Description
Prevention of bankruptcy, simplification of bankruptcy procedures and support for a fresh start.
A second chance
for entrepreneurs
PREVENTION OF BANKRUPTCY,
SIMPLIFICATION OF BANKRUPTCY PROCEDURES
AND SUPPORT FOR A FRESH START
Final Report of the Expert Group
European Commission
Enterprise and Industry
EUROPEAN COMMISSION
ENTERPRISE AND INDUSTRY DIRECTORATE-GENERAL
Promotion of entrepreneurship and SMEs
Entrepreneurship
REPORT OF THE EXPERT GROUP
A SECOND CHANCE FOR ENTREPRENEURS:
PREVENTION OF BANKRUPTCY, SIMPLIFICATION OF
BANKRUPTCY PROCEDURES AND SUPPORT FOR A FRESH START
J anuary 2011
Legal Notice
2
This project was conducted with national experts nominated by the national authorities of
the EU Member States, Candidate/Accession Countries and EFTA/EEA countries under
the Competitiveness and Innovation Programme.
Although the work has been carried out under the guidance of the Commission officials,
the views expressed in this document do not necessarily represent the opinion of the
European Commission.
Reproduction of this report is authorised provided the source is acknowledged.
Further Information:
European Commission
Enterprise and Industry Directorate General
Unit E.1. "Entrepreneurship"
B-1049 Brussels, Belgium
E-mail: [email protected]
http://ec.europa.eu/sme2chance
Information on other Projects
Information on other projects jointly carried out by the European Commission and by the
national administrations that are addressing the issue of improving the business
environment can be found at:http://ec.europa.eu/enterprise/policies/sme/business-environment/index_en.htm
3
1. Introduction
Business entry and business exit are natural processes that are inherent to European
economic life. In fact, 50% of enterprises do not survive the first five years of their life
and of all business closures, bankruptcies account in average for 15%.
Even though today's failure can hold the germ of tomorrow's success, business closure is
not yet seen as an opportunity for a more reinvigorated entrepreneurship and business
activity. Despite their setback, failed entrepreneurs still prefer an entrepreneurial career
to a salaried job after market exit. They learn from their mistakes and those that re-start
have lower rates of failure and experience faster growth than newly established
companies
1
.
Yet, even though only 4-6% of bankruptcies are fraudulent, public opinion makes a
strong link between business failure and fraud. Many honest bankrupts feel discouraged
to re-start due to the stigma and difficulties or discrimination faced after a bankruptcy. In
addition, bankruptcy has an important secondary effect on entrepreneurship: many
would-be entrepreneurs do not start a company because of their fear of the consequences
of business failure
2
.
The latest data indicate that in the euro zone bankruptcies grew by 5% in 2010 after
having grown by 46% in 2009
3
. The deterioration in 2009 came on top of a severe
increase in 2008, that saw bankruptcies grow in Spain (+187%), Ireland (+113%),
Portugal and Denmark (+67%), Italy (+45%) and the UK (+31%). In terms of total
numbers, corporate insolvencies grew 22% in 2009 to 185,111 for Western Europe
(EU15 +Norway and Switzerland). This made it the worst year in more than a decade for
countries such as Sweden (since 1996), the United Kingdom (since 1993), the United
States and Norway (since 1992) and was an all-time negative record for countries such as
France, Spain, the Netherlands, Belgium, Switzerland, Austria, Finland, Ireland and
Portugal.
The total number of insolvency related job losses in Europe in 2009 is estimated at 1.7
million (1.2 million in 2008)
4
A second chance policy that enables formerly bankrupt entrepreneurs restart may
represent one of the most promising and under exploited policy options for company
creation and job growth.
Research shows that businesses set up by re-starters grow faster than businesses set up by
first timers in terms of turnover and jobs created
5
. But acting on second chance would
bring an even larger impact on entrepreneurship: many would-be entrepreneurs do not
1
E. Stam, D. B. Audretsch and J . Meijaard, "Renascent Entrepreneurship", ERIM, 2006.
2
The European Commission's Flash Eurobarometer 192 "Entrepreneurship Survey of the EU (25 Member States), United States
Iceland and Norway" (2007) and Flash Eurobarometer 283 "Entrepreneurship in the EU and beyond" (2009). The possibility of going
bankrupt the greatest fear of setting a business amongst European citizens ahead of the "uncertainty of income", "job insecurity" or
"need too much energy or time"
3
Euler Hermes, Communiqué de presse 4/06/2009 "Accélération historique du nombre des défaillances d’entreprises dans le monde
en 2009 : +35%"
4
Source: "Insolvencies In Europe 2009/10" CreditreformEconomic Research Unit
5
E. Stam, D. B. Audretsch and J . Meijaard, "Renascent Entrepreneurship", ERIM, 2006.
4
start a company because of their fear of the consequences of business failure
6
and
thousands of companies are not created and tens of thousands of jobs are not created
every year in Europe. Fear of bankruptcy and its consequences acts as an effective
deterrent to entrepreneurship. An effective second chance policy is fundamental to send a
message that entrepreneurship may not end up as a "life sentence" in case things go
wrong.
This report collects the conclusions and recommendations of a group of experts from 33
European countries on what are the key issues that public authorities should address to
reduce the burden of bankruptcy on entrepreneurship. It is not about how to save
companies at any cost regardless of their situation and perspectives but recognition that
public policies and programmes during the time leading to, during and beyond
bankruptcy/insolvency can create a business environment that helps entrepreneurs save
viable businesses and create more companies.
2. Latest Commission activities
7
The 2007 Communication from the Commission, “Overcoming the stigma of business
failure – for a second chance policy; implementing the Lisbon Partnership for Growth
and J obs”
8
, recognized that EU countries should facilitate “a second chance for
entrepreneurs who are at risk or have failed” and invited Member States to act in order
to reduce stigmatization of business failure.
Building on this, the Communication "A Small Business Act for Europe" (SBA)
9
,
adopted in 2008, devoted the second of its 10 principles to the issue. Principle II "Ensure
that honest entrepreneurs who have faced bankruptcy quickly get a second chance" calls
on the Commission to promote a second chance policy by facilitating exchanges of best
practicebetween Member States and asks the Member States to:
? promote a positive attitude in society towards giving entrepreneurs a fresh start,
? enable the completion of all legal procedures to wind up a business, in the case of
non-fraudulent bankruptcy, within a year,
? ensure that re-starters are treated on an equal footing with new start-ups.
3. The 2008-2010 project on Bankruptcy and Second chance
In order to fulfil its SBA commitments, the European Commission asked Member States,
EEA countries and candidate countries to nominate a representative to participate in a
two year project on "Bankruptcy and Second Chance". All EU Member States plus
Croatia, Iceland, Montenegro, Norway, Serbia and Turkey nominated an expert. The
experts met four times in 2009 and 2010 to share information and good practices and
discuss the key issues surrounding bankruptcy and second chance.
6
Flash Eurobarometer 192 "Entrepreneurship Survey of the EU (25 Member States), United States Iceland and Norway" (2007) and
Flash Eurobarometer 283 "Entrepreneurship in the EU and beyond" (2009). The possibility of going bankrupt the greatest fear of
setting a business amongst European citizens ahead of "uncertainty of income", "job insecurity" or "need too much energy or time"
7
Information on all Commission projects on bankruptcy and second chance can be found inhttp://ec.europa.eu/sme2chance
8
COM(2007) 584 final
9
COM(2008) 394 final
5
The main goal of the project was to find ways to minimise the "lost entrepreneurship
potential" associated with bankruptcy and second chance with the ultimate goal of
identifying policies that could get more companies and more jobs in the market.
The efforts of the group were supported by an independent study on "Business
Dynamics" which analysed separately the impact of current practices on entrepreneurship
in each of the areas of bankruptcy and second chance
10
This final report collects the main conclusions and key policy recommendations of the
group of experts.
Bankruptcy and 2nd chance. Conclusions
The focus of this paper is on the entrepreneur and how the processes in and around
bankruptcy and insolvency support or impede entrepreneurship with a particular focus on
second chance: supporting the return of honest failed entrepreneurs to the market.
Bankruptcy legislation has to balance two conflicting interests. On the one hand, the
creditor’s interests must be protected. On the other any system must keep viable
businesses alive and, more importantly, create an environment that aids an entrepreneur
to take risks and start a new business. This is valuable for the entrepreneur and for
society at large.
Keeping the pool of entrepreneurs in the system is essential. Entrepreneurs have specific
skills and attitudes that are not transferrable and in Europe they represent a lesser
percentage of the population than in the US. Many policies have focused on the necessity
to "produce" more entrepreneurs and not so much on the necessity to preserve the stock
of entrepreneurs.
In terms of the scope of this report we have taken a wide perspective. There are different
approaches when defining what is understood by bankruptcy and insolvency procedures
and practices, but we have taken a view similar to that of the OECD
11
, which is
presented in the scheme below:
10
The study on "Business Dynamics" covered the areas of start-up and licensing procedures, transfers of business, bankruptcy and
second chance. Available in:http://ec.europa.eu/enterprise/policies/sme/business-environment/failure-new-beginning/index_en.htm
11
CFE/SME(2006)3 "Working party on small and mediumsized enterprises and entrepreneurship – entrepreneurship policy indicators
for bankruptcy legislation in OECD member and non-member economies". OECD 2006
This paper presents separate conclusions for each of the four, consecutive sub-areas that
compose the bankruptcy process taken in its widest possible sense: from the time the
company starts experiencing considerable financial problems until the company is
eventually re-organised or liquidated and the subsequent effects of bankruptcy on the
entrepreneur.
These chapters are:
1. Prevention, (early warning systems, support mechanisms)
2. Out-of-court settlements,
3. In-court procedures,
4. Treatment of the entrepreneur post-bankruptcy and conditions for a second
chance (liquidation, discharge and its consequences)
The last chapter, "Recommendations", lists specific actions that public authorities
should undertake so that bankruptcy and second chance are more conducive to
entrepreneurship.
1. Prevention
In terms of maximising asset value and preserving jobs, a financially distressed
enterprise is usually more valuable as a going concern than if it is liquidated. It is
therefore often in the interest of all parties to have effective procedures to help
financially distressed companies. In addition, countries with efficient early warning
systems most commonly feature efficient bankruptcy and insolvency systems.
6
7
Effective prevention measures are based on the principle that, the earlier the recognition
and intervention, the better the results. Yet entrepreneurs are unlikely to request
assistance at an early stage.
Entrepreneurs are intrinsically characterised by self assurance and self reliance which
makes them regard financial difficulties as something that can always be overcome
without external involvement. In many cases, this will lead them not to seek help until it
becomes unavoidable which in many cases may mean that it is already too late. Two
additional factors reinforce this: the risk that they will lose control of their business if
they seek a financial arrangement with the creditors and more importantly, the
psychological trauma of admitting defeat will both weigh against corrective measures
being taken by the entrepreneur. Thus, there are strong "incentives" not to act in time.
Failure to take positive action when insolvency is a possibility is far too common and
will exacerbate a difficult situation.
In this context, government intervention is crucial and active assistance should be offered
to entrepreneurs in financial difficulties. Initiatives, programmes and support groups at
this stage can all play a valuable role but it is accessibility and awareness of the tools and
resources available to the entrepreneur entering the 'twilight zone' that are vital. This
assistance should be based on making the maximum use of the available structures and
support programmes, and therefore:
? Diagnostic tools should be guaranteed by public institutions since many enterprises
will not be able to afford such services on a commercial basis.
? More information from public organisations on support measures should be made
available to raise awareness by entrepreneurs
In terms of prevention, taxation can be a useful tool. Governments could take
extraordinary actions, such as tax deferrals, graded multiple payments or the reduction of
guarantees required to postpone payments, during periods of general economic duress.
Tax agreements for companies on a one to one basis can also be an option or a
development of the above point, such as, for example, renegotiating outstanding taxes
over a longer time frame for repayment. An important caveat is that these measures must
be structured and implemented in a way that do not create market distortions or undercut
general competition.
Finally, strict vigilance against payment delays by public bodies, especially during
periods of financial duress, is a key supporting tool to prevent companies falling into
insolvency.
2. Out-of-court settlements
Entrepreneurs may experience financial problems during the life of their enterprise. Yet
they are often not able to afford a long restructuring process involving external advisors
and considerable financial costs. This is particularly applicable to the smallest SMEs.
Inexpensive and simple procedures for restructuring are therefore important. Out-of-
court settlements or re-organisations offer speedier and more inexpensive solutions for
companies suffering severe financial distress and will, in the vast majority of cases, save
8
more company value than the judicial alternative. The main goal of the out-of-court
procedures must be the survival of the company as a going concern.
As with prevention, greater efforts must be made to communicate the existence and
benefits of out of court settlements amongst entrepreneurs. This is especially relevant as
it is problematic to overcome the initial reluctance from entrepreneurs to participate
because of the stigma associated with a failure. In as much as it is difficult, from a policy
point of view, to create incentives for the entrepreneur to seek financial restructuring as
early as possible, it should be possible to avoid disincentives to act, by, for example,
ensuring that the entrepreneur will be able to keep control of the business in restructuring
cases. Allowing a business to reach a compromise with its creditors, whilst providing the
freedom to trade through difficulties, can lead to a better result for all stakeholders than a
court-based process.
Also, any measures to reduce the negative image of a failed entrepreneur (or an
entrepreneur in distress) will increase the willingness of entrepreneurs in a (financial)
crisis to accept help and take the necessary actions. In this respect out-of-court
procedures must minimise publicising the entrepreneur's problems. They will not only be
a barrier to more entrepreneurs opting for this solution but may also impede the
company's turnaround if it erodes goodwill and reputation.
For out-of-court procedures to work, creditors must feel that there are guarantees to the
process. Since an informal agreement may leave some creditors out and hence risk the
integrity of the agreement, an efficient out-of-court settlement must legally preserve the
agreement for all creditors. In this respect it is important that the greatest number of
creditors and not just the largest ones are included in any refinancing process in order to
reduce stigma.
To support this process it is important that there is the right infrastructure of insolvency
and turnaround professionals to support such procedures, such as a licensed insolvency
practitioner to supervise the process and pay creditors or, as in France and Italy, where
private agreements are homologated by the court which supervises the fairness of the
agreement. This provides integrity and credibility to the process.
In order to facilitate more out-of-court procedures, it is important to recognize that:
? Success depends on a timely start of such proceedings by the entrepreneurs so they
must have access to information about out-of-court settlements.
? There is no "one size fits all" solution and a range of attractive formal "non
bankruptcy" alternatives and informal work out plans should be available to satisfy the
largest number of cases possible.
? Out-of-court procedures will be greatly supported if they include a system that
facilitates re-financing of troubled companies as an alternative to the judiciary system.
This is relevant as in the world of re-financing "size matters" and many SMEs do not
participate as they have no negotiating leverage in the process
Finally, to support the process, a company that has signed a refinancing agreement
should be allowed to participate in public tenders and public funds on equal conditions to
any other company.
3. In-court procedures
If it is not possible to re-organise a firm out-of-court, the firm can be re-organised
through formal court procedures. This will often involve drafting a re-organisation plan
and allowing the discharge of part of the debt; a solution that will normally be preferable
to both debtors and creditors if the firm is viable after the re-organisation.
If a firm is not viable it is equally important to have effective procedures for shutting it
down. In this respect data collected by the World Bank
12
strongly suggests that there is a
strong and direct link between length of procedures and loss of available company value.
Importantly, the study on Business Dynamics indicates that the level of efficiency of the
bankruptcy law is positively correlated to employment rate as it can be seen in the graph
below.
Efficiency of bankruptcy procedures versus employment rate in European countries
AT
HR
CY
FI
DE
EL
IT
LV
LT
MT
NO
PL
PT
RO
ES
SE
UK
SI
TR
BG
DK
EE
FR NL
SK
IE
0
1
2
3
4
5
6
7
40 45 50 55 60 65 70 75 80
Employment rate %
I
n
d
e
x
o
f
e
f
f
i
c
e
n
c
y
o
t
h
e
b
a
n
k
r
u
p
t
c
y
p
r
o
c
e
d
u
r
e
s
Source: Business Dynamics: Start-ups, Business Transfers and Bankruptcy", European Commission, 2011
In-court procedures provide predictability and safeguards, so an infrastructure of courts
and properly trained judiciary is indispensable. Specialised courts or specialised
practitioners or specialised support to courts is fundamental. Good laws poorly applied
do not make a good system.
A smooth credit system requires predictable, transparent, effective and affordable
systems for both secured and unsecured creditors to protect their rights. This system has
to provide a good balance between the rights of creditors and the rights of debtors and
provide protection not only for creditors but also for debtors to make reorganisation
proceedings more effective.
12
www.doingbusiness.org
9
10
If a case is launched by creditors and not by the debtor, an administrator should be
appointed and an analysis of the case should be launched immediately prior to the
opening of court procedures to minimise the risk of value loss.
Courts add time and cost and court-managed procedures may not benefit anyone. Yet,
once started, normal bankruptcy proceedings should be fast, cost-efficient and be able to
save a reasonable amount of the value of the assets. If the process takes too long, the only
certain results are that asset values will be eroded and any potential restart will be
delayed. Despite this, deadlines may not be the best solution to increase speeds as the
process needs to be as flexible as possible for practical reasons. Simplified procedures
for micro-enterprises for bankruptcy and reorganisation proceedings should be
considered by national legislators.
Simple and predictable in-court procedures will not only result in speedier processes but
will also increase the chances of cases being resolved via out-of-court procedures as in
court procedures will not be used as a delay manoeuvre by any of the parties.
Finally, in-court procedures should be a less-preferred option. In Ireland the introduction
of a Pre-Action Protocol is being considered. Under this protocol prior to creditors
bringing a petition for bankruptcy, creditors and debtors would be obliged to consider
attempting to reach a Debt Settlement Arrangement or to negotiate a voluntary debt
management plan.
4. Treatment of the entrepreneur post-bankruptcy and conditions for a 2nd chance
More and more countries have started viewing bankruptcy as a learning experience for
the entrepreneur. However, if no clear distinction is made between honest but unlucky
and dishonest or fraudulent bankrupts, honest bankrupts can be stigmatised through
association with the dishonest, especially in terms of social acceptance of the failed
entrepreneur. Thus, lack of discharge and/or lengthy and burdensome debt repayments
will make it difficult to finance a new startup.
It is therefore important to have liquidation and discharge procedures that allow the
entrepreneur a fresh start. This impacts directly those entrepreneurs who have a business
for which they are personally liable. But it will also affect the creation of new limited
companies as many banks and credit institutions demand personal guarantees from the
entrepreneur if the company is seeking to secure a loan. A study commissioned by the
Insolvency Service in the UK
13
shows that discharge periods have a very pronounced
effect on levels of entrepreneurship.
The concept of a fair and quick second chance is not adequately recognised by national
legislations. Most of the time business failure is not due to the incompetence of the
entrepreneurs but to external circumstances, yet legislation and support programmes do
not discern among an entrepreneurial failure and a personal failure. A system must be put
in place that does not exacerbate pressure by creditors to declare an entrepreneur as
dishonest.
13
Bankruptcy Law and Entrepreneurship, J . Armour and D. Cumming, University of Cambridge Centre for Business Research
Working Paper No. 300, 2005
11
This separation and strengthening of initiatives to help the re-starters should be
promoted. Amongst them increased networking among entrepreneurs / re-entrepreneurs
is important to foster a solid and realistic second chance.
The systematic recognition of honest vs. dishonest entrepreneurs is essential to reduce
the stigma from bankruptcy. There has to be more effective measures against fraudulent
bankruptcies in order to separate the non-culpable from the dishonest. In the UK,
dishonest entrepreneurs are identified by the behaviour prior to or during the bankruptcy
process (reckless expenditure of credit, paying family members, "evaporation" of assets,
etc.) and are then liable for prosecution (civil procedures can deliver protection for the
public from rogue traders in addition to any criminal punishment). This not only keeps a
level playing field in the economy but acts as a deterrent for others who might act in a
similar way. Importantly, effective mechanisms to identify wrong-doers give creditors
some safeguards and help those who come cleanly through bankruptcy gain a better
chance of a fresh start.
A modern system for discharge is paramount to reduce the stigma of bankruptcy. In this
system discharge should be as automatic and as reasonably limited in time as possible. In
principle one to three years could be a good target to aim for. Contribution beyond the
period of discharge is not reasonable and all debts should be discharged after this time.
Moral hazard has to be addressed and there has to be a good balance between comfort for
the debtor and what is acceptable for society in general and specifically for the creditors.
If the latter is disregarded there is potential for a spectacular backfire where giving a
second chance would result in a higher risk willingness of entrepreneurs (gambling) and
in turn would only result in higher interest rates charged on loans or other actions being
taken by the creditors to ensure against the higher risk of default. A good balance
between the debtor's interests and those of the creditor is crucial for all actions being
taken in order to reduce the level of stigma associated with failure.
Access to finance is paramount for a second chance. Suitable financing solutions for re-
entrepreneurs need to be put in place. Re-starting entrepreneurs need capital, cash flow
and credit, with few, if any, restrictions on future trade, without being encumbered with
long repayment periods of debts captured by a bankruptcy proceeding.
Distinction between honest and dishonest entrepreneurs should translate into non-
discrimination of those entrepreneurs which are non-fraudulent bankrupts in becoming
beneficiaries of any supportive programs available on the market for starting up a new
business whilst simultaneously avoiding any preferential treatment of "reborn"
entrepreneurs, as this may lead to unfair competition and moral hazard.
12
RECOMMENDATIONS OF THE GROUP OF EXPERTS
1
st
Recommendation
Considering the available programmes and policies, and the results that can be achieved,
Member States should prioritise their interventions to support SMEs in the following
order:
1st Prevention;
2nd Post bankruptcy and second chance;
3rd Out-of-court settlements;
4th In-court procedures.
2
nd
Recommendation
Discharge is key for second chance: a 3 year discharge and debt settlement period should
be a reasonable upper limit for an honest entrepreneur and as automatic as possible. It is
fundamental to send a message that entrepreneurship may not end up as a "life sentence"
in case things go wrong. Otherwise it acts as an effective deterrent to entrepreneurship.
3
rd
Recommendation
Decisive actions must be taken for a greater differentiation of honest and dishonest
bankruptcies. It is best to assume in principle that all are honest and then identify those
that are dishonest and prosecute/penalise them.
Insolvency regimes should differentiate between debtors who have acted honestly in their
conduct or business giving rise to the indebtedness, and those who have acted
dishonestly in that regard and contain provision that wilful non-compliance with legal
obligations by a debtor be subject to civil sanction and, where appropriate, criminal
liability.
4
th
Recommendation
Reorganisation can be extremely costly for micro and small companies to the extent that
some of them may not be able to afford it and have only bankruptcy as a viable option.
Solutions must be implemented by the legislator so that the costs of reorganisation for
SMEs are lowered. Capped fees can provide a solution. Alternative procedures must be
put in place so that adequate solutions are available for all types of SMEs. Procedures
must be proportionate to the size of the business.
5
th
Recommendation
Out-of-court procedures must be available for all types of debtors regardless of the
amount that can be repaid by the debtor.
6
th
Recommendation
Insolvency proceedings should be adjudicated upon by specialist judges. Specialised
training should be available to judges and court officers adjudicating in or administering
such proceedings.
7
th
Recommendation
The European Commission is requested to continue exchanges of information and good
practices among Member States on a regular basis.
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A second chance for entrepreneurs:
PREVENTION OF BANKRUPTCY,
SIMPLIFICATION OF BANKRUPTCY PROCEDURES
AND SUPPORT FOR A FRESH START
Final Report of the Expert Group
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doc_654366644.pdf
Prevention of bankruptcy, simplification of bankruptcy procedures and support for a fresh start.
A second chance
for entrepreneurs
PREVENTION OF BANKRUPTCY,
SIMPLIFICATION OF BANKRUPTCY PROCEDURES
AND SUPPORT FOR A FRESH START
Final Report of the Expert Group
European Commission
Enterprise and Industry
EUROPEAN COMMISSION
ENTERPRISE AND INDUSTRY DIRECTORATE-GENERAL
Promotion of entrepreneurship and SMEs
Entrepreneurship
REPORT OF THE EXPERT GROUP
A SECOND CHANCE FOR ENTREPRENEURS:
PREVENTION OF BANKRUPTCY, SIMPLIFICATION OF
BANKRUPTCY PROCEDURES AND SUPPORT FOR A FRESH START
J anuary 2011
Legal Notice
2
This project was conducted with national experts nominated by the national authorities of
the EU Member States, Candidate/Accession Countries and EFTA/EEA countries under
the Competitiveness and Innovation Programme.
Although the work has been carried out under the guidance of the Commission officials,
the views expressed in this document do not necessarily represent the opinion of the
European Commission.
Reproduction of this report is authorised provided the source is acknowledged.
Further Information:
European Commission
Enterprise and Industry Directorate General
Unit E.1. "Entrepreneurship"
B-1049 Brussels, Belgium
E-mail: [email protected]
http://ec.europa.eu/sme2chance
Information on other Projects
Information on other projects jointly carried out by the European Commission and by the
national administrations that are addressing the issue of improving the business
environment can be found at:http://ec.europa.eu/enterprise/policies/sme/business-environment/index_en.htm
3
1. Introduction
Business entry and business exit are natural processes that are inherent to European
economic life. In fact, 50% of enterprises do not survive the first five years of their life
and of all business closures, bankruptcies account in average for 15%.
Even though today's failure can hold the germ of tomorrow's success, business closure is
not yet seen as an opportunity for a more reinvigorated entrepreneurship and business
activity. Despite their setback, failed entrepreneurs still prefer an entrepreneurial career
to a salaried job after market exit. They learn from their mistakes and those that re-start
have lower rates of failure and experience faster growth than newly established
companies
1
.
Yet, even though only 4-6% of bankruptcies are fraudulent, public opinion makes a
strong link between business failure and fraud. Many honest bankrupts feel discouraged
to re-start due to the stigma and difficulties or discrimination faced after a bankruptcy. In
addition, bankruptcy has an important secondary effect on entrepreneurship: many
would-be entrepreneurs do not start a company because of their fear of the consequences
of business failure
2
.
The latest data indicate that in the euro zone bankruptcies grew by 5% in 2010 after
having grown by 46% in 2009
3
. The deterioration in 2009 came on top of a severe
increase in 2008, that saw bankruptcies grow in Spain (+187%), Ireland (+113%),
Portugal and Denmark (+67%), Italy (+45%) and the UK (+31%). In terms of total
numbers, corporate insolvencies grew 22% in 2009 to 185,111 for Western Europe
(EU15 +Norway and Switzerland). This made it the worst year in more than a decade for
countries such as Sweden (since 1996), the United Kingdom (since 1993), the United
States and Norway (since 1992) and was an all-time negative record for countries such as
France, Spain, the Netherlands, Belgium, Switzerland, Austria, Finland, Ireland and
Portugal.
The total number of insolvency related job losses in Europe in 2009 is estimated at 1.7
million (1.2 million in 2008)
4
A second chance policy that enables formerly bankrupt entrepreneurs restart may
represent one of the most promising and under exploited policy options for company
creation and job growth.
Research shows that businesses set up by re-starters grow faster than businesses set up by
first timers in terms of turnover and jobs created
5
. But acting on second chance would
bring an even larger impact on entrepreneurship: many would-be entrepreneurs do not
1
E. Stam, D. B. Audretsch and J . Meijaard, "Renascent Entrepreneurship", ERIM, 2006.
2
The European Commission's Flash Eurobarometer 192 "Entrepreneurship Survey of the EU (25 Member States), United States
Iceland and Norway" (2007) and Flash Eurobarometer 283 "Entrepreneurship in the EU and beyond" (2009). The possibility of going
bankrupt the greatest fear of setting a business amongst European citizens ahead of the "uncertainty of income", "job insecurity" or
"need too much energy or time"
3
Euler Hermes, Communiqué de presse 4/06/2009 "Accélération historique du nombre des défaillances d’entreprises dans le monde
en 2009 : +35%"
4
Source: "Insolvencies In Europe 2009/10" CreditreformEconomic Research Unit
5
E. Stam, D. B. Audretsch and J . Meijaard, "Renascent Entrepreneurship", ERIM, 2006.
4
start a company because of their fear of the consequences of business failure
6
and
thousands of companies are not created and tens of thousands of jobs are not created
every year in Europe. Fear of bankruptcy and its consequences acts as an effective
deterrent to entrepreneurship. An effective second chance policy is fundamental to send a
message that entrepreneurship may not end up as a "life sentence" in case things go
wrong.
This report collects the conclusions and recommendations of a group of experts from 33
European countries on what are the key issues that public authorities should address to
reduce the burden of bankruptcy on entrepreneurship. It is not about how to save
companies at any cost regardless of their situation and perspectives but recognition that
public policies and programmes during the time leading to, during and beyond
bankruptcy/insolvency can create a business environment that helps entrepreneurs save
viable businesses and create more companies.
2. Latest Commission activities
7
The 2007 Communication from the Commission, “Overcoming the stigma of business
failure – for a second chance policy; implementing the Lisbon Partnership for Growth
and J obs”
8
, recognized that EU countries should facilitate “a second chance for
entrepreneurs who are at risk or have failed” and invited Member States to act in order
to reduce stigmatization of business failure.
Building on this, the Communication "A Small Business Act for Europe" (SBA)
9
,
adopted in 2008, devoted the second of its 10 principles to the issue. Principle II "Ensure
that honest entrepreneurs who have faced bankruptcy quickly get a second chance" calls
on the Commission to promote a second chance policy by facilitating exchanges of best
practicebetween Member States and asks the Member States to:
? promote a positive attitude in society towards giving entrepreneurs a fresh start,
? enable the completion of all legal procedures to wind up a business, in the case of
non-fraudulent bankruptcy, within a year,
? ensure that re-starters are treated on an equal footing with new start-ups.
3. The 2008-2010 project on Bankruptcy and Second chance
In order to fulfil its SBA commitments, the European Commission asked Member States,
EEA countries and candidate countries to nominate a representative to participate in a
two year project on "Bankruptcy and Second Chance". All EU Member States plus
Croatia, Iceland, Montenegro, Norway, Serbia and Turkey nominated an expert. The
experts met four times in 2009 and 2010 to share information and good practices and
discuss the key issues surrounding bankruptcy and second chance.
6
Flash Eurobarometer 192 "Entrepreneurship Survey of the EU (25 Member States), United States Iceland and Norway" (2007) and
Flash Eurobarometer 283 "Entrepreneurship in the EU and beyond" (2009). The possibility of going bankrupt the greatest fear of
setting a business amongst European citizens ahead of "uncertainty of income", "job insecurity" or "need too much energy or time"
7
Information on all Commission projects on bankruptcy and second chance can be found inhttp://ec.europa.eu/sme2chance
8
COM(2007) 584 final
9
COM(2008) 394 final
5
The main goal of the project was to find ways to minimise the "lost entrepreneurship
potential" associated with bankruptcy and second chance with the ultimate goal of
identifying policies that could get more companies and more jobs in the market.
The efforts of the group were supported by an independent study on "Business
Dynamics" which analysed separately the impact of current practices on entrepreneurship
in each of the areas of bankruptcy and second chance
10
This final report collects the main conclusions and key policy recommendations of the
group of experts.
Bankruptcy and 2nd chance. Conclusions
The focus of this paper is on the entrepreneur and how the processes in and around
bankruptcy and insolvency support or impede entrepreneurship with a particular focus on
second chance: supporting the return of honest failed entrepreneurs to the market.
Bankruptcy legislation has to balance two conflicting interests. On the one hand, the
creditor’s interests must be protected. On the other any system must keep viable
businesses alive and, more importantly, create an environment that aids an entrepreneur
to take risks and start a new business. This is valuable for the entrepreneur and for
society at large.
Keeping the pool of entrepreneurs in the system is essential. Entrepreneurs have specific
skills and attitudes that are not transferrable and in Europe they represent a lesser
percentage of the population than in the US. Many policies have focused on the necessity
to "produce" more entrepreneurs and not so much on the necessity to preserve the stock
of entrepreneurs.
In terms of the scope of this report we have taken a wide perspective. There are different
approaches when defining what is understood by bankruptcy and insolvency procedures
and practices, but we have taken a view similar to that of the OECD
11
, which is
presented in the scheme below:
10
The study on "Business Dynamics" covered the areas of start-up and licensing procedures, transfers of business, bankruptcy and
second chance. Available in:http://ec.europa.eu/enterprise/policies/sme/business-environment/failure-new-beginning/index_en.htm
11
CFE/SME(2006)3 "Working party on small and mediumsized enterprises and entrepreneurship – entrepreneurship policy indicators
for bankruptcy legislation in OECD member and non-member economies". OECD 2006
This paper presents separate conclusions for each of the four, consecutive sub-areas that
compose the bankruptcy process taken in its widest possible sense: from the time the
company starts experiencing considerable financial problems until the company is
eventually re-organised or liquidated and the subsequent effects of bankruptcy on the
entrepreneur.
These chapters are:
1. Prevention, (early warning systems, support mechanisms)
2. Out-of-court settlements,
3. In-court procedures,
4. Treatment of the entrepreneur post-bankruptcy and conditions for a second
chance (liquidation, discharge and its consequences)
The last chapter, "Recommendations", lists specific actions that public authorities
should undertake so that bankruptcy and second chance are more conducive to
entrepreneurship.
1. Prevention
In terms of maximising asset value and preserving jobs, a financially distressed
enterprise is usually more valuable as a going concern than if it is liquidated. It is
therefore often in the interest of all parties to have effective procedures to help
financially distressed companies. In addition, countries with efficient early warning
systems most commonly feature efficient bankruptcy and insolvency systems.
6
7
Effective prevention measures are based on the principle that, the earlier the recognition
and intervention, the better the results. Yet entrepreneurs are unlikely to request
assistance at an early stage.
Entrepreneurs are intrinsically characterised by self assurance and self reliance which
makes them regard financial difficulties as something that can always be overcome
without external involvement. In many cases, this will lead them not to seek help until it
becomes unavoidable which in many cases may mean that it is already too late. Two
additional factors reinforce this: the risk that they will lose control of their business if
they seek a financial arrangement with the creditors and more importantly, the
psychological trauma of admitting defeat will both weigh against corrective measures
being taken by the entrepreneur. Thus, there are strong "incentives" not to act in time.
Failure to take positive action when insolvency is a possibility is far too common and
will exacerbate a difficult situation.
In this context, government intervention is crucial and active assistance should be offered
to entrepreneurs in financial difficulties. Initiatives, programmes and support groups at
this stage can all play a valuable role but it is accessibility and awareness of the tools and
resources available to the entrepreneur entering the 'twilight zone' that are vital. This
assistance should be based on making the maximum use of the available structures and
support programmes, and therefore:
? Diagnostic tools should be guaranteed by public institutions since many enterprises
will not be able to afford such services on a commercial basis.
? More information from public organisations on support measures should be made
available to raise awareness by entrepreneurs
In terms of prevention, taxation can be a useful tool. Governments could take
extraordinary actions, such as tax deferrals, graded multiple payments or the reduction of
guarantees required to postpone payments, during periods of general economic duress.
Tax agreements for companies on a one to one basis can also be an option or a
development of the above point, such as, for example, renegotiating outstanding taxes
over a longer time frame for repayment. An important caveat is that these measures must
be structured and implemented in a way that do not create market distortions or undercut
general competition.
Finally, strict vigilance against payment delays by public bodies, especially during
periods of financial duress, is a key supporting tool to prevent companies falling into
insolvency.
2. Out-of-court settlements
Entrepreneurs may experience financial problems during the life of their enterprise. Yet
they are often not able to afford a long restructuring process involving external advisors
and considerable financial costs. This is particularly applicable to the smallest SMEs.
Inexpensive and simple procedures for restructuring are therefore important. Out-of-
court settlements or re-organisations offer speedier and more inexpensive solutions for
companies suffering severe financial distress and will, in the vast majority of cases, save
8
more company value than the judicial alternative. The main goal of the out-of-court
procedures must be the survival of the company as a going concern.
As with prevention, greater efforts must be made to communicate the existence and
benefits of out of court settlements amongst entrepreneurs. This is especially relevant as
it is problematic to overcome the initial reluctance from entrepreneurs to participate
because of the stigma associated with a failure. In as much as it is difficult, from a policy
point of view, to create incentives for the entrepreneur to seek financial restructuring as
early as possible, it should be possible to avoid disincentives to act, by, for example,
ensuring that the entrepreneur will be able to keep control of the business in restructuring
cases. Allowing a business to reach a compromise with its creditors, whilst providing the
freedom to trade through difficulties, can lead to a better result for all stakeholders than a
court-based process.
Also, any measures to reduce the negative image of a failed entrepreneur (or an
entrepreneur in distress) will increase the willingness of entrepreneurs in a (financial)
crisis to accept help and take the necessary actions. In this respect out-of-court
procedures must minimise publicising the entrepreneur's problems. They will not only be
a barrier to more entrepreneurs opting for this solution but may also impede the
company's turnaround if it erodes goodwill and reputation.
For out-of-court procedures to work, creditors must feel that there are guarantees to the
process. Since an informal agreement may leave some creditors out and hence risk the
integrity of the agreement, an efficient out-of-court settlement must legally preserve the
agreement for all creditors. In this respect it is important that the greatest number of
creditors and not just the largest ones are included in any refinancing process in order to
reduce stigma.
To support this process it is important that there is the right infrastructure of insolvency
and turnaround professionals to support such procedures, such as a licensed insolvency
practitioner to supervise the process and pay creditors or, as in France and Italy, where
private agreements are homologated by the court which supervises the fairness of the
agreement. This provides integrity and credibility to the process.
In order to facilitate more out-of-court procedures, it is important to recognize that:
? Success depends on a timely start of such proceedings by the entrepreneurs so they
must have access to information about out-of-court settlements.
? There is no "one size fits all" solution and a range of attractive formal "non
bankruptcy" alternatives and informal work out plans should be available to satisfy the
largest number of cases possible.
? Out-of-court procedures will be greatly supported if they include a system that
facilitates re-financing of troubled companies as an alternative to the judiciary system.
This is relevant as in the world of re-financing "size matters" and many SMEs do not
participate as they have no negotiating leverage in the process
Finally, to support the process, a company that has signed a refinancing agreement
should be allowed to participate in public tenders and public funds on equal conditions to
any other company.
3. In-court procedures
If it is not possible to re-organise a firm out-of-court, the firm can be re-organised
through formal court procedures. This will often involve drafting a re-organisation plan
and allowing the discharge of part of the debt; a solution that will normally be preferable
to both debtors and creditors if the firm is viable after the re-organisation.
If a firm is not viable it is equally important to have effective procedures for shutting it
down. In this respect data collected by the World Bank
12
strongly suggests that there is a
strong and direct link between length of procedures and loss of available company value.
Importantly, the study on Business Dynamics indicates that the level of efficiency of the
bankruptcy law is positively correlated to employment rate as it can be seen in the graph
below.
Efficiency of bankruptcy procedures versus employment rate in European countries
AT
HR
CY
FI
DE
EL
IT
LV
LT
MT
NO
PL
PT
RO
ES
SE
UK
SI
TR
BG
DK
EE
FR NL
SK
IE
0
1
2
3
4
5
6
7
40 45 50 55 60 65 70 75 80
Employment rate %
I
n
d
e
x
o
f
e
f
f
i
c
e
n
c
y
o
t
h
e
b
a
n
k
r
u
p
t
c
y
p
r
o
c
e
d
u
r
e
s
Source: Business Dynamics: Start-ups, Business Transfers and Bankruptcy", European Commission, 2011
In-court procedures provide predictability and safeguards, so an infrastructure of courts
and properly trained judiciary is indispensable. Specialised courts or specialised
practitioners or specialised support to courts is fundamental. Good laws poorly applied
do not make a good system.
A smooth credit system requires predictable, transparent, effective and affordable
systems for both secured and unsecured creditors to protect their rights. This system has
to provide a good balance between the rights of creditors and the rights of debtors and
provide protection not only for creditors but also for debtors to make reorganisation
proceedings more effective.
12
www.doingbusiness.org
9
10
If a case is launched by creditors and not by the debtor, an administrator should be
appointed and an analysis of the case should be launched immediately prior to the
opening of court procedures to minimise the risk of value loss.
Courts add time and cost and court-managed procedures may not benefit anyone. Yet,
once started, normal bankruptcy proceedings should be fast, cost-efficient and be able to
save a reasonable amount of the value of the assets. If the process takes too long, the only
certain results are that asset values will be eroded and any potential restart will be
delayed. Despite this, deadlines may not be the best solution to increase speeds as the
process needs to be as flexible as possible for practical reasons. Simplified procedures
for micro-enterprises for bankruptcy and reorganisation proceedings should be
considered by national legislators.
Simple and predictable in-court procedures will not only result in speedier processes but
will also increase the chances of cases being resolved via out-of-court procedures as in
court procedures will not be used as a delay manoeuvre by any of the parties.
Finally, in-court procedures should be a less-preferred option. In Ireland the introduction
of a Pre-Action Protocol is being considered. Under this protocol prior to creditors
bringing a petition for bankruptcy, creditors and debtors would be obliged to consider
attempting to reach a Debt Settlement Arrangement or to negotiate a voluntary debt
management plan.
4. Treatment of the entrepreneur post-bankruptcy and conditions for a 2nd chance
More and more countries have started viewing bankruptcy as a learning experience for
the entrepreneur. However, if no clear distinction is made between honest but unlucky
and dishonest or fraudulent bankrupts, honest bankrupts can be stigmatised through
association with the dishonest, especially in terms of social acceptance of the failed
entrepreneur. Thus, lack of discharge and/or lengthy and burdensome debt repayments
will make it difficult to finance a new startup.
It is therefore important to have liquidation and discharge procedures that allow the
entrepreneur a fresh start. This impacts directly those entrepreneurs who have a business
for which they are personally liable. But it will also affect the creation of new limited
companies as many banks and credit institutions demand personal guarantees from the
entrepreneur if the company is seeking to secure a loan. A study commissioned by the
Insolvency Service in the UK
13
shows that discharge periods have a very pronounced
effect on levels of entrepreneurship.
The concept of a fair and quick second chance is not adequately recognised by national
legislations. Most of the time business failure is not due to the incompetence of the
entrepreneurs but to external circumstances, yet legislation and support programmes do
not discern among an entrepreneurial failure and a personal failure. A system must be put
in place that does not exacerbate pressure by creditors to declare an entrepreneur as
dishonest.
13
Bankruptcy Law and Entrepreneurship, J . Armour and D. Cumming, University of Cambridge Centre for Business Research
Working Paper No. 300, 2005
11
This separation and strengthening of initiatives to help the re-starters should be
promoted. Amongst them increased networking among entrepreneurs / re-entrepreneurs
is important to foster a solid and realistic second chance.
The systematic recognition of honest vs. dishonest entrepreneurs is essential to reduce
the stigma from bankruptcy. There has to be more effective measures against fraudulent
bankruptcies in order to separate the non-culpable from the dishonest. In the UK,
dishonest entrepreneurs are identified by the behaviour prior to or during the bankruptcy
process (reckless expenditure of credit, paying family members, "evaporation" of assets,
etc.) and are then liable for prosecution (civil procedures can deliver protection for the
public from rogue traders in addition to any criminal punishment). This not only keeps a
level playing field in the economy but acts as a deterrent for others who might act in a
similar way. Importantly, effective mechanisms to identify wrong-doers give creditors
some safeguards and help those who come cleanly through bankruptcy gain a better
chance of a fresh start.
A modern system for discharge is paramount to reduce the stigma of bankruptcy. In this
system discharge should be as automatic and as reasonably limited in time as possible. In
principle one to three years could be a good target to aim for. Contribution beyond the
period of discharge is not reasonable and all debts should be discharged after this time.
Moral hazard has to be addressed and there has to be a good balance between comfort for
the debtor and what is acceptable for society in general and specifically for the creditors.
If the latter is disregarded there is potential for a spectacular backfire where giving a
second chance would result in a higher risk willingness of entrepreneurs (gambling) and
in turn would only result in higher interest rates charged on loans or other actions being
taken by the creditors to ensure against the higher risk of default. A good balance
between the debtor's interests and those of the creditor is crucial for all actions being
taken in order to reduce the level of stigma associated with failure.
Access to finance is paramount for a second chance. Suitable financing solutions for re-
entrepreneurs need to be put in place. Re-starting entrepreneurs need capital, cash flow
and credit, with few, if any, restrictions on future trade, without being encumbered with
long repayment periods of debts captured by a bankruptcy proceeding.
Distinction between honest and dishonest entrepreneurs should translate into non-
discrimination of those entrepreneurs which are non-fraudulent bankrupts in becoming
beneficiaries of any supportive programs available on the market for starting up a new
business whilst simultaneously avoiding any preferential treatment of "reborn"
entrepreneurs, as this may lead to unfair competition and moral hazard.
12
RECOMMENDATIONS OF THE GROUP OF EXPERTS
1
st
Recommendation
Considering the available programmes and policies, and the results that can be achieved,
Member States should prioritise their interventions to support SMEs in the following
order:
1st Prevention;
2nd Post bankruptcy and second chance;
3rd Out-of-court settlements;
4th In-court procedures.
2
nd
Recommendation
Discharge is key for second chance: a 3 year discharge and debt settlement period should
be a reasonable upper limit for an honest entrepreneur and as automatic as possible. It is
fundamental to send a message that entrepreneurship may not end up as a "life sentence"
in case things go wrong. Otherwise it acts as an effective deterrent to entrepreneurship.
3
rd
Recommendation
Decisive actions must be taken for a greater differentiation of honest and dishonest
bankruptcies. It is best to assume in principle that all are honest and then identify those
that are dishonest and prosecute/penalise them.
Insolvency regimes should differentiate between debtors who have acted honestly in their
conduct or business giving rise to the indebtedness, and those who have acted
dishonestly in that regard and contain provision that wilful non-compliance with legal
obligations by a debtor be subject to civil sanction and, where appropriate, criminal
liability.
4
th
Recommendation
Reorganisation can be extremely costly for micro and small companies to the extent that
some of them may not be able to afford it and have only bankruptcy as a viable option.
Solutions must be implemented by the legislator so that the costs of reorganisation for
SMEs are lowered. Capped fees can provide a solution. Alternative procedures must be
put in place so that adequate solutions are available for all types of SMEs. Procedures
must be proportionate to the size of the business.
5
th
Recommendation
Out-of-court procedures must be available for all types of debtors regardless of the
amount that can be repaid by the debtor.
6
th
Recommendation
Insolvency proceedings should be adjudicated upon by specialist judges. Specialised
training should be available to judges and court officers adjudicating in or administering
such proceedings.
7
th
Recommendation
The European Commission is requested to continue exchanges of information and good
practices among Member States on a regular basis.
ENTERPRISE & INDUSTRY MAGAZINE
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(http://ec.europa.eu/enterprise/e_i/index_en.htm) covers issues related to SMEs,
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13
A second chance for entrepreneurs:
PREVENTION OF BANKRUPTCY,
SIMPLIFICATION OF BANKRUPTCY PROCEDURES
AND SUPPORT FOR A FRESH START
Final Report of the Expert Group
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