Transparency around exit costs across Europe

1. Transparency around exit costs across Europe Karin S. Thorburn Dartmouth College

2. Objective of bankruptcy • Restructure economically viable firms • Terminate unprofitable operations and reallocate assets to higher-value use • Do this as cost-efficiently as possible Karin Thorburn, Dartmouth College

3. Bankruptcy costs • Direct costs • Lawyers, bankers, court hearings • Indirect costs • Decline in sale, loss of employees, etc. • Inefficient allocation of assets • Continuation versus liquidation • Fire sales • Delayed filing and risk-shifting incentives • Predictability/transparency of proceedings Karin Thorburn, Dartmouth College

4. EU insolvency regulation • Regulation on Insolvency Proceedings • Rules for cross-country proceedings • Main insolvency proceedings in member state where firm has its “center of main interest” • Secondary proceedings in other member countries, limited to winding up assets and run parallel to main proceedings • No harmonization of bankruptcy law between different EU countries Karin Thorburn, Dartmouth College

5. Bankruptcy systems • Reorganization codes (US, France) • Formal framework to renegotiate claims • Incumbent management retains control • Equityholder friendly • Auction codes (Sweden, UK) • Sale of the firm in a mandatory auction • Creditor rights at the forefront Karin Thorburn, Dartmouth College

6. France • Court appoints an administrator • Objectives are firm continuation, job preservation and, third, creditor claims • Automatic stay, super-priority debt • Creditors are removed from process • Tax and employee claims take priority to proceeds from secured assets Karin Thorburn, Dartmouth College

7. Germany • 3-month grace period from creditors • Administrator contrives a reorganization plan • Approval from creditors by majority vote • Court may cram down on dissenting creditors Karin Thorburn, Dartmouth College

8. The UK • Secured creditor appoints receiver • Receiver looks after the interests of the secured creditor • Receiver decides whether to restructure firm or sell assets • No automatic stay or super-priority financing Karin Thorburn, Dartmouth College

9. Sweden • Mandatory auction of firm as a going concern or piecemeal • Automatic stay of debt and super-priority financing • Buyer decides whether to retain incumbent management • Payment in cash Karin Thorburn, Dartmouth College

10. Reorganization code • Pros: • Encourages management to file early • Cons: • Joint negotiation of firm value, use of assets and creditor payoffs risks prolong the bankruptcy procedure • Inefficient continuations • Less transparent Karin Thorburn, Dartmouth College

11. Auction code • Pros: • Assets are valued by the market • Highest bidder decides use of assets • Cash allows payoffs following APR • Cons: • Asset fire sales • Delayed filing and excessive risk-shifting Karin Thorburn, Dartmouth College

12. Direct and indirect costs • Swedish auctions speedy—2 months— and relatively low cost (Thorburn 00) • UK bankruptcy higher direct costs (Franks and Sussman 04) • Lowest debt recovery rates in France, highest in UK and Sweden (Davydenko-Franks 04, Thorburn 00) Karin Thorburn, Dartmouth College

13. Inefficient continuation and liquidation • France: too much continuations? • UK, Germany: too many liquidations? • Sweden: buyer decides, so no real distortion of incentives • Most liquidations in French bankruptcy (Kaiser 96, Davydenko-Franks 04) • Auctioned firms perform well (Eckbo-Thorburn 03) Karin Thorburn, Dartmouth College

14. Asset fire sales • UK, Sweden: depressed prices? • Managers repurchase assets in period of industry distress (Stromberg 00) • Secured creditors provide liquidity to competing bidders (Eckbo-Thorburn 04) • Auction prices do not vary with fire-sales variables in continuation sales (Eckbo-Thorburn 06) Karin Thorburn, Dartmouth College

15. Delayed filing • UK, Sweden: excessive risk-shifting? • France: encourages early filing? • Managerial incentives to retain control benefits (Eckbo-Thorburn 03) • Personal liability for late action Karin Thorburn, Dartmouth College

16. Out-of-court solutions • France: many workouts? • UK, Sweden: few workouts? • Similar rates of bankruptcy filing for defaulted firms across UK, Germany and France (Davydenko-Franks 04) • German banks form bank pools to facilitate voluntary workouts (Brunner-Krahnen 04) Karin Thorburn, Dartmouth College

17. Recent reform • EU encourages its member countries to strengthen their provisions for reorganization • Recent reforms in many European countries undermine creditor rights and decrease transparency in exit costs • US development towards using market mechanisms (Baird-Rasmussen 04) and increased transparency Karin Thorburn, Dartmouth College

18. Summary • Different bankruptcy codes impose different costs on distressed firms • French reorganization code appears to fail successfully restructuring firms • Swedish auction code seems relatively low-cost and transparent, along with UK code • Is reform in Europe going in the wrong direction? Karin Thorburn, Dartmouth College