Doing Business 2018 Resolving Insolvency The challenges of successfully implementing insolvency reforms ƒƒ Since 2013/14, 19 economies have Access to finance is key to the development of the private sector. Lenders need tools to introduced reorganization procedures assess not only the risk of non-repayment but also what happens if a debtor cannot repay and another nine economies have debts as they mature. A good insolvency framework—one with clear rules, that efficiently improved their existing procedures. rehabilitates viable companies and liquidates non-viable ones—provides entrepreneurs However, making them workable in and lenders with tools to evaluate the consequences of a worst-case scenario. practice can be challenging. ƒƒ France introduced a restructuring Existing literature shows that legal pro- may decrease the failure rate of insolvent procedure—the procédure de tection of creditors and efficient enforce- firms. Research on the 1999 Colombian sauvegarde (safeguard procedure)— ment are conducive to larger and more bankruptcy reform shows that by reducing in 2005 to enable debtors to prevent economic and financial difficulties. developed capital markets and that there reorganization costs through, for example, Today, the procedure facilitates is a link between insolvency reforms and streamlining the reorganization process business survival in three out of four access to credit.1 The specific features of and establishing mandatory deadlines on initiated cases. an economy’s insolvency regime and its the length of proceedings, the new law enforcement are important aspects for enabled viable companies to reorganize ƒƒ Slovenia brought its legal framework the legal protection of creditors. Several and inefficient ones to liquidate (this was closer to international good studies show that reforms strengthening not possible before the reform).6 practices in 2013. Greater access to the insolvency framework may reduce the the reorganization procedures for cost of credit, increase the level of credit Doing Business tracks insolvency reforms creditors has been accompanied by and lower interest rates on large loans.2 A across 190 economies. Since Doing an impressive survival rate of viable study on the 2005 Brazilian bankruptcy Business 2005, 110 economies have companies. reform found a reduction in the cost of introduced 205 changes aimed at facili- debt together with a significant increase tating the efficient resolution of corporate ƒƒ Although it took some time for stakeholders in Thailand to get in the amount of total and long-term insolvency. This case study uses the accustomed to reorganization debt.3 A more recent study found that the specific examples of France, Slovenia and procedures, filings at the Central same reform led to an increase in secured Thailand to illustrate successful insol- Bankruptcy Court increased steadily loans, as well as an increase in invest- vency reforms that can inspire similar from 1% of total insolvency cases in ment and value of output in the years efforts elsewhere. 2011 to almost 9% in 2016. after the reform in Brazilian municipali- ties with less-congested courts.4 Another study shows that, across a sample of HOW HAVE ECONOMIES Organisation for Economic Co-operation REFORMED THEIR and Development (OECD) countries, INSOLVENCY SYSTEMS? efficient bankruptcy procedures are asso- ciated with a higher proportion of new Insolvency laws have traditionally focused bank loans to large firms.5 on enabling the swift liquidation of insolvent companies while organizing the Other studies show that insolvency repayment of creditors. The focus of mod- reforms that introduce or promote reorga- ern insolvency regimes has been to offer nization procedures through the adoption restructuring tools to companies that are of several international good practices economically viable but face temporary RESOLVING INSOLVENCY 57 financial distress in order to maintain the selected for this case study because they Many companies, however, still ended up business activity. Recent reform efforts implemented insolvency reforms that stopping operations and being liquidated, around the world have introduced this brought them closer to internationally mainly because they began the reorgani- modern feature to insolvency frameworks -recognized good practices—particularly zation process when their financial situa- while also allowing the speedy liquidation through the introduction and improve- tion was already severely compromised. of nonviable businesses. ment of restructuring procedures (table In response, the government amended 7.1). There is also a significant amount the insolvency law in 2005 to focus on In 2013/14, the resolving insolvency indica- of information available on the evolu- preventing firms’ economic and financial tors started measuring whether insolvency tion of court procedures following these difficulties. A new restructuring tool—the laws complied with certain international reforms. Business reorganization has procédure de sauvegarde (safeguard proce- standards, including access to reorganiza- become an increasingly utilized option dure)—was introduced. It allowed debt- tion proceedings for debtors and creditors. for viable firms in financial distress in all ors that are facing difficulties (but which Since then, the most common type of three countries. have not yet ceased payments) to apply reform recorded by the indicators has for court protection while they negotiate been the introduction of or improvements The case of France a restructuring plan with creditors. to reorganization procedures. During this Since the 1980s France has regularly period, 19 economies introduced reorgani- assessed and updated its insolvency Contrary to initial expectations, the safe- zation procedures and another nine econo- legal framework to encourage business guard procedure was not widely used. mies improved their existing procedures.7 rescue. In the mid-1980s—when the When the procedure became available number of firms declaring bankruptcy for the first time in 2006, only 509 safe- Providing creditors with greater access to doubled compared to the previous guard applications were filed (compared and participation in insolvency proceedings decade—liquidation was the only to 16,046 judicial reorganizations and has been another common area of reform. option available to companies in finan- 31,045 judicial liquidations).8 One reason Economies including Cyprus, Jamaica, cial distress. The number of business was that the criteria required to initiate Kazakhstan, Mexico, Mozambique, St. liquidations rose from 11,000 in 1970 the safeguard procedure were too strict. Vincent and the Grenadines, Switzerland to 25,000 in 1984. Members of the Debtors had to demonstrate that they and Uganda have implemented reforms in legislature realized that some of these were facing difficulties that would result this direction. Enabling creditors’ meaning- companies could have been saved had in insolvency, which was challenging. ful participation in the process can make they been given the tools to restructure. Another reason was that the law did not them more cooperative and less litigious, The legislature subsequently adopted clearly stipulate which party—the com- and it can result in shorter proceedings. three laws in 1985 with the objective of pany managers or the court-appointed saving viable businesses. A reorganiza- administrator—was responsible for the Many factors, however, can make it tion procedure, open to debtors in ces- preparation of the safeguard plan, an challenging to implement insolvency sation of payments that had a prospect issue which could deter managers from reforms. Doing so requires not only the of survival, was introduced. starting the proceedings. adoption of an insolvency law or amend- ments to existing legislation but also TABLE 7.1  France, Slovenia and Thailand successfully implemented insolvency changes to regulation to make the law reforms workable in practice. An insolvency law Country Motivation Reform content Outcome often requires setting up new structures France High number of bankruptcy Starting in 1985, introduced Increased number of under the regulatory framework such cases; no possibility for restructuring procedures with focus initiated and successful as, for example, a professional body companies to reorganize on preventing firms economic and reorganization cases prior to the reform financial difficulties of insolvency administrators. Successful implementation also requires the buy-in Slovenia High number of insolvent Starting in 2008, introduced Increased number of companies as a result of the preventive restructuring procedure initiated and successful and active participation of the judiciary. 2008 global financial crisis; for medium and large-size reorganization cases features of restructuring companies and simplified procedures not suited; reorganization procedure for micro no preventive procedures and small-size companies; improved WHAT DID SUCCESSFUL available access to reorganization proceedings for creditors REFORMERS DO Thailand High number of non- Starting in 1998, introduced Increased number of DIFFERENTLY? performing loans in the reorganization procedure for initiated and successful context of the 1997 Asian corporate debtors; created reorganization cases financial crisis; no possibility specialized bankruptcy court Doing Business has recorded several for companies to reorganize notable insolvency reforms. However, prior to the reform France, Slovenia and Thailand were Source: Doing Business database. 58 DOING BUSINESS 2018 The insolvency law was amended again FIGURE 7.1  A significant number of companies undergoing restructuring proceedings in 2008 to make the safeguard proce- in France continue operating at the end of proceedings dure more accessible and attractive to debtors by simplifying the eligibility Companies continuing to operate after specified procedure (%) criteria. Debtors had only to demonstrate 60 difficulties—economic, financial, or legal —that they could not overcome, without 50 having to define or qualify the gravity or extent of those difficulties. The 2008 40 amendment also made the procedure more attractive by clarifying that the man- 30 agers of the company were responsible for preparing the safeguard plan with the 20 assistance of the court-appointed admin- istrator. Furthermore, in 2011 France 10 introduced a procedure—the sauvegarde 0 financière accélérée (accelerated financial 2007 2008 2009 2010 2011 2012 2013 2014 safeguard)—under which a debtor can reach an out-of-court arrangement with Safeguard procedure Judicial reorganization a majority of its financial creditors and then initiate summary court proceedings Source: Deloitte and Altares 2016. to validate the agreement without nega- Note: Companies that continue operating include companies that adopted a reorganization or safeguard plan, or that were sold as a whole. tively impacting non-financial creditors. These changes led to a significant increase measured by the rate of new firm entry and financial claims, as well as a new simpli- in the number of new safeguard pro- entrepreneurship support.9 fied compulsory settlement procedure to cedures filed, to 1,386 cases in 2009. offer a reorganization option for micro Since then the number of filings has The case of Slovenia and small companies. A change was also risen steadily, to 1,620 new cases in The early 2000s were a period of sig- made to the existing compulsory settle- 2014. Not only did the use of safeguard nificant reform in Slovenia as the country ment procedure to enable creditors to procedures increase, but three out of prepared to join the European Union initiate the reorganization of companies four cases terminated with an agreement in 2004. A new insolvency law was for the first time. with creditors to enable the company to adopted in 2007, but it was insufficient continue operating (figure 7.1). However, to cope with the challenging economic The procedures quickly became a popu- the increased use of the safeguard proce- and financial conditions brought on by lar option for debtors and creditors. In dure was accompanied by a significant the global financial crisis of 2008; many the first two years following the reform, number of filings for liquidation, which in companies became insolvent. Firms suf- the proportion of companies using one of 2014 amounted to 69% of all insolvency fered from over-indebtedness and had the three procedures more than doubled, cases filed. difficulties repaying their loans, leading to rising from 6% of total insolvency an increase in corporate non-performing proceedings in 2013 to 14% in 2015.11 By allowing viable companies to restruc- loans to around 20% of total loans.10 Microenterprises, however, underwent ture and continue operating as going con- Firms in Slovenia needed effective cor- corporate liquidation proceedings in the cerns, the amendments to the insolvency porate restructuring procedures to guide vast majority of cases (96%) in 2016. law aimed to support entrepreneurial risk- the restructuring of their debt. Microenterprises have less capacity taking and encourage enterprise creation. to face a reorganization and to secure Insolvency reforms may have contributed To address these needs and to bring the resources to enable them to operate in in part to the surge in new businesses legal framework closer to international a situation of financial distress. Despite in France—525,000 companies were good practices, the government modified these challenges, microenterprises have created in 2015, twice as many as in the corporate restructuring framework in also benefited from the restructuring 2000. This growth underscores the con- 2013. The changes included the creation options. Indeed, the number of simplified nection made in the literature between of a new pre-insolvency restructuring compulsory settlement proceedings for sound insolvency systems and the procedure for distressed medium and the benefit of microenterprises increased level of entrepreneurship development as large-size companies to restructure their from 59 cases in 2014 to 85 in 2016. RESOLVING INSOLVENCY 59 Creditors have progressively taken FIGURE 7.2  Corporate reorganizations in Slovenia have become more successful advantage of the enabled access to com- over time pulsory settlement proceedings granted Procedures (number) to them in 2013; by 2016 they initiated almost one-third of all cases. During the 100 same period, the number of successfully 90 terminated reorganization proceedings 80 increased significantly. In 2016, most 70 ended with an approved settlement 60 (figure 7.2). 50 40 One of the companies that benefited from the restructuring procedures was 30 Pivovarna Laško, Slovenia’s largest brewer. 20 By the end of 2014, the company’s total 10 financial liabilities stood at 226.8 million 0 euros (about $268 million). It negotiated a 2013 2014 2015 2016 restructuring plan with its creditors, which Rejected compulsory settlement and simpified compulsory settlement/conversion to bankruptcy included a two-year debt rescheduling, Approved compulsory settlement and simplified compulsory settlement the sale of shares in other companies and an intensive search for additional capital. Source: Slovenia Ministry of Justice 2017. Following the agreement, the company was bought by Heineken International BV, which committed to provide financial regimes may encourage entrepreneur- plan with creditors. A specialized bank- stability to the company. Following the ship and accelerate the speed of adjust- ruptcy court was established in 1999 sale of its assets in various corporations ment of non-performing loans.12 to adjudicate cases. Also, the Business and entering into long-term loan agree- Reorganization Office (within the Legal ments with Heineken, the company was The case of Thailand Execution Department) was set up to able to repay its creditors in full in October The 1997 Asian financial crisis prompted administer new reorganization cases. 2015. Its value increased, the brewery a major insolvency reform in Thailand. was able to continue operating, saving Non-performing loans had been increas- Considerable time was needed in Thailand hundreds of jobs. ing before the crisis, reaching a peak of for stakeholders to become accustomed 42.9% of total loans in 1998. Thailand’s to reorganization procedures. Finding Apart from increasing the likelihood of antiquated insolvency law needed to be expertise within Thailand to prepare business survival—as shown by the ris- revised and given the features necessary reorganization plans proved challenging; it ing number of successfully-terminated to perform. The 1940 Thai Bankruptcy required the capacity to negotiate a plan compulsory settlement and simplified Act established the procedure of judicial with multiple creditors in a short period of settlement procedures—the insolvency liquidation for debtors unable to meet time to return the company to profitability. reform may have contributed to broader their financial commitments. It relied on Managers of companies in financial dif- positive economic effects. First, the an agency within the Ministry of Justice— ficulties found it challenging to formulate level of entrepreneurship and company the Legal Execution Department—to a reorganization plan effectively. Debtors formation in Slovenia increased. One direct the proceedings. The only aim of turned to large companies with foreign year after the reform was introduced, the law was to organize the repayment of human capital that had expertise in draft- 6,243 new businesses were registered in creditors through liquidation procedures; ing such plans. However, this approach Slovenia, the highest number in a decade it did not offer a channel for viable com- was expensive, making reorganization (and similar to pre-crisis levels). Second, panies to survive. procedures accessible to only a small progress has been made in addressing number of large debtors. Slovenia’s high level of non-performing Amendments brought by the Bankruptcy loans, which decreased from 15% of total Act of 1998 built on the existing legal and As a result, in the years following the loans in 2012 to 7.9% in 2016. While institutional framework. They introduced reform, the number of annual applica- these results do not establish a causal a reorganization procedure for corporate tions for reorganization was modest, relationship with the insolvency reform, entities, giving insolvent debtors the averaging 30 to 70 (compared to approx- they suggest that sound insolvency chance to negotiate a reorganization imately 700 annual applications for 60 DOING BUSINESS 2018 liquidation).13 Realizing that the benefits The connection between the insolvency business, compared to 12.2% of firms in of the procedure had to be explained to reform and the likelihood of business the region and 26.5% in all economies. stakeholders, the government undertook survival is reflected in Doing Business While no causal relationship can be outreach efforts. As local firms gained data. Resolving simple reorganization established between these results and the necessary expertise to advise debtors cases in Bangkok has become easier over the bankruptcy reform in Thailand, they during the reorganization process, time. Companies are now more likely to do show that access to credit improved reorganization practices progressively continue operating at the end of reorga- in the years following the reform. became more widespread in Bangkok. nization procedures. Also, today it takes Consequently, all parties were able to 18 months on average, half the time it experience the advantages of the new took in 2010, for a small company to go CONCLUSION mechanism, enabling them to make use through reorganization, counted up to of it to save viable businesses. Together the moment the reorganization plan is The successful implementation of insol- with a greater understanding of the law, approved by creditors. vency reforms is not easy. Many factors reorganization filings rose to 3.5% of must come into play for an insolvency total insolvency cases in 2014 (from 1.1% Studies on the effect of insolvency reform to yield positive effects in both in 2011).14 The share almost doubled in reforms that accelerate the procedures insolvency practice and the economy. 2015 and continued to rise in 2016, when find that they increase the aggregate Even in economies with strong legal 8.5% of insolvency petitions received by level of credit. Other studies suggest frameworks and institutions, insolvency the judiciary were reorganization cases that where insolvency regimes are most reforms take time. It is a complex area (figure 7.3). effective, creditors are more willing to of law, which is why different agencies— lend because they are more likely to including the judiciary as well as insol- The rising use of reorganization proceed- recoup a larger share of a troubled loan.15 vency administrators—need to be trained ings in Thailand has driven an increase Following the reform in Thailand, domes- and given the means to carry out the tasks in the rate of successful reorganizations tic credit to the private sector rose from envisioned in the law. (that is, cases that end up with the 93% of GDP in 2001 to 147% of GDP in approval of the reorganization plan, 2016.16 Banks are more willing to lend in Lessons can be drawn from reforms regardless of whether they continue Thailand than in other parts of East Asia implemented worldwide. The French operating in the longer term). The Central and the Pacific. Data from the World and Slovenian examples show the Bankruptcy Court’s reorganization plan Bank Enterprise Surveys show that only importance of constantly assessing the approval rate reached 25% in 2016, up 2.4% of firms in Thailand identify access insolvency system. Insolvency law is from 20% in 2015. to finance as a major constraint to doing not a static field. Rather, it serves the economic system and needs to adapt as the structure of the economy evolves. FIGURE 7.3  Distressed businesses in Bangkok are more likely to pursue reorganization today than seven years ago Implementing and refining insolvency reform takes time; a quick fix will not New reorganization cases as a share bring positive long-term results. The of total insolvency cases (%) example of Thailand illustrates the 10 importance of utilizing the existing 9 infrastructure to drive change—the focus 8 should be on building on existing laws 7 and institutions and creating new ones 6 only when the existing system cannot 5 be adapted. A new framework requires 4 training along with patience. Amending 3 the law should not be seen as a goal in itself, but rather as a first step to be 2 followed by the thorough implementation 1 of the amended law. 0 2009 2010 2011 2012 2013 2014 2015 2016 All in all, the three examples suggest that sound insolvency reforms can have a positive impact on an economy. Providing Source: Thailand Office of the Judiciary 2016. corporate debtors with the option to RESOLVING INSOLVENCY 61 reorganize increases the chances of debt recovery by creditors, positively influencing their willingness to lend. The availability of reorganization procedures also increases the likelihood that viable firms will continue operating despite financial difficulties, thus decreasing the failure rate of firms, preserving jobs and encouraging entrepreneurship. NOTES This case study was written by Faiza El Fezzazi El Maziani, Raman Maroz and María A. Quesada. 1. La Porta and others 1997; La Porta and others 1998; Klapper 2011. 2. Visaria 2009; Funchal 2008; Rodano, Serrano- Velarde and Tarantino 2011. 3. Araujo, Ferreira and Funchal 2012. 4. Ponticelli and Alencar 2016. 5. Neira 2017. 6. Foley 1999; Dewaelheyns and Van Hulle 2006. For Colombia, Giné and Love 2008. 7. The 19 economies that have introduced reorganization procedures are Brunei Darussalam, Cabo Verde, Cyprus, the Dominican Republic, Grenada, India, Jamaica, Kenya, Kosovo, Liberia, Malawi, Mozambique, Panama, St. Kitts and Nevis, St. Vincent and the Grenadines, the Seychelles, Trinidad and Tobago, Uganda, and the United Arab Emirates. The nine economies that improved their existing reorganization procedures are Chile, Georgia, Kazakhstan, Kenya, Mexico, Romania, Slovenia, Thailand, and Switzerland. 8. Deloitte and Altares 2016. 9. Lee and others 2011; Peng, Yamakawa and Lee 2010. 10. IMF 2015. 11. Slovenia, Ministry of Justice 2017. 12. Carpus-Carcea and others 2015. 13. Wisitsora-at 2015. 14. Thailand, Office of the Judiciary 2016. 15. Visaria 2009; Funchal 2008. 16. These data are from the World Development Indicators database (http:/ /data.worldbank .org/indicator), World Bank.