Insolvency

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 in the EBRD region to an improved 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 current financial crisis highlights the fact 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.
  
• Strong 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 administrators. There is increasing recognition that efficiency of insolvency regimes depends on the quality of institutions such as the judiciary, insolvency administrators and professional organisations for insolvency practitioners, as much as on the legal provisions.

Insolvency laws assessment project

An assessment project to benchmark insolvency laws in each country against best international practices was conducted in 2009.  This assessment built on previous studies conducted in 2004 and 2006. In the assessment, the EBRD compared a checklist of benchmark issues to existing laws, regulations, decrees, and so on, in a given country. It incorporates the World Bank’s Principles and Guidelines for Effective Insolvency Systems, the UNCITRAL Legislative Guide on Insolvency Law, and the EBRD Insolvency Office Holder Principles. It enables the EBRD and each country to identify gaps, conflicts or other deficiencies in the insolvency legal framework.

Trends

•  Improved Legal Frameworks for Creditors. Nearly all jurisdictions scored highest in the 2009 Insolvency Sector Assessment in the area of creditor treatment. In fact more than half of the countries assessed scored their highest marks in this area, showing that the involvement of creditors in the process and the ability, profile, priority and equality of claims is improving in the region and features prominently in the laws.
  
•  Need for reform of Insolvency Office Holder Frameworks. As a whole, the laws and regulatory frameworks governing insolvency of office holders needs improvement to ensure proper qualification and licensing of insolvency administrators and to ensure they act within clear and effective standards of professional and ethical conduct. Very few countries were rated as  "High" or "Very High" compliance in the 2009 Insolvency Sector Assessment and a startling number were rated as "Very low" compliance in this area, signalling a clear need for reform.
  
•  Reorganisation procedures still need reform. The 2009 Insolvency Sector Assessment confirmed that reorganisation remains a weakness in many insolvency laws throughout the region. A lack of provisions for allowing reorganisation financing for fair and equitable voting on a plan of reorganisation are among common weaknesses that should be addressed in future reform efforts. 

Further reading
Bankruptcy law: what is fair? (335KB - PDF) 
Law in Transition, Spring 2000

Multi creditor restructuring in transition countries: lessons from developed jurisdictions (340KB - PDF) Law in Transition, Spring 2000

The case for debtor-in-possession financing in early transition countries: Taking a DIP in the distressed-debt pool (3MB - PDF) LiT online, Autumn 2004

Insolvency law and practice in Europe's transition economies, Butterworths Journal of international banking and financial law (775KB - PDF) December 2004 (originally appeared in Butterworths Journal of International Banking and Financial Law)