Fixing Failed Firms Should Be Based On Economics,
Not
Revenge
Introduction
The title of this article is the result of unashamed plagiarism. It comes
from an article in the Economist of December 15, dealing with business
failures against the background of the collapse of the giant US Corporation,
Enron, constituting the largest of bankruptcy ever in that country. The USA
is probably unique in its tolerance of business failures: its famous Chapter
11 is criticised by many as encouraging financial adventurism, allowing the
"guilty" to go free while the creditor is by law prevented from
pursuing his debt. It is based on the fresh-start policy that is designed to
provide the honest but financially troubled business a form of relief
against the creditor in the short-term allowing it to return to solvency in
the medium-term.
How societies should deal with individuals and businesses who run into
financial trouble has been debated vigorously over several decades and has
pitted creditors against debtors and the moralists against the pragmatists.
The pendulum has swung one way and then the other but there is no doubt that
the purists who would seek to criminalise defaulting debtors are losing
ground. There is justifiable moral outrage that some crooks posing as
entrepreneurs should be out there enjoying the lifestyle of the rich. Many
of these should be behind bars but such bandits are the exception. They are
protected not by bankruptcy legislation but rather by a Court system that is
overloaded, inefficient and archaic. They are also protected by a society
that regards stealing a few fruits to eat as more criminal than stealing a
million dollars in taxes. The suggestion that the entire national budget
would be spent on jails for all the country's tax evaders is too cynical for
reasonable debate.
 Unprecedented
corporate failures
In Guyana the debate on insolvents and bankrupts has hardly begun despite
the spate of receiverships during the year. Never in the history of Guyana
has there been so many business failures in so short a period of time. No
type of business has been spared - whether in the public or private sector,
in mining, rice, gold, trading or financial services. The combined effects
of these failures is a matter of national concern, not only that of the
business sector which itself seems unsympathetic to the plight of their
colleagues. In the recent Business Outlook Survey 2002 conducted by Ram
& McRae only forty percent opposed the largely hands off policy of the
Government on businesses in distress.
In Guyana, to the extent that the law on corporate failures is an issue,
we still seem steeped in the distant past, one that gave to the creditor
unfettered right to move against the debtor and said that to offer
protection to the debtor is undue interference in a contractual
relationship. The law reflects a form of inverted morality that insists that
the borrower repay his debt regardless of the circumstances or the
consequences on the economy of putting the debtor out of business. The
socialist legacy tells us that the poor always repay their debts and that it
is only the "fat cats" and those who have shipped tons of money
abroad who are now crying out for help. Yet it is these same reformed
socialists who advocate entrepreneurship and investments - conditions which
inevitably result in some failures.
Both our insolvency and bankruptcy laws are rooted in the British legal
system and it is no surprise that the first reaction to a failure is to
blame the borrower (investor or entrepreneur) for any number of reasons.
Indeed the Minister of Finance is reported to have attributed many of the
business failures to mismanagement and capital flight, an oversimplification
if ever there was one.
Chapter 11
On the other hand, Chapter 11 provides relief to debtors through the
automatic stay. It shelters the insolvent debtor's business from the instant
action of creditors. The underlying thinking was summed up in the case - United
States V Whiting Pools Inc. where the view was expressed that by
permitting reorganisation, Congress anticipated that the business could
continue to provide jobs, to satisfy creditors' claims and to provide a
return for its owners. Congress presumed that the assets of the debtor would
be more valuable if used in a rehabilitated business than if sold in a fire
sale.
This provision could well benefit unsecured creditors in the long term
while protecting jobs, the property market and the economy in the short
term. The receivership route, which is common to the British type
legislation, does not debar the instant action of creditors and consequently
does not readily allow the foregoing objectives to be achieved.
Receiverships
Like the rest of the Caribbean, most bankruptcies in Guyana are in the
nature of corporate insolvencies and are dealt with via receiverships, a
remedy of the secured creditor for enforcing his security. In a comment,
which has resonance in Guyana, Grenville Phillips, leading Caribbean
insolvency practitioner, wrote several years ago "rarely have receivers
applied themselves to the tedious task of trying to save the insolvent
corporation. This in part may arise from the reluctance of secured creditors
who usually wait until the moment of corporate sunset before making the
appointment, by which time any hope of rescuing the insolvent debtor's
business has already began to fade."
"Most receivers are then forced to apply themselves, with what is
perceived to be varying degrees of ruthlessness, to the task of liquidating
the business of the insolvent debtor to recover monies subject to the
secured creditor's charge. Regretfully at the end of a receiver's occupation
there is usually little, of anything worthwhile, left of the debtor
company." Even in situations where a receiver/manager seeks to salvage
the business of the insolvent debtor, he is constantly buffeted by creditors
who wish to exert whatever leverage they can to obtain speedy repayment of
their debt. The creditor as well as the receiver often ignore the fact that
the receiver has a duty of care not only to the creditor making the
appointment but also to the debtor company whose agent they usually are
under the debenture or charge appointing them.
In Europe they are realizing that this type of policy has failed and
those countries have found that the state often bears a significant cost
resulting from corporate failure. They are belatedly recognising that even
though it is not a perfect system, the Chapter 11 route still serves the
economic interest of the country more efficiently than the traditional
system under which debtors are at the mercy of their creditors. We should be
coming to this same conclusion.
Conclusion
Whatever the system we hopefully will eventually adopt, it will no doubt
reflect the social, economic and political influences and pressures facing
our society. Rooted as it is in the conservative ethos and socialist values
of personal responsibility and the absence of grass roots consumer and other
organisations serving the politically under-represented insolvents and
bankrupts, it is unlikely that there is going to be overwhelming support for
excessive forbearance for failed businesses. There is no indication that,
despite the spate of failures the trades unions movement, the private
sector, civil society or the press has placed this issue on their agenda.
At the political level, it is equally unlikely that any
"active" consideration has been given to modernising the relevant
laws. Our Insolvency Act is over one hundred years old while the law
relating to corporate insolvency escaped the modernisation of the Companies
Act which itself was largely untouched for over eighty years.
Several years ago, I along with legal expert Bryn Pollard was part of the
Caribbean Law Institute's team that worked on a Draft Insolvency Act that
was intended to accompany the introduction of the new Companies Act. With
the several and successive changes in the Attorneys General throughout the
Caribbean it is interesting to speculate how many of them are aware of, let
alone have read, the draft Act or the Digest which accompanied it.
There is no more appropriate time for us in Guyana to seize the moment
and introduce new legislation that is designed if not to forgive debtors, at
least see them not all as a bunch of crooks but as persons who may have had
some bad luck and who can yet contribute to the development of the country.
A blessed Christmas to all debtors, creditors
and readers!!
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