Vol 2 (2005) - Issue 5

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The Convergence of Creditor-Driven and Formal Insolvency Models

Introduction

The position of secured creditors upon the insolvency of their debtor is at once secure and precarious. It is secure to the extent that the law accords priority to their interest for reasons of economic efficiency, given that lending is seen as a prime catalyst for the encouragement of entrepreneurship, and so as not to discourage contractual determination of outcomes upon acts of default by the debtor. It is precarious to the extent that ‘overreaching’ by judicial or legal processes resulting in the postponement of the security through involuntary or equitable subordination can occur. Furthermore, on occasion, the legal framework behind the security may fail resulting not only in the loss of priority but also that of the security itself. That said, a certain amount of insecurity may also arise from the availability of pre-insolvency and insolvency measures under domestic legislation. The paradox is that, in legal terms, the security (in the sense of safety) that is granted by having a legally determined insolvency framework with observable rules and a reasonably predictable outcome may not be in the creditor’s interest to experience because of the inherent delays to which all legal process is subject and also because of the risk that the security obtained may be judicially overreached, postponed or avoided, often by reference to other applicable principles of insolvency and the intervention of other interests deemed superior, often because of inherent doctrines and social views in that legal system. For those reasons, the resolution of insolvency cases by means of informal workouts has been seen to act in the creditor’s favour by encouraging a participative approach to resolving insolvencies.
The relative speed of the process, flexibility and informality, despite the often complex legal advice supplied and documentation required, assist the re-financing needs of the debtor and any hiving off as well as sales, acquisitions or consolidations of assets necessary. However, even agreements seen as watertight may be in theory later upset, despite the willingness of debtor and creditors to continue performance. Nonetheless, informal workouts, standstill arrangements, mediated resolution and arbitrated disputes are popular and seen as advancing all the interests involved. Perhaps because of this, insolvency systems have developed models seeking to take the perceived advantages of creditor-debtor negotiated outcomes, essentially in deference to the ideal of laissez-faire, while circumscribing certain undesirable outcomes by providing for scrutiny and/or validation by a court at certain points in the process. Conversely, in certain jurisdictions, informal arrangements hitherto outside insolvency frameworks have acquired as part of the process a phase where agreements are voluntarily submitted for approbation by a court as a form of risk management strategy. Although not universal in practice, the tendency to incorporate some court involvement leads to a rapprochement with the formal insolvency model.
There is quite considerable interest shown in this field by the European Bank for Reconstruction and Development (‘EBRD’), International Monetary Fund, Asian Development Bank (‘ADB’) and the World Bank, all of which have been working on insolvency models appropriate for their constituencies. In many instances, the recommendation is for a more ’formal’ informal approach with framework guidance for those jurisdictions without an active history of workouts, which would certainly be of interest to many countries in the developing and developed world. Often, the availability of debtor-friendly approaches in voluntary arrangement schemes seen in many Western European jurisdictions have usefully served as models in this respect. Conversely, formal insolvency regimes appear to become more streamlined in their structure and seem to be taking on elements that might conceivably appeal to those seeking a negotiated solution.