers at an undervalue; pref-
erential payments to certain creditors; and invalid security interests.104
As to each of these, legal systems vary as to whether the transferee—the
person who received the property—can be required to return it if the
person receiving the transfer acted in good faith, gave value, or had no
knowledge of the crucial facts. Some systems permit such defenses by
the transferee, while others require a return of the property regardless,
although with some protection for any value actually given by the trans-
feree. In addition, many systems exempt certain types of transactions
from recapture. A common example is the exemption of certain financial
transactions, such as borrowing against stock or closing a derivative con-
tract. Financial contracts are frequently exempted from insolvency rules
because of arguments from the financial community that their contracts
require preferred treatment if the financial system is to function prop-
erly.105
... Generally
Three of the four types of avoidable pre-proceeding transactions are
avoidable because they are generally regarded as unfair or financially
harmful to the interests of all of the debtor’s stakeholders, especially
if they are executed in contemplation of a likely insolvency. These are
transfers in intentional fraud of creditors, transfers at an undervalue,
and preferential transfers to certain creditors.106 A transaction may fall
into these categories retrospectively—that is, it may be a transaction that
would not be regarded as morally or legally wrongful ordinarily but is
104 However, Germany has much broader provisions that may permit avoidance of
almost any action that disadvantages creditors. Christoph G. Paulus, Lessons to Learn
from the Implementation of a New Insolvency Code, Conn. J. Int’l L. ().
105 See, for example, § , United Kingdom Companies Act . See also ...
106 These general types of avoiding actions also appear in many systems in forms
directed at specific sorts of conduct. An example is the Canadian “settlement,” which
voids gratuitous transfers within one year of proceeding. See American Law Institute,
Transnational Insolvency Project, International Statement of Canadian Bankruptcy Law
() [hereinafter “Canadian Statement”] at .
corporate insolvency legislation
seen as harmful in light of insolvency. As discussed below, this area is
one in which a delicate balancing of competing social benefits is struck by
each jurisdiction. When the balance suggests that a particular transaction
is harmful, it may become legally avoidable. One tool that insolvency
systems often use to strike the necessary balance is an allocation of the
burden of proof in different ways for different transactions. For example,
a particular sort of transfer may be avoidable only if the person receiving
the transfer knew certain facts, but there may be a presumption that
person did know those facts unless that person proves otherwise.107
These avoidable transactions are different from other issues arising
in an insolvency proceeding, including various other types of fraud or
improper conduct, because the insolvency representative seeks to void a
specific transfer of the debtor’s property (or cancel a specific obligation)
that arises from a specific category of transaction often seen in the context
of insolvency.
These three types of avoidable pre-proceeding transactions are made
avoidable for the following reasons, inter alia:
i. To prevent fraud (for example, transfer of assets to hide them for
the later benefit of the debtor);
ii. To ensure distribution among creditors pari passu or by whatever
priority system the law establishes for distribution;
iii. To prevent favoritism, where the debtor wishes to advantage certain
pre-proceeding creditors at the expense of the rest;
iv. To prevent a sudden loss of value in a company that may force the
debtor into an insolvency proceeding that may have been unneces-
sary or that may impoverish the debtor just before court supervision
is imposed; and
v. To create a framework for out-of-court settlement so creditors will
know that last-minute seizures of assets by other creditors can be
set aside, an assurance that makes it more likely that creditors will
be willing to work with debtors to arrive at workable settlements
without court intervention.
These five policies, in turn, have evolved from three general principles in
insolvency cases: equal treatment of creditors with similar legal rights,
107 The German system of changing burdens for different types of transactions is
illustrative. Braun, supra note , at §§ –, –. Another example is from
the United States system: a provision that presumes insolvency for the days before
bankruptcy, for the purpose of preference avoidance. United States Bankruptcy Code
§ (b)(). See infra ...
chapter three
maximization of value to be shared, and encouragement of out-of-court
settlements. They in turn are balanced against policies concerned with
free and predictable commercial transactions, as discussed below.
The right to recapture transfers arising from these types of pre-pro-
ceeding transactions is generally limited to transactions that took place
within a certain period before the opening of an insolvency proceeding,
often called the “suspect period.” In some systems the period is a fixed
number of days, weeks, or months while in others it is measured from
the time the debtor became insolvent in one sense or another. Some
systems have one suspect period for all types of transactions while others
have different periods for different categories. The suspect period may
also vary for transfers to “insiders,” such as officers, directors, and their
relatives. There also may be changes in the burden of proof with respect
to insiders.
The fourth type of avoidable transaction, cancellation of a security
interest, rests on a different footing. The cancellation of a security interest
improperly created or perfected under security law is simply an instance
of enforcement of the rules concerning such interests in the context of
insolvency. The laws governing security interests have certain require-
ments, and creditors who fail to meet those requirements cannot expect
to see their security interests enforced. The policies served are those
established in the laws permitting the grant of security to creditors.108 On
the other hand, as noted above, even a security interest valid under those
non-insolvency laws may be avoidable in insolvency under one of the first
three headings listed above. For example, the grant of a security interest
shortly before the opening of an insolvency proceeding, although oth-
erwise valid, may be found to have been preferential because it favored
unfairly a certain creditor at the expense of the rest.
Although some or all of these four types of pre-proceeding transac-
tions may be subject to avoidance or a Paulian action by a creditor out-
side of an insolvency proceeding, the insolvency representative generally
has more opportunity and more incentive to bring such actions than any
one creditor. As a result, these actions are perhaps the most unique and
characteristic consequence of commencement of an insolvency proceed-
ing.
108 See supra ..
corporate insolvency legislation
... Intentional Fraud
Virtually all legal systems give creditors the right to avoid or cancel trans-
actions executed by the debtor with the intent to defraud creditors. A typ-
ical example would be a transfer to a trusted confederate, often a relative,
with the agreement that the property would be held for the debtor’s bene-
fit and re-transferred when the debtor’s creditors had ceased their efforts
to collect (a “fiduciacum amico”). Typically, the greatest difficulty in these
cases is proof of the intent to defraud. Some systems have presumptions
or other legal methods for making it easier for a court to find intentional
fraud under certain circumstances. For example, in Germany a transfer
within the proceeding years can be avoided if the debtor intended to
disadvantage its creditors and the person receiving the transfer knew of
that intention. If the person receiving the transfer knew of the debtor’s
illiquidity and the disadvantage to the creditors that would result, that
person is presumed to have known of the debtor’s intent.109 In many sys-
tems, these doctrines have evolved into rules that eliminate any require-
ment of bad intent on the part of the debtor, as explained below concern-
ing transactions at an undervalue. Where a debtor’s fraudulent intent is
found, systems vary as to the existence or absence of a requirement that
the person receiving the transfer also have a bad motive or guilty knowl-
edge, a point discussed under the heading “Defenses” below.
... Transactions at an Undervalue
A debtor who has no intent to defraud may nonetheless be in great need
of cash and may therefore sell property at a price substantially below its
real worth in order to obtain a quick sale. The result may be to reduce the
amount of property available to creditors when an insolvency proceeding
is commenced. In a number of jurisdictions, it is possible to recapture
such transfers, although frequently the person receiving the transfer is
assured of getting the return of the actual amounts paid to the debtor
for the property. Generally, the debtor must have been insolvent in one
sense or another at the time of the transfer or the transfer must have been
within the suspect period.
For example, in Germany such a transaction done during a three-
month suspect period may be recaptured if the person receiving the
109 See, e.g., Braun, supra note , at (German law).
chapter three
transfer knew the debtor was illiquid. The same transaction might be
set aside in the Netherlands if done within one year of insolvency, if the
debtor knew of damage to creditors from the transaction (presumed) and
it is shown that the person receiving the transfer knew of the prejudice to
creditors. In the United States, a transfer can be avoidable, and the prop-
erty recovered, regardless of the intent of the debtor or the knowledge
of the transferee, if the debtor was insolvent at the time of the transfer,
the value given the debtor by the other party was “less than reasonably
equivalent value,” and the transfer was made within one year of the filing
of the insolvency proceeding.
The changes in knowledge required or, just as important, in the burden
of proof concerning knowledge are well illustrated by a German example.
If the debtor transferred property to another during the suspect period,
the transfer might be characterized in three ways: as a congruent delivery,
an incongruent delivery, or an immediately detrimental contract. If a
transfer is a congruent delivery—that is, a transfer performed by the
debtor within the suspect period—and was in perfect accordance with
the underlying contractual or legal obligation, it would not be avoidable
unless the receiving person had knowledge that the debtor had ceased to
fulfill its obligations as they became due or knew about the filing of the
petition. If, however, such delivery did not take place in accordance with
the underlying obligation—i.e., if such delivery was performed before the
due time, if what was delivered was different than what was owed, or if
there had been no obligation at all for such delivery—then such delivery
was incongruent and recoverable if the receiving person could not prove
its ignorance about the debtor’s ceasing of payments or the filing of a
petition. The third category—the immediate detrimental contracts such
as an undervalue sale—covers more broadly what is already dealt with
by the section on transactions for inadequate consideration, except as to
remedy. If the contractual obligations were performed within the suspect
period, the section on immediate detrimental contracts allows for a full
recovery of the delivered goods—and not just that part for which no
consideration was given.110
The ultimate example of a transaction at an undervalue is a gift.
Because the debtor receives no exchange for a gift, if it is given at a time
when the debtor is in financial distress and unable to pay creditors, it is
often avoidable. In a number of systems (for example, Canada) the gift
110 To be sure, in detail these rules are a bit more complicated than described here. See
Braun, supra note , at –.
corporate insolvency legislation
may be avoidable regardless of insolvency or financial difficulty or of the
parties’ intent or knowledge if it is given within a stated period before an
insolvency proceeding.
It is noteworthy that these transactions may not involve any moral
or legal failing by the debtor or the person receiving the transfer. Often
they would be valid and unavoidable under normal circumstances. A
transaction for a below-market price is simply a bargain ordinarily. A
gift to charity might even be admirable in the usual case. It is the debtor’s
inability to pay creditors that makes these transfers subject to challenge
and possible avoidance. An old legal proverb explaining the difference is
“A man must be just before he is generous.” Another factor is the difficulty
of proving intent to defraud. A rule that looks at results, not intent, will
be easier to enforce, while an innocent transferee can be protected by
defenses, discussed below.
A central question in this category is how great the undervaluation
must be to make the transaction avoidable. This determination is gener-
ally left to the courts by the use of standards like “reasonable value” or
“market value.”111
... Preferential Transfers
Most insolvency systems provide for voiding a payment or other trans-
fer of debtor property to a creditor when the transfer gives that cred-
itor an unfair advantage in recovery over the other creditors with the
same legal rights. The common example is a payment to one unsecured
creditor shortly before the filing of an insolvency proceeding, enabling
that creditor to obtain a larger percentage of what it is owed than the
other unsecured creditors. There are various requirements and limita-
tions imposed on avoidance of such transactions but the most common
are that the debtor must have been insolvent in some sense at the time of
the transaction and that it took place within the suspect period.
Some systems, including the English, require that the debtor be “influ-
enced” by a desire to prefer the creditor.112 This requirement means that
the law in those jurisdictions is focused on the avoidance of debtor
favoritism for certain creditors rather than maximization of value or
encouragement of settlement. The great importance of this requirement
111 See supra ..
112 Historically, the test was a tougher one that the debtor “had a dominant intention
to prefer.”
chapter three
is illustrated by the United States case of In Re Maxwell Communication
Corporation plc,113 in which the application of United States law, which
has no intent requirement, or English law, which has such a requirement,
determined whether US million of payments to three banks would
be recoverable as preferential.
The leading English authority, Re MC Bacon Ltd, holds that the word
“desire” is subjective—and therefore that the debtor must have wished
to improve the creditor’s position. Thus, where the creditor puts genuine
pressure on a debtor to pay or threatens legal action against the debtor,
the debtor’s payment will not be found to have been influenced by a desire
to prefer the creditor.114 Given this rule, a creditor in such jurisdictions
can thus take certain steps to minimize the likelihood that the debtor’s
payment will later be characterized as a preference.
Unlike the subjective English approach, the American approach is
to look more to preferential effect than to intention or desire. Such an
approach may, at times, be under- or over-broad, but it has the advantage
of ease of administration.
Although the concept of avoidance of payments that give a preferred
position to a certain creditor is connected with the concept of fraudulent
or undervalued transfers, it represents a distinct concept with its own
justification. A fraudulent transfer is not necessarily made to a creditor,
but a preferential transfer is always made to a creditor. For that reason, a
preferential transfer is nearly always made for equivalent value because
the transfer discharges all or part of the debt that is being paid, while a
fraudulent or undervalued transfer may be attackable precisely because
too little was given to the debtor in exchange. The problem with a
preferential payment is that it gives one member of a class of creditors (for
example, the class of general unsecured creditors) a greater percentage of
the debtor’s assets than is that creditor’s legal entitlement.
Other types of transactions during the suspect period that may be
avoidable are: (a) pre-payment of debts not then due to be paid; and (b)
payments by commercially unusual methods.
Preferential payments are like undervalued transfers or gifts in that
they are often perfectly proper transactions under normal circumstances
but are viewed differently when the debtor is insolvent and an insolvency
proceeding is filed shortly afterward. In some systems a preferential
113 F.d (d Cir. ). English law applied: no preference
114Philip Smart, Charles D. Booth & Stephen Briscoe, Hong Kong Corporate Insol-
vency Manual, p. ().
corporate insolvency legislation
payment must involve a blameworthy intent or knowledge of the debtor
and the creditor who received the payment, although often providing
that certain circumstances create presumptions that such an intent or
knowledge was present. In other systems, however, no such intent or
knowledge is required.
... Defenses
Although the avoidance of harmful transactions serves important poli-
cies, it also creates some serious risks in the marketplace. The assur-
ance that legal and customary transactions are final and legally protected
is very important. The possibility of avoidance of an otherwise proper
transaction risks introducing uncertainty into the market, with a conse-
quent reduction in efficiency and an increase in costs. For that reason, the
gains from avoidance actions in an insolvency context must be carefully
balanced against the costs imposed on ordinary market transactions. Dif-
ferent insolvency systems have drawn the line at different points. The
principal method for protecting the market has been to give defenses to
the person receiving the transfer. The defenses may include a claim that
this person lacked a certain knowledge or state of mind, gave full value,
or was engaged in a protected sort of transaction. Where such a defense
exists, a person in the market who fits one of these categories need not
be concerned about the risk of having to return the property obtained in
a transaction.
Sometimes these protections are stated as defenses, while in other
jurisdictions they may instead be one of the elements that constitute the
avoidance action. In either situation, presumptions are often employed,
depending on the circumstances of the transfer.
.... Defenses to Avoidance Other Than Preferential
Excluding defenses to preferential transfers, discussed below, the most
common defenses by a transferee to an avoidance action are based on
the transferee’s innocence or lack of knowledge. Yet in some countries,
including the United States, the bankruptcy law does not recognize this
defense for the initial transferee but grants it to subsequent transferees
from the initial transferee.
There may also be a partial defense for a transferee who gave value
for a transfer. The transferee may be entitled to return of the value
actually given, although it may also have to show its good faith or lack
chapter three
of knowledge. Thus, for example, in Canada an avoidable transfer to
a related party at an undervalue is avoided only to the extent of the
undervalue, permitting the person receiving the transfer to retain the
value actually given.115
.... Defenses to Preferential Transfer Avoidance
The concern to protect the marketplace may be especially strong as to
preferential transfers, so there are often more defenses to such an action.
Lack of knowledge of the debtor’s insolvency is a commonly recognized
defense, although not universally recognized. Another defense often
found is that the payment was made in the regular course of business.
As noted above, several countries require that the debtor have an intent
to prefer the creditor. There are also a number of defenses that protect
particular types of transactions.
... Suspect Periods
There are two approaches to calculating the “suspect period” in which
transactions are subject to review under the foregoing rules. One is to
state a fixed period in the statute. The period may be a certain time
before a request for an insolvency proceeding is made or before such a
proceeding is actually opened. The other is to measure the period from
the time that the debtor first ceased to make payments as they became
due, an event known as “cessation of payments.” Fixed periods often vary
depending on the type of transaction involved and upon circumstances,
such as the relationship between the debtor and the person receiving the
transfer. For example, the recent Estonian statute provides for a two-year
period for a preferential transfer to a creditor who is related to the debtor,
unless it can be shown that the debtor was not insolvent at the time. The
two may be combined, so that some “cessation” systems also have an outer
limit on the length of the suspect period, while a fixed-period system may
require insolvency or illiquidity as a further condition to avoidability.
In some systems, the relevance of the suspect period is only to create a
presumption of necessary intent or knowledge in the debtor or the person
receiving the transfer or both.
115 See ALI Canadian Statement at .
corporate insolvency legislation
The time periods vary greatly from jurisdiction to jurisdiction. For
example, the time period for avoiding a gift is four years before a request
for insolvency proceedings in Germany but only one year in Switzer-
land. For deliberate fraud with knowledge by both debtor and the person
receiving the transfer, the period stretches backwards years in Ger-
many but only five in Switzerland.
Many jurisdictions—including both the United Kingdom and the
United States—dramatically increase the suspect periods for transac-
tions involving payments to “associates” or “insiders.” Associates nor-
mally include the spouse or relatives of corporate directors, partners,
employees, and employers. It normally also extends to corporate groups
both upstream and downstream. In addition, in the United Kingdom and
many jurisdictions adopting its approach, where it is found that a suspect
transaction involves certain associates, the relevant desire to prefer will
be presumed (unless the contrary is shown).116
... Security Interests
Among the transfers that can sometimes be avoided are those involving
security interests. It is significant in this section to discuss only a key
difference between two different grounds for avoidance of such interests.
One reason for avoiding a security interest is that it is invalid under
the law governing security, regardless of insolvency. Thus, for example,
those systems that require the public registration of certain sorts of
security may provide that the security will be unenforceable or void in
an insolvency proceeding if the registration was not made. Although this
result is consistent with insolvency policy, the insolvency proceeding is
merely an appropriate occasion for enforcing the requirements of the law
of security interests.
On the other hand, a security interest may be valid under security law
(for example, it may be properly registered in systems requiring registra-
tion) but may be avoidable on one of the grounds set forth above.117
116 However, due to one of a series of drafting errors in Hong Kong, this is not the
case for corporate directors who receive preferences. Smart et al., supra note , at
pp. –. These drafting errors exist in Hong Kong because the changes to the corporate
preference provisions were made by incorporating the definition of “associate” from
personal bankruptcy law rather than through the promulgation of a definition better
suited to corporate transactions.
117 See supra ...
chapter three
... Procedure
Generally, it is the administrator of the insolvency who is authorized
by law to bring Paulian actions. Such actions in many systems require
a full lawsuit just as in the case of a commercial lawsuit of the usual kind.
As indicated above, such litigation may require of either party proof of
state of mind or knowledge, which is very difficult. The difficulty of proof
may mean that the party with the burden of proof will most often lose.
Perhaps even more difficult are questions of valuation, especially if the
relevant time for valuation is some time in the past. For an appraiser to
testify as to the value of a property claimed to have been transferred at
an undervalue two years before is very difficult, especially if property
values have been volatile since that time. As with other elements of an
insolvency system, the shape of the avoiding powers may depend on the
resources available to the system. If accountants and appraisers are hard
to find and expensive to employ, then a system may focus on intentional
or reckless transfers rather than merely unwise ones.
.. Avoiding Post-Insolvency Transfers118
Obviously, the debtor should not be allowed to transfer property to others
after an insolvency proceeding has been opened. Some systems, as in the
United States, treat this problem as a question of avoidable transactions.
Others, for example in Germany, consider that the dispossession of the
debtor of its property makes it conceptually impossible for the debtor
to have transferred any interest to another after the proceeding has
commenced.119 Regardless of the theory, the effect is the same: a general
rule that post-opening transfers by a debtor are ineffective and any
property so transferred should be returned to the administrator and
any obligation so created should be unenforceable against the property
subject to the insolvency.
On the other hand, many systems reflect a concern about persons
receiving such transfers who may have been unaware of the insolvency
proceeding at the time of the transfer, especially if such a person gave
value in good faith in the transaction. Some systems therefore make
such transactions valid as to such innocent persons until notice of the
118 UNCITRAL Legislative Guide, §§ –, pp. –.
119 Braun, supra note at § , at pp. –.
corporate insolvency legislation
insolvency proceeding has been published. Other systems make most
such transfers void or voidable, but provide some exceptions. For exam-
ple, in the United States such transfers are avoidable, except: (i) those
made to innocent purchasers of immovables until the insolvency has
been recorded in the land records;120 and (ii) those made by third par-
ties holding certain assets of the debtor who transfer them to others in
good faith and without knowledge of the insolvency proceeding.121 On
the other hand, any exception creates a risk that creditors will be deprived
of property to which they should be entitled. In some systems the risk
continues over a substantial period of time (typically until some formal
method of notice is satisfied by publication or otherwise), increasing the
risk greatly as the “notice” period is expanded.
Similar issues are presented by transfers made to debtors after an
insolvency has commenced. For example, is payment to a debtor of a
pre-existing debt a valid satisfaction of that debt if made after insolvency
proceedings have commenced? Once again, some systems make the
answer dependent upon publication of the insolvency while others have
a general rule of non-satisfaction of such debts, with stated exceptions
because of lack of notice or other factors.
Finally, questions arise about the validity of transfers made and obli-
gations incurred by debtors after the filing of an insolvency proceeding
but prior to the court’s ruling thereupon (that is, prior to the opening of a
proceeding). In some systems, this “gap period” only arises in involuntary
cases because the filing of a voluntary application leads automatically to
opening of a proceeding. In other systems, where even a voluntary filing
leads to the opening of a proceeding only after a court determination that
an opening is appropriate, transfers during a gap period may arise in any
case.122 As with the notice problem, the longer the gap period provides
an exception to the no-transfer rule, the greater the risk to creditors.
.. Special Treatment of Partnerships
The insolvency of general partnerships creates its own set of problems.
Without exploring the details, we note here the key issues each insol-
vency system must address. Unlike the insolvency of legal entities such
120 United States Bankruptcy Code § (c).
121 United States Bankruptcy Code § .
122 See supra ...
chapter three
as corporations where the legal separateness and individuality provide a
kind of anchor for the doctrinal treatment of that entity, the case is dif-
ferent with partnerships because they are somewhat hybrid institutions
lying between the poles of personal liability of the partners and that of the
economic unit. Three questions reflect the central points. All three relate
to the treatment of the partnership as a single entity or as a collection of
individuals:
Is the partnership eligible to file an insolvency proceeding as an entity
distinct from the individual partners?
If the partnership files an insolvency proceeding, is the power to enforce
the individual partner’s liability reserved to the insolvency administrator?
Are the assets of the partnership and the individual partner segregated for
purposes of access and priority by their respective creditors?
The questions arising from the dual nature of partnerships are clearly
reflected in the German legislation: even though partnerships (in par-
ticular the so called Offene Handelsgesellschaft [OHG] and the Kom-
manditgesellschaft [KG]) generally are not entrusted with their own legal
individuality, they do have some legal capacities that reflect the economic
need of treating them as more than just an aggregation of several (nat-
ural and/or legal) entities. One of these capacities is that a partnership
as such is potentially subject to an insolvency proceeding; i.e., a part-
nership can be the debtor in an insolvency proceeding. One has, thus,
to distinguish precisely between the insolvency of that partnership and
those of its partners—they do not necessarily go hand in hand. To the
degree, however, that the partners are personally liable for all debts owed
by the partnership, the partnership’s creditors have next to their regu-
lar insolvency claim against the insolvent partnership an accessory claim
against the partners who might not yet be in an insolvency proceeding.
To avoid in such an instance the risk that those creditors will act against
the partners directly, Section of the German Insolvency Ordinance
entrusts the administrator during the course of the partnership’s insol-
vency proceeding with the exclusive right to enforce such claims against
the partners; they are to be realized to the benefit of the estate as a whole.
The United States has a similar approach.
How complicated this issue might become in practice is amply demon-
strated by the law of the United Kingdom; it provides more than dif-
ferent ways of dealing with a partnership’s insolvency. The main (but not
exclusive) legislative guidance is the Insolvent Partnerships Order .
As a general paraphrase, however, it is fair to summarize that the law’s
corporate insolvency legislation
main task is to balance the various interests at stake. Thus, it is up to
the creditors to decide to pursue their claims against the partnership or
against a single partner (or several of them). While it is self-evident that
the partnership’s estate is to be used for the benefit of its creditors, things
are seen to be different with respect to the estate of the individual part-
ners. There, by contrast with the United States and German examples, a
common law rule states that the partners’ individual creditors should take
priority over the partnership’s creditors unless the partnership’s liquida-
tion estate has absolutely no funds (i.e., the presence of just one British
pound in the partnership insolvency estate would allow application of
this rule).
A somewhat comparable approach is to be found in the Austrian
Bankruptcy Ordinance, Section . According to this law, the partner-
ship creditors are admitted to each partner’s insolvency proceeding only
with a claim reduced by the dividend they have received (or are to
receive) in the partnership’s proceeding. That is to say that these credi-
tors are forced to seek satisfaction first from the partnership’s estate; as
such, the partnership creditors are subordinate to the partner’s personal
creditors. In the partner’s insolvency proceeding, however, those same
creditors of the partnership are of equal rank with the individual credi-
tors of the respective partner.
In contrast to the English example, legislation gets much simpler once
a partnership is excluded from the insolvency regime; then one has to
deal only with the insolvency of the single partners. France is an example
of this legislative approach. The partner’s personal debts add to the debts
resulting from the partnership’s activities and the respective personal
liability of that partner.123
These key issues demonstrate the difficulty of discussing partnerships
in a book devoted to the insolvency of business corporations because
every issue is ultimately tied to the rules governing individual bankrupt-
cies, a subject beyond our scope. However, the key issues discussed do
represent the conceptual link between the two types of proceedings.
123 Code civil, art. §§ –, al. and .
chapter four
CORPORATE REHABILITATION PROCEEDINGS
.. Introduction
In almost all developed countries, as well as in a number of develop-
ing countries, insolvency systems have two distinct formal pathways for
handling the problem of debtors unable to pay their debts as they fall
due. First, there is the traditional approach, which can be said to have
dominated insolvency systems up until a generation or so ago and that
is often called liquidation. This refers to the process by which the unpaid
or underpaid creditors seize control of the assets belonging to the debtor
(most often through a representative, not surprisingly often called a “liq-
uidator”) and arrange for the piecemeal sale of these assets and distribu-
tion of the proceeds amongst themselves. This process generally entails
the dismantling of the business belonging to the debtor and, with that
destruction, the loss of employment for the employees, the termination
of transactions and assignments before completion, and other wasteful
or disruptive consequences.
Second—perhaps in reaction to what was seen as unnecessary waste-
fulness—the approach of debtor rehabilitation has been developed.
A number of general points should be made in connection with this
bifurcated approach to bankrupt debtors. In the first place, the idea of
rehabilitation is also rooted in legal tradition but not the same tradition
as that from which liquidation originates. The latter may be described
as a formal process, most commonly arising from a court order initiat-
ing a process that takes place under the supervision of the court.1 The
traditional rehabilitation process, by contrast, may be more informal;
it springs from the collective concerns of creditors and is subsequently
translated into an agreement with the debtor as to the future conduct
1 However, it should be noted that many Commonwealth jurisdictions supplement
the compulsory, court-centered procedure with a streamlined creditors’ voluntary liqui-
dation procedure.
chapter four
of the business. The importance of the process in this context lies in its
independence of any assistance from, or approval by, any court or other
public institution. Yet its inability to bind creditors who refuse to be party
to the agreement made a formal rehabilitation pathway inevitable.
.. History and Key Issues
The concept of a formal business rescue regime in modern times can
be traced back at least to when, under the description of Judicial
Management, it was introduced into South Africa by the South African
Company Law Amendment Act of that year.2 This regime was adopted
almost in its entirety by Australia in , where it was called “Official
Management.”3 Both these regimes have been widely recognized as fail-
ures.4 Following the recommendations of the wide-ranging Australian
Law Reform Commission Report, Official Management was abolished
in and replaced by the regime of Voluntary Administration. South
Africa’s Judicial Management remains on the statute book,5 and although
much work has been done on radical reform in this area,6 a new imple-
menting statute (a Companies Act) with a wholly new business rescue
regime is still in bill form and its enactment is not expected before .
Insolvency “rehabilitation,” or “reorganization” or “rescue” is every-
where devoted to maintaining all or a major part of a business as a going
concern. It may be devoted to saving the company (which remains in the
hands of the original owners) or merely to saving the business (which is
sold to the highest bidder as a complete unit). The former was often the
goal with rehabilitation laws and the original Chapter in the United
States, while the latter is the common result under some more recent
enactments and in many contemporary Chapter cases.
2 For another view of this history, see Philip Wood, Principles of International
Insolvency – ().
3 See Part IX, Australian Companies Act .
4 On Judicial Management, see Harry Rajak & Johan Henning, Business Rescue
for South Africa S. Afr. L. J., , – (). On Official Management, see
Australian Law Reform Commission (the Harmer Report, ) . For a plea in defense
of Official Management, see McCabe, Official Management v. Reorganisation Under
Chapter of the United States Bankruptcy Code: In Defense of Official Management
[] Australian Business Law Review .
5 Now at §§ –, South African Companies Act .
6 See, for example, Rajak & Henning, op. cit.
corporate rehabilitation proceedings
The Common Law of the United Kingdom, on the other hand, has
its own provision for business rescue—the institution of receivership
that, for one reason or another, was rejected by the South African legal
system.7 Flexible and responsive principles of equity in the legal system
were skillfully fashioned to create this institution, which is discussed
more fully below8 and which may be regarded as the mainstay of the
United Kingdom’s business rescue provision for the last hundred years
or more.
Nor is the United Kingdom unique in the creation of a Common Law
system to provide for the possibility of a rescue rather than a liquidation
of a bankrupt business. The United States, which shares the same Com-
mon Law system as the United Kingdom, developed what was described
as the “equity receivership” as an instrument for the reorganization of
bankrupt corporations, both independently of and alongside Federal
Bankruptcy Acts, for the period of at least years prior to the enact-
ment of the US Bankruptcy Code in .9 Unlike the United Kingdom’s
institution of receivership, the equity receivership in the United States has
passed into history, eclipsed by statute, although its debt to the common
law is clear. “When [the U.S.] Congress finally added a meaningful cor-
porate reorganization option to the Bankruptcy Act in the s,” Pro-
fessor Skeel tells us, “it took all of its cues from the railroad receivership
techniques that had long been used in the courts.”10
The modern era in statutory rehabilitation regimes was initiated by
the United States, with Chapter of its Bankruptcy Act of . Some
countries like the United Kingdom followed this lead by creating statu-
tory regimes for the first time; in other cases, like Australia and Germany,
the newly created regimes in and , respectively, replaced out-
dated ones. In Central and Eastern Europe, after the fall of the Soviet
Union, new bankruptcy codes were enacted in some countries and, in
7 This is a vastly interesting topic but not one we can pursue here. A starting point
for those interested in this kind of divergence between legal systems may be the South
African Appellate Division decision of Conradie v. Roussouw [] ad (South
African Law Reports), in which South Africa rejected the Common Law doctrine of
Consideration in contract.
8 See infra ...
9 See David Skeel, Jr., Debt’s Dominion () , , –; Clifford Billig,
Corporate Reorganization: Equity vs. Bankruptcy, Minn. L R ().
10 Skeel, supra note , at .
chapter four
other countries, long dormant codes from the pre-Soviet-era were resus-
citated and updated. The German reform has been especially important
and influential.11
This new-style rehabilitation regime can now be found in a substan-
tial number of legal systems throughout the world, and the process of
rescue and rehabilitation of a bankrupt business (as opposed to its liqui-
dation) is recognized by all recent international treaties and other instru-
ments dealing with insolvency proceedings.12 It is important to observe
that all such regimes are created by statute and that such statutes usually
lay down a comprehensive procedure to be followed by whoever seeks
protection under the regime. One might describe such regimes as “for-
mal rehabilitation” regimes, although terms such as “rescue,” “reorgani-
zation,” “restructuring,” “arrangement,” “administration,” “composition”
or “reconciliation” are all used.
There is little significance, if any, in the differing terminology thus
employed, but it may be of interest to note that in the United King-
dom, for example, discussion has centered on the desirability of avoid-
ing reference to words such as insolvent, insolvency, and bankruptcy
when describing business rehabilitation regimes. It is thought by some
that avoiding the use of such words helps to remove a stigma that might
otherwise attach to those associated with the insolvent business that is
likely to benefit from the regime. If it is indeed the case that a business
rehabilitation regime might be shunned, despite its potential for bene-
ficial use, on account of the terminology used, then clearly it would be
desirable to avoid the off-putting terms.
... Formal and Informal Rescue and Rehabilitation Regimes
Under the old-style business rehabilitation regimes, where the entry
threshold was often intolerably high, the realistic choice for debtor and
creditors alike usually lay between a private workout and a formal liqui-
11 See Harry Rajak, Rescue Versus Liquidation in Central and Eastern Europe, Tex.
Int’l L. J. () , ff.
12 See the European Union’s, Council Regulation (EC) on Insolvency Proceedings,
No /, arts. (), (a) read with Annex I, UNCITRAL, Model Law on Cross
Border Insolvency (), preamble (e), art. (a), OHADA Uniform Act Organising
Collective Proceedings for Wiping off Debts arts , (http://www.jurisint.org/ohada/text/
text..en.html); World Bank Principles & Guidelines for Effective Insolvency and Cred-
itor Rights Systems, Introduction and Executive Summary, ¶¶ –; Principles –.
corporate rehabilitation proceedings
dation.13 Even where the entry threshold to the formal regime is substan-
tially lower, a private workout in the form of a creditors’ composition—
which could be seen as an example of an informal business rehabilitation
regime—retains its attractiveness. By taking an informal route, the reha-
bilitation can be conducted without the necessity of oversight or approval
by the court, which can be costly, complicated, and time-consuming.
This lack of court oversight may, however, also be a disadvantage
where, for example, the debtor takes advantage of it to defraud the
creditors. There is a further disadvantage with informal rehabilitation
in that there is nothing equivalent to the automatic stay or moratorium
provided by legislation to prevent a creditor from initiating or continuing
legal proceedings, or, where appropriate, self-help remedies14 against the
debtor for payment of a particular debt. And if a substantial number of
creditors favor an informal rehabilitation but one creditor demurs and
threatens legal proceedings against the debtor, there will be a temptation
to remove the threat to the business life of the debtor posed by the
rogue creditor by assisting or encouraging the payment of that creditor
in preference to the others.
This difficulty is often described as the “hold out” problem, because it is
in the interest of one creditor to threaten to “hold out” in order to receive
better treatment than other creditors with similar legal rights. Naturally,
the other creditors will be unwilling to agree under those circumstances.
A type of commercial blackmail might thus be seen to be encouraged.
Furthermore, and of particular relevance to an insolvent debtor with
assets in a different jurisdiction, the contract enshrining the informal
workout is unlikely to give sufficient authority to anyone seeking the
repatriation of assets belonging to the debtor from a foreign court.
One of the developments in large corporate bankruptcies in the United
Kingdom in the past two decades has been a mechanism to secure
13 For example, under the ancient German company rehabilitation regime (vergleichs-
verfahren) for a composition to be accepted, a minimum of of the claims of the unse-
cured creditors had to be guaranteed. This regime did not provide an automatic stay and
did not apply to preferential or secured creditors. See Oscar Couwenberg, Survival Rates
in Bankruptcy Systems: Overlooking the Evidence, Eur. J. L. & Econ. () (this
article is of much value and can also be found at http://www.som.eldoc.ub.rug.nl/FILES/
reports/themeE//E/E.pdf).
14 For example, a creditor who has supplied goods to the debtor may be able to assert
rights of ownership against those goods in the possession of the debtor (by reference to
a provision in the contract of supply in terms of which the supplier retained ownership
until the goods had been paid for in full) and simply remove those goods from the debtor.
For a discussion a creditor’s right of retention, see supra ., ...
chapter four
agreements among the banker creditors of the debtor. This mechanism
is known as the “London Approach” and is masterminded by the Bank
of England. It is specifically designed to secure agreement among the
debtor’s bank creditors. Here, of course, we are concerned with a huge
indebtedness owed to several, sometimes dozens, or even hundreds of
banks and where the economic and possibly political consequences of the
outright failure of the debtor are unthinkable. This particular approach
to rescue and rehabilitation is discussed elsewhere.15
... Survival of the Business and Liquidation
It is an oversimplification to see the survival of the business and liquida-
tion as mutually exclusive. Liquidation can entail either liquidation of the
debtor itself (where the latter is an incorporated organization) or merely
liquidation of the business. The former is a technical term describing the
process, invariably laid down by statute, as a result of which the debtor’s
assets are realized, the creditors’ claims are met as far as possible, and
the debtor’s personality extinguished. The latter is a non-technical term
that describes the process by which the business is brought to an end by
dismantling its constituent parts: dismissing the employees, selling the
assets piecemeal to different purchasers, and so on. A liquidation of the
debtor itself, therefore, may involve the sale of the debtor’s business as a
going concern and its continuation in the hands of the purchaser.
While liquidation may result in the continuation of the business—and
thus be seen as a rehabilitation procedure—it suffers from one serious
disadvantage for this purpose. In many jurisdictions, the liquidator (or
other official charged with the responsibilities of liquidation) is required
to dispose of the assets as quickly as possible and is permitted to carry
on the business of the debtor only insofar as this is necessary for the
liquidation process.16 This may further depress the value of the debtor’s
assets. To overcome this disadvantage of liquidation, the United King-
dom Insolvency Act included in the part of the statute that created the
statutory business rehabilitation regime—Administration—a power that
15 See infra ...
16 This principle is deeply established in U.K. insolvency law. It rests on a th century
decision, Re Wreck Recovery and Salvage Co. () Ch D , and might be even
more firmly applied today in view of the added jurisdiction now available to insolvency
practice of Administration.
corporate rehabilitation proceedings
enables the administrator to effect “a more advantageous realization of
the company’s assets than would be effected on a winding up.”17
The extra flexibility that Administration brought to United Kingdom
insolvency in this respect has all but eliminated the difficulty that a
liquidator might face in not being able to continue the business, except
strictly for the purposes of the winding up. Of course, petitioners must
be sure, where an extended period is desirable in the liquidation of the
business, that Administration, and not Liquidation, is the chosen course.
In jurisdictions where there is a single insolvency gateway rather than—
as in the United Kingdom—a separate gateway for rescue and liquidation,
this problem should not arise. And in the United States, technically a
dual gateway jurisdiction, the problem hardly arises on account of the
ease and popularity of electing the rescue route. It would appear that
no rule similar to that of the United Kingdom exists in the United
States, requiring any continuation of the debtor’s business in a liquidation
process to be used solely for the purposes of the liquidation.18
Alternatively, the liquidation regime may be destructive of the busi-
ness for the opposite reason. Given that liquidation is more than likely
to require court oversight and approval, it may be too cumbersome to
enable the liquidator to act with the speed that may be necessary—given
the nature of the business—to ensure survival of the business as a going
concern. Businesses that rely on commission agents (who may have built
up substantial goodwill) may only be able to survive if there is as little
hiatus as possible between the onset of liquidation and the transfer of
the business to a purchaser wishing to continue it. To overcome this dis-
advantage, a liquidator in the United Kingdom has the power, exercis-
able without requiring court involvement or sanction, “to sell any of the
company’s property by public auction or private contract, with power to
transfer the whole of it to any person or to sell the same in parcels.”19
... A Single or a Dual Gateway?
Some jurisdictions, for example France and Germany, provide a single
entry point for insolvent debtors moving into a formal regime. The
17 See § ()(d), UK Insolvency Act .
18 See Douglas G. Baird, The Elements of Bankruptcy, , p. .
19 Sch. , Part III, para. , read with secs. and , Insolvency Act . Cf.,
UNCITRAL, Legislative Guide on Insolvency Law – () (advocating the
value of flexibility in this regard).
chapter four
rationale for this is to maximize the possibility of a rehabilitation. Under
the French law that created this type of regime, the redressement judici-
aire, a statutory observation period enables the court to decide whether a
long-term rehabilitation is possible or the debtor must be put into liqui-
dation. Other jurisdictions, for example the United States, have separate
entry points for a prospective rehabilitation of an insolvent debtor and
for the liquidation of the debtor. Research in France shows that the over-
whelming number of debtors ended up in liquidation; and more recent
legislation in provides for a drastic reduction in the observation
period, leading in certain instances to the almost immediate consign-
ment of the debtor to the liquidation regime.20
The fact that liquidation can act as a framework for rehabilitating the
debtor’s business reduces the significance of whether the system has a sin-
gle or dual gateway into an insolvency proceeding. The important point
is not to lose an opportunity of rescuing a salvageable business. As long
as the liquidation regime is sufficiently flexible, the business can—where
appropriate—be transferred as a going concern. The entity in which the
business was housed will, of course, be lost and with that the potential for
any return for the original investors. Interestingly, the United Kingdom
has both separate gateways for the rescue and liquidation of insolvent
companies, as well as a single gateway. As we shall see, one of the purposes
for which administration is permitted is the better realization of the com-
pany’s assets than would be achieved in liquidation—a rescue of sorts but
essentially a liquidation within the rescue regime. And, as we have seen,
there is a certain amount of flexibility within liquidation such that some-
times a rescue might be fashioned and put into effect within liquidation.
Although a sale of the debtor’s business in liquidation is rightly seen
as a rehabilitation of that business, there is good reason for encourag-
ing rehabilitation through the rescue regime, rather than through liq-
uidation, wherever possible. Apart from the loss (in liquidation) of the
debtor’s equity, rehabilitation carries with it a potentially higher return
for unsecured creditors than in liquidation. While accepting without
20 Régis Blazy, Bertrand Chopard, Agnès Fimayer, Jean-Daniel Guigou, Financial Ver-
sus Social Efficiency of Corporate Bankruptcy Law: the French Dilemma?, d Annual Con-
ference on Empirical Legal Studies Papers (). Although the United States techni-
cally has a multiple-entry system, recent empirical work suggests that Chapter of the
Bankruptcy Code functions like a single entry system for most corporate debtors that
are larger than tiny. Elizabeth Warren and Jay L. Westbrook, The Success Of Chapter :
A Challenge To The Critics, Mich. L. Rev. () (Most significant corporate
debtors file in Chapter and the courts then promptly separate winners and losers).
corporate rehabilitation proceedings
reservation the proposition that seeking to keep alive a business that has
no likelihood of survival is a serious waste of resources, the dynamic
effects of rehabilitation should not be ignored or underestimated. Reha-
bilitation may carry with it the endeavor and commitment of equity hold-
ers and unsecured creditors, and this may be crucial in effecting the busi-
ness’s rescue. In assessing the likelihood of rehabilitation, therefore, the
opportunity must be provided for evaluating the degree of active and
beneficial support that the rehabilitation will be likely to receive from
the debtor’s equity holders and unsecured creditors.
.. Structural Features of Rehabilitation Statutes
Many of the conditions considered to be indispensable to a commercially
and economically effective rehabilitation procedure raise issues of cul-
tural and economic significance. Their consideration should begin with
an overview.
... Access
Some jurisdictions permit the debtor to take steps of its own accord lead-
ing directly to the establishment of the rehabilitation regime and the pro-
tective moratorium against the creditors’ claims (“automatic access”).21 In
contrast, other regimes require initiation of a process—almost always a
court process—during which the court will investigate the claim that the
debtor should be placed in the rehabilitation regime and decide one way
or the other. The extent to which it is likely that the debtor will regain
financial independence is invariably of central concern to the decision-
maker in this process and it is therefore appropriate to describe such
regimes as having “discretionary access.”
Two variations in jurisdictions with automatic access should be ob-
served. In the United States, the debtor can obtain automatic access to
protection under Chapter of the United States Bankruptcy Code
by filing a notice in the Bankruptcy Court, which ipso facto triggers the
rehabilitation regime and its protective moratorium. In Australia, on the
other hand, the rehabilitation regime (called “voluntary administration”)
21 The United States and Australian business rescue regimes have been longstanding
examples of automatic access at the instance of the debtor. Recent legislative changes have
now brought automatic access to the UK, see infra.
chapter four
is initiated by the mere resolution to this effect by the debtor’s board of
directors. It is put into effect by a written appointment by the debtor
company of an administrator once the board has resolved that in its
opinion the company is insolvent or is likely to be become insolvent and
should be placed in voluntary administration.22
The Australian system is not restricted to this form of entry into the
business rescue regime. The Administrator can also be appointed by a
liquidator23 or by a chargee,24 although not by the court.25 The United
Kingdom, on the other hand, having begun with purely discretionary
access, has recently extended its statutory business rescue provision so
as to include automatic access at the instance of the debtor, although this
is subject to certain conditions. This approach deserves some detailed
attention.
By its Insolvency Act , the United Kingdom established two re-
gimes, the Corporate Voluntary Arrangement (“CVA”) and Adminis-
tration. Only the latter provided a moratorium against the claims and
enforcement processes of creditors. The CVA was designed partly as a
regime to facilitate the establishing of the plan to mark the final stage of
a successful Administration but also as a stand-alone regime to effect a
business rescue in circumstances where there was no substantial threat
of a creditor taking potentially fatal enforcement proceedings against the
debtor. The original Administration, unlike the CVA, called for substan-
tial court involvement and discretion.
When first enacted in the Insolvency Act of , the legislation laid
down, first, that the debtor or a creditor seeking the protection of an
Administration had to present a petition to the court and, second, that the
protective regime would only come into existence if the court accepted
that it was likely that:
a. the debtor and all or part of its business would be likely to survive;
or
b. an Administration would enable a more advantageous realization
of the debtor’s assets than would have been possible on a winding
up and made an order to that effect.
22 § A, Australian Corporations Act .
23 Id. at § B.
24 Id. at § C.
25 Id. at § C ()(a). The court may, however bring the administration to an end, Id.
at §§ ()(a), .
corporate rehabilitation proceedings
This original Administration regime has now been restricted to large
corporate entities operating within sectors of the economy designed to
finance large infrastructural initiatives, such as the transport and water
industries, building societies, and the public/private partnership initia-
tive.26 The new Administration regime—which applies to all company
debtors, other than those referred to in the previous sentence—was cre-
ated by the Enterprise Act and came into force in September .27
It completed a package of reform of business rescue provisions in the
United Kingdom that had been begun with the Insolvency Act and
that created a radically revised CVA regime.
The new United Kingdom provision provides something of a third way
between the automatic and discretionary entry business rescue regimes.
Essentially, the new Administration and CVA regimes provide for auto-
matic entry, which quickly activate the moratorium against creditors’
claims and enforcement processes. At the same time, because access is
subject to certain conditions, the legislation has preserved entry into
Administration by petition to the court.
Given the now singular nature of the United Kingdom’s “automatic
entry subject to conditions,” these “conditions” are worthy of note. In
addition to the application of the condition, applied under the ancien
regime, that the company debtor must be insolvent or nearly insolvent,
automatic Administration is barred to a company debtor:
– if within the last months, the company has been in Administra-
tion on an out of court appointment by the company or the directors
or by application to the court by the company or its directors;28
– if within the last months, a moratorium was obtained with a view
to a [company] voluntary arrangement but the arrangement was not
achieved;29
– if within the last months, a moratorium was obtained with a view
to a [company] voluntary arrangement and the arrangement was
achieved but ended prematurely;30
26 § , UK Enterprise Act .
27 It was contained in § and schedule of the Enterprise Act , which were to
be inserted as § and schedule B of the UK Insolvency Act .
28 ¶ (), Sch. B, UK Insolvency Act .
29 Id. at ¶ ().
30 Id.
chapter four
– a winding up petition or an Administration application has been
presented and not yet been disposed of; or
– an administrative receiver is in office.31
In addition, certain companies are excluded from the new CVA on
account of their involvement in major financial and international finan-
cial transactions.32 In fact this regime is only open to any company which
qualifies as being a “small company” within the meaning of the UK’s
Companies Act ,33 and the following conditions must be satisfied:
– the company must not be subject to any of the following: Adminis-
tration, winding up, administrative receivership, voluntary arrange-
ment, or provisional liquidation;34
– if, during the -month period ending with the filing for a morato-
rium, there had been a moratorium in force for the company, that
moratorium must have been followed by a fully completed (i.e., not
prematurely ended) voluntary arrangement;35
– during the -month period ending with the filing for a morato-
rium, there must not have been in office an Administrator appoint-
ed to the company either by the company itself or by its directors;36
– there must not have occurred both (a) a voluntary arrangement
on a proposal by either an Administrator or a Liquidator which
was terminated prematurely and, (b) during the -month period
ending with the filing for a moratorium, an order by the court under
Section () either, (i) if the company was being wound up, staying
all proceedings in the winding up of the company or, (ii) if the
company was in Administration, stating that the Administration
cease to have any effect.37
A discretionary access regime presents the problem of the interim period
between initiation of the procedure and the decision by the court. This is
31 ¶ (), Sch. B, UK Insolvency Act .
32 Id. at Para (), Sch. A.
33 § ().
34 ¶ ()(a)–(e) Sch. A, UK Insolvency Act , the retrospective effect of § (),
which backdates the commencement of the winding up to the date of the presentation of
the winding up petition, does not apply, so a company whose winding up has commenced
by the date on which the notice is filed for the moratorium solely by reason of § () is
not regarded as being wound up for the purposes of Sch. ()(b)—see Sch. ().
35 ¶ ()(f) Sch. A, UK Insolvency Act .
36 ¶ ()(fa), Sch. A, as amplified by ¶ , Sch. B, UK Insolvency Act .
37 ¶ ()(g) Sch. A, UK Insolvency Act .
corporate rehabilitation proceedings
likely to be the debtor’s most vulnerable period, given that in almost all
instances, it will be making a public statement of its insolvency and that
anything between a few hours and a few weeks might elapse between
the presentation of the petition and the court’s decision granting the
order of Administration. This problem was solved in the UK—in relation
to its old-style Administration—by a provision to the effect that the
initiation of the Administration proceedings itself, automatically brought
into immediate effect a preliminary protective moratorium prohibiting
any enforcement procedures against the debtor, except the appointment
by a secured creditor of an administrative receiver under the provisions
of a floating charge.38 This preliminary moratorium remained in force at
least until the court reached its decision and was continued if the court
decided to grant an administration order.39
Without a provision automatically triggering the moratorium on pre-
sentation of the petition, a debtor might be seriously compromised in
searching for the protection of the business rescue regime. The petition
might be challenged on the ground that the debtor did not meet the insol-
vency or near insolvency standard and the delay caused by this might
make the difference between the survival or death of the debtor. In these
circumstances, it is imperative that procedures are available for ensuring
that, if there is such a requirement, it can be established one way or the
other, simply and quickly.40
An insolvency or near-insolvency requirement will clearly have some
effect on when a debtor seeks the protection of the rescue regime. Such a
requirement will prevent too early a move for such a protection. Creditors
would rightly object to a moratorium at a time when the debtor was
able to meet their claims. On the other hand, it is important for any
effective business-rescue regime that debtors be encouraged to initiate
rescue proceedings earlier rather than later. The opening of a proceeding
while the debtor still has assets and operations of value, before all has
been lost, is of special importance in rehabilitation. The hospital is of no
use if the patient is already in a terminal condition.
The two Japanese rehabilitation procedures provide an illustration
of different approaches. In a civil rehabilitation proceeding, a secured
38 § , UK Insolvency Act ; see (c) “Sufficient Protection for all Interests”, below.
Infra ...
39 § , UK Insolvency Act .
40 See supra ..; see also UNCITRAL, Legislative Guide on Insolvency Law
().
chapter four
creditor can enforce its security interest but a debtor can apply for a tem-
porary stay that prohibits enforcement of a security interest for a certain
period. On the other hand, commencement of a corporate reorganiza-
tion proceeding automatically operates as a stay on the enforcement of
security interests.
Where there is an automatic moratorium, there is a risk of debtor
abuse. Because most creditors operate in the dark, at least to some
extent, they often have too little information to be able to accurately
assess whether the debtor, who has sought the protection of the rescue
provision, has truly reached a stage of financial distress so close to
insolvency that the creditor will not be able to succeed in opposing
the maintenance of the proceeding. Policymakers must make a difficult
choice. Systems that place too heavy a burden on a debtor both as
to seriousness of financial condition, and proof as to that condition,
discourage filing until it is too late for effective rescues to be undertaken.
On the other hand, a system that permits abuse of the moratorium will
lose the confidence and support of creditors.
More often, perhaps, the risk is that debtors will fail to initiate insol-
vency proceedings soon enough. It is possible—indeed desirable—to
tackle this issue from both creditor and debtor standpoints. As noted in
the section on enforcement of security,41 an effective system of enforce-
ment of both unsecured and secured debts is one answer to this problem.
If a debtor has not paid, but can pay, then threatening to seize its assets is
likely to produce payment. On the other hand, if the debtor cannot pay,
that same threat is likely to precipitate an appropriate insolvency filing
by the debtor.
From the debtor’s standpoint, two common approaches may encour-
age appropriate early initiation by debtors. The first is to provide sanc-
tions against officers and directors who unduly delay initiation. These
sanctions have been discussed above.42 The second is to provide incen-
tives for filing (or to curtail disincentives). The debtor-in-possession rule,
which permits the company management to run its own rehabilitation
effort, greatly reduces the disincentive that loss of control of the com-
pany presents to management. Management is likely to be much more
willing to seek insolvency protection if it has a prospect of continuing its
employment and its direction of the enterprise. This advantage, although
41 See supra ...
42 See supra ....
corporate rehabilitation proceedings
considerable, has to be weighed against the concerns that naturally arise
from leaving possibly inefficient management in control, a problem that
some systems seek to meet by entrusting the management of the debtor
both to the board, and to an outside, neutrally appointed monitor.43
Another incentive operates at the level of the debtor’s shareholders,
rather than its management. If the rehabilitation regime permits equity
to retain some interest in the business, subject to creditor approval, then
it is much more likely that shareholders will encourage management to
initiate any necessary rehabilitation proceeding. Otherwise, shareholders
have little incentive but to encourage the company to continue trading
and hope for the best. Experience suggests that even a small hope of
equity participation in a rehabilitation plan may have an important effect
in obtaining its cooperation. Note that this incentive can operate even if
management is to be replaced in the proceeding by an administrator, as
long as the equity holders have some possibility of a stake in the rescue.
Thus there are two distinct issues that are often confused: will the owners
or managers of the debtor be allowed to manage the insolvency and will
the owners be permitted some hope of salvaging some value from the
company?
... Timely and Efficient Administration of the Proceedings
As noted earlier, at least three different formal approaches can be iden-
tified in answer to the question of how to administer the rehabilita-
tion regime proceedings. Once again, the United States and the United
Kingdom provide the extremes. In the United States, the debtor contin-
ues to manage the business in the rescue regime, as it had done before;
whereas in the United Kingdom the management of the business passes
to an “Administrator,” namely a person who has the professional status
of an insolvency practitioner. The third approach, which can be found,
inter alia, in the Netherlands and France, is a combination of the previ-
ous management and a third person appointed by the court.44 The latter
(called the administrateur judiciaire in France, and the bewindvoerder in
the Netherlands) has both powers and obligations in relation to the assets
and the business of the debtor. In the absence of cooperation between the
43 See infra .., see supra ...
44 For descriptions of this management model, see Harry Rajak, European Corpo-
rate Insolvency Law (H. Rajak et al. eds., nd ed., ) (chapters on France and Hol-
land), pp. – and –, respectively.
chapter four
original management of the debtor and the third person, the latter may
ask the court to bring to an end the protective rehabilitation regime.
In addition to these formal approaches, it is worth noting that in prac-
tice it is not uncommon for an Administrator in the United Kingdom
to seek—and often to find—cooperation with the existing management.
Much will depend on the circumstances of each case, especially the rea-
sons for the insolvency and the anticipated reliability and responsibil-
ity of the original management. In the new-style Administration regime,
which retains the feature of an outside, professionally qualified insol-
vency practitioner being appointed to act as Administrator with all the
powers of the board of directors, this appointment will now frequently
be made either by the board of directors itself or by the creditor (almost
invariably the debtor’s bank) that holds a floating charge.45 It seems
highly likely that, at least in the cases where the appointment is made
by the board, there will be an increase in fruitful cooperation between
the Administrator and the board in the management of the debtor.
In enacting this new-style Administration, the United Kingdom had
to deal with the problem of the competition between the debtor and
its bank creditor. Until , the latter was often entitled to appoint an
Administrative Receiver—as opposed to an Administrator—to manage
the debtor in the regime of Administrative Receivership, rather than
Administration.46 The big difference between these regimes was that the
Administrative Receiver was under a primary obligation to the bank
creditor, whereas the Administrator’s primary responsibility is to the
creditors as a whole. It was in recognition of this huge role played by the
bank creditor in the management of its bankrupt debtor that the bank
retained a share of the right to appoint the Administrator in the new-
style Administration.
Now that both debtor and bank creditor are committed to Administra-
tion, the issue may well come down to “whose Administrator?” Under the
new legislation, before a company or its directors can make an appoint-
ment out of court, they must give five business days’ notice to a float-
ing charge holder who is empowered to appoint an Administrator.47 In
giving the requisite notice, the company or its directors must reveal to
the floating charge holder the identity of the proposed Administrator.
45 See infra ...
46 The regime of Administrative Receivership and the changes effected in are
described below. See infra ...
47 ¶ , Sch. B, UK Insolvency Act .
corporate rehabilitation proceedings
This could open up depressing possibilities as the company and the float-
ing charge holder cultivate their particular pet Administrators. One may
hope that the professionalism of the insolvency practitioners will elimi-
nate this kind of competition. It is unrealistic to expect the same degree
of cooperation between the board and the Administrator where the latter
is appointed by the bank creditor, as existed when the appointment was
made by the board; but it is realistic to expect the same degree of coop-
eration as existed between board and Administrative Receiver under the
prior regime.
In the United States, there may also be something similar by way of
informal cooperation between dominant creditors and a board of direc-
tors, despite the stark picture to the contrary that the concept of the
debtor in possession often conjures. It is clearly sometimes the case that,
prior to the debtor’s filing for protection under Chapter , an arrange-
ment will have been arrived at whereby the funding of the debtor in an
insolvency proceeding will have been arranged and some members of the
board of directors selected in accordance with the wishes of the dominant
creditors.48 It is also worth remembering that the U.S. Bankruptcy Code
also enables the court to appoint an examiner or a trustee to assist or
replace the existing management of the debtor.
It is invariably the case that whoever manages the debtor while the
latter is in the rehabilitation regime is under an obligation to prepare a
plan for the payment of the debts of the business and the future regulation
of the debtor.
... Protection of Secured Parties
Apart from the protection afforded by supervision of the process, almost
all systems have a particular provision for each of the different interests.
Thus, the Netherlands is one of those countries in which the morato-
rium does not apply to secured and preferential creditors. In Australia,
receivership provides special protection for a creditor whose claim is
secured by a floating charge that permits the appointment of a receiver
48 This statement hardly needs authority, it being implicit in much that is now written
about Chapter ; but see e.g. David A. Skeel, Jr., Creditors’ Ball: The “New” New Corporate
Governance in Chapter U. Pa L. R. (); Lubben The “New and Improved”
Chapter Ky. L. J. (); Henry Hu & Jay Lawrence Westbrook, Abolition of the
Corporate Duty to Creditors, Colum. L. Rev. (). See also, infra, ...
chapter four
where the charge has become enforceable.49 The Australian institution of
receivership is modeled closely on the office of Administrative Receiver
in the United Kingdom (formerly known as the office of Receiver and
Manager). The appointment of an Administrative Receiver is a contrac-
tual right frequently conferred on the debtor’s major creditor (invariably
its bank lender) as part of the security known as the floating charge.
Under this charge, the bank has security over all the debtor’s assets and in
appointing an Administrative Receiver, thereby enables the latter to exer-
cise full control, akin to that of the board of directors over the debtor.
The business rescue systems of the United States and the United King-
dom permit the debtor or administrator to deal with assets belonging
to the debtor and that constitute security for certain creditors’ claims,
provided those creditors are given alternative protection of a similar or
improved nature. Furthermore, most systems provide for any creditor to
apply to court for permission to enforce his or her claim during the mora-
torium. In deciding whether to accede to such an application, the court
will probably adopt a balancing test, weighing the hardship to the credi-
tor if he or she is not able to enforce the security, as against the effect on
the success or failure of the rehabilitation and the commensurate bene-
fit to the interests of all the other creditors. Although general in nature,
this right of application to court to enforce a claim against the debtor is
almost invariably restricted in practice to secured creditors.
Finding the correct balance between the interests of the secured cred-
itor who often will wish to enforce his claim irrespective of the effect on
the debtor and the interests of the creditors in general, who are likely to
want to see the continuation of the debtor as the only realistic chance of
any recovery, may be said to be at the heart of the business rescue pro-
vision. It is here that the court has to decide whether the moratorium
should be maintained.
This balance has been considered with considerable sensitivity and
sophistication by the English courts in a manner that is likely to be
of value to all jurisdictions. It was the subject of two Court of Appeal
decisions, in the first of which, Re Paramount Airways Ltd, Bristol Airport
plc v. Powdrill,50 the court held that the assertion of a statutory lien by
the airport against the airline debtor in an attempt to enforce a claim
for unpaid airport charges was prohibited by the moratorium and that
the airplanes held under the lien had to be released. This was applied
49 § C, Australian Corporations Act .
50 [] BCC .
corporate rehabilitation proceedings
in Re Sabre International Products Ltd.,51 where the lien was asserted by
a haulage contractor. This was forbidden by the moratorium, although,
given that the creditor was being made to give up a form of security,
it was incumbent on the Administrator to make reasonable alternative
proposals to the creditor. This did not, however, save the creditor from
having to pay the costs of the proceedings for having held on to the goods
in the face of the demand by an officer of the court and thus having been
in contempt of court.52
In the second of the court of appeal cases,53 the court laid down the
principles in accordance with which the Administrator should make his
decision as to whether or not to grant leave to the creditor to begin, or
continue, proceedings to enforce his claim. The court emphasized the
fact that it has to conduct a balancing exercise, bearing in mind that
the continuation of the Administration without granting leave to secured
creditors to enforce their claims or repossess their goods would in effect
be running the company at the expense of the secured creditors. On the
other hand, if there was a genuine chance of a recovery and this would
be impeded were the secured creditor’s claim to be enforced, this was the
purpose of Administration and permission should be refused.54
... Providing a Structure to Facilitate Fair Negotiation of a Plan
Almost all systems recognize the enhanced status of secured creditors,
although few follow the Dutch system under which the moratorium does
not apply to secured creditors. This does not always prevent productive
negotiations among all interests, especially where the debtor seeks the
protection of the rehabilitation regime in good time and is able to take
advantage of the moratorium to carry out effective restructuring of its
assets and commercial undertakings.
51 [] BCC .
52 See also London Flight Centre (Stansted) Ltd. v. Osprey Aviation Ltd. [] BPIR
, where the creditor only acquired the lien after the commencement of the adminis-
tration, made no application for leave to maintain it, and was obliged to surrender it.
53 Re Atlantic Computer Systems plc [] BCC .
54 See also David Meek Access Ltd [] BCC , Polly Peck International plc (in
administration) (No ) [] BCLC , Re Carter Commercial Developments Ltd.
[] BCC . In the United States, the value of the secured creditor’s collateral must
be “adequately protected.” The protection is generally provided by periodic payments
compensating for a decline in value, by an additional lien on unenbumered property, or
by an “equity cushion,” which is found to be adequate where the creditor is substantially
oversecured. United States Bankruptcy Code §§ –.
chapter four
An ideal system—to which any actual system might be compared—
might include in the period between the entry of the debtor into the
business rescue regime and the approval of the plan in accordance with
which the debtor will return to the (unprotected) market place, the
following operations:
– investigating the causes of the debtor’s failure;
– securing the debtor’s assets so as to ensure that they are brought
wholly under the control of the insolvency regime;
– taking whatever action is necessary to ensure that any causes of
commercial failure are eliminated; and
– making a realistic assessment as to which parts of the debtor can
survive unprotected in the marketplace, separating those, and then
disposing of any parts that would continue to act as a drain on the
resources of the debtor.
This is clearly a time when the debtor’s future is best served by inde-
pendent and realistic action. Needless to say, whoever is charged with
executive responsibility may have to take action that will be unpopular
with some people or interests associated with the debtor. This is likely to
be easier where the debtor during this period is under the control of an
outside, professionally qualified person. However, in systems where the
debtor remains solely in charge of itself, the court can and should act to
ensure that appropriate actions are taken. The question then arises: how
can information be drawn to the attention of the court so as to ensure
that such action is ordered? A related question arises where the process
is under the control of the independent outsider: namely, how does this
person acquire the necessary information so as to enable him or her to
take appropriate action?
Clearly the creditors must be expected to play an important role in this
process. It is common to many systems to facilitate and even require the
establishment of a creditors’ committee and to ensure a proper channel
of communication between the creditors (through the committee if there
is one) and either the person or institution in charge of the rescue
process.55
Many systems insist on the provision of adequate information to all
interests, without which there clearly cannot be fair negotiations leading
55 The UNCITRAL, Legislative Guide on Insolvency Law recommends creditors’
committees where a case includes a large number of creditors. Id. at – (¶ –).
corporate rehabilitation proceedings
to a plan that both is realistic and takes account of as many of the
interests in the debtor as possible. Other common features of structures
facilitating the negotiation of a plan are meetings (where proposals by
the management can be discussed) and voting procedures. Most systems
require that a plan be approved by a certain percentage of the total
creditor claims, an idea not without its complications when it is borne in
mind that the notion of “creditors” may well need to be unpacked to take
account of different interests such as secured and preferential creditors
and creditors who are neither secured nor preferential. The amount of
the percentage of approving creditors varies from system to system.
The goal of an acceptable plan calls for consultation, transparency,
methods of securing appropriate information, and an effective system
for the calling and holding of meetings, the establishment of appropriate
majorities for the carrying of proposals, the qualifications for voting, and
the taking and recording of votes. The issues of information gathering
and voting are discussed further below.56
... Judicial or Other Supervision
There are various levels of protection afforded by the many different
regimes at various stages of the business rehabilitation process. In the
United States, where the procedure is automatic and it is often the case
that the original management will be in control of the debtor in an
insolvency proceeding, the overall protection of other interests relies
partly on the general principles of law outlawing fraudulent and reckless
conduct and partly on the fact that the court plays a leading role in
supervising the process. The general level of supervision in the United
States may seem too minimal for many jurisdictions, although there is no
empirical evidence to suggest that the process in the United States is more
prone to fraudulent and reckless conduct on the part of the management
than elsewhere.
Almost all, if not all, business rehabilitation systems are supervised by
the court to one extent or another. It is also common for creditors or
other interested parties to be allowed access to the court to seek redress
in the event of any alleged unfair, prejudicial, or corrupt practice on the
part of the management of the debtor, either under a specifically enacted
56 See infra ., ..
chapter four
statutory provision57 or under general principles of law that grant reme-
dies for loss caused by fraud and other unacceptable conduct.58 The
widespread requirement for full information as to the management of
the debtor to be disseminated among all creditors59 provides the basis on
which any malpractice may be detected and appropriate redress sought.
Some jurisdictions provide additional safeguards; for example, the Unit-
ed Kingdom requires that all administrators be members of the insol-
vency practitioners’ profession, a body that maintains comprehensive
rules for disciplining members who fail to observe high standards in the
conduct of their work.60
... Shareholders’ Interests
The common picture is one of the primacy of creditors’ interests over
equity interests. Thus, it is, in the main, the creditors who will have the
final say as to whether or not the plan for the future of the debtor is
approved. This follows naturally from the fact that in a world of limited
liability companies, insolvency is, by definition, a loss suffered by the
creditors of the business run by the bankrupt company. Of course, the
investors (or owners or shareholders—all synonyms) will lose as well, but
their plight attracts less sympathy because it was their business and they
ran it.
Thus, creditors are paid their debts before any distribution is made to
shareholders on the liquidation or partial liquidation of a solvent com-
pany. And, correspondingly, in the rehabilitation of a bankrupt company,
it is natural to ensure that creditors’ interests are protected as far as possi-
ble before any thought is given to the interests of the owners of the busi-
ness. This result could be seen most clearly in the United Kingdom’s tradi-
tional Administrative Receivership regime, where often the outcome was
the sale of the business out of the bankrupt company with proceeds then
distributed among the creditors to the complete exclusion of the share-
holders. In fact, a further hierarchy was very much in evidence there,
57 See, for example, § and ¶¶ –, Sch. B, UK Insolvency Act .
58 See Andrew Keay, McPherson’s Law of Company Liquidation () –.
59 See, e.g., § D, Australian Corporations Act , para. ()(b), Sch. B, UK
Insolvency Act .
60 Part XIII, at §§ –, UK Insolvency Act , and the subordinate legislation
referred to therein.
corporate rehabilitation proceedings
with the proceeds of the sale of the business being generally applied in
discharging the claims of preferential and secured creditors, often to the
virtual exclusion of the ordinary creditors.
Yet, some systems—notably Chapter in the United States—permit
the possibility of equity retaining some value. That approach may be of
special value where a business that has fallen on hard times may depend
for its recovery and survival on its owners. A famous chef, for example,
may be the key to the survival of a restaurant. Rigid rules about eliminat-
ing equity may make it impossible for creditors to negotiate a satisfactory
resolution with such essential equity owners, even where most creditors
might wish to do so. In such circumstances, the route to a successful res-
cue may well be a preparedness on the part of the creditors to grant a
continuing (although perhaps smaller) stake for all or some of the share-
holders of the bankrupt company in the rescued company. This may be
seen as little different from the necessity of granting priority to those pre-
pared to finance the bankrupt company so as to ensure its survival over
all those creditors whose debts were incurred prior to the insolvency.
.. Stabilizing and Sustaining Business Operations
... Financing
Priority given to post-insolvency commencement lenders to induce the
financing of a rescue process is effectively a surcharge against the entire
estate and its assets. One form of priority for those advancing money or
goods is an administrative priority that gives precedence in repayment
over the general unsecured creditors, but not over a secured creditor,
with respect to its collateral. An intermediate approach allows lenders
and those advancing goods to take a security interest in the debtor’s
secured and unsecured assets. In some jurisdictions, a senior or priming
security interest or lien can be granted in exceptional circumstances.
Some countries make all options available to accommodate the unique
needs and circumstances of particular cases, either by their bankruptcy
code or by general principles of law, especially the law of contract.
Thus, if a court concludes that priority financing involving collateral is
in the best interests of the creditors and is not prejudicial to the existing
secured creditors, the court should be able to approve the financing.
Such financing alternatives are likely to present a threat to unsecured
creditors who may see the remaining assets of the debtor consumed by
chapter four
the financing party, leaving nothing for them if the rehabilitation effort
fails.61 This calls for a carefully balanced approach.
It is no exaggeration to describe the issues of post-commencement
financing and priority as presenting some of the most difficult issues of
the rescue process. It is undeniable that singling out a business for a reha-
bilitation attempt—however achieved—may deal a double blow to the
existing unsecured creditors. In the first place, the latter are temporarily
denied the normal commercial remedies for attempting to recover the
property or money that they are owed. Second, the selected business will
commonly require not only the negative help of a creditors’ moratorium
but also the positive assistance of a further cash injection. Without this, it
is likely that most rehabilitation attempts will fail and thus bring into dis-
repute the rehabilitation process. And it is obvious that the further cash
injection will only materialize if this new credit is prioritized sufficiently
to make repayment probable. Thus, existing unsecured creditors both are
denied their commercial remedies and suffer new creditors (or, at least,
new credit) leapfrogging ahead of them. Added to this, they may have
to stomach the grant to the erstwhile investors in the failed company a
stake in the rescued company. Secured creditors, on the other hand, are
generally protected against this possible watering down of their interest.
The issue of post-insolvency funding exposes not only the often oppos-
ing interests of secured and unsecured creditors62 but also the tension
between pre-existing creditors and those whose ongoing supplies are crit-
ical to the continuation of the business. The obvious necessity of giving
priority to the providers of new cash or liens or to creditors who supply
essential goods appears in the earliest and most restrictive of business
rehabilitation regimes.63 Yet even in the more modern systems, this pri-
ority must be carefully delineated so as to ensure the least possible inter-
ference with the claims of the pre-existing creditors. In France, for exam-
ple, the law is drafted so as to ensure post-insolvency priority only where
the new debts are incurred for the purpose of continuing the enterprise
and only so long as the appointed administrator or the debtor have not
exceeded the power conferred on them by the judgment establishing the
rehabilitation regime.64 On the other hand, these limitations must not be
61 The UNCITRAL Legislative Guide recommends giving post-commencement fi-
nance providers a priority over, at least, unsecured creditors. Id. at (¶¶ –).
62 See supra ..
63 See § , Companies Act (South Africa). A fine example in the modern rescue
regime is § , UK Insolvency Act .
64 Article , Law of January .
corporate rehabilitation proceedings
constructed in a way that leaves those who supply essential goods to the
bankrupt debtor unsure about whether they will be paid. Needless to say,
the monopoly or near monopoly capacity to supply vital products for the
continuation of a business provides fertile opportunities for commercial
exploitation and potential havoc with traditional hierarchies in claims in
insolvency.65
The position of secured credit is central to the question of what priority
may be conferred on creditors who extend credit or deliver goods to
the debtor after the onset of the insolvency. The traditional and still
widely held position is to permit no interference with the control by
a secured creditor over the property that constitutes the security. This
substantial championing of the position of secured credit, however, must
now be seen as under threat by imaginative provisions that go so far as to
enable the uncoupling of the secured creditor from the debtor’s assets that
constitute the security (the collateral). Some jurisdictions even provide a
priority for post-insolvency creditors ahead even of pre-existing secured
creditors, although this must be seen as somewhat unusual.
The point is that the dynamic use of the debtor’s assets, perhaps by
new management, may have a marked effect in increasing the debtor’s
resources to the obvious benefit of all the unsecured creditors and that a
secured creditor should not be permitted to hinder this. There is scope
for allowing the debtor to dispose of property that constitutes security or
collateral but this should not be prejudicial to the creditor with an interest
in the collateral.66
At first blush it may seem surprising that the United Kingdom’s Insol-
vency Act of has taken a lead in this regard. The United Kingdom,
with its floating charge, has often been seen as a jurisdiction that ele-
vates the protection of secured credit high above the claims of unsecured
creditors and investors seeking a continuation of the business in the hope
of its trading out of insolvency. Yet it is perhaps because of the exten-
sive nature of the floating charge, very often drafted to ensure security
for a single creditor (almost invariably the bank) over all the debtor’s
assets, that the legislature felt it was necessary to give other interests pri-
ority over this form of security,67 including granting to an Administrator
65 See Leyland DAF Ltd v. Automotive Products plc [] BCC .
66 See ¶¶ –, Sch. B, UK Insolvency Act .
67 See §§ (), (), UK Insolvency Act , which enable preferential creditors
in administrative receivership and liquidation, respectively, to look to the floating charge
assets inasmuch as there are insufficient funds to meet their preferential claims. The
chapter four
during a business rehabilitation attempt the right to deal with assets
that constitute collateral.68 This right extends to fixed as well as floating
security, although careful safeguards for the secured creditor are built
into this provision.
.. Disclosure of Information
... Who Gathers the Information?
A crucial structural question is where ultimate authority lies in conduct-
ing the process of eliciting the information necessary for an informed
assessment of the prospects of the debtor’s business. This question is, of
course, closely bound up with—and indeed, complicated by—the ques-
tion as to who controls the management of the business during the pro-
tective rehabilitation regime.69 The process of obtaining the information
necessary to make an informed assessment of the prospects of the busi-
ness will include examination of people who will have been members
of the company management before the onset of the insolvency. If such
people continue to manage the business while it is in the protective reha-
bilitation regime, can they be expected to disclose information that may
well be painful, or even self-incriminating, to reveal?
In the United States, this problem is resolved by assigning the bank-
ruptcy court an active supervisory role and by giving the creditors’
committee a right to demand and receive a great deal of information.
Thus the U.S. Bankruptcy Code authorizes a creditors’ committee to
“investigate the acts, conduct, assets, liabilities, and financial condition
of the debtor, the operation of the debtor’s business and the desirability
of the continuance of such business, and any other matter relevant to the
case or to the formulation of a plan.”70
In the United States, the appointment by the court of an independent
“examiner” is an alternative solution. The problem is also somewhat
expenses incurred by Administrators and Administrative Receivers may also be paid out
of floating charge assets, see § ()(c), (), Sch. B, UK Insolvency Act .
68 See ¶¶ –, Sch. B, UK Insolvency Act .
69 See supra ..
70 United States Bankruptcy Code , ¶¶ (c)(), (a)(); see also ¶¶ –
Sch. B, UK Insolvency Act on the power to seek information and ¶¶ – on the
establishment and operation of the creditors’ meeting.
corporate rehabilitation proceedings
mitigated by management changes. Empirical evidence suggests that it
is not uncommon for the composition of the management to change
when the business goes into the rehabilitation process, especially in
the case of large debtors.71 This is, however, insufficient as a general
safeguard. Hence the importance of the court’s active surveillance of the
rehabilitation process.
In the United Kingdom, the role of the court is much less pronounced.
From the beginning of the process, the court accepts a substantial depen-
dency on the reliability and insight of the professional cast involved:
lawyers (in the United Kingdom, this involves two separate lots, bar-
risters and solicitors) and insolvency practitioners. The latter are in the
main qualified accountants but now members of a separate and sepa-
rately regulated profession.72 As an example of a country that provides
discretionary access to its rehabilitation regime, the judgment exercised
by the court relies heavily on the report prepared by an insolvency practi-
tioner on the likelihood of the debtor achieving the objects for which the
administration order is being petitioned.73 An insolvency practitioner is
appointed as the administrator and has overall control of the rehabilita-
tion process subject to the (much lighter) surveillance of the court.
There is much to be said for the idea that the preparation of an appro-
priate questionnaire, and gathering any additional information that may
be forthcoming, is a vital operation that needs to be undertaken by some-
one who is highly skilled and close to, but independent of, the manage-
ment of the debtor. A strong structure for ensuring maximum disclosure
of useful and relevant information can be found in the rehabilitation pro-
cesses of the United Kingdom and other countries where an independent
administrator is appointed with authority over the rehabilitation process
(e.g., France and the Netherlands).74
While the independence and professional qualification of an indepen-
dent administrator who is an insolvency practitioner makes that person
ideal for the process of eliciting information, it is less clear whether this
person should also play a central role in managing the business. There
is much to be said for managers, especially managers immersed in the
71 Stuart C. Gilson & Mike Vetsuypens, CEO Compensation in Financially Distressed
Firm: An Empirical Analysis, J. Fin. (); Lynn M. LoPucki & William C. Whit-
ford Corporate Governance in the Bankruptcy Reorganization of Large Publicly Held Cor-
porations U. Pa. L. Rev. , ff. ().
72 See supra ..
73 Id.
74 See infra ...
chapter four
very business of rehabilitation, taking up that role, provided there are
safeguards against the obvious potential for corruption to which such a
system can give rise. The United Kingdom’s system permits such cooper-
ation, while the systems in Canada and Mexico institutionalize it.
Following on the heels of eliciting information is the assessment of
the prospects of the business. The stark choice here would seem to be
between the adversarial process as it operates in the United States and
reliance on the professional judgment of the insolvency practitioner
as in the United Kingdom and elsewhere.75 Again, a combination of a
professional and the existing management may be a good compromise,
remembering that professional judgment may also suffer from certain
limitations, including over-cautiousness.
... What Information and How Obtained?
Disclosure of basic data, including financial statements, operating statis-
tics, and detailed cash flows, is a pre-requisite for sound risk assessment.
Fundamental factors underpin the determination of which option—
reorganization or liquidation—provides the best and quickest return for
creditors. The administrator and creditors need to assess: () the com-
pany’s immediate liquidity needs and whether new financing is prudent;
() the company’s business prospects and whether the business is viable
on a long-term basis; and () if management is qualified to continue to
lead the company. Assessment of long-term viability will often involve
development of a business plan based on comparable historical data.
Time is of the essence and speed is vital in business rehabilitations,
requiring fast decisions and actions before the value of the assets dis-
sipates. Although incentives for gathering and providing information
are somewhat intangible, all parties—be they lenders, potential lenders,
directors, shareholders, courts, receivers, or administrators—require in-
formation that is complete, accurate and reliable, provided on a timely
and frequent basis, and sufficiently comprehensible. The law generally
prescribes, broadly, the substance of the information to be provided and
how and when that information is to be provided, usually by officers and
other relevant third parties. Safeguards may be needed to protect confi-
75 The UNCITRAL Legislative Guide would impose on the debtor a duty to disclose
relevant information but would ultimately charge the “insolvency representative” with
gathering such information. Id. at , .
corporate rehabilitation proceedings
dential information (such as trade secrets). In addition to providing
the type of information mentioned above, one or more officers of the
debtor may be represented and required to attend a main (possibly initial)
meeting of creditors and answer questions. In cases where information
is withheld, a form of “public examination” of officers and directors
or other persons may be required to compel the provision of relevant
information.76
Some jurisdictions have developed disclosure requirements to the
point of standardized information schedules that must be completed by
the debtor or its management (with sanctions for false or misleading
information) or by an independent person or administrator. Where the
business of the debtor is to continue, important information will go
beyond merely indicating possibilities to include projections of profits
and losses, cash flow, marketing, industry trends, and other information
relevant to the feasibility of a successful rehabilitation. Revenue and
growth assumptions should be carefully scrutinized. Although it may not
be considered necessary for the law to intrude and exhaustively recite
such matters, it can be beneficial in countries that have little experience
with formal (or informal) rehabilitation techniques to spell these out.
Other relevant information includes the causes of the debtor’s financial
difficulty and a review of past transactions that may be avoided under the
avoidance provisions of the insolvency law.77 The provision and analysis
of information should not be left to the debtor alone but should be
available to the administrator and the creditors’ committee. Thus, it is
important to provide for the appointment of an independent person to
review or comment on the information.
There is a serious dilemma in relation to the search for information
in cases where an outside independent Administrator or other officer is
appointed to manage the debtor. Often this information is to be sought
from people who have been responsible for the debtor’s failure and
who could be placed in a position in which they are asked to provide
information as to their own negligent or even fraudulent conduct. The
Anglo-American systems are extensive in their provision of the means for
the acquisition of information in this context, and are also very insistent
in wishing to protect a person questioned against self-incrimination.
In the United Kingdom this dilemma has been resolved decisively in
favor of the Administrator’s right to use the wide statutory powers to
76 See infra and § , UK Insolvency Act .
77 See supra ..
chapter four
acquire information as to the operation of the debtor leading up to its
entry into the business rescue regime. Thus, the Administrator in an
Administration in the United Kingdom has power to ask the court to
summon an appropriate person:
– to submit an affidavit containing an account of his dealings with the
company;78
– to produce any books, papers, or other records in his possession or
under his control that relate to the company.79
– to pay any amount that he owes to the company;80 and
– to be examined on oath either orally or by interrogatories concern-
ing the company or its promotion, formation, business, dealings,
affairs, or property.81
This issue came before the Constitutional Court of South Africa in rela-
tion to a provision of that country’s Insolvency Act82 that purported to
authorize the imprisonment of a person summoned to appear before
a meeting of creditors and who refused to be sworn in by the presid-
ing officer at the meeting, failed to produce any book or document that
he was required to produce, and refused to answer a question lawfully
asked.83 The provision was challenged as unconstitutional, in particular
as it allegedly infringed the right to freedom and security of the person
guaranteed under the Constitution. The majority of the Constitutional
Court upheld the exercise of the power conferred by the Insolvency Act,
provided that the committal to prison, if required, was the act of a judicial
officer.
In his judgment, Judge Ackermann, speaking for the majority, noted
that in several foreign countries surveyed, government personnel other
than judicial officers were not permitted to commit to prison a reluctant
witness in an insolvency proceeding. He concluded that this was because
non-judicial government officers lacked the independence of the judi-
ciary. Judicial officers, on the other hand, including magistrates (in this
case a magistrate had presided at the insolvency meeting in question)
could commit to prison an uncooperative witness in aid of an insolvency
inquiry.
78 § (), UK Insolvency Act .
79 Id.
80 Id. at § ().
81 Id. at § ().
82 § (), South African Insolvency Act .
83 De Lange v. Smuts N.O. and others () SA (CC) .
corporate rehabilitation proceedings
An Administrator appointed under the Australian Corporations Act
is under a similar obligation to “investigate the company’s business,
property, affairs and financial circumstances” of the debtor and is given
equally wide investigatory powers to enable him to do so.84
.. Plan: Formulation, Consideration, and Voting
This section discusses the limitations that might be imposed on the
process of formulating a plan and on the contents of a plan, the process
of stakeholder consideration, and voting procedures.
... Formulation
The decision of how much external public supervision should be given
to possible rehabilitation plans is a delicate one that should be tailored
to each jurisdiction’s political, cultural, and economic circumstances.
Flexibility is crucial, given the enormous variations in businesses and
industries and the varying challenges faced by particular debtors. On
the other hand, where expertise is limited, more structure and public
supervision may ensure more realistic and sustainable plans. It is rare,
now, for legislation to be over-prescriptive in this regard, given the major
breakthrough achieved by the new wave of rehabilitation regimes in
departing from the earlier generation’s insistence on entitlement to the
benefit of the regime being dependent on establishing the likelihood that
the creditors would all be paid in full.85
Although restrictions on the plan are undesirable, a jurisdiction just
beginning the development of a rehabilitation culture may wish to adopt
rules that describe the key elements of a plan that must be addressed.
Examples would include a clear and complete description of the rights of
each creditor (or class of creditors) under the plan and default provisions
that would go into effect if the debtor defaults in performing under the
plan. There should also be a detailed explanation of the likely results for
84 § B–C, Australian Corporations Act .
85 See supra .. Norwegian legislation lays down requirements for different majorities
depending on the amount of the debt that a proposal would offer. If the proposal offers
a minimum of , it requires approval by a majority of and, if less than , the
required majority goes up to .
chapter four
creditors if the plan is defeated and the debtor is put into liquidation.
Plans or schemes in use in various countries can be consulted for the key
points to be included.86
... Sponsorship and Negotiation
Equally important is the question of who will negotiate and present a
plan. As noted, the law should designate a party responsible for pro-
ducing a plan within a set time. Typically, that party would be the
debtor’s management, the administrator, or the creditors’ committee.
Others should be permitted to present plans as well, but there should be a
preference for the designated party to focus the negotiations in one place.
In the United States, for example, the debtor’s management, or an admin-
istrator if one is appointed, has the exclusive right to propose a plan for
days (and to confirm it within a total of days) and that time can
be extended by the court.87 After that period expires, any creditor may
present a plan. In the United Kingdom, the responsibility rests with the
Administrator, who starts by setting out proposals for achieving the pur-
poses of the Administration.88 These proposals are then considered by
the creditors,89 followed by revisions, if necessary.90 The court has a wide
variety of powers if the proposals—as amended, if it is the case—are not
approved.91
Major creditors are generally closely involved in negotiating details rel-
evant to the treatment of their claims, as well as other significant details
regarding the restructuring (e.g., asset sales, changes in management).
Likewise, the creditors’ committee, along with other important stake-
holders, should have an important role in plan negotiations.
86 See, e.g., American Law Institute, International Statement of United States Bank-
ruptcy Law at Appendix G, at (sample plans in large cases in various countries).
For further illustrations of typical U.S. plan provisions see any one of hundreds of
reported cases, e.g. In Re Kreider Bankr. LEXIS ; Bankr. Ct. Dec. . A
Corporate Voluntary Arrangement (“CVA”) often constitutes the plan that concludes a
U.K. Administration, see Roy Goode, Principles of Corporate Insolvency Law (rd
ed., ) –. See also UNCITRAL, Legislative Guide on Insolvency Law –
().
87 United States Bankruptcy Code § .
88 ¶ , Sch. B, UK Insolvency Act .
89 Id., at ¶¶ –.
90 Id., at ¶ .
91 Id., at ¶ .
corporate rehabilitation proceedings
... Voting and Classes
In the UK, when the regime of Administration was first created in ,
it was anticipated that a successful Administration would be concluded
by a transfer of the process to either a CVA, which was also created
by the Insolvency Act ,92 or a Scheme of Arrangement,93 a much
older institution that had been created by and that is still set out in
the Companies Act.94 It was anticipated that the CVA would provide a
simpler and quicker route for the majority of successful Administrations,
and the Scheme of Arrangement—which provides for separate meetings
and separate voting of each different class of creditors and each different
class of shareholders—would deal with complex Administrations.
In the case of a CVA, the plan is not permitted to affect the rights of
secured or preferential creditors without their consent, and such credi-
tors do not have the right to vote on the plan. The requisite majority for
the plan to be binding on all creditors is percent of the value of the
claims, at least half of which must be held by creditors unaffiliated to the
debtor. There is also a requirement for a vote in favor of the plan by the
shareholders of the debtor company, in which case the required majority
is anything over half.
In the case of a Scheme of Arrangement, voting is conducted at sepa-
rate meetings of each class of creditors and shareholders. For the scheme
to be approved, each meeting must vote in favor by a majority of at least
percent in value. Unlike the position in the United States, there is no
provision enabling the approval of the plan to be forced upon an unwill-
ing class that did not support the plan by the requisite majority.
More often, however, the power to bind secured creditors and pref-
erential creditors is critical to a feasible plan. In the jurisdictions where
that power exists, those creditors are, naturally, allowed to vote, usually
by classes. They must approve the plan if it is to be adopted, except as
noted below.
Even more important than the question of the precise majority re-
quired is the issue of classes. Some systems lump together all unsecured
creditors and demand a certain majority in that unified class. Others
divide the creditors into classes according to the treatment each will
92 Part , §§ –.
93 See § ()(b) & (c) (the old § ), UK Insolvency Act .
94 The current one being that of ; see §§ – for the provisions relating to the
Scheme of Arrangement.
chapter four
receive, so that all the creditors in a class are given the same treatment (or
the same choices). The advantage of the second system is that it permits
different treatment of different creditors while avoiding potential con-
flicts of interest among creditors in a particular class. Different treatment
of creditors with the same legal rights is often desirable. For example,
banks and public bondholders may prefer very different treatment, even
though both are secured or both are unsecured. More often, lenders and
suppliers will have different interests even if they have the same types of
claims from a legal perspective. Suppliers, for example, may more often
be willing to receive less payment in exchange for quick cash, while banks
would prefer a larger percentage of what they are owed, even if paid over
a longer period.
This, indeed, is the French system. The creditors are divided into two
separate classes, apparently not on the basis of preferential and non-
preferential or secured and non-secured but on the basis of suppliers of
goods and services on the one hand and credit establishments on the
other. Two committees are formed and any creditor with five percent
or more of the total debt of his class is entitled to be a member of the
committee. The committees vote separately and the decision is taken by
each committee by a majority of its members, representing at least two-
thirds of the total amount of the debts owed to all the members of the
committee.
In jurisdictions that support classification of claims, rules governing
classification should be clearly stated and designed to avoid abuse. The
primary purpose for classifying claims is to satisfy the requirement to
provide fair and equal treatment of creditors, treating similarly situated
claims in the same manner. Classification also makes it easier to ensure
that special claims such as those of secured and preferential creditors are
treated in accordance with the priority established under the law.
In some cases, classification makes it easier to treat the claims of major
creditors, who may be persuaded to opt to receive a different treatment
from the general class of unsecured creditors, where such treatment is
necessary to render the plan feasible. In such cases, the treatment for
these major creditors is generally on less favorable terms than other,
similarly situated creditors. Finally, classification may be a useful means
of overriding the vote of a class of creditors that votes against the plan
where the class is otherwise treated in a fair and equitable manner.95
95 This override, which has come to be known as a “cramdown” based on its effect,
corporate rehabilitation proceedings
Most laws require a qualified majority of creditors to vote in favor of
the plan, with voting conducted en masse or by classes. In cases where
classes vote separately, the requisite majority is usually required of each
class. In some countries a hybrid test is used that requires class approval
by a requisite majority of the total number of creditors in the class and by
a qualified majority of the total debt of the class. Failure of one or other
requirement would be fatal to class acceptance.
The two types of Japanese proceedings have different rules in this
regard. In a civil rehabilitation proceeding, a plan is accepted if a simple
majority of creditors who attend the creditor meeting and hold more than
half of the total amount of unsecured claims to the debtor accept the plan.
On the other hand, in a corporate reorganization proceeding, a plan is
accepted by unsecured creditors if creditors holding more than half in
amount accept the plan.96
In the new Mexican law, the voting process is more complex. First, tax
and labor claims, which must be paid in full unless there is agreement to
the contrary, are not included in the voting computation at all. Secured
creditors are divided into those that subscribe to the plan of reorgani-
zation and those that do not. The majority required for approval of the
plan is only percent of the sum of “recognized” unsecured creditors
plus the subscribing secured creditors, but the dissenting secured credi-
tors must be paid at least the value of their collateral, and the dissenting
unsecured creditors must receive no less than the entitlement of similar
claims of creditors who do accept the plan.97
It would follow from this that unless secured creditors are fully pro-
tected by being able to exercise their enforcement rights at any time or
by being able to veto any attempted use by the debtor of the assets that
allows the court to conclude that a rejecting class should be compelled to accept the plan
where the class is to be paid in strict accordance with the relative priority of creditor
claims and will receive under the plan a distribution in an amount equal to or greater
than such creditors would receive in a liquidation proceeding. The rationale is that these
creditors cannot claim “foul” if their recovery is at least as good as they would have
received if they had prevailed in having the enterprise liquidated.
96 We are indebted for these insights into Japanese business rescue provision to assis-
tance from Professor Junichi Matsushita of Tokyo University and to the paper filed by Dr.
Shinjiro Takagi at the World Bank’s Global Forum on Insolvency Risk Management Stan-
dards and Strategies for the Next Decade, January –, , Washington D.C. Shinjiro
Takagi, Restructuring in Japan Int’l Insolv. Rev. ().
97 ALI Mexican Statement at –.
chapter four
constitute the security, they should not only be entitled to vote on any
proposal but that voting on a plan should be by separate classes with
a “cramdown” to prevent obstruction of a feasible plan. An insolvency
system must address the electoral structure of forced acceptance of a
plan. One is majority rule by a vote of creditors overall while the other is
acceptance by the majority in each class. Dissenting minorities overall
or by class are required to accept the results of the vote. Nearly all
modern systems have this feature, which solves the “hold out” problem.98
Fairness can be ensured, as in the United States and Mexican examples,
by providing that dissenters must receive equal treatment with approvers.
As indicated above, “cramdown” usually refers to a rule that imposes a
rehabilitation plan on a whole class, a majority of which has voted against
the plan.99 It constitutes an exception to the rule that a plan fails in a
“by class” system unless every class accepts. The United States’ system
is one example with such a rule. Naturally, a cramdown rule requires
strict control over the circumstances in which it can be used. In the
United States, for example, cramdown against a secured creditor requires
payment of the secured creditor’s collateral value plus a market rate of
interest (thereby giving that creditor the equivalent of the “present value”
of its collateral), while cramdown against unsecured creditors requires
that any junior interests, including the equity owners, receive nothing,
so that the creditors effectively own the company.
Voting in separate classes also protects bona fide creditors from the
oppressive behavior of certain creditors who may, for example, wish
to undermine the debtor so as to further other, unrelated interests.100
A related problem is presented by insider creditors. The concept of
the “inside creditor” is well established in insolvency law. Essentially it
connotes a creditor who can be expected to cast his vote as a creditor
contrary to the interests of the creditors as a class, on account of wanting
to favor the interest of a director or shareholder or other insider of the
company. The creditor in question is likely to have a close relationship
with the insider, as a spouse or other relative. The United Kingdom
98 For information on “hold outs”, see supra ...
99 For a discussion of the cramdown see Charles D. Booth, The Cramdown on Secured
Creditors: An Impetus Toward Settlement, Am. Bankr. L.J. ().
100 Consider the circumstances in the English cases (both of companies as going
concerns) of Re Holders Investment Trust Ltd. [] W.L.R. and Re Hellenic &
General Trust Co Ltd. [] W.L.R. .
corporate rehabilitation proceedings
legislation describes a person in this position as being “connected with
a company”101 and disallows this creditor’s vote in appropriate circum-
stances.102
Given that all creditors would be expected to cast their vote according
to their own interests, it may not always be a simple matter to exclude cer-
tain votes as illegitimate, but the courts must be given the ability to exer-
cise this power where, for example, corrupt or wholly unrealistic expec-
tations of insiders influence the vote. It is conceivable that outside credi-
tors, too, may have wholly unrealistic expectations, but this is unlikely to
be decisive. If unsecured creditors vote to continue an evidently failing
business in circumstances where this would jeopardize the interests of
secured creditors, the latter would almost certainly vote decisively against
continuation.
There may be a need for an independent assessment of the proposed
plan, especially to assist small, unsecured creditors in deciding where
their interests lie and in determining whether the plan is “feasible.”103
Sometimes, however, testimony by so-called experts engaged by oppos-
ing interests leads to an escalation of the court process with, quite pos-
sibly, a reduced chance of an independent assessment of the proposal.
Some jurisdictions may consider permitting the court to engage an inde-
pendent expert (e.g., an unconnected accountant or appraiser) whose
report would be available to all creditors. France or the Netherlands
might be said to fall into this category. Each arranges for the appoint-
ment of a neutral independent judge or other official to run (or assist in
the running of) a debtor placed in the rehabilitation regime. The United
Kingdom has, on the whole, a very reputable insolvency practitioner pro-
fession, but its close association with bank creditors might rule out its
being able to act as independent experts.
... Pre-packaged Plans
In recent years there has been considerable interest in what the United
States calls “pre-packaged plans” or “pre-packs.” The idea here is to try
to combine out-of-court workouts with formal rehabilitation to get the
101 See §§ , , UK Insolvency Act .
102 See e.g. art. .()(c), UK Insolvency Rules .
103 Under the United States statute, the court must find that the plan is feasible in that
its approval is “not likely to be followed by liquidation, or by the need for further financial
reorganization,” except as provided in the plan itself. U.S.C. § (a)(). Opposing
experts routinely testify on this point in the larger cases.
chapter four
best features of each. Most of the restructuring of the company and the
negotiation of a new capital structure is done outside of court, but then a
rehabilitation plan is presented to an insolvency court for approval, often
already endorsed by creditors. The main benefit of the formal proceeding
is, once again, to force dissenters to acquiesce and thus resolve the hold-
out problem.104
... Plan Approval
There are some difficult questions as to the role of the court in plan
approval and the answers will vary, depending on the legal culture of the
jurisdiction and the level of commercial expertise expected of its judges.
In all systems, the decision on whether to accept a rehabilitation plan is
principally one for the creditors, although the court must be empowered
to act against fraud, corruption, duress, or other malpractice in the voting
process. Different interests may have very dissimilar information as to the
state of the debtor and, consequently, the likelihood of effective survival.
Some jurisdictions that have less of a laissez-faire tradition than, say,
the United Kingdom and the United States, may wish to provide for an
independent expert to assist the judge. In the Netherlands, for example,
it is emphasized that even where the requisite majorities in favor of the
proposal are attained, the court is not obliged to give its consent to the
proposal. This is, of course, also true of the United Kingdom and the
United States, but its emphasis in the Netherlands seems to suggest a
more obtrusive role by the latter’s courts in this process. Perhaps it would
help if the independent report made available to the creditors prior to the
vote is the report that is also available to the court. This might increase
the reluctance of the court to interfere with the creditors’ decision.
This is just one of a number of circumstances in the insolvency process
where jurisdictions will differ, as much as a consequence of cultural
factors as any other. Some societies are more likely to have judges (or
other officials designated to decide questions such as the feasibility of
a rehabilitation plan) who have a grasp of commercial practice. As a
result, they are more likely to make accurate practical determinations
about feasibility but are also highly unlikely to challenge the decisions
of creditors in the absence of fraud, corruption, duress, or other similar
vitiating factors. Where appropriate officials and judges are less likely to
104 See Vanessa Finch, Pre-Packaged Administrations: Bargains In The Shadow Of Insol-
vency or Shadowy Bargains, , J.B.L. –; see also infra ...
corporate rehabilitation proceedings
have been immersed in commercial practice, it is helpful if the court can
be advised by an expert with an independent commercial judgment.
... Plan: Implementation and Amendment
It is common in the rehabilitation regimes of the European Union for
there to be some external monitoring of the agreed plan. Thus, in the
United Kingdom, when a CVA has been reached, the insolvency prac-
titioner—who will have performed certain functions in facilitating the
CVA—becomes the supervisor of the plan. As such, he has power to seek
the guidance of the court and is susceptible to complaints by creditors
or anyone else dissatisfied by any act or omission on the part of the
supervisor. In Denmark, the court may require the appointment of an
administrator (tilsynsførende) to monitor the plan. The supervisor plays
a similar role in the Netherlands, where he is called the bewindvoerder.
When a plan has been agreed upon in Italy, the debtor manages the
enterprise under the surveillance of a judicial commissioner. In the
United States, there is no statutory provision for a plan monitor but it is
increasingly common for a plan to provide for a “plan trustee” to monitor
or carry out the plan’s provisions.
A further variation lies in the extent of the court’s involvement. This is
extremely difficult to establish since, here again, the commercial culture
will play a vital role. Thus, while in the United Kingdom, the court’s
approval is required and the court seems to play an active part, the
reputation of the insolvency practitioner profession is sufficiently high
to enable the court’s oversight to consist, often, of a light touch. In
the United States, the role of the court in the monitoring of the plan
is minimal, but the court is perhaps more readily available to resolve
disputes under the plan than in other jurisdictions.
Along with these law reforms, practices to deal with insolvency cases
(liquidation cases and rehabilitation cases) are changing dramatically.
Almost all courts in Japan are opening their gates wider to insolvency
cases, and the cases are being handled more expeditiously. Before these
reforms, the Japanese courts were reluctant to admit insolvent debtors to
the older composition process for fear of debtors defaulting on any plan
approved by the court.
Most jurisdictions require court approval to amend a plan once that
plan has received court approval, inevitably introducing some formality
into any subsequent alteration of the plan. In certain instances, with
skillful drafting, it may be possible to create a less formal mode for
chapter four
altering the plan. In the main, however, this is likely to be satisfactory
only where minor changes to the agreed plan are sought. Major changes
will inevitably reignite the clash of various interests, which are unlikely
to be resolved within the terms of a contractual provision. It would be
unfortunate if the consequence of trying to make the plan self-sufficient
added litigation as to the interpretation of the plan to the substantive
business issues underlying the need for alteration. As elsewhere in this
field, the critical consideration is reaching a balance that enables as
much as possible to be accomplished informally while still retaining a
seriousness that inspires confidence in those interested in a successful
outcome.105
... Plan: Discharge and Binding Effects
There are two important concepts in this area. The first is the need
for commercial certainty by giving binding effect to the forgiveness,
cancellation, or alteration of debts in accordance with the approved
plan. This principle is particularly important for ensuring compliance
with the plan provisions by the creditors who rejected the plan or who
did not participate in the approval process. A plan must be seen to be
final and binding or the necessary commitment from investors, lenders,
employees, suppliers, and other key actors will not be forthcoming. In
some countries (such as Canada), the approved plan is regarded more as
a contract than as a court order, but it is better to put the past behind
by replacing the old obligations in their entirety with those set forth in
the plan. The requirement of notice to all creditors is emphasized in
this regard106 because the plan must bind all possible creditors to the
maximum extent possible and because binding a creditor who did not
have notice of the proposed plan may be a denial of natural justice (due
process). Every creditor who was sent notice in a proper way and every
creditor who had actual knowledge of the proceeding should be bound.
Tied to notice is the extent to which systems take advantage of evolving
technology to try to reach more creditors with actual notice through the
use of emails, for example, rather than newspaper ads and traditional
mail.
105 The UNCITRAL Legislative Guide recognizes the possibility of amendments to
a plan but stresses the importance of notifying potentially affected creditors. UNCITRAL
Legislative Guide, – (¶¶ –).
106 See infra Chapter .
corporate rehabilitation proceedings
A successful plan will very often require the creditors to accept a
reduction in their original entitlements; the quid pro quo consists of the
continuation and recovery of the debtor. Loyalty shown by creditors at
the recovery stage is likely to be repaid by continued business if and when
the debtor regains its independence. With trust as an essential ingredient
in this process, it is vital to eliminate, insofar as possible, fraud and
corruption by debtors (perhaps in collusion with some creditors) that,
for example, might conceal assets or otherwise misrepresent the state of
the business to the mass of creditors.
On the other hand, there may be a doctrine that requires claims of
fraud or concealment to be raised, if known or reasonably knowable,
before the plan is approved, or else be barred. There may also be a short
period given for revoking a plan for fraud so as to avoid prejudicing the
expectations and reliance of innocent persons. Of course, civil and crim-
inal penalties for persons who engaged in fraud will remain available.
There is a connection between the requirements for a final discharge
and those of full disclosure to enable fully informed decisions to be
made by all those interested in the rehabilitation. Some businesses will
inevitably be impervious to rehabilitation, and the sooner this is estab-
lished, the better for all concerned. Governments may provide appropri-
ate incentives in the form of tax relief for bad debts and—for debtors—
exemption from investigation where the debtor has acted openly and
honestly. In the United Kingdom, for example, there is a regime under
which those who were directors of a company that goes into insolvent
liquidation may be put through the process leading to their disqualifi-
cation from acting as company directors for a specified period. Where
directors have assisted the rehabilitation process and acted candidly and
truthfully, however, they can expect to avoid this process. In jurisdictions
where a quick decision can be made in clear cases of honest and open
conduct that the disqualification process will not be invoked, the poten-
tial for such sanctions will serve as a useful incentive for management to
act appropriately.
.. Conclusion
One cannot overemphasize the importance of providing a system under
which debtors are encouraged to seek the help of the protective rehabil-
itation regime early enough to ensure that the maximum benefit can be
achieved, with the caveat that too great an incentive (negative or positive)
chapter four
to seek this help early might have the effect of pushing some debtors into
rehabilitation regimes too soon, with possible adverse consequences for
existing creditors.
The issue here is linked with that of ease of access. In general, the more
complicated and expensive the procedure for access, the more reluctant a
debtor is to seek the help of the rehabilitation regime, especially at a time
when, to the debtor, recovery would seem probable. This would argue
for the United States’ system of automatic entry, but European coun-
tries and countries that were formerly British colonies have a long his-
tory of resistance to automatic entry to a regime that bars creditors—
however temporarily—from their enforcement rights. There are, it must
be recognized, certain cultural sensitivities that have to be considered.
Throughout Europe, even where practice suggests that protection under
a rehabilitation regime is readily granted, court involvement is still, gen-
erally, insisted upon. Only in the United Kingdom have recent proposals
been made for providing automatic access into a protective rehabilitation
regime without court sanction, although even there this reform has been
hedged in with certain significant qualifications.107
The rehabilitation culture in Europe is less well-developed than it is
in the United States. In general, the structure of rehabilitation regimes
in Europe is comprehensive, but it would be fair to add that there is little
participation by unsecured creditors and stockholders in the process. The
general assumption is that such interests do not have much to gain from
the rehabilitation process and that to attempt to do so is a waste of time
and money.108
In the United Kingdom, it has been argued that the ubiquity of the
floating charge and administrative receivership, with its propensity for
overall control of the insolvent debtor, has been a major disincentive to
the active participation of unsecured creditors and stockholders. Some
contend that this is a major cause of the lack of confidence that prevails
in the business rehabilitation process. They say that the receivership sys-
tem negates the many enterprising features in the rehabilitation processes
of the United Kingdom and other western European countries, including
such features as the establishment of creditors’ committees, the require-
ment of sharing full information as to the conduct of the rehabilitation
process, and so on. The predominant legal and commercial culture is of
considerable significance in the operation of the rehabilitation regime.
107 See supra ...
108 See supra ...
corporate rehabilitation proceedings
It is certainly true that the recent United Kingdom reforms introducing
automatic entry to the rescue regime and drastically limiting the role of
administrative receivership explicitly acknowledged the need to stimu-
late business rescue.
It would be no exaggeration to say that the United States’ Chap-
ter regime is viewed with considerable skepticism by financing insti-
tutions in Western Europe. It is highly likely that this procedure is inad-
equately understood and the actual practice not appreciated. Given this
widespread skepticism, coupled with the reluctance of governments to
antagonize the financial sector, an effort to stimulate a rehabilitation
culture in Western Europe by introducing the Chapter approach is
unlikely to be successful unless it is a carefully monitored and controlled
form of Chapter . A system not unlike Chapter was introduced in
Germany in but there are, as yet, insufficient reports as to how it is
working. Despite a number of apparent “success stories,” it cannot be said
with any confidence that this new rescue regime has been fully accepted
by insolvency practitioners.
Key differences from Chapter are that the German system, as a
rule, replaces management with an Administrator from the start109 and
that it is a “unitary” system—that is to say, it could lead either to rescue
or liquidation—with an observation period of up to three months. In
principle, the survival of equity investors in a rescue will depend on the
agreed plan, which, of course, is in the hands of the creditors.
Central to the success of assessing the prospects of the business are
two issues: who will undertake the assessment and what information
will be available to this body or person in the performance of this task.
But arriving at legislative solutions to resolve these tensions and con-
flicts among creditors is just part of the process. It is not an easy task
to replace in one fell swoop a liquidation regime with a well-functioning
corporate rehabilitation procedure. Rehabilitation cultures do not take
hold overnight. Law reformers and practitioners alike should appreci-
ate that this is a slow process that can only take hold if other neces-
sary institutions—cooperative creditors, qualified judges, and effective
lawyers and insolvency professionals—are also in place. The recent law-
reform experience in Asia in the aftermath of the financial crisis—
perhaps “experiments” is the better word—demonstrates this point. Hav-
ing a well-crafted corporate rehabilitation law on the statute books in
109 Although it should be noted that the appointment of a rescue officer to the existing
board of the firm under rescue has some precedent in Germany.
chapter four
a growing number of jurisdictions in Asia has not led to a significant
increase in the number of insolvency cases; and where cases have been
commenced, such law has not led to a dramatic increase in successful
restructurings. However, the experience in Asia demonstrates another
point—which is the subject of the next chapter—that perhaps the most
important piece of the process in developing an effective corporate res-
cue system is the establishment of an informal, out-of-court rescue pro-
cedure.
chapter five
INFORMAL WORKOUTS AND RESTRUCTURING1
.. Introduction
There seems to be a consensus in most commercial cultures that infor-
mal procedures that solve problems are preferable to litigation with its
much added expense and time. By definition, such procedures are not
enshrined in law, although background legal rules may shape them in
important ways. Thus in this chapter we seek to provide a discussion that
enables the reader to evaluate informal approaches in various legal situ-
ations and as to debtors in various circumstances.
An informally agreed solution may enhance the trust and goodwill
that are often vital to the future commercial relationships among the
parties. This is particularly true where the issues concern the attempt
to rescue an insolvent debtor with potential for survival and where
continuing support for the debtor from existing customers or clients
will be an important factor in the survival. Furthermore, an informal
procedure can enjoy secrecy, something that might be of special value in
circumstances where adverse publicity might have a further detrimental
effect on the weakening debtor.
An informal procedure would in appropriate circumstances provide
something more flexible and less rigid than the process available under
formal rescue regimes. Many cases of corporate financial difficulty re-
quire an earlier and more active response from key bank and financial
institution creditors, which is normally not possible under formal rescue
regimes. It is less confrontational and so provides a better environment
for market negotiations, both between creditors and the debtor and
among creditors themselves. It is perceived to carry a lesser stigma than
the formal process.
1 For instructive and entertaining descriptions of the workout process, see Michael
Mortitz & Barrett Seaman, Going for Broke: The Chrysler Story (); Tom Wolfe,
A Man in Full, Chapter ().
chapter five
Some countervailing considerations are heard. It may be thought that
informal arrangements are not sufficiently transparent and may advan-
tage large and sophisticated creditors. They may also be employed, as they
were said to be in the United States during the Great Depression, as a
device by which certain groups of corporate stakeholders could “squeeze”
other groups, taking more of the enterprise’s value for themselves.2 On
the other hand, when informal procedures are used to affect primarily
the interests of lenders and other sophisticated creditors, those concerns
are largely avoided and the benefits of the informal approach are more
difficult to deny.
An informal workout probably would not be attempted unless a num-
ber of well-defined conditions were present; for example, a significant
amount of debt should be owned by a number of bank or financial insti-
tution creditors, the debtor should be unable to service that debt, and it
should be possible to carry out all the arrangements without the need
for a formal moratorium. Further, it almost goes without saying, there
should be agreement to carry out such discussions not only between the
debtor and the creditors but also among creditors.
INSOL International, in a document endorsed by the World Bank,
the Bank of England, and the British Bankers’ Association, expressed
considerable support for informal workout procedures in the following
terms:3
During the last thirty years there has been a growing recognition amongst
the world’s financial institutions that, as creditors, they can achieve better
returns through supporting an orderly and expeditious rescue or workout
of a business in financial difficulty than by forcing it into formal insolvency.
This realization has coincided with efforts by certain regulatory and official
authorities to encourage financial institutions to co-operate with each
other when dealing with debtors to whom they are collectively exposed,
particularly in cases of large exposures.
In their document, INSOL International identified eight principles to
ensure the best practice in multi-creditor workouts. In brief, these prin-
ciples would require that all relevant creditors should be prepared to
2 See generally, United States Securities And Exchange Commission, Report on the
Study and Investigation of the Work, Activities, Personnel, and Functions of Protective
and Reorganization Committees ().
3 See e.g., Statement of Principles for a Global Approach to Multi Creditor Workouts,
INSOL International at p. .
informal workouts and restructuring
cooperate in avoiding any enforcement actions against the debtor for a
period (the “standstill period”) during which all relevant information
as to the debtor might be obtained and evaluated. The debtor would
help the creditors obtain such information and would also agree to take
no action that would adversely affect the return to creditors. Informa-
tion so obtained would be made available to all creditors but otherwise
would remain confidential. The creditors would agree to coordinate their
response to the debtor through selected representatives and appointed
professional advisers. The creditors would conduct themselves in accor-
dance with existing legal principles, and, finally, any funding of the debtor
during the standstill period would have priority treatment vis-à-vis any
other claims of the creditors.
INSOL International was quite explicitly addressing the issue of
large-scale business failure and clearly restricted its comment to one
group of creditors, namely financial institutions. In some circumstances,
Small- and Medium-Sized (“SAM”) enterprises should consider them as
well.
Certain legal preconditions seem important to widespread use of in-
formal rescue agreements. In particular, these agreements are facilitated
where efficient legal procedures exist for enforcement of security interests
and judgments as well as effective insolvency and reorganization laws.
Also important are legal mechanisms for creation and enforcement of
workout agreements outside a formal legal proceeding, including neces-
sary “bridge” or temporary financing of operations.
.. What is an Informal Rescue?
An informal rescue arises within the concept of business rescue and pre-
supposes a debtor either in or near serious default vis-à-vis its creditors. It
is classed as informal because it is contemplated as being outside the legal
institutions of insolvency, in particular the business rescue regime (which
is more than likely to have been created by statute). The rescue may well
seek to alter the rights of some or all of the creditors vis-à-vis the debtor
in order to enable the latter to continue or renew trading with either no
debt or a smaller burden of debt than it had before rescue. In principle,
the alteration of these rights requires the consent of each creditor and
therefore presupposes unanimous agreement among all the creditors to
the informal rescue. In fact, as we shall see, in the large scale rescue in
which a substantial part of the claims against the debtor is carried by
chapter five
financial institutions, there are mechanisms that will enable agreement
to be achieved and made binding on dissenting creditors.4
The prize of achieving agreement for a workout in such circumstances
is the avoidance of waste of time and money that inevitably attends
contentious court processes. On the other hand, it must be remembered
that a superficial agreement that later breaks down and is followed by
contentious litigation, quite possibly in the context of the debtor’s further
depleted estate, may be a worse outcome than if formal procedures had
initially been invoked. Thus it might be said that informal workouts and
restructurings must never lack seriousness of consideration by all parties
as well as genuine agreement. Apart from anything else, this genuine
agreement may be an important positive contribution to the dynamic
rescue process. Spurious or temporizing agreement must be seen as
contrary to the spirit of the exercise.
.. Key Elements of a Rescue
In the case of a large-scale default, there will almost certainly be a large
body of creditors with claims that are likely to be quite varied. Some
will have preferential claims and others will have claims that are secured
against assets owned by the debtor. Some may be able to assert a setoff
against money that they in turn owe to the debtor. It is, thus, highly
unlikely that anything like the necessary agreement will exist among the
creditors to even contemplate informal rescue proceedings. If, however,
a substantial part of the claims against the debtor is held by financial
institutions—quite possible where the debtor is a large corporation or
group of corporations—it has been shown that there may well be suffi-
cient homogeneity to sustain a collective view while investigations are
carried out to establish whether a viable plan for the debtor’s rescue can
be put to all the creditors.5
In this chapter, we discuss various approaches that seek to provide for
the workout and restructuring of the debtor where the role of the court
will, at most, be limited to conferring a public blessing on the parties’
agreement but where, initially, one or more of the interested parties
opposes the course of workout.
4 See infra ...
5 Id.
informal workouts and restructuring
Large business failure is, of course, also likely to impinge on many
creditors other than financial institutions. The restriction implied by
INSOL, however—and quite properly, in our view—reflects the fact that
only groups of financial institutions possess the homogeneity that is deci-
sive in achieving informally an agreed approach to the insolvent debtor’s
future.6 Informal approaches to business failure are also employed in rela-
tion to small- and medium-sized business failure.
It needs to be stressed that for successful informal rescues and restruc-
turings to take place a clear and comprehensive formal legal environment
must be in place. Thus, the parties should be aware that any agreement
properly and voluntarily reached may be enforced by the courts of the
country concerned. Furthermore, it has to be appreciated that failure in
the informal negotiations might well lead to formal, court-based, or oth-
erwise enforceable insolvency procedures. It is this potential threat by
dissatisfied creditors to utilize the formal corporate rescue process that
serves as an important counterweight to holdout creditors that might
otherwise disrupt the out-of-court process.
Ideally, the parties will have access to clear, comprehensive, and rele-
vant information as to the debtor’s past as well as sufficient information
from which careful assessments may be made as to the debtor’s prospects,
if rescued. Here, too, formal processes may play a part in countries that
have formal procedures for the gathering of information to assist the
appropriate officer in formal insolvency processes. Any failure to pro-
vide relevant information in informal procedures might be met with the
threat that the formal processes may be employed.
In addition, certain positive institutions should be in place. Thus, the
legal system should enable the financing of the debtor, either positively
by way of loan or investment or negatively by way of the writing off
of part or all of the debt. There are many imaginative instruments by
which this form of financing can be achieved—a debt/equity swap is
but one example—and it is of considerable assistance if the tax system
will support the enterprise of serious informal rescues. The legal sys-
tem should include provisions that can effectively eliminate the destruc-
tive opposition of minority interests such as majority voting provisions
to overcome the unreasonable opposition of a stubborn creditor. We
6 See the discussions on the London Approach and Pre-packaged Bankruptcy, infra
.., ...
chapter five
would also argue, certainly in the case of large-scale debtors but also more
widely, in favor of as wide representation as possible of all groups that
have an interest in the debtor’s business.
A successful reorganization also presupposes that one or more of
those who are directly interested in the debtor’s business believe that
some form of rescue of the debtor is both possible and desirable. It is
possible, although highly unusual, that all those who are interested in
the debtor’s business—employees, other senior creditors, other junior
creditors, management, investors, possibly one or more public interests
with legally enforceable powers vis-à-vis the debtor such as a relevant
government department, the debtor itself—are in agreement as to the
way forward for the debtor. Such might be described as a successful
informal workout and, to the extent agreed, restructuring of the debtor.
Any court involvement would be simply to provide an official imprimatur
for the parties’ agreement.
A further significant feature of an informal rescue is the absence of a
moratorium on all claims and enforcement processes against the debtor;
hence, the need for strong initial support for the informal process. It
follows that an informal process is almost invariably restricted to cases
where either: () there is substantial agreement among all the creditors
as to the way forward for the debtor; or () the senior creditors have the
will to seek agreement for a plan for the debtor’s future and they carry
the weight or authority to restrain other creditors from taking steps that
might lead to the liquidation of the debtor or are able to provide the
financing that will permit smaller creditors to be satisfied.
.. Preventive Action
There can be little doubt that early action in the form of consultation
between a debtor that is insolvent, or nearing insolvency, and major
creditors substantially increases the chances of a successful informal
outcome for all who have an interest in the debtor’s business. A recent
development in the United Kingdom has been the increasing role for
insolvency practitioners in acting as monitors and advisers in the debtor’s
business while the latter is a going concern, as opposed to carrying out
what has so often been the provision of last rites and a decent burial for
a business beyond rescue for failing to seek help early enough.
The fact that this has emerged especially in the United Kingdom may
be connected with two important initiatives in the radical overhaul of
informal workouts and restructuring
the United Kingdom’s insolvency principles by that country’s Insolvency
Act of . The first of these was the creation of a jurisdiction, wrongful
trading, discussed earlier.7
The second of the two major United Kingdom reforms was the cre-
ation of the insolvency practitioner profession. There had been, for many
years leading up to , a growing group of specialist accountants and
lawyers, and the creation of a separate profession with its own qualifica-
tion regime and principles for sound ethical practice has emphasized the
public role of the insolvency practitioner. This may have enabled insol-
vency practitioners to escape from their popular images as servants of
the senior (bank) creditors and undertakers of failed businesses and to
replace these with the more wholesome one of business advisers.
With a more cooperative and less confrontational relationship be-
tween management and insolvency practitioners, earlier diagnosis of
impending business failure is more likely as is the finding of a less radical
remedy than liquidation or contested formal rescue proceedings. This
more informal attitude might also assist in enabling management to be
more open about its failures at a time when repair and rehabilitation is
either easier or possible. It may also assist in seeing insolvency as a natural
part of the business cycle and in reducing the stigma attached to business
failure.
.. The Main Aspects of an Informal Workout
It may be important to assure the proper and meaningful participation
of representatives of all interests in the debtor’s business.8 In the case of
large debtors, this may well include separate employee representation as
well as representation of all other classes of creditors and of investors
and management.9 In some cases, even representatives of the consuming
public and of relevant public officers may be included. Although it is
often the case in insolvency that creditors and, in particular, senior
7 See supra .....
8 Consider the approach of the Corporate Debt Restructuring Committee in Malay-
sia, briefly described by Chris Wai Kit Lee in his presentation to the Forum for Asian
Insolvency Reform, – February (Relationship Between Informal Workouts and the
Courts in Malaysia), http://www.oecd.org/dataoecd///.pdf.
9 “In any restructuring, the support of all stakeholders is essential to reach a common
goal, that is, to achieve a solution that is supported by creditors, shareholders and
management.” (Chris Wai Kit Lee, op. cit. p. ).
chapter five
creditors are the most powerful interests in the debtor’s business, some
jurisdictions give powerful voice to the public interest10 and others grant
blocking powers to organized labor.11 Furthermore, it is possible that
senior creditors themselves may favor a rescue. In that case the agreement
of, or at least some compromise with, the most junior interests, such
as management and investors, may need to be sought. However weak
a hand the latter might have, they are quite likely to have the potential
of wrecking a rescue attempt by carrying out a threat to put the business
into liquidation.
... Commencing the Process
Someone must bring together the debtor and creditors (at least the main
creditors). There will rarely be any law to facilitate this and the debtor
may not be willing to have a dialogue with creditors. Among creditors,
some will be concerned for their own position and may not want a
collective process. Well-established and widely used creditor remedy and
insolvency law regimes can be used to influence the commencement and
progression of an informal workout. In that case, if the debtor refuses the
opportunity to engage in informal discussions, it will face the prospect
that individual creditor remedies or formal insolvency proceedings will
be pursued. Unwilling creditors face a similar sanction.
This threat is generally sufficient to initiate some type of dialogue.
In countries where creditor remedy and formal insolvency regimes are
suspect, it may be desirable to provide, in some semi-official way, for a
facilitator to encourage the commencement of the process. This approach
has been adopted, with some success, in some Asian countries. A forum
must be selected in which the debtor and relevant creditors can come
together to negotiate an arrangement to deal with the debtor’s financial
difficulty.
10 This sentiment can be seen, for example, expressed by Robert Zafft (Senior Corpo-
rate Governance Specialist, OECD) and Lampros Vassiliou, in their presentation Policy
Implications from the Second Forum on Asian Insolvency Reform, to the Second Forum of
the OECD’s regional overview on the form and substance of Asian Insolvency Reform,
December , at (“While cutting up and selling off pieces of the business might
fully satisfy secured creditors’ claims, it is wasteful to the economy—and unfair to unse-
cured creditors, shareholders and employees—to do so where the claims of creditors can
be satisfied in some other manner.”), available at http://www.oecd.org/dataoecd///
.pdf.
11 The best example may be France, although it should be added that the blocking
mechanism has been somewhat watered down in recent years.
informal workouts and restructuring
... Engaging Advisers
Few if any attempts are made at a workout in the absence of independent
advisers or experts. They provide expertise and a fresh, more detached
view for debtors and the reassurance of independence for creditors. They
may be accountants, finance officers, lawyers, business reorganization
specialists, marketing executives, and so on. It is here where potentially
divisive issues such as the cost of the process and the surrender of control
will need to be resolved.
... Coordinating the Participants
A lead creditor should be appointed to provide leadership, coordination,
management, and administration. The lead creditor typically reports to
a committee that is representative of creditors (a steering committee) to
help the lead creditor and to act as a sounding board for proposals for the
debtor and creditors.
... Stabilizing the Business
As soon as possible, to allow business operations to continue, parties will
need to provide for a negotiation period. This is generally accomplished
by entering into a standstill agreement (a contractual agreement to sus-
pend adverse actions by both the debtor and the main creditors) that
endures for a defined, usually short, period. This is akin to the mora-
torium or stay under the formal rescue process.
... Ensuring Adequate Cash Flow
This requirement imposes a need for financing and therefore is often
a serious problem. The law of the jurisdiction under which the infor-
mal negotiations take place might not provide for the super priority
of any funding during the informal standstill. It may be possible to
provide for this under contract, but equally the law of the jurisdiction
might invalidate such an agreement. What often results is an “inter-
creditor” agreement among major creditors that emergency funding by
one or more will rank for repayment in advance of their other entitle-
ments in the event of a formal insolvency administration of the debtor.
Here as elsewhere, a senior creditor may be required to make some
sacrifices to save the business. In particular, it may be crucial to find
chapter five
cash to satisfy smaller creditors and thus keep the negotiations to a
manageable number of parties.
... Securing Access to Complete and Accurate Information on the
Business
This is essential for reaching a consensual agreement. The creditors will
seek information about the debtor’s business activities, current trading
position, general financial position and assets and liabilities. This is
akin to the statutory requirement for similar disclosure found in most
formal rescue regimes. The provision of information is a key role for
independent professionals, because it makes the information provided
more credible.
... Negotiating, Agreeing to, and Implementing the Restructuring Plan
The creditors should establish what majorities will be required for adop-
tion of various aspects of the plan. Thus it is common for the follow-
ing majorities to prevail: – percent for restructuring, percent for
moratoriums, percent for capital spending, credit draws and asset
sales, and percent for new money. Many credit agreements or inter-
creditor agreements in syndicated lending arrangements will already
have specified the level of approval required for making decisions and
these should be respected to the extent possible. In the absence of such
agreement, all decisions will have to be unanimous. The plan will also
need to take account of creditors with valid security rights.
... Dealing with Outside and Dissenting Creditors
In most cases, the number and diversity of the claims will make it
impossible to include or involve every creditor in the workout process.
Some creditors will be owed small amounts and others will have little or
no commercial expertise, knowledge, or will to participate in the process
in a constructive manner. But such creditors may be important to the
continued business operations of the debtor. Moreover, given that this is
an informal process, no creditors can be compelled to accept the decision
of a majority of their number.
Often in an informal workout, trade and small creditors recover pay-
ment in full that is provided by the larger financial creditors. Although
this smacks of inequality, it may make commercial sense to a group
informal workouts and restructuring
of major creditors. Alternatively, complete unanimity might be sought.
Thus, where the major creditors have agreed on a rescue with the debtor,
the plan is circulated to all creditors and their agreement is requested. The
latter are advised that such a plan would be the likely result if the affairs
of the debtor were to be dealt with under the formal rescue law and that
if unanimity is not obtained, the debtor will volunteer itself under that
law, with the likely result that the plan will be approved thereby binding
all creditors. This highlights the desirability of an adequate formal rescue
law.12
... The Restructuring Agreement must be Legally Binding on all
Creditors
The final restructuring agreement is made legally binding on a dissenting
minority, provided it is party to an inter-creditor agreement that binds it
to the majority decision. Parties who have not bound themselves con-
tractually would not be bound by the decision of majority creditors thus
raising a risk that the restructuring could be rendered meaningless by the
independent action of minority and holdout creditors. In such a situa-
tion, one would have to revert to a formal process. In formal proceedings
the statute creates the mechanism for binding minority creditors.
.. Some Well-Known Informal
Rescue and Restructuring Procedures
... Receivership13
Despite the growing interest in multilateral approaches, the grand old
lady of private workout and restructuring is a decidedly unilateral insti-
tution, namely Receivership, discussed earlier. It was developed by the
Common Law in England and Wales and exported to several countries
in the period of the British Empire. Although this institution may now
be—at least in the United Kingdom—in serious decline,14 its conception
and efficacy is not without interest in the present discussion.
12 Consider in this context the pre-packaged bankruptcy. See infra ...
13 For a fuller discussion of the operation of receivership, see Harry Rajak, Company
Liquidations (d ed., ) ch. .
14 See supra ..
chapter five
Under the English15 system of Receivership, a single creditor, almost
invariably the major lending bank, was16 enabled to take complete con-
trol of the debtor’s management and all its assets. This not infrequently
led to an effective rescue, most often through the receiver’s exercise of
the power to abandon the loss-making side of the business and the sale
of the remainder as a going concern. The not-infrequent inefficiencies of
democracy were thus avoided and remedial action quickly undertaken.
Undoubtedly, the system of Receivership saved certain businesses (espe-
cially those where immediate and urgent action was vital) that the demo-
cratic process might well have further endangered. And, most relevant
to this discussion: (a) the appointment of a receiver with all these powers
was effected by a simple appointment by the creditor whose contract with
the debtor conferred on that creditor this power to appoint a receiver; and
(b) the receiver was deemed the agent of the company, not the secured
creditor, thus limiting the potential liability of the latter. A more simple
and informal process could hardly be envisaged.
The problem with an autocratic institution like Receivership is, of
course, that the autocrat necessarily has sufficient power to deploy the
process for its own ends to the detriment of all other interests, which the
creditor has a right to do under such a system.
The United Kingdom reform is not without interest. By the Enterprise
Act of , it simultaneously drastically reduced the efficacy of Receiver-
ship and also reformed its court-driven business rescue process—Ad-
ministration. The reform was designed to simplify the process in such
a way as substantially to increase the role of the insolvency practitioner
and to reduce the participation of the court.17 These reforms may have
the effect of informalizing Administration and at the same time making
it more responsive to interests beyond those of the senior creditor. If sig-
nificant advances are made by the United Kingdom’s reformed Adminis-
tration procedure, it may offer valuable lessons for other systems.
15 Receivership evolved out of the principles of the English Common Law. Scotland,
for example, which has a somewhat different legal system from England and Wales, only
received the institution of receivership by statute, as recently as with the passing of
the Companies (Floating Charges and Receivers) (Scotland) Act.
16 This analysis is couched in the past tense, because, apart from a few very specialised
exceptions, the institution of Administrative Receivership was abolished by the Enter-
prise Act , see supra ...
17 This is described briefly above, see id.
informal workouts and restructuring
... The London Approach
The London Approach was, as its name suggests, developed in London,
in fact by the Bank of England, which until had a supervisory role
as the United Kingdom bank regulator. The substantial increase from
the s in the number of banks operating in England, the growth
in the syndicated bank loan market, of which corporations in London
took considerable use as they expanded through acquisitions, and the
recessions in the s and s, created a very volatile situation. Large
corporations with temporary liquidity problems were potentially at the
mercy of one or only a few of their lenders, despite the fact that all other
lenders might have wished to keep the corporation afloat.
Some agency was necessary to coordinate the actions of all lenders
of a corporation and in the Bank of England circulated a letter to
banking associations with the aim of ensuring that every bank in London
would follow an informal code to support corporations in difficulty. This
was designed to avoid the potentially catastrophic effects of an insolvent
liquidation of a large corporation at the behest of one, quite possibly
small, lender despite the fact that all other lenders were prepared to
support the corporation through its liquidity crisis.
The London Approach has been described as existing on four major
tenets. First, lending banks will be initially supportive and not seek to
exercise their rights to open an official insolvency process. Second, any
decision is made on the basis of reliable information that must be shared
among all the lending banks. Third, banks and, where appropriate, other
creditors should work together to try to form a collective view on whether
support for the debtor should continue and, if so, in what form this
should be. Finally, the burden of supporting the debtor should be shared
equally by all lending banks.18
These four tenets are closely in line with the usual stages of a workout
under the London Approach—a standstill, followed by an investigation
into the debtor’s affairs, followed by negotiations fronted by the selected
lead bank and, finally, either the abandonment of the debtor or, where
the investigation has revealed circumstances ripe for rescue, a monitored
plan for new financing.
The London Approach has been able to operate on the basis of una-
nimity, and insiders speak of a great deal of market pressure that trans-
18 See Alice Belcher, Corporate Rescue: A Conceptual Approach to Insolvency
Law () p. ff.
chapter five
lates into the comment that “[a] bank which frustrates an orderly work-
out for a company may find that other banks are less likely to be construc-
tive next time round when their roles are reversed.”19 It is also pointed out
that with a now active distressed corporate debt market, dissenting finan-
cial institutions can sell their debt and not incur the opprobrium of the
other banks by breaking ranks.20
The procedure of the London Approach is, thus, essentially the agree-
ment by all banks for voluntary restraint for a period to enable the debtor
to seek to work out its difficulties. This voluntary procedure owes much
to the strong support (and therefore authority) of the Bank of England,
which in the early years of the London Approach took an active role in
some of the major workouts. It is now content to leave the workout to
the lending banks concerned. It cannot be denied that the success of the
London Approach owes a great deal to the weighty authority of the Bank
of England although there are clearly other factors that pull banks and
other financial institutions into line in support of a multi-bank workout
of a large corporation.21
The success of the London Approach—and quite possibly of the pre-
packaged insolvency approach discussed in the next section—may also
in a deeper and more indirect way owe much to the approach to corpo-
rate and commercial activity in the common law world, in particular the
United Kingdom and North America. These approaches may be related to
a growing acceptance in the common law world of an informal and dereg-
ulated environment as being best for business and of the corporation as
an appropriate vehicle for purely private commercial arrangements.
In civil law countries, however—and perhaps here Germany is a sound
example—the corporation may be perceived to a greater extent as a pub-
lic institution. This may, in turn, suggest a more formal commercial and
financial environment that is perhaps less ready to embrace informality
in the approach to workouts and reconstructions.
19 P. Kent, The London Approach () Bank of England Quarterly Bulletin ,
; see also John Armour and Simon Deakin, Norms in Private Insolvency Procedure:
The “London Approach” to the Resolution of Financial Distress (ESRC Centre for Busi-
ness Research, Univ. of Cambridge Working Paper No , ), pp. –, and at
http://www.cbr.cam.ac.uk/pdf/wp.pdf.
20 Belcher, Ibid.
21 Armour & Deakin, op. cit.
informal workouts and restructuring
... The Post- Adaptation for Asia
A significant advantage of out-of-court rescue procedures is that they
can be put into place much more quickly than their formal legisla-
tive counterparts. This is especially important for jurisdictions in the
midst of financial turmoil where law reform efforts will be too slow to
save companies already in distress. And this clearly was the situation in
Asia in the aftermath of the Asian Financial crisis. In jurisdiction
after jurisdiction, the London Approach was adapted for local use—e.g.,
the Bangkok Approach, Malaysia’s Corporate Debt Restructuring Com-
mittee (CDRC), the Hong Kong Approach, the Jakarta Initiative, and
the Workout Accord in South Korea.22 Some of these adaptations were
premised on the need for government intervention to force the parties to
the negotiating table. These procedures were implemented quickly and
were responsible for many of the corporate rescue successes in Asia in
the aftermath of the crisis. Through the use of these procedures, finan-
cial creditors were able to rescue some companies that would have lan-
guished in court for years—and likely have been liquidated—if recourse
had been made to the formal corporate insolvency laws then applicable.
Formal data is hard to come by because one of the advantages of out-
of-court workouts is that it is able to preserve the secrecy of the process.
However, an early study by the Asian Development Bank after the onset
of the crisis (through mid-) highlighted the greater use of out-of-
court rescue procedures in most countries in comparison to their formal
legislative counterparts.23
A further advantage of the promulgation of out-of-court workout
procedures is that their use is often the first important step on the path
towards developing an effective corporate rescue culture. Banks that are
able to work together and structure workouts out of court are more likely
to be receptive to the use of formal corporate rescue legislative codes
that are enacted at a later stage. Reforms that might have initially proved
controversial when such laws were first proposed—e.g., a moratorium on
the enforcement activities of secured creditors—will no longer be feared
as much by such creditors.
22 Douglas W. Arner, Charles D. Booth, Paul Lejot & Berry F. Hsu, Property Rights,
Collateral, Creditor Rights and Insolvency in East Asia, Tex. Int’l L.J. , ().
23 See ADB Office of the General Counsel, Insolvency Law Reforms in the Asian and
Pacific Region, Report of the Office of the General Counsel on TA -Reg: Insolvency
Law Reforms, Law and Policy Reform at the ADB , – (). South Korea was the
one jurisdiction that the study noted as an exception to this observation. Id.
chapter five
... The Pre-Packaged Insolvency Procedure
Pre-packaged insolvency emerged as a form of workout and reconstruc-
tion process in the United States in the early s. It combines both the
informality of private negotiations and the formality of the Chapter
process. The importance of the background of formal insolvency proce-
dures, against which informal workouts are conducted, has already been
noted. Here the formal process takes center stage together with the infor-
mal process. The central idea is to solicit support for a plan by which the
debtor may go forward before any formal procedure is invoked and, when
this is achieved, to then open a formal Chapter procedure together
with the plan.
One advantage is immediately apparent. The substantial agreement
to the plan will reduce substantially the time and cost that might oth-
erwise be expended in the Chapter proceeding while opposition to
the plan is whittled away. Given the spiraling legal costs, most would
agree that this could well constitute considerable savings. On the other
hand, the use of the formal procedure permits the majority to over-
rule a minority that may be uninformed or seeking preferred treatment.
Perhaps the principal disadvantages to the process are that it is non-
transparent and that smaller creditors and equity holders may be disad-
vantaged.
.. Conclusion
Formal and informal workout procedures are not mutually exclusive,
and in both informal procedures discussed in this chapter, the Lon-
don Approach and Pre-packaged Insolvency, the informal process gains
much of its authority and success from the existence of the formal pro-
cedures. Indeed, in the case of the latter approach, the formal process is
actually invoked.
We have also noted some of the features that have served to make
these informal workout procedures successful. The authority of the Bank
of England may be one contributing factor to the success of the Lon-
don Approach (and its adaptations), but the fact that an uncooperative
bank may, on account of its obduracy, suffer a retaliatory lack of cooper-
ation on a subsequent occasion may also contribute to the success of that
approach. The Pre-packaged Insolvency relies on cooperation in its solic-
itation of support for the plan prior to any formal process. Thereafter, it
informal workouts and restructuring
relies on the threat of formal procedures that, given the substantial sup-
port for the plan, are more than likely to defeat the stubborn holdout.
The success of these procedures will rest in large part on whether
their supporting backgrounds—in one case the authority of the partic-
ular agency, in the other the formal procedures—are in place. Another
possibility is to hope that through the establishment of such informal
processes, the opportunity would arise to strengthen the authority of the
agency chosen to be responsible for the implementation of the process.
The fiscal regime may be influential in underpinning or undermining a
particular process. If a jurisdiction offers fiscal advantages as an incentive
to encourage the employment of particular procedures, they may have a
better opportunity to succeed.
Finally, it may be of some interest to consider very briefly the matter
of informal workout procedures for small- and medium-sized debtors.
This has not been addressed in the body of this chapter because it would
seem that the discussion in the previous chapter that is concerned with
formal procedures provides a perfectly good example of what is, in
effect, an informal regime for small company debtors. Recent reforms to
the United Kingdom’s Corporate Voluntary Arrangement24 enable this
regime to be invoked by the debtor itself with a minimum of formality
thus underlining an observation made in this chapter, namely that formal
and informal workout procedures are not now—if they ever were—
mutually exclusive.
24 See supra ...
chapter six
EMPLOYEE RIGHTS IN INSOLVENCY
.. Introduction
Of the several types of contracts that are common in the commercial
environment, one is of particular relevance in this chapter—the contract
between employer and employee. The reader is referred generally to the
most extensive survey ever done concerning insolvency law treatment
of the employer-employee relationship, a report by Professor Janis Sarra
of the University of British Columbia under the auspices of the Interna-
tional Insolvency Institute, among others.1
The interdependence between employers and employees in the com-
mercial context is obvious. Where insolvency strikes an employer, there
will almost invariably be employees to whom money is owed by way of
unpaid salary or other obligations arising under the employer/employee
contract that have not yet been paid by the employer. At this compara-
tively simple level, therefore, employees are a component of the category
of creditors in the debtor’s insolvency proceeding.
It would, however, be misleading to restrict the role of employees to
that of creditors in the insolvency proceeding. It is the case that employ-
ees are very often much more closely integrated within the debtor’s busi-
ness than creditors whose claims against the debtor arise by way of goods
supplied but not yet paid for or by way of loans to the debtor that are still
outstanding. The role of employees is thus often perceived as being within
the business by which they are employed as opposed to the arms length
perception characteristic of most of the debtor’s other creditors. Employ-
ees can justifiably claim to participate in the business and are thus to be
consulted on business decisions and even to exercise constraints on pro-
posed business decisions of which they—as a group—disapprove. That
they may exercise such powers in practice cannot be doubted, but it is
also the case that several legal systems confer rights such as these.
1 Janis Sarra, Employee and Pension Claims During Company Insolvency: A
Comparative Study of Jurisdictions ().
chapter six
There is a strongly held view that insolvency law should, as far as
possible, seek to protect the rights and obligations that existed during
the debtor’s solvency. Clearly this would provide the theoretical (and
quite possibly the legal) justification for the continuation of employee
contractual rights as well as any rights of the employees to participation
and consultation in the management and governance of their employer
when the latter is solvent and into the period of the employer’s insolvency
proceeding.
.. Special Status of Employees
Whether for these reasons or because of the political and economic
strength of employees, or the necessarily integrated nature of their role
within the business by which they are employed, they have achieved sig-
nificant recognition at a public or macro level which, in turn, influences
their role in an insolvency proceeding of their employer, both within the
category of creditor and as a separate interest group. Within the category
of the bankrupt’s creditors, the significance of employees is recognized
by many insolvency jurisdictions by an enhanced status vis-à-vis other
creditors. This enhanced status, known generally as that of preferential
creditor, ensures that the claims of employees are often met before those
of some other creditors.
Furthermore, some jurisdictions go beyond the grant of preferential
creditor status for employees and make available public funds for unpaid
salary and other contractual benefits to which employees are entitled but
which sometimes not even preferential status can command due to the
seriously depleted nature of the bankrupt estate. The justification for this
additional protection for employees, as against other creditors, is easy
to appreciate. When their employer goes bankrupt, employees stand to
lose their employment in addition to unpaid salary for work already
performed. There can be little doubt that the overall effect on employees
and their families is qualitatively far worse than it is on other creditors.
This point has been expressed in financial terms by the observation that
employees are unlike other creditors in that their investments are severely
undiversified.
To this can be added a further serious setback suffered specifically by
some employees on the insolvency of their employer. It is not uncommon
for large corporate employers to provide employee pension arrangements
linked to the corporation’s fortunes. Pension funds—which in some mea-
employee rights in insolvency
sure will include money contributed by the employees themselves—may
be invested in the employer corporation itself or in funds under the con-
trol of trustees who, while nominally independent, may be selected by
the directors of the corporation and subject to their influence. In recent
years, there has been a noticeable incidence of high-profile corporate col-
lapse that has caused substantial pension fund losses for the employees.2
Many of these collapses have involved the failure of huge multinational
corporations and this has resulted not only in widespread unemployment
but also in huge pension fund losses.
We discuss in Section . the status of preferential creditor for employ-
ees and the possibility of a public fund or some other guarantee to ensure
that employees recover arrears in salary and other contractual entitle-
ments even where there are insufficient funds in the bankrupt estate.
In some countries under some circumstances, there may be an addi-
tional avenue for vindicating employee contractual rights: personal lia-
bility of officers and directors for unpaid compensation or pension con-
tributions.
There is a further important feature of the position of employees as
an interest group, separate from their status as creditors. Contempo-
rary debates as to the management and governance of large corporations
include a discussion of the role of the corporation’s employees in influ-
encing its management. This is not simply an academic or theoretical
discussion. There are examples in several jurisdictions3 of the right of
employees to participate in and be consulted about matters relating to
the running of the business of their employer. Even without the under-
pinning of legislative rights in this regard, there is the simple fact of the
economic power that a large group of employees might wield in the for-
tunes of their employer.
This power alone might be of considerable importance in the search
for a rescue plan of a large bankrupt corporate debtor. In addition,
some jurisdictions have established a role for employees in the legislation
that provides for business rescue and have done so with the expressed
aim of encouraging the rescue of the debtor rather than its liquidation.
2 Perhaps the most famous have been the Maxwell Companies in the United King-
dom, cite, and Enron in the United States.
3 The most obvious is Germany, see infra ..
chapter six
In France, saving jobs is a main purpose of an insolvency proceed-
ing. This has attracted some very interesting and innovative legislation
in certain countries but its controversial nature cannot be underesti-
mated.
Legislation of this kind tends to reduce the traditionally very powerful
position of secured credit in the hierarchy of claims against the bankrupt
estate, at least by limiting the circumstances under which the secured
creditor might seek to realize the secured property in execution of the
underlying claim.4 Thus, where the encouragement of a business rescue
is linked to the employees’ preferential creditor status, secured creditors
will feel doubly victimized. In the first place, the creation of the status
of preferential creditor may have enabled employees to leapfrog above
secured creditors in the hierarchy of claimants against the bankrupt
estate.5 This dispensation is now well-embedded in many jurisdictions,6
but the added feature of encouraging business rescue, which is a very
recent innovation, will inhibit, to a greater or lesser extent, the secured
creditor’s remedy of selling the secured property and recovering the loan
out of the proceeds. This adds a further twist to the competition between
preferential employee and secured creditors.7
Collective bargaining agreements are another aspect of the employees’
role in the management of the insolvency and the future of the enterprise.
In most countries these agreements remain effective in an insolvency
proceeding, but the extent to which they continue to protect employee
rights varies considerably. In the United States, for example, the provi-
sions of such agreements are regularly modified in major respects in a
Chapter proceeding, almost always to the detriment of employee enti-
tlements and control.
Employees are greatly concerned in the insolvency of their employers
—in protecting their contractual rights and pensions on the one hand and
in affecting management of the bankrupt debtor on the other. We will
sample typical approaches to these two types of issues in the following
sections.
4 This opposition or tension was one reason the Chinese Bankruptcy Law took
years to prepare.
5 The UK dispensation in this regard is especially interesting, see infra ...
6 See infra ..
7 See infra ...
employee rights in insolvency
.. Protecting Employees as Creditors
... Wages and Benefits
The principle that employees should have a superior claim as against
other creditors is widely accepted in insolvency systems throughout the
world. In the words of the influential UK Report on Insolvency Law and
Practice:8
The preferential treatment of employees in an insolvency in respect of their
claims for unpaid wages was originally a social measure. It was introduced
in an effort to ease the financial hardship caused to a relatively poor and
defenseless section of the community by the insolvency of their employer.
In the early days of the Bankruptcy Acts there was no welfare state, and
wages were low.9
Even the establishment of a comprehensive welfare state in the United
Kingdom has not dented the case for a system that prioritizes the pay-
ment of employee claims in an insolvency proceeding. Indeed, the Cork
Committee recommended the further strengthening of employee claims,
which at present are treated as preferential, by arguing that such claims
should be paid with public funds.10 This would have the effect not only of
removing such claims from the bankrupt estate but also of guaranteeing
their satisfaction. Obviously, where the estate is very small even prefer-
ential claims may not be met in full or even at all.
The Cork Committee’s purpose in making this recommendation was,
it has to be said, less to benefit the employees than to benefit the other
non-preferential creditors (the ordinary creditors) who often recover
little if anything from the bankrupt estate.11 This was underlined by
the further recommendation that in exercising its right of subrogation,
the government department responsible for the administration of the
public fund out of which employee claims would be met should not
enjoy any priority as against other (ordinary) creditors in an insolvency
proceeding. In a number of other jurisdictions, however, such public
funds do have a priority.
8 The Cork Report (so named after the chair of the review committee responsible for
the report, Sir Kenneth Cork), (cmnd ).
9 Id. ¶ , p. .
10 Id. ¶¶ –, pp. –, ¶ (f), p. .
11 Id. ¶ , p. .
chapter six
It is important to generalize this discussion. In the first place, there are
many countries that do not enjoy the benefit of a comprehensive welfare
state and where, therefore, a strong case exists for a system under which
unpaid wages, if not guaranteed, are at least prioritized. However, it is also
clear from the recommendations of the Cork Report that the existence of
such a system does not depend on the absence of a welfare state. The case
for the continued protection of employee wage payments has recently
been made directly and eloquently in the following terms:
There can be no doubt that employees do deserve special protection. Very
often their wages or salaries are their sole source of income. The loss of
employment can thus have a devastating effect on them and their fami-
lies, an effect exacerbated by non-payment of their entitlement by their
employer. The relationship between employee and employer is a continu-
ing relationship requiring mutual trust and confidence and it is a relation-
ship in which the employee is very clearly the subordinate. Moreover, with-
out the work of the employees, the employer’s business would not function
and creditors would not get paid.12
A very helpful paper13 alludes to the competition among creditors, espe-
cially that between lenders and employees,14 and records in its annex the
order in which creditors of a bankrupt entity are paid in countries.
This annex is summed up in the following terms:15
a. Give the employees absolute priority protection, i.e. employee rights
come prior to secured creditors’ rights. Countries with such regula-
tions are Brazil (this section is being modified in a new law), Chile,
Columbia, Indonesia (specified in the New Labour Law in ),
and Mexico.
b. Provide absolute priority to employee creditors with certain restric-
tions. For example, employee creditors meeting certain require-
ments have priority over secured creditors within a certain period.
Countries using this approach are the Czech Republic . . . Russia
and Mexico.
12 Roy Goode, Principles of Corporate Insolvency Law (d ed., ), p. .
13 Wang Huaiyu, An International Comparison of Insolvency Laws, (OECD Fifth
Forum for Asian Insolvency Reform, (– April ), http://www.oecd.org/dataoecd/
//.pdf.
14 “It is very important for enterprises to maintain their banking relationships as a
source of financing. But employees are necessary to actually run an enterprise.” (Id. p. ).
15 Id. p. .
employee rights in insolvency
c. Secured creditors come prior to employee creditors while employee
creditors come prior to floating security creditors. Examples are
Australia; Bermuda; England; Hong Kong; China; Israel; Romania;
Scotland; Singapore; Slovakia; and Wales.
d. All secured creditors’ rights are prior to employee creditors’ rights
while employee creditors’ rights are prior to common creditors’
rights. See Austria, Canada, Hungary, Japan, Malaysia, Norway,
South Africa, Sweden, Switzerland, Thailand, Venezuela, Viet Nam,
[and] the US . . . .
Among the above, generally speaking, there are certain restrictions on
employee creditors’ rights in items c and d, including restrictions on
time and amount.
e. Employee creditors do not enjoy any priority. They are repaid to-
gether with common creditors. Estonia, Germany and other coun-
tries have such regulations.16
An even more comprehensive survey of jurisdictions has been made
by Professor Janis Sarra.17 It summarizes its priority findings as follows:
– Absolute priority, including over secured creditors, for a capped
amount; examples include Brazil, Chile, Colombia, Malaysia.
– Restricted absolute priority, secured creditors and employees paid
preferentially only for a percentage of assets; for example, Czech
Republic.
– Split priority, distinguishing types of employees in ranking; for
example, India.
– Priority as a Cost of Insolvency, with first priority as part of costs of
administration; for example, Slovenia.
– Priority after secured creditors but prior to floating security credi-
tors, Australia, Israel, Ghana, Slovakia.
– Priority by time frame, for example, France, with different priorities
for different time frames.
– Priority over unsecured creditors, for example, Austria, Hungary,
Japan, Norway, Thailand, and Switzerland.
There are at least three broad observations which may be made. First,
very few countries afford the employee creditors no priority. Second, the
16 Such an approach usually requires a strong Social Security System. In Germany, for
instance, a non-bankruptcy employers fund compensates the employees.
17 See Sarra, supra note , at .
chapter six
Sarra survey makes it apparent that a wide variation in the nature and
scope of the employee priority exists from country to country. The report
of the survey contains a series of charts and country summaries that set
forth these variations in detail. Claims by employees may stretch from
unpaid wages or salary, to damages for unfair dismissal or termination
of employment without cause or requisite notice, to unclaimed benefits
such as holiday pay or maternity leave. And even within each of these cat-
egories there are further variations—for example, caps as to the amount
or as to the period of employment for which a priority is granted.18 It
is also the case that in some of these countries, other provisions outside
the insolvency system ensure that employees recover some, or even all,
of salary or wage arrears.
Third, employee preferential claims generally cede priority to the
claims of secured creditors, where the security is fixed or immovable.
As we have seen above, only five countries—Brazil, Chile, Columbia,
Indonesia, and Malaysia—resist this dominant position absolutely, and
four more—the Czech Republic, France,19 Russia, and Mexico—do so
under certain conditions. This picture does, however, change consider-
ably where the security is not fixed or immovable but consists of the tan-
gible and intangible assets that the debtor uses, acquires, consumes, and
disposes of in the course of the operation of the business. This type of
security is described in the OECD Report discussed above as a “floating
security.” In further countries—actually eight if one treats England,
Scotland, and Wales as the single country of Great Britain—employee
creditors have priority over secured creditors, whose claim is protected
by a floating, as opposed to a fixed, security.
International and regional organizations have given much thought to
the issue of the claims by employees in the event of their employer’s insol-
vency. The International Labour Organization adopted the Protection of
Wages Convention in , Article of which provides that:
In the event of the bankruptcy or judicial liquidation of an undertaking,
the workers employed therein shall be treated as privileged creditors either
as regards wages due to them for service rendered during such a period
prior to the bankruptcy or judicial liquidation as may be prescribed by
18 Id. at –.
19 France appears in the Annex to Wang Huaiyu, An International Comparison of Insol-
vency Laws, as conferring priority, subject to certain conditions, to employee creditors
over secured creditor claims, but is not identified as such in the summary quoted above
(see supra note ).
employee rights in insolvency
national laws or regulations, or as regards wages up to a prescribed amount
as may be determined by national laws or regulations.
The European Union has not addressed the issue of priority for employee
claims against an insolvent employer but it has addressed the issue of
an employee payment guarantee. It issued a Directive in ,20 the first
preamble of which provided as follows: “Whereas it is necessary to pro-
vide for the protection of employees in the event of the insolvency of
their employer, in particular in order to guarantee payment of their out-
standing claims, while taking account of the need for balanced economic
and social development in the Community; . . . .” Under Article . of this
Directive, member states of the European Union were required to estab-
lish a guarantee institution that would pay employees any outstanding
contractual claims they have against their employer that would not be
paid on account of the employer’s insolvency. Provision was made for
member states to limit the extent of the guarantee institution’s liabil-
ity. Furthermore, under this Directive, member states were required to
ensure that where prior to insolvency the employer had failed in its duty
to make compulsory contributions on the employees’ behalf to insur-
ance institutions under national statutory social security schemes, the
employees’ benefit entitlement was not to be adversely affected. The point
is made in this provision of the Directive that a deduction at source of
income will have been made by the employer from the employees’ salary
or wages to fund the employees’ social security contributions.21
The Directive was amended in 22 essentially to take account
of insolvency developments within the European Union. This amending
Directive makes this clear in the following preamble:
In order to ensure legal certainty for employees in the event of insolvency
of undertakings pursuing their activities in a number of Member States,
and to strengthen workers’ rights in line with the established case law
of the Court of Justice, provisions should be introduced which expressly
state which institution is responsible for meeting pay claims in these
cases and establishes as the aim of cooperation between the competent
administrative authorities of the Member States the early settlement of
employees’ outstanding claims. Furthermore it is necessary to ensure that
20 Council Directive of October on the approximation of the laws of the
Member States relating to the protection of employees in the event of the insolvency of
their employer (//EEC).
21 Article , Directive //EEC.
22 Directive //EC of the European Parliament and of the Council, September
.
chapter six
the relevant arrangements are properly implemented by making provision
for collaboration between the competent administrative authorities in the
Member States.
The amending Directive inserted into the original Directive a provision23
that declares that where an employer undertaking has activities in at least
two member states the guarantee institution responsible for meeting any
employee claims will be that of the member state in whose territory the
employees “work or habitually work.” The Directive also makes clear that
the obligation to protect employees from the insolvency of their employer
is not restricted to cases of liquidation. In defining insolvency for the pur-
poses of this protection, the amending Directive adopts a formulation
similar to that of the European Union’s regulation on insolvency proceed-
ings, namely:
[A]n employer shall be deemed to be in a state of insolvency where a
request has been made for the opening of collective proceedings based
on insolvency of the employer, as provided for under the laws, regulations
and administrative provisions of a Member State, and involving the partial
or total divestment of the employer’s assets and the appointment of a
liquidator or a person performing a similar task . . . .
By way of example, the relevant United Kingdom legislation requires
the Secretary of State to meet claims by employees to whom money is
owed by an insolvent employer.24 The payment will come from what is
described as the National Insurance Fund and the actual amount paid to
an employee will depend on a number of factors to do with the latter’s
employment, such as the length and continuity of that employment. It is
also provided that any rights to which the employee might be entitled in
relation to the money owed shall be transferred to the Secretary of State
to enable the latter to recover whatever is recoverable from the employer’s
bankrupt estate. Thus, the Secretary of State will, where appropriate,
succeed to the employee’s preferential creditor status.25
The value of preferential status naturally depends upon its priority vis
à vis other preferential creditors. Many countries retain a large number
of categories of preferential creditors who will compete with employees,
the most common one being fiscal and related state authorities.26 In some
23 Article a–d.
24 See §§ –, Employment Rights Act .
25 See § ()(a), Employment Rights Act .
26 The UK removed the preferential creditor status of tax and related state claimants;
see the UK Enterprise Act .
employee rights in insolvency
jurisdictions other preferential creditors may be superior to employees;
but even where they rank equally with employees, they will reduce the
employees’ dividend from the bankrupt estate.
The most important threat to employee recovery, however, comes in
the competition between secured creditors and employees (as well as
other preferential creditors), which has long been recognized as one of
the major points of tension in the resolution of claims in an insolvency
proceeding. This tension was recognized by the recent World Bank’s
Principles and Guidelines for Effective Insolvency and Creditor Rights
Systems in terms that made clear how it should be resolved.
The rights of creditors and priorities of claims established prior to insol-
vency proceedings under commercial or other applicable laws should be
upheld in an insolvency proceeding to preserve the legitimate expectations
of creditors and encourage greater predictability in commercial relation-
ships. Deviations from this general rule should occur only where neces-
sary to promote other compelling policies, such as the policy supporting
reorganization or to maximize the insolvency estate’s value. Rules of prior-
ity should enable creditors to manage credit efficiently consistent with the
following additional principles:
The priority of secured creditors in their collateral should be upheld
and, absent the secured creditor’s consent, its interest in the collateral
should not be subordinated to other priorities granted in the course of the
insolvency proceeding. Distributions to secured creditors should be made
as promptly as possible.27
Nonetheless, in the United Kingdom, and other common law countries
like Australia, New Zealand, Singapore, and Ireland, which treat deci-
sions of the United Kingdom courts as persuasive authority, a creditor
whose claim is secured by a floating charge is entitled to the benefit of
the realization of the company’s assets that are the subject of the charge
only after the employees’ claims (and other preferential claims) have been
accounted for.
By and large, developed societies have come to accept a responsibility
for alleviating the crisis where employers go into an insolvency proceed-
ing leaving unpaid arrears in employees’ salaries or wages plus other con-
tractual benefits to which employees are entitled. Priority status for such
27 Annex C, .–., World Bank’s Principles and Guidelines for Effective Insolvency
and Creditor Rights Systems, accessible at http://www-wds.worldbank.org/external/
default / main?pagePK = & piPK = & theSitePK = & menuPK =
& searchMenuPK = & theSitePK = & entityID = _
&searchMenuPK=&theSitePK=. See also Legislative
Guide at Two V ¶ .
chapter six
claims against the bankrupt estate is common but, given the competition
for funds out of this estate and the strong claims of secured creditors,
such status will rarely be the complete solution.
The result has been adoption of the two-pronged approach of prefer-
ential creditor status and a state-administered guarantee fund to cover
a reasonable part of the loss suffered by employees. While the guaran-
tee fund is not as widespread as preferential creditor status, it is a legal
requirement in all member states of the European Union and is also
a feature of the legal systems of Australia and Japan. The introduction
of such an institution is under active consideration in both China and
India.
... Pensions
The recovery of contractual entitlement to current wages and benefits
is not the only or even necessarily the major concern of employees faced
with a bankrupt employer. Many loyal, longstanding employees may have
a substantial proportion of their overall income—perhaps between
percent and percent—invested in a retirement pension and in many
cases this pension investment will have been with the bankrupt employer.
In many instances the decline in the employer’s financial health cou-
pled with the control that the employer is able to exercise over the man-
agement of the pension fund has led to the pension being inadequately
funded. In the worst cases, the employer has used the pension fund in a
desperate attempt to shore up the business. The control by the employer
over the pension fund, effected by the appointment of directors of the
employer corporation as trustees of the pension fund, and the failure of
the latter to act as independent trustees have enabled this gross conflict
of interest and duty.
A lack of funding generally creates a claim against the insolvent com-
pany but the priority given to that claim varies considerably. Professor
Sarra has summarized the results of her survey in this regard:
Numerous jurisdictions of the studied treat pension related claims on
the same basis as wage claims in terms of priority or preference. They have
created a statutory priority for pension claims, including claims for failure
to make remittances to a pension or superannuation fund and for general
underfunding of the pension promise.. . .
In contrast, other jurisdictions treat such claims as unsecured claims, even
where wage claims are given a preference. However, these jurisdictions
need to be assessed on the basis of whether or not employer-sponsored
employee rights in insolvency
pension plans form any, or a significant, part of their pension system.
Where the system is exclusively state funded or state and industry funded,
the impact of any failed contributions by the debtor company at the
point of insolvency may not affect the actual pension that the employee
will receive. However, where the pension promise is employer-sponsored,
employees may face losses from outstanding contributions to the pension
plan or from a serious underfunding of the plan . . . .28
This problem has been addressed in two other ways: legislation to try to
ensure independence in the administration of pension funds and invest-
ment guarantee institutions established by the state to replace lost funds.
As an illustration of the first approach, the United Kingdom moved
swiftly in the wake of the Maxwell scandal, establishing a committee of
enquiry29 and acting on its report. In , the United Kingdom legisla-
ture enacted the Pensions Act, which has since been replaced by the Pen-
sions Act . This provides for a Pensions Regulator with wide powers
to oversee the administration of pension funds, including provision for
the appointment of independent trustees and for the removal or suspen-
sion trustees. Among its many far-ranging provisions, the Pensions Act
has what was described in its predecessor Act as a whistleblowing
section:30
Duty to report breaches of the law
. Subsection () imposes a reporting requirement on the following per-
sons—
a. a trustee or manager of an occupational or personal pension scheme;
b. a person who is otherwise involved in the administration of such a
scheme;
c. the employer in relation to an occupational pension scheme;
d. a professional adviser in relation to such a scheme;
e. a person who is otherwise involved in advising the trustees or man-
agers of an occupational or personal pension scheme in relation to
the scheme.
. Where the person has reasonable cause to believe that—
a. a duty which is relevant to the administration of the scheme in
question, and is imposed by or by virtue of an enactment or rule of
law, has not been or is not being complied with, and
28 See Sarra, supra note . Professor Sarra points out that general social insurance, as
in China, may serve some of the same purposes as a guarantee fund.
29 Pension Law Reform—The Report of the Pension Law Review Committee. The
Committee was chaired by Professor Sir Roy Goode and the report was published in
September .
30 Section of the UK Pensions Act .
chapter six
b. the failure to comply is likely to be of material significance to the
Regulator in the exercise of any of its functions, he must give a
written report of the matter to the Regulator as soon as reasonably
practicable.
Professor Sarra describes such institutions established in a number of
other countries, including Sweden, Germany, Ontario (Canada), Japan,
the United Kingdom, and the United States. There are, unsurprisingly,
many variations, on such matters as eligibility, the capping of benefits,
and whether the benefits are index-linked. In an ideal world, pensions
will be doubly protected by both a vigilant authority and a state-backed
guarantee.
.. Personal Liability of Officers and Directors
Professor Sarra reports that only a minority of jurisdictions establish
direct liability against officers and directors for unpaid employee com-
pensation, but a majority of the jurisdictions surveyed make them per-
sonally liable for violation of non-insolvency statutes relating to em-
ployee compensation.31 For example, in many instances in Canada offi-
cers and directors may be personally liable for six months of unpaid
wages under corporate law or employment standards legislation.
.. Employees, Consultation, Participation, and Business Rescue
In the previous section we discussed the employees as a sub-group within
the group of creditors of the insolvent debtor. In this section, we con-
sider the role of the employees in the management and governance of
the employer. We will begin by reviewing briefly the current trends in
employee participation in the governance of large corporations and we
will consider the provision for the consultation of employees in cases
where the corporate employer wishes to dismiss large sections of the
workforce on the grounds of redundancy. Thereafter we will consider the
role of the employees in the management of the insolvency proceeding.
31 See Sarra, supra note , at –, graph .
employee rights in insolvency
... Employee Participation in Large Corporations
The role of employees in the governance and management of large cor-
porations was often dominated by the capital versus labor divide. Com-
mon assumptions included, first, that employees were essentially outside
the corporation engaged in collective bargaining negotiations with the
corporation over traditional matters such as wages, hours of work, and
so on. Second, it was assumed that the corporation was governed in the
interests of the stockholders by a board of directors elected from among
the stockholders. A serious and sustained challenge was mounted in the
early s by Berle and Means. They argued that the directors exercised
power without property and that they governed the corporation in their
own, rather than in the stockholders’, interests.
There has been much debate around this thesis, but one tenet has
emerged and been accepted in many countries: namely, that the board
of directors is more than simply the agent of the stockholders.32 This
coincided with the acceptance by influential courts of the proposition
that directors, having been elected, should be left to manage the cor-
poration and should not be dictated to by the stockholders. If dissatis-
fied, the latter’s remedy lay in voting out the board or some of its mem-
bers and electing others. Another more or less coinciding development
was the adoption by Germany of the principle of Mitbestimmung (co-
determination)—the governance of large corporations by representatives
of the investors and the employees.33 Although this idea spread to a few
neighboring European countries, as a formal principle of corporate gov-
ernance, it remains a minority position. The attempt by the European
community to have co-determination adopted as a formal principle for
all corporations throughout the European community has failed. Nev-
ertheless, consultations between employers and employees in large cor-
porations on a wide variety of issues have become commonplace, and
of particular relevance here is the formalization of such consultations
on corporate proposals for the dismissal of employees on the grounds
of redundancy.
It should be noted that even in countries without co-determina-
tion or other employee rights of governance or consultation, collective
32 But see Henry Hu and Jay Lawrence Westbrook, Abolition of the Corporate Duty to
Creditors, Colum. L. Rev. ().
33 This principle is addressed also in the EU Directive on Co-determination within a
SE (= Societas Europea = European corporation) as one of the prerequisites for a SE.
chapter six
bargaining agreements often give employee organizations some rights
with respect to the operation of the business. In some countries, notably
the United States, reorganization provisions include the opportunity for
the debtor to weaken or eliminate those employee rights through modifi-
cation of its collective bargaining agreements.34 On the other hand, Pro-
fessor Sarra has found that most countries have successor employer pro-
visions that impose upon purchasers of an enterprise the obligation to
continue to recognize existing employee contracts.
Dismissal on grounds of redundancy are likely to be closely associ-
ated with a downturn in the corporation’s fortunes and might be part
of a package to stave off insolvency. The principle, even the obligation,
to consult on such proposals could be said to have been formalized at
least by when international standards were agreed under the aus-
pices of the International Labour Organization in the Termination of
Employment Recommendation. This recommendation was further for-
malized by the ILO’s Termination of Employment Convention, .35
This Convention has been ratified by countries. In addition, the United
Kingdom and the other European Union countries have enacted legis-
lation implementing the European Union Directive on the approxima-
tion of the laws of the member states relating to collective redundan-
cies, which also imposes an obligation on employers to consult with the
workforce when contemplating mass dismissals on grounds of redun-
dancy.36
The ILO’s Termination of Employment Convention, , provides:37
. When the employer contemplates terminations for reasons of an
economic, technological, structural or similar nature, the employer
shall:
a. provide the workers’ representatives concerned in good time
with relevant information including the reasons for the termi-
nations contemplated, the number and categories of workers
likely to be affected and the period over which the termina-
tions are intended to be carried out;
34 U.S.C. § –.
35 C Termination of Employment Convention, ; for the text, see http://www
.ilo.org/ilolex/english/convdisp.htm.
36 Council Directive //EC of July ; for the text, see http://eur-lex.europa
.eu / smartapi / cgi / sga-doc?smartapi!celexapi!prod!CELEXnumdoc&lg=EN&numdoc=
La&model=guichett.
37 Article .
employee rights in insolvency
b. give, in accordance with national law and practice, the work-
ers’ representatives concerned, as early as possible, an oppor-
tunity for consultation on measures to be taken to avert or
to minimize the terminations and measures to mitigate the
adverse effects of any terminations on the workers concerned
such as finding alternative employment.
The provisions of the European Union Directive have a like effect, as does
the implementing legislation in the member countries.38
... Employees in the Management of the Insolvency Proceeding
There is a complex interrelationship between the protection of employee
interests and the encouragement of business rescue, as opposed to the
piecemeal liquidation of the debtor’s property. Given that a business
rescue generally carries with it an automatic stay that has the effect of
temporarily neutralizing the secured creditors’ power to sell the property
that comprises the security, the position of the employees who wish to
carry on the business is strengthened. There may be something of a
connection between countries that encourage business rescue and the
existence of pro-employee provisions in their insolvency laws.
Thus, in France, where there is a single gateway into formal insolvency,
under the previous law it was necessary after opening insolvency pro-
ceedings to begin an observation period with a view to a rescue before
thought could be given to the ordering of liquidation. However, in cases
of clear and outright failure, the courts developed the practice of order-
ing judicial administration (redressement judiciaire, the business rescue
regime) and then pronouncing the liquidation on the same day. This was
unnecessarily cumbersome. The Reform Law of simplified the pro-
cedure so that liquidation was the only viable option for an insolvent
company. Now, a court may order the liquidation of a company directly
without placing it under judicial administration.
A number of countries have undergone recent legislative changes that
have encouraged business rescue instead of liquidation. For example,
in Brazil, this seems to have been specifically linked to a strong pro-
employee provision.39 In Sweden, the encouragement of business rescue
seems to have involved extending the employees’ wage guarantee to the
38 See s. , UK Trade Union and Labour Relations (Consolidation) Act .
39 See Sarra, op. cit. p. .
chapter six
restructuring regime under which rescues are attempted. Previously the
guarantee had existed only in the insolvency regime under which the
business was liquidated.40
On the other hand, the reduction of employee rights is often seen as
necessary to achieve reorganization. Perhaps the most aggressive reorga-
nization regime in the world is found in the United States under Chap-
ter , which has routinely been used to undo collective bargaining agree-
ments on the argument that the enterprise can no longer support the
wages and benefits that had been promised to the employees. Conversely,
a standard criticism of the Mexican composition system prior to the
adoption of its new insolvency law was that its generous treatment of
workers made reorganization impossible.41
The tension between reorganization and employee rights is revealed by
the history of the European Union Acquired Rights Directive originally
enacted in 42 and recently replaced by an updated Directive.43 The
purpose of this Directive is to protect employees in the circumstances
where a business is sold and the sale is the cause of the dismissal of some
or all of the employees. The original Directive provided that in such a
case—unless the dismissal of the employees was for an economic, tech-
nical, or organizational reason—the claims that the dismissed employees
might have against the seller of the business would be transferred to the
purchaser of the business. This Directive applied irrespective of whether
the sale of the business was by a bankrupt seller.
This Directive attracted much criticism from insolvency practitioners
and others engaged in the attempted rescue of bankrupt businesses on
the grounds that the transfer of employee liabilities to the purchaser
made it difficult to sell such businesses and thus inhibited rescues to the
detriment, among others, of the employees themselves. This criticism
has been addressed in the new Directive, which, while reenacting the
transfer of rights,44 gives to member states the option of not applying this
provision:
40 See Nina Baecklund & Mathias Winge, Wage Guarantee in Reconstructuring [sic]
Proceedings in Sweden, Global Insolvency & Restructuring Yearbook ,
pp. –.
41 ALI Mexican Statement –.
42 Council Directive //EEC.
43 Council Directive //EC of March .
44 Article . “The transferor’s rights and obligations arising from a contract of em-
ployment or from an employment relationship existing on the date of a transfer shall, by
reason of such transfer, be transferred to the transferee.”
employee rights in insolvency
. . . to any transfer of an undertaking, business or part of an undertaking
or business where the transferor is the subject of bankruptcy proceedings
or any analogous insolvency proceedings which have been instituted with
a view to the liquidation of the assets of the transferor and are under the
supervision of a competent public authority (which may be an insolvency
practitioner authorized by a competent public authority).45
Thus the interests of employees are argued both to be served by reorga-
nization and to make reorganization difficult or impossible.
45 Article ..
chapter seven
JUDICIAL AND ADMINISTRATIVE INSTITUTIONS
.. Overview
Any law—be it the best one—is of little use unless there are personnel
who are willing and capable to transform the written rules into reality and
daily practice.1 If the current authors were forced to choose, we would
opt for bad law and good personnel over good law and bad personnel.
Any discrepancy between the law on the books and the law in action
leads inevitably to some kind of implementation gap2 that need not
necessarily cause inefficiency but that in any case distorts to a higher or
lesser degree the original intentions of the law. In the field of insolvency
there are two actors whose integrity and expertise are central to the
functioning of the insolvency system: judges and administrators. While
lawyers, accountants, and other professionals are also important, these
two actors perform the core tasks. Thus learning about the qualities of
these actors is almost always more important to an understanding of an
insolvency system than knowledge of its legal rules and procedures.3 The
key elements are their backgrounds—educational and practical—their
expertise, and their roles in the system. Closely related is knowledge
of the procedural systems in a given jurisdiction, systems that likely
operate in insolvency among many other aspects of that country’s legal
institutions. We do not attempt a discussion of procedures in that broader
sense.
1 See Christoph Paulus, Germany: Lessons to Learn from the Implementation of a New
Insolvency Code, Conn. J. Int’l. L., p. ff. ().
2 Important observations about the problems leading to and resulting from such
implementation gap are presented by Terence Halliday, Closing the Implementation Gap:
Why Good Laws Fail and We Can Help Them Succeed, available at: http://www.worldbank
.org / WBSITE / EXTERNAL / TOPICS / LAWANDJUSTICE / GILD / ,contentMDK:
~ pagePK:~piPK:~theSitePK:,.html.
3 Especially in this area it is important to view debt collection and enforcement of
security outside of insolvency as part of the overall “insolvency” system. See supra ..
chapter seven
A country’s insolvency system is defined in large part by its alloca-
tion of functions between judges and administrators and by the legal and
organizational relationships between them. Some systems give adminis-
trators broad powers, subject to limited judicial oversight. In those sys-
tems, the courts serve almost entirely to adjudicate legal disputes that
arise in the course of the proceeding. In other systems, the courts are
closely involved in the proceeding and administrators are required much
more often to get judicial approval for their decisions.
Beyond these specifics, the student of insolvency systems will look for
three main characteristics in these institutions: efficiency, transparency,
and accountability. Efficiency encompasses a proceeding without undue
delays and an enforcement mechanism for decisions rendered by the
court that permits a swift handling of cases. Systems will strike differ-
ent balances between the obvious importance of assuring that the parties
involved have an opportunity to be heard to the extent possible and the
need to avoid giving stakeholders the chance to abuse judicial remedies
to delay and distort the proceeding. The Mexican experience is an impor-
tant example. Prior to the recent reforms, cases would be delayed for years
by an elaborate and formal process of reviewing claims. Creditors had lit-
tle or no protection as long as the debtor could delay the completion of
that process. The new law in Mexico has a reasonable claims procedure
that avoids those delays.4
Transparency, in the present context, means in particular that proce-
dural stages are foreseeable, that the court and administrator’s staffs fulfill
their tasks in strict compliance with the legal prescripts, and that there are
safeguards against corruption. Related to transparency is accountability,
a tool for monitoring both the court and the legality of the procedure. The
files relevant for the proceeding should be accessible for the public. This
does not necessarily mean the public in general; in many legal systems
access will be restricted to those persons who can demonstrate a justified
interest in seeing the files—such as creditors, potential contracting par-
ties, and others. Adequate notice to stakeholders and the availability of
regular reports of officials are important as well. The accountability factor
also embraces a meaningful right to appeal.
4 See ALI Mexican Statement at .
judicial and administrative institutions
.. Judiciary
Because the great majority of countries use their courts to supervise
insolvency proceedings, we focus on courts and judges first of all, along
with two broad structural points. We start with a general point often
undiscussed. In many countries, particularly in developing or transition
economies, much remains to be done to improve the social standing
of the judges. Low income, bad reputations, and the general public’s
prejudices about their corruptness might well force them into exactly
this sort of behavior and thus work as a kind of self-fulfilling prophecy.
The details of a country’s laws may be of limited relevance where these
conditions exist.
Jurisdictions can be distinguished by three key variations: civil law or
common law; full career judges or late career judges; and specialized or
general courts supervising insolvency cases. This book is not the place to
undertake a full discussion of the distinctions between the two great legal
systems of the world, but it is worth noting that observers all too often err
in both directions in considering the effects of the distinction between
the civil law and the common law: they fail to recognize important
intellectual and practical differences or they exaggerate those differences.
The first mistake is illustrated by the person who expects a civil law judge
to exercise the kind of wide-ranging discretion often given to common
law judges. The second is illustrated by the person who imagines that
common law judges do as they please and will not feel bound by the
wording of a governing statute.
The second variation—the career paths of judges—is often ignored but
is of crucial importance. In many countries, especially civil law jurisdic-
tions, judges spend most if not all of their careers as government offi-
cials. Often they are trained as judges, not as advocates per se, and serve
in judicial capacities throughout their professional lives. The result is
often a high level of legal expertise but little commercial experience. In
many other countries, especially common law jurisdictions, judges are
typically appointed as judges after successful careers as lawyers. Many
of them may have less judicial expertise but more commercial experi-
ence.
Relatively few countries have specialized insolvency courts (the United
States is the leading example) but a number have commercial courts
that deal with business disputes generally, including insolvency. The
Commonwealth in general and the commercial division of the Ontario
court in Toronto specifically are good examples of the latter approach.
chapter seven
Many other countries leave insolvency matters to be handled by the
courts that exercise general civil jurisdiction. France, the Czech Republic,
and Estonia exemplify this approach.
A related point is whether a particular system “attracts” all disputes
concerning a debtor to the insolvency court or leaves many of them to be
resolved in other courts despite the initiation of the insolvency proceed-
ing. Some jurisdictions adopt a middle course, where some disputes go to
the insolvency court and others do not. The system adopted can make an
important difference in the evolution of commercial law. If there is a vis
attractiva concursus, insolvency law may be a legal area of its own and def-
initely distinct from other areas. All disputes emerging in this context are
seen and treated as specific insolvency matters irrespective of what they
would be—e.g., commercial, tax, or administrative matters—outside the
proceeding. Thus, there is the potential for developing a coherent body
of insolvency law. This can be seen both as an advantage and as a disad-
vantage. It is an advantage since any coherence is to be welcomed as it
aids the understanding of this body of law, yet at the same time it may
isolate insolvency law from other areas of law in that it develops its own
rules. There has long been a passionate debate in the United States as to
the role of insolvency law as mere procedure or as a body of law that may
alter the ordinary legal rules after a general default.5
To be sure, those jurisdictions that do not follow the concept of vis
attractiva concursus create also their own body of insolvency law. How-
ever, they avoid the danger of a somewhat isolated development by seeing
insolvency law as something like a template that is laid over the rest of
the law; for them, insolvency law modifies other law but does not replace
it. Again, there are pros and cons. On the positive side, since under this
concept insolvency law tends to be adjusted to the rest of law in a more
coherent way, there are no sharp changes in rights following default. On
the other hand, different court competences might result in incompati-
ble decisions and create tensions within this body of law. In addition, it is
plausible to argue that a general default changes the social and economic
context of a commercial law rule and may require a different result to
achieve the desired goals.
5 See, e.g., Elizabeth Warren, Bankruptcy Policy, U. Chi. L. Rev. ();
Douglas G. Baird, Loss Distribution, Forum Shopping, and Bankruptcy: A Reply to Warren,
U. Chi. L. Rev. ().
judicial and administrative institutions
.. Administrators
It is the prevalent pattern in most of the existing insolvency laws that
administrators are entrusted with the central tasks of managing and han-
dling insolvency proceedings; the success, speed, and efficiency of such
proceedings depend primarily on the administrators’ skills, knowledge,
and experience. Therefore, an understanding of an insolvency regime
depends upon knowing the rules of the process of selecting administra-
tors and of the safeguards for the administrators’ trustworthiness, ongo-
ing qualification, and integrity.6 After all, it is this person who deals with
the debtor’s assets in a way that promises the creditors the greatest return
or serves other purposes inherent in the particular insolvency law. In ful-
filling this task the administrator, depending on the particular circum-
stances, has to manage the continuation of the debtor’s business or to sell
it (as a whole or piecemeal)—thereby staying in contact with the debtor’s
employees and its creditors (each of whom might have different inter-
ests in this particular case) and fulfilling all kind of legal and contractual
obligations—and has to be throughout as quick and efficient as possible.
The risk of an “implementation gap” between the statute and the reality
of practice is greatest here.
To be sure, the said distortion of the law in action as compared to
the law on the books is less dangerously imminent in jurisdictions that
place the main responsibility for the effectiveness of insolvency cases
on the courts and have the administrators exercise more or less a mere
executive role; this pattern is quite often found in transition countries
that, for obvious historical reasons, tend to place their trust more in the
courts than in independent professionals. However, even then it is to
be considered that it is the administrator who is doing the “field work,”
who—unlike the court or the individual judges—is in direct contact with
the debtor and its assets and maybe also the creditors. Because of that, at
least the integrity requirement (as described below) is highly relevant for
this type of administrator as well.
Being aware of the danger or problems resulting from such an imple-
mentation gap, an observer can look for some legislative devices that may
serve to a certain degree as a bridge over this omnipresent separation
between written rules and their practical application. These devices are
6 See also Legislative Guide at –.
chapter seven
not mutually exclusive and are exercised with varying emphasis. One is
to develop and guarantee a certain level of constant high qualification,
trustworthiness, and professional ethos among the administrators (see
Section . below). Another complementary device is to make it finan-
cially attractive to follow the path of the statutory provisions (see Section
. below).
A few jurisdictions from various backgrounds have been selected
for the demonstration of the diversity with which these issues may be
resolved in legislation (see Section . below). Needless to say that there
is no abstract generalization intended (nor possible) as to which solution
might be more preferable than the other. But it is noteworthy that all
laws take at least some pain to make sure that the administrator displays
special qualifications that make him suitable for this kind of fiduciary
position between the debtor and the creditors and that justify special
rules about its remuneration.
It should also be noted that jurisdictions vary as to the professional
training usually expected of an administrator.7 In the majority of juris-
dictions, lawyers perform this function, but in a good number of juris-
dictions (mostly common law countries) accountants are typically em-
ployed. In yet a third group of countries, the function is performed by
public officials. The choice likely depends upon a mix of highest possible
qualification, local tradition, controllability, and trustworthiness. Also to
be considered is whether an administrator should be in every case an
individual or whether a legal entity should be admissible for this posi-
tion as well.
.. Comparative Approaches
... General Remarks
For obvious reasons, admission to the body of administrators is not
granted to everyone who happens to be interested in this job.8 This is
7 To the degree that the debtor’s reorganization becomes increasingly an alternative
to plain liquidation, it is worthwhile to reconsider the distrust in independent adminis-
trators. As reorganization is a highly economic undertaking, courts (and mere lawyers as
such) might not be the ideal candidates for fulfilling this task.
8 Yet some laws, such as the Moroccan one from (Code de Commerce), leave the
selection to the judge alone without giving any indications as to necessary qualifications.
judicial and administrative institutions
true, at least, for all those jurisdictions that entrust the administrator
with more power than just being a kind of executing arm of the court
or any other decisionmaker. It is a truism not only in times of economic
difficulties that insolvencies have an enormous impact on the overall
(macro) economy. The administration of these cases requires so much
economic, legal, organizational, and, quite often, psychological skills that
most jurisdictions put some effort into establishing a selection system
that attempts to ensure that only highly qualified persons in fact become
administrators.
The most common baseline requirements are education and a profes-
sional qualification or business experience. As discussed elsewhere, juris-
dictions are divided between using lawyers or accountants as administra-
tors. Generally, either type of professional must have satisfied the relevant
professional requirements, which usually include the necessary educa-
tion. However, it is possible for business people to serve as well. Where
that is true, it is necessary to state education and experience requirements
for them.
The following examples from a few different jurisdictions demonstrate
that the selection, supervision and remuneration of administrators can be
done in quite a number of ways. To begin with the latter, remuneration
might be calculated either on a time basis or on a value basis whereby
the latter is capable of many specifications. Not least important is the
identity of the person who decides about the remuneration (court or
creditors or a supervising body). Depending on the choice, incentives for
efficiency can be given: the time-based remuneration model encourages
the administrator to really engage in the affairs rather than just ticking off
the various tasks. On the other side, the danger with this approach is that
proceedings might be dragged on endlessly,9 a problem that is apparently
non-existent in Switzerland but is complained of, however, in numerous
other countries. In case of a value-based remuneration, the administrator
is induced to increase the estate to the greatest extent possible that, in
turn, is for the benefit of the common creditors. The disadvantage thereby
is the administrator’s potential concentration on value increasing efforts
and, thus, a lesser interest in other topics in the proceeding.
9 As just one example out of many possible, Colombia has developed such a sys-
tem despite contradicting legal rules in its Reorganization Law of December ,
.
chapter seven
One has to distinguish selection10 from supervision.11 Selection re-
flects a two-step process: first, the creation of a pool of potential adminis-
trators and, second, the appointment of the individual who is to admin-
ister a given case. These two steps may be governed by a single authority
or divided between two institutions, one to test and qualify the available
pool and the second to make an appointment in a particular case. For
example, a regional or national agency expert in the field might qualify
applicants, but a court might choose the administrator for each case.
The appointment of an administrator is usually left to the courts—
increasingly subject to subsequent approval by the creditors.12 This works
at the same time as a kind of supervision as the court is, after all, the
institution with usually the closest contact to the administrator and that,
therefore, can judge best its (initial and increasing/decreasing, respec-
tively) abilities and performance. On the other hand, an insolvency pro-
ceeding serves, inter alia, the ultimate purpose of achieving the best pos-
sible outcome for the creditors; therefore, it is justifiable that they have
the power to replace the original court-appointed administrator. How-
ever, given the realities of insolvency proceedings, this right of the credi-
tors can easily be abused in that the most powerful creditors have some-
one acting as administrator who might not be entirely independent from
these creditors.
Supervision of the administrator is of material relevance because it
helps to reduce the mentioned perils. Supervision can be conducted
in various ways. The most prevalent one is that the insolvency court
exercises control over all acts of the administrator in the case at hand;
however, one has to keep in mind that this form of control is primar-
ily restricted to legal affairs rather than economic ones. However, since
insolvency administration is in many respects economic activity, the con-
trol of this part of activity is very often left to the creditors.13 They can
10 Pursuant to §§ and of the Swiss Schuldbetreibungs- und Konkursgesetz, the
competent administrator (a civil servant working in a public authority, Konkursamt, see
also § ) is determined by the domicile of the debtor. This is to say that the selection of
the pool of administrators is done by the debtor itself.
11 For an overview of jurisdictions that have established a formal system of supervi-
sion, see http://www.insolvencyreg.org.
12 See, e.g., § , U.S. BC; §§ , Italian Legge Fallimentare; § , German
Insolvency Ordinance; § Chinese Bankruptcy Statute. art. in connection with art.
of OHADA’s Uniform Act Organizing Collective Proceedings for Wiping Off Debts.
13 It is noteworthy that China, in the course of drafting a new law, switched from
an official-controlling system () to a system where control of the administrator is
entrusted to a creditors’ committee.
judicial and administrative institutions
sue the administrator who generally is personally liable for his adminis-
tration if they think that something has been done less efficiently than
it could or should have been done.14 Some jurisdictions, however, have,
apart from the two control mechanisms described so far, a third one: a
supervising authority independent from the insolvency courts and the
creditors in the given case.15
All these measures serve the purpose of safeguarding the best possible
outcome in each insolvency case and, at the same time, of strengthening
the general public’s confidence in the administrators’ qualification. It is
hard to overemphasize this task: Whereas neither commercial law nor
the overall economy usually demand any specific personal abilities or
particular qualifications from general business persons—as long as these
persons are acting successfully—the pattern changes when the enterprise
gets into financial difficulties and begins to threaten the credit given by
the creditors. If and when this is the case and an insolvency proceeding
is to be opened, there exists proof of a certain failure that is seen in most
jurisdictions as a justification for a change of the requirements. From
now on, the interests of the creditors need to be taken into stronger
(sometimes even exclusive) consideration.16
It is for this reason that the general scheme of activity changes once an
insolvency proceeding has been opened. The most evident indication of
this change is the appointment of the administrator who is now put in
charge over the debtor’s estate. This is true also in most jurisdictions that
provide for the possibility of a debtor in possession (DIP)—that is, the
managing person is left in charge despite the opening of the insolvency
proceeding; they pay tribute to the new circumstances by establishing
a surveillance institution such as a trustee or examiner who supervises
all or certain acts and transactions (to be) done by the DIP.17 In light
14 Of course, a system that permits such suits too liberally will find that few are willing
to serve as administrators or that they demand very high fees.
15 For an overview of jurisdictions that have established a formal system of supervi-
sion, see http://www.insolvencyreg.org.
16 See generally Henry Hu and Jay Lawrence Westbrook, Abolition of the Corporate
Duty to Creditors, Colum. L. Rev. () (criticizing this trend).
17 See IMF, Orderly & Effective Insolvency Procedures, , p. et seq., and World
Bank, Revised Principles for Insolvency and Creditor Rights Systems (Draft ), Prin-
ciple C ., Legislative Guide on Insolvency Law (); available at: http://www
.uncitral.org/pdf/english/texts/insolven/–_Ebook.pdf. As practical examples,
see, e.g., § of the Vietnamese Bankruptcy Law (); § f. German Insolvency
Ordinance.
chapter seven
of this almost dramatic change of responsibility it should be sufficiently
evident that the administrator or trustee is highly dependent on the
general public’s and the individual creditors’ confidence in his abilities
and qualifications.
... Australia
The Corporations Act (Cth) provides rules in Sections et seq.,
et seq., , and et seq. as to how to become an administrator.
These rules are specified by the Policy Statement of the Australian
Securities & Investments Commission (ASIC) from Sept. , .18
Accordingly, to become a “registered liquidator” a natural person resid-
ing in Australia must fulfill the following criteria: (s)he must either be
a member of The Institute of Chartered Accountants in Australia (or
another prescribed body) or hold a university degree (or diploma of
an equivalent institution) that certifies that the candidate has attended
three years of study in accountancy and two years in commercial law
or can provide other qualifications equivalent to the two criteria men-
tioned before; furthermore, the candidate must have experience with the
winding up of companies; and, finally, the ASIC must be satisfied that
the applicant is capable of performing the duties and is otherwise fit and
proper.
With respect to the appointment for a given insolvency case, Sections
C and D establish standards that disqualify the respective person—
namely having certain connections with the debtor or being themselves
the subject of an administration proceeding. Once appointed, the admin-
istrator has to present to the creditors prior to the first meeting a state-
ment of independence; this is supposed to be a safeguard against dispro-
portionate friendliness towards the debtor.
Section E rules that the administrator’s remuneration shall be
determined by the debtor’s creditors or by the court—in both cases based
on the calculation offered by the administrator. The administrators are
regulated and supervised by the ASIC.
18 Policy Statement External administration: liquidator registration. Part .—
Registration of auditors and liquidators, Issued //, available at http://www
.services.thomson.com.au/asic/ps/ps.pdf.
judicial and administrative institutions
... Canada
Pursuant to Section of the Bankruptcy and Insolvency Act (), the
Superintendent of Bankruptcy—a governmental authority—is in charge
of licensing and supervising administrators. The requirements for receiv-
ing a license differ depending on whether an individual or a corporation
applies. The details of the prerequisites are set down in a directive19 that
has been issued by the Superintendent on the basis of Section ()(d)
of the Act. Accordingly, an individual needs either a university degree,20
a minimum of five years relevant work experience, or a relevant pro-
fessional designation. Furthermore, the applicant must have completed
the three-year National Insolvency Qualification Program by passing the
final National Insolvency Examination successfully. Finally, the appli-
cant must be of good reputation and character and he is supposed to
be suitable—that is, he must demonstrate in an oral exam, apart from
his skills and abilities, his ethical standards and so on.21 If a corporation
applies for a license, it is supposed to prove inter alia, its solvency and the
majority of its directors and officeholders must hold a license as individ-
uals.22
Section et seq. of Appendix A of the Directive reserves investiga-
tion rights to the Superintendent in that he shall verify (and guarantee)
that the licensed administrator meets at any time the requirements and
qualifications necessary for obtaining a license.
For the specific case, the administrator has to be neutral towards
the debtor and the secured creditors,23 and in exercising his duties he
shall “. . . comply with such code of ethics respecting the conduct of
trustees. . . . ”24 He may be replaced by the creditors at any time pursuant
to Section . Creditors also decide the administrator’s remuneration.25
... Finland
Finland has no insolvency licensing system. Any member of the Finnish
Bar Association may be chosen for a specific case to become adminis-
19 Directive No. , Trustee Licensing, issued on March , , available at: http://
www.strategis.ic. gc.ca/epic/internet/inbsf-osb.nsf/en/bre.html.
20 Not necessarily a degree in law.
21 See supra n. , §§ –.
22 See supra n. , §§ – for details.
23 §§ . and . of the Bankruptcy and Insolvency Act ().
24 See id., § ..
25 See id., § .
chapter seven
trator. Pursuant to Section of the Bankruptcy Law from September ,
, the court selects and appoints the administrator after having given
the main creditors the opportunity to be heard. The general suitability
requirement for being appointed is specified in Section ; it comprises,
inter alia, possessing the “ability, skills and experience required for the
duty” as well as neutrality, independence and impartiality.
Until , the supervision of the administrator was left to the cred-
itors in each given case and to the Bar Association in general. However,
since this was felt to be insufficient, a new statute was enacted26 that
introduced the completely novel institution of a Bankruptcy Ombuds-
man. This is an independent authority that is organizationally affiliated
with the Justice Department. The Ombudsman has to be impartial; that
is, he is not the advocate of any group such as debtors or creditors and so
on, but rather the advocate of the legality of the handling of insolvency
proceedings. He shall help to develop proper practice of administering a
bankrupt’s estate.
His task is the supervision of any insolvency proceedings including
those that have been closed because of lack of sufficient assets. The
Ombudsman does not have the power to give any directions to an admin-
istrator or the court. Instead, he has quite a far-reaching right to acquire
information and to inspect the minutes of any case. For this purpose,
administrators have the duty to inform and to cooperate, even after a
case has been closed. He is also in the position to supervise the decision-
making of the creditors. If he finds any improperness or illegality, he shall
point this out to the persons concerned. If this does not suffice, he shall
turn to the court and demand adequate steps to be taken, such as fining
that person, dismissing the administrator or reducing his fees, and so on.
... United Kingdom
The United Kingdom has in its Insolvency Act a number of general
rules, Section et seq., about Insolvency Practitioners and their qual-
ification. They require, in order to be admitted to the group of adminis-
trators (or to be allowed to remain there), an authorization by either the
Secretary of State, Section , (or another Competent Authority)27 or by
26 Law No. / from Jan. , .
27 This option has so far not been utilized.
judicial and administrative institutions
a recognized Professional Body.28 There are presently seven such bodies
and they are elected (directly or indirectly) by the Secretary of State pur-
suant to Section . They must have the capacity to control their “mem-
bers” (Section ()) with respect to their qualifications, their ongoing
education, and their practical experience. The grant of admission (revo-
cable under Section ) is dependant on a showing that the applicant29
is, and continues to be, “fit and proper.” What this means is clarified in
Regulations – of the Insolvency Practitioners Regulations (IPR).
The applicant must, according to Regulation (e), fulfill his duties
“with the independence, integrity and the professional skills appropri-
ate to the range and scale of the practice and the proper performance of
the duties of an insolvency practitioner and in accordance with generally
accepted professional standards, practices and principles.” Moreover, the
applicant must not only have a clean record with respect to convictions
for offences involving fraud, dishonesty or violence30 but he must, addi-
tionally, not even have appeared “to be deceitful or oppressive or oth-
erwise unfair or improper, whether unlawful or not, or that otherwise
cast doubt upon his probity or competence for discharging the duties of
an insolvency practitioner.” In sum, the applicant must have acted in all
related matters—inside as well as outside the administration office—in
a way that does not allow any doubts as to his integrity, his professional
ethos,31 and his lawfulness.
Apart from these personal requirements, an applicant has to deliver
proof of his professional qualifications as set down in Regulations –
of the IPR. They require good English language, the passing of the
Joint Insolvency Examination, and a minimum time and case amount
of practice respectively. The grant of admission is limited to three years
pursuant to Regulation of the IPR and needs, therefore, constant
renewal.
Rule . of the Insolvency Rules entitles the administrator to
receive remuneration “for his services as such.” Its fixing can be done on
the basis either of a “percentage of the value of the property with that he
28 See Insolvency Practitioners (Recognised Professional Bodies) Order .
29 This must always be an individual, § ().
30 See, in addition, § () of the Insolvency Act .
31 For this, see Guidance to Professional Conduct and Ethics for persons authorised by the
Secretary of State as insolvency practitioners (available at: http://www.insolvency.gov.uk/
guidanceleaflets/conductethics/conductethics.htm). In addition, the Insolvency Prac-
tices Council was established in for the investigation and examination of the
professional and ethical standards of the insolvency profession.
chapter seven
has to deal” or of the time he has spent with the case. The determination
of which of these alternatives is to be chosen in a specific case is left to
the creditors or if they fail to do so, to the court.
... United States
The Attorney General appoints regional United States Trustees whose
task, apart from, inter alia, exercising surveillance powers, pursuant to
U.S.C. Section (a)() (Judiciary and Judicial Procedure), is to
“establish, maintain, and supervise a panel of private trustees.” This panel
constitutes the pool of potential candidates out of which the competent
U.S. Trustee appoints the one to serve in a given case. The general
qualification requirements for the private trustees in order to enter into
and to remain within this pool are to be set down by the Attorney
General pursuant to Section (d).32 Section of the United States
Bankruptcy Code has some details about the eligibility for a particular
case. They differ slightly depending on whether the appointee is an
individual or a corporation. An individual need not necessarily be a
lawyer.
The appointment is preliminary, however, in that this person is sub-
ject to replacement by another one through a vote of creditors.33 As a
warranty for proper treatment of the case, the “interim trustee” is gen-
erally bound to file a bond with the court “conditioned on the faith-
ful performance of such official duties.”34 He acts as a representative
of the estate and is entitled to remuneration that is determined by the
Bankruptcy Court based on the “nature, the extent, and the value of such
services, taking into account all relevant factors, including the time spent
on such services, the rates charged for such services, whether the ser-
vices were necessary to the administration . . . etc.”35 Section of the
Bankruptcy Code puts, however, a cap on the amount of such remuner-
ation.
32 For the details, see Code of Federal Regulation Part . § .(b) makes as a
condition, for example, that the candidate possesses “integrity and good moral character,”
“be courteous and accessible to all parties with reasonable inquiries,” “be a member of
good standing of the bar of the highest court,” or be a certified public accountant, holding
a certain bachelor’s degree, and so on.
33 See §§ and of the Bankruptcy Code.
34 See § (a) of the Bankruptcy Code.
35 See § of the Bankruptcy Code.
judicial and administrative institutions
... Slovakia
In its newly enacted Insolvency Trustees Act (), Slovakia sets out
the pre-conditions that a person (or legal entity) must fulfill in order to
get into the administrator pool.36 Thus, a prospective administrator—
not necessarily a lawyer—must participate in a professional training
and learning program, pass a professional exam, and register with the
authorities. Furthermore, it is requested that this person has unrestricted
legal capacity and a good reputation. The pool of administrators stands
under the supervision of the Ministry of Justice, which is given broad
powers, including the right to impose fines or even remove a person
from the administrators’ registry. For an individual case, the court selects
“randomly;”37 the creditors are given the opportunity, however, to replace
this randomly selected administrator by another administrator through
a vote in the first creditors’ meeting.
... China
The new Chinese Insolvency Statute from provides in Section
the selection and appointment process of the administrator. Accordingly,
pursuant to Paragraph , it is up to the Supreme Court to determine the
method for selection and remuneration of an administrator. In contrast,
Paragraph states that the insolvency court (peoples’ court) appoints
the administrator in the individual case. However, if the creditors are
of the opinion that this particular administrator does not cope—legally
and/or factually—with the tasks of this position the creditors’ assembly
can request an exchange.
A similar mechanism applies with respect to remuneration: it is the
peoples’ court that determines the amount. But the creditors’ assembly is
given the right to express its different view to this court.
36 Like the present Slovakian law (but unlike its predecessor rules), the Estonian one
has quite elaborate rules about the administrators’ qualification, selection, and remuner-
ation in§ ff. of the Bankruptcy Act .
37 It should be noted that in some small countries, the neutrality requirement for
an administrator sometimes poses problems because there are just not enough peo-
ple who would not know each other. Random selection could be an escape from this
trap.
chapter seven
.. Competence of Insolvency Administrators
The administrator’s competence is crucial for the efficiency and success
of any insolvency proceeding—where success means the optimal result
in a given case (liquidation or reorganization).38 Because of the complex-
ity of the tasks—including completing agreements with employees, com-
mencing proceedings against banks and tax authorities, commencing
lawsuits, continuing the viability of economic units, finding prospective
customers, and negotiating the sale of individual assets or the company
itself—the necessary competence reaches beyond mere legal or business
knowledge and experience. This is not something that can be learned
either exclusively theoretically or practically but only (or at least best)
through an education that combines both aspects.
Thus, the initial and continuous proof of this competence is a highly
important aspect of an insolvency system. As already indicated, in this
context it is helpful to (at least theoretically) differentiate between two
stages of the selection process:
– At the first stage, a pool of potential candidates for exercising the
job of an administrator has to be created. At this level it is usually
sufficient to provide for more general capabilities such as certain
professional requirements, good reputation, proof of ongoing edu-
cation, and so on.39
– The second stage is the one on which an individual—be it a natural
person or a legal entity—is to be selected from this pool for act-
ing as the administrator in a given case. At this level more specific
requirements can be requested, such as the administrator’s neutral-
ity or pre-existing experience in the debtor’s economic surrounding.
This bifurcation is more or less visibly reflected in the described legis-
lation. With respect to the creation of the pool, the legislation makes
clear that the proof of the qualifications need not necessarily be proven
38 See the General Commentary to the Principles of European Insolvency Law, et seq.
(W. McBryde, A. Flessner, & S. Kortmann, eds., ). See also UNCITRAL, Legislative
Guide on Insolvency Law – (¶¶ –) ().
39 Note that the US law, for example, requires as a general attitude “being courteous,”
see supra n. ; the new Brazilian Insolvency Law from states in art. that “the
administrator shall be a reputable professional, preferably a lawyer, economist, business
manager or accountant . . ..” Similarly, the UNCITRAL Legislative Guide states that it
“may be desirable for the insolvency representative to possess certain personal qualities,
such as integrity, impartiality, independence and good management skills.” UNCITRAL,
Legislative Guide on Insolvency Law – (¶ )().
judicial and administrative institutions
through performance on an examination, as in Canada, or through mem-
bership in a prescribed committee, as in Australia. The Finnish example
of the Ombudsman shows that the constant possibility of unexpected
control and the credible threat of considerable sanctions might also
serve as a disciplining factor that pushes the administrators to “volun-
tarily” improve their skills and knowledge. Moreover, the Finnish exam-
ple shows that the creation of a common pool of administrators need not
be particularly specific.40 The selection process is in such a case a sort of
market behavior—only those who offer best services are taken and “sur-
vive” in that market.41
The problem with this approach—at least seen from a theoretical point
of view—as well as a list solution (that is, where a judge has a list of
potential candidates42 from which the administrator is selected in any
given case) is that it entrusts the court with the power to decide upon
qualifications about which the deciding judges often have no personal
experience.43 As a rule of thumb, judges are experts in legal matters
but in many systems have little economic (let alone, troubleshooting)
experience. However, this theoretical deficit might be compensated to a
certain degree by a judiciary that (alone or together with the creditors)
has supervisory powers throughout the duration of the insolvency cases.
If this is the case, the judges are in the position to correct their initial
decision as to the qualification of the administrator in question.
The licensing system facilitates the ongoing control of the administra-
tor’s competence—provided that the license is granted not for a lifetime44
40 In Austria, practically everyone interested is allowed to put their name on the
general list on the internet from which judges are supposed to select the administrator for
a given case. See § of the Insolvenzrechtseinführungsgesetz. Such generality, however,
looks more impressive on paper than it is when used in practice; there, an attitude
similar to the Slovakian (or German) listing system prevails—that is, a given judge will
in practically all cases appoint a person known to him as a qualified administrator so that
it might be said that there is a “list” in the judge’s mind.
41 Sweden follows a similar approach by having a “supervisory authority” monitoring
the administration under various aspects. See chapter , § of the Bankruptcy Act.
42 With respect of such lists, one has to distinguish between what might be called
“closed lists”—that is, where the circle of candidates remains practically unchanged—and
“open lists.” Generally speaking, the latter appear to be more acceptable.
43 Even though Finland and Slovakia are aligned on this point, the division line is most
likely not that between common law and continental law. It might rather have to do with
a different educational tradition: in England (and its “derivatives”) the strong power of
the Inns of Court and on the Continent the judge as the all-knowing jurist.
44 As is the case, for example, according to art. of the Bankruptcy and Insolvency
Act of Barbados.
chapter seven
but for a certain period of time (for example, three years as is the case in
the United Kingdom). However, such a system requires certain adminis-
trative costs that might appear to be superfluous because a person who
falls behind the standard of professional administering will no longer be
appointed as administrator in individual cases. This observation leads to
the insight that the above-mentioned bifurcation continues to exist with
respect to the control of the competence of a once-admitted administra-
tor. It can be exercised, too, on two levels: first, on a general level—that
is, the person in question becomes expelled from the pool of adminis-
trators; or, second, on an individual level—that is, he will no longer be
entrusted with the administration of individual cases.45 The latter is prob-
ably cheaper and the former more thorough in that it erases even the pos-
sibility of collusive actions between a judge and an unsuitable adminis-
trator.
.. Integrity of Administrators
The importance of the integrity of administrators has to be seen in close
connection with what is said above about the eminently important con-
fidence and trust in the actors in any insolvency proceeding.46 The exam-
ples given stress the prerequisite of an administrator’s good reputation—
thereby emphasizing personal qualities that are beyond those required
for most other legal or economic professions. This is justifiable only on
the grounds that confidence in the insolvency system is crucial for its
efficiency.
Integrity on the part of the administrator implies that he acts with
impartiality. Even if a law like Australia’s expressly states that the admin-
istrator is to be seen as the representative of the creditors, this does
not permit the neglect of the justified interests of, for example, the
debtor. This is particularly true in reorganization cases. Therefore, it
is just another facet of said integrity that the administrator has to be
independent, too, from the parties and the debtor’s business involved.
45 It is noteworthy in this context that the German Constitutional Court has decided
that a once frequently appointed administrator has no claim whatsoever that he will be
re-appointed in the future as well, see Decision from May , , available at http://
www.bundesverfassungsgericht.de/entscheidungen/rs_bvr.html.
46 See supra ..
judicial and administrative institutions
It must, therefore, undoubtedly be of great concern if a businessman
serves as administrator in the case of his competitor.47
Whereas the competitor example is self-evident, the independence
issue becomes a bit more complicated when the question arises as to
whether someone should be admitted to administer a reorganization pro-
ceeding who has advised the debtor before the opening of this proceeding
—be it as accountant, lawyer, or consultant. The answer is dependent on
the weight given either to the conflict of interest in which this person
(possibly) is entangled or to the simple economic insight that a reorga-
nization attempt is usually better and more promptly managed by a per-
son who has gained previous insight into the debtor company and its
functioning. If the latter shall be given priority, the question is whether
safeguards have been established to exclude to the extent possible the
threat of abusing this system—for example, the necessity to disclose all
previous income from and connections with the debtor in order to put
the judge (or other authorized institution) into the appropriate position
to estimate that person’s independence. Similar conflicts of interest can
arise when a jurisdiction permits access to the administrators’ pool not
only by natural persons but also by legal entities. It might then happen
that, for instance, the accounting branch of such an entity has previously
worked for a debtor that, after the opening of the insolvency proceed-
ing, stands to be rescued or liquidated by the insolvency branch of this
very entity. Evidently, one must look for measures that assure—ex ante as
well as ex post—that conflicts of interest are excluded. Depending on the
respective jurisdiction’s emphasis on this issue, the erection of “Chinese
walls”48 within that company might suffice; a harsher alternative would
be the need to keep these branches legally distinct in different legal enti-
ties.49
Another protection for the administrators’ integrity and, thus, another
safeguard for ensuring the confidence in the system and its actors is the
47 Explicitly regulated, for example, in art. , par. of the Spanish Ley Concursal
/, de de Julio. In contrast, art. of Cameroon’s Uniform Act on Insolvency from
excludes only the debtor’s family members from appointment, whereas the new
Chinese Bankruptcy Law from excludes, inter alia, those administrators “interested
. . . with this bankruptcy case.”
48 This term is used to describe temporary arrangements within a firm that are meant
to ensure that information available to the firm in a certain capacity is not conveyed to
other parts of the firm. It is sometimes extended to the idea that one part of the firm is
acting independently so as not to be influenced by the interests of the rest of the firm.
49 The expression “Chinese walls” is meant to express the idea of separation by effective
but temporary partitions that can be erected or removed as needed.
chapter seven
more or less formalized control of the administrators. Apart from dis-
ciplining administrators by means of the credible threat of personal lia-
bility,50 most jurisdictions have exercised this control through both the
creditors’ assembly and the courts—with the latter, however, acting usu-
ally not on their own but only upon the filing of a complaint or a spe-
cific request. To base this sort of control on solid ground, administrators
are generally obliged to present reports and accounts in regular periods
to the court and/or the creditors. As important as this particular task is
with respect to an effective control system, it should be noted that this
aspect should not be too exaggerated. A former draft of the Moldovian
Insolvency Statute provided for a monthly report; taking into account
that administrators, due to the remuneration system, needed dozens of
cases in order to earn a living, this task turned into a serious hurdle for
performing an administrator’s daily tasks.
By contrast—and supplementing the topic of judicial oversight—a
considerable number of jurisdictions have set up specific surveillance
institutions like the ones grouped together in the International Associ-
ation of Insolvency Regulators.51 These countries have established inde-
pendent institutions that exercise their monitoring function according to
their internal or statutory rules. This is, so to speak, a third step of provid-
ing safeguards for the functioning and integrity of the insolvency system
in general and its main actors in particular. Moreover, especially in times
of increased numbers of insolvencies, the general public throughout the
globe displays a certain tendency to grow irritated and blame, inter alia,
administrators for the development. A surveillance institution is partic-
ularly valuable at such times as it absorbs such criticisms.
An alternative way of exercising such control functions exists, for
example, in Germany: there the association of administrators relies on
a kind of “soft law” by imposing certain behavioral rules on their mem-
bers as a kind of code of conduct.52 The sanction for an administrators
transgression is (apart from other possible legally relevant repercussions)
the lowered regard of his peers. One might call this approach a “Code
of Ethics.” Still another remarkable possibility of surveillance is realized
50 One might call this control mechanism “internal control” in that it applies to the
administrator’s own sense of responsibility.
51 See supra ...
52 See http://www.arbeitskreis-insolvenzverwalter.de under Verhaltensrichtlinien.
judicial and administrative institutions
in Austria: the Kreditschutzverein (credit protection association)53 which
was founded in with the general purpose of protecting entrepre-
neurs from financial damage; part of this task is the representation of
creditors (even beyond its members) in insolvency proceedings and the
maintenance of their rights. In the course of time, this institution has
gathered such an enormous amount of knowledge and insight that its
judgment over each particular administrator, as a matter of fact, forms a
credible threat to every administrator. This association has developed,
thus, into something like a standard-setter in insolvency administra-
tion.
It deserves, however, to be mentioned that institutionalized controls,
like those described here, are of lesser importance in those jurisdictions
that entrust their administrators with mere executive functions within a
court-driven proceeding.
.. Rules of Compensation of Professionals
The compensation of professionals (that is, of both administrators and
judges) plays an essential role in developing a proper pool of insolvency
personnel that fulfils the confidence requirements explained in the pre-
vious two sections. Compensation is the financial tool that helps give
an incentive for creating the necessary professional ethos that is indis-
pensable for any effective insolvency law.54 Thus, as a starting point, an
observer should look for a system of compensation that places profes-
sionals in a position to earn a decent living commensurate with their
education and qualifications and that does not force them to look for
other sources of income.
As the examples of the country descriptions discussed above show,
there are different methods of remunerating administrators. The com-
mon thread through them all is that it is never left to the administrator
alone to decide the matter. Instead, the decision is either entrusted to the
53 For a description of the history, task, and success of this institution, see H.G. Kant-
ner, The Protection of Creditors in Austrian Insolvency Proceedings, Eurofenix (Au-
tumn ).
54 As just one example, see Thomas Richter, The New Czech Insolvency Act—New Insol-
vency Regime for Czech Corporate Debtors and Their Creditors, Butterworth J. Intl.
Banking Fin. L. () (discussing the law in force until June , ).
chapter seven
creditors55 or to the court.56 In both cases such a decision might be
subject to further investigation upon application of either a party or a
third person, such as is the case with the Ombudsman in Finland. The
decision not only might be about the fixing of a certain sum to be paid to
the administrator, but also can include the basis on which the sum is to be
calculated—on the money received in the course of the proceedings,57 on
the value of the estate (United Kingdom), on the time spent on the case
in question, or on a combination of all these criteria, as is the case in the
United States.58
Evidently, there are several advantages to giving the decision about
the administrator’s remuneration to someone different from the one
who receives it (that is, the administrator). Not only does this measure
increase transparency, it also serves at the same time as a confidence-
creating measure and functions thus as an incentive for the administrator
to do “a good job.” Nevertheless, there are also some caveats to be kept
in mind: if it is the court that decides, then transparency can easily
be lost if both sides work closely together in a collusive or corruptive
manner. Therefore, such a regulation is conditional on a justified trust
of the impartiality of the participants, particularly of the judiciary. If the
decision is given to the creditors, however, the administrator might feel
the need to give up (or reduce) his neutrality as to the parties at stake
and support in a one-sided way the interests of all or a certain group
of creditors.59 In the worst case scenario, one creditor might blackmail
the administrator—a fact that makes institutionalized surveillance all the
more desirable.
Apart from the question of who decides about the amount of remuner-
ation, there is the further question of how the amount of remuneration
should be calculated. It has already been mentioned that one answer is
55 See additionally, for example, art. of the Bankruptcy and Insolvency Act
of Barbados.
56 See, e.g., the Chinese Bankruptcy Statute, § par. . The Swiss example of a public
authority acting as administrator (Konkursamt) demonstrates that the remuneration can
also be fixed by means of legislation; see art. ff. Gebührenverordnung zum Bundesgesetz
ueber Schuldbetreibung und Konkurs—based on art. of the Schuldbetreibungs- und
Konkursgesetz (a combination of time- and value-based calculation).
57 See, e.g., the example of Australia above. The same is found, for example, in§ ()
of the Estonian Bankruptcy Act .
58 See also art. , par. of the Spanish Bankruptcy Law, supra n. , that combines
the complexity of the case with the assets and liabilities.
59 This is less problematic in a jurisdiction such as Australia where the administrator
explicitly acts as a “representative of the creditors.”
judicial and administrative institutions
to base this calculation on the time spent. Even though this is a fairly
objective standard, it has its flaws60 in that it might give an incentive for
unnecessary prolongation of the proceeding. The alternative is to take the
value of the estate as the basis for calculation. But here, a further distinc-
tion can be made: if the relevant value is that of the estate at the beginning
of the proceeding, later efforts to increase the estate’s value through, for
example, the use of avoidance powers might be neglected. In contrast, if
the relevant value is the estate as it is to be distributed to the creditors,
then previous efforts to clarify which assets do and do not belong to it
might be neglected. The examples show that there is, generally speak-
ing, no “one size fits all” answer. Under such circumstances, it might be
worthwhile to consider the use of a fixed amount to which can be added
or from which can be deducted certain amounts depending on the par-
ticular case at hand. On the other hand, calculations based on the size of
the dividends to creditors are also found in a number of systems.
.. Periodic Reports
Many systems require periodic reports and accounts from the adminis-
trator as an insolvency case proceeds.61
60See supra ..
61See, e.g., U.S.C. § (a)() for the United States requirement. See Eberhard
Braun, Commentary on the German Insolvency Code – ().
chapter eight
CROSS-BORDER CONSIDERATIONS
.. Overview
As a consequence of the general rule that any state has the power to
enact laws that are applicable and enforceable only on its own territory,
problems necessarily arise when and if a debtor’s insolvency stretches
beyond the borders of a state. This is primarily the case when the debtor
has assets in more than one jurisdiction. In such a case, the creditors will
be interested in including assets from the other jurisdiction in “their”
proceeding; the liquidation of these additional assets might increase the
dividend. Also in case of an envisaged rescue of the debtor, the inclusion
of assets located abroad might be essential for success or failure of the
attempt. On the other hand, creditors in the other jurisdiction might have
entered into contractual relationships with the debtor in reliance upon
the location of assets in “their” jurisdiction. The question then arises
as to whether or not this reliance on assets “at hand” deserves, or even
needs, protection—a question that is all the more valid if and when these
creditors are employees of the debtor. But reliance aside, some would
question whether it can ever be legitimate that the insolvency law of
one jurisdiction reaches out to assets positioned in another jurisdiction.
As desirable as this result might be economically, can it be reconciled
with the fundamentals of national sovereignty? On the other hand, does
this very doctrine necessitate (at least) the formal recognition of the
foreign proceeding? These are some of the questions that mark the initial
problems of international insolvency law. Needless to say, innumerable
further problems exist in this area. However, this chapter confines itself
to describing and commenting upon only the more fundamental ones—
those that have formed the starting point for national legislation.
Because of ever-growing multinational trade and investment, every
jurisdiction—even smaller ones1—must consider regulating not only
1 See, for example, Uganda, that has in its draft Insolvency Bill provisions dealing
with trans-border issues. See infra ...
chapter eight
purely domestic insolvencies but also cross-border insolvency cases.
Even though the advent of cross-border cases reaches far back into his-
tory,2 the common and worldwide need for regulating this phenomenon
in some detail is becoming, more and more, an indispensable task for
any legislator—with predictably increasing intensity as a consequence of
constantly intensifying globalization. The key multinational legislation
is found in the European Insolvency Regulation and the UNCITRAL
Model Law on Cross-Border Insolvency.3
Before explaining the fundamentals of cross-border insolvency law,
two caveats need to be made: () independent of the foregoing, the
common understanding is that the treatment of foreign creditors is
an issue for purely domestic regulation—the recommended rule being
that of equal treatment;4 () the international community has not yet
found a satisfactory and widely accepted solution for the treatment of
insolvencies involving more than one legal entity bound together as a
group, despite its frequency and enormous practical importance. Such
“group insolvencies” form statistically the predominant pattern of cross-
border insolvencies, but there has not yet evolved something like a “best
practice” for dealing with such situations.5
.. Fundamental Issues
Because this subject is so new, this discussion requires more theory and
analysis than areas that are well-developed in all national legislation. As a
matter of fact, any cross-border related insolvency legislation has to take
into account a multiplicity of considerations resulting from, for example,
2 See, for example, Friedrich Meili, Die geschichtliche Entwicklung des internationalen
Konkursrechtes, Festschrift v. Bar (Orell Füssli ); Hans Hanisch, Bemerkungen zur
Geschichte des Internationalen Insolvenzrechts in Festschrift für Franz Merz, et seq.
(W. Gerhardt et al. eds., RWS-Verlag ); Josef Kohler, Lehrbuch des Konkursrechts,
et seq. (F. Enke ).
3 Council Regulation (EC) No / (available at: http://www.europa.eu/eur-
lex/pri/en/oj/dat//l_/l_en.pdf); UNCITRAL Model Law
on Cross-Border Insolvency (available at: http://www.uncitral.org/uncitral/en/uncitral_
texts/insolvency/Model.html). For an in-depth discussion of both, see infra ...,
...
4 The Model Law on Cross-Border Insolvency, discussed infra .., specifically
requires equal treatment of all creditors, whether domestic or foreign, although there
is a special problem with foreign tax claims. Id. at ¶ .
5 In December , UNCITRAL started an initiative to elaborate such best practice.
See also infra . (b).
cross-border considerations
the economic system of the respective country, the overall purpose of its
insolvency law, the whole legislative body relating to the pre-insolvency
situation (this might be called “turnaround or reorganization legisla-
tion”), its relationship with particular other countries, or the hoped-for
treatment of its businesses abroad. After all, an effective cross-border law
has far reaching implications including, for example, fostering informal
workout attempts at the outset of a debtor’s financial distress as it might
help to prevent the possibly troublesome task of going through an insol-
vency proceeding.
Irrespective of this multi-dimensional task, however, there are a few
fundamental issues6 that more or less explicitly underlie practically all
laws in the world on this subject. They require some brief listing and
description.
... Basic Terminology and Concepts
.... Territoriality vs. Universality
The most basic distinction of these concepts refers to the scope of the
law’s applicability. Since any cross-border case implies that assets of the
debtor are located in a country other than the one in which the insolvency
proceeding is commenced, the question arises as to whether these assets
can be subjected to the present proceeding. Therefore, the alternatives
are, generally speaking, that the scope is either restricted to the respective
legislator’s area of dominion or extended to all over the world.7
(a) The restrictive approach is called territoriality (or the terri-
toriality principle). It designates a law that confines its applicability
strictly to that physical area governed by the respective jurisdiction.
It does not claim to reach out to assets located outside of this terri-
6 See, for example, Philip Wood, Principles of International Insolvency,
().
7 See for a discussion of both approaches Jay L. Westbrook, A Global Solution to Multi-
national Default, Mich. L. Rev. (); Lynn LoPucki, The Case for Coopera-
tive Territoriality in International Bankruptcy, Mich. L. Rev. (); Frederick
Tung, Fear of Commitment in International Bankruptcy, Geo. Wash. Intil. L. Rev.
(); Charles D. Booth, Living in Uncertain Times: The Need to Strengthen Hong
Kong Transnational Insolvency Law, Colum. J. of Transit. L. , – ()
[hereinafter Living in Uncertain Times]. See additionally Jay L. Westbrook, Multinational
Financial Distress: The Last Hurrah of Territorialism, Tex. Int’l L.J. ().
chapter eight
tory.8 Territoriality, thus, complies with the concept of sovereignty that
was developed by the French philosopher Jean Bodin in the th century,
that has guided public international law ever since, and that still exercises
great influence today.9 The territoriality principle, in its purest version,
not only confines its own applicability overseas (outbound application),
it additionally bars another state’s claim to reach assets that happen to be
located within the reach of such state’s territory (inbound application).10
Such a universalistic claim is blocked by a strict territorialism.
In this context, it is of more than just historical interest that the
legislative power in insolvency matters always rested (and still rests) in
at least most (if not all) national jurisdictions with the biggest relevant
territorial (and economic) unit.11 The most prominent example is, of
course, the United States, which had in its Constitution right from the
beginning a provision that entrusted the federation with the legislative
power in insolvency matters; but this observation is true also for other
states such as Argentina, Australia, Brazil, Canada, Germany, Russia, and
Switzerland. Considering these examples and the increasing convergence
of the world’s economies, it seems likely insolvency law will expand in its
scope to fit regional or even global markets.12
(b) By contrast, universality (or the universality principle) ignores such
territorial restrictions and claims instead worldwide applicability of the
law governing the case. This approach does not, as a matter of fact, ignore
the other states’ sovereignty; rather, it pays respect to it by leaving it to
the foreign states whether or not they accept such outreaching claims. It
is, therefore, consistent that the universality principle does not confine
8 Note as an aside that the question of where assets are located deserves increasing
attention due to the volatility of those “important” goods and financial assets that can be
transferred very quickly from one jurisdiction to another.
9 It should be noted that this concept of sovereignty that guarantees “the ruler” full
authority over his territory (see Christian Tomuschat, International Law: Ensuring the
Survival of Mankind on the Eve of a New Century, et seq. (Martinus Nijhoff )) has
become in recent years less and less accepted in light of countervailing values advocating
for the future togetherness of the people of this world. Suffice it to mention here the
extension of public international criminal law that started with the Nuremberg Trials and
that is now—after Rwanda, Pinochet, Milosevic, and so on—a solid and steady feature of
modern international law; see also Christoph Paulus, Some Thoughts on an Insolvency
Procedure for Countries, Am. J. Comp. L. ().
10 Prominent examples for such an approach were Japan, until its new legislation came
into operation in , and China, before its new law came into operation in .
11 See also Westbrook, supra note , at .
12 See infra ..
cross-border considerations
itself to a one-way approach but includes acceptance of a respective
claim from another state’s insolvency law. It would be a consequence of a
strict application of this approach that insolvency cases with cross-border
implications would be governed by just one law—no matter where the
assets might be located.
(c) However, these two principles have rarely existed in their purest
versions; legislative practice quite often mixes or modifies them:
i. As to the mixture—a common version might be called a one-sided
universality (or one-sided territoriality). Its characteristic is that a
jurisdiction requests worldwide recognition (or at least expects it) of
its own domestic trans-border cases but bars foreign cases with the
same claim on its own territory.13 One-sided universality is not only,
shall we say, esthetically disturbing, it is obviously either arrogant
or inconsistent. A somewhat softer version requests reciprocity in
exchange for recognition of the foreign claim to universality.14
Under the present-day conditions, however, the justification for
such distrust becomes more and more doubtful. Whereas in earlier
times skepticism might have been understandable (or even appro-
priate) in light of the enormous differences among the various insol-
vency laws, today there exists a world-wide convergence in the area
of these laws.15 This is in large part because of the insolvency initia-
tives of the multilateral institutions such as the International Mone-
tary Fund (IMF), World Bank, and UNCITRAL as a reaction to the
13 A recent example is the interpretation given to the old Chinese bankruptcy law prior
to the promulgation of the Chinese Enterprise Bankruptcy Law. CCIC Finance Ltd.,
v. Guangdong Int’l Trust and Inv. Corp. and Guangdon Int’l Trust and Inv. Corp. Hong Kong
(Holdings) Ltd., (In Liq.), HCA of (July , ), noted in Charles Booth,
Drafting Bankruptcy Laws in Socialist Market Economies: Recent Developments in China
and Vietnam, Colum. J. of Asian L. , , note ().
14 Article of the new Chinese Enterprise Bankruptcy Law. Moreover, a few juris-
dictions that have adopted the UNCITRAL model law make its applicability dependent
upon reciprocity—for example, Argentina (draft), British Virgin Islands, Mexico, Roma-
nia, South Africa, or (prospectively) New Zealand. UNCITRAL, Status: —Model
Law on Cross-Border Insolvency. Look Chan Ho, Overview, Cross-Border Insolvency: A
Commentary on the UNCITRAL Model Law , (Look Chan Ho ed., ).
15 See Christoph Paulus, Rechtsvergleichung im nationalen wie internationalen Insol-
venzrecht: Eine Erfolgsgeschichte, in Einheit und Vielfalt des Rechts, Festschrift für R. Gei-
mer, et seq. (R. Schütze ed., ).
chapter eight
Asian financial crisis and the subsequent creation of a Finan-
cial Stability Forum by the G States that spotted the effectiveness
and efficiency of insolvency laws as one of the decisive factors for
a state’s financial stability.16 Given this development towards a har-
monization of the world’s insolvency laws, territorial defense mech-
anisms lose much of their justification and tend to become some-
what outdated.17 This is all the more true as a remedy of last resort
usually exists, so to speak, in that a foreign law’s applicability might
be rejected (in toto or in a special respect) on grounds of the viola-
tion of domestic public policy (ordre public).18
ii. The modification of laws governing multinational cooperation may
consist in carving out certain fields of law (such as securities, treat-
ment of labor contracts, secured transactions, tax law, or corpora-
tion law) in order to support the insolvency proceeding on a terri-
torial level. This fact indicates that modifications are made because
of the great differences that still exist in the laws of different coun-
tries in the present world. The degree of modification forms part
of a second fundamental distinction—whether there should be just
one proceeding or several.
.... Unitary vs. Multiple Proceedings
(a) A more or less natural consequence of the universality principle is
that, ideally, there should be just one proceeding dealing with the debtor’s
insolvency—no matter where in the world its assets are located: one case,
one law, and one proceeding. Seen from a purely theoretical perspective,
this solution would be the best in avoiding unnecessary costs such as
multiple administrators or exchange of information.
(b) However, it has already been mentioned that such a unitary approach
faces, at least for the time being, insurmountable practical obstacles
resulting from the still existing (or perceived) disparities of quite many
areas in the laws of the various countries of this world.19 In order to over-
16 See http: // www.fsforum.org / compendium / key_standards_for_sound_financial_
system.html.
17 See Jay Lawrence Westbrook, Theory and Pragmatism in Global Insolvencies: Choice
of Law and Choice of Forum, Am. Bankr. L.J. ().
18 As just one example, see art. of the Croatian Bankruptcy Law from .
19 There are few examples that document the possibility for providing unitary proceed-
ings on a regional level. A prerequisite is that two (or more) countries have such a close
legal relationship that the differences are negligible. This was the case (at least to a certain
cross-border considerations
come these obstacles, two solutions have been developed in practice so
far. The first one uses the private international law method of determin-
ing the applicability of a certain law; this method is used only for selected
issues in the context of an insolvency proceeding. That means that even
though the law of the main proceeding—commonly called lex concur-
sus—governs the proceeding as a whole under the universality princi-
ple, more or less exactly defined areas might be governed by the law (or,
narrower, the insolvency law) of another jurisdiction. Prominent exam-
ples for such exceptions are, inter alia, rights in rem, avoidance and setoff
rules, or certain financial devices.
The second solution that has emerged is to split up the one, and
ideally only, proceeding into several—potentially into as many as there
are foreign jurisdictions involved. However, what looks like a fallback
into the territoriality principle is avoided by providing for a ranking of
the proceedings20 and the coordination of them as well as the cooperation
of the persons involved. This approach is commonly called “modified
universalism.” The degree to which such modification takes place allows
for a further subdivision:21
i. Because the UNCITRAL Model Law on international insolvency is
designed to assist and support the foreign proceeding on its own
territory by reducing the applicability of the local insolvency law
more or less to the degree necessary for the protection and fair
treatment of the local creditors, the ancillary proceeding approach
has gained prominence. Since an ancillary proceeding is not a full-
fledged insolvency proceeding, it has the theoretical22 advantage of
degree) for two countries like Austria and Germany with a long lasting common legal his-
tory and parallel developments; see Treaty between Germany and Austria on Bankruptcy,
Winding-up, Arrangements and Compositions from . See infra .. and Scandina-
vian concord. However, the Peoples’ Republic of China and Hong Kong have, even since
, not yet come to any agreement regarding the mutual recognition of their respective
insolvency proceedings.
20 It is crucial to designate thereby as precisely as possible the one and only main
proceeding.
21 See for what follows Jay. L. Westbrook, Multinational Enterprises in General Default:
The UNCITRAL Model Law and Related Regional Reforms in: Aktuelle Entwicklungen des
europäischen und internationalen Zivilverfahrensrechts (), sub part II B.
22 The example of Switzerland amplifies that a full local insolvency proceeding is not
necessarily expensive and that it can be performed in great speed. Moreover, the proto-
col in the AIOC Resources, AG case (available at: http://www.iiiglobal.org/international/
protocols/AIOCResourcesAGProtocol.pdf) shows the flexibility of the Swiss
authorities.
chapter eight
being cheaper, swifter, and more flexible. However, most existing
ancillary proceedings provide for both procedural and substantive
regulations; a supportive proceeding containing only procedural
rules has not yet been developed.
ii. The alternative to an ancillary proceeding is a parallel proceeding.
This is a regular insolvency proceeding with all its consequences
as to time, effort, and costs, but it is restricted in its reach to the
territory of the state in question (under the territoriality principle).
The justification that is commonly given for this approach is the
allegedly necessary protection of the local creditors.23 A closer look,
however, gives the impression in a great number of cases that the
real reason might instead be the protection of the local law and its
applicability.
The deference of a parallel proceeding to a main proceeding is of vary-
ing intensity. On the one side of the scale, it can be completely isolated
in its performance, that is, there is no co-operation and no informa-
tion exchange between the office holders of this proceeding and that of
the main proceeding—with the only exception that any surplus will be
handed over to the main proceedings; an informative example for this
is Switzerland. The great disadvantage of this approach is the difficulty
arising from such isolationism in case the debtor in question could be
reorganized.24 This is hardly possible under such a separatist attitude.
At the other end of this spectrum,25 the parallel or concurrent pro-
ceeding can be employed in close cooperation with the main proceed-
ing. This may be called the universality/plurality approach.26 A secondary
proceeding is a full insolvency brought in a jurisdiction other than the
primary jurisdiction for that debtor. In contrast to an ancillary type of
proceeding, it can exercise all of the usual powers of an insolvency court
rather than merely assisting the primary court. Such a parallel proceed-
23 For the value of this argument see John Pottow, Greed and Pride in International
Bankruptcy: The Problems of and Proposed Solutions to “Local Interests,” Mich. L. Rev.
().
24 It is noteworthy that Switzerland so far has not enacted a full-fledged reorganization
proceeding; drafts are currently under discussion. Also, it should be noted that even in
liquidation cases, cooperation may lead to a greater realization of value. See supra ...
25 Somewhere in the middle of this spectrum is the frequent rule that a parallel
proceeding is not automatically initiated but only when and if certain conditions are
fulfilled; see for example, the Croatian International Bankruptcy Law (described by
Jasnica Garašić in INSOL Europe— International Case law-Alert II/, p. et seq.)
available at http://www.brsi.de/pdfs/international_caselaw_AlertNo.pdf.
26 It is also consistent with “Modified Universalism.”
cross-border considerations
ing is secondary to the extent it fashions its actions in an effort to defer
to and cooperate with the primary proceeding. In some forms there
will even be mutual conformity between the concerned administrators
and judges. The more intensive such coordination and cooperation is
prescribed (or performed), the more similar becomes the parallel pro-
ceeding to an ancillary one. The European Union Regulation (discussed
below) clarifies this deference and assistance of the parallel proceeding
by calling it a secondary proceeding; however, it provides for a coopera-
tion duty of just the administrators (and not the judges) and is therefore
not as close to the ancillary proceeding as the UNCITRAL Model Law
approach.27
... Jurisdiction
The experience especially of the last years has shown that the legisla-
tive as well as practical attempts to determine where the just-mentioned
main proceeding is to be located is anything but an easy undertaking.
These difficulties are particularly felt in the context of insolvencies of
groups.28 The formation of groups is today the predominant way of struc-
turing businesses, especially multinational firms. Instead of having all
activities bundled in one corporation, they are split up and attributed
to several separate companies that are bound together under the roof of
(usually) one company.
Practice teaches as a strong rule of thumb that, fairly often, if one com-
pany of such group goes bankrupt, the other ones will follow in a kind of
domino effect. Such an event provokes a number of intricate questions,
one of them being which jurisdiction shall be competent to open a main
proceeding and which one a parallel or ancillary proceeding, respectively.
This problem is currently probably one of the most intensely debated
issues in international insolvency law. The background of this discussion
is the need and desire to determine ex ante the competent jurisdiction
and to exclude thereby forum shopping29 to the extent possible.
27 UNCITRAL Model Law () at Ch. (arts. –) (Concurrent Proceedings).
28 See Neil Cooper, Corporate Groups & Insolvency (paper presented at the Seminario
internacional de insolvencia, insolvencia transfronteriza y contratación pública, held in
Bogota, Colombia, on March , ) at ; Christoph Paulus, Group Insolvencies—
Some Thoughts About New Approaches, Tex. Int’l. L.J., et seq. ().
29 About forum shopping see A. Smits and I. O’Hearn, Multinational Insolvency Forum
Shopping in: James R. Silkenat & Charles D. Schmerler, The Law of International
Insolvencies and Debt Restructurings, , et seq.
chapter eight
.... Determination of the Main Proceeding
There are at least two options imaginable: Following the priority princi-
ple one could say that the jurisdiction in which to open a main proceed-
ing shall be the court where the first filing of a petition has been lodged.
However, such a rule could easily result in randomness when, for exam-
ple, an obvious branch of the company gets the lead in the insolvency
of the whole company or group; moreover, such a rule could easily be
misused by creditors or debtors who were free to choose a jurisdiction
for the main proceeding that is most favorable for them (forum shop-
ping).30 Therefore, it appears to be preferable to determine in advance
which court has the jurisdiction to open a main proceeding and which
court only a subordinated proceeding rather than leaving this decision
to chance or strategic behavior.
Since there is some dispute among courts, practitioners, and schol-
ars about the correct way of making such a determination within cor-
poration law (should it be the statutory seat or the actual seat), interna-
tional insolvency law is seeking its own solution. Under the lead of the
European Union Regulation and the UNCITRAL Model Law it becomes
nowadays increasingly accepted31 that the correct place for opening the
main proceeding should be the center of the debtor’s main interests. As
a consequence, jurisdiction to open a main proceeding is with that court
where this center is located.32 All other courts in the world, then, have
just the competence to open a subordinated proceeding if the debtor has
an “establishment” in the local jurisdiction (see below). If under such a
rule two different courts, nevertheless, should be of the opinion that the
debtor’s center of main interests is located in their respective district, this
conflict might be solved by the application of the aforementioned priority
principle.
However, even though the European Union Regulation has been in
force only since , the experiences of the first years of application of
this law have made quite obvious that the term “center of main interests”
30 A vigorous dispute about these questions has arisen in the United States. See
Symposium, William C. Whitford, Courting Failure? The Effects of Venue Choice on Big
Bankruptcies, Buff. L. Rev. , (). See generally Elizabeth Warren and Jay
Lawrence Westbrook, The Law of Debtors and Creditors (th ed., ).
31 See, for example, art. of the Croatian Bankruptcy Law from .
32 In re Bear Stearns High-Grade Structured Credit Strategies Master Fund, Ltd.,
B.R. (Bankr. S.D.N.Y. ), aff ’d B.R. (S.D.N.Y. ) (applying a strict
reading of the center of main interests requirement).
cross-border considerations
is far from being sufficiently clear. Despite the additional specification
that this center is to be presumed at that place where the legal person or
the company has its registered office,33 uncertainties exist as to whether
an affiliate’s center is where its own office is registered (that is, located)
or where the parent company (so called “head office functions” or “mind
of management”) is registered.34 This is where the jurisdictional question
interacts with the unsolved problem of the treatment of insolvent groups.
To find a more precise determination of the competent jurisdiction is cer-
tainly one of the most urgent challenges of the present-day international
insolvency law.
.... Minimum Requirements for a Non-Main Proceeding
Closely related to the preceding remarks is the consequential question
about which country should have jurisdiction to open a non-main pro-
ceeding or, respectively, under what conditions shall this possibility be
granted. Does it suffice if only a few of the debtor’s assets (or even just
non-central interests) are located in the jurisdiction or should more than
that be required, such as a branch (however this might be defined)? The
decision for the one or the other alternative depends on the degree to
which a country’s law wants to protect its local insolvency policies. As a
matter of fact, certain local creditors, who will be among the beneficiaries
of a local proceeding, for various reasons (language, travel efforts, famil-
iarity with local authorities, and so on), will be more comfortable with a
domestic proceeding than a foreign one. On this basis, a number of coun-
tries establish, as a sufficient reason for opening a domestic proceeding,
that the debtor has just a single asset located within this jurisdiction.35
However, such an approach opens avenues for fragmenting coherent
trans-border cases and thus destroying the approach of the universality
33 See art. () of the EU Regulation.
34 For this, see (out of innumerable publications) Gabriel Moss & Christoph Paulus,
The European Insolvency Regulation—The Case for Urgent Reform, et seq., Insolv.
Int. (); in contrast, however, see the European Court of Justice in the “Eurofood”
case, available at: http://curia.eu.int/en/content/juris/index_form.htm. For comments on
this decision by, e.g., Jay L. Westbrook, Locating the Eye of the Financial Storm, and
Gabriel Moss, Group Insolvency—Choice of Forum and Law: The European Experience
Under the Influence of English Pragmatism, ( Brooklyn J. Int’l L. ); Christoph
Paulus, Group Insolvencies—Some Thoughts About New Approaches, Tex. Int’l L.J.
().
35 An example is the United States. U.S.C. § (a). If such a proceeding is limited
to local assets and there is no other proceeding pending in the world, the problem is not
chapter eight
principle that strives to have, to the extent possible, one proceeding gov-
erned by just one law. This is all the more a realistic danger since, under
the given economic circumstances, it becomes increasingly easy to trans-
fer assets from one place to another. Therefore, the decision for establish-
ing minimum requirements for the opening of a non-main proceeding
should always bear in mind that the ultimate goal should be a unitary-
universalistic proceeding. When and if this proposition is accepted, it is
self-evident that the mere location of an asset should not be enough for
opening a non-main proceeding. A prominent representative for such a
“more than just an asset” approach is the requirement of an “establish-
ment,” a requirement found in both the European Union regulation and
the Model Law. This is a term, however, that is not self-explanatory but
rather that is apt to be defined in a way that might add to the existence of
an asset, for example the presence of business activity;36 further elements
or different ones could easily be added for a more precise definition of
what shall be understood by the term “establishment.”37
... Choice of Law
Since insolvency law is, in fact, a sort of meta level of any national law—
meaning that it is related to and intertwined with virtually all areas of this
law—it is obvious that not all rules of a given jurisdictional insolvency
regime are equally adaptable to those of another. This statement presup-
poses, of course, that the jurisdiction in question adheres in one way or
another to the universality principle since, by definition, the territoriality
principle does not care about mutual adaptability. In some cases an adap-
tation is easier than in others so that in multi-jurisdictional cases the har-
monization of the laws involved becomes a problem. Prominent exam-
ples for a particularly hard adaptability are the administrator’s avoidance
one of cross-border law and may not be problematic at all. The point discussed in the text
arises because there are also insolvency proceedings concerning the same debtor in other
countries.
36 This is what the European Insolvency Regulation and the UNCITRAL Model Law
define as “establishment.” UNCITRAL, Model Law () at Art. (“ ‘Establishment’
means any place of operations where the debtor carries out a nontransitory economic
activity with human means and goods or services.”).
37 In re Bear Stearns High-Grade Structured Credit Strategies Master Fund, Ltd.,
B.R. (Bankr. S.D.N.Y. ), aff ’d B.R. (S.D.N.Y. ). That case rejected
the idea that a jurisdiction of incorporation, with only formal contacts with the debtor,
could be even a non-main jurisdiction.
cross-border considerations
powers or the treatment of secured rights; less hard (but still troublesome
in many cases) is, for example, the scope of the administrator’s powers or
the granting of special privileges in insolvency proceedings. The problem
is large and complex, and we introduce only the main elements in this
brief treatment.
It is of central importance to distinguish between choice of insolvency
law and choice of non-insolvency law. As to a given dispute, both choices
may be necessary and it is crucial to see which choice a particular statute
or court decision is making. For example, take a particular claim arising
in contract and asserted to be entitled to priority in distribution. The
law governing the validity of the contract, the amount of damages, and
related issues are usually governed by non-insolvency law. Once those
questions have been answered and the amount of the claim determined,
then insolvency law will determine the proper priority in distribution.
The general rules of conflicts of law are usually not seen as per se appli-
cable in cross-border insolvency cases but are said to need adjustment to
the particular needs and peculiarities of these proceedings. The two cor-
nerstones in between which this adjustment must be placed are, on the
one hand, the above-mentioned ideal of one proceeding handling one
case according to one law. On the other hand, there is the confidence
of the people of other countries in the application of a law under which
they have acted before and have performed legal transactions. Whereas
the former principle would lead to an export of the whole body of the
domestic insolvency law to all countries where the debtor might have
assets, the latter approach tends toward a multiplicity of applicable laws:
beyond the borders of the opening jurisdiction only those jurisdictions’
laws are applicable where assets (or establishments)38 of the debtor are
located.
The contemporary compromise for the solution of these two conflict-
ing approaches is that, as a general rule, the lex fori concursus shall be
applicable, that is, the insolvency law of that jurisdiction where the insol-
vency proceeding in question has been commenced. However, there are
exceptions to this unitary and universal approach: wherever the need is
felt to protect nationals and their trust in “their” law, there are specific
rules providing either for the exclusive applicability of this law or for at
least mitigating the strict effects of the application of the lex fori con-
cursus. Widely accepted examples for such exceptions are—apart from
38 See supra ....
chapter eight
the above-mentioned securities and avoidance powers—the treatment of
lease and employment contracts, of setoff and netting rights, and of the
exercise of the administrator’s enforcement powers.
... Recognition of Foreign Proceedings
.... Meaning of Recognition
The implementation of the universality principle results in the necessity
to recognize a foreign country’s insolvency proceedings. Recognition,
therefore, is something like the other side of the universality coin or the
threshold for reaching out beyond the borders of the opening jurisdic-
tion. Such recognition, however, requires trust of that foreign country’s
legal system, such as its adherence to the rule of law and/or the com-
parability of that insolvency proceeding’s policy goals. Accordingly, the
intensity of this trust is crucial for the method of recognition and the
speed at which a decision is made.
.... Forms of Recognition
..... No Trust, No Recognition
The most extreme result is no trust and no recognition. This was for a long
time (and still is nowadays in many regions of this world) the prevailing
attitude of those jurisdictions following the territoriality principle (or the
one-sided universality approach).
..... General Trust
At the other end of the spectrum is general trust of the other jurisdictions’
laws, with the consequence of an automatic recognition accordingly. This
is the general rule underlying, for example, the European Union Regu-
lation.39 It is self-evident that such an approach usually requires a rather
long-lasting common tradition plus a legal or economic interrelation-
ship. However, if the future really belongs to the universality principle,
the world as a whole has to come to this stage of development. This is
facilitated to a certain degree by the above mentioned endeavors of the
39 Described below in ... For the trust requirement in particular, see Christoph
Paulus & Marc Udink, European Law and Trust, EUROFENIX, ().
cross-border considerations
multilateral institutions like IMF, World Bank and UNCITRAL to estab-
lish generally accepted (or at least acceptable) principles and standards
in the world’s insolvency laws.
..... Mid-Ground Modifications
Between these extremes, there are common alternatives. This mid-
ground is where the modifications of the universality principle come into
play.40 A general distrust can be mitigated by offering, for example, an
ancillary or parallel proceeding, as described above. Another quite com-
mon modification is to make recognition dependent on an explicit deci-
sion by a court or agency. The granting of such an “exequatur,” as it is
usually called, can be subject to conditions; prominent examples are reci-
procity of recognition, the conviction that the foreign proceeding fulfils
the domestic functions and requirements of what an insolvency proceed-
ing is; jurisdiction of the foreign court or institution to open the proceed-
ing in question; and / or the compliance of the foreign proceeding with
the domestic public policy (ordre public). The consequence of granting an
exequatur generally is that the foreign administrator may, all or in part,
act in this jurisdiction as he may in his home-jurisdiction or, alternatively,
as a domestic counterpart would be allowed to act.
..... Speed and Efficiency of Recognition
Speed and efficiency are decisive for the outcome of any insolvency
proceeding and, thus, as a matter of fact, for trans-border cases as well.
This determination is true for liquidation proceedings but all the more
for those that aim for the debtor’s rehabilitation. Here, speed of the
proceeding and the recognition is of utmost importance for efficiency.
Seen from a theoretical point of view, one might be tempted to believe
that an exequatur approach is speedier than the necessity to initiate a sep-
arate proceeding. Practice, however, shows that promptness does not (or
at least not totally) depend on either one of the concepts. The require-
ments for the granting of an exequatur can go on forever (and through
several court instances) whereas the requirements for the opening of an
ancillary proceeding can be highly specified and, therefore, expeditious.
Given this insight, speed depends in large part on statutory conditions
for recognition that are as precise as possible. This supports the attempt
40 See supra ....
chapter eight
to recognize quickly the foreign proceeding in the domestic jurisdiction
and, thereby, to improve the law’s efficiency. Lack of clarity will often lead
to expensive litigation and delay at the very moment that the court needs
to get control and protect assets.41 The Model Law’s provision in articles
– is drawn in just that way.
..... Access and Assistance (Effects of Recognition)
One of the most important benefits of the approach of provisions per-
mitting rapid recognition is that they enable a very rapid activation of a
moratorium or stay against debtor and creditor activity—that is, a freeze
that protects all concerned until the court can learn the facts. This point
is illustrated by the Model Law because recognition of a main proceeding
triggers an immediate moratorium with the same scope as that provided
under the law of the local, recognizing jurisdiction.42
It has already been pointed out that the effects of recognition differ
according to the approach that has been chosen. The extremes are, on
the one side, that the foreign administrator has no access at all to the
domestic institutions and/or proceeding; everything is handled by a
local procedure (be it insolvency or any other form of execution) and
its authorities, who may finally hand over any collected surplus to the
administrator. The extreme on the other side is the permission to the
foreign administrator to act domestically in the same way as he is allowed
to act in the opening jurisdiction and/or as his domestic counterpart
would do under domestic law. To be sure, such an approach pre-supposes
usually a high degree of compliance with and confidence in the other
jurisdiction’s law.
Between these extremes there are, again, various alternatives that are
possible and practiced. Thus, there is the possibility to restrict the effects
of a foreign proceeding to those legal acts that do not require an admin-
istrator’s intervention; examples would be the interruption of a pending
domestic lawsuit because of the opening of a foreign insolvency proceed-
ing or, for the same reason, the possibility to terminate contracts that are
at the time of the proceeding’s opening not yet fully performed from both
41 As is the case in Hong Kong. Nevertheless, the Hong Kong Law Reform Commission
has rejected recommendations for incorporating the common law jurisdictional criteria
into detailed statutory provisions. See The Law Reform Commission of Hong Kong, Report
on the Winding-Up Provisions of the Companies Ordinance (July ), at pp. –,
paras . to . & p. , ¶¶ ..to ..
42 UNCITRAL, Model Law, art. .
cross-border considerations
sides. If, in contrast, the foreign administrator is permitted to act, this
permission can reach from granting standing before local courts to col-
lect assets to requesting support from the local authorities for support in
enforcing the administrator’s powers. It should be noted that the ideal of
the universality principle would ask for granting the foreign administra-
tor as much of the home jurisdiction’s power as possible.
..... International Cooperation
...... General Meaning This term increasingly plays an essential
role in international insolvency law today; it has already been mentioned
above in the context of the prevalent modifications of the universality
principle.43 However, it has a history that goes back to the introduction
of the universality principle in its double-sided appearance. This is so
because when a jurisdiction is willing to accept another jurisdiction’s
claim for universality, such acceptance is justifiably called cooperation.
Thus, all that is written above about recognition is a form of support for
the foreign insolvency law.
...... Modern Meaning Today the term cooperation has a more
specific meaning: the most important tool for coordination is cooper-
ation among the main actors in a proceeding, that is, among the admin-
istrators and, according to recent (and not yet generally accepted) devel-
opments in international insolvency law, the judges.44
Cooperation implies, inter alia, that under these circumstances, the
relevant actors communicate with each other.45 Thereby, they follow the
goal that the debtor’s insolvency case is handled in a way that is in
the best interest of all parties involved. Even though these actors deal
with their respective cases according to their respective domestic law,
they attempt to harmonize the results of their actions. It is self-evident
43 See supra ..
44 For cooperation of the judges see Jay L. Westbrook, International Judicial Negoti-
ation, Tex. Int’l L. Rev. (); idem, The Duty to Seek Cooperation in Multi-
national Insolvency Cases in Annual Review of Insolvency Law (J. Sarra ed., );
Christoph Paulus, Judicial Cooperation in Cross-Border Insolvencies (), available at:
http://siteresources.worldbank.org / GILD / Resources / GJF Judicial Cooperationin-
Insolvency_PaulusEN.pdf.
45 For the attempt to proceduralize such communication and to put it in line with
the requirements of a fair proceeding, see the IBA “Concordat” available at http://www
.ibanet.org/ aboutiba/IBA_Resolutions.cfm.
chapter eight
that the intensity of such cooperation varies depending on whether a
reorganization proceeding or a liquidation proceeding is at stake; in the
former case, there is for obvious reasons greater demand for it than in
the latter, although it will fairly often be true that cooperation will add
value even in liquidation—as, for example, where a corporate division
has factories in more than one country and will sell for a higher amount
as a unit.
One of the mostly hidden problems of cooperation is the precise
definition of what is in the best interest of all parties involved. This
question need not come up as long as the jurisdictions involved in the
actual case follow the same understanding of what the goals of insolvency
law are. However, sometimes formidable differences exist hereby in the
various insolvency laws. Whereas one jurisdiction designs insolvency law
as a tool to satisfy the debtor’s creditors to the fullest extent possible
(which implies that insolvency law is understood as a qualified law of
execution),46 another one might shape insolvency law as a way to grant a
debtor the possibility for a fresh start,47 to save enterprises48 or as many
facilities and workers as possible,49 or (sometimes) to save certain credits
given to the debtor by the state.50 Given these differences and assuming
that in a given insolvency case cooperation is required of administrators
or judges from such diverging approaches, there is a need for a common
definition of what should be achieved through such cooperation.
However, such harmonization of the results creates a possible further
problem: if the main proceeding pursues the liquidation of the debtor’s
estate, does that mean that all assets of the debtor wherever located shall
be liquidated even if they form in some jurisdiction a viable enterprise?51
46 This is traditionally the approach of, for example, Austria, Germany, or Switzerland.
47 The main representative of this approach still is the US (even after the Bank-
ruptcy Code amendments). However, even more rigid in protecting the debtor is the
current bankruptcy law of Colombia (Law of December , ), which was enacted
in times of—then—serious economic difficulties for the Colombian economy as a whole.
48 See, for example, Argentina.
49 See, for example, France.
50 See, for example, Italy with respect to its Amministrazione Straordinaria di Grandi
Imprese in Crisi; for this proceeding see, for instance, Angelo Castagnola and Roberto
Sacchi, La nuova disciplina della amministrazione straordinaria delle grandi
imprese in stato di insolvenza ().
51 This is the understanding of, for example, the European Insolvency Regulation,
art. , par. § ; see Manfred Balz, The European Union Convention on Insolvency Pro-
ceedings, Am. Bankr.L.J., , f. (). For criticism see Gordon Johnson, The
European Union Convention on Insolvency Proceedings: A Critique of the Conventions Cor-
porate Rescue Paradigm, Int. Insolv. Rev. , ().
cross-border considerations
Or should it rather be possible for the other—non-main—proceeding to
aim for a (locally confined) rehabilitation?
Finally, other considerable problems of cooperation result from histor-
ical differences in the approaches to the exercise of judges’ powers and the
judges’ own perceived limitations as to their role.52 Whereas especially in
the common law world the judge has always been a law maker, his conti-
nental European colleague and the ones following this model have always
been more or less a “servant of the statute” or even just its “mouth-piece.”
To be sure, this classification is just a very rough generalization, is his-
torical, and is no longer as accurate as in years past. However, as a gen-
eral phenomenon, these differences of the traditions are strong enough
to establish great reluctance towards a judicial cooperation in an essential
part of the world. The Model Law has great potential importance in this
regard because it specifically mandates communication and cooperation
with foreign courts.53
This deficit, however, is particularly troublesome with respect to a new
stage of cooperation that is the result of quite a recent development. In the
last years or so, trans-border insolvency cases have emerged, starting
with the Maxwell case,54 that could not be resolved by the strict adherence
to the respective national laws. These cases showed a complexity and
complication for which the relevant laws did not offer any constructive
solutions. The escape from this situation was to set up something new:
both the administrators and judges who were involved in these cases
acted together in drafting what they called a protocol that was in effect
nothing less than a tailor-made law for the individual case.
Once the success of this new tool was discovered, its use has grown
beyond the original idea.55 Nowadays protocols are used, inter alia, to
bundle the world-wide unsecured creditors’ efforts to investigate into the
debtor’s directors’ failures or to shift the place for the sale of the debtor’s
52 For these differences see generally, Europäische und Amerikanische Richterbilder
(A. Gouron, L. Mayali, A. Padoa Schippoa & D. Simon eds., ).
53 Model Law, arts. –, .
54 See for example, Evan Flaschen & Ronald J. Silverman, The Role of the Examiner
as Facilitator and Harmonizer in the Maxwell Communication Corporation Insolvency, in
Current Developments in International and Comparative Corporate Insol-
vency Law, at et seq. (Jacob Ziegel ed., ); Jay L. Westbrook, The Lessons of
Maxwell Communications, Fordham L. Rev. et seq. (); Burkhard Göpfert,
In Re Maxwell Communications—ein Beispiel einer “koordinierten” Insolvenzverwaltung
in Parallelen Verfahren, ZZP Int , et seq. ().
55 Numerous protocols are accessible under: http://www.iiiglobal.org/international/
protocols.html. See ALI Principles.
chapter eight
assets to a country where the tax laws guarantee a better surplus. How-
ever, judicial consent is crucial; if the administrators alone were to agree
on such protocols without the judges’ consent, the risk of legal liability
is extremely high. Therefore, international efforts should be increased to
find a solution that allows bridging the different historical backgrounds.56
.. International Initiatives
The specific problem of any trans-border insolvency case results from the
fact that different jurisdictions clash not only in a particular question of
law (such as an issue of the laws of contract or copyright or succession)
but in a whole bundle of such questions. Suffice it to repeat what has
already been said about insolvency law as a meta-level of any domestic
law: it is closely enmeshed in the whole body of that law and it forms
even a kind of focal point for numerous fields of business law.57 The
problems resulting therefrom—problems that in earlier days led many
countries to follow the territoriality principle—can be handled by at
least three different approaches, all of which involve different degrees
of harmonization of national laws. The first is to reduce the complexity
of domestic insolvency law by distilling the underlying fundamental
principles and, thereby, to encourage present and future legislators to
follow a certain path of legal reform leading to the optimal result, with
a consequent convergence of domestic laws.58 This is more or less the
approach of the multilateral institutions such as the IMF,59 World Bank,60
and UNCITRAL61 in their respective texts. They serve, inter alia, to a
certain degree as model for some regional efforts.62
56 For this see Jay L. Westbrook, International Judicial Negotiation, supra note ;
for a guide as to how judge-to-judge communication can be established see http://www
.iiiglobal.org/international/guidelines.html (available in various languages).
57 As to the latter observation see Christoph Paulus, Verbindungslinien des Modernen
Insolvenzrechts, Zeitschrift Für Wirtschaftsrecht, et seq. ().
58 See infra ..
59 Orderly & Effective Insolvency Procedures, (); available at: http://www.imf.org/
external/pubs/ft/orderly/index.htm.
60 Revised Principles on Insolvency and Creditor Rights Systems, (Draft ); avail-
able at: http://www.worldbank.org/WBSITE/EXTERNAL/TOPICS/LAWANDJUSTICE/
GILD / ,,contentMDK:~pagePK:~piPK:~theSitePK:,
.html.
61 Legislative Guide on Insolvency Law, (); available at: http://www.uncitral.org/
pdf/ english/texts/insolven/–_Ebook.pdf.
62 See for example, The General Commentary to the Principles of European Insolvency
Law (W. McBryde, A. Flessner & S. Kortmann, eds., Kluwer ).
cross-border considerations
The two other approaches are: () drafting a model law focused on
procedure and cooperation that draws its strength from the authority of
its author. This is the path of the UNCITRAL Model Law on International
Insolvency;63 or () reducing the complexity and multiplicity of the
world’s existing international insolvency laws by creating bigger units
(regions) that share a common international insolvency law. This is what
has been done by some South American States, by the European Union,
and in Africa by OHADA.64 A first step has been taken by the NAFTA
states as well.
... UNCITRAL Model Law on Cross-Border Insolvency
.... A Global Impact
In , UNCITRAL adopted a Model Law on Cross-Border Insolvency
that had been drafted by the Commission in close cooperation with
INSOL and the IBA.65 By definition, the model law has no binding force
but tries to convince local (national as well as regional)66 legislators by
its quality and the authority of its authorship. In contrast to the regional
attempts at harmonization,67 the immediate impact of the model law
is a global one. The Model Law is designed in such a way that it can
be adopted without greater efforts by any legislator of this world (thus,
bridging, inter alia, the dichotomy of Common Law and Civil Law),
whereas the regional initiatives are quite deeply rooted into their specific
surroundings in that they concentrate primarily (or even exclusively) on
their inner relationships. Therefore, they hardly can be taken on without
63 See infra .. on the UNCITRAL model law.
64 See infra ..., ..., ..., .... For a similar recommendation concerning
the region of Southern Africa see David Ailola, Recognition of foreign proceedings, orders
and officials in insolvency in Southern Africa: a call for a regional convention, Comp. And
Int’l L.J. S. Afr., et seq. ().
65 For a discussion of the Model Law see especially Westbrook, Multinational Enter-
prises in General Default, supra note , at part III; K. Wimmer, Die UNCITRAL-Mo-
dellbestimmungen über grenzüberschreitende Insolvenzverfahren, in Zeitschrift für Wirt-
schaftsrecht et seq. (),; Claudia Tobler, Managing Failure in the New Global
Economy The UNCITRAL Model Law on Cross-Border Insolvency, B.C. Int’l &
Comp. L. Rev., et seq. (): Bob Wessels, Will UNCITRAL Bring Changes to Insol-
vency Proceedings Outside the USA and Great Britain? It Certainly Will!, Int. Corporate
Rescue et seq. ().
66 The latter point is important. The regions described in .., .., .., .. below
could use the model law as their international insolvency law insofar as the model law
works on a higher level than these regional initiatives.
67 Described in ..., ..., ..., ... below.
chapter eight
many adaptations, corrections, and changes. However, this observation
unveils a highly important development in the present cross-border
insolvency law world: in a complementary way, regions are building on a
closer network within these regions and the model law provides (possi-
bly) for their connection. In summary terms, the regional initiatives are
focused on the relations among nations in the region whereas the model
law focuses outward to nations generally.
The global impact of the model law on cross-border insolvency has
become more and more visible. Although at the outset there was not
a “big run” on the national enactment of the model law—most coun-
tries adopted a wait-and-see attitude—the model law nevertheless influ-
enced the national theoretical discussions right from its publication.
And those discussions eventually did lead to enactment, with adop-
tion in Australia (), British Virgin Islands; overseas territory of the
United Kingdom of Great Britain and Northern Ireland (), Colom-
bia (), Eritrea (), Great Britain (), Japan (), Mexico
(), Montenegro (), New Zealand (), Poland (), Repub-
lic of Korea (), Romania (), Serbia (), South Africa (),
and United States of America (). Various Asian countries are about
to follow.68
.... The Basic Ideas
According to Article , the Model Law shall apply in any collective
judicial or administrative proceeding in a foreign state, including an
interim proceeding, for the purpose of reorganization or liquidation. The
insolvencies of banks, insurance companies, or other institutions can be
excluded from the Model Law’s applicability if they are dealt with in
special legislation. The Model Law is drafted on the assumption of the
following considerations: first, there is just one main proceeding; second,
the recognition of a foreign proceeding does not restrict the right to
initiate a domestic proceeding; third, a domestic proceeding can be given
local priority against the foreign proceeding, although not necessarily
68 See http://www.uncitral.org / uncitral / en / uncitral _ texts / insolvency / Model_
status.html. See also Kazuhiko Yamamoto, New Japanese Legislation on Cross-Border
Insolvency—As Compared with the UNCITRAL Model Law, Japanese Ann. of Int.
Law, et seq. (). For the peculiarities in South Africa, see Alistair Smith & Andre
Boraine, Crossing Borders into South African Insolvency Law: From the Roman-Dutch
Jurists to the UNCITRAL Model Law, Am. Bankr. Inst. L. Rev. et seq. ().
cross-border considerations
so; whenever there are two or more proceedings pending they shall be
coordinated by means of cooperation; fourth, such coordination may
encompass support for the foreign administrator, provided that assets are
at stake that “belong” to the foreign proceeding’s estate; fifth, creditors
are allowed to lodge their claims in any one of the proceedings, but their
dividend in one proceeding will be recognized in another one; sixth, the
court may turn over local assets for distribution in the main proceeding;
and seventh, a surplus in a non-main proceeding shall be handed over to
the main proceeding.
.... Universality Principle
Building on these premises, the Model Law approaches the universality
principle by allowing several proceedings under the lead of one main
proceeding. According to Article , this is the proceeding in that state
“where the debtor has the center of its main interests.” In contrast, a
foreign non-main proceeding is in a state “where the debtor has an
establishment,” meaning any place where the debtor carries out a non-
transitory economic activity with human means and goods or services.
The goal of the Model Law, according to Article , is to supply assistance
for any of these foreign proceedings. Article , however, has the general
proviso that no court is required to grant such assistance where the action
in question would be manifestly contrary to the public policy (ordre
public) of this state.
(a) As a general rule, Chapter II of the Model Law, pursuant to Article ,
entitles a foreign representative to apply directly to a court in this state;
thereby, the otherwise indispensable diplomatic support is eliminated.
Thus, a foreign representative is in the position to file a petition to open
a (parallel) proceeding in this state, pursuant to Article .
(b) A foreign proceeding, however, will not be recognized automatically.
The application of a foreign representative shall be based on, for example,
“a certified copy of the decision commencing the foreign proceeding
and appointing the foreign representative” whereby a translation of the
respective documents may be requested. If these requirements are met,
the recognition (exequatur) shall be granted if the domestic court comes
to the conclusion that within the meaning of Article : (a) the foreign
proceeding is a (main or non-main) insolvency proceeding; and (b) the
person applying for recognition is a proper representative. Since the
chapter eight
recognition procedure may take some time, despite the aids to expedition
in Articles –, Article provides for possible interim relief that may
granted in order to protect the debtor’s assets or the creditors’ interests.
(c) The effects of such recognition are, inter alia, that the foreign rep-
resentative is entitled to participate in the domestic proceedings;69 the
foreign creditors will be notified whenever necessary according to the
domestic law;70 and the foreign representative has standing pursuant to
Article , to initiate a lawsuit before the local courts regarding his avoid-
ance powers. The main effect, however, is put down in Article : subject
to the law of the recognizing state, the “commencement or continuation
of individual actions or individual proceedings concerning the debtor’s
assets, rights, obligations, or liabilities is stayed; execution against the
debtor’s assets is stayed; and the right to transfer, encumber or otherwise
dispose of any assets of the debtor is suspended.” This adds up to a mora-
torium that is, in terms of efficiency, particularly essential for any rescue
attempt, especially if it is granted promptly. Article lists further relief
that may be granted upon the representative’s request, including gather-
ing information and empowering the foreign administrator to administer
the local assets or to turn over those assets for distribution through the
main proceeding.
(d) In Chapter IV, the Model Law describes in more detail how the coor-
dination and cooperation of the multiple proceedings shall be performed.
It is especially noteworthy that it entitles not just the representatives but
also the judges to communicate with each other directly, without any
diplomatic intermediaries.71
.... Incompleteness of the Model Law
The Model Law contains necessarily only partial and rather abstract
provisions. This is the inescapable consequence of its global approach.
Therefore, it is self-evident that it cannot go too deeply into details and
that important features are just left aside. However, this may add some
attractiveness to it since it leaves the interested countries much space
to fill the gaps individually. In any case it is a grand step forward in
69 See UNCITRAL Model Law at Art. .
70 See id., Art. .
71 See id., Art. . See, e.g., ALI Principles, Appendix B.
cross-border considerations
the development of international insolvency law that such a Model Law
has been accepted at all by the world’s people represented by the United
Nations.
... Latin American States
As early as some Latin American states entered into a Treaty that
is called the “Montevideo Treaty on Commercial International Law;” the
ratifying states were Argentina, Bolivia, Colombia, Paraguay, Peru, and
Uruguay. This treaty was updated in but was then ratified only
by three states: Argentina, Paraguay, and Uruguay. Independently, and
therefore additionally, another treaty with regulations concerning cross-
border insolvency law—called the Bustamante Code from 72—was
entered into by more states: Brazil, Bolivia, Chile, Costa Rica, Cuba,
Dominican Republic, El Salvador, Ecuador, Guatemala, Haiti, Honduras,
Nicaragua, Panama, Peru, and Venezuela. These lists reveal that there are
only few overlapping memberships. Moreover, the development of the
Montevideo Treaty shows a tendency of diminishing acceptance. Finally,
as remarkable as it is that these countries have developed treaties on
this subject at a time when other countries did not even think of the
possibility—let alone the need—for this kind of cooperation, the date of
their origin makes clear that they, being “children of their time,” are not
aligned with the needs of modern insolvency law in that they concentrate
solely on liquidation proceedings.
.... Contents
(a) The Montevideo Treaty of deals with “Bankruptcies” in Arti-
cles –. This title of the treaty is applicable when a debtor has assets
not just in one jurisdiction but also abroad. Competence to commence a
proceeding is with the court where the debtor has its “commercial domi-
cile.”73 Once such a proceeding has been opened it shall have universal
effect; it does not, however, become totally clear from the text’s word-
ing how the recognition in the other member states is supposed to work.
Article states, only with respect to provisional remedies in the opening
jurisdiction, that they shall be enforceable in the other states as well; and
Article provides that the administrator’s authority will be recognized.
72 The Havana Convention on Private International Law, February , .
73 See art. of the Montevideo Treaty of .
chapter eight
There are modifications to this universalistic approach. They concern
at first certain secured creditors as well as priority creditors and allow
them the realization of their rights even though the assets in question
are located in another jurisdiction or have been transferred thereto.74
Second, Article permits local creditors to initiate a parallel proceeding
restricted in its applicability to the respective member state (territoriality
principle) where the debtor has one “economically autonomous business”
(out of at least two).75 If there is a surplus in any one of the multiple
proceedings after the distribution of proceeds, it has to be handed over
to the other ongoing proceedings.
(b) The updated Montevideo Treaty from rephrases the predecessor
treaty without adding substantially76 new regulations.
(c) Compared with these treaties, the Bustamante Code impresses with
more clarity and precision. Chapter I of Title IX of the Convention
is titled “Unity of Bankruptcy or Insolvency.” Accordingly, Article
declares that the opening of a proceeding encompasses all assets of the
debtor wherever located within the realm of the contracting states. The
universality principle underlying this approach is specified in Article
et seq.; thus, there is automatic recognition with respect to the adminis-
trator’s powers,77 and the opening decision is, pursuant to Article ,
to be deemed res judicata also in the other contracting states—provided
that contingent publicity requirements, set out in Article , have been
fulfilled in the other states. The out-reaching effect of such universalistic
proceeding is extended also to agreements between debtor and creditors
as well as “the rehabilitation of the bankrupt.”78
The Code also arranges exceptions to the universality approach. Arti-
cle allows parallel proceedings in the other contracting states if
the debtor has “in more than one contracting State various commercial
establishments entirely separate economically.” Article declares the
lex rei sitae applicable for certain rights in rem—irrespective of the insol-
vency proceeding that has been opened in another contracting state and
that has the above-mentioned extraterritorial effect.
74 See id., arts. and .
75 See id., art. .
76 There is, for example, an extension of the treaty’s applicability to related proceedings
such as judicial liquidations, suspension of payments, and so on.
77 See supra note , art. .
78 See id., arts. and .
cross-border considerations
.... Deficiencies
Seen from a perspective as of today, the omissions and deficiencies are
obvious: all three sets of rules concentrate on a liquidation proceeding;
they neglect the quite fundamental insolvency principle of equal treat-
ment of creditors but rather care explicitly for the protection of local
creditors; and they coordinate the parallel proceedings in an insufficient
way.79 With respect to the Montevideo Treaties, it might be added that
they lack the necessary legislative clarity to limit differing interpretations
in different member states. Nevertheless, it should be emphasized once
more that the mere fact of the existence of such early international agree-
ments is noteworthy and that they already apply a number of features that
are described as the modern standard.
... Nordic European States
In , Denmark, Finland, Iceland, Norway, and Sweden signed an
agreement, called “Nordic Bankruptcy Convention,”80 that forms the
basis for insolvency proceedings that are commenced in one of the mem-
ber states and whose estates comprise assets situated in more than one of
the member states.81 With its articles it is a remarkably short body of
law whose effectiveness for now more than years has demonstrated
the close ties and the common ground of the Scandinavian countries.
.... Contents
The Convention is based on the principle of a modified universality. Any
insolvency proceeding within a member state is automatically recognized
in all other member states; no exequatur is necessary or admissible. This
79 Article of the Montevideo Treaty excludes explicitly a judicial cooperation.
80 Available at: http://www.iiiglobal.org/international/treaties/nordic_treaties.pdf; for
a discussion see Michael Bogdan, International Bankruptcy Law in Scandinavia, Int’l &
Comp. L.Q. , ff. (); Ian Fletcher, Insolvency in Private International Law
(d ed. ), p. ; C.H. Parment, The Nordic Bankruptcy Convention—An Introduc-
tion, available at http://www.iiiglobal.org/country/netherlands/Nordic_Bankruptcy.pdf.
81 Certain restrictions apply with respect to Sweden and Finland after the enactment of
the European Insolvency Regulation; see, for example, Odd Swarting & Ulrika Malmberg
Livijn, The European Council Regulation of May on Insolvency Proceedings—
the First Year From a Swedish Perspective (), available at http://www.iiiglobal.org/
country/netherlands/ Nordic_Bankruptcy.pdf.
chapter eight
is true both for liquidation and for composition proceedings.82 The out-
reaching effect comprises, inter alia, the seizure of property abroad as well
as the automatic stay; as a general rule of thumb, the insolvency law of the
opening state (lex concursus)83 is applicable throughout the area covered
by the territory of the member states.84 However, primarily in order
to protect the interests of the domestic creditors, many exceptions are
provided for those assets situated in a member state where the insolvency
proceeding has not been opened, such as those in Article .
It is left to the member states to determine the criteria for opening
a proceeding. However, Article influences this free choice insofar
as it excludes from the Convention’s applicability all those proceedings
that are not based on the ground of the debtor’s residence or registered
office.85 With respect to privileged claims, Articles , , and present
a rather complicated (albeit apparently functioning) diagram that dis-
tinguishes between privileged claims against particular assets—that is,
primarily secured claims—and those of a general nature. With respect
to the latter category, a further distinction is drawn between tax claims
and other privileged claims such as labor related ones. Whereas the for-
mer may receive satisfaction only out of the sale of assets located in the
respective member state, the authorities of which do have such claim, the
other privileged creditors are entitled to their privileged satisfaction out
of all assets wherever situated.
.... Achievements and Deficiencies
Despite its age, the Convention is a remarkably modern piece of leg-
islation. In abstaining from almost any substantive rules, it proved to
be sufficiently flexible. Further flexibility arises from its broad coverage,
extending to both liquidation and reorganization proceedings. However,
the Convention governs proceedings exclusively within its member states
without the slightest indication as to how to proceed in cases where other
jurisdictions might be involved. Like the European Union Regulation,
82 See Nordic Bankruptcy Convention, art. par..
83 This includes the avoidance powers; but art. excludes them from the rules about
contracts that have not yet been fully performed by both parties as of the opening of the
case.
84 See supra n. , art. .
85 The main alternative would be the mere presence of assets in the opening state; for
this approach see Bogdan, supra n. , at f.
cross-border considerations
described in the following section, the Convention creates a kind of
artificial insular unit (a territory on a somewhat higher level) that in an
increasing number of instances is bound to fail in correspondence with
the economic realities.
The almost complete omission of substantive rules is a strong indica-
tion for the mutual trust of the member states in the soundness of their
respective statutes. Thus, even though the Convention seems to be work-
ing smoothly and efficiently, it can serve as a model only to a limited
degree as there are not too many regions on this globe of a comparable
intense cross-relationship. The rather complicated rules about the treat-
ment of privileged claims, for example, would under other conditions
very likely lead to problems that could easily undermine the applicability
of such Treaty.
... European Union Regulation on Cross-Border Insolvency
Among the more recent endeavors, the European Union Regulation86 has
exercised quite intense influence on other efforts at reform, including the
Model Law.
.... Basic Elements
The European Union Regulation is a good example of a quite com-
mon sort of cherry picking from the above-mentioned fundamental
issues. Like the Latin American Treaties, it contains elements of ter-
ritoriality and universality as well as those of unity and multiplicity,
and it also provides for cooperation and coordination of the parallel
proceedings. It is to be applied to all collective insolvency proceed-
ings (listed in an Annex to the Regulation) with the exception of insol-
vency proceedings concerning insurance undertakings, credit institu-
tions, and certain investment undertakings.87 It entered into force on May
86 For a profound discussion of its legislative history and its contents see Balz, supra
note , at et seq. Moreover, see Gabriel Moss, Ian Fletcher & Stuart Isaacs, The
EC Regulation on Insolvency Proceedings, (): Miguel Virgòs & Francisco
Garcimartín, The European Insolvency Regulation: Law and Practice, ();
Paul Omar, European Insolvency Law, (); Christoph Paulus, Europäische In-
solvenzverordnung, (); Bob Wessels, International Insolvency Law, (),
p. et seq.
87 For these institutions, there exist special Directives.
chapter eight
, ;88 it needs no intermediary legislative adoption steps from the
member states—the Regulation is directly applicable.
.... Universality Principle
The Regulation’s starting point is the ideal of a unitary proceeding with
a universalistic approach. It tries to achieve this goal by three sets of
rulings.89
(a) First, in Article (), the Regulation grants jurisdiction to open a
main proceeding to that court where the debtor’s center of its main
interests is situated.90 This jurisdiction is binding for all member states
and cannot be overridden. If, however, two states or courts claim to have
such jurisdiction, the main proceeding shall be under that law where the
first petition has been filed.91
(b) Second, once a proceeding has been opened it will automatically be
recognized in all member states; there are no further requirements. The
only admissible objection according to Article is that the recognition
results in a violation of the domestic ordre public. This automatic recog-
nition means that the judgment opening the main proceeding shall “pro-
duce the same effects in any other Member State as under the law of the
State of the opening of the proceeding unless the Regulation provides
otherwise.”92 Thus, if an insolvency proceeding has been opened for a
private consumer in, for example, Austria, this proceeding will automati-
cally be recognized in France or Belgium irrespective of the fact that these
countries’ insolvency laws are applicable only to merchants and legal enti-
ties and, therefore, not applicable to other individuals’ insolvencies. This
means that an administrator may generally act in all member states as he
may do in his “home country” and under that insolvency law.
88 As to preceding attempts to reach common ground in international insolvency law
cf. Harry Rajak, European Cross Border Insolvency Developments, European Corporate
Insolvency Law: A Practical Guide (Rajak et al. eds., ), p. et seq.
89 See Christoph Paulus, A Theoretical Approach to Cooperation in Transnational Insol-
vencies: A European Perspective, Eur. Bus. L. Rev. et seq. ().
90 For the determination of this center see European Court of Justice in its Eurofood
decision (see supra note ).
91 See Recital of the Regulation.
92 See id., art. .
cross-border considerations
(c) Third, according to Article “the law of the State of the opening
of proceeding shall determine the conditions for the opening of those
proceedings, their conduct and their closure.” The second paragraph of
this article contains a rather elaborate and still not exclusive list of what
is to be seen as belonging to the lex concursus: for example, that debtors
can be subjected to an insolvency proceeding; that assets form part of
the estate; the respective powers of both administrator and debtor; the
effect of the proceeding’s opening on current contracts of the debtor; the
admissible claims to be lodged against the debtor’s estate; the ranking of
claims; the creditors’ rights after the closure of the proceeding; and so on.
.... Restrictions of the Universality Principle
What has been described so far is a remarkably close approximation
to the universality and unitary principle. However, even though the
Regulation’s Europe is an area with a strong and rather long-lasting
common history, a highly interrelated economy, and a common legal root
(Roman law),93 it is not yet ready for such a purist approach. Therefore,
the Regulation contains mainly two sets of provisions that bring the ideal
back to political reality.
(a) First, there is the possibility to open parallel proceedings. This is
dependent on the existence of an establishment in that member state—
establishment meaning “any place of operations where the debtor carries
out a non-transitory economic activity with human means and goods.”94
Such parallel proceedings are dealt with under the domestic insolvency
law. They follow a strict territorialistic approach, that is, neither the main
proceeding may reach into this member state nor may this state extend
its actions or effects beyond its borders. In order to mitigate the effects
of this breach with the universality principle, Article provides for a
cooperation duty of the respective administrators but fails to include the
respective judges as well.
(b) Second, partly because of the enormous differences in their respective
laws, and partly due to the wish to protect domestic creditors, the Regula-
93 This is true also for England; see Reinhard Zimmermann, The Law of Obliga-
tions—Roman Foundations of the Civilian Tradition (); Reinhard Zimmer-
mann, Roman Law, Contemporary Law, European Law: The Civilian Tradition
Today ().
94 EU Regulation, Art. .
chapter eight
tion lists a number of exceptions to the applicability of the lex concursus.95
Probably the most important exception is found in Article , which states
that the opening of an insolvency proceeding “shall not affect the rights
in rem of creditors or third parties in respect of tangible or intangible,
moveable or immoveable assets belonging to the debtor that are situated
within the territory of another Member State at the time of the opening of
the proceedings.” In light of the well-known fact that many debtor’s assets
are subject to such rights in rem and that primarily security rights tend
to occupy most of the debtor’s assets without leaving very much for the
common creditors, this is a fundamental restriction of the lex concursus
concept.
Other exceptions refer to employment contracts or contracts relating
to immovables, to the right of setoff, to payment systems and financial
markets, and so on. Even though Article has in its long list also the
applicability of the opening state’s avoidance powers, this lex fori concur-
sus becomes softened by Article : if the person in question is able to
prove that “the said act is subject to the law of a Member State other than
the State of the opening of proceedings, and that law does not allow any
means of challenging that act in the relevant case,” then the action (or
transaction) in question is avoidance-proof. However, the effect may be
to make transactions unavoidable that would be avoided by the law of
each of the relevant countries because of the need to satisfy the differing
requirements of both. To that extent, an important insolvency policy may
be undermined.
.... Deficiencies of the Regulation
(a) The Regulation has a number of deficiencies. Taking into account the
newest development of international cooperation, as described above, it
is surprising that Article addresses only the administrators as parties
to the mutual cooperation and information duty, leaving the judges aside.
The historical reasons for such an omission have already been addressed
supra; but it would have been time to dare a new step.
(b) Another lacuna in the Regulation is its complete silence about matters
of highest practical importance, namely group insolvencies. To be sure,
this is probably, at least for the time being, the most complex and difficult
95 See id., arts. –.
cross-border considerations
problem in international insolvency law at all and a commonly accepted
solution is not yet in sight.96 The Regulation however, does not even
provide for a joint administration or the pulling together of parallel
proceedings. Instead, it explicitly states in Article () that any secondary
proceeding has to be a liquidation proceeding; as almost any trans-
border insolvency cases of some significance plainly demonstrate, such
an inflexible order is counter productive in cases where a complete or
partial reorganization appears to be feasible.
(c) Another deficiency of the Regulation is its complete neglect of the
world outside its member states. There is no indication as to how cases
shall be treated with respect to non-EU member states. It is left to each
member state to decide on these problems so that the respective interna-
tional insolvency laws of each of these members remain of great impor-
tance. It is for this reason that the Regulation excites the impression that it
creates, irrespective of its internationality, something like a territoriality
principle on a larger, European scale.
... American Law Institute’s Transnational Insolvency Project
.... The Approach
In May , the American Law Institute approved a project called Amer-
ican Law Institute, Transnational Insolvency Project, Principles of Cooper-
ation in Transnational Insolvency Cases Among the Members of the North
American Free Trade Agreement.97 After the European Union Regulation,
this is a further regional step forward to a closer cooperation and harmo-
nization of a number of trans-border insolvency laws. However, unlike
the EU Regulation these Principles are just recommendations, although
backed by the prestige of the initiating institution.98
This project is remarkable for several reasons, one being the way
the members of the project proceeded: each one of the three involved
countries—the United States, Canada, and Mexico—appointed reporters
96 However, UNCITRAL started to work on this topic in late .
97 Available at: http://www.ali.org, under “ALI Projects online.”
98 For an authoritative report about the process and the contents see Jay Lawrence
Westbrook, Managing Defaulting Multinationals Within NAFTA in Foundation and
Perspectives of International Law – ().
chapter eight
who had, in a first step, to produce statements of their respective insol-
vency laws and, after having distributed them to the others, to com-
ment on the statements of the other two countries involved. This enabled
the reporters to familiarize themselves with, inter alia, the laws of the
other countries. On this basis, the reporters then produced in a second
step a statement with a set of agreed principles governing multinational
insolvency cases that would offer useful approaches to managing such
cases.
It is quite obvious that such a project becomes all the more compli-
cated the more countries or insolvency laws, respectively, are involved.
However, if there are just three as in the present case, the problem of
different legal traditions (common law and continental law) is obviously
surmountable.
.... Basic Considerations
The statement is based on three central ideas that form its fundament.
First, that the law of these three NAFTA countries reflects fundamentally
similar purposes despite their considerable dogmatic and methodologi-
cal differences. Second, the ideal is to have a unified proceeding with a
universalistic approach; this would be the best way to serve fully the pur-
poses of insolvency law. Third, since this ideal is at the time being not
yet achievable, the second best solution is to have a close co-operation
between the stakeholders of the national proceedings in order to get as
close as possible to the result of the ideal unitary proceedings, called
“modified universalism.” The statement explicitly identifies the bene-
fits of that ideal: namely, maximizing the value of the enterprise and
its assets; providing equality of treatment for creditors and other inter-
ested parties with similar legal rights; preventing and undoing fraud; and
providing commercially predictable results and transparent legal proce-
dures.
.... Universality Principle
Between the NAFTA countries, there is a long-lasting tradition of eco-
nomic and legal cooperation that includes mutual recognition of the
other countries’ insolvency cases.
(a) Even though the statement does not grant an automatic recognition,
but follows the UNCITRAL Model Law approach of an exequatur, it
cross-border considerations
comes in fact to a virtually automatic result because of speedy issuance
of recognition.99 In addition, a moratorium (or a stay on any creditors’
actions) may be granted.
(b) One of the consequences of the recognition is that the foreign admin-
istrator has direct access to the local courts, including the right of the
foreign administrator to intervene in civil actions pending by or against
the debtor and the right to initiate such civil actions or insolvency pro-
ceedings. If there is more than one proceeding, the Principles provide
for communication between administrators and courts. In an annex it is
recommended, inter alia, to make use of modern multi-media devices
for such communication. The administrators are also encouraged to seek
agreements of cooperation, that is, protocols. Unlike the European Union
Regulation, the Principles do not eliminate the choice of how a secondary
proceeding shall be dealt with if the main proceeding strives for the
debtor’s reorganization. Instead, it recommends that in the non-main
proceeding everything should be attempted to assist the efforts of the
main proceeding.
(c) With respect to group insolvencies, Principles and try to encour-
age coordination and cooperation among proceedings involving affili-
ated debtors to the maximum extent consistent with honoring the cor-
porate form under applicable law.
(d) Principles and make a plan adopted in a main proceeding
binding on all creditors who participated in the proceeding or who were
subject to its jurisdiction, even if they dissented from the plan.
(e) Finally, the Principles present recommendations to the legislators
of the three countries that state how further improvements could be
achieved in the trans-border insolvency field. Most importantly, they
refer to a desirable harmonization of the different priority systems among
the three countries.
99 Adoption of the Model Law, which the Principles recommend, largely moots this
point. It has been adopted in Mexico and the United States and will become effective in
Canada in the near future.
chapter eight
... OHADA
.... The Project
In , African states founded an organization for the harmonization
of their commercial laws, called Organisation pour l’harmonisation en
Afrique du droit des affaires or OHADA,100 that has developed a number
of common legislative acts. One of them is the Uniform Act on Collective
Proceedings for Wiping off Debts from , which deals in Part VI (Sec-
tions –) with International Collective Proceedings. Its approach
is also that of one proceeding at the place where the debtor has its main
place of business (principal établissement) or where the corporate body
is registered.101 However, this unitary proceeding can be subdivided into
several in any other member state. If this happens, coordination shall be
guaranteed by a mutual information duty of the administrators.
.... Coordination of Several Proceedings
Article distinguishes between principal and secondary collective
proceedings; the latter ones are applicable where the debtor does not have
its main place of business or where the corporate body does not have its
registered office. This distinction is important insofar as the administra-
tors of any secondary proceeding shall enable the administrator of the
principal proceeding to present proposals about the way to deal with the
debtor’s assets in that secondary proceeding (liquidation or reorganiza-
tion).102 In addition, the closure of a secondary proceeding shall be done
only with the consent of the principal administrator’s consent pursuant
to Article .
.... Recognition and its Consequences
The opening or closure of a collective proceeding in one of the contract-
ing states is in any other of the contracting states to be treated as a res
100 For details see http://www.ohada.com/traite.php; see also, Boris Martor et al., Busi-
ness Law in Africa—OHADA and the Harmonization Process (d ed. ); in
particular, on the international insolvency rules, see Filiga Michel Sawadogo, OHADA—
Droit des Enterprises en Difficulté, et seq. ().
101 See Uniform Act on Collective Proceedings for Wiping off Debts, art. .
102 See id., art. .
cross-border considerations
judicata,103 once the competent court’s decision has become irrevoca-
ble.104 Thus, there is a quasi-automatic recognition that has as the fol-
lowing consequences:
a. It does not bar the commencement of another collective proceeding
in another contracting state.105 This possibility leads to the afore-
mentioned plurality of proceedings.
b. The administrator, pursuant to Article , if appointed by the
competent court, has in all contracting states the powers conferred
on him by the Uniform Act as long as no other collective proceeding
has been commenced in that state.
c. If it comes to such plurality of proceedings, Article provides that
the administrators shall exchange all necessary information about
their proceedings that might be useful for the other ones, especially
the statement of production and verification of claims and measures
aimed at completing the proceedings for which they are appointed.
d. The administrators of any proceeding (as well as any creditor) are
entitled to lodge the claims of “their” proceeding at any other pro-
ceeding as well. In that case, however, it is to be guaranteed that
creditors of the same rank do get an equal share.106
.... Incompleteness of the Act
The rules are not very detailed107 even though the Uniform Act shares
the main features of modern trans-border insolvency legislation, namely
the division of parallel proceedings into one main and one or more sec-
ondary proceedings as well as automatic recognition in combination with
mutual information duties. However, here (like in the European Union
Regulation) this duty is confined to the administrators and, thereby,
excludes the judges. However, in the Act the way in which the proceed-
ings are to be harmonized is regulated in a fairly flexible manner by giving
the administrator of the main proceeding the decisive word.
However, what is missing here as in the two other aforementioned
regional harmonization attempts is a showing of how these regions could
one day possibly grow together. For the Act, as for the European Union
Regulation, the adoption of the UNCITRAL Model Law could serve as
103 See id., art. .
104 See id., art. .
105 See id.
106 See id., arts. and . See also art. , that contains a hotch-pot rule.
107 See Sawadogo, supra note , at .
chapter eight
the connecting link. A second best alternative would be to incorporate
third countries or regions by means of treaties into the applicability scope
of the regional initiative.
.. Possible Future Developments
Even though the terminology of international insolvency law does not,
strictly speaking, cover this development, the efforts of the multilateral
institutions (in particular the IMF, World Bank, UNCITRAL) in creating
standardized principles of worldwide applicable insolvency laws is lead-
ing already to a certain convergence of the insolvency laws in this world.
One striking example makes the point: whereas the insolvency law of the
United States developed reorganization procedures over a period of more
than years without leading to any significant number of imitators,
the development of effective, formal reorganization regimes is nowadays
becoming the centerpiece of law reform efforts. These efforts have been
at the heart of most major corporate insolvency law reforms over the last
decade—not least due to the fact that all those multilaterals’ insolvency
guides demonstrate a strong favor towards this type of proceeding.108
This global convergence among regional approaches may foster greater
acceptance (or acceptability) of cross-border cooperation. Such dual
action might strike a balance between globalization and localism respec-
tively. Be that as it may, it is a fair guess that the law of cross-border insol-
vencies will increase in importance as the economic world grows more
and more integrated.
Irrespective of these observations or speculations, one development
must be observed with great attention and concern. As a consequence
of the increasing economic globalization, some of the bigger enterprises
might feel the wish (or need) to have insolvency laws not applied to them.
One example is the Cape Town Protocol as developed by UNIDROIT109
that offers the possibility to provide certain industries with a worldwide
applicable super-priority under any national insolvency law. Even though
these existing Protocols currently have only a strictly limited range of
applicability, it seems to be a fair assumption that any successful attempt
108 See for example, Thomas Felsberg, Steven Kargman, & Andrea Acerbi, Brazil over-
hauls restructuring regime, Int’l Fin. L. Rev. (Jan. ).
109 See http://www.unidroit.org / english / conventions / mobile-equipment / main.htm
NR.
cross-border considerations
to opt out of regular insolvency regimes nurtures the temptation of
other industries or institutions to seek an analogous privilege. If such
arrangements spread, insolvency law would apply only for small creditors
and those who do not have a respective lobby at their disposal. There is
a trend in this direction already in the United States. Needless to say, the
present authors believe this development has to be tamed.110
110 See Christoph Paulus, The Global Insolvency Law and the Role of Multinational
Institutions, Brook. J. Int. L. (). Elsewhere in globally applicable treaties
and agreements one finds similar trumping of national laws; for example, art. of the
Convention on the Settlement of Investment Disputes between States and Nationals of
Other States (ICSID) provides for an award that has to be recognized by all states; for this
see Guiliana Cane, Enforcement of ICSID Awards: Revolutionary or Ineffective? Am.
Rev. of Int. Arb., ff. ().
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INDEX
Access issues informal workouts and restruc-
automatic access, , n, turing in, ,
, , – law reform in, –
discretionary access, , , , London Approach adopted in,
, Asian Development Bank,
information access, –, Asian Wall Street Journal on Enron
–, , , , , collapse,
ASIC (Australian Securities &
rehabilitation statutes and, – Investments Commission),
Asset management companies
single vs. dual gateway, – (AMCs),
Accountability in insolvency Assets
systems, abandonment of,
Accountants as insolvency adminis- administered in insolvency, –
trators, ,
Account debtors, asset constraint,
Accounts receivable, , –, concealment of, ,
disposing of debtor’s, –
Ackermann, Judge, post-default control of, –
Acquired Rights Directive (EU), preservation and collection of,
– structural security and,
Administrators. See Insolvency Associates, transfers to, ,
administrators; Judicial and n
administrative institutions Attachment, enforceability against
AMCs (Asset management compa- debtor as,
nies), Attorney General (US),
American Law Institute, Principles Auctions,
for law reform, Australia
Ancillary proceeding approach, access issues in, –
–, , employees’ rights in,
Anti-assignment clauses, , , fraudulent trading in,
n, – information disclosure in,
Appeal, right to, judicial and administrative
Approval rights, – institutions in, ,
Article . See Uniform Commercial rescue regimes in,
Code secured creditor protection in, ,
Asia. See also specific countries –
corporate governance in, – tax claims in,
debt collection and insolvency wrongful/insolvent trading in,
laws in, –
financial crisis of in, n, , Australian Securities & Investments
, , , Commission (ASIC),
index
Austria Benefits, employee, –
insolvency administrators in, Berle, Adolf,
n, BGB (Bürgerliches Gesetzbuch,
partnerships in, Germany),
Automatic access regimes, , Bid rigging,
n, , , – Blackmail,
Avoidance provisions Bodin, Jean,
defenses to, – Bonds, , ,
information disclosure and, Book debts, –
preferential transfer and, Brazil
employees’ rights in,
Bailouts, corporate funds for, insolvency administrators in,
Balance-sheet tests of insolvency, n
Balancing tests, , Breaches of peace, ,
Bangkok Approach, , Breakup fees,
Bank accounts, , Bright-line tests, –
Bank of England, , , , , British Bankers’ Association,
Burden of proof, , , ,
Bankruptcy Act of (U.S.),
Bankruptcy and Insolvency Act of Bürgerliches Gesetzbuch (BGB
(Canada), Germany),
Bankruptcy Code (U.S.) Business judgment rule,
automatic access under, Business operations, –
collective bargaining and, Bustamante Code of , ,
employees’ rights and, Buy back options,
European skepticism of,
examiners and trustees under, California, judgments against
movable property in, n
information disclosure and, Canada
insolvency of banks and insur- defenses in,
ance companies under, employees’ rights in,
pre-packaged plans and, favoring of claimants in,
as “pro-debtor,” gratuitous transfers in, n
as single entry system, n judicial and administrative
trustees under, institutions in,
Bankruptcy Law of (Finland), lease registration in,
piercing the corporate veil in,
Bankruptcy Law of (China), PPSAs in,
n secured credit systems in, n
Bankruptcy Ombudsman (Finland), winding up procedure in,
, , Cape Town Protocol (UNIDROIT),
Bankruptcy Ordinance (Austria),
Carve out provisions,
Banks. See Financial institutions Cash flow, , –
Banks Administration Proceedings Cash injections,
Order (UK), CDR (Corporate Debt Restructuring
Belgium, security sales fraud in, Committee, Malaysia), ,
index
Cessation of payments, Common law
Chapter . See Bankruptcy Code director and office liability in, –
(U.S.)
Charges, fixed and floating. See judges in,
Fixed and floating charges Companies Act (UK), ,
China
AMCs in, Companies (Amendment) Bill
cross-border judgment enforce- (Hong Kong),
ment and, Companies (Corporate Rescue) Bill
employees’ rights in, (Hong Kong),
insolvency administrators in, Companies House (UK),
n, n Companies Ordinance (Hong
judicial and administrative Kong),
institutions in, Company Directors Disqualification
SOEs in, – Act (UK), –
winding up procedure in, Company Law Amendment of
workers’ claims in, n, (South Africa),
Chinese walls, , nn– Compensation of administrators.
Choice of law, , – See Remuneration of insolvency
Civil law, judges in, administrators
Civil Procedure Law (China), Competence of insolvency adminis-
trators, –
Class action suits, Concealment of assets, ,
Classes of creditors and sharehold- Confidentiality agreement,
ers, – Congruent and incongruent delivery
Closely held companies, , transfers,
Codebtorship with security function, Conservative privileges, n
, Consolidation of laws, –
Co-determination principle, Constitution (U.S.), legislative
Collateral powers in insolvency in,
cross-border insolvency and, Constitutional Court (Germany),
EU Directive on, n
registries for, Constitutional Court (South Africa),
sale of, ,
secured transaction constraints Consultation with employees, –
and,
security interests and, , – Contempt of court, ,
Content review approach,
transformation of types of, Contracts
Collective bargaining agreements, adoption of, –, n, –
, –, , n
Comfort letters, , collective bargaining agreements,
Commercial Code (France), , –,
Commercial reasonableness corporate insolvency legislation
doctrine, and, –
Commission on European Contract generally, –
Law, assignment of, –,
index
corporate insolvency legislation comparative legislative survey,
and (continued) –
contract continuation, –, corporate governance and, –
n, –,
contract termination, – directors’ disqualification and,
leases and, – –
procedural issues, – fraudulent trading and,
risks to counterparties, – specific statutory provisions of,
setoff, netting, and derivatives, –
– wrongful/insolvent trading,
special contracts, – –
default, cure of, governance management, –
employment contracts, , – administrator/debtor in
possession, –
executory contracts, administrator’s financial
immediate detrimental contracts, responsibility, –
creditors, organization of, ,
insurance contracts, n
specific performance of, creditors and creditors’
Copyright Office (U.S.), – committees, –
Cork Committee, creditors’ committee functions,
Corporate bailout funds, –
Corporate Debt Restructuring creditors’ committees,
Committee (CDR, Malaysia), , organization of, –
liquidation and, –
Corporate governance, –, – rehabilitation and, –
transparency and approval
Corporate insolvency legislation, , rights, –
– moratorium and suspension of
background, – actions, –
contracts and, – gap moratorium, –
generally, – lawsuits on, –
assignment of, –, other exceptions,
contract continuation, –, receivership regimes and, –
n, –,
contract termination, – secured creditors and, –
derivatives, –, n state regulatory actions and,
leases and, – partnerships and, –
procedural issues, – post-insolvency transfers,
risks to counterparties, – avoiding, –
setoff and netting, – pre-proceeding transfers,
special contracts, – avoidance of, –
debtor’s asset disposal, – generally, –
director and officer liability, – defenses, –
intentional fraud,
common law/case law preferential transfers, –
approach, – procedure for,
index
security interests, pre-packaged plans, –
suspect periods, – sponsorship and negotiation,
undervalue transactions and,
– voting and classes, –
property collection, preservation, rehabilitation statutes, structural
and disposition, – features of, –
other priorities, – access and, –, –
procedure for, administration of proceedings,
secured creditors’ rights and, –
– judicial or other supervision,
title claimant retention, –
scope and commencement of negotiation of plan, –
insolvency cases, – secured parties, protection of,
assets administered in –
insolvency, – shareholders’ interests and,
commencement criteria, – –
financial institutions, insur- rescue and rehabilitation regimes,
ance companies, and regu- –
lated industries, – single vs. dual gateway, –,
insolvency defined, –
scope of application, – Corporate Voluntary Arrangement
SOEs and, – (CVA, UK), –, , ,
valuation and,
Corporate rehabilitation proceed- Corporations Act (Australia),
ings, , –. See also Rehabil- ,
itation and rehabilitation statutes Corruption, , ,
generally, – Cost-benefit analysis, –
business operations, stabilizing Counterparties, risks to, –
and sustaining, – Court orders
business survival and liquidation, freezing property and,
– for rehabilitation initiation,
disclosure of information, – for seizure and sale of property,
,
information gathering, – Courts. See Judicial and administra-
tive institutions; Judiciary
types of information obtained, Cramdown, , n,
– Creditors and creditors’ committees.
financing of rescue process, – See also Secured creditors;
Unsecured creditors
plan formulation, consideration, classes of, –
and voting, – creditors, organization of, ,
formulation, – n
plan approval, – creditors’ committees, function
plan discharge and binding of, –,
effects, – creditors’ committees, organiza-
plan implementation and tion of, –
amendment, – creditors’ rights, ,
index
Creditors and creditors’ committees terminology and concepts,
(continued) –
employees as, – territoriality vs. universality,
pensions and, – –
wages and benefits and, – unitary vs. multiple proceed-
ings, –
equal treatment of, , n, future developments, –
international initiatives, –
foreign, European Union Regulation
governance management and, on Cross-Border Insolvency,
– –
insider creditors, Latin American states, –
insolvency plan negotiation and,
Model Law on Cross-Border
inter-creditor agreements, , Insolvency, UNCITRAL,
, –
judgment creditors, , , – Montevideo Treaty, –
lead creditors, appointment of, Nordic Bankruptcy Conven-
tion, –
outside and dissenting, – Nordic European states, –
preferential, , , –
super-priority creditors, , , OHADA, –
Transnational Insolvency
title creditors, , Project, –
transparency and approval rights universality principle and,
and, – –, –, –
Criminal law and liability overview of, –
debt nonpayment and, recognition of foreign proceed-
directors’ disqualification and, ings, –
fraud and, , access and assistance, –
non-disclosure of information forms of recognition, –
and, general meaning of interna-
Cross-border insolvency, , – tional cooperation,
debt enforcement systems and, general trust, –
– international cooperation in,
enforcement of judgments and, –
meaning of recognition,
fundamental issues, – mid-ground modifications,
choice of law, –
determination of main modern meaning of interna-
proceeding, – tional cooperation, –
jurisdiction, – no trust, no recognition,
minimum requirements for speed and efficiency of, –
non-main proceeding, –
Cross-Border Insolvency Regulation.
recognition of foreign See European Union Cross-
proceedings, – Border Insolvency Regulation
index
CVA. See Corporate Voluntary Default and default judgments
Arrangement in contracts,
Czech Republic, courts’ handling of grace periods for,
insolvency in, insolvency plan formulation and,
Danaharta (Pengurusan Danaharta post-default asset control, –
Nasional Bhd), priority and,
Debt enforcement systems, , – secured credit systems and, ,
overview of, – Defenses
secured credit systems, – to avoidance other than preferen-
ambiguity of interests, – tial, –
consolidation of laws, – to preferential transfer avoidance,
cross-border, –
enforcement in, – pre-proceeding transfers and,
exemptions in, –
immovables and, – Delivery transfers, congruent and
international initiatives, incongruent,
lien types permitted in, – Denmark, insolvency plan monitor-
personal guarantees for, – ing in,
priority and, –, n Derivatives, –, n
proceeds and, – Directive of October and
publicity and, , – amendment (on protection of
registration and, – employees in event of insol-
secured transaction con- vency), –
straints, – Directive on Collateral (EU),
security interests generally, Director and officer liability
– comparative legislative survey,
setoff and, –
title finance and, – common law/case law
valid security interest and, approach, –
unsecured rights enforcement, directors’ disqualification and,
– –
generally, fraudulent trading and,
cross-border enforcement of specific statutory provisions of,
judgments, –
enforcement process, – wrongful/insolvent trading, ,
exempt property, – –
priorities in, – corporate governance and, –
provisional remedies for, –
corporate insolvency legislation
third parties and, and, –
types of seizable property, employee rights and, ,
Debtor flight, Directors. See also Director and
Debtor in possession (DPI) ap- officer liability
proach, –, , disqualification of, –,
Debt Recovery Tribunals (India), public examination of,
Deed of Trust system, sanctions against, ,
index
“Directors in the Twilight Zone” Enronitis,
project, , Enterprise Act (UK), , ,
Disclosure of information. See n
Information access and disclosure Enterprise Insolvency Law (China),
Discretionary access regimes, , –, n,
, , , Enterprise mortgages,
Disqualification of directors, –, Equal treatment, rule of, , n,
Disqualified Directors Register, Equity cushions, n
Dissenting creditors, – Equity interests, ,
DPI approach. See Debtor in Estonia
possession courts’ handling of insolvency in,
Due process requirements,
suspect periods in,
Efficiency in insolvency systems, , Ethics of insolvency administrators,
, , , – , ,
Email for notice purposes, European Bank for Reconstruction
Employees and employee rights, , and Development, n,
– European Community,
generally, – European Union. See also European
administrator’s personal liability Union Regulation on Cross-
and, Border Insolvency; specific
consultation, participation, and countries
business rescue, –, – Acquired Rights Directive, –
employee participation in large Directive on Collateral,
corporations, – directive on employee protection
employees in management of in insolvency, –
insolvency, – employee rights in, –, ,
employee redundancy, , –, –
employment contracts, – insolvency plan monitoring in,
in liquidation, , European Union Regulation on
officers and directors’ personal Cross-Border Insolvency. See also
liability, European Union
priority and, – basic elements of, –
protecting employees as creditors, cross-border insolvency and,
– deficiencies in, –
pensions, – general trust in,
wages and benefits, – jurisdictional issues and, ,
secured creditors and, , ,
, parallel proceedings and,
Enforcement and enforcement universality principle and, –
process. See Debt enforcement
systems Examiners, bankruptcy, , –
England. See United Kingdom ,
Enron, , Executory contracts,
index
Exemptions, secured credit systems Forum shopping, –
and, France
Exequatur approach, , , class system of creditors in,
contracts in, n
Favoritism, , , debt enforcement process in,
Federal Bankruptcy Acts (U.S.), directors’ disqualification in,
Filing incentives, – employees’ rights in, , n
Financial crisis of (Asia), n, enterprise mortgage in,
, , , , partnerships in,
Financial institutions. See also priority in, , n,
specific institutions secured creditor exemptions in,
differential treatment of,
informal workouts and, secured credit systems in, , –
INSOL International and,
insolvency cases and, – single gateway system in, –
London Approach and, – ,
receivership and, title retention in, ,
Financial responsibilities of adminis- Franchises,
trators, – Fraud
Financial Stability Form, asset disposal and,
Financing of rescue process, – criminal penalties for, ,
, , , – fraudulent trading, , –,
Finland, judicial and administrative –
institutions in, –, , insolvency plans and, ,
Finnish Bar Association, – intentional, , ,
Fixed and floating charges judicial supervision and, –
book debts and, preferential transfers and,
employees’ claims and, pre-proceedings transfers and,
moratorium on debtor and ,
creditor actions and, in restructuring plan approval,
negative pledge clauses and, , in sale of property,
n in sale of securities, –
priority and, – suretyship and,
receiverships and, , suspect periods and,
secured creditor protection and, title registration and,
Freezing of property,
in UK, –, , n, – Future property interests, ,
, n,
under UK Administration, – Gap moratorium, –
Gap period,
in U.S., – Germany
Floating security, corporate governance in,
Florida, judgments against moveable debt enforcement process in,
property in, n directors’ disqualification in,
Foreign proceedings, recognition employees’ rights in, ,
of. See Recognition of foreign insolvency administrators in,
proceedings n,
index
Germany (continued) OHADA and, ,
intentional fraud in, territorial defense mechanisms
organization of creditors in, and,
partnerships in, , Transnational Insolvency Project
post-insolvency transfers in, and, ,
procedural issues in, Hawaii, property registration in,
proceeds in, Health and safety regulations,
rehabilitation regimes in, n Hold out problems, , , ,
sale of collateral in,
secured creditors in, , Hong Kong
secured credit systems in, –, associates, transfers to, n
n, , n directors’ disqualification in,
secured transaction characteriza- fraudulent trading in,
tions in, moratorium on debtor and
suspect periods in, creditor actions in, –
title retention in, , –, property collection in,
undervalue transactions in, , regulated industries in, ,
workers’ claims in, –
unitary system in, wrongful/insolvent trading in,
wrongful/insolvent trading in, ,
Hong Kong Approach, ,
Gifts, –, , Hong Kong Association of Banks
Global Corporate Governance (HKAB),
Forum, Hong Kong Law Reform Commis-
Globalization, , , sion, , n
Good faith, , , – Hong Kong Monetary Authority
Grace periods, – (HKMA),
Great Britain. See United Kingdom Hungary, secured credit system in,
Group insolvencies, , , , n
–,
G States, IBA (International Bar Association),
Guarantees
contract, IBRA (Indonesian Bank Restructur-
guarantee funds, ing Agency),
guaranty trust devices, ILO (International Labour Organi-
independent, , zation), ,
personal, – IMF. See International Monetary
third-party, , Fund
Immovables (real estate)
Harmonization of insolvency laws debt enforcement systems and,
choice of law and, –
complexity of insolvency law and, enforcement against,
lease of, , –
international cooperation and, registries for,
– sale of,
Model Law on Cross-Border trusts and,
Insolvency and, – Implementation gaps, ,
index
India information gathering, –
Debt Recovery Tribunals in,
employees’ rights in, insolvency administrators and,
Indonesia ,
Jakarta Initiative in, London Approach and,
title retention in, negotiation of insolvency plan
Indonesian Bank Restructuring and, –
Agency (IBRA), types of information obtained,
Informal workouts and restructur- –
ing, , – Inns of Court (UK), n
generally, – In re. See name of party
cross-border insolvency and, In rem rights,
informal rescue and, , – Insider creditors,
INSOL International, , –,
main aspects of informal ,
workout, – Insolvency
business stabilization, corporate insolvency legislation
cash flow and, – and, –
commencing process of, corporate rehabilitation proceed-
coordinating participants, ings and, –
engaging advisers, cross-border, –
information access, debt enforcement systems and,
legally binding restructuring –
agreement, defined, –
negotiating, agreeing, and employee rights and, –
implementing restructuring goals of,
plan, informal workouts and restruc-
outside and dissenting turing and, –
creditors, – judicial and administrative
preventive action, – institutions and, –
procedures for, – terminology of,
London Approach, –, Insolvency Act (South Africa),
post- adaptation for Asia, Insolvency Act (UK)
Administration under, –
pre-packed insolvency Corporate Voluntary Arrange-
procedure, – ment under, –,
receivership, – employment contracts and,
rescue, key elements of, – n
Information access and disclosure. floating charges under, –,
See also Access issues n
accountability and, insolvency practitioners and, ,
corporate rehabilitation proceed-
ings and, –, n, liquidation and, –
Secretary of State and, –
informal workouts and, , , winding up under, n
Insolvency Act (UK),
index
Insolvency administrators. See Intangibles (property)
also Judicial and administrative registration of,
institutions rights retention in,
appointment and functions of, security interests in,
–, n, Integrity of insolvency administra-
competence of, – tors, –
contract administration and, – Intellectual property
in French secured credit system,
creditors’ committees and,
ethics of, , , security interests in,
information disclosure and, as seizable property,
integrity of, – Intentional fraud, , ,
liability of, –, , n, – Inter-creditor agreements, , ,
, n,
remuneration of, , , , International Association of
–, , – Insolvency Regulators, n,
role in judicial and administrative
institutions, – International Bar Association (IBA),
secured party rights and,
Insolvency clauses, – International Collective Proceedings
Insolvency Law and Practice, UK (OHADA),
Review Committee’s Report on, International Insolvency Institute,
,
Insolvency Law of (Brazil), International Institute for the
n Unification of Private Law
Insolvency Ordinance (Germany), (UNIDROIT),
International Labour Organization
Insolvency plans. See Plans, (ILO), ,
insolvency International Monetary Fund (IMF),
Insolvency Practitioners Regulations , , ,
(IPR, UK), Internet,
Insolvency Rules (UK), – Investment bankers,
Investment securities,
Insolvency Statute of (China), IPR (Insolvency Practitioners
Regulations , UK),
Insolvency termination contract Italy
clauses, – insolvency plan monitoring in,
Insolvency Trustees Act of
(Slovakia), secured creditor exemptions in,
Insolvent Partnerships Order
(UK), –
Inspectors and inspectors’ commit- Jakarta Initiative, ,
tees, Japan
The Institute of Chartered Accoun- corporate governance in,
tants (Australia), employees’ rights in, ,
Insurance and insurance companies, insolvency plans in, ,
–, perfection law in, n
index
rehabilitation procedures in, – Cross-Border Insolvency and,
–
Joint Insolvency Examination, minimum requirement for non-
Judges. See Judicial and administra- main proceeding, –
tive institutions; Judiciary Justice Ministry (Slovakia),
Judgment creditors, , , –
Judicial and administrative institu- Kreditschutzverein (credit protection
tions, , –. See also Judi- association),
ciary
administrators’ role, – Latin American states, cross-border
comparative approaches to, – insolvency and, –
Law reform
generally, – in Asia, –
Australia, creditors’ committees and,
Canada, secured transactions and, , n
China, suggestions for,
Finland, – Law Reform Commission Report
Slovakia, (Australia),
United Kingdom, – Lawyers as insolvency administra-
United States, tors, , , –
compensation rules of profession- Lead creditors, appointment of,
als, – Leases
competence of insolvency assignment of contracts and,
administrators, – commercial,
integrity of administrators, – corporate insolvency legislation
and, –
judiciary’s role, – of goods,
overview of, – of immovables, , –
periodic reports, registration of, ,
Judicial Management (South Africa), sub-leases,
Legislative Guide (UNCITRAL), ,
Judiciary n, n
debt enforcement and, – Letters of credit,
informal workouts and, Lex concursus, , –, ,
insolvency plans and, – –
international cooperation and, Lex rei sitae,
Liability of directors and officers. See
judicial and administrative Director and officer liability
institutions and, – Liens
rehabilitation statute supervision blanket liens,
by, –, – conservative privileges, n
Jurisdictional issues future (after-acquired) collateral,
cross-border insolvency and, –
– future (after-incurred) credits,
determination of main proceed- –
ings, – on immovables, –
European Union Regulation on judgment,
index
Liens (continued) insolvency proceedings efficiency
non-possessory security interests, in,
secured credit systems in, n,
rescue process financing and, ,
secured credit systems and, – trust system in,
voluntary insolvency petitions in,
statutory,
types of, – winding up procedure in,
vendor’s liens, Mitbestimmung principle (co-
Liquidation determination),
asset disposal and, Model Law on Cross-Border
business survival and, – Insolvency (UNCITRAL)
contract assignment and, adoption of,
corporate insolvency legislation basic ideas of, –
and, cross-border insolvency and, ,
creditors’ committee functions in, –
– efficiency of recognition and,
debt enforcement system and, equal treatment in, n
governance management and, foreign insolvency proceedings
– and, –
registered liquidators, global impact of, –
regulated industries and, – harmonization of insolvency laws
rehabilitation and, , , and, –
rescue regimes and, incompleteness of, –
secured credit systems and, international cooperation and,
as traditional approach to
insolvency, jurisdictional issues and, ,
wrongful/insolvent trading and,
moratorium on debtor and
Liquidity tests for insolvency, –, creditor actions and, –,
,
London Approach, , , –, universality principle and, –
Model Law on Secured Transac-
Malaysia, Corporate Debt Restruc- tions of (European Bank
turing Committee in, for Reconstruction and Develop-
Matsushita, Junichi, n ment), n
Maxwell Communication Corp., In re Modified universalism, –,
(), , , , –,
Maxwell scandal, Moldova, insolvency administrators
MC Bacon Ltd, Re (), in,
Means, Gardiner, Montevideo Treaty on Commercial
Mexico International Law ( and
contracts for services in, n update), –
debt enforcement in, Moratorium on debtor and creditor
employees’ rights in, actions
insolvency plan voting in, access issues and, –,
index
corporation insolvency legislation London Approach and,
and, – Netherlands
gap moratorium and, – insolvency plans in, ,
informal rehabilitation and, , secured creditors in, ,
, undervalue transactions in,
lawsuits on, – Netting (contract law), , –,
Model Law on Cross-Border n
Insolvency and, –, , New Zealand, fraudulent trading in,
other exceptions, Non-payment, risk of, –
receivership regimes and, – Non-performing loans (NPLs), ,
recognition of foreign proceed-
ings and, Non-possessory security interests,
secured creditors and, –, –
state regulatory actions and, Nordic Bankruptcy Convention of
Transnational Insolvency Project
and, achievements and deficiencies of,
Morocco, selection of administrators –
in, n content of, –
Mortgages, , cross-border insolvency and,
Movables (property) –
enforcement against, , n Nordic European states, cross-
priority rules and, border insolvency and, –
publicity issues and, North America. See also specific
receivables as, countries
registries for, priority in,
secured credit systems and, – private debt enforcement in,
security interests in, proceeds in, ,
secured credit systems in, –,
NAFTA states, , n, ,
Nantissement du fonds de commerce secured transaction constraints
(general business lien), in,
National Insolvency Examination title retention in, –
(Canada), Norway, insolvency plans in, n
National Insolvency Qualification Notaries and notarization, , ,
Program (Canada), Notice and notice requirements. See
National Insurance Fund (UK), also Publicity and publicity issues
National Westminster Bank plc. v. accountability and,
Spectrum Plus Ltd. (), collateral liens and,
Natural persons, exempt property of, to creditors, –
– debt assignment and, –
Negative pledge clauses, , n debt enforcement and,
Negotiations email and,
business stabilization and, insolvency plans and,
informal workouts and, , post-insolvency transfers and,
of insolvency plans, –, , –
of private sales,
index
Notice and notice requirements Paramount Airways Ltd, Bristol
(continued) Airport v. Powdrill, Re (),
secured property, –
warning notices, Partnerships, corporate insolvency
NPLs (Non-performing loans), , legislation and, –
Patents
freezing property and,
Officer liability. See Director and as seizable property,
officer liability Paulian actions, ,
Official Management (Australia), Pengurusan Danaharta Nasional
Bhd (Danaharta),
Offset. See Setoffs Pension funds, –, –
OHADA (Organisation pour Pensions Act (UK),
l’Harmonisation du Droit des Pensions Act (UK),
Affaires en Afrique) Perfection (third-party enforce-
as centralized registry, ment), , , n,
complexity of insolvency law and, Personal Property Securities Acts
(PPSAs Canada), n,
coordination of several proceed- Piercing the corporate veil,
ings, Plans, insolvency
cross-border insolvency and, approval of, –
– discharge and binding effects of,
incompleteness of, – –
project basics, formulation of, –
recognition and consequences, implementation and amendment
– of, –
Ombudsman. See Bankruptcy negotiation of, –, ,
Ombudsman (Finland)
Ontario (Canada) pre-packaged, –, –
commercial courts in, sponsorship of,
registration of security interests voting and classes and, –
in, Pledge laws,
Ordre public. See Public policy PPSAs (Personal Property Securities
Organisation for Economic Co- Acts, Canada), n,
operation and Development Predictability in insolvency, ,
(OECD), , Preferential creditors, , , –
Outside creditors, –
Pre-packaged plans (pre-packs),
Parallel proceeding approach –, –
cross-border insolvency and, Pre-proceeding transfers. See
Transfers
European Union Regulation on Principles and Guidelines for
Cross-Border Insolvency and, Effective Insolvency and Creditor
, , Rights Systems (World Bank),
Montevideo Treaty and, , Principles of European Contract
OHADA and, Law (Commission on European
use of, –, n Contract Law), –
index
Priority rules Public interest and public interest
categorical priority, petitions, , –
choice of law and, Publicity and publicity issues.
consolidation of laws and, See also Notice and notice
debt enforcement systems and, requirements; Registration and
–, –, n registries
employee rights and, – asset disposal and,
exemptions and, characterization of secured
extent of, – transactions and,
financing of rescue process and, consolidation of laws and,
– movables and,
jurisdictional issues and, proceeds and,
Model Law on Cross-Border secured credit systems and, ,
Insolvency and, – –
publicity and, , – title retention and, ,
registration and, – Public land records,
super priority, , , , Public policy (ordre public), ,
tax claims and, , ,
unsecured creditors and, , Public sales,
Private sales, PWIF (Protection of Wages on
Proceeds, security interest in, – Insolvency Fund),
Property
collection, preservation, and Re. See name of party
disposition of, – Recapture, right to, , ,
other priorities, – Receivables, ,
procedure for, Receivership
secured creditors’ rights and, Administrative Receivership in
– UK, –, , ,
title claimant retention, debt enforcement and, ,
exempt property, – equity receivership,
freezing of, informal workouts and restruc-
future interests in, , turings, –
seizure and sale of, –, , liability of receiver, –
– moratorium on debtor and
types of seizable, creditor actions and, –
Protection of Wages Convention post-default asset control and,
(ILO), – –
Protection of Wages on Insolvency in rescue regimes,
Fund (PWIF), secured creditors’ protection and,
Protocols, drafting of, – –
Provisional Supervision (Hong Reciprocity in recognition, ,
Kong), – Recognition of foreign proceedings
Provisional Supervision legislation access and assistance and, –
(Hong Kong),
Public examination of officers and cross-border insolvency and,
directors, –
Public funds, , forms of recognition, –
index
Recognition of foreign proceedings administrators’ financial responsi-
(continued) bility and,
general trust, – contract enforcement and,
international cooperation in, contract performance and,
– creditors’ committee functions in,
general meaning of, –
modern meaning of, – default, cure of,
meaning of recognition, employment contracts and,
mid-ground modifications, governance management and,
Model Law on Cross-Border –
Insolvency and, insolvency termination contract
no trust, no recognition, clauses and,
OHADA and, – liquidation and, , ,
reciprocity in, , structural features of, –
speed and efficiency of, – access and, –
Transnational Insolvency Project administration of proceedings
and, – and, –
universality principle and, – judicial or other supervision,
–
Redressement judiciaire (business negotiation of plan, –
rescue regime), , secured parties, protection of,
Redundancy, employee, , –
Reform Law of (France), shareholders’ interests, –
Registered liquidators,
Registration and registries. See also Remedies
Publicity and publicity issues non-damage,
content review approach to, unsecured rights enforcement
Disqualified Directors Register, and, –
Remuneration of insolvency
of fixed and floating charges, – administrators, , , ,
–, , –
of intangibles, Repurchase agreements (repos), ,
of judgments and judgment liens, –, n
Rescue regimes
of leases, , employee rights and, –,
of priority, –
of property, financing of, –
secured credit systems and, – formal, –
history of, –
of secured interests, , informal, –, –
title registration, initiation of proceedings,
title retention and, , key elements of, –
Regulated industries, insolvency Res judicata, ,
issues in, – Resolution Trust Corporation (U.S.),
Rehabilitation and rehabilitation
statutes. See also Corporate Restructuring. See Informal
rehabilitation proceedings workouts and restructuring
index
Retention of title. See Title finance international initiatives,
and retention lien types permitted, –
Revolving loans and lines of credit, personal guarantees for, –
priority issues, –
Russia, bond obligations in, exemptions and,
extent of, –, n
Sabre International Products Ltd., Re proceeds and, –
(), publicity and, , –
Safety and health regulations, registration and, –
Sale and lease of goods, secured transaction constraints,
Sale-leaseback, –
SAM enterprises. See Small- and security interests generally, –
Medium-Sized (SAM) enterprises
Sanctions against officers and setoff and,
directors, , title finance, –
Sarra, Janis, , –, –, generally, –
, ambiguity of interests, –
Saudi Arabia, secured transaction valid security interest and,
constraints in, Secured transactions
Savings & Loan crisis of , constraints on, –
Scheme of Arrangement (UK), law reform, , n
Scotland, receivership in, n Securities accounts,
Search logic (computer), , n Securities and Exchange Commis-
Secrecy in informal procedures, sion (SEC),
Secretary of State (UK), , – Security interests
avoiding,
Secured creditors cancellation of,
corporate insolvency legislation financing of rescue process and,
and, –
debt enforcement and, – See also Unsecured rights, Unse-
employees’ rights and, , , cured creditors
, Self-help enforcement, , , ,
moratorium on debtor and –, ,
creditor actions and, – Self-incrimination,
priority rules and, –, Setoffs, , , , –,
property collection, preservation, Settlements, out-of-court, –
and disposition, – Shareholders and shareholders’
protection for, –, –, interests, , –, –,
, –
secured credit systems and, – Sharia law,
Secured credit systems Siebe Gorman & Co. Ltd. v. Barclays
consolidation of laws, – Bank Ltd. (),
cross-border, – Skeel, David A.,
debt enforcement systems and, Slovakia, judicial and administrative
– institutions in, , n
enforcement in, – Small- and Medium-Sized (SAM)
immovables and, – enterprises, , ,
index
SOEs (State-owned enterprises), – public enforcement in, n
, selection of insolvency adminis-
Soft law, trators in, n
South Africa suspect periods in,
Constitutional Court of,
fraudulent trading in, Takagi, Shinjiro, n
property collection in, TAMC (Thai Asset Management
rescue regimes in, – Company),
Sovereignty principle, , n Taxation and tax issues, , ,
Spain Ten Core Principles (European
priority in, Bank for Reconstruction and
secured credit systems in, , Development), n
title retention in, Termination of Employment
Speed in insolvency proceedings. See Convention (ILO), –
Efficiency in insolvency systems Termination of Employment
Sponsorship of insolvency plans, Recommendation (ILO),
Stalking horse bidders, Territoriality principle
Standby letters of credit, , choice of law and,
Standstill periods and agreements, complexity of insolvency law and,
, ,
State Council (China), – European Union Regulation on
State-owned enterprises (SOEs), – Cross-Border Insolvency and,
, ,
Statutes of limitations, – recognition of foreign proceed-
Stockholders. See Shareholders and ings and,
shareholders’ interests universality and, –,
Structural security, – Thai Asset Management Company
Sub-prime mortgage crisis, (TAMC),
Subrogation, right of, Thailand
Superintendent of Bankruptcy balance-sheet tests in,
(Canada), Bangkok Approach in,
Super-priority creditors, , , , debt recovery in,
Thai Petrochemicals decision (TPI),
Suretyship, – , n
Suspect periods, , –, , Third parties
– contract assignments and, –
Swaps, n, debt assignment and,
Sweden property collection and, –
employees’ rights in, , – registration requirements and,
secured credit systems and,
insolvency administrators in, third-party guarantees, ,
n unsecured rights and,
Sweetheart rates, Time limits in contract procedure,
Switzerland , nn–, n
debt collection office in, n Title claimants, ,
insolvency proceedings in, Title finance and retention
n, , n generally, –
index
ambiguity of interests, – institutions and,
debt enforcement systems and, negotiation of insolvency plan
– and,
non-disclosure exemptions and, pre-packaged plans and,
remuneration of administrators
priority and, and,
title claimant retention, title retention and, ,
TPI (Thai Petrochemicals) decision, Trial Insolvency Law for SOEs
, n (China),
Trading, fraudulent or wrongful, , True sale statutes,
–, – Trust in recognition of foreign
Transfers proceedings, –
congruent and incongruent Trusts and trustees
delivery, Attorney General appointed,
post-insolvency, – debtor in possession and,
preferential, – guaranty trust devices,
pre-proceeding transfers, immovables and,
avoidance of, – plan trustees,
generally, – Turkey, enforcement of mortgages
defenses, – in,
intentional fraud and, “Twilight Zone” project, ,
procedure for,
security interests and, Ultra vires doctrine,
suspect periods, – UNCITRAL. See United Nations
undervalue transactions and, Commission on International
– Trade Law
Transnational Insolvency Project, Undervalue transactions, , –
Principles of Cooperation in , , . See also Valuation
Transnational Insolvency Cases UNIDROIT (International Institute
Among the Members of the North for the Unification of Private
American Free Trade Agreement, Law),
American Law Institute Uniform Act on Collective Proceed-
approach of, – ings for Wiping off Debts of
basic considerations of, (OHADA), ,
cross-border insolvency and, Uniform Commercial Code (UCC)
– Article , n, , , , ,
universality principle, – n, , –
Transparency registries under, –
asset disposal and, Uniform Customs and Practices ,
characterization of secured
transactions and, Unitary approach to insolvency
corporate governance and, – proceedings
in credit markets, corporate insolvency legislation
creditors and, – and, ,
as goal of insolvency, European Union Regulation on
informal workouts and, Cross-Border Insolvency and,
judicial and administrative ,
index
Unitary approach to insolvency secured creditor exemptions in,
proceedings (continued)
Germany and, secured creditor protection in, ,
jurisdictional issues and, –,
multiple proceedings vs., – secured credit systems in, –,
n, ,
OHADA and, secured transaction constraints
United Kingdom in,
access issues, –, – single and dual gateways in,
Administration regime in, – suspect periods in,
, , –, –, title retention in,
winding up procedures in, ,
administrators’ personal liability wrongful/insolvent trading in,
in, United Nations,
case law approach to director United Nations Commission
liability in, on International Trade Law
contract adoption in, (UNCITRAL). See also Model
directors’ disqualification in, – Law on Cross-Border Insolvency
Draft Convention on Assignment,
employees’ rights in, , ,
, – insolvency initiatives of, , ,
floating charges in, , , n, –
–, Legislative Guide, , n,
fraudulent trading in, n
information disclosure in, – model law on assignment of
, – receivables,
insider creditors in, – United States
insolvency plans in, –, automatic access in, , ,
,
insolvency practitioners’ role in, choice of law rules in,
– collective bargaining agreements
judicial and administrative in,
institutions in, –, corporate failures in,
n corporate governance in,
liquidation in, – cramdown in,
netting in, creditors’ committees in, –
partnerships in, – cross-border judgment enforce-
preferential creditors in, ment and,
preferential transfers in, debt enforcement process in,
priority in, , n debtor in possession approach in,
property collection in, –
receiverships in, , , –, Deed of Trust system in,
, –, , , – defenses in,
directors’ disqualification in,
regulated industries in, – employees’ rights in, , ,
rehabilitation regime in, ,
–, equity receivership in,
index
information disclosure in, – jurisdictional issues and, –
, ,
insolvency as body of law in, Model Law on Cross-Border
insolvency in Constitution in, Insolvency and, –
insolvency law development in, modification of, –, ,
, , –,
insolvency plans in, , , Montevideo Treaty and,
involuntary rehabilitation in, Nordic Bankruptcy Convention
judgment registries in, and, –
judicial and administrative recognition of foreign proceed-
institutions in, , n, ings and,
territoriality principle and, –
liquidation in,
negative pledge clauses in, Transnational Insolvency Project
partnerships in, and, –
post-insolvency transfers in, – University of British Columbia,
preferential transfers in, Unsecured creditors. See also
priority in, n Unsecured rights
private sales in, carve out provisions and,
procedural issues in, , , debt enforcement and, –
registries in, , – financing of rescue process and,
regulated industries in, –, –
secured creditors’ protection in, insolvency plans and,
, , , , n preferential transfers to,
secured credit systems in, –, priority rules and, ,
n, property collection, preservation,
secured transaction constraints and disposition, , n
in, recognized,
security sales fraud in, – unsecured creditors’ committees,
self-help options in, –
setoff in, unsecured rights enforcement
shareholders’ interests in, and, –
specific performance of contracts Unsecured rights
in, , n enforcement of, –
sub-prime mortgage crisis in, generally,
suspect periods in, cross-border enforcement of
title finance in, judgments,
true sale statutes in, enforcement process, –
undervalue transactions in,
valuation in, exempt property, –
voluntary insolvency petitions in, priorities in, –
provisional remedies for, –
Universality principle
European Union Regulation on third parties and,
Cross-Border Insolvency and, types of seizable property,
, –
index
Valuation Winding up procedures, –, ,
asset disposal and, n
corporate insolvency legislation Workers’ claims in insolvency,
and, n, –
market value, Workout Accord (South Korea), ,
procedural issues,
reasonable value, Workouts, informal. See Informal
Vis attractiva concursus principle, workouts and restructuring
World Bank
Voluntary Administration (Aus- author’s experience with,
tralia), corporate governance and,
Voluntary winding up, INSOL International and,
Voting issues insolvency initiatives of, , ,
informal workouts and,
in insolvency plans, , – law reform and,
Principles and Guidelines for
procedural issues and, , Effective Insolvency and
Creditor Rights Systems,
Wages, , , – Worldcom,
Welfare state, , Wreck Recovery and Salvage Co., Re
Whistleblowing, – (), n
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