Abstract
This paper provides original empirical evidence on the financial outcome of insolvency filings in Europe. We adopt a cross-country analysis of the determinants of recovery rates isolating three types of creditors (junior, senior, and new money claims). We investigate the structure of recoveries on a unique hand-collected sample of bankrupt firms in France, Germany, and the UK. We initially question value maximization, and study to which extent the legal provisions prevailing after insolvency filing can influence creditors’ overall recoveries. Three procedures differ significantly from our benchmark (UK liquidations). French continuation and UK receivership exert a positive influence onto total repayments, while such influence becomes negative under French liquidation. We relate this finding to the ability of the two former procedures to improve coordination among the creditors, monitoring of the debtor, and/or incentives to file early. We then analyze value distribution by examining competition between the categories of creditors. We show that the insolvency systems do not converge. Junior and senior creditors are better served under the German and the French continuation procedures than in any other bankruptcy path. At the opposite, the UK liquidation procedures fail to satisfactorily serve the junior/senior creditors. Still, nearly all the insolvency procedures support fresh financing by protecting quite well new money claims. Overall, we do not confirm any superiority of one family of insolvency system over another, but rather stress the importance of an appropriate design of the procedures, especially regarding the incentives they create before and after insolvency filing.
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Notes
All national rankings are available at http://www.doingbusiness.org/rankings.
The case corresponds to a restaurant with 201 employees and 50 suppliers that is financed by one bank.
In the Davydenko and Franks’ sample, default is resolved via either informal workout or formal bankruptcy.
Those claims are related to debtor-in-possession (DIP) financing (Dahiya et al. 2003).
The encompassed period ends in year 2005. Indeed, the files must be closed at the time of analysis, and some bankruptcy files take several years before closure.
For instance, the UK insolvency system proposes different procedures to resolve financial distress: administration, liquidation, and administrative receivership (until 2003). A preventive procedure (company voluntary arrangement) also applies.
In France, the Court itself can trigger the procedure, but this way of opening the procedure remains scarce.
E.g., illiquidity (France), suspended business (UK), excessive liabilities compared to the assets (UK), etc.
They rank lower than do the employees and the secured creditors owning a fixed charge.
Because the French bankruptcy procedure is primarily under the control of the court, data might to some extent reflect the Parisian practice rather than the countrywide application of the bankruptcy code. More specifically, local conditions might have some influence on continuation decisions. We assume, however, that this potential geographic specificity is limited in comparison with the expected international differences. A high number of French firms are located nearby Paris, which is the most important location in terms of economic activity. A comparison of our sample with the characteristics of corporate bankruptcies located in other regions shows little differences in terms of structural dimensions (i.e., size and sector). Yet our sample entails slightly more limited liability companies compared to other French regions.
The UK database encompasses insolvent firms located in the following regions: Greater London, Yorkshire, North, North West, East Midlands, East Anglia, Rest of South East, South West, and West Midlands.
Actually, in our sample, we have another set of 46 unopened German cases. For those firms, the value of assets is not high enough to pay bankruptcy costs. Since their default is not resolved on a collective basis, they cannot be compared to the cases observed in the two other countries. Yet, in the section dedicated to regression analysis, we shall mention some results that include those unopened cases. Since we lack information on their actual repayments, we consider that such files lead to null recoveries (this assumption is quite realistic for companies whose assets have mostly disappeared at the time of default).
This issue does not affect Germany because only one procedure prevails.
Insolvency Service (UK) provides the latest statistics of filings under different bankruptcy procedures: https://www.gov.uk/government/collections/insolvency-service-official-statistics. For France, similar figures are computed by OCED: http://www.oced.cci-paris-idf.fr/statistiques-oced.
For each claimholder, we separate the part that is due and not due. Most of our UK and German files showed due claims only. Some French cases showed not-due claims that were discounted and added to the due claims.
In Germany/UK, the files contain explicit information on direct bankruptcy costs, which largely correspond to the administrator’s fees. In France, this information is not part of the file but it can be reconstituted using the regulatory formulas provided by the French legislation (“Décret n°85-1390 du 27 décembre 1985”). Those formulas depend upon a set of observable characteristics (recovered amounts, number of employees, and turnover). The estimated costs were checked with the help of a Parisian bankruptcy practitioner.
Note that all claims come due once a firm is liquidated and/or sold as a going concern.
In France, the plan—as designed by the court—cannot force debt forgiveness but can impose longer delays.
For France, we can identify the companies whose continuation plan failed and those whose continuation plan ended successfully. To do so, we compare our sample with an external database gathering the identity of firms that filed for bankruptcy, even after our period of analysis (source: INSEE, “série nationale des défaillances d’entreprises”, Bulletin des Annonces Civiles et Commerciales). We are thus able to identify the reorganized firms that failed and got liquidated. We observe that 89% of continuation plans are successful. Whenever a continued company re-defaults, we make the assumption that the future recoveries are null. For the successful plans, we discount the recoveries, using the French Treasury bill rates (5–10 years) at the time of filing. Following Blazy et al. (2011), our discounting formulas set the time horizon to 7 years, which corresponds to the average duration of the French plans. Let us note that this point is irrelevant when considering the UK and Germany, as all firms in our sample are ultimately liquidated or sold as a going concern.
Some bankruptcy files contain accounting information (balance sheets and income statements on three years prior to default). However, these data are not always available. In the UK, this information is scarce. In Germany, accounting data are not a mandatory piece in the procedure. When available, accounting data might also be outdated: in Germany, 42% of the available accounting data are older than one year and 10% older than two years. Thus, using even basic accounting figures would have led to substantial losses in data.
The complete list of codes is available on request. It is similar to the codification used by Blazy et al. (2011).
However, if we include the German unopened cases in our sample—and under the assumption that such cases cannot generate positive recoveries for the creditors—the mean overall recovery rate drops to 13%.
This observation also conflicts with the findings of previous works on the UK (Frisby 2004; Armour and Mokal 2005). However, these works exclude the liquidation files from their samples. The reason lies in the difficulties with accessing their content. The inclusion of liquidation procedures is essential because they represent the bulk of bankruptcies. From that perspective, our paper innovates by including such information.
In all countries, the liquidation procedure is by far the most common. Nevertheless, one can wonder whether the alternative procedures lead to greater recovery rates.
Blazy et al. (2011) explain, “The court in Paris has set up several prevention units (“cellules de prévention-détection” and “cellules de prévention-traitement”) that implement meetings with the firm’s managers when the court receives clear signals of economic and/or financial difficulties”.
Since the 1994 French reform, new money is ranked below secured claims with financed tangible assets.
Because liquidation is the dominant procedure in all countries, the analysis by procedure helps to understand the global results. For instance, in the United Kingdom, the juniors’ and seniors’ recovery rates that we observe on liquidations explain the corresponding (low) recovery rates at the national level.
To avoid a multicollinearity issue, the share of junior claims is excluded from the models.
We expect those instrumental variables to explain the bankruptcy path more than does the recovery rate. The model is non-linear: to be identified, the explanatory variables in the selection function need not differ from those in the response schedule (see Briggs 2004). However, in such a configuration, the identification of the system is weak (Breen 1996). We thus exclude the quoted instruments from Eq. (2) (response schedule).
The estimates for the selection function are available on request.
As several files have missing values, the econometric models—which use all the variables at the same time—are computed on a subset of these observations. Here, 15 observations are excluded out of 911 files.
The German bankruptcy procedure allows for a screening of the debtor. This potentially introduces a selection bias relatively to the French and UK observations, as the legislation in both countries do not incorporate such provision. To control for this effect, we run additional regressions including German unopened files. We cannot observe the actual recovery rate for those firms, simply because they are not recorded by the bankruptcy courts. Hence, we make the conservative assumption that their recovery rate is null. This amounts assuming that the costs of an uncoordinated creditors' race are at least as high as the costs of a collective bankruptcy procedure. Since these firms hold assets with lower market value than these costs, the excepted recovery of the creditors is zero. This leads to the introduction of 46 additional files in the regressions. We further apply weights to opened and unopened German files to reflect the average proportions of 50% of opened cases for all German bankrupt firms over the 1999–2005 period. The results, available upon request from the authors, remain qualitatively unchanged, that is, the rankings at the country and procedure levels are the same. Moreover, we have also excluded from the French and UK samples files where the initial value of assets is lower than bankruptcy costs, i.e. files that would not have been opened given the firms would have been located in Germany. This leads to the exclusion of 80 observations. However, the replication of the OLS and Tobit regressions leads to similar results.
The administrator has up to three months to send his/her recommendations to the creditors.
Such results remain valid even when we run the OLS and Tobit models on our sample without including the French continuation files (indeed, this latter procedure may appear as quite specific, compared to the others).
Deviations from the APR are not commonly observed in our countries of interest.
16 observations out of 911 have missing values in the 3SLS system.
In France, for instance, the banks (among the senior creditors) outrank new money in case of piecemeal liquidation, whereas such a priority order is reversed under continuation or sale as a going concern.
Elasticities are not strictly equal to recovery rates. Indeed, they measure the marginal increase in recoveries corresponding to one additional euro of due claim.
The OLS estimates on senior claims lead to the following (decreasing) order: the German bankruptcy (87.7%), the French continuation (79.2%), the French liquidation (44.8%), the receivership (39.1%), the administration (34.8%), and the UK liquidation (23.7%).
Our 3SLS estimates are nearly unchanged when excluding the French continuations from the sample.
This delay was extended to 45 days in 2005.
Since 1994, under liquidation, the secured creditors having financed tangible assets outrank new money.
With the noticeable exception of “superprivilège” claims, which are always repaid first.
The court cannot force debt forgiveness but can impose longer delays of repayment. However, the creditors can accept a reduction of their claims in exchange of faster repayment.
In 2005, a voting procedure (“comités de créanciers”) was introduced for the largest affairs. However, the court has the power to override the creditors’ decision.
The courts can interview the managers in case of early signs of troubles (“cellules prévention-détection”).
One might expect that the German files hold structurally more assets than the French or UK firms in the sample, all things being equal. In this study however, this potential bias should be alleviated by controlling for the coverage rate (assets divided by due amounts) at the beginning of the procedure. Another potential bias could be that (bankrupt) firms holding more assets could also be larger firms, hence introducing a size bias across the three countries. When considering only the German sample and employment as a size proxy, opened files are not statistically larger than non-opened files despite the fact that the firms in the German sample appear to be larger than the typical bankrupt firm in Germany. Moreover, further considering employment, we do not find any difference between the German and the French samples, this variable being unfortunately unavailable for the UK firms.
The debtor is not the only agent entitled to trigger the procedure. Creditors, under some conditions, can also file a firm for bankruptcy. In practice, most procedures are triggered by the debtor.
They represent 3.9% in our sample.
Our German sample does not contain any “Insolvenzplan”.
The floating charges are not attached to one specific asset: the value of the assets they encompass can fluctuate over time. When the administrative receivership is triggered, the value of the assets is crystallized.
The MVL procedure takes place when the shareholders convene a general meeting and voluntarily decide to appoint the liquidator. Here, the company has enough assets to pay off all the liabilities and the creditors are not required to be notified. Consequently, we do not include MVL cases in our sample as they do not deal with distressed companies.
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Acknowledgements
ANR (Agence Nationale de la Recherche, EURODEF program) and OSEO (BPIfrance) provided this research with financial support. We are grateful to the journal’s referees for their helpful remarks and suggestions. Any remaining errors are ours.
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Appendices
Appendices
1.1 Appendix 1: Bankruptcy systems (France, Germany, and United-Kingdom)
1.1.1 Appendix 1.1: French bankruptcy system
In 1985/1994, the French legislation established three means of resolving financial distress: (1) piecemeal liquidation, (2) sale as a going concern, (3) reorganization through a continuation plan. This legislation prioritized continuation plans and sales over piecemeal liquidations, with the aim of protecting business and employment. In 2005/2008, a new legal framework was implemented; although the hierarchy of objectives was preserved, a new procedure (“sauvegarde”) dedicated to solvent firms with early problems was added. As default is not a required condition, this procedure is beyond the scope of our analysis. The French legislator also established various means of facilitating prevention through court-supervised private renegotiation (“règlement amiable”, 1984, “mandat ad-hoc” and “conciliation”, 2005). These preventive procedures do not deal with bankruptcy stricto sensu: the targeted firms are still solvent and the procedure is confidential. Still, a higher prevention can impact on the firms’ health when they enter bankruptcy.
Any firm facing a cash shortage (“cessation des paiements”; when the liquid assets do not cover the due debts anymore) must trigger bankruptcy. Such filing should not be delayed beyond 15 days,Footnote 41 and can be initiated by the debtor, by the creditor(s), or by the court. Then, provided the debtor’s assets still exist, the firm is audited for a period of time that can last up to 20 months (“période d’observation”). During this period, a stay of claims prevails, and the managers still run the business, under the supervision of an administrator. Meanwhile, a creditor representative is appointed to check the actual value of the claims and of the assets. In case of piecemeal liquidation, the creditor representative supervises the liquidation process. During the observation period, the bankrupt company keeps on running the business. In that purpose, the maintenance of the previous contracts can be enforced, and the new money creditors are granted a higher position in the APR.
The priority order is quite specific in France. The last two months unpaid wages are granted a “superprivilège” and are repaid prior to the other claims. Overall, the creditors are repaid successively following an APR that depends upon the final outcome. In case of liquidation (“liquidation judiciaire”) and/or sale, the liquidation proceeds and/or the sale price is the basis for repayment: the APR is (from highest to lowest) “superprivilège”, bankruptcy costs, new money, preferential and secured claims,Footnote 42 and last, unsecured claims. In case of continuation (“redressement judiciaire”) through a reorganization plan, all the claims are repaid on an equal basis.Footnote 43 The plan states the delayed repayments (up to 10 years) and the debt forgiveness (if any).Footnote 44
In France, the creditors do not play any significant role in the decision-making process.Footnote 45 The court decides either to piecemeal liquidate (which happens in 95% of the cases, according to the Observatoire Consulaire des Entreprises en Difficultés), or to put the firm up for sale (2.5% of the cases), or to continue business through a plan (2.5%).
In a nutshell, two bankruptcy paths prevail in France: continuation (plan) and liquidation (piecemeal and/or sale). Both procedures require the same triggering criteria that give the debtor incentives to enter the procedure rapidly (Step 1). The French system has also implemented prevention and warning toolsFootnote 46 to shorten the lag between default and bankruptcy filing. Consequently, the procedure is expected to be triggered off at the early stage of default, which ceteris paribus should preserve the value of the firms’ assets.
Step 2 is about the management of the procedure itself. As the French bankruptcy code promotes reorganization over liquidation, it gives a rationale for implementing an observation period that restricts repayments. Indeed, by freezing the debtor’s financial obligations, the bankruptcy procedure provides time for the potential elaboration of a plan. Provided such flexibility preserves the assets, one might expect such observation period to have a positive effect on recoveries in case of reorganization. In contrast, piecemeal liquidation can be pronounced immediately, without any observation period.
Last, the ultimate trade-off between liquidation and reorganization (i.e., Step 3) lies in the hands of a judge, whose primary objective is to rescue the debtor (see above). Such court-administered decision process can resolve coordination issues between the competing claimholders, but it can also generate ex-post inefficiencies whether the court’s objectives systematically favor reorganization.
1.1.2 Appendix 1.2: German bankruptcy system
The German current legislation has been applied since 1999. It allocates the control rights over the bankrupt firm to creditors under a court’s supervision. When a distressed firm files for bankruptcy (“Regelinsolvenz”), the court appoints an administrator who assesses the debtor’s assets and liabilities. Based on the results of this audit, the administrator makes a recommendation to the court on whether to open the procedure. Here, accessing the procedure depends upon a specific condition that reflects a cost coverage provision. Specifically, the expected value of the remaining assets should be greater than the direct bankruptcy costs, which correspond mostly to the administrator’s fees for a procedure to be launched. When the case is rejected, the file remains “unopened”. In such a situation, civil law applies on a “first arrived, first served” basis given contractual priority rules, and the debtor is finally dissolved. Since the 1999 reform—which has softened the triggering criteria—the proportion of opened files has been increasing to more than 50% (even over 70% in recent years; see Destatis 2016). Such screening mechanism aims at increasing the final recoveries, as the procedure is restricted to firms whose assets are high enough to justify a collective treatment of their claims. We consequently restrict the analysis to opened files because unopened files are not resolved on a collective basis.Footnote 47
A potential determinant of the effectiveness of a bankruptcy code lies in its perceived attractiveness (Step 1).Footnote 48 The incentives to opt for early default resolution might be decisive to limit any additional deterioration of the assets. An early triggering should enlarge the scope of possible alternatives to liquidation. The 1999 reform widened the legal definition of default by introducing two new modalities of triggering: imminent suspension of payments and over-indebtedness. Here, an effective cessation of payments is no longer necessary to observe to enter the procedure. Yet, these two new criteria are rarely invoked, and represent less than 3% of total insolvencies in 2005Footnote 49 (Angele 2008). Another attempt to promote early filing is to maintain the manager(s) in position (whereas the default solution is a replacement by the administrator). Again, this feature remains largely scarce (about 0.5% of total insolvencies in 2007).
Germany shows specificities in the way the procedure is managed (Step 2). When the case is opened, the administrator gains managerial rights over the firm. An automatic stay applies during this period. Contrary to France, this supervised management is limited to three months only. Such a short delay may have two opposite effects in terms of value creation. On the one hand, it saves costs and protects the debtor against any further decrease in the assets’ value. On the other hand, a short delay might not be long enough to identify the best solution to implement.
At the end of this time limit, the administrator must propose a course of action, i.e. to recommend liquidation, the search of a buyer (sale as a going concern), or (since 1999) the working-out of an Insolvenzplan, which theoretically allows for partial debt relief and departures from the APR. In practice, continuation plans remain scarce (<1%Footnote 50 of bankruptcy filings). The final decision stems from a creditor’s vote on the administrator’s proposal (Step 3). A major difference with the French bankruptcy law deals with the way the final outcome is decided. In Germany, the creditors coordinate themselves directly through a vote. One might expect such a voting process to have a positive effect onto the overall recoveries, provided the creditor’s democratic choice fully reflects their individual incentives to maximize the debtor’s value.
1.1.3 Appendix 1.3: UK bankruptcy system
In the United Kingdom, corporate bankruptcy was ruled initially by the Insolvency Act 1986. This legislation was replaced by the Enterprise Act 2002 that interestingly specifies a set of new objectives: (1) “to facilitate company rescue” and (2) “to produce better returns for creditors as a whole”. This reform, which came into force in 2003, reflects a slight shift toward the debtor’s interests, although creditors remain well protected.
The UK legislation offers a menu of three procedures: (1) receivership (10% of the cases, according to the London Gazette), (2) administration (5%), and (3) liquidation (85%). In addition, a fourth procedure (“company voluntary arrangement”, known as CVA) is dedicated to renegotiation attempts under the court’s supervision between the debtor and creditors. Yet, this latter means of resolving distress is not a bankruptcy procedure stricto sensu because it is closer to a workout (a firm need not be in default to file for CVA).
The first procedure (receivership) gives the secured creditors in possession of a floating charge Footnote 51 the right to appoint a receiver (or an administrative receiver if such receiver manages the firm at the same time), with the mission to protect their interests (in practice, the receivers are mostly given the mission to prepare liquidation). The receiver’s duty is to preserve the appointer’s interests prior to those of all the creditors. In such framework, the procedure is managed primarily to serve the interests of one sole type of creditor(s). Thus, choosing between a floating charge and any other collateral(s) is a strategic decision: on the one hand, a floating charge gives the creditors the power to escape a collective procedure, but on the other hand, it does not grant them a high position in the APR (under receivership, the repayment order is, decreasingly: secured and preferential claims, floating charges, liquidator’s fees (if the receivership ends up with liquidation), and junior claims). The receivership was cancelled in 2003. Actually, this procedure was increasingly viewed as a mere liquidation procedure (Armour and Mokal 2005), and was long suspected to be costly and to undermine the overall recoveries. Indeed, the creditors in possession of a floating charge might have little incentives to behave in a way favoring the unsecured creditors’ interests (Armour et al. 2008). However, the receivership provides a framework for analyzing the effect of a floating charge on the incentives of creditors to trigger the procedure and on the procedure outcome.
The second procedure (administration) is a way of either reorganizing the company, preparing a future CVA, or planning liquidation. An administrator is appointed by the court: (s)he replaces the manager(s) and protects both the debtor’s and the creditors’ interests (individual pursuits are suspended under administration). The administration can be triggered either by the debtor (shareholders and/or managers) or by the creditors. The company should be illiquid or insolvent, and the administrator’s mission (as described in the “administrative order”) should be a priori attainable. The administration ends with the vote of the creditors who endorse the administrator’s plan. The creditors play an active role in the decision-making process, but their participation remains under the supervision of the court that can force a solution if the administrator’s plan is rejected.
The third procedure (liquidation) is the most common outcome in the United Kingdom. Three types of liquidation can apply, depending on the situation of the firm. Compulsory liquidation (CL) should prevail under a large set of circumstances: short-term illiquidity, long-term (prospective) financial difficulties, lower number of members than two, and/or suspended business for a whole year. The petition for CL is usually presented by the creditors or by the company itself. Liquidation can be triggered also on a voluntary basis: the UK code distinguishes between creditor voluntary liquidation (CVL) and member voluntary liquidation (MVL).Footnote 52 The CVL procedure takes place when the shareholders or the directors of the company voluntarily decide to put the company into liquidation, realizing the fact that the company is unable to pay its debts and has become insolvent (it is interesting to note that despite its misleading name, CVL cannot be initiated by the creditors). For the liquidation procedure, a liquidator is appointed, either by the court or by the creditors. Most creditors are subject to an automatic stay of claims, but some secured creditors can be exempt from this legal provision. The liquidation ends with either a piecemeal liquidation or a sale as a going concern. Once the liquidation process has ended, a priority order of repayment applies. The proceeds from secured assets are used to pay the secured creditors, and the residual, if any, goes toward paying liquidator fees, followed by preferential creditors and unsecured creditors. The proceeds from unsecured assets are first used to pay the liquidators fees, followed by preferential creditors and unsecured creditors.
In a nutshell, the UK legislation offers three bankruptcy paths to resolve financial distress: receivership, administration, liquidation (compulsory or voluntary). Receivership is certainly the most specific path because it is not a collective procedure stricto sensu. The triggering condition (Step 1) relies on the willingness of the sole appointer and is not related to a finite list of criteria. The management of the procedure (Step 2) lies in the hands of the receiver who has the duty to serve the appointer’s interests first. Such prioritization can affect the overall recoveries, and eventually have some detrimental influence on junior claims. Nonetheless, such procedure interestingly isolates the debtor’s assets from competition between the various claimants. Moreover, the receivership can also save the costs attached to other procedures. Now turning to the final outcome of receivership (Step 3), one can suspect that the prioritization of the appointer’s sole interests leads (too) often to liquidation. The two other bankruptcy paths (administration and liquidation) differ in many ways. First, administration allows for different outcomes (depending upon the mission assigned to the administrator) and prioritizes a priori the company’s rescue over the creditors’ repayment. Administration settles a statutory moratorium that provides breathing space to the debtor, and allows a stay on the debtor’s assets. Second, liquidation procedures are restricted to the realization of the debtor’s assets (either piecemeal or as a going concern). Thus, the set of possible outcomes is a priori restricted from the beginning of the procedure (Step 3). This contrasts with France where liquidation is decided at the end of the procedure. Now turning to the triggering criteria (Step 1), the conditions to initiate liquidation are wider than those in France, because the former encompass both short-term illiquidity situations and long-term financial difficulties. Ceteris paribus, this should lead to earlier liquidations and hence speed up the collective treatment of default. However, some secured creditors can escape the stay of claims under liquidation, which partially restricts the collective aspect of the procedure (Step 2).
1.2 Appendix 2: Time distribution of the sample (opening dates)
1.3 Appendix 3
See Table 7.
1.4 Appendix 4
See Table 8.
1.5 Appendix 5
See Table 9.
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Blazy, R., Petey, J. & Weill, L. Serving the creditors after insolvency filings: from value creation to value distribution. Eur J Law Econ 45, 331–375 (2018). https://doi.org/10.1007/s10657-017-9560-9
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DOI: https://doi.org/10.1007/s10657-017-9560-9