Insolvency Reform in Asia
The Role of the Judiciary
Manfred Balz
Deutsche Telekom AG
Bali, Indonesia, 7 February 2000
Overview
• Links with Bankruptcy Philosophy and
Institutions
• The German Model
• Judicial Involvement: Selected Issues
• Jurisdiction for Bankruptcy Related Litigation
• Judicial Liability and Social Responsibility
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Court Involvement in Economic Decisions I
Organizing Collective Action
Insolvency (insufficiency of assets to cover debt) makes bankruptcy a
common pool problem. Creation of a pool of assets (estate) and the stay
on individual creditor action require collective action. Legislative options
and bankruptcy philosophies are:
• The judge weighs and balances claimant interests and controls all
junctures of proceedings (making issues of justice of all economic
issues)
• The administrator articulates (presumptive) common creditor interest
under procedural judicial control
• Claimants negotiate in a pluralistic process (individually, or in
structured way - through committees and bodies) essential administration issues under the moderation of the administrator and/or the
court
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Court Involvement in Economic Decisions II
Bankruptcy: A Multiparty Private Dispute
High complexity and diversity of claimant interests:
• Monetary v. monetary plus legitimate or illegitimate non-monetary
interests (business relationships, employment, macroeconomic goals;
harassment or removal of a competitor),
• Valuable v. depreciated pre-bankruptcy entitlements (secured v.
unsecured debt; debt v. equity) and
• Different risk inclination and cash preference
influence claimants’ preference for speed and for rehabilitation v.
liquidation. Rescue means re-investing one’s potential liquidation cash
dividend in a new venture. Therefore, decisions on bankruptcy
adjudication, case administration, continuation or break-up, and rescue
are essentially adversary issues of an economic nature.
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Court Involvement in Economic Decisions III
Efficiency and Legitimacy
• Negotiated solutions/decision-making by financial stakeholders are
generally preferable in terms of economic efficiency (i.a., because
legitimate non-monetary interests may not be disclosed and will not be
priced and considered in authoritative decision-making).
• Paternalistic decisions on economic issues (e.g., risk taking, time value
of money, cash preference, rescue or market exit) are not legitimate
state functions in market economies; forcing such decisions upon the
judiciary may jeopardize confidence in judges and the rule of law.
• In terms of institutional economics, the ideal system allows for a
maximum of decision-making by stakeholders and allots influence
rights according to the bankruptcy value of entitlements; the cost of
delay (time value of money-interest) should be borne by those causing
delay.
• The price of stakeholder decision-making may be time. Fixed
deadlines for resolving critical issues may often be the realistic second
best.
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Court Involvement in Economic Decisions IV
The German Model (a)
A unitary proceeding with unitary rules within which a break-up
liquidation, a sale of the going concern, and a rescue plan may be
pursued by creditors. The judge supervises the legality of proceedings
and moderates trustee and creditor action.
No court involvement in essentially economic issues, such as:
• Closing down or continuing the debtor business
• Lifting the stay on secured creditors
• Assumption or rejection of pending contracts
• Liquidation v. rehabilitation
• Assessing viability of the debtor, and feasibility of a rescue
• Sale of assets in a piecemeal fashion or as going concern
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Court Involvement in Economic Decisions V
The German Model (b)
A minimum of judicial involvement in economic issues is achieved by:
• Granting broad powers to a trustee (both for liquidations and in
rehabilitations) owing his function to the continued trust of creditors
• Reasonable personal liability of the trustee toward the estate and
energetic enforcement,
• Granting creditors a maximum of influence rights on the course and
outcome of proceedings, and
• Legal rules pricing delay and risk-taking adequately by requiring the
trustee to pay regular contractual interest out of the estate to secured
creditors on the secured portion of their claims.
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Issues: The Opening Decision
Adjudication should be speedy without burdening the judge with complex
economic inquiries.
• Clear cut trigger criteria: Illiquidity/Nonpayment of mature debt (no
balance sheet test)
• Debtor filings: Automatic commencement of case (subject to good
faith review)
• Creditor filings: Hearing within a short deadline with possibility of
protective measures and appointment of interim trustee. Serious civil
creditor liability for intentionally wrongful and frivolous filings.
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Issues: Appointment of a Trustee
• Autonomous initial choice by the judge of an independent and
qualified trustee (and interim trustee during the opening stage) unless
debtor is left in possession
• Right for creditors’ assembly to elect a/another trustee by qualified
majority vote or to leave debtor in possession
• A licensing system for insolvency practitioners will reduce judicial
responsibility for initial choice and curb possible misuse of creditor
discretion
• Powers of the court to relegate an incompetent or unworthy trustee at
its own motion with right of creditors to name new trustee
• Disciplining incompetent or negligent trustees by a licensing body or
other government institution (such as the U.S. Trustee system) will
reduce judicial responsibility for trustee conduct.
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Issues: Continuation of Debtor Business
• Initiative/decision for the trustee, subject to control by creditors
(creditors‘ committee or assembly); no judicial control needed.
• Stay of ongoing liquidation, if a rescue appears possible or a
rehabilitation plan has been proposed: A temporary judicial halt is
needed only until a creditor decision can be sought. Manifestly
unreasonable plan proposals should be disregarded by the judge.
• End business continuation and start piecemeal sale: Subject to creditor
decisions an issue for the trustee; no judicial involvement needed.
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Issues: Lifting the Stay on Secured Creditors
• Adequate creditor protection for secured creditors must create
economic incentive for trustee/estate to abandon collateral to creditors
which is inconsequential for the estate or for a possible reorganization.
• Preferable form of adequate protection: Full guarantee of secured
claim/collateral value as of opening of proceedings plus regular
contractual interest on secured portion of claim.
• No judicial involvement needed when adequate protection for secured
creditors is strong enough.
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Issues: Lodging and Verification of Claims
• Claims should be lodged with the trustee; no court involvement needed
• Verification of claims in a creditor hearing monitored by the court
(clerk); claims shall be deemed accepted if neither the trustee nor any
creditor objects as to justification, amount, or priority/secured status.
• A contested claim shall be deemed rejected for bankruptcy purposes
unless the creditor concerned sues the opposing party-in-interest for
declaratory judgment on the claim and and eventual priority/secured
status [possibly within a statutory deadline]; fees should be based on
presumptive dividend, not on amount of claim.
• For voting purposes (in creditor assemblies or in a vote on a plan)
contested claims should be determined preliminarily in a summary
fashion by the court (clerk or judge).
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Issues: Business Rescue I
(Two Types of Rescues)
• Sale of All, or Substantially All, Assets (Possibly also of Debtor
Equity) to a New Entity (Liquidation Type)
– Sale of Going Concern on the Market
– Distribution of Cash Proceeds According to Priority
• Rehabilitation via Plan (Reorganization/Composition Type)
– „Sale“ of Entity to Claimants
– Distribution of Value Open to Negotiation (Treatment of
Dissenting Claimants - Policy Choices: Unrestrained Majority
Rule, Liquidation Value, Absolute Priority)
– Cash and Non-Cash Compensation Possible
– Valuation May be Needed (Uncertainty, Cost, Delay, Litigation)
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Issues: Business Rescues II
(Liquidation Type Rescues)
• No judicial involvement needed
• Critical issues such as
- fair market price formation
- insider dealing
may be controlled by appropriate legal rules and/or
creditor approval of auction methods and conditions
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Issues: Business Rescues III
(Reorganization/Composition Type Rescues)
Effective and fair reorganization type rescues in bankruptcy require
considerable judicial involvement in economic issues for plan
confirmation, e.g.:
• Assessing the hypothetical liquidation value of claimant entitlements
(under the “common interest of creditor” or “best-interest” tests)
• Possible valuations of the debtor business as a going concern when a
plan is to be confirmed against one or several dissenting classes of
claimants (via “cram-down”)
Judges may be exposed to conflicting expert valuations and have to make
far-reaching policy choices of an economic nature.
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Issues: Business Rescues IV
Policy Choice
• If minimal strains on the legitimacy and credibility of the court system
are desired, primary reliance should be on liquidation type rescues.
They involve courts least in the investive issues (A: who should carry
on the debtor business?) and the distributional issues of rescue (B: who
gets which portion of the reorganization „pie“). Issue A is taken care
of by market forces, and issue B by the distribution scheme and
priorities set out in the law.
• Reorganization type rescues may be needed only for public ownership
enterprises, utilities, or enterprises with regional or special societal
importance where a change of control may be undesirable or
impossible.
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Issues: Post-Confirmation Jurisdiction
in Reorganizations
• In some systems, such as the U.S., bankruptcy judges retain
jurisdiction over the debtor long after a plan has been confirmed, e.g.,
for plan implementation and modification of an approved plan.
• During this phase judges will often have to deal with economic and
social pressures to make a success of the reorganization.
• Post-confirmation jurisdiction ought not to exceed a maximum time (of
say, 3 years) and be reserved for cases where supervised plan
implementation is agreed by requisite creditor vote in the plan
(German law).
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Issues: Bankruptcy Related Litigation
• Bankruptcy may occasion complex civil and commercial litigation
(avoidance; adjudication of claims contested as to existence, amount,
priority, or secured status; director and parent corporation liability;
employee rights).
• Some systems (such as the German) provide for jurisdiction of the
general civil, commercial, or labor courts for such matters. Others,
such as the U.S., acknowledge an overriding jurisdiction of the
bankruptcy courts.
• The need for close coordination with case administration, for speed
and consistent decisions in parallel cases appears to militate for broad
jurisdiction of bankruptcy courts, especially in countries with less
experienced general or commercial court systems.
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Judicial Liability and Social Responsibility
• In matters requiring judicial dispute resolution, judges should be
exempt from all civil liability except where they have been found
guilty of a criminal offence (such as corruption, intentional breach of
the law etc.) in a final judgment (German system).
• To the extent that judges are involved in case administration and
economic choices it may be possible to impose civil liability on judges
for intentional or grossly negligent wrongs; but primary liability should
be that of the State/Government, and judicial liability be enforced only
via a recourse action by the government (German system).
• If judges are, by appropriate legislation, allotted minimal
responsibility for case administration and for economic decisions, the
judiciary will be protected best from undue social pressures and
criticism.
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Thank you!
Manfred.Balz@telekom.de
Tel.: +49 228 181 74000
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