Bankruptcy History & Famous Bankruptcies

BankruptcyHistory & Famous Bankruptcies Dr Clive Vlieland-Boddy

Introduction • Economies are Darwinian. They compete with each other, adopt best practices and evolve. • Just as capitalism overtook communism as the better system for maximizing wealth, procedures for rescuing distressed companies should overtake systems that focus on receiverships and liquidations at the expense of lower recoveries and the disenfranchisement of creditors. • The prevalence of bankruptcy systems focusing on receiverships and liquidations reflect the historical emphasis on tangible property rights, the rights of secured creditors and the realization of assets to discharge debts.

Introduction • Viable entities should be encouraged to reorganize via a balance sheet restructuring and non-viable enterprises should be liquated and the assets and capital redeployed to more productive uses. • The preferred outcome is that which maximizes economic recovery and which seeks to minimize (but not avoid) negative externalities. • To promote effectiveness and efficiency, the bankruptcy regime should strive to create a collective process with active participation by the economically affected parties.

Introduction • But in modern economies we talk of cash flows and enterprise values, values that invariably exceed tangible asset values. • A business should be worth more than just its net assets! • Maximizing these values when companies are in distress demands more flexible solutions than those provided by formal bankruptcy. • In a modern capitalist economy, the primary role of a bankruptcy regime should be to differentiate between balance sheet distress and operational distress.

History of Bankruptcy • Roots of word traced to medieval Italy – “banco rotto” which means broken bench • Early U. S. bankruptcy law was modification of British law • Debtor courts as well as debtor prisons. • 1800’s – First federal bankruptcy law signed by President John Adams in 1800 2 more laws passed and repealed until the Bankruptcy Act of 1898

Bankruptcy – Historical Vignettes • The penalty for declaring bankruptcy in Ancient Rome was slavery or being cut to pieces. The choice was left to the creditor. • By the Middle Ages, the treatment of insolvent debtors had softened considerably. • In Northern Italy, bankrupt debtors hit their naked backsides against a rock three times before a jeering crowd and cried out, “I declare bankruptcy.” • In French medieval cities, bankrupts were required to wear a green cap at all times, and anyone could throw stones at them.

The UK Poor Law Amendment Act The Poor Law of 1601 in England assigned responsibility for the poor to the parishes (local government). These parishes built workhouses to employ the poor on a profitable basis. This turned out be a difficult thing to accomplish and in the 18th century workhouses turned into receptacles where anybody could be dropped off at. A lot of times orphans were dropped off at workhouses simply because orphanages were crowded.

Punishment Punishment in the Victorian era could range from mild to the severe. Most punishment was capitol punishment and resulted in death.

Debtor Prisons Debtors prison is a prison where people who couldn’t pay off their debts where sent to until they could pay their debt off. Most people never left because they couldn’t pay of their debts. Prisoners often had to make potato sacks or other mass produced items in debtors prison.

Conditions in Debtor Prisons One variation of the debtors prison was the “Sponging House” it housed people who couldn’t pay off their debts. Some people in the prison were upper class people. Imprisonment was a common practice in Victorian England. When entering workhouses people were known as inmates and given small portions of cheap food such as bread, cheese, broth, rice, milk, and potatoes. Conditions in workhouses were basic. Sickness wasn’t considered a problem for the Poor Law Act.

Why Work Houses Workhouses were made in 1834. Workhouses were used through the 19th century by some places such as Victorian England. Workhouses were used for people who couldn’t pay off debts.

Bankruptcy & Debt If and when you were bankrupt your name was published in the official biweekly London Gazette. The Bailiff would take your goods and your house. Creditors would try and liquidate your possessions for the debt. When you were in debt there were bill brokers and money lenders.

Prisons in the 1800’s In debtors prison poor people who were in debt worked it off in this type of prison. Jails during this time period were mostly dark, overcrowded, and very filthy, all the prisoners were herded together with no separation.

Debtor Courts & Prisons • In the UK, up until the mid 1900’s, there were debtor prisons. • These were distressful places where recover or release was unlikely. • The courts sentenced all bankrupts to either prison or in some cases death.

Debtor’s Prison Originally a pre-judgment remedy Common law did not allow for default judgment Debtor could avoid judgment simply by avoiding appearing in court. Attachment of debtor’s goods was developed to compel appearance (not as security against the claim) Subsequently the law developed to allow defendants to be imprisoned in order to insure appearance From here it was a natural step to imprisonment of judgment debtors as a means of compelling payment.

Pre-Judgment Arrest Arrest and Examinations Act S.1(2) Where in an action brought or to be brought. . .a person by affidavit . . .shows to the satisfaction of the judge. . .that he has a cause of action against another person to an amount exceeding twenty dollars, and also shows . . .that there is good cause for believing that the person against whom the application is made is about to quit the Province, the judge or other official may order that the person against whom the application is made be arrested...

Pre-Judgment Arrest This remedy is draconian and archaic Very poorly integrated with the Rules of Court regarding examination The arrest under s.1(2) is in aid of examination It is not for failure to pay the debt The debtor is entitled to be released on making full disclosure The order releasing the debtor would also order the sheriff to seize the assets Difficult to enforce because it is usually too late when application is brought

Pre-Judgment Legal Process Remedies against the assets of the debtor Absconding Debtors Act Mareva Injunction (Freezing Order) Pre-judgment garnishment

Absconding Debtors Act If any person indebted. . . [1] depart from or keep concealed within the Province, [2] with intent to defraud his or their creditors, a creditor may make the affidavit. . .stating the reasons for their belief to the satisfaction of a judge, whereupon such judge may issue a warrant. . . and the warrant on delivery to a sheriff has priority over all other processes not actually executed. Most jurisdictions this remedy is only available after an action has been commenced – in NB anytime “indebted” – applies to action for debt, not damages Elements [1][2] are difficult to establish and it may be too late by the time the evidence is available

Mareva Injunction “If it appears that the debt is due and owing, and there is a danger that the debtor may dispose of his assets so as to defeat it before judgment, the court has jurisdiction in a proper case to grant an interlocutory judgment so as to prevent him disposing of those assets” per Lord Denning The Mareva [1980] 1 All ER 213 (CA)

Mareva Injunction Used to prevent debtor from dissipating assets or removing them from the jurisdiction before the creditors could reduce their claims to judgment and execute. Often the debtor is not within the jurisdiction. The injunction is usually served on third parties, normally the debtor’s bank: “freeze the assets of D which you hold” Persons having knowledge of the injunction must assist in preserving the assets or be guilty of contempt of court.

Mareva Injunction Do the assets need to be within the jurisdiction? Yes, in the original English cases, and this requirement is referred to in First Farm, but English law has changed and worldwide Mareva injunctions are now available.

Mareva Injunction To summarize 1) Clean hands (Lord Denning’s comment) 2) Prima facie case on the merits/serious question to be tried 3) It is likely that any judgment would remain unsatisfied if the injunction were not granted 4) Undertaking in damages, sometimes with requirement of security

Entrepreneurship • The need to encourage business and by that the risks associated, made governments appreciate that the bankruptcy laws were very out of date. • It became increasingly less a crime and more a social issue.

1900’s and Beyond • A bankruptcy environment that had as its focus helping debtors seek a new start remained in place for most of 20th century. • Bankruptcy in an emerging global economy had to adapt to encouraging risk. • By beginning of 21st century creditors successfully argued that this current law and environment were too easy on debtors. The procedures were being misused.

Bankruptcy in the 21st Century • Growing acceptance of the benefits of a recovery culture worldwide. • Almost all countries including China have introduced reconstruction procedures as laws. • Need to balance globalisation with risk. • Need for global laws and cross border insolvency procedures. • Convergence of bankruptcy law worldwide.

Famous Bankruptcies • Whilst many famous people became bankrupt, the stigma associated with that act means that they try and hide this fact. • Otherwise, the famous are those associated with fraud.

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Bankruptcy History & Famous Bankruptcies