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What should we do with failed businesses?

By Jason Kilborn

What should we do with failed businesses? This question has plagued societies around the world for centuries. With the advent of formal “bankruptcy” or “insolvency” procedures in the Middle Ages, the questions have multiplied as societies on every continent except Antarctica have struggled to implement the most effective techniques for managing private economic collapse.

The average lay person’s perspective on “bankruptcy” generally reflects the now distant historical position that bankrupt businesses should be disintegrated through a piecemeal public auction of the business’s assets, and the proceeds parceled out equally among creditors. For many, bankruptcy is still best illustrated by a sad looking soul relegated to wearing a barrel on shoulder straps and advertising a willingness to work for food.

Though this approach still exists in some areas today, a phase shift toward a policy of rescue and reintegration of distressed business has swept the globe in recent years. National laws from Canada to China and from Germany to Cameroon most often now juxtapose two possible responses to administering the insolvency of distressed businesses: the classic liquidation approach and an often preferred alternative of reorganization, debt restructuring, and rebirth. A few decades ago, the United States represented the only prominent jurisdiction that actively sought to avoid the waste and loss of a liquidation, offering the (in)famous “Chapter 11” reorganization procedure to businesses large and small. Today, the US Chapter 11 model has spurred the development of rescue-type insolvency procedures throughout much of the world.

Reorganizing an ongoing business presents far more complexities than imposing a simple liquidation and summary death. Even if a broad range of diverse societies have converged on a rescue model of insolvency administration, they have chosen a kaleidoscope of varying structures and techniques for effectuating such rescues. Some laws require initiation of a formal process as soon as the debtor-company becomes “insolvent” by some identifiable measure, while others leave this decision to the discretion of creditors or debtor management. Some laws allow or even encourage creditors to initiate a formal insolvency process against a debtor-company, while others all but reserve the decision to debtor management, actively discouraging creditor-initiated processes. Some laws assign responsibility for complex insolvency cases to the generalist court system, while others reserve such cases for specialized commercial courts or even insolvency-specific tribunals. Some laws assign ongoing management authority over the debtor-company to an appointed official (with widely varying regimes of qualification, selection, and regulation of such an administrator), while an increasing number allow for a “debtor-in-possession” model of continued self-governance. However administrative authority is assigned, a reorganization effort must be financed somehow, though systems differ substantially as to allowing or facilitating public or private funding, especially by third party financiers. Even if one could identify “the best” approach to any of these issues, chronic deficits of legal and administrative infrastructure, professional legal culture, and funding in many areas of the globe all but guarantee that major differences among rescue procedures will persist.

Descending into the details of more minute operational questions reveals further and more substantial contrasts among national approaches. Diversity at this level seems to be driven by entrenched cultural and philosophical division, and such disparities are thus likely to be enduring. For example, systems differ dramatically with respect to classification of different kinds of creditors and their rights, responsibilities, and restrictions in dealing with an insolvent debtor-company and participating in the process of insolvency administration. Social and economic policies produce a dizzying array of approaches and exceptions to empowering and restraining certain creditors (especially current and former employees), as well as to allocating a limited fund for distribution among various claimants. No creditor wants to “take a haircut,” as the industry calls the process of reducing creditors’ claims. It is startling, however, the degree to which seemingly similar societies continue to allow different sub-groups of creditors to evade the barber’s blade, forcing other creditor groups to be shaved to the scalp or worse.

The steady drift toward more effective rescue procedures is accelerating around the world. Near consensus appears to be within reach on the notion that a collective compromise produces superior results in the aggregate than the single bankruptcy paradigm of forced sale and crystallized loss. With reform after reform of local insolvency laws, the formal processes of business reorganization have undergone a remarkable convergence even in the past several years, though important and telling differences persist. These differences reveal much about the core social, political, and economic boundaries that still divide the modern world. The rapid pace of erosion of these differences reveals equally as much about the drivers and effects of globalization and about a unifying modern pursuit of compromise, cooperation, and reaction to collapse with rebuilding.

Jason Kilborn is a professor of law at John Marshall Law School in Chicago. He currently occupies the Van der Grinten Chair in International and Comparative Insolvency Law at the Radboud University Nijmegen’s Business and Law Research Centre in the Netherlands, and he served a one-semester term in fall 2011 as the Robert M. Zinman Scholar in Residence at the American Bankruptcy Institute. Professor Kilborn contributed the chapter on the US and is one of the editors of Commencement of Insolvency Proceedings, the first volume of the new Oxford International and Comparative Insolvency Law Series, published in March 2012.

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Recent Comments

  1. Ann Rutledge

    A discussion of bankruptcy is incomplete without discussion of securitization. See another Oxford publication, Elements of Structured Finance, Rutledge & Raynes, ISBN 978-0-19-517998-9

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