Resolving Bankruptcy: Laws That Govern the Restructuring or Dissolution of Insolvent Companies Continue to Evolve Worldwide

By Mota, Diana | Business Credit, May 2015 | Go to article overview

Resolving Bankruptcy: Laws That Govern the Restructuring or Dissolution of Insolvent Companies Continue to Evolve Worldwide


Mota, Diana, Business Credit


The comingling of various adverse factors on the heels of the 2008 financial crisis has inspired a number of countries--including the United States--to re-evaluate or reform their bankruptcy laws. The global economic downturn, credit crunch and reduction in cross-border lending, trade finance, remittances and foreign direct investment converged to create an environment ripe for addressing weaknesses within insolvency structures worldwide, said World Bank's Leora Klapper in a blog entitled "The Challenges of Bankruptcy Reform."

"The increase in the number of distressed firms has made policymakers more concerned about the effectiveness of existing bankruptcy regimes, including both the laws that address reorganization and liquidation, as well as improved enforcement of laws in court," wrote Klapper, a lead economist with the Finance and Private Sector Research Team of the Development Research Group. Klapper also recently co-authored a paper on the challenges of bankruptcy reform, which summarizes theoretical and empirical literature on designing bankruptcy laws, discusses challenges of introducing and implementing bankruptcy reforms and presents examples of recent global reforms.

Theoretical and empirical literature on designing bankruptcy laws show a consensus "that effective bankruptcy laws that allow viable firms to reorganize and unviable ones to liquidate or be sold is a necessary condition for economic growth," Klapper said. "Such laws encourage new firms to enter and surviving firms to become more efficient. In the alternative scenario where bankruptcy is costly, timely and recovery rates are low, inefficient firms tend to be reluctant to file for bankruptcy and continue to operate at a financial loss."

As conditions change, legislators make an effort to change the laws, said John McMickle, president of JDM Public Strategies and a former counsel to the U.S. Senate Judiciary Committee. "Bankruptcy laws tend to lag a bit. It takes government a little time to catch up."

Since the peak period of the crisis, World Banks Doing Business project found at least 65 global economies have made changes to their insolvency regimes. "The global financial crisis spurred bankruptcy reforms around the world," it states on its website. Systems were tested in unprecedented ways. "How insolvencies are resolved matters for the health of an economy." Many countries look to the United States' bankruptcy structure when revising their own, said Bruce Nathan, Esq., a partner at Lowenstein Sandler LLP. As laws change, members who do business with other countries should keep abreast of the changes.

The Basis of Bankruptcy Laws in Other Countries

Substantial divides exist between countries in the use of legal procedures "because of differences in legal traditions, accounting standards, regulatory frameworks, capital market structure and macroeconomic factors," Klapper said. "For instance, bankruptcies are less common in countries with concentrated banking relationships and are more common in countries with firms that have more complex capital structures." Local social norms and stigmas about responsibility also influence the resolution of insolvency.

Popular trends included shorter time limits on bankruptcy procedures (Lithuania, Tajikistan) and the establishment of reorganization procedures or prepackaged arrangements (Italy, Kuwait, Czech Republic, Poland, Estonia, Mauritius, Uruguay, Rwanda, Sierra Leone, Philippines and France). Some countries even unveiled new professional requirements for bankruptcy administrators. "For example, Albania, Colombia and Russia introduced new licensing requirements for bankruptcy receivers and training courses to improve professional qualification standards," Klapper said.

World Bank's Doing Business studies the time, cost and outcome of insolvency proceedings. It now also measures the Strength of Insolvency Framework Index, which evaluates the adequacy and integrity of the legal framework applicable to liquidation and reorganization proceedings. …

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