Comparative Insolvency Law, Asset Management Companies - Assignment Example

Comparative Insolvency Law Name Institution Comparative Insolvency Law Question 1 Part A A floating charge is a security mortgage that has an underlying group of assets or asset that is subject to change in quantity and value. Corporations using floating charges still are able to use the underlying asset normally. It is only when the company fails to repay the loan and or goes to liquidation when the floating charge becomes frozen into a fixed charge (Westbrook, Booth, Paulus, & Rajak, 2010, pp. 55-56). At this point, the lender becomes the first-in-line creditor thus is able to draw against the underlying asset―its value to make up for its loss on the loan. The floating charges find best applications when dealing with assets that are prone to changes on daily basis such as securities. Fixed charge on the other hand, is a charge held over specific assets or items whereby the debtor has no right to sell the assets without the prior consent of the secured creditor or repaying the amount secured by the charge. In essence, a specific asset is assigned as collateral for a certain debt, for an example, a fixed charge debenture, or loan. This limitation led to the realization that a lender had no need for security while a business was successful and that the need for security mainly will rise if the borrower defaulted. A solution to this meant that a form of security could be granted over all the debtors’ assets (movable and unmovable) assets, but be suspended to avoid clogging the running of business until the security became necessary on the failure of the borrower. In essence, the floating charges are similar to fixed charges only when they crystallize but until then, it “floats” ― does not attach any of the charge’s assets – and thus, the holder remains free to deal with it or even to dispose it (Westbrook et al., 2010, p.55). A floating charge is not so much as effective as fixed charge but is more flexible. As long as the debtors do not violate the requirements and conditions of the floating charges, they are eligible to use the said property just like any other company assets. The floating charges take effect in equity only and are therefore, defeated by a bona fide purchaser for the value without prior notice of any asset caught by them. Practically, the scope of the collateral extends to give power to the holder to dispose the assets or individual items under a floating charge. It is only of any consequence in relation to disposals after crystallization of the charge. Fixed scope is limited to the consent and position of the creditor (Westbrook et al., 2010, pp. 55-56). For the fixed, there have been a few inroads into the rights of the holders especially where collateral can be set aside if it was taken shortly before insolvency occurred. Either way, the floating charge is prioritized and affected through freezing it to fixed charge when default occurs or debtor becomes insolvent. Under non-solvent law, a floating charge is highly flexible unlike the fixed charge. Part B The US article 9 applies to any transaction irrespective of its form, which is intended to create a security property. A security interest is enforceable if the debtor signed the security agreement that provides the “security interest” and contains a description of the collateral. In essence, the law provides lenders with legal relief in case of default by the borrower by allowing them to take security interest on the collateral owned by debtor’s asset (Westbrook et al., 2010, pp. 31-33). The U.S article 9 regulates creation and enforcement of these security interests in intangible property, movable property, and fixtures. These security interests are especially valuable in insolvency cases since the creditors with security in an insolvent debtor’s asset take precedence over the unsecured creditors who lack such interests. On the other hand, in the United Kingdom’s jurisdiction, secured creditors too, enjoy the security interest to enforce it against collateral in case the debtor defaults payment. For example, if the creditor is secured and uses the floating charges over the debtor by way of security ― not mainly as collateral or security for the payment of their own debts, rather because floating charge serves to ensure that no other creditor will, ordinarily, can lend to the debtor, and hence takes advantage of holding the charge. The other main advantage is that the lender enjoys and takes security over all of the borrower’s assets including those acquired in the course of its trading. When a fixed charge is in effect, the borrower cannot exercise overall authority over the asset unless fulfilling one of these two conditions; refunding the collateral worth held by the charge or obtaining permission from the secured creditor. A comparison of both acts shows that lenders are in a way secured because they both have a form of collateral despite the differences in effecting or executing them. In addition, in both cases, the debtor independence on the management of the collateral held against the loan is limited. In case of fixed charge, the debtor’s management of the asset held as security is actually limited to the consent of the lender. Floating charge after the debtor defaults payment changes to fixed charge out-rightly and the terms of fixed charge therefore, too take effect. The UK system of floating and fixed charges therefore seem to more favored and more stringent than the U.S. security interest. Question 2 Asset Management Companies (AMC’s) connotes investment management firms that invest pooled funds of retail investors in securities in respect to the stated investment objectives and therefore strategies in management and disposal of impaired assets. However, this depends mainly on features such as the asset type, size and distribution, the banking system structure and the available management capacity in both public sector and the banks. In essence, AMCs often derive their success from prevailing conditions such as supportive legal and regulatory environment, operational independence coupled with strong leadership, well-structured incentives, and commercial orientations. The nonperforming assets can be disposed through preservation of payment systems, an approach mainly used in restructuring regulated industries in an effort to liquidate or to get rid of the non-performing assets. A distinguishing characteristic of an Asian financial crisis has been system distress― insolvency of significant number of banks and firms. As such, financial and corporate restructuring in such circumstances left many unresolved technical problems, yet, the knowledge of best practices of managing financial difficulties and systemic distress is still evolving. Companies to help in the restricting process have therefore increased in Asia. Asset Management Companies (AMC’s) has served as a model in the aftermath of the 1997 of Asia financial crisis in many jurisdictions in that financials sectors were reeling from the high levels of non- performing loans to make them marketable with other culminating to bad debts. As a result, AMCs were established to assist with restructuring and the disposal of non-performing assets in an orderly and credible manner. An example is Korean Asset Management Corporation (KAMCO), which was established to provide effective resolutions mechanism for both non-performing loans and assets and loans and to enhance regional financial cooperation among the East Asian countries. These procedures were implemented quickly and were responsible for many of the corporate rescue success in Asia in the aftermath of the crisis (Westbrook et al., 2010, p. 179) some of these companies’ cases would have languished in courts for years, with high possibility of being liquidated. The government intervention to force parties to a negotiating table helped many corporations rise above the financial distress. Question 3 Part A Bankruptcy code provides for development of a plan that will allow the debtor, unable to pay his debt obligations, to resolve his debts through either restructuring or reorganization of business operation or simply to divide the assets among his creditors. Under the U.S. law, the Attorney General has the directive to appoint regional Trustees who shall set up, preserve, and oversee private trustees (Westbrook et al., 2010, p. 216). The trustee can be a person or corporation, under the United States’ bankruptcy code. In the context of FMC, the trustee is the representative of this company and is entitled to compensation in terms of remuneration determined by the Bankruptcy Court depending on the nature, extent and value the trustee renders. The trustee is therefore expected to offer supervisory and administrative services during the bankruptcy proceedings. In this case, after FMC filled for insolvency, it under the US law entered into the liquidation process. Under US chapter 7, 12, 13 provisions, the trustee is responsible for managing the properties of the debtor. Therefore, the trustee has the ability to reject actions taken in respect to the debtor’s property for a specified period prior to filling of the bankruptcy (Westbrook et al., 2010, pp. 74-75). This is the principle that the trustee is expected to apply in respect to the court proceedings filed by BB in December 2010 since FMC subsequently filed for bankruptcy in January 2011. In essence, the preference actions permit the trustee to avoid or turn down certain transfers of the debtor’s property ― FMC that benefits creditors occurring 90 days of the date of bankruptcy. This means that the trustee should confirm the October date in which SS loan was paid and confirm whether it lies within 90 days from the date bankruptcy was filed. If indeed, it is within this period, the trustee is mandated to recover the $20,000 paid to Stan Smith. Since, Smith is one of the directors of FMC; hence, an “insider” the “reach back” period is typically a year. Therefore, Smith is legally obligated by law to return the payment. This provision is under the US bankruptcy code hence the advice is bound to succeed since its pillars are founded on law thus binding (Westbrook et al., 2010, p.66). Part B The Hong Kong Bankruptcy Amendment Ordinance came into effect in April 1998 thus overhauled Hong Kong bankruptcy law. A common frustration facing liquidators in Hong Kong is funding― the lack thereof. The liquidator in the case of FMC, too, may identify causes of action vested in the firm but may lack funds to pursue them. In this context, the frustration is exacerbated by the fact that the claims lie against the very persons who drove the company into insolvency through deliberate dissipation or even mere mismanagement or otherwise. For example, Smith’s loan despite being unsecured, just like BB, and gets paid before the payment period while ignoring the BB loan which was due. To make the matter worse, Smith is an “insider” hence complicating the case further. In the event that a business is ended to total wind up, the Liquidator’s main role is to establish total worth of the debtor’s assets in an effort to settle the debt obligations. As such, the liquidator is expected to review FMC management conduct, decisions and actions regarding its operations and management of the company affairs. By paying Smith’s debt before BB’s loan, this amounted to unfair preference. As per the provisions of Companies Ordinance code, ‘unfair preference’ in settling company liabilities prior to filling of bankruptcy is outlawed. In this case, paying Smith in October 2010, so near the filling of insolvency in January 2011, commencement of winding up, greatly shows unfair preference. Secondly, the payment is made to Smith, who is in better position than other creditors by virtue of being a director in the same company! Under HK ordinance, the liquidator is mandated to review all transactions, which took place six (6) months before starting of the winding up. These all constitute unfair preferences. If by any chance, the unfair preference is extended in favor of an associate of the company, family, business associate and so on, liquidator is empowered to go back two (2) years to overturn transactions if this nature. It is assumed that the debtor was under pressure to effect the payments to a close associate than a distant creditor. While Smith may challenge the decision by filing immunization against the preference law, the fact that an “outsider” who loan was due but defaulted sufficiently proves that FMC was influenced into paying Smith by the fact of being an associate. Question 4 Insolvency is a condition whereby a business is unable to meet its debt obligations often resulting from insufficient investment capital on either the front end or even a negative change in cash flow. A business once becomes insolvent is entitled to seek bankruptcy protection as means of restructuring the debt or perhaps in order to embark on the process of liquidating its assets a part of the company shutdown. The insolvency procedures utilized, however, depend on whether the business owners wish to salvage the business or to dissolve in line with the directives of the court of law overseeing its compulsory liquidation. As globalization of both investments and employment has increased tremendously, there has been rise of interest in the application of insolvency procedures as part of the commercial and corporate law (Westbrook et al., 2010, p.1). Secured creditor refers to a person or a business that loaned another business or person money under the condition that if the debt is not paid, they have a right to one or some of its possessions. For example, a financial institution that holds one’s mortgage. Failure to make the payments leads to the creditor possessing or selling the house. Secured debts are not usually included in bankruptcy proceedings as the bankruptcy and insolvency act only pertains to the unsecured debts. This means that if a business or a person has any secured debt at the time of bankruptcy, such a person is expected to honor the payments up to the fair market value of the items held as security. Therefore, a secured creditor enjoys benefits provided by protection of the assets that collateralize their loans. Secondly, they have right to repossess or foreclose on an asset against which a lien is held. In essence, automatic stay confers protection to the debtor from his creditors and brings all of the debtors’ assets and creditors to the bankruptcy court where the rights of both parties are balanced. As such, automatic stay prohibits collection of calls, repossessions, beginning, or continuing lawsuits, foreclosure sales or garnishment and levies. It will therefore remain in effect until a judge lifts the stay as requested by the creditor, or when the asset is no longer a property of the estate. A country like England favors strongly secured creditors and permits very broad liens and creditor management of many defaults (Westbrook et al., 2010, p. 17). Liquidation can be voluntary or compulsory in public interest so it could be through “creditor’s winding up” or when the firm due to its liabilities cannot continue with its business. As much as the secured debts are not included in bankruptcy proceedings, the interest of both the debtors and the creditors must be considered. I hold the opinion that secured creditors should be bound by automatic stay. However, at the end I will show some situations in which the secured creditors can challenge an automatic stay. The London approach was developed to influence settling debts and act as guidelines for multi-creditor out-of- court debt restructurings (Westbrook et al., 2010, p. 177). Under these guidelines, UK banks set informal guidelines on collective process for voluntary workouts to restructure business debts under distress while maximizing their value as going concerns. Under this approach therefore, instead of pressuring the debtors or possessing their assets, creditors are better placed to achieve better returns through collective efforts to support an orderly rescue of a corporate in distress. This is further important because it prevents the creditors from forcing the corporate into a formal insolvency. In the light of this, London approach offers the best approach to protect the creditors by only restructuring payment period while protecting the debtors from total close down. Therefore, a creditor with claim arising before the commencement of the bankruptcy filing will be forced to hold on or stop all collection efforts. This is only a temporary reprieve, and it’s automatic in many cases. This implies that no court hearing is made or signature required to that effect as long as the bankruptcy filing was done to the letter. The stay thus binds all creditors immediately and willful violation can result to severe penalties against the said creditor. Moreover, the stay remains in operation until conclusion or dismissal. For example, after the Asian Crisis, the international federation of insolvency practitioners published in the year 2000, statement of principles of Global Approach to Multi-creditor workouts, which build up the London Approach However, the creditor, can bring a motion of relief from the automatic stay. Exception from the automatic stay is also possible. Secured creditors, nonetheless, can move forward with their collection efforts prior to the end of the bankruptcy but are required to file a motion with the bankruptcy court, a principle referred to as “relief from an automatic stay” (Westbrook et al., 2010, p. 32). Normally, the motion must have real grounds and the creditors’ argument must convince the judges that their collateral is losing value and failure halting their collection efforts will cause them additional losses. For example, when a secured creditor seeks a relief from the stay on basis that the property, with a significant value, is subject to unacceptable risk or its value is rapidly depreciating. In such situations, the secured creditors can pursue recovery of their collateral, which is an exceptional case and effectively protects the creditors. Question 5 Corporate insolvency affects all business stakeholders: creditors, employees, suppliers, secured creditors and lenders and various levels of government. Just like the creditors, workers who are owed wages and salaries share in the remaining assets of their insolvent employer. Employees should be treated as preferential creditor so that their claims are considered before those of other creditors (Westbrook et al., 2010, p. 184). At times, it is regrettable that the assets are inadequate to meet all the workers’ salaries and wage claims. Others may receive part payments or payment is totally defaulted. The issue of how workers should be compensated for their unpaid wages and whether they should be prioritized above secured creditors has attracted much debate. This raises the question: Should the rights of secured creditors receive special attention beyond that of the employees? Yet, is not true that workers posses a contractual right and thus entitlements accrued under such work contracts? Well, critically speaking, in terms of relative priority, these contract entitlements and rights are no different than those of other normal unsecured/normal creditors holding contractual rights and claims to debt payment. As such, all creditors―secured and unsecured, should be paid from the disposal of the company property by the fact that bankrupt company owes them money. This is different from the rights of secured creditors whose liens rights protect them by entitling them satisfaction from the specific asset in the event of insolvency or default in payment (Westbrook et al., 2010, p. 31) Workers commonly lose voice when their employers file bankruptcy and its subsequent proceedings. Incongruously, outside the collective bargaining process, workers have little bargaining power in insolvency proceedings yet they stand to lose the most from insolvency. My claim, just like Student A, is that workers deserve special protection. Employees’ contractual rights should be restructured to reflect this. This is because wages and salaries constitute a considerable portion of the workers’ wealth, thus leaves them with few options to fall back on the event of their company insolvency. Secondly, my feeling is that overwhelming majority of workers has no idea or at least imagined and assumed the risk that their employer may fail to pay them. Critically examining the lending process, creditors― secured or unsecured, do factor in such possibilities of default of payment in their lending rates or interest charges, while workers typically are left with no recourse. The workers lack concise information about the financial status of their employer yet take up job appointments on assumption that the employer is in position to meet their wages (Westbrook et al., 2010, p. 183). Again, from a critical perspective, even if such economic or financial information was availed or at least understood by the worker, since they are under standardized contract, there is very little that a worker can do to at least factor in the risk of his employer going insolvent. In addition, in the vent that a worker indeed, does learn of the shaky financial position of his/her employer before a formal declaration of bankruptcy, that employee may again remain powerless, with very little influence as job prospects and mobility today, tend to be highly limited. Conversely, creditors are obviously in the know about the financial status of the borrower and therefore factor in the assumed risks either through increasing interest rates or setting stringent terms and conditions of the loan. Therefore, further protecting them, rather prioritizing them, above the clueless and powerless employees is quite unfair. To make the matter worse, in the event of insolvency and eventual closure, creditors often have a variety of sources of income, from the varied client base, while workers often work for a single firm. From a social perspective, the financial security of workers in the event of corporate insolvency is an issue with potential far-reaching societal impact. Taking a simple example, workers holding pension benefits, which are derived from their businesses operations or stock, may later discover that their pension plans have been diverted to cover expenses of the business. More astoundingly, is when they realize that their mutual funds are now worthless yet retirement ages are knocking! Insolvency has therefore far-reaching effects. For one, if company declared insolvent is forced to compulsory liquidation, it is barred from further trading and workers are subsequently laid off causing considerable social implications (Westbrook et al., 2010, p.187). Moreover, insolvency may cause employees to lose their retirement benefits thus putting them at the mercy of taxpayer sponsored state support or even forcing them to extend their employment life well into the retirement years. An example of jurisdiction in this context is the 1980 European Union (EU) directives. The council of European communities issued a directive for protection of employees in the event of their employer insolvency (Westbrook et al., 2010, p.191). Section II, Article 3.1, requires guarantee institutions should secure that employee’s outstanding claims relating to their employment. Section II, Article 4.2, further compels all Member States to ensure that workers outstanding claims from the last 18 months are fully paid. However, Section II, Article 4.3, mandates affiliated States to have their own regulations on employees’ liabilities provided communication is made to the European commission on the procedures and basis of implementing such regulations. The International Labor Organization (ILO) seeks protects workers by requiring that in case a debtor files for bankruptcy or judicial liquidation is imposed, workers must be treated as privileged creditors in respect to their wage dues prior to their employer running insolvent or the judicial liquidation raking effect but subject to various State’s laws (Westbrook et al., 2010, p. 190). From my personal considered opinion, layoffs and insolvency are a worse combination at a period when economic distress is hitting corporate world. Most world economies typically have weak social protection system for workers and as such, employees are left at the mercy of discretionary measures and treatment by their employers. From this discussion, numerous policy questions are evident. For example, should general worker’s claims take precedence over claims of secured creditors (as supported by student A) or should they be treated no better than other unsecured creditors (as supported by student B)? Secondly, should the increase in risk to creditors be passed on to the debtors in terms of lending interests/ rates that ultimately raises prices for goods and services and therefore jeopardizing labor intensive business and inadvertently impending job creation? Finally what available measures can they be taken, to protect the most vulnerable creditors, the employees, in the event of insolvency? In the view of the above, I give unwavering support to student A. Question 6 Corporate insolvency arrangements and governance are important pillars in any prosperous economy. In insolvency, three aspects are especially important: The insolvency system relationship to corporate finance arrangements in different countries, its function as a set of governance norms for insolvent going-concerns, and its function as a key benchmark for corporate attitudes towards assumed risks. Insolvency arrangements, historically, have not been conceived to serve as frameworks for financial distress or hardships but rather as to putting an end to the dead companies or non-performing companies. Insolvency laws should therefore, lay emphasis on re-organization which often works better as we move towards further a wide diversity of finance providers for modern corporation financing. This is because more and more businesses are coming up to provide the much-needed financial assistance to businesses and therefore prudent insolvency laws should be put in place. This is to say weak insolvency systems, devoid of credibility and profound mechanisms have serious negative effect on corporate governance. If company X chooses to use the US based approach, various implications must be considered. The US uses debtor-in-possession (DIP) mechanism whereby the possibility of debtors’ management to remain in possession and the effectiveness of debtors in possession arrangements is considered. The US law (Chapter 11) is mainly based on the debtor in possession approach (Westbrook et al., 2010, p. 216) The British-style system provide for a professional administrator or even a trustee to take over the management of the debtor. Debtor management, however, changes most of the time even when the debtor remains in possession. The bankrupt party is known as the debtor in possession and serves as a trustee. Its advantages arise from the fact that the debtor is allowed to operate the business and to develop a plan for reorganization. If competent, the debtor understands the business operation best and therefore best suited to oversee the agreed restructuring process. Furthermore, it protects business from draining into total insolvency pits by providing mechanisms for rescue. This approach is widely regarded as a restructuring procedure rather than insolvency procedure and therefore eliminates stigma associated with bankruptcy. It is only when the debtor is proved to be incompetent or uncooperative that a trustee is chosen to administer the business. In that case, the creditors at their discretion, can elect a trustee, if they don’t, the U.S. Trustee appoints one. During the period of reorganization or restructuring, borrowings are too, required. The U.S approach implies that any person or business entity making a debtor-in-possession loan to the said debtor, it is necessary to determine, in light of the available evidence, whether there is sufficient remaining equity in the debtor’s assets after considering the existing secured loans in order to support the DIP financing. The limitation of this model is that, lenders tend shun from financing this model when there is insufficient equity. Secondly, for this model to be financed in efforts to restructure, the debtors will likely need to obtain a court order that grants them “super priority” over existing lenders. Moreover, super-priority DIP financing requests authorization is only rarely made unless the security for such financing or loans can be sufficiently provided by hitherto unsecured assets. This is further limited by the fact that holders of statutory liens and purchase-money security interest are typically not subordinated to the debtor-in possession loans (Westbrook et al., 2010, pp. 86-90). As such, secured creditors may challenge any decision that may deprive them priority in payments of finances advanced prior to insolvency. The British-system that presupposes appointment of an administrator as opposed to the DIP model is more flexible approach in some ways. Administration is can to a large extent help in the purpose of rehabilitating companies in financial distress. It can help reorganize a business to become profitable again or to a financial position whereby it can honor its debt obligations. In addition, this system is flexible in the sense that once the business goes back to its profitability footing, administration can be returned to the control of the directors and other shareholders. Furthermore, it is far much beneficial to run a business through an external administrator, if possible, than forcing a company into winding up and closing down its operations. The UK systems also do essentially support voluntary restraint for a given period to enable the debtor work out the business difficulties (Westbrook et al., 2010, p. 178). Administrators serve to protect interest of other unsecured debtors such as the employees who suffer the most incase of legal wind up the organization. Additionally, an external administrator appointment does not often guarantee a reviving, actually, possibility of continued financial distress is still real and threatening. The administrator may too take some time before fully get acquainted with the ailing business operations or before pin pointing the shortcomings. Developing rescue strategies may therefore consume considerable time. The company may in addition, suffer various unwanted effects of administration such as future difficulty in obtaining finance since most suppliers and lenders often wish to deal with the company on cash-upfront basis. In the view of above discussion, country X can evaluate which model to adopt for its insolvency law reforms. However, it will be necessary for country X to provide information on its existing insolvency law and guidelines, in addition, to its corporate management practices and regulations. Information about creditors and other shareholder protection is especially critical here. It is on that basis that formidable insolvency law reforms can be made. Whichever approach chosen, country X must have mechanisms to support the approach. For example, the success of the London’s Approach was mainly through support by the Bank of England, which took an active role in some of its major workouts (Westbrook et al., 2010, p.178). Pillars to support the system adopted must be considered, as they will determine the success of the reforms. References Westbrook, J. L., Booth, C. D., Paulus, C. G., & Rajak, H. (2010). A global view of business insolvency systems. Leiden/Boston: World Bank & Martinus Nijhoff Publishers. Read More