Insolvency Law

Insolvency Law and Practice in Europe’s transition economies

In 2004 the European Bank for Reconstruction and Development (EBRD) completed two major insolvency-related studies: the Insolvency Sector Assessment (ISA) and the Legal Indicator Survey on Insolvency (LIS).

Since its inception in 1998, the EBRD’s Legal Transition Programme has made the assessment of commercial laws and legal systems a key component of its contribution to the reform of transition economies. These assessments have been continuously refined over the years and provide, among other things, detailed information to the EBRD’s 27 countries of operation as to how their legal systems compare with international standards and best practices; they also help to inform the transition projects of the EBRD.

Extensiveness and effectiveness

Insolvency is one of the five areas of focus of the Legal Transition Programme and highlights the EBRD’s unique status in the region as both a ‘user’ of insolvency legal regimes (in its context as a lender recovering bad debts) and a reformer of these systems. The EBRD’s assessment work takes two broad measurements of insolvency legal regimes: their extensiveness and their effectiveness.

The extensiveness study – the ISA – looks at the ‘law in transition’ and measures the extent to which a country’s key insolvency legislation complies with international standards and best practices. The effectiveness study – the LIS – looks at the ‘law in action’ and the extent to which the regime, in practice, achieves results in a timely, predictable and efficient manner. These two assessments, rather than measuring the same elements of the legal regime, assess its various practical and theoretical components to provide a complete, multi-dimensional picture of the legal system.

Bankruptcy and insolvency legal systems are often incorrectly thought to be solely about helping creditors recover loans made to debtors. In fact, these legal systems encapsulate a number of the commercial, social and political values of a society. Ultimately, the purpose of any insolvency regime is to redistribute the assets of uncompetitive or inefficient entities. This is done in many ways, including auctioning assets to more efficient entities, distributing assets to various constituencies such as governments and employees, or turning the inefficient entity itself into a more efficient one through corporate reorganisation. Empirical evidence suggests, however, that legal systems that fulfil this purpose well, in a predictable and efficient manner, will attract greater investment and make the cost of credit more affordable by giving creditors the certainty they crave (in particular, see the work of R La Porta, F Lopez-de-Silanes, A Shleifer and RW Vishny in “Legal Determinants of External Finance”, Journal of Finance, Vol 52; and A Ramasastry, “Assessing insolvency laws after ten years of transition”, Law in transition, EBRD (Spring 2000)).

The results of the LIS and the ISA reflect, in part, the sheer variety of legal and political cultures found in the EBRD’s countries of operation. Some countries stress the sanctity of the debtor-creditor contract, while others place a high level of importance on ensuring that the claims of employees and state agencies are met. If each country were an island unto itself, one could perhaps adopt a relativist view of these varying systems. Certainly, in any case, in reviewing each system local peculiarities and traditions must be respected. Nevertheless, the free movement of global capital and the desire of all countries, particularly emerging market ones, to attract the same pool of scarce capital make it necessary for all countries to strive for certain standard levels of extensiveness and effectiveness.

The insolvency sector assessment

The methodology of this assessment involved constructing a list of 97 fields of inquiry, created using the most widely accepted international standards adopted by the World Bank and the United Nations Commission on International Trade Law, among others. Experts in the field of insolvency, retained by the EBRD, compiled legislation from all EBRD countries of operations and analysed these laws with regard to the 97 areas of inquiry. In almost every case, local practitioners in each country then verified this analysis.

The 97 fields of inquiry were then grouped into the five core areas listed below:

• commencement of proceedings;

• treatment of estate assets;

• treatment of creditors;

• reorganisation processes; and

• terminal/liquidation processes.

The fields of inquiry chosen and the scores assigned reflected the view that an insolvency legal regime should:

• allow for relatively easy and predictable access to insolvency proceedings by both debtors and creditors;

• provide alternative remedies (ie, liquidation and rehabilitation) for the financial problems of an insolvent debtor;

• permit the efficient, proper and timely administration of an insolvency case; and

• on balance, treat the interests of creditors as paramount.

In virtually every case, practitioners in each country were used to verify the assessments of the EBRD experts.