Business Page December 23rd, 2001


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!!