The US Debtor-In-Possession Approach versus UKs Caretaker Approach - Essay Example

Comparative Insolvency Law Student’s Name: Institution’s Name: Fixed charge and Floating Charge 1. A. Explain the difference between a fixed charge and a floating charge in the United Kingdom. Please discuss the types of collateral that each type of charge extends to, the level of protection it offers the creditor holding the charge, and the level of priority under non-insolvency law and insolvency law in the United Kingdom. [5 points] A fixed charge debenture is where a company agrees to use specific fixed assets as security against which a loan is extended whereas a floating charge refers to the overall company assets that can be liquidated if the company defaults. In this case, the debenture holders can then seek the court’s authority to convert the floating charge into a fixed charge over specific assets which can be nominated by the company, these assets can then be sold by the debenture holders. The type of collateral that is extended by a fixed charge is that the company loses the authority to dispose of (sell) any asset that has been signed over at will. In the floating charge arrangement, the company is free to sell things as long as they are replaced by other assets. B. Given your answer in Part A above, in your view, under US Article 9 secured transactions law and the US Bankruptcy Code, is a security interest in the United States treated more or less favourably than a fixed or floating charge under UK law? [5 points] Citing a case between Spectrum Plus Ltd; National Westminster Bank plc v. Spectrum Plus Ltd. And others [2005] 2 BCLC 269; The outcome in this case was heavily influenced by the UK House of Lords’ passing a rule that limited the validity of fixed charges over book debts to a case in which the secured creditor exercised sufficient control over the collateral. They brought in a provision in the debenture requiring the deposit of proceeds of book debts into a blocked account. Using this as an example, I feel that security interest in the US is treated more favourably. The UK system requires the registration of many types of charges over book debts and floating charges over the general undertaking of a company but the statutory rules are less clear and comprehensive than U.S. UCC Article 9 where security interest cannot be attached to collateral described in the agreement unless value to the said collateral has been given. Further, the debtor has right in the collateral. This is not the case in UK where once an asset has been attached; both the debtor and creditor have very limited influence over what happens in cases of bankruptcy. In the US for example, courts do not attach to any collateral unless its value had been established, better still the debtor still has a rights in the collateral. 2. Explain how Asset Management Companies (AMC's) are used as mechanisms to assist with bank and corporate restructuring. In your answer, discuss at least one example from Asia. [5 points] The Asset Management Companies mechanisms are applied in the restructuring of Corporate and banks as they are used as a means of disposal of Non-Performing Loans. The transfer of such burdens to AMCs instils confidence in the banking system (this is their primary role) by improving their balance sheets which in turn enable the banks to lend to the corporate sector thereby unclogging the economy. Such a move is meant to kick start economies. It has worked in many countries in Asia as well as America. The AMC’s have made a lot of economic sense for most financial institutions as it has improved the competency and quality of insolvency. Most jurisdictions, particularly in Asia, have improved the risk management mechanisms and processes. Both local and cross border insolvencies can now be managed with less hustle due the well thought jurisdictions which have been effected. Unlike Indonesia where a different mechanism (formation or IBRA) was applied to try and stabilize the economy failed, the AMC of Malaysia realised a recovery rate of 58%. This was a spectacular performance; actually the best in the region at that time. They had to restructure the underlying businesses to achieve the kind of success they realised. This further confirms how effective AMC’s can be. It would be good to mention that the most likely reason that made Indonesia’s mechanism to flop was because: they had not embraced the debtor-in-possession jurisdiction, Booth (2009), who goes further to propose that Asian nations should consider adopting a modified version of the aforementioned jurisdiction. Post-petition financing is another proposal Booth (2009) floats for consideration by those nations that have not thought about it. This is not all; out-bound transactions should be used as instruments to design cross-border insolvency cooperation. 3. First Manufacturing Co (FMC) manufactures furniture. Broadway Bank (BB) lent $10,000 to FMC in January 2010 on an unsecured basis. In February 2010, Stan Smith (SS), one of the directors of FMC lent FMC $20,000, also on an unsecured basis. FMC began experiencing financial difficulties in March 2010 and realized that it was unable to repay its creditors in full. Nevertheless, it repaid SS's loan in full on March 20, 2010 (although the loan was not actually due and payable until June 2010). FMC defaulted on BB's loan in October 2010. BB sued FMC, got a judgment and enforced the judgment against FMC in December 2010. In January 2011, FMC filed an insolvency petition. A. Assume that FMC is a debtor under the US Bankruptcy Code. Please advise the trustee in bankruptcy as to any possible preference actions and whether you think that he will be successful. [5 points] One of the directors of the company can be rightly called, “insider creditor” The insolvency law understands the skewed manner in which an insider creditor is like to behave where their interests are concerned. The United Kingdom Legislation Describes such a person as “connected to the company” in this case; it is obvious the director abused his proximity to the management and the company. The best scenario that should have played out is the directors making efforts to protect the external creditors instead of rushing to have his debt settled. The directors, employees and shareholders come last after the debtors have been sorted out. Whatever remains then can be shared among the later three. The best description of such a situation is fraud. It qualifies to be a fraud since Stan Smith; one of the directors, had his debts settled well before it was due and just before the bankruptcy case was filed. Under sections 151 through 158 of Title 18 of the United States Code, the FMC is attempting to evade repayment by fraudulently filing for bankruptcy. Nevertheless, the US Bankruptcy Code generally provides for reorganization where a debtor proposes a plan to keep the business running and pay the creditors over agreed period of time. In this scenario where the FCM has already filed for bankruptcy, BB can seek the intervention of the court to seek for an appointment of a case trustee who will be mandated to manage the property, if appropriate, file a plan of reorganization as soon as practicable according to Section 1106 of the Bankruptcy Code. B. Assume that FMC is a debtor under the HK Companies Ordinance. Please advise the liquidator as to any possible preference actions and whether you think that he will be successful. [5 points] The role of Hong Kong Companies Ordinance among others is to deregister defunct, solvent private companies; the prosecution of companies together with their managers if there is breach of the regulatory provisions . . . and to obtain company information. If FMC was a debtor under HK Company Ordinance, the preferred action against it that can yield positive result would be to object to the intended insolvency where every creditor of the company who at the date fixed by the court is entitled to any debt or claim which, if that date were the commencement of the winding up of the company, would be admissible in proof against the company, shall be entitled to object to the reduction;( Chapter 32, section 59 of Companies Ordinance). This would compel FMC to enter into serious agreement on how it would pay what is owed to BB. Secured Creditors Should be bound by The Automatic Stay in a Corporate Insolvency. Do you agree or disagree with this statement? Please explain in the context of liquidation, formal restructuring and out-of-court restructuring regimes (with reference to the London Approach and its variations) and offer examples from various jurisdictions in support of your view. [25 points] The London Approach has been described as existing in 4 major tenets; first, lending banks will be initially supportive and not seek to exercise their right to open an official insolvency process. Second, any decision is made on the basis of reliable information that must be shared among all the lending banks. Third, banks and, where appropriate, other creditors should work together to try to form a collective view on whether support for the debtor should continue and, if so, in what form this should be. Finally the burden the burden of supporting the debtor should be shared equally by all lending banks. It is a well known fact that filing bankruptcy automatically shields the debtor from most actions by the creditor. This goes as far as protecting the debtor's property as well as any litigation that may be filed against the debtor.  I am more inclined to support the statement mainly because some securities are pegged only on particular assets. The obligation for repayment of the debt is bound by the value of that particular property which was used as security. The London Approach which was adopted by Bank of England in the early 1970’s ensures that all the parties are somehow protected as it minimizes loses to all the stake holders. It can be put to force faster than the bankruptcy since the latter takes longer to be effected. The stake holders can sit round a table to come up with non-binding principles to guide the repayment of the debt. If say an organization liquidates its assets to settle debts, chances of incurring losses are very high. It is the best approach to weather financial crises. Furthermore it creates a platform for managing more concrete solutions. When the secured creditors are bound by automatic stay; formal restructuring becomes comparatively easier than if they did not. With the London Approach as the means; different restructuring alternatives can be explored. Every stakeholder’s interest will be taken into consideration. Such a platform further gives an opportunity for assessment of different classes of debts and exploring the possibility of legal subordination. Rescheduling of the repayments can also be reached as an option instead of liquidation. The London Approach makes out-of court restructuring an agreeable option since it is more of a mutual agreement than an obligation. It gives the lenders more options such as working with the defaulter to resolve the situation, agreement on control issues and restructuring of the organization can also be reached. The primary aim of this approach is to avoid corporate collapses as a direct result of inter-creditor wrangles or uninformed decisions. When lenders come together to support a debtor during the initial period of difficulty, it is generally agreed that the chances of yielding recovery is higher than if other means such as receivership or insolvency and other jurisdictions were applied. In England for example, such agreements are recognized by law. The only time a court may come in is if the agreed repayment schedule is not honoured, in that case it would be treated as a breach of contract. How Workers should be Treated in Cases of Corporate Insolvencies The right question that should be asked is what happens to employees’ wages that are unpaid at the time of the liquidation? Should this make employees be given an upper hand than the creditors in such a situation? My position is influenced by these carefully worded lines contained in the UK’s Cork Report, (1982) on insolvency: “The preferential treatment of employee in insolvency in respect of their claims for unpaid wages was originally a social measure. It was introduced in an effort to ease the financial hardship caused to a relatively poor and defenceless section of the community by the insolvency of their employer. In the early days of Bankruptcy Acts there was no welfare and the wages were low.” The superior place of the employees against other creditors, in cases of insolvency is widely accepted in insolvency procedures all over the world. The crafty nature and collusion of some corporations has seen incidences of high profile firms collapse. Whenever such things happen, colossal sums of pension funds are lost by the employees (2). Several jurisdictions (3) on the rights of employees to participate in and be consulted about matters relating to the running of the business of their employer. These claims are not fallacies since examples exist. An example is Maxwell Companies of UK and Enron of the US. There some in Germany as well. Some nations like UK have reacted to try and lessen the burden on the employee. The government scheme provides that certain monies; pegged on statutory maximum figures; be paid to such employees by the Department of Trade and Industry. The law provides for settlement of the outstanding salaries or wages within the last few months (4) before going under. The same law stipulates that unpaid dues are sorted out, otherwise the each employee, under the current law, is entitled to the statutory maximum of £310 gross on a weekly basis. According to the US laws, there are mainly two chapters (chapter 7 and 11) under which a company can file for bankruptcy. Chapter 7 is also called liquidation chapter. Chapter 11 has a provision that allows such companies the opportunity to service their debts as they continue operating. When an insolvency petition is filed under chapter 11, the court appoints a caretaker who is mandated to make financial decisions in the company as the managers continue overseeing the daily operations of the company. The two students who were arguing whether or not employees should be given priority over the secured creditors in cases of insolvency must have been referring to the first scenario under chapter 7. Perhaps to make the point clearer, it would be important to understand what secured creditors mean. As defined in Section 285, Companies Act, 1963, they are those whose credits to the company are secured as a fixed charge against specific assets. In cases of insolvencies, they are paid off before the employees. Whether or not this is morally right has been raised with the Company Law Review Group, that employees are the most disadvantaged should a company undergo liquidation since they are least able to brave the financial implications of liquidation. Based on this reasoning and fact, I am of the opinion that student A made a lot of sense. The employees should be given the first priority over all the other stakeholders. In my opinion, they are the disadvantaged lot. My view is supported by the Protection of Employees (Employers’ Insolvency) Act, 1984. Further still, the Federal Government put into force the Corporations Law Amendments (Employee Entitlements) Bill 2000 (“the Employee Entitlements Bill”) into Federal Parliament for debate. This was intended to clearly signal, the corporate world that protection of employee entitlements was a serious issue. The Employee Entitlements Bill proposed, inter alia, to task the managers not to engage in insolvent trading . . . [or] uncommercial transactions in relation to employee entitlements. A more concrete resolution is yet to be reached as these are just attempts. If only what Thompsons Law states was embraced by other nations that “In UK the purpose of behind insolvency arrangements is to free the indebted from debt, not to ensure creditors are paid.” Then the poor labourer would find some peace of mind. While student B may have had valid reasons to back his or her position, recent statistics should, however, change their minds. The following companies for example, speak volumes about what employees experience when companies go through liquidation: In September, 1999, Brybrook Manufacturing Collapsed and with the collapse, 70 employees lost a staggering $2 million which was their entitlement; In January 2000, another 342 employees lost more than $11 million, fortunately for them the Federal Government stepped in to compensate these employees, the company involved was National Textiles. The next Victims were 61 workers of Fabric Dye Works in Cobourg; Dye Works owed its employees in excess of $600, 000. This was in 9 March 2000. Shockingly it looked as if the company had been on business but under insolvent basis. And most recently were the Lehman Brothers. Such statistics reveal how exposed workers are when companies sign for insolvency; definitely something needs to be done to protect the labourers. Even with the suggested legislations in place, (Davies, 2009) states that, “the law in this area is notoriously uncertain.” There should be a clear-cut legislation across the labour market to cushion employees against such unfortunate events when companies go insolvent. One way or another, a long lasting solution should be established to protect the worker who least contributes in the decisions that steer the companies into insolvency. The first step should be to make directors squarely responsible for lost employee entitlements in certain circumstances. Actually a more severe penalty should be instituted to act as a deterrent for the defaulting companies. Something like serving a jail term by the directors could deter many from defaulting. Penalties and exposure to personal liabilities already exist, but the problem still persists. The government should also come up with a fund to protect the wage earner. In 1988 Harmer Report, among others proposed that a wage earner protection scheme should be instituted. This was meant to provide some payout of a certain amount towards loss of entitlements. Of course there are employees who would lose more than the payout. In that case the payout would be token compensation. The Labour party on the other hand suggested that an insurance scheme should be established. The challenge that this idea posses is who would contribute the premium and what if a company is already taking good care of their employees in case of losses. Ibid. There is no doubting the trauma those employees who lose compensations because their employer is insolvent go through. Because they are defenceless and exposed in a situation like this; they need to be covered by a solid legislation. Thompson’s law sums it all up, “I the UK the purpose behind insolvency arrangements is to free the indebted from debt, not to ensure that the creditors are paid.” With legislation like this, the labourers would be protected at times of insolvency. My support for preferred treatment of the employees is well summarised by Goode (2005) who says that there can be no doubt that employees do deserve special protection. Very often their salaries are their sole source of income. The loss of employment can thus have a devastating effect on them and their families, an effect exacerbated by non-payment of their entitlement by their employer. The relationship between employee and employer is continuing relationship requiring mutual trust and confidence and it is a relationship in which the employee is very clearly the subordinate. Moreover, without the work of the employees, the employer’s business would not function and creditors would not get paid. US’ Debtor-in-Possession Approach Versus UK’s Caretaker Approach The main striking distinction between chapter 7 and chapter 11 and 13 is the arrangement that both parties enter into in order to sort out the outstanding debts. Chapter 11 is much more flexible than chapter 7 for it makes it possible for the company in question to restructure itself and the debts to explore the chances of recovering from the debt. Restructuring here means that the firm will renegotiate the terms of the credit with its creditors where a plan of repayment is agreed upon. Meanwhile, judicial managers assume the responsibility for running the company and proposing a plan of reorganization for creditor approval, Suet & Lin (2003), it means that a trustee is appointed to keep an eye on the operations of the debtor and its assets. The assets are not disposed of but the debtor is normally allowed to operate the business with the intention of recovering and settling the debt. While this is the case with the chapter 11, chapter 7 offers a kind of instant relief as the debtor is absolved of all the debts. The other advantage of filing for bankruptcy is that there is no ceiling as far as the minimum and maximum debt is concerned, any amount debt can be discharged. It further discharges all amounts outstanding after the assets have been liquidified. Chapter 7 also allows a debtor to keep all assets acquired after filing for the bankruptcy and finally the cases do not drag for long in the courts. With debts being discharged, not only does this bring you financial freedom but it also relieves one emotionally; free from the distress and anxiety over how you will make ends meet. In Berry’s (2000) own words, such relief can transform one’s predicament to give hope for a new beginning. Berry (2000) clearly states: “There is some degree of logic in drawing a link between stress and emotional health. If one is constantly under stress causing pressure such as debt, one is in effect being psychological prodded to deliver. Since humans are emotional beings as well as logical thinkers, it should come as no surprise debt causes stress and therefore has an effect on emotional well-being.” Chapter 7 carries with it, a heavy burden as well. It gives the trustee absolute authority to dispose all the assets that are not exempted. It is a temporary solution as far as foreclosures are concerned; moreover not all debts are discharged. Chapter 7 also exposes your guarantors, unless they too sign for bankruptcy. To further complicate this option, it is very difficult to recall once it is filed and the filing can only be done once in a period of six years. Perhaps the worst mark it leaves on the debtor is the credit rating; it messes up credit worthiness. After critically analyzing the pros and cons of the two bankruptcies, I would, without reservations prescribe the US debtor- in possession approach. While I am aware that Chapter 11 does not entirely relieve the debtor from the burden of the debt, it is still a better option. The trustee committee appointed to take care of the creditors’ interest will support the debtor in generating schemes and plans which will see the reorganization of the firm in order to get it out of troubled waters of debt. The chances of the firm re-emerging as profitable entity are at least above 0%. While there are companies that have suffered bankruptcy like Lehman Brothers Holdings Inc. in September 15, 2008, there are those companies which have turned around bad debts and become profitable. Some of those successful comebacks have been due to reorganizations by firms hamstrung by legal issues among other factors. Take for example, Texaco which in the late 1980s, filed what then was the largest deal with a court judgment of more than $12 billion that was awarded to Pennzoil; the bone of contention had been acquisition of Getty Oil. The two oil giants settled on a $3 billion payment made after Texaco recovered from bankruptcy. Companies that opt for Chapter 11 expect to spring back to normal operations and steady financial footing in the future. Chapter 11gives corporations time to restructure debts that have become unmanageable. It gives the debtor a fresh start. The flipside of Chapter 11 is the complexities involved; it is known to be the most costly of all bankruptcies. This is because the debtor has to pay all attorney fees for self and creditors. Thee figures here can run to the tune of up to $100,000+. Since most firms, at that particular moment, cannot raise both the attorney’s and court levies due to cash flow, the judges, more often than not, order them liquidated. This in most cases spells a death sentence for most organizations. It considered an option only after an organization has keenly analyzed its options. This notwithstanding, it is preferred by most firms because it allows them to control the bankruptcy process rather than turning over its assets to a trustee. Should all the attempts prove futile, all assets are liquidated and stakeholders sorted out according to absolute priority. Another disadvantage of this option is that crucial decisions rest in the judge’s hand as he has absolute oversight of your firm. Your main role is to run the day-to-day operations. This one also carries some fair degree of risks; bankruptcy judge and the appointed trustee scrutinize the actions of the firm’s leadership before and during the bankruptcy. If anything odd is noticed, the management risks civil penalties and possibly arrest and imprisonment. Further Information Regarding Country X Bankruptcy laws are created to assist individuals and businesses when things fail to work financially. There are different bankruptcy legislations in almost all the nations of the world. India for example has had these legislations since 1874, Holden (2010); they have existed in India in various forms, both to separate the assets of a business or individual from those of the family and to protect those family assets from creditors. Before offering advice to the Law Reform Commission, it would be important to understand the existing laws regarding insolvency. Using India as an example still, there exist a number of laws regarding bankruptcy. For example the Married Women's Property Act which was passed in 1874. This was basically to “allow a married man to name an insurance policy in benefit of his wife and children,’’ (Provincial Insolvency Act1920). This was meant to guard the property from creditors. This act was the first of its kind in India and was the first law to protect any assets of an Indian citizen from creditors. The act protects the policy holders from taxes and even bankruptcy proceedings. I would then proceed to advice on matters that qualify to be considered for insolvency and if so how should creditors proceed to attach or recover their monies. Details of court proceedings would also be discussed and proposals given. Establishment of a strong bankruptcy code would be explored to protect the creditor and the debtor. This would be followed by a firm set of legislations for liquidation of assets. Understanding certain aspects of credit management of country X would help the advisor give informed decisions. This will require that certain questions are answered: such as what policies are in place to ensure smooth and efficient means of debt collection and security enforcement outside of bankruptcy and what effective corporate governance procedure are in place. It would also be enlightening to understand whether insolvency is the rule rather than the exception in country X. References Booth, D. (2009). Forum for Asian Insolvency Reform: The Need for Continued Development of Effective Insolvency Infrastructure. Bangkok: Thailand, pp. 17-18 Davies, Alex. (2009). A Work Place Law Handbook. Work Place Law Group: UK. EU (Safeguarding Employees Right). (1977). Protection of Employment Act, 1977. Holden, Amanda. (2010). Bankruptcy Laws in India. Retrieved 15th February, from http://www.ehow.com/list_6833820_bankruptcy-laws-india.html#ixzz1E64N5Ni6 Hockey, Joseph. (2000). Corporations Law Amendment (Employee Entitlements) Bill 2000. Second Reading Speech by Mr Joseph Hockey the Honourable Member for North Sydney, MP, and the Minister for Financial Services and Regulations at 13636. Suet, L. & Lin, J. (2003). Is Singapore’s Insolvency Regime Excessively Pro-creditor? Vol 12 International Insolvency Revival 37. The Australian Labour Party. (2000). Protecting Employee Entitlements – A Better Alternative: The National Employee Entitlements Guarantee Model Vakilbabu Law House Ltd. Provincial Insolvency Act, 1920. (2008). Retrieved 15th February, From http://www.vakilbabu.com/Laws/Acts/PIAct/PIAct00.htm Read More