About insolvency reform

When the process of transition to market economy started in central and eastern Europe, insolvency systems served principally as a conduit to filter public assets to the private sector. Generally, this was done inefficiently and without appropriate institutional and regulatory framework. Substantial reform efforts have since contributed to an effective insolvency culture and legal practice to distribute, re-distribute, or use assets from a failed business more efficiently, effectively and fairly through liquidation or reorganisation.

Why reform is needed

The East Asian financial crisis confirmed that credit automatically flows to places where creditors are fairly treated. Modern insolvency systems and debtor-creditor regimes are the cornerstone of sustainable economic development and provide a safety valve for financial failures:

• Predictable insolvency regimes encourage creditors to work with debtors to avoid the closure of a business rather than opportunistically withdrawing credit and seizing assets at the first hint of financial distress.

 

• Insolvency laws promote distribution, re-distribution and use of assets from failed businesses more efficiently, effectively and equitably.

 

• In many transition countries in central and eastern Europe and the former Soviet Union, insolvency provisions are unadapted to newly established market economies. Legal reform and technical assistance are needed to modernise rules and procedures to reach international standards of best practice.

 

The EBRD's role

The EBRD supports transition countries to revise their insolvency laws and implementing institutions. Early in the transition effort, the EBRD assisted Azerbaijan and the Kyrgyz Republic. The Bank also assisted Russia to develop implementation regulations for one of its early insolvency law revisions in the mid-1990s. The Bank is now working with authorities in Serbia and the Russian Federation to improve the supervision and discipline of insolvency adminstrators. There is increasing recognition that efficiency of insolvency regimes depends on the quality of institutions such as the judiciary, insolvency adminstrators and professional organisations for insolvency practitioners, as much as on the legal provisions.

The EBRD also supports countries to enact special legislation for insolvent banks, recognising the destabilising risk that insolvency of one bank can have for the whole sector. Russia, for example, enacted a new law in 1999 to deal with insolvent financial institutions, partly as a reaction to the bank failures that occurred in 1998. The EBRD is helping develop model bank insolvency legislation for the CIS countries working with the CIS Inter-parliamentary Assembly.

Insolvency laws assessment project

An assessment project to benchmark insolvency laws in each country against the best international practice has been conducted. An analytical tool compares a checklist of benchmark issues to existing laws, regulations, decrees, etc. in a given country. It incorporates the World Bank’s Principles and Guidelines for Effective Insolvency System. It enables the EBRD and each country to identify gaps, conflicts or other deficiencies in insolvency legal framework.

Trends

• Unawareness of liquidation priorities. While nearly all jurisdictions recognise the right of secured creditors to have first priority for payment of their debts during liquidation or to have property securing their debt removed from the debtor’s estate, practitioners are frequently uncertain whether secured creditors take first priority or the order of priority. In some instances, conflict may exist between provisions on secured lending and insolvency laws.

 

• Unclear role of the liquidator. Practitioners are often uncertain of the extent of an insolvency liquidator’s authority and power. This is because specific provisions concerning the liquidator are contained in a number of laws. Moreover, their powers may develop through custom and practice and are not easily discerned from reading insolvency law. Recent legislative changes attempt to address this by specifying a liquidator's or trustee’s powers more clearly.

 

• Uncertainty when to commence insolvency procedures. If procedures to trigger an insolvency proceeding are unclear, debtors and creditors are uncertain whether to commence insolvency proceedings. Amendments designed to speed up the insolvency process can create confusion.

Further reading
Bankruptcy law: what is fair?  (0.3Mb) , Law in Transition, Spring 2000
Multi creditor restructuring in transition countries: lessons from developed jurisdictions  (0.3Mb), Law in Transition, Spring 2000
The case for debtor-in-possession financing in early transition countries: Taking a DIP in the distressed-debt pool, LiT online, Autumn 2004
Insolvency law and practice in Europe's transition economies, Butterworths Journal of international banking and financial law  (0.8Mb), December 2004 (originally appeared in Butterworths Journal of International Banking and Financial Law)