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Misuse of Bankruptcy Laws Dr. Clive Vlieland-Boddy Personal Insolvency Poverty, Debt and Bankruptcy • Introduction • Borrowing, debt and the poor • Bankruptcy • Bankruptcy reform Introduction • Why is there poverty & why does poverty persist? • The vicious cycle of poverty • Various approaches: – Poor are dysfunctional or have atypical preferences – Poor have restricted opportunities because of systemic problems – Poverty is the result of perverse incentives created by policy • Various mechanisms: – Education – Unemployment – Health – Discrimination – Credit and borrowing Borrowing, debt and the poor • Historically borrowing and debt have often been seen as problems for the poor. – Too poor to cover their expenditures – Borrow from lenders who charge high interest rates – Sometimes perpetually indebted, debtors prison, slavery or worse • Some economic theories imply that borrowing helps the poor – Smoothing consumption during income shocks – Allows large, unexpected expenditures – medical bills, legal fees – Obtain resources which help to increase economic opportunities – education, small business Borrowing, debt and the poor, cont. • Poor are more subjected to unexpected income and expenditure shocks – Job loss – Health problems – Car problems Ability to withstand shocks from own resources is low • Poor are restricted in their borrowing opportunities and pay higher interest rates – Hidden fees, fines on credit cards, flexible rates – Pawnshops, payday lenders, rent-to-own stores • Interest payments increase, further debt • Possibility of bankruptcy Bankruptcy • Large increase in personal bankruptcy filings – about 2 million in 2005 • More of a low-income problem. So what are the causes? • High debt – Why high debt? High spending and income and expenditure shocks – High spending: – relative consumption and what is subsistence – due to low income – used cars, high repairs, furniture – credit card lending, other lenders, high interest rate • Rise in unemployment, job insecurity, changes in government policies, health insurance and coverage Who or what is to blame? – Person going bankrupt using the system? – Problem with opportunities, system? – Easy bankruptcy laws? – Seen as an easy escape route? Bankruptcy reform • Lenders embarked on a huge lobbying campaign • Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCA) passed in 2005 • Sharp increase in personal bankruptcy prior to passage, then sharp fall, but then steady increase, but lower than before Bankruptcy reform, cont. • Debtors cannot choose between Chapter 7 and Chapter 13 – must pass means test to file under Chapter 7 based on income • Debtors cannot propose own Chapter 13 repayment plan – income and normal spending taken into account • Increase in cost – credit counseling course, lawyers have to certify accuracy, filing fees higher. Costs now $2,500 and $3,500 for bankruptcy, compared to $600 and $1600 before Bankruptcy reform, cont. • Much more creditor-friendly • Reduce loopholes for the rich • For the poor? – Higher costs make filing much more difficult – Lenders find lending more lucrative, increase loan pushing • What needs to be done? – Need for stricter regulation of lenders – Broader issues: macroeconomic policy, health, transportation, inequality between rich and poor Corporate Insolvency INSOLVENCY SYSTEMS AND RISK MANAGEMENT: CONCEPTUAL ISSUES The creation of an effective insolvency regime is a successful interplay of three key elements: design, legislation and implementation. The government needs to understand that it is the ultimate risk manager (David Ross: Harvard Business School). The development of a modern insolvency system gives the government the ability to manage risk. The creation of a transparent system with predictable outcomes greatly enhances long- term capital formation. 14 The Legal Structure- Requirements The ideal legal structure would be specialized judges. Two key ingredients are present Speed. Insolvency proceedings need to be expedited quickly. Predictability. There has to be real confidence in the outcome INSOLVENCY SYSTEMS AND RISK MANAGEMENT: CONCEPTUAL ISSUES (Cont’d) When the liquidation values of companies are greater than the going-concern value, you do not need an insolvency system. You merely need to tighten your recovery laws, systems and procedures. Enacting a law is relatively easy. Making it work (i.e., implementation) is often very difficult. Political support is crucial. Specialized laws need a state-of-the-art enabling environment to deliver results. Capacity-building and institution- strengthening. 16 What Should be Saved? “Sickness worthy of revival”: Not all companies are worth reviving – e.g., inefficient, obsolete technology, etc. In fact, owing to competitive disadvantages, sometimes entire industries can be considered to be “unworthy” – e.g., textile products in North Asia, sugar in Pakistan, etc. 17 Amnesty Schemes • Amnesty schemes protect inefficient managements: Very often the root cause of sickness is the management. In such cases, a change of management can convert sick entities into healthy companies. • Moral hazard: Such schemes promote the “default culture” and have a cumulative effect that can last for decades. 18 CORPORATE REHABILITATION ACT: LEGAL ARCHITECTURE The need is to have a system with elements of both re-organisation and liquidation was a key concern. Re-organisation without effective liquidation creates a very unbalanced insolvency system. If liquidation provisions are not credible, then bankruptcy law doesn’t do its work If re-organisation provisions are not practicable, then companies are liquidated unnecessarily. Uncertainty results in either case”. 19 CORPORATE REHABILITATION ACT: LEGAL ARCHITECTURE (Cont’d) • To be effective, an insolvency process requires the pro-active participation of both the “interested” parties – i.e., debtors and creditors. • It should not enable inadequate management to obtain a court sanction when there is little real hope of success. • All too often a stay of actions is granted where there is no real plan for recovery. • These are merely delaying tactics. • Often companies in the recovery plan continue for years absorbing all the creditors funds until they are extinguished and the inevitable 20 CORPORATE REHABILITATION ACT: LEGAL ARCHITECTURE (Cont’d) The English model: The English Model, involves “debtor-eviction”. This advantage allows “contested entry”, which enables the removal of the possibility of countless frivolous insolvency petitions. A further advantage is that the management is by a judicial administrator who also prepare the rehabilitation plan for the court. This is an independent officer from the management 21 CORPORATE REHABILITATION ACT: LEGAL ARCHITECTURE (Cont’d) The American model (Chapter 11). Entry into rehabilitation proceedings should be a legal right. However, debtors must consider such a step carefully because of the provision for automatic conversion into liquidation in the event that no rehabilitation plan is approved. Various quantitative tests for entry should be considered The process should be entirely stakeholder driven. Both the debtor and the creditor(s) can file plans. The entire process should be compressed with finite time-frames. For example, the debtor to have a maximum of one month after entry into rehabilitation proceedings to file a plan. This is normally the case. The cram-down feature is a threat designed to force consensus on a rehabilitation plan. 22 NON-SPECIALISED JUDGES WILL DELIVER POOR QUALITY JUDGEMENTS: HOW TO PLUG THE KNOWLEDGE GAP?? (Cont’d) We have achieved this by building into the CRA a multi-disciplinary vision - the judiciary is only one component. 23 NON-SPECIALISED JUDGES WILL DELIVER POOR QUALITY JUDGEMENTS: HOW TO PLUG THE KNOWLEDGE GAP?? “War is too important a subject to be left to the generals.” Winston Churchill, 1943 “Insolvency is too complex a subject to be left to the judges.” Salman, 1999 24
"Presentation Dr Clive Vieland Boddy"