THE WORLD BANK
Corporate Restructuring: International Best Practices
Washington, D.C.
March 22-24, 2004
KEYNOTE ADDRESS:
Are More Restructuring Regimes Becoming Like the U.S. Chapter 11 System?
James H. Zukin, Co-Founder & Senior Managing Director
Houlihan Lokey Howard & Zukin
Alan Fragen, Managing Director & Dorian Lowell, Senior Vice President
Houlihan Lokey Howard & Zukin
Assisted in preparation of this outline
Preface
This presentation will cover the state of the global market for corporate
and sovereign restructurings. The first part includes a discussion of the
basic principles of reorganizations, the required enabling infrastructure
and a few observations regarding the use of a Chapter 11-style
reorganization system.
Next, I will present a brief overview of new restructuring paradigms in
several Western European countries that support the apparent trend
towards Chapter 11-style reorganizations vs. traditional liquidations. I will
then comment on such trends in emerging market countries followed by
discussion of how a Chapter 11-style system could be applied in cases of
systemic crisis as part of a recovery plan utilizing a process of rapid
sequencing.
Finally, I will conclude with a brief comment on the current state of
sovereign debt restructuring techniques utilizing the principles of a
Chapter 11 system.
1
Bankruptcy – Historical Vignettes
The penalty for declaring bankruptcy in Ancient Rome was
slavery or being cut to pieces. The choice was left to the
creditor. By the Middle Ages, the treatment of insolvent
debtors had softened considerably. In Northern Italy,
bankrupt debtors hit their naked backsides against a rock
three times before a jeering crowd and cried out, “I declare
bankruptcy.” In French medieval cities, bankrupts were
required to wear a green cap at all times, and anyone could
throw stones at them.
- Source: World Bank, Doing Business in 2004
2
Introduction
Economies are Darwinian. They compete with each other, adopt best practices
and evolve. Just as capitalism overtook communism as the better system for
maximizing wealth, procedures for rescuing distressed companies should overtake
systems that focus on receiverships and liquidations at the expense of lower
recoveries and the disenfranchisement of creditors. The prevalence of bankruptcy
systems focusing on receiverships and liquidations reflect the historical emphasis on
tangible property rights, the rights of secured creditors and the realization of assets
to discharge debts. But in modern economies we talk of cash flows and enterprise
values, values that invariably exceed tangible asset values. Maximizing these values
when companies are in distress demands more flexible solutions than those
provided by receiverships and liquidations.
In a modern capitalist economy, the primary role of a bankruptcy regime should be
to differentiate between balance sheet distress and operational distress. Viable
entities should be encouraged to reorganize via a balance sheet restructuring and
non-viable enterprises should be liquated and the assets and capital redeployed to
more productive uses. The preferred outcome is that which maximizes economic
recovery and which seeks to minimize (but not avoid) negative externalities. To
promote effectiveness and efficiency, the bankruptcy regime should strive to create
a collective process with active participation by the economically affected parties.
Examples of restructuring techniques can be found in the accompanying paper by
Alan Fragen, “Financial Restructuring – Techniques and Negotiating Dynamics”.
3
What Is Chapter 11?
Chapter 11 is the chapter under Title 11 of the United States
Bankruptcy Code providing for the reorganization of a
company; other chapters deal with case administration,
liquidation and other related procedures. Reorganizing under
Chapter 11 means allowing a company to survive as a goingconcern, maximizing enterprise and recovery values for
creditors and discharging the old debts. It allows the
company to survive and have a second chance. It is not a
liquidation or a receivership for the benefit of secured
creditors.
4
The Seven Basic Objectives of Chapter 11
1. Stabilizing business operations
2. Financing the business after the commencement of
insolvency
3. Maximizing the value of the business operations
4. Providing for the representation of unsecured creditors
5. Providing a central forum for creditors to exercise remedies
6. Allowing a plan of reorganization to be proposed based on
an objective valuation of the post-reorganized enterprise
7. Providing a framework for formulating and approving a plan
of reorganization
5
The Eight Principles of Corporate Restructuring
1. Creditors should cooperate with each other and give a debtor time to resolve
its financial difficulties during a standstill period
2. During the standstill period creditors should refrain from taking action against
the debtor
3. During the standstill period the debtor should not take any action prejudicial
to the creditors
4. Creditors should coordinate with the debtor, typically through a committee,
and through the appointment of professional advisors to assist the committee
5. During the standstill period, the debtor should provide the creditors and their
professional advisors all relevant information to evaluate its financial condition
and any restructuring proposals
6. Any proposal for resolving the debtor’s financial difficulties should reflect
applicable law and the creditors’ relative positions
7. All information should be made to all relevant creditors and, unless public, be
treated as confidential
8. Any necessary additional funding should be accorded priority status for
repayment
-Source: INSOL 2000
6
The Four Requirements of Chapter 11-style Bankruptcy Laws
1. Stay against individual creditors
2. Mechanism to force responsible debtor behavior
3. Prioritization of new money (to provide liquidity)
4. Bind holdouts
7
Chapter 11 Refinements
1. The system has become routinized and much legal work
is boilerplate. Efficiency increases with use and
professional fees actually fall as timeframes shorten.
2. Pre-arranged or pre-negotiated bankruptcies are
emerging – solicited through the court.
3. SEC solicitation of a pre-packaged plan of bankruptcy is
also a key new technique.
4. 363 sales of assets before resolution of inter-creditor
bankruptcy issues is a key system refinement.
5. A two-tier system has developed as WorldCom is
different from the insolvent corner grocery store and so
is the process to restructure them.
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Developed Countries Restructuring Regimes
In many jurisdictions the emphasis of insolvency proceedings is
receivership, liquidation, or proceedings dominated by politics or
courts. This suggests business rescue is not the prevailing culture. For
many countries, corporate insolvency is stigmatized by failure and
deserving of liquidation. It takes a fundamental change in thinking to
see insolvency instead as an opportunity to fix a bad balance sheet of a
good business.
Agents of change are the private investors in the international capital
markets. The distressed debt and hedge funds of today have
proliferated in number and size, see themselves as the catalysts of
corporate renewal and have become highly sophisticated in using
Chapter 11 to reallocate assets and capital.
A system that saves everything, such as one in which every insolvent
company is recapitalized or restructured, is as problematic for an
economy as one that liquidates everything. A good system quickly
chooses between reorganization and liquidation and then provides an
efficient process to execute the result.
9
Selected Countries
1. France
2. Germany
3. Italy
4. United Kingdom
10
Examples of Foreign Companies Filing for Chapter 11
Under the U.S. Bankruptcy Laws
1. Edelnor SAA – Chilean power generation company
2. Chivor SA – Colombian power generation company
3. FLAG Telecom – Bermuda-registered telecom
company
4. Global Ocean Carriers Ltd. – Greece-headquartered
shipping company
5. Cenargo International PLC – English freight and
passenger ferry company
6. Petroleum Geo-Services ASA – Norwegian oil field
services company
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Developing Countries Restructuring Regimes
1. Argentina
2. Dominican Republic
3. Indonesia
4. Iraq
5. Korea
6. Mexico
7. Russia
12
Requirements of a Rapid Sequencing Process
To promote recovery in a crisis-affected economy, it is essential to
link together a restructuring of the financial and the corporate
sectors, a so-called rapid sequencing restructuring of the economy.
1. A trained independent judiciary for financial claims and bankruptcy
2. A working private property system for perfecting creditors’ rights
in default
3. Proper credit information systems
4. Lending based on credit worthiness and a solvency monitoring
system
5. A working simplified Chapter 11-type system
6. Functioning professionally managed CRVs for each distressed asset
class
7. The ability to attract foreign direct investment
13
State of Sovereign Debt-Restructuring Regimes
THE MERITS OF A CHAPTER 11 SYSTEM FOR COUNTRIES
Techniques perfected in complex corporate restructuring may be transferable
to sovereign debt situations. In particular, a successful process should seek to
resolve all classes of creditor claims simultaneously, and the process should be
transparent. Any sovereign debt-restructuring plan needs to be feasible from
a commercial point of view and consider existing cash-generation capabilities
and internal and external factors that may impact future cash flows. Such an
approach works in the business world and is considerably different from the
piecemeal approach typically employed to restructure sovereign obligations.
The Paris and London Club procedures may provide the basis for such a
process if it becomes more routine.
The most practical and broadly acceptable reform to facilitate future
sovereign debt restructurings would be a commitment by sovereign
borrowers to put a package of new clauses (“Collective Action Clauses”) into
all future debt contracts. The clauses are intended to create a more orderly
and predictable workout process and should describe as precisely as possible
what happens when a country decides it has to restructure its debt.
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State of Sovereign Debt-Restructuring Regimes
THE MERITS OF A CHAPTER 11 SYSTEM FOR COUNTRIES (continued)
Recently, the IMF put forth a detailed sovereign bankruptcy scheme (SDRM)
that includes many admirable features, including a majority rule for sovereign
debt holders. But, the IMF would limit the scheme to dealings with “private”
creditors. This approach doesn’t recognize the fact that, in a sovereign
restructuring, all pre-existing debt is similarly situated (with the same legal
entitlements). Unless a restructuring plan applies to all similarly situated
creditors, it will be difficult to achieve consensus among the private creditors.
In this environment, the role of the Paris Club is particularly important. This
unique organization of sovereigns that seeks to restructure the debts of
sovereigns facing financial distress is a likely candidate for the role of “lead
creditor.” In particular, the Paris Club members have the opportunity to
create incentives for global investors to abide by consensual plans that garner
support by an appropriate majority. In the future, a mediation forum could
develop in Paris, which would seek to resolve all classes of creditor claims
simultaneously.
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Conclusion
1. Chapter 11-type restructuring concepts are important and
spreading
2. Chapter 11-type restructuring concepts are critical to affect
turn-arounds instead of liquidation and this is important to the
company and economy as a whole
3. Chapter 11-type restructurings are critical to attracting new
capital, which is a required element of an effective restructuring
4. The trend toward Chapter 11 around the world is accelerating
and maturing. Capacity building will be critical to the success of
these new systems
5. The basic principles of Chapter 11 restructurings can and
should be made applicable to sovereign debt restructurings
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