Description
The Uneasy Case For Bankruptcy Legislation And Business Rescue
1
Prof. dr. Jan Adriaanse
1
The uneasy case for bankruptcy legislation and business rescue
Preface
This article
2
proposes that the attempt to strengthen insolvency legislations, in terms of
‘promoting the ability to reorganize and rescue a company in distress’ through adaptations in
European bankruptcy laws, is insufficient in saving companies from bankruptcy. Moreover, new
legislations in the current ‘corporate rescue culture’ may actually have the opposite effect. The
real issue in a rescue attempt is rebuilding trust amongst all parties involved. Legislation and
financial restructuring are only to be considered means in reaching this goal.
1. Corporate rescue trend
Currently a ‘corporate rescue trend’ can be spotted worldwide where each country would ideally
have effective legislation in place, focused on ‘reorganization and rehabilitation of the debtor’.
3
By adopting rehabilitation paragraphs in insolvency legislation, the aim is to reduce the amount
of viable businesses that fall prey to liquidation (bankruptcy). In that line of thought, insolvency
legislation ought to encourage companies to look for protection against creditors at an early stage
in order to create a ‘stable environment’ in which the company can get ‘back on its feet’, with the
appointed administrator playing a central role.
1
Jan Adriaanse is professor of turnaround management at the department of Business Studies of the Leiden
Law School in the Netherlands.
2
This article is based on a previously published article in Dutch insolvency journal ‘TvI’. Current content
is updated en revised. See: Adriaanse, J.A.A., J.G. Kuijl, W.P. Moleveld, Faillissementswetgeving redt
bedrijven niet, Tijdschrift voor Insolventierecht (TvI), 2007, p. 149-154.
3
See for example current IMF, World bank, UNCITRAL, Asian Development Bank and EU
(web)publications on the subject. For an overview of more historic developments regarding the subject, see
among others: J.A.A. Adriaanse, Restructuring in the Shadow of the Law. Informal Reorganisation in the
Netherlands (diss. Leiden), Deventer: Kluwer 2005.
2
2. The problem
Although I am not in principle against the aims of bankruptcy legislation reform, I cannot fail to
observe a fundamental problem. Empirical evidence shows that companies in financial difficulties
can only be saved when a process of active turnaround and stakeholder management is initiated.
In this, altering bankruptcy legislation is - in the best case scenario - a positive contribution, no
more than that. The potential downside is however that new judicial debtor-friendly instruments
(or one could say: creditor-unfriendly instruments) to be put in place will (further) isolate
important lenders (banks, suppliers/creditors etc.). Furthermore, placing a great(er) emphasis on
‘forced’ deals within and outside of insolvency – think about debt-discharge voting-mechanisms
(‘haircuts’) - will further complicate reorganizations rather than provide solutions. Bankruptcy
legislation – at least the reorganization paragraph thereof – ought to be viewed as an ‘option of
last resort’
4
, which should be treated with caution, or at least not freely and opportunistically
‘applied’ in case of financial difficulty by entrepreneurs and their advisors.
Below, these arguments are strengthened by use of several findings from a research project
conducted by Leiden University between 2003-2005. Currently, researchers in Leiden are
working on new projects which are partially aimed at mapping causes for financial difficulties in
practice. The first results seem to underline these earlier findings.
The earlier research has been conducted at the so-called Intensive care divisions of four Dutch
banks - ABN-Amro, Rabobank, ING and [now former bank] Fortis - as well as a number of
consultancy firms. The size of the enterprise was made irrelevant; an average of the Dutch
businesses has been researched in the project. In total 35 attempts to save companies from
bankruptcy have been examined, by use of intensive case-study research, as well as 23 interviews
4
See also V. Finch, ‘The Recasting of Insolvency Law’, The Modern Law Review, Vol. 68, nr. 5, 2005, p.
713-736.
3
and over 465 surveys have been conducted (among insolvency office holders, SME-accountants,
credit managers and turnaround consultants).
5
The results have been, for the purpose of this
article, tested against a number of standard works within the turnaround literature, such as (but
not limited to): Argenti (1976), Bibeault (1982) and Slatter & Lovett (1999).
6
3. Difficulties in a rescue mission
The current ‘rescue rush’ by legislators seems mainly driven by the phenomenon that many
formal (court-led) reorganizations in practice actually fail. From that perspective it is vital to
address the many bottlenecks and fail factors in practice. Clearly, revised legislation should be
aimed at eliminating difficulties which practice (so far) has not been able to eliminate. Based on
the conducted research, the following summary of difficulties can be formulated (written down in
the form of a worst practice overview).
Firstly, there is often an underestimation by management concerning the necessity for quick,
comprehensive and adequate reorganization of the business activities from an integral new vision
and strategy. When underlying causes of financial difficulties are examined, (1) lack of strategic
entrepreneurship, (2) insufficient financial insight, and (3) too high variable and fixed (overhead)
costs have been identified; these being the three most prominent categories.
In virtually any case of a (near) bankrupt company – be it a local convenience store or a
multinational enterprise – one can detect that questions such as: “in which markets is the
company active?” “In which one should it be active?” As well as: “In which way should it be
active?”, have been insufficiently posed. This also applies to questions like: “what are the true
5
For more information about the problem definition, research plan and results, see Adriaanse (2005).
6
See J. Argenti, Corporate Collapse: The Causes and Symptoms, McGraw-Hill, London, 1976, D.B.
Bibeault, Corporate Turnaround. How managers turn losers into winners, Mcgraw-Hill Book Company,
New York, 1982 (reprint 1998) and S. Slatter, D. Lovett, Corporate Turnaround, managing companies in
distress, Penguin Books, London, 1999.
4
‘needs’ of the company’s customers?” “Who are the major (and true) competitors?” And “What is
truly the competitive advantage (unique selling point) of the company?”. More often than not, a
discrepancy can be detected– an assumption gap – between the necessary market behavior and
the actual behavior of the company in practice. Apart from a faulty strategy, distressed companies
also appear to be insufficiently driven by parameters (key performance indicators) such as profit,
cash-flow, solvency and liquidity.
7
There is often a weak administrative organization and
insufficient cash planning which can cause expenses to get out of hand without management
noticing. In short, there are invisible inefficiencies in the primary process of the company which
explains why so often action is taken (too) late. The final factor to be addressed here, the use of
an (iterative) business plan as a management tool, is utilized relatively rarely, even though there
is an (empirically proven) positive correlation between plan-driven entrepreneurship – where a
combination of acting strategically based on financial insights takes a central role – and the
diminishing likelihood of bankruptcy.
8
Actually, 71% of the respondents in our survey among
insolvency office holders confirmed that in court-led reorganizations a sound business turnaround
plan is most of the time missing.
9
On top of that, managers are often insufficiently aware of the
severity of the crisis situation in which they find themselves and are also frequently hesitant –
particularly in SME-related situations – to involve specialized turnaround advisers.
Another recurring theme is that important financiers such as banks and large suppliers are often
consciously left out of the reorganization-process. Management does not allow much or any say
in the turnaround process and/or is scared of informing (read: ‘scaring off’) these parties of their
financial loss-making situation. Additionally, junior creditors are often confronted in a too late a
7
Regarding solvency and liquidity ratios, see e.g. B. Ganguin, J. Bilardello, Fundamentals of Corporate
Credit Analysis, McGraw-Hill, New York, 2005, p. 80-107.
8
See e.g. S.C. Perry, ‘The relation between written business plans and the failure of small businesses in the
U.S.’, Journal of Small Business Management, nr. 39(3), 2001, p. 201-208.
9
See Adriaanse 2005, p. 337
5
stadium with (often harsh) proposals for discharge of debts. On top of that, management is
frequently insufficiently transparent towards involved parties concerning the reorganization
process and the development of the financial situation. In this manner, parties involved do not
have sufficient information to estimate the ever-changing risks involved. Finally, through a
worsened situation (read: financial losses) solvency and liquidity has often greatly deteriorated. In
a large number of failed rescue operations, the possibilities of addressing private equity and/or
looking for take-over attempts appear to have been insufficiently researched, this in combination
with the aforementioned difficulties.
4. Restoration of trust
The research conclusively underlines that the factors that cause failure are often a result of lack of
communication between involved parties, as well as their respective levels of risk perception. In
fact, one could say that the potential for a successful rescue operation is mostly dependent on the
question whether or not the management team can adequately convince its most important
financers of the viability of their struggling business. In other words, the main issue is whether
management is sufficiently able to create trust i.e. restore trust in light of (potential) future
viability of the company, as well as in its own entrepreneurial (i.e. managerial) capabilities to
guide the distressed firm to that desired future state. In other words, the core question is whether
those in charge of the company are able to manage creditors’ perceptions such that they feel that
‘their interests will be met, for they are in good hands’. This is of vital importance, for when
financiers (once more) support the company, room has been created for a solution because of the
renewed availability of time – a basic condition – as well as credit (the latter both literally and
figuratively). In other words, through engaging with creditors and providing them with ample
insight into the financial situation and ultimately a sound turnaround plan, a solid basis for
success is created. Also, pro-actively communicating during the reorganization about the
progress, as well as embodying a clear intention not to transfer entrepreneurial risk to creditors
6
(unless no others options are left), the chance of conflicts and unwillingness of creditors to
cooperate will likely decrease tremendously, and with it the chance of bankruptcy. Conversely,
conflicts (with potential disastrous consequences) are significantly increased when the factors
discussed above are ignored. The restoration of damaged relationships is therefore an essential
part of any business rescue attempt; this being completely contradictory to judicial means that
have been designed to keep creditors at bay and/or force them to discharge debts. In that case a
company does not create ‘natural viability’; in other words, involved financiers and suppliers
have to be intrinsically motivated to support the survival of the company, they should not be
‘blackmailed by insolvency law’. In this light, it is evident that by judicially forcing a company to
abandon its contractual rights – what most rehabilitation procedures in fact imply – it is
impossible to achieve needed trust. So, based on the points mentioned above, attempts to do so
should be minimized as much as possible in order to increase success rates of business rescue. In
other words, combatting the aforementioned bottlenecks with new insolvency legislations is
simply fruitless, also because suppliers and financiers will probably ex-ante sharpen their credit
and risk management systems in turn, simply in order to restore the natural balance i.e. the
desired cooperation model between companies, banks and other creditors.
10
They will in a much
earlier stage than currently is the case – perfectly fair since they are the providers of risk-averse
capital – take precautionary measures. For instance, by asking for direct upfront payments and/or
to denounce (trade)credit agreements sooner. Apart from this, one should not forget that in case
of approaching insolvency, economically speaking, creditors already become part-owners –
indeed, the company is at this point mostly comprised of debt – and finds itself in a situation
where future existence is for the most part in their hands. The call for right of say, supervision
and insight are in this situation very well explicable and these instruments ought not to be
discarded without proper consideration. On top of that, external stakeholders often have
10
See in the same sense Finch 2006, p. 713ff. and D.G. Baird, R.K. Rasmussen, ‘The End of Bankruptcy’,
Stanford Law Review, Vol. 55, 2002-2003, p. 751-789.
7
substantial market knowledge and in particular banks have in-depth knowledge concerning
dealing with turnaround and restructuring challenges. In that light the involvement of creditors
should most certainly be viewed as positive; research from e.g. Couwenberg and De Jong
confirms this view, particularly concerning the role of banks.
11
Furthermore, none of the involved
stakeholders will be primarily interested in forcing bankruptcy (liquidation). This ‘last resort’ will
only be addressed when the viability of the company, or at least the perceived viability thereof
has proven to be completely lost; this, after careful consideration amongst stakeholders and often
only after an extensive period of monitoring – could a newly appointed administrator truly make
a difference in case of perceived viability lost? The answer is most likely to be negative.
5. Ability to reorganize
In the process of value restoration and new to be found viability
12
, the (turnaround) vision and
strategy ought to be utilized in an integrated fashion in order to tackle problems. Indeed, durante
causa durat effectus, if the fundamental causes of decline are not eliminated the (negative) results
will continue to appear. Financial restructuring – e.g. in the form of an informal or judicially
forced debt-agreement with remission – as well as cutting costs are always merely means during
the search for renewed trust, the search for new customers, and with that the search for viability
of the company in the long term. No more, no less. A reorganization of debt as such does not in
any shape or form contribute to the renewed viability of the company; it merely functions as an
(undesirable) ‘emergency brake’ when there is insufficient time to address liquidity influxes.
Thus, a company does not revive (‘phoenixesque’) unless the involved parties – shareholders,
management, suppliers, banks/creditors, customers, employees – explicitly or implicitly feel that
11
See O. Couwenberg, & A. de Jong, (2006). It takes two to tango: An empirical tale of distressed firms
and assisting banks, International Review of Law and Economics, 26, pp. 429-454.
12
See in the same sense N.R. Pandit, ‘Some recommendations for improved research on corporate
turnaround’, M@n@gement, Vol. 3, No. 2, 2000, p. 31.
8
their cooperation (‘nexus of contracts’
13
) ought to stay intact. However, they will only agree with
this sentiment in case it be in their best interest. A company can therefore survive solely in case
value is created for all stakeholders involved. As long as this is the case, the tendency will be to
maintain cooperation. By not breaking up the (current and potential) nexus of contracts – in effect
by filing for bankruptcy liquidation – the stakeholders show the perceived (going concern) value
of their cooperation. In turn, when bankruptcy is indeed filed, the deciders – for instance the
company’s main bank that terminates its credit, employees that file for bankruptcy,
simultaneously or not with (a group of) competing junior creditors/suppliers – do not perceive the
added value and with that the viability of the company: cooperation has been terminated and the
end is near. Parties that want to prevent such a scenario – for instance management and/or
shareholders – thus ought not to blindly trust in a judicial reorganization procedure, and they
should (remain to) show the potential economic value of the now distressed company. The only
way to achieve this is to, on the one hand, utilize a structured and methodical process of value
recovery – by use of a turnaround vision and strategy which translates into a detailed yet
pragmatic turnaround management process – and on the other hand by actively managing
perceptions of all stakeholders involved. By use of this methodology, the chance augments that
the company will once more be able to independently prosper and with that prove its (long-term)
viability. The ‘ability to reorganize’ can therefore be viewed as the equivalent of the ability to
create value and the restoration of trust as such. It is therefore a necessity that discussions
regarding ‘insolvency rehabilitation legislation’ focus more on above mentioned aspects.
Otherwise, the imminent danger is that the emphasis will lie too much on e.g. more ‘debtor-
friendly’ voting quorums for compulsory settlements, as well as other ways to distance creditors,
13
See among others M.C. Jensen, W.H. Meckling, ‘Theory of the Firm: Managerial Behavior, Agency
Costs and Ownership Structure’, Journal of Financial Economics, Vol. 3, 1976, p. 305-360 en R.R.
Kraakman e.a., The Anatomy of Corporate Law, A Comparative and Functional Approach, Oxford: Oxford
University Press 2004, p. 6-8.
9
which will in fact emphasize the factors that in practice have proven to lead to failure, therefore
possibly leading to the reverse of the desired result.
Co-funded by the
Civil Justice Programme
of the European Union
Co-funded by the
International Insolvency Institute
Disclaimer
This publication has been produced with the financial support of the Civil Justice
Programme of the European Union. The contents of this publication are the sole
responsibility of Leiden University and/or Trent University and can in no way be taken to
reflect the views of the European Commission.
doc_993309558.pdf
The Uneasy Case For Bankruptcy Legislation And Business Rescue
1
Prof. dr. Jan Adriaanse
1
The uneasy case for bankruptcy legislation and business rescue
Preface
This article
2
proposes that the attempt to strengthen insolvency legislations, in terms of
‘promoting the ability to reorganize and rescue a company in distress’ through adaptations in
European bankruptcy laws, is insufficient in saving companies from bankruptcy. Moreover, new
legislations in the current ‘corporate rescue culture’ may actually have the opposite effect. The
real issue in a rescue attempt is rebuilding trust amongst all parties involved. Legislation and
financial restructuring are only to be considered means in reaching this goal.
1. Corporate rescue trend
Currently a ‘corporate rescue trend’ can be spotted worldwide where each country would ideally
have effective legislation in place, focused on ‘reorganization and rehabilitation of the debtor’.
3
By adopting rehabilitation paragraphs in insolvency legislation, the aim is to reduce the amount
of viable businesses that fall prey to liquidation (bankruptcy). In that line of thought, insolvency
legislation ought to encourage companies to look for protection against creditors at an early stage
in order to create a ‘stable environment’ in which the company can get ‘back on its feet’, with the
appointed administrator playing a central role.
1
Jan Adriaanse is professor of turnaround management at the department of Business Studies of the Leiden
Law School in the Netherlands.
2
This article is based on a previously published article in Dutch insolvency journal ‘TvI’. Current content
is updated en revised. See: Adriaanse, J.A.A., J.G. Kuijl, W.P. Moleveld, Faillissementswetgeving redt
bedrijven niet, Tijdschrift voor Insolventierecht (TvI), 2007, p. 149-154.
3
See for example current IMF, World bank, UNCITRAL, Asian Development Bank and EU
(web)publications on the subject. For an overview of more historic developments regarding the subject, see
among others: J.A.A. Adriaanse, Restructuring in the Shadow of the Law. Informal Reorganisation in the
Netherlands (diss. Leiden), Deventer: Kluwer 2005.
2
2. The problem
Although I am not in principle against the aims of bankruptcy legislation reform, I cannot fail to
observe a fundamental problem. Empirical evidence shows that companies in financial difficulties
can only be saved when a process of active turnaround and stakeholder management is initiated.
In this, altering bankruptcy legislation is - in the best case scenario - a positive contribution, no
more than that. The potential downside is however that new judicial debtor-friendly instruments
(or one could say: creditor-unfriendly instruments) to be put in place will (further) isolate
important lenders (banks, suppliers/creditors etc.). Furthermore, placing a great(er) emphasis on
‘forced’ deals within and outside of insolvency – think about debt-discharge voting-mechanisms
(‘haircuts’) - will further complicate reorganizations rather than provide solutions. Bankruptcy
legislation – at least the reorganization paragraph thereof – ought to be viewed as an ‘option of
last resort’
4
, which should be treated with caution, or at least not freely and opportunistically
‘applied’ in case of financial difficulty by entrepreneurs and their advisors.
Below, these arguments are strengthened by use of several findings from a research project
conducted by Leiden University between 2003-2005. Currently, researchers in Leiden are
working on new projects which are partially aimed at mapping causes for financial difficulties in
practice. The first results seem to underline these earlier findings.
The earlier research has been conducted at the so-called Intensive care divisions of four Dutch
banks - ABN-Amro, Rabobank, ING and [now former bank] Fortis - as well as a number of
consultancy firms. The size of the enterprise was made irrelevant; an average of the Dutch
businesses has been researched in the project. In total 35 attempts to save companies from
bankruptcy have been examined, by use of intensive case-study research, as well as 23 interviews
4
See also V. Finch, ‘The Recasting of Insolvency Law’, The Modern Law Review, Vol. 68, nr. 5, 2005, p.
713-736.
3
and over 465 surveys have been conducted (among insolvency office holders, SME-accountants,
credit managers and turnaround consultants).
5
The results have been, for the purpose of this
article, tested against a number of standard works within the turnaround literature, such as (but
not limited to): Argenti (1976), Bibeault (1982) and Slatter & Lovett (1999).
6
3. Difficulties in a rescue mission
The current ‘rescue rush’ by legislators seems mainly driven by the phenomenon that many
formal (court-led) reorganizations in practice actually fail. From that perspective it is vital to
address the many bottlenecks and fail factors in practice. Clearly, revised legislation should be
aimed at eliminating difficulties which practice (so far) has not been able to eliminate. Based on
the conducted research, the following summary of difficulties can be formulated (written down in
the form of a worst practice overview).
Firstly, there is often an underestimation by management concerning the necessity for quick,
comprehensive and adequate reorganization of the business activities from an integral new vision
and strategy. When underlying causes of financial difficulties are examined, (1) lack of strategic
entrepreneurship, (2) insufficient financial insight, and (3) too high variable and fixed (overhead)
costs have been identified; these being the three most prominent categories.
In virtually any case of a (near) bankrupt company – be it a local convenience store or a
multinational enterprise – one can detect that questions such as: “in which markets is the
company active?” “In which one should it be active?” As well as: “In which way should it be
active?”, have been insufficiently posed. This also applies to questions like: “what are the true
5
For more information about the problem definition, research plan and results, see Adriaanse (2005).
6
See J. Argenti, Corporate Collapse: The Causes and Symptoms, McGraw-Hill, London, 1976, D.B.
Bibeault, Corporate Turnaround. How managers turn losers into winners, Mcgraw-Hill Book Company,
New York, 1982 (reprint 1998) and S. Slatter, D. Lovett, Corporate Turnaround, managing companies in
distress, Penguin Books, London, 1999.
4
‘needs’ of the company’s customers?” “Who are the major (and true) competitors?” And “What is
truly the competitive advantage (unique selling point) of the company?”. More often than not, a
discrepancy can be detected– an assumption gap – between the necessary market behavior and
the actual behavior of the company in practice. Apart from a faulty strategy, distressed companies
also appear to be insufficiently driven by parameters (key performance indicators) such as profit,
cash-flow, solvency and liquidity.
7
There is often a weak administrative organization and
insufficient cash planning which can cause expenses to get out of hand without management
noticing. In short, there are invisible inefficiencies in the primary process of the company which
explains why so often action is taken (too) late. The final factor to be addressed here, the use of
an (iterative) business plan as a management tool, is utilized relatively rarely, even though there
is an (empirically proven) positive correlation between plan-driven entrepreneurship – where a
combination of acting strategically based on financial insights takes a central role – and the
diminishing likelihood of bankruptcy.
8
Actually, 71% of the respondents in our survey among
insolvency office holders confirmed that in court-led reorganizations a sound business turnaround
plan is most of the time missing.
9
On top of that, managers are often insufficiently aware of the
severity of the crisis situation in which they find themselves and are also frequently hesitant –
particularly in SME-related situations – to involve specialized turnaround advisers.
Another recurring theme is that important financiers such as banks and large suppliers are often
consciously left out of the reorganization-process. Management does not allow much or any say
in the turnaround process and/or is scared of informing (read: ‘scaring off’) these parties of their
financial loss-making situation. Additionally, junior creditors are often confronted in a too late a
7
Regarding solvency and liquidity ratios, see e.g. B. Ganguin, J. Bilardello, Fundamentals of Corporate
Credit Analysis, McGraw-Hill, New York, 2005, p. 80-107.
8
See e.g. S.C. Perry, ‘The relation between written business plans and the failure of small businesses in the
U.S.’, Journal of Small Business Management, nr. 39(3), 2001, p. 201-208.
9
See Adriaanse 2005, p. 337
5
stadium with (often harsh) proposals for discharge of debts. On top of that, management is
frequently insufficiently transparent towards involved parties concerning the reorganization
process and the development of the financial situation. In this manner, parties involved do not
have sufficient information to estimate the ever-changing risks involved. Finally, through a
worsened situation (read: financial losses) solvency and liquidity has often greatly deteriorated. In
a large number of failed rescue operations, the possibilities of addressing private equity and/or
looking for take-over attempts appear to have been insufficiently researched, this in combination
with the aforementioned difficulties.
4. Restoration of trust
The research conclusively underlines that the factors that cause failure are often a result of lack of
communication between involved parties, as well as their respective levels of risk perception. In
fact, one could say that the potential for a successful rescue operation is mostly dependent on the
question whether or not the management team can adequately convince its most important
financers of the viability of their struggling business. In other words, the main issue is whether
management is sufficiently able to create trust i.e. restore trust in light of (potential) future
viability of the company, as well as in its own entrepreneurial (i.e. managerial) capabilities to
guide the distressed firm to that desired future state. In other words, the core question is whether
those in charge of the company are able to manage creditors’ perceptions such that they feel that
‘their interests will be met, for they are in good hands’. This is of vital importance, for when
financiers (once more) support the company, room has been created for a solution because of the
renewed availability of time – a basic condition – as well as credit (the latter both literally and
figuratively). In other words, through engaging with creditors and providing them with ample
insight into the financial situation and ultimately a sound turnaround plan, a solid basis for
success is created. Also, pro-actively communicating during the reorganization about the
progress, as well as embodying a clear intention not to transfer entrepreneurial risk to creditors
6
(unless no others options are left), the chance of conflicts and unwillingness of creditors to
cooperate will likely decrease tremendously, and with it the chance of bankruptcy. Conversely,
conflicts (with potential disastrous consequences) are significantly increased when the factors
discussed above are ignored. The restoration of damaged relationships is therefore an essential
part of any business rescue attempt; this being completely contradictory to judicial means that
have been designed to keep creditors at bay and/or force them to discharge debts. In that case a
company does not create ‘natural viability’; in other words, involved financiers and suppliers
have to be intrinsically motivated to support the survival of the company, they should not be
‘blackmailed by insolvency law’. In this light, it is evident that by judicially forcing a company to
abandon its contractual rights – what most rehabilitation procedures in fact imply – it is
impossible to achieve needed trust. So, based on the points mentioned above, attempts to do so
should be minimized as much as possible in order to increase success rates of business rescue. In
other words, combatting the aforementioned bottlenecks with new insolvency legislations is
simply fruitless, also because suppliers and financiers will probably ex-ante sharpen their credit
and risk management systems in turn, simply in order to restore the natural balance i.e. the
desired cooperation model between companies, banks and other creditors.
10
They will in a much
earlier stage than currently is the case – perfectly fair since they are the providers of risk-averse
capital – take precautionary measures. For instance, by asking for direct upfront payments and/or
to denounce (trade)credit agreements sooner. Apart from this, one should not forget that in case
of approaching insolvency, economically speaking, creditors already become part-owners –
indeed, the company is at this point mostly comprised of debt – and finds itself in a situation
where future existence is for the most part in their hands. The call for right of say, supervision
and insight are in this situation very well explicable and these instruments ought not to be
discarded without proper consideration. On top of that, external stakeholders often have
10
See in the same sense Finch 2006, p. 713ff. and D.G. Baird, R.K. Rasmussen, ‘The End of Bankruptcy’,
Stanford Law Review, Vol. 55, 2002-2003, p. 751-789.
7
substantial market knowledge and in particular banks have in-depth knowledge concerning
dealing with turnaround and restructuring challenges. In that light the involvement of creditors
should most certainly be viewed as positive; research from e.g. Couwenberg and De Jong
confirms this view, particularly concerning the role of banks.
11
Furthermore, none of the involved
stakeholders will be primarily interested in forcing bankruptcy (liquidation). This ‘last resort’ will
only be addressed when the viability of the company, or at least the perceived viability thereof
has proven to be completely lost; this, after careful consideration amongst stakeholders and often
only after an extensive period of monitoring – could a newly appointed administrator truly make
a difference in case of perceived viability lost? The answer is most likely to be negative.
5. Ability to reorganize
In the process of value restoration and new to be found viability
12
, the (turnaround) vision and
strategy ought to be utilized in an integrated fashion in order to tackle problems. Indeed, durante
causa durat effectus, if the fundamental causes of decline are not eliminated the (negative) results
will continue to appear. Financial restructuring – e.g. in the form of an informal or judicially
forced debt-agreement with remission – as well as cutting costs are always merely means during
the search for renewed trust, the search for new customers, and with that the search for viability
of the company in the long term. No more, no less. A reorganization of debt as such does not in
any shape or form contribute to the renewed viability of the company; it merely functions as an
(undesirable) ‘emergency brake’ when there is insufficient time to address liquidity influxes.
Thus, a company does not revive (‘phoenixesque’) unless the involved parties – shareholders,
management, suppliers, banks/creditors, customers, employees – explicitly or implicitly feel that
11
See O. Couwenberg, & A. de Jong, (2006). It takes two to tango: An empirical tale of distressed firms
and assisting banks, International Review of Law and Economics, 26, pp. 429-454.
12
See in the same sense N.R. Pandit, ‘Some recommendations for improved research on corporate
turnaround’, M@n@gement, Vol. 3, No. 2, 2000, p. 31.
8
their cooperation (‘nexus of contracts’
13
) ought to stay intact. However, they will only agree with
this sentiment in case it be in their best interest. A company can therefore survive solely in case
value is created for all stakeholders involved. As long as this is the case, the tendency will be to
maintain cooperation. By not breaking up the (current and potential) nexus of contracts – in effect
by filing for bankruptcy liquidation – the stakeholders show the perceived (going concern) value
of their cooperation. In turn, when bankruptcy is indeed filed, the deciders – for instance the
company’s main bank that terminates its credit, employees that file for bankruptcy,
simultaneously or not with (a group of) competing junior creditors/suppliers – do not perceive the
added value and with that the viability of the company: cooperation has been terminated and the
end is near. Parties that want to prevent such a scenario – for instance management and/or
shareholders – thus ought not to blindly trust in a judicial reorganization procedure, and they
should (remain to) show the potential economic value of the now distressed company. The only
way to achieve this is to, on the one hand, utilize a structured and methodical process of value
recovery – by use of a turnaround vision and strategy which translates into a detailed yet
pragmatic turnaround management process – and on the other hand by actively managing
perceptions of all stakeholders involved. By use of this methodology, the chance augments that
the company will once more be able to independently prosper and with that prove its (long-term)
viability. The ‘ability to reorganize’ can therefore be viewed as the equivalent of the ability to
create value and the restoration of trust as such. It is therefore a necessity that discussions
regarding ‘insolvency rehabilitation legislation’ focus more on above mentioned aspects.
Otherwise, the imminent danger is that the emphasis will lie too much on e.g. more ‘debtor-
friendly’ voting quorums for compulsory settlements, as well as other ways to distance creditors,
13
See among others M.C. Jensen, W.H. Meckling, ‘Theory of the Firm: Managerial Behavior, Agency
Costs and Ownership Structure’, Journal of Financial Economics, Vol. 3, 1976, p. 305-360 en R.R.
Kraakman e.a., The Anatomy of Corporate Law, A Comparative and Functional Approach, Oxford: Oxford
University Press 2004, p. 6-8.
9
which will in fact emphasize the factors that in practice have proven to lead to failure, therefore
possibly leading to the reverse of the desired result.
Co-funded by the
Civil Justice Programme
of the European Union
Co-funded by the
International Insolvency Institute
Disclaimer
This publication has been produced with the financial support of the Civil Justice
Programme of the European Union. The contents of this publication are the sole
responsibility of Leiden University and/or Trent University and can in no way be taken to
reflect the views of the European Commission.
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