Comparative Company Law Arrangements

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Requirement

The topic is: "All developed legal systems provide mechanisms designed to protect creditors from the risks generated by abusive behaviours of shareholders and directors. Has there been any formal or functional convergence of the legal strategies boosting creditor protection or on the recognition of creditors' interests in modern company laws in the past 25 years?"

Solution

Creditor Protection

In order to protect the creditors’ interests around the world, there is a general rule called minimum capital requirement, which requires the incorporators to contribute the assets with a value of minimum specified limit for any company before it gets registered. As the logic goes, due to the liberalization of the business that took place in the nineteenth century, it was easier on the part of the entrepreneurs to form their own companies and also limit their liability. In view of this, limiting the liabilities became one of the most important milestones in the field of commercial lawas it permitted each and every kinds of enterprises to be undertaken. Therefore, due to the fact that shareholders were able to limit their liabilities to the capital invested in the smaller firms, the rule of minimum capital requirement made its way towards protecting the creditors’ interests.

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The basic idea, however, was via a provision of limited liability, the shareholders confine their losses only to the amount invested in order to gain unlimited profits. So, because of that a bigger part of the risk associated with the business was shifted to the creditors(Galindo &Micco, n.d.). The shareholders can also benefit from the distribution of the dividends as well as share capitalization, while the creditors have to only pursue the company’s assets. Also, the assets of the shareholders get diverted from the company by means of distribution of dividends and salaries etc. Which means, in other words, shareholders are protected more than creditors. Therefore, in view of this, some costs are being imposed on the shareholders in order to decrease the disparity in risks and benefits among shareholders and creditors of a limited liability company. It is also understood that the creditors look at the minimum capital as a guarantee fundas security so that it could become as a source for the collection of the payments in terms of their claims regarding insolvency. So, as per this concept, in case of the larger minimum capital in terms of the legal act, the creditors become able to enjoy larger level of protection. As a general agreement, the legal capital rules significantly advantage involuntary creditors and the creditors who are technically voluntary but do not have the bargaining power in order to protect themselves via covenants, securities and similar instruments. However, there are certain disadvantages of minimum capital requirement for the creditors, such that it doesn’t efficiently protect the creditors, minimum capital misleads the creditors and it creates an unnecessary barriers to incorporations(Galindo &Micco, n.d.).

In light of the creditors’ interests, whenever a company or an individual becomes unable to pay the debts. These are of two types – Cash-flow Insolvency and Balance sheet insolvency. According to the former, in case a company or a person has enough assets to pay what it owes, but lacks the proper means of payment. Whereas, the situation is completely opposite in the latter case. Once, the loss is registered and accepted by all the parties, then negotiation is done by them to resolve the situation without bankruptcy at first. However, it is tremendously crucial for the creditors to avoid such a situation from arising. Therefore, there are numerous insolvency procedures in the statutes of law in different countries that come to the rescue of creditors and protect their interests.

1.    Insolvency Laws and Creditors’Protection in UK 

The Insolvency Act 1986 is the fundamental source of insolvency for the companies of UK. It has gone through various significant changes the moment it was implemented. Along with this act, the Enterprise Act 2002 had also supplemented insolvency rules which help in governing the procedural matters. These laws have been amended as well as revised until 2009. Also, the specific issues that directors may need to consider are set out in the Company Director’s Disqualification Act 1986. The contributing factors for the body of the insolvency laws are multiple which are largely beneficial for the industries like financial markets, credit institutions  water and railway companies. In light of this fact, European legislation has played an important role to have been a source of insolvency laws and the EC regulations on the insolvency proceedings have been important in this regard. Moreover, the role played by the case law has also been a significant interpretation of insolvency legislation(Berensmann& Herzberg, 2009). 
It is very important to understand the fact that UK has a very advanced corporate rescue system and which is largely referred by the most of the countries world-wide. Since, UK is the country that has undergone so many dramatic reforms in terms of rescue regimes under Insolvency Act 2000 as well as Enterprise Act 2002. So, an extensive research work done on the rescue laws will be going to hold some value theoretically as well as practically. Also, the UK government has been a pioneer in using a corporate rescue practice in order to promote the Insolvency Law reforms towards a modern corporate culture of rescue. However, the all-encompassing acceptance and reference of the UK in the other regimes show a clear indication that UK is a perfect country that influences the creditor rescue regimes of the other countries.Innovative Rescue Regimes in the Insolvency Act 1986 towards a Modern

Corporate Rescue Culture 

As is the case, the UK has for a long time been concerned about the innovation and formulation of a profound corporate rescue culture. However, initially the rescue procedures were simple but unfortunately lacked protection for the company(Boubakri&Ghouma, 2010). Therefore, the two innovative rescue regimes in terms of the Insolvency Act are as follows:
I.    Company Voluntary Arrangements (CVAs):
The procedure of the CVA had been introduced in the reforms carried out in 1985 – 86 Insolvency Laws that were based on the recommendations of the Cork Report in an attempt to create user friendly and inexpensive rescue device. The whole idea was to come up with a reorganization plan in order to reach an arrangement of indebtedness between the company and its creditors. The crucial feature of this process is that it is voluntary and hence, presents a easy access for the directors as well as shareholders to the rescue regime so that the fear of wrongful trading liabilities would be eased up. On having this fact in mind, the company that faces the financial difficulty can be potentially cured at any point in time. Also, the attraction with regards to the CVA procedures is that the directors remain under the control of the company’s affairs and the monitoring of the proposed nominee. Later, the proposal is to be approved by the creditor’s meeting as well as shareholders’ meeting. The procedures regarding the Company Voluntary Arrangements are simple, quick and unitary which are quite different from the schemes of arrangement. Now the voting structure in the CVA regime by the entitlement of vote on the proposed voluntary arrangement to do so in single class of meeting.

The procedure followed in the CVA is an agreement based on the contract that can be explored out of court. However, the court can still provide a complete supervision regarding the implementation of the given proposals (but it somehow involves itself in the procedure only to prevent unfair prejudice). Therefore, the court’s involvement facilitates the approval of the rescue arrangements because it is on the part of the court to remove the difficulties to avert unnecessary delay and litigation. The CVA procedure despite being easy and simple has not played the expected role in rescuing the companies that face the financial difficulty, so in view of this, the procedure was largely underused. Therefore, in an attempt to figure out as to why the procedure was greatly underused, it was seen that the main weakness of the procedure was the lack of moratorium. The CVA procedure has, then, became unstable as well as vulnerable and so if this could be resolved by applying for an administration order, this course of action would be extremely costly in case of smaller firms which are already troubled financially(schall, 2005). Due to this very fact, reforms for this perceived deficiency of the existing lack of moratorium has become the main focus of the Insolvency Act 2000.  

II.    Debtor Control
It refers to the restrictions imposed on the activities of the firms in order to reduce the risk of default. It generally focusses on the transactions as well as operations on the part of the shareholders and directors that may render the company vulnerable to failure that may deprive the creditors to take access to all or part of the company’s assets. The remedies include the provisions relating to the amount of minimum capital required to start a firm. The restrictions are put on the payment of the dividends which are defined by the reference of the firm’s capital, the rights of the courts to pierce the corporate veil and protect creditor’s interests. It is very important for protecting the unsecured creditors as well as public enforcement of directors’ liabilities in the event of insolvency.

III.    Credit Contracts
It deals with the existence, feasibility as well as enforcement of self-help mechanisms which are used by the creditors in order to protect their interests. The main aim of including these laws is to protect the ability to take various forms of security or collateral. In order to do so, some variables are covered that include those relating to mortgages, floating charges, financial collateral as well as the retention of the title clauses.

IV.    Insolvency Procedures
It is the set of the statutes that consist of the procedures that govern corporate reorganizations and liquidations. These rules trigger the insolvency proceedings by shareholders and directors. Whether secured creditors alone, unsecured creditors, shareholders, or courts have the power to appoint a bankruptcy trustee or administrator; rules on voting over the firm’s exit from bankruptcy; and priorities between different creditor groups in liquidation and rehabilitation proceedings.

2.    Insolvency Laws and Creditors’ Protection in USA

It is clearly laid down in the Article 1, Section 1 and Clause 4 of the Constitution of United States. It states that the Authority has been given to the Congress in order to establish the uniform laws that are concerned with the insolvency as well as bankruptcy. For the last two centuries, there have been numerous laws regarding bankruptcy enacted on the part of Congress. The Title 11 of the Code of United States is also called as United States Bankruptcy or Insolvency Code. Hence, the statute that covers the US Insolvency Code protect the creditors and debtors the same. The central idea of the US Bankruptcy Code requires that majority of the assets of a debtor would be administered and distributed in a proper and orderly fashion for the advantage of the creditors.


In light of this, the UNCITRAL is the body that has successfully adopted the US Model Law in terms of cross-border Insolvency. This approach on the part of the legislation has effectively replaced section 304 of the Bankruptcy Code. Further, as per this body, the US interpretation must be in accordance with the ones that have been promulgated by the other countries that have adopted them in order to promote a uniform as well as legal regimes for the Insolvency cases(Armour, 2000). In view of this, there have been five major mechanisms that have drafted to deal with the cases of Insolvency involving debtors, assets, claimants and other parties that might belong to more than one countries.

These objectives are as follows:

  • 1.    Promoting the cooperation between the Courts of United States and the courts of interested parties and other competent authorities belonging to the foreign countries which are involved in the cross-border insolvency cases.

  • 2.    It is intended in establishing a greater legal certainty for trade and investment.

  • 3.    Providing a regime of fair and efficient ad cross-border insolvencies with an aim of protecting the interests of all the creditors as well as other interested entities

  • 4.    It protects as well as maximizes the value of the debtor’s assets , and

  • 5.    Facilitation of the rescue of financially troubled businesses so that the protection of investment and preservation of the employment are maintained. 

Generally, there are two types of Bankruptcies that exist in United States. These are:

1.    Liquidation: the majority of the Bankruptcy cases which are filed in the territory of United States constitute Liquidations. The process of Liquidation begins by allowing a trustee to be automatically appointed by the Insolvency Court by making him responsible for the collection of the non-exempt assets of the debtor. After that, he converts those assets to cash and then distributes it to the creditors as well as shareholders based on the distribution scheme regarding Bankruptcy Code. There are five stages that constitute the process of Liquidation – a) Commencement of the case, b) Securing debtors’ assets, c) Liquidating the non-exempt assets of the debtor, d) Distributions of the creditors, and e) Honest discharge of the Bankruptcy Code.

2.    Reorganizations: The United States Bankruptcy Code takes into account the process of Reorganization by the specific types of the debtors. In such scenarios of the cases of Reorganization, the creditors look towards the future income of the debtors in order to satisfy their claims. In majority of such cases, the retention of the control of the possessions is with the debtors. So, the commencement of the case needs the filing of the bankruptcy petition voluntary or involuntary. The operation in terms of debtor’s business as well as successful reorganization of a commercial enterprise requires that the debtor continues with the operation on the part of the management of the debtors’ business dealings(FRANKS & TOROUS, 1989). Therefore, the plan of reorganization exists against the debtor and establishes in a way in which claims would be paid or satisfied. The reorganization also talks about the acceptance as well as confirmation of the plan.

3.    Insolvency and Creditors Protection Laws in India: The Insolvency and Bankruptcy Laws in India are widely applicable to the individuals, corporations as well as organizations for that matter. When these entities become unable to meet their financial obligations with regards to the payment of the dues. The facts suggest that Insolvency happens because of the poor cash management or increase in the cash expanses or decrease in the cash flow. In all the likelihood of cash flow, any business could be insolvent yet might look complete in the balance sheet. As an example, the illiquid assets help to maintain the solvency of the balance sheets and not the cash flows. The exact reverse of the process can also happen in terms of negative net assets and a positive cash flow.
The Insolvency and Bankruptcy Law is covered under the Article 246 of the Seventh Schedule of the Constitution of India. In India, the winding procedures of the companies are being regulated by the Companies’ Act under the supervision of the Court. However, if employment is put under consideration, there are several restrictions on the closure of any industrial undertaking. In other words, it means that there are freedoms to undertake any kind of industrial activities, but no freedoms to exit at all. According to the Insolvency laws prevalent in India, the restrictions on the process of deregulation and liberalization on undertaking industrial activities have been withdrawn and relaxed(Armour, Deakin, Lele, &Siems, n.d.). Such processes are required to be further ordered to recognize that so long as a company is acting in the interests of the shareholders, then there is a need to have the necessary freedom in managing, merging, amalgamating, restructuring and recognizing the plans in the interests of its stakeholders.

Indian Insolvency Laws for Individuals and Corporates

India has the following laws for individuals and corporations for Insolvency and Bankruptcy:
•    Pre-Insolvency Workouts
Pre-insolvency Work-out Schemes include: 
• Companies Act, 1956 (Sections 391 to 396)
• The Sick Industrial Companies (Special Provisions) Act, 1985 
• Corporate Debt Restructuring Scheme 
• Asset Reconstruction under Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI) 
• RBI Guidelines on Special Mention Accounts.

•    Insolvency of individuals and unincorporated entities
In case of the individuals as well as their partnership firms getting insolvent in any situation, they are effectively taken care of and dealt accordingly under the laws. As a result of that, the declaration of the insolvency and incapacity of contract is made. This provision is covered by the Provincial Insolvency Act, 1920 and Presidency Towns Insolvency Act, 1909.

•    Corporate Insolvency
The provisions that are applicable under the Corporate Insolvency cases are helpful in winding up the companies being covered under the Companies Act, 1956.

•    Incorporated Associations’ Insolvency
It includes the insolvency of the bodies such as co-operative societies and certain bodies incorporated under specific legislations.
The Insolvency Procedures that are used in India have the following important steps:
1.    The insolvency or liquidation processes that are followed in India address all the aspects of recovery, revival, reconstruction as well as winding up(Umashankar, n.d.). This procedure can also be seen as a holistic approach and should be understood accordingly.
2.    It is observed that there is a coherent lack of a separate Unified Insolvency Code which covers all of the above mentioned aspects. Because of this, the process becomes more complex, time consuming as well as ineffective.
3.    The legal as well as procedural framework regarding the present scenario is related to the insolvency on the part of corporations so that several special provisions like debt recovery laws being laid down by the major legislations are as:

  • i.    Companies Act 1956 

  • ii.    Sick Industrial Companies (Special Provisions) Act, 1985 [SICA]

  • iii.    Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI) Act, 2002 also known as the Securitization Act 

  • iv.    Recovery of Debts due to Banks and Financial Institutions Act, 1993 (RDB Act)

4.Insolvency and Creditors Protection Laws in France 

The Insolvency and Bankruptcy Laws that are followed in France help in providing restructuring as well as pre-insolvency proceedings that are categorized into two sub-groups – Court Assisted and Court Controlled. There are two Court Assisted proceedings that are also called The Mandat ad hoc and conciliation proceedings, while Court Controlled proceedings, on the other hand, and are of four types (Judicial Reorganization, Judicial Liquidation, Sauvegarde and Accelerated Financial Sauvegarde Proceedings). The Court Assisted proceedings are the ones that are both informal and amicable at the same time under which no creditor can be forced into a restructuring agreement while the management is still working in business operations. The proceedings and negotiations are governed by the contractual law which imply that the consent of all the stakeholders such as debtor is included in the restructuring process(DAVYDENKO & FRANKS, 2008). Therefore, it is imperative on the part of debtor to decide whether to enter into these kinds non-compulsory proceedings that are processed under supervision of court-appointed practitioner. Because of that, the debtor reaches an agreement with its creditors, particularly by the process of rescheduling indebtedness. The Court-controlled Proceedings share some of the following similar features:

  • The claims that are in the pre-filing stage, excluding a few of them, are automatically stayed.

  • All the creditors, except for the employees,are required to file proof of their claim within a time durationof two or more months after the opening judgment gets published first. In certain exceptions, this period can be extended for those creditors who are located outside France.

  • The debts that were identified after the beginning of commencement of proceedings, will be covered in terms of priority as compared to the debts that were incurred well before their commencements.

  • As far as Judicial Reorganizations and Judicial Liquidation Proceedings are concerned, certain kinds of transactions could also be made aside by the court, if, for example, they were entered into the debtor and a hardening period be given before a judgment opening a judicial reorganization or a judicial liquidation. This period starts from the date on which the company is termed as insolvent. Therefore, such date would be fixed by the court and may predate the judgment commencing significant insolvency proceedings by up to 18 months.

5.German Insolvency and Creditors’ Protection Laws

The Insolvency and Bankruptcy Laws that are applicable in Germany are covered under a profound set of Insolvency Code that was enforced from 1st January 1999. The provisions governed under this law, have been amended from time to time. A recent amendment in this Act was termed as the Further Facilitation of the Restructuring of the Company that was applicable from March 2012. Germany has one basic but also a profound Insolvency procedure that is applicable mostly for both individuals and companies. The proceedings, therefore, are initiated against any person under any natural or legal circumstances unless of course the defendant is organized under the public law. The objective of the proceedings, in Germany, has always been the non-discriminatory satisfaction for the creditors. Therefore, for achieving it, there is a well-crafted framework for the liquidation of the insolvent’s debtors’ assets with the help of a practitioner that was appointed by a court. 
Stages of the Insolvency
The stages with regards to the insolvency in Germany are mostly divided into Preliminary as well as final Insolvency proceedings which are both being supervised by the Insolvency Court. These proceedings are then initiated only in the situations whenever the financial crisis of the company prompts the management to file for Insolvency in the competent court as well as for avoiding any personal criminal or financial liability. Apart from the management itself, the filings for insolvency on the part of creditors are not only possible but are usual(Pistor, Raiser, &Gelfer, 2000). Once the procedure is initiated, the Insolvency Court reacts by appointing a preliminary creditor’s committee as well as preliminary Administrator for Insolvency. This administrator is given the task of securing the assets of the debtor and start preparing for the grounds for the Insolvency.
Grounds regarding Filing for Insolvency
The ultimate proceedings for the insolvency are opened whenever the findings and observations of the court give way to the conclusions that include a) the debtor is illiquid meaning unable to pay its debts, and b) the debtor is over-indebted. In view of this, the question arises whether a positive business continuation forecast can be made. Pursuant to the case law, illiquidity does not exist in the event of certain limited temporary liquidity gaps.

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6.    Insolvency and Creditor Protection Laws in Brazil

Brazil is the country where there exist a large number of securities over the assets. In majority of the cases, the security is seen in traditional terms such as Mortgage in terms of real property and Pledge in terms of moveable assets. In both of the securities, however, the debtor acquires the relevant asset in order to secure the obligation which is being underlying.Even in case if the transfer of the ownership of the asset to the creditor is not taken place perfectly, the priority, however, is still made over the respective asset which can be opened against the unsecured creditors. If default happens on the part of debtor, the creditor is given an entitlement for filing a foreclosure proceedings against the debtor who seeks the collection of the secure debt. Other than the Mortgage and Pledge, the debtor is also brought under the obligation of transferring the fiduciary ownership over the asset given to the creditor for securing a debt. Further, the creditor is often exempted from the effects of bankruptcy as well as Judicial or extra-judicial reorganization. In the case of proceedings under the judicial reorganization, the subject to some of the limitations is given an entitlement in order to repossess the asset, particularly during the situation whenever the debtor is submitted to an insolvency proceeding(Araujo, Ferreira, &Funchal, 2012).
Brazil also does not have any particular tests for the insolvency as financial benchmarks. However, the creditors can also make requests about the bankruptcy liquidation of a company that is essentially a defaulter on a liquid obligation. As for an example, if in case a company exceeds 40 minimum wages and is formalized through a protested instrument allowing a creditor filing for an enforcement proceeding against the company. Therefore, the companies resort to the reorganization proceedings or voluntary liquidation in the case of inability on the part of paying the required obligations.
A company, in Brazil, may be placed into a bankruptcy liquidation proceeding in the following cases:

  • a)    If it defaults on a certain obligation materialized under the instrument of protested enforcement.

  • b)    Under an enforcement proceeding that is filed against the debtor, if he does not pay, deposit or offer assets for attachment that is sufficient to cover the amount of the debtor.

  • c)    If it performs any of the so-called bankruptcy acts, such as premature liquidation of assets, fraudulent payments as well as transfer of assets to the third party.

References

  • Araujo, A., Ferreira, R., &Funchal, B. (2012). The Brazilian bankruptcy law experience. Journal Of Corporate Finance, 18(4), 994-1004. http://dx.doi.org/10.1016/j.jcorpfin.2012.03.001

  • Armour, J. (2000). Share Capital and Creditor Protection: Efficient Rules for a Modern Company Law.Modern Law Review, 63(3), 355-378. http://dx.doi.org/10.1111/1468-2230.00268

  • Armour, J., Deakin, S., Lele, P., &Siems, M. How Do Legal Rules Evolve? Evidence from a Cross-Country Comparison of Shareholder, Creditor and Worker Protection. SSRN Electronic Journal. http://dx.doi.org/10.2139/ssrn.1431008

  • Berensmann, K. & Herzberg, A. (2009). SOVEREIGN INSOLVENCY PROCEDURES - A COMPARATIVE LOOK AT SELECTED PROPOSALS. Journal Of Economic Surveys, 23(5), 856-881. http://dx.doi.org/10.1111/j.1467-6419.2009.00604.x

  • Boubakri, N. &Ghouma, H. (2010). Control/ownership structure, creditor rights protection, and the cost of debt financing: International evidence. Journal Of Banking & Finance, 34(10), 2481-2499. http://dx.doi.org/10.1016/j.jbankfin.2010.04.006

  • DAVYDENKO, S. & FRANKS, J. (2008). Do Bankruptcy Codes Matter? A Study of Defaults in France, Germany, and the U.K. The Journal Of Finance, 63(2), 565-608. http://dx.doi.org/10.1111/j.1540-6261.2008.01325.x

  • FRANKS, J. & TOROUS, W. (1989). An Empirical Investigation of U.S. Firms in Reorganization.

  • Galindo, A. &Micco, A. Creditor Protection and Credit Volatility. SSRN Electronic Journal. http://dx.doi.org/10.2139/ssrn.1818728

  • Galindo, A. &Micco, A. Creditor Protection and Financial Cycles. SSRN Electronic Journal. http://dx.doi.org/10.2139/ssrn.1817242

  • Pistor, K., Raiser, M., &Gelfer, S. (2000). Law and Finance in Transition Economies. The Economics Of Transition, 8(2), 325-368. http://dx.doi.org/10.1111/1468-0351.00047

  • schall, A. (2005). 'The UK Limited Company Abroad – How Foreign Creditors are Protected.EUROPEAN BUSINESS LAW REVIEW, (6).

  • Umashankar, S. Evolution of Environmental Policy and Law in India. SSRN Electronic Journal. http://dx.doi.org/10.2139/ssrn.2508852

        

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