Insolvency legal indicator survey

2004 Legal Indicator Survey on Insolvency

To complement its assessment of insolvency legislation, the EBRD launched the 2004 Legal Indicator Survey. The aim of the Survey was to assess how the legislation, together with the local institutional framework (including rules of procedure, courts and judges and insolvency administrators), in each country works to create a functional (or dysfunctional) insolvency legal regime. 

Employment of case study methodology

Following on the methodology devised for the 2003 survey, a case study method was again employed. This involved presenting practitioners in each country with a “real-life” case that they might encounter in their practice and asking them to answer a series of questions relating to how the law might operate in regard to such a case (including basic but important information, such as time, cost and complexity associated with certain processes) and how they might advise the hypothetical ‘client’ in regard to the case. The EBRD worked with the leading insolvency lawyers  (0.1Mb) in the region, ranging from those practicing in large, global firms to sole practitioners. 

Two case studies

It was determined that a single case-study scenario could not adequately measure the practical workings of insolvency law regimes. Insolvency laws affect a variety of constituents, including banks, employees and governments.  Ultimately, however, the users or “clients” of insolvency laws can be divided into two broad groups: debtors and creditors. Consequently, proceedings under most insolvency laws can be commenced by one of these two groups.  Although each group is affected by the action of the other, the party commencing the proceeding often dictates, at least at the outset, what type of proceeding will be taken. As a result, it was determined that the functioning of the insolvency regime needed to be measured both in instances where a creditor commences proceedings (which could result in either liquidation or rehabilitation of the relevant debtor) under the insolvency law and when a debtor commences proceedings (which would normally seek rehabilitation).  Accordingly, two different hypothetical cases were employed  (0.1Mb), asking participants to advise, first, a creditor who seeks to apply a relevant insolvency law to a debtor and, secondly, a debtor who seeks relief under the insolvency law.

Scope and dimension of case studies

The scope and dimension of the Survey was necessarily limited by the subject matter. Insolvency laws differ widely in their design and substance. While it may be possible to test the entirety of an insolvency regime (if only one such regime were being tested), to examine a number of regimes under a single exercise requires the consideration of many variables and alternative possibilities that arise from those differences in legislation. The results of any such testing would produce an incoherent final product. In addition, any attempt to consider a large number of variables requires them to be “weighted” (allocating particular areas a greater scoring potential than others based on perceptions of relative importance).  The exercise of weighting, however, is subjective and if a survey extends into too many areas, the temptation and opportunity to weight results, and thereby distort them, increases.

Accordingly, it was determined to focus the Survey on the most critically important area of an insolvency law: the ability of either core constituent to effectively initiate insolvency proceedings concerning an insolvent debtor to a point at which the debtor’s affairs would be dealt with under the umbrella of the insolvency law. The broad purpose of this methodology is to test whether and the extent to which the law may be effectively applied in practice. More particularly, that test should embrace critical factors involved in that usage, such as time, cost, barriers to efficient application, the adequacy of the institutional capacity (particularly the courts), and general effectiveness.

Legal and economic importance of the Survey

The insolvency laws of the relevant countries apply, in a general sense, to enterprises that:

• are part of the public or private sector economy;
• engage in trade and commerce;
• fund their infrastructure and operations from proprietors’ capital, external financial investment or a combination thereof;
• may employ a significant number of employees;
• create local markets for the supply of goods and services; and
• are users of credit.

The Survey is important from both legal and economic perspectives because it is concerned with the application of quite critical laws relating to the financial difficulty of enterprises whose involvement in the economy is often significant at a number of levels.  

From a legal perspective some of the more important questions that the Survey may be expected to answer include:

• May the law be conveniently, expeditiously and inexpensively accessed by the two main users of the law – financially troubled debtors (being business enterprises) and their creditors?
• Is there an appropriate commercial environment for properly organised ‘collective’ bargaining between the stakeholders in determining the appropriate remedy for a financially troubled enterprise?
• Does recourse to the law (by, for example, the initiation of insolvency proceedings against a financially-troubled debtor) produce a real ‘credible threat’ to the debtor (such that the debtor might be prompted to initiate reorganisation proceedings itself)?
• Is there adequate institutional capacity within the courts to apply the law?
• Is there general adherence to the maxim of the ‘rule of law’ (in particular, whether it is undermined as a result of, for example, political patronage, cronyism, other interference or corruption)?

From an economic perspective, important questions include:

• Do insolvent debtors have reasonable access to protective rescue processes such that creditors will be induced to work with debtors on an amicable basis?
• Through whatever form of rescue ‘remedy’, does the insolvency law operate in practice to at least provide the chance of preserving viable businesses and maximise returns to creditors, thereby encouraging and preserving financial investment?
• Does the insolvency law act, in practice, as a ‘weapon-of-last-resort’ for a creditor and, in appropriate cases, does it enable the liquidation of uncompetitive and inefficient enterprises?
• Is it practically possible for an enterprise to be effectively reorganised for the commercial benefit of the principal stakeholders?
• Can certain stakeholders effectively block or disrupt collective proceedings?
• The hypothetical cases employed are set out here and were each accompanied by a number of questions concerning each case.

SCORING METHODOLOGY OF THE SURVEY

The majority of the questions provided for multiple-choice responses. Each question was individually scored on a range of 0 to 4 (zero representing the lowest and four the highest score). It reflected a 5-point progression from a clear "yes" to a clear "no" (or from 'extremely low' to 'very high').

In addition, narrative text responses regarding most areas of inquiry assisted in obtaining further information within each hypothetical. It also had impact on the scoring of related questions (for instance, by reinforcing other answers or indicating contradictions). Narrative explanations were not scored individually.

Some participants indicated that their insolvency systems lack experience in the field. This was reflected in the scoring, specifically where such experience was most relevant .

Core areas and principal criteria

Ultimately, the questions of each hypothetical were merged to measure and test critical core areas involved in the use and operation of the relevant insolvency laws. 

Each core area was individually scored by aggregating the scores of its constituent questions. Finally, the core areas were merged to measure the degree of effectiveness of three principal criteria - speed, efficiency and transparency/ predictability.

No 'weighting' was applied between core areas or between questions and issues raised in each core area.

The principal criteria

As mentioned above, these principal criteria were derived from a composite of the core areas.

• Speed is the most straightforward of the criteria. It is a simple test of the time that it might take from the initiation of a legal process to the point where it is, in effect, concluded. In the case of a process initiated by a creditor, it refers to the time between the initial filing of the process with the court and the court making a final determination of the result of the application. In the case of a debtor-initiated process, it is from the filing of the process to the confirmation of a reorganisation plan. In this respect, it should be noted that the prospect of and the time that might be taken with any appellate process was disregarded for the purposes of the survey .
• Efficiency tests a number of factors involved in legal processes such as the formalities that might be imposed (for example, amount of documentation and the formal procedural steps), the relative cost (for example, court fees, legal representation costs) and the degree of complexity (for example, court appearances required, procedural technicalities). It is therefore a composite of a number of factors and is designed to test the extent to which legal processes are excessively formal, create procedural barriers, increase cost and, as a result, act as a barrier or disincentive and limit access to and the use of the law.
• Predictability/Transparency addresses, firstly, judicial predictability and competence and, secondly, the competence of office holders appointed to supervise, control or generally administer the affairs of an insolvent debtor. It also addresses the extent to which outside ‘influences’ might intrude on both the courts and the office holders (for example the influence of political patronage, cronyism and corruption).

RESULTS OF SURVEY

The essential results are presented in various graphic forms to illustrate both the performance of each country separately and an overall comparative view, as follows:

• the scores obtained by each country on the ‘creditor-initiated’ case and the ‘debtor-initiated’ case  (0.1Mb);
• the degree of effectiveness scored by each country in each of the three ‘principal criteria’  (0.1Mb) (speed, efficiency and predictability/transparency); in each of the two cases; and
• Comprehensive country-by-country analysis of the results of each case  (0.1Mb), using multiple criteria and presented in graphic form.

For additional information, please contact the EBRD’s insolvency specialist, Melissa Burgess, at burgessm@ebrd.com