It’s easier to go bust in the US.
This is one of the reasons put forward to explain why the US has come out of recession earlier and faster than Europe. It is argued that the bankruptcy regime in the US is quicker at killing off companies that deserve to go under and better at helping viable ones back to health than its counterparts in Europe.
The main US track, known as Chapter 11, has its critics. It is very expensive, for a start, and works better for large companies than small. Indeed, the process is the subject of a major study in the US to see what reform it requires. But its overriding aim is to keep companies alive, and administrators are given significant powers – the ability to retain management, and give companies “breathing room” from creditors – to do so.
In Europe, although regimes differ across countries, bankruptcy is a measure of last resort, which assumes a distressed debtor has negotiated all possible remedies with creditors without success. Management is ousted when the receivers come in and, because distressed businesses are not given even temporary protection from creditors, suppliers and customers tend to make for the doors, speeding up the company’s demise.
This is one reason why Europe’s companies, often aided and abetted by banks unwilling to recognise losses on their balance sheets, will do anything to avoid formal bankruptcy proceedings. And why, when possible, they often opt instead for out-of-court proceedings in England, where the insolvency regime is seen as more flexible and friendlier to creditors. London, it seems, is not just a good place to get divorced, but a good place to go broke.
Applying English legal solutions to the debt problems of a continental European company became a regular feature of the financial crisis. Since 2009, lawyers have often opted to move a company’s “centre of main interest” (COMI) to England, enabling a scheme of arrangement to be applied. This allows a company to restructure its debt with only 75 per cent of each class of lender agreeing, carrying recalcitrant minority lenders along with the deal.
This made possible, for example, the restructuring of La Seda de Barcelona, a large Spanish packaging manufacturer that was nearly dragged down by its debts in summer 2009. After some nifty legal footwork, and because it had debt facilities governed by English law, the company was able to establish a scheme of arrangement, a concept that was unknown in Spain.
The country has now amended its law to allow such schemes. It is not the only continental European government to have tinkered with its insolvency regime as a result of lessons learnt during the financial crisis. The European Commission has also taken note, and recommended last year simplifying and reforming the rules governing cross-border insolvencies to put more emphasis on rescuing distressed companies than liquidating them. The key recommendations included expanding the legislation to include out-of-court proceedings such as schemes of arrangement, and simplifying the process of dealing with debtors with cross-border operations.
The recommendations were broadly welcomed by business and passed by the European Parliament last month. However, MEPs modified and added to the commission’s recommendations in a way that risks setting back the progress they represent. The inclusion of out-of-court proceedings was voted down by MEPs, who also introduced a “look back” period, which means that, for three months after a company has moved its COMI, it will continue to be subject to the insolvency rules of the country it has left. The latter proposal, in particular, seems designed to create greater obfuscation for investors and difficulties for companies in distress.
The commission’s recommendations were meant to clarify often obscure rules around establishing a company’s COMI. The new proposals make this more, not less, difficult. Secondly, the three-month time period chosen appears arbitrary. If the aim is to stop companies “gaming” the system by moving their COMI before bankruptcy so that they benefit from a more flexible regime, then why not make it six months or a year?
Most importantly, though, the proposals suggest that rather than reforming the system, MEPs are more interested in protecting the interests of practitioners and lawyers in countries unwilling to adopt more flexible insolvency regimes, rather than help struggling businesses make it back to health. Which, given the state of Europe’s economy, seems mistimed as well as misguided.
Sarah Gordon is the FT’s Europe business editor