Economic Policy Review ISSN 1313 - 0544

The Idea of Effective Bankruptcy

Author: Metodi V. Metodiev / 12.03.2009
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When we live during times when the failures of companies and collapse of businesses could be a more frequent event than 1-2 years ago, it is important to start thinking about what are the actions when a given business eventually fails.  We are talking about mechanisms how to bankrupt[1] an insolvent company and how to protect its creditors and shareholders. The procedure of insolvency is a coordinated mechanism, which aim is the maximum satisfaction of the creditors and the shareholders of the company.

On a World scale the practice identifies three basic types of procedures of insolvency (bankruptcy):

  • Proclaiming that a dept is overdue - a process of compulsory collection by the creditor of an asset, given to him as a collateral on a loan, when the debtor does not carry out his obligations. We have to note that this approach does not protect creditors which have not taken collateral for their claims. This is a widely used procedure which in many countries does not involve the courts and which is overall quite flexible. For example in Singapore and Australia the creditors get about 90 cents for every dollar dept;
  • Liquidation procedure - this procedure requires intervention by the court and overall is quite slow. In Bulgaria the procedure of liquidation may precede the procedure of insolvency;
  • Procedure of reorganizing the company - this procedure is widely used in many of the OECD countries. According to the Bulgarian legislation there is a possibility to prepare a plan for recovery of the company and undertake a procedure of reform[2] and reorganization.

The main objectives when building an effective insolvency procedure are:

  • To maximize the total value of the company (on monetary terms), which must be distributed between creditors and shareholders;
  • To protect the absolute right of making claims and the order of repayments to creditors and shareholders;
  • To get through the process as fast as possible and with the possibly smallest costs.

If we review carefully the "Doing Business" index of the World Bank we will see that one of the composite indices measures the effectiveness of the insolvency procedures. In the annual ranking for 2009 at the first place is Japan, followed by Singapore and Norway. The time necessary to conclude the insolvency procedure in the OECD countries is on the average approximately 1.7 years, while in Bulgaria it is 3.3 years. It is interesting to note the measurement of the total recovered value of the company before the beginning of the procedure. For the OECD the average value is approximately 68.6 cents from a dollar, while for Bulgaria it is barely 32.1 cents from a dollar, in other words the difference is a bit over two times.

Table: Doing Business - insolvency procedure

Economies

Duration (in years)

Price (per cent of the business' value)

Recovered value (cents from a dollar)

OECD

1,7

8,4

68,6

East Asia and Pacific

2,7

23,2

28,4

East Europe and Central Asia

3,1

13,4

28,3

Latin America and the Caribbean

3,3

15,9

26,8

Sub Sahara Africa

3,4

20,2

16,9

Middle East and North Africa

3,5

14,1

29,9

South Asia

5.0

6,5

19,9

Bulgaria

3,3

9

32,1

Source: Doing business 2009

In Bulgaria the insolvency procedure is regulated by the Bill on Commerce. The declaration of insolvency is preceded by initial proceedings for declaration of insolvency and preparation of a recovery plan for the company. Unfortunately the bureaucratic obstacles and the sluggish procedure cost enormously for the company, which by itself leads to low level of real satisfaction of the creditors and the shareholders. 

It is necessary to optimize the insolvency process and the highest importance should be given to the effectiveness of the legal system and respect to the contractual relations. This is extremely important, because every entrepreneur must find it easy to start up his business, but it should also be possible to exit the business with the lowest costs

* The article has borrowed ideas from studies of Simeon Djankov. He is a doctor of economics from the University of Michigan, vice president of sector "Finance" with the World Bank and one of the originators of the study "Doing Business".


 


[1] The closest to the term bankrupt used in the Anglo-Saxon legislation is the term insolvency used in Bulgarian law. Bankruptcy in the Bulgaria legal system is part of the criminal law, which is the legal norm regulating the public norms, which regulate the public relations resulting from criminal acts. 

[2] Art. 261 from the Commerce Bill states: "Company for which a procedure of insolvency has been initiated could be reorganized only if the recovery plan foresees continuation of the activity."