WORLD BANK GROUP INSOLVENCY AND CREDITOR/DEBTOR REGIMES TASK FORCE W O R K I N G G R O U P O N T H E T R E AT M E N T O F M S M E I N S O LV E N C Y Saving Entrepreneurs, Saving Enterprises: Proposals on the Treatment of MSME Insolvency © 2018 The World Bank Group 1818 H Street NW Washington, DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org All rights reserved. This volume is a product of the staff and external authors of the World Bank Group. The World Bank Group refers to the member institutions of the World Bank Group: The World Bank (International Bank for Reconstruction and Development); International Finance Corporation (IFC); and Multilateral Investment Guarantee Agency (MIGA), which are separate and dis- tinct legal entities each organized under its respective Articles of Agreement. We encourage use for educational and non- commercial purposes. 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Photo Credits: World Bank Photo Library and Shutterstock Table of Contents FOREWORD ..............................................................................................................................................V BACKGROUND....................................................................................................................................... VII EXECUTIVE SUMMARY...........................................................................................................................IX ACRONYMS AND ABBREVIATIONS......................................................................................................XI CHAPTER 1. INTRODUCTION.................................................................................................................. 1 CHAPTER 2. DISCHARGE FOR THE NATURAL PERSON ENTREPRENEUR AS A PRIMARY GOAL OF MSME INSOLVENCY..........................................................................................................................3 THE ELEMENTS OF AN EFFECTIVE DISCHARGE REGIME FOR INDIVIDUAL MSME DEBTORS.........................4 Open Access.........................................................................................................................................................................4 Discharge of Both Personal and Business Debts........................................................................................................5 Specific, Substantiated Challenges to Debtors’ Good Faith in Exceptional Cases............................................5 Controlled Costs by Reducing Formalities.................................................................................................................. 6 Carefully Constrained Expropriation of Current Wealth and Future Income.................................................... 6 Limited Civil Restrictions and Stigma...........................................................................................................................7 EFFECT ON AVAILABILITY OF CREDIT FOR MSMES.................................................................................................... 8 HISTORICAL APPROACH AND THE DEVELOPMENT OF DISCHARGE..................................................................... 9 EMPIRICAL REVIEW OF MODERN DISCHARGE REGIMES FOR MSMES................................................................ 11 The Netherlands................................................................................................................................................................ 11 Spain.....................................................................................................................................................................................12 Germany..............................................................................................................................................................................12 Denmark..............................................................................................................................................................................13 Finland..................................................................................................................................................................................14 Sweden.................................................................................................................................................................................14 SAVING ENTREPRENEURS, SAVING ENTERPRISES: PROPOSALS ON THE TREATMENT OF MSME INSOLVENCY I CHAPTER 3. CREDITOR-CONTROLLED, SIMPLIFIED RESTRUCTURING AS PART OF AN MSME INSOLVENCY REGIME........................................................................................................................... 17 THE ELEMENTS OF A SIMPLIFIED RESTRUCTURING PROCEDURE.......................................................................18 Open Access, No Maximum Debt Limits or Minimum Dividend Requirements................................................18 Plan Adoption by Majority Vote of Unsecured Creditors........................................................................................19 Exclusion or Deemed Consent of Unsecured Creditors Not Participating.........................................................19 Plan Confirmed Absent Specific Objection For Carefully Defined Abuse..........................................................20 EMPIRICAL REVIEW OF RESTRUCTURING REGIMES FOR INDIVIDUAL ENTREPRENEURS – CREDITOR- CONTROLLED.......................................................................................................................................................................20 England, Canada, Australia (IVAs, Proposals, Agreements).................................................................................20 Japan (Civil Rehabilitation for Individuals with Small-Scale Debts).................................................................. 22 Chile (Renegotiation Procedures for Individual Debtors)....................................................................................... 22 EMPIRICAL REVIEW OF RESTRUCTURING REGIMES FOR ENTREPRENEURS – COURT-IMPOSED............ 22 United States (Chapter 13)............................................................................................................................................ 22 Republic of Korea (Individual Rehabilitation Proceeding)..................................................................................... 23 CHAPTER 4. JURIDICAL PERSONS AND NATURAL PERSONS SHOULD ACCESS THE SAME RESTRUCTURING PROCEDURE.........................................................................................................25 BALANCING REORGANIZATION AND LIQUIDATION FOR JURIDICAL ENTITY MSMES.................................... 25 OPTIMIZING JURIDICAL ENTITY MSME RESTRUCTURING PROCEDURE...........................................................26 ELIGIBILITY LIMITS AND REQUESTING TRANSITIONS FROM MSME PROCEDURES TO CORPORATE REORGANIZATION............................................................................................................................................................... 27 EMPIRICAL REVIEW OF RESTRUCTURING REGIMES FOR MSME JURIDICAL ENTITIES................................29 United States (“Small Business” Chapter 11)............................................................................................................29 Argentina, India, Greece, OHADA.................................................................................................................................30 England (Company Voluntary Arrangements).........................................................................................................30 Japan (Civil Rehabilitation).............................................................................................................................................31 Republic of Korea (Summary Rehabilitation Proceedings)................................................................................... 32 CHAPTER 5. INSTITUTIONAL STRUCTURE: SPECIALIZED PROFESSIONALS AND/OR INSTITUTIONS WITH OVERSIGHT, TRAINING, AND PROCEDURES SPECIFIC TO MSMES SHOULD ADMINISTER THE PROCESS.............................................................................................. 35 DESIGNATING THE PROFESSIONALS WHO WILL HANDLE MSME INSOLVENCY AND DISCHARGE IS AN IMPORTANT PART OF DESIGNING THE SYSTEM .......................................................................................................35 THE KEY ROLE OF ATTITUDES AMONG PROFESSIONALS AND INSTITUTIONS .............................................36 II TABLE OF CONENTS CHAPTER 6. PRELIMINARY DISCUSSION OF THE WORLD BANK GROUP PRINCIPLES FOR EFFECTIVE INSOLVENCY AND CREDITOR/DEBTOR REGIMES........................................................................................... 39 ONE STAND-ALONE PRINCIPLE TO INCORPORATE MSME INSOLVENCY...........................................................40 AMENDING EXISTING ICR PRINCIPLES TO INCORPORATE MSME INSOLVENCY.............................................40 Principle B2: Director Liability for Insolvent Trading...............................................................................................41 Principle B3: Enabling Legislative Framework..........................................................................................................41 Principle B4.1: Role of Supervisor in Informal Workouts........................................................................................41 Principle C1: Key Objectives and Policies................................................................................................................41 Principles C3-C4: Eligibility, Applicability and Access........................................................................................41 Principle C7: Creditors’ Committees........................................................................................................................... 42 Principle C8: The Estate and Exemptions, Disposable Income............................................................................ 42 Principle C12: Treatment of Stakeholder Rights and Priorities........................................................................... 42 Principle C13: Claims Resolution.................................................................................................................................. 42 Principle C14: Discharge following Liquidation........................................................................................................ 42 Principles D1.2, D1.5: Role of Court or Administrative Agency............................................................................ 43 CHAPTER 7. PRELIMINARY DISCUSSION OF THE WORLD BANK GROUP PRINCIPLES FOR EFFECTIVE INSOLVENCY AND CREDITOR/DEBTOR REGIMES............................................................................................ 45 APPENDIX 1: ACKNOWLEDGMENTS................................................................................................................... 49 ENDNOTES...............................................................................................................................................................51 REFERENCES........................................................................................................................................................... 63 SAVING ENTREPRENEURS, SAVING ENTERPRISES: PROPOSALS ON THE TREATMENT OF MSME INSOLVENCY III Foreword In the aftermath of the Asian financial MSMEs can vary in size and encompass a crisis, the Financial Stability Board wide spectrum of businesses, including sole mandated the World Bank Group to proprietorships. They face varied challenges, as identify and develop internationally evidenced by the $5.2 trillion funding gap for formal recognized best practices for assessing MSMEs and the $2.9 trillion funding gap for informal effective insolvency and creditor MSMEs (IFC 2017), which are inextricably tied rights systems. In response, in 1999, the World Bank to the World Bank Group’s agenda for promoting Group organized the Insolvency & Creditor/Debtor financial inclusion. The World Bank Group’s Regimes Task Force (ICR Task Force) comprising Finance, Competitiveness and Innovation (FCI) more than 70 leading international experts. The ICR Global Practice helps develop credit infrastructure to Task Force informs the World Bank Group’s role assist MSME entry, growth and exit, and the role of as a joint standard setter (together with the United insolvency regimes is considered key in promoting Nations Commission on International Trade Law both entrepreneurship and financial sector stability. (UNCITRAL) in the field of insolvency and creditor/ The Report on the Treatment of MSME Insolvency debtor rights. Since 2001, the principles developed by arose from a panel presentation that took place the Task Force have been applied in the World Bank’s during the 2015 meeting of the ICR Task Force and assessments of country insolvency systems and the subsequent discussion among Task Force members provision of technical assistance. These principles in 2016. It aimed to identify the specific challenges have been periodically revised and updated to reflect that insolvent MSMEs face and to provide analysis evolving best practices, and new or emerging areas of of how legislation in a number of jurisdictions aims insolvency of particular concern to the World Bank to address these challenges. This latest report on Group’s member nations. Proposals on the Treatment of MSME Insolvency Expanding on the discussion of the first report, Report seeks to expand on this earlier discussion by putting on the Treatment of MSME Insolvency, published in forward concrete proposals for standard-setting 2017, there is increasing recognition that addressing or best practices in designing MSME insolvency the needs of insolvent micro, small, and medium regimes. Specifically, it identifies the importance enterprises (MSMEs) is vital for economic growth. of a discharge for natural person MSMEs, and of For instance, formal MSMEs employ more than one- a simplified restructuring regime for all MSMEs, third of the world’s total labor force, and generate regardless of legal form. It also further develops the economic value, representing around 52 percent of empirical research, providing a historical account private sector value added on a global scale (World of the evolution of MSME insolvency regimes in Bank Group Policy Research Paper 5538, 2016). numerous jurisdictions along with lessons learned. Accordingly, many governments and regional trading This report has been developed under the leadership blocs around the world are currently examining of Antonia Menezes (Co-Chair of the ICR Task- policies to address this large but fragile group of Force), with extensive technical research and economic actors to maximize value preservation and significant support from Professor Jason Kilborn facilitate market exit where necessary. (John Marshall Law School (Chicago) and Van der SAVING ENTREPRENEURS, SAVING ENTERPRISES: PROPOSALS ON THE TREATMENT OF MSME INSOLVENCY V Grinten Chair in International and Comparative Law), Susan Maslen (World Bank Group), Justice Insolvency Law at Radboud University Nijmegen Alastair Norris (High Court of England and Wales), in the Netherlands). Hugo Sanchez Ramirez (La Superintendencia de Insolvencia y Reemprendimiento, Chile), Anjum A number of World Bank Group staff and Rosha (IMF) and Dr. Ignacio Tirado (Universidad consultants contributed to various aspects of Autonoma de Madrid). this report, including Fernando Dancausa, Sarah Degenova, Andres F. Martinez (Co-Chair of the We are very grateful to the Senior Management of ICR Task-Force), Nina Mocheva, Ronen Nehmad, the World Bank Group FCI Global Practice, Ceyla Will Paterson, Angana Shah and Oleksandra Pazarbasioglu and Sebastian Molineus, for their Svyryba. overall guidance and leadership. Our appreciation is further extended to all the Finally, we thank Susan Boulanger for editing this members of the 2018 ICR Task Force, listed in publication and Aichin Lim Jones for overall design Appendix 1 of the report, for their guidance and and production services. support, and in particular our presenters and peer reviewers, including: Wolfgang Bergthaler (IMF), Professor André Boraine (University of Pretoria), Professor Juanitta Calitz (University of Johannesburg), Justice June Young Chung (Seoul June 30, 2018 Bankruptcy Court), Jenny Clift (UNCITRAL), Valeriya Goffe (World Bank Group), Professor Mahesh Uttamchandani Min Han (Ewha Womans University Law School), Global Practice Manager – Financial Inclusion, Robert Hertzberg (Pepper Hamilton LLP), Justice Infrastructure and Access Kanok Jullamon (Supreme Court, Thailand), Pooja Finance, Competitiveness & Innovation Global Mahajan (Chandhiok & Associates, India), Professor Practice Bruce A. Markell (Northwestern Pritzker School of VI FOREWORD Background Following deliberations on the importance of • Insufficient assets to fund a formal insolvency developing insolvency regimes that address the procedure, given that MSMEs often lack the needs of insolvent micro, small, and medium resources to cover the costs and fees for a formal enterprises (“MSME Insolvency”), the World Bank insolvency procedure; Group Insolvency and Creditor/Debtor Regimes • Commingling of personal debts, as MSMEs are Task Force (“ICR Task Force”) established a often financed with a mixture of corporate debt Working Group on the Treatment of MSME and personal debt taken on by the entrepreneur Insolvency. (potentially including personal guarantees as The Working Group published the Report on the well), which may result in severe consequences Treatment of MSME Insolvency in 20171 (MSME for entrepreneurs and their families, including Insolvency Report), which sets out several findings social stigma; and regarding the key challenges surrounding MSME • Natural persons operating as enterprises, insolvency, namely: as many MSMEs might be informal entities • Complex insolvency systems, which deter that have not been incorporated, such as sole MSMEs from resorting to formal procedures to proprietorships, and in many jurisdictions, are tackle financial distress; therefore subject to the same insolvency regime as natural persons, potentially putting both the • Creditor passivity, where creditors have few business and personal affairs of the debtor- incentives to deal with MSME debtors through entrepreneur at risk. legal processes. Unsecured creditors generally have limited participation in the process and Accordingly, the ICR Task Force reached the secured creditors typically focus on enforcement following conclusions, set out in more detail in the of security at the first sign of financial distress, MSME Insolvency Report: often leading to lost efficiencies in the system; • Any definition of “MSME insolvency” should • Lack of information about MSME debtors, as not be overly prescriptive, because of the good records and reliable financial information varying definitions of MSMEs around the often do not exist or are limited regarding world; MSMEs, making it harder to assess business • As a starting point, consideration should be viability and discouraging creditor trust in the given to addressing the particular issues that MSME debtor; arise in the case of MSME insolvency through • Post-insolvency financing, where many specific MSME provisions in the existing insolvency systems do not permit or incentivize insolvency frameworks; the ICR Task Force financing after formal insolvency proceedings members did not recommend establishing are filed, even though such financing is typically separate regimes for MSME insolvency at vital to MSME survival; this stage, but they acknowledged that further investigation into this topic was needed; SAVING ENTREPRENEURS, SAVING ENTERPRISES: PROPOSALS ON THE TREATMENT OF MSME INSOLVENCY VII • Since the majority of MSMEs facing insolvency as follows: “Working Group V is mandated to are more likely to go into liquidation rather develop appropriate mechanisms and solutions, than reorganization/restructuring (by virtue of focusing on both natural and legal persons engaged their size), frameworks should not only focus in commercial activity, to resolve the insolvency of on reorganization/restructuring, but should also MSMEs. While the key insolvency principles and the consider expeditious liquidation mechanisms; guidance provided by the UNCITRAL Legislative • Due to the lack of sophistication on the part of Guide on Insolvency Law should be the starting MSMEs, jurisdictions should consider providing point for discussions, the Working Group should out-of-court assistance to MSMEs, such as aim to tailor the mechanisms already provided in the mediation, debt counseling, financial education, Legislative Guide to specifically address MSMEs and or the appointment of a trustee (although develop new and simplified mechanisms as required, funding such assistance would require further taking into account the need for those mechanisms consideration); to be equitable, fast, flexible and cost efficient. The form the work might take should be decided at a later • Further exploration is needed between the time, based on the nature of the various solutions intersection of personal insolvency frameworks that were being developed.”2 and MSME insolvency; and In light of the conclusions in the MSME Insolvency • Further exploration is also needed to determine Report and the mandate of UNCITRAL’s Working if it is advisable to revise some of the World Group V to consider MSME Insolvency as its next Bank ICR Principles to provide specific priority, this report aims to advance the discussion guidance for dealing with MSMEs. on MSME Insolvency by considering possible Concurrently, the issue of MSME insolvency is proposals for treating the rescue and rehabilitation being considered in more depth by the United of MSMEs (“the Report”). The Report is discussed Nations Commission on International Trade Law in the context of other proposals for the treatment (UNCITRAL). Specifically, at its 47th session of MSME Insolvency and, at this stage, does not (2014), the Commission gave Working Group V aim to be prescriptive nor examine processes on a (Insolvency) a mandate to undertake work on the granular level. It does aim, however, to advance the insolvency of MSMEs as a next priority, and at discussion beyond merely simplifying corporate its 49th session (2016), the Commission noted the insolvency proceedings for MSMEs, by identifying importance of MSME insolvency and the wide core concepts and principles that any MSME support that had been expressed in the Working insolvency regime should enshrine. Group in favor of exploring that topic. The Commission clarified Working Group V’s mandate VIII BACKGROUND Executive Summary This Report refines and expands on the earlier lack of available financing, and creditor apathy, deliberations of the ICR Task Force regarding the among other problems. Liquidation regimes in optimal approaches for treating MSME insolvency. many countries offer natural person entrepreneurs As a matter of terminology, it should be stressed no relief from debt not covered by liquidation that the term “MSME” in this Report is intended proceeds, or they impose severe restrictions on to cover both individual natural persons and access to such relief or on the entrepreneur’s juridical business entities, unless specifically continued business activities, thus suppressing stated. As detailed in the earlier MSME Insolvency the future entrepreneurial contributions of these Report of 2017, the term “MSME” has different individuals. Addressing insolvency policy in cases definitions depending on the context and location where the characteristics of the business and the in which it is used. This means that the size of an person operating it are largely overlapping, and at MSME differs from country to country and even least closely tied together, is of particular concern industry to industry, making comparisons between given the multitude of such businesses worldwide. jurisdictions and global standard-setting difficult. The scope of this Report is designed to be Whereas the Report recognizes that the definition nonprescriptive and dynamic across countries of MSME is a policy decision that must be rooted and contexts. It proposes that an optimal MSME in the relevant domestic context, it aims to identify insolvency regime, applicable in the broadest range of aspects of insolvency regimes that impact MSMEs countries and contexts, should include the following however defined, whether as an individual natural two main components: (1) a liquidation-and- person operating as an entrepreneur of a business discharge regime for natural person entrepreneurs or a juridical business entity. That said, it is and (2) a simplified, creditor-controlled restructuring acknowledged that the Report’s proposals are most regime applicable to both natural and juridical likely to apply to micro and small enterprises on persons. Accordingly, this Report aims to consider the MSME spectrum (and representing the bulk rescue and restructuring for all viable MSMEs, with of MSME entities), with the rationale being that the objective of preserving individual entrepreneurial many medium-sized enterprises are more likely to initiative, including in the context of liquidation, and be complex and sophisticated enough to warrant of preserving businesses that can continue to operate the more thorough treatment offered by the general and add value in an economy. corporate insolvency framework. In line with the Task Force’s recommendations, Micro and small enterprise insolvency is particularly the Report examines liquidation, but specifically likely to impact not only the business, but also the with an eye toward its function in rehabilitating personal and family life of the owner-operator(s) natural person debtors engaged in business. By of such businesses, raising particular concerns undertaking significant empirical research and that apply much less frequently in the context of tracing the historical concept of discharge, the corporate insolvency. All too often the businesses Report aims to illustrate how the rehabilitation operated by these entities end in liquidation due of indebted natural persons through a process to complex, costly, and unpredictable procedures, SAVING ENTREPRENEURS, SAVING ENTERPRISES: PROPOSALS ON THE TREATMENT OF MSME INSOLVENCY IX concluding with discharge relief has become the This Report’s empirical reviews also re-emphasize most common and seemingly effective approach to that both effective liquidation-and-discharge and promoting entrepreneurship and innovation in any restructuring regimes rely on crucial institutional given economy. Effective liquidation-and-discharge support. Particularly the restructuring alternative regimes provide open access to over-indebted requires careful policy consideration and entrepreneurs, leading to broad discharge relief in development of the appropriate gatekeeper, either the absence of substantiated objections by creditors individual insolvency practitioners or a specialized or an insolvency administrator identifying fraud or public body charged with insolvency administration. other debtor misbehavior. They do not distinguish Many key issues in both liquidation-and-discharge between personal and business debt, providing a and restructuring regimes depend on an effective broad discharge to both types of indebtedness in institutional structure. Among the most notable of exchange for carefully controlled expropriation of these issues is the efficient and effective prevention the current assets and perhaps future disposable of fraud and abuse by debtors, creditors, and income of debtors, with minimal formalities and other parties, which all but requires a carefully few if any restrictions on future activities by debtors selected insolvency professional or other system in all but exceptional cases. administrator. This Report is only able at this point to flag this critical issue without coming to any Liquidation is not the only viable option, however, particular conclusions or making specific proposals. and this Report does not intend to suggest that This is a matter that likely warrants further liquidation-and-discharge is to be preferred over consideration in the Task Force’s future work on a business rescue option. The empirical reviews MSME insolvency. set out in this Report reveal that, where a rescue option is viable and desired, some approaches to The final section of the Report starts the process MSME restructuring have been markedly more of examining the ICR Principles in light of the successful than others. In light of the institutional proposals made in this report. In this section, the challenges and the costs involved, this Report recommended approach is that a new ICR Principle concludes that a simplified, largely out-of-court be developed addressing the main features of an restructuring procedure subject to ultimate creditor MSME insolvency regime. However, the alternative control is the preferred option in most contexts. would be going through the ICR Principles, one by Moreover, taking into account the similarities one, with the objective of adding language specific between smaller juridical entities and natural to MSME insolvency. person entrepreneurs, this Report concludes The empirical research undertaken in this Report that the same simplified restructuring procedure has been done via desk-top research with key should be available to both natural and juridical consultations from leading practitioners in specific persons, subject to requests initiated by creditors jurisdictions. The jurisdictions examined here or insolvency administrators to convert such cases were selected because they have relatively recently to full corporate reorganization procedures where implemented the concepts examined, seeking the complexity of the case so warrants. specifically to support the treatment of small business insolvency, and therefore have generated data and lessons learned that can usefully contribute to the discussion on MSME insolvency. X EXECUTIVE SUMMARY Acronyms and Abbreviations CRA The Japanese Civil Rehabilitation Act of 1999 CVA Company Voluntary Arrangements FSAP Joint IMF-World Bank Financial Sector Assessment Program FW Faillissementswet (Netherlands Bankruptcy Law) IAIR International Association of Insolvency Regulators ICR Insolvency and Creditor/Debtor Regimes INSOL International Association of Restructuring, Insolvency & Bankruptcy Professionals IP Insolvency Professional IRP Individual Rehabilitation Proceeding (Republic of Korea) IVA Individual Voluntary Arrangement (England & Wales) MSME Micro, Small and Medium Sized Enterprises NBRC National Bankruptcy Review Commission NPL Non-Performing Loan OHADA Organization for the Harmonization of Corporate Law in Africa ROSC Reports on the Observance of Standards and Codes SRP Summary Rehabilitation Proceeding SSD Small-Scale Debts UNCITRAL United Nations Commission on International Trade Law WSNP Wet Schuldsanering Natuurlijke Personen (Netherlands Law on Debt Adjustment for Natural Persons) SAVING ENTREPRENEURS, SAVING ENTERPRISES: PROPOSALS ON THE TREATMENT OF MSME INSOLVENCY XI 3 CHAPTER 1. Introduction MSMEs form the majority of enterprises in often required to take on or guarantee business debts most economies, and having insolvency laws that personally in service of the business. Discharging serve their needs is accordingly an important this debt is a necessary step to allow such individuals consideration. In both developed and emerging to become economically productive again. Securing economies, MSMEs face a high failure rate, as voluntary release of this debt, even in part, has discussed in more detail in the MSME Insolvency proven to be an all but insurmountable challenge for Report. Even in resource-rich, robust markets like individual MSME operators. When significant value the European Union and the United States, about is available to engage professional support and to half of all businesses fail within five years, rising to offer creditors a substantial dividend, restructuring two-thirds by year ten, and the failure statistics can negotiations can be successful, but the numbers of be even starker in emerging markets. successful cases have paled in comparison to the failures for many reasons, including those identified The collapse of an MSME business is different in the MSME Insolvency Report. A legally imposed from that of a larger business entity. First, the exchange of discharge-for-wealth-relinquishment company’s and owner’s identities are often not has been the most common and effective approach clearly distinct, either because of personal guarantees in recent years to reinvigorating failed individual given by the owner, thereby commingling personal entrepreneurs. and business debt, or because as a matter of legal form, the enterprise is in fact one or more natural When the business remains viable, MSME person entrepreneurs who bear unlimited liability for cases generally require fundamentally less business debts. Moreover, the brand, goodwill, and complex restructuring procedures. Corporate customers of an MSME may be tied to the identity, entities effectively confer on their owner-operators family, history, and personal affinity networks of an advance discharge of unpaid debts in case of the entrepreneur-owner. Most important, a salient business failure, by virtue of the limited liability difference between MSMEs and larger business shield. Accordingly, court-imposed liberal discharge entities is a lack of resources, which can preclude is neither necessary nor generally available to reliable recordkeeping and the ability to adequately corporate entities.3 Given the relatively low stakes disclose financial information, and prevent effective involved and the variety of impediments on the negotiations with creditors. Likewise, MSMEs path to semi-voluntary restructuring, as identified often have few, if any, assets to sell to provide a in the MSME Insolvency Report, MSME juridical distribution to creditors. entities also require both less complex procedures and more support in establishing compromise For individual natural persons, MSME workouts. Such plans should be creditor (as insolvency usually requires legally imposed opposed to court) controlled, adopted by vote of a relief from a debt overhang to rehabilitate the majority of participating creditors, with required entrepreneur’s productive energies. Even if the secured creditor approval of plans that affect their MSME operates through a formally incorporated rights. The rights of individual dissenting (or entity, the owners or directors of such entities are absent) creditors should be protected by the ability SAVING ENTREPRENEURS, SAVING ENTERPRISES: PROPOSALS ON THE TREATMENT OF MSME INSOLVENCY 1 to object on specific, objective grounds ensuring • For MSMEs wishing to preserve non-exempt fundamental fairness. It is acknowledged that business assets, creditor-controlled but simplified other forms of restructuring, such as purely out-of- procedures for restructuring should be an court negotiated workouts, might also be effective available alternative to liquidation; in the MSME context. However, such workouts • Juridical entity MSMEs should access the generally fail in the absence of substantial value same simplified restructuring procedures as to be offered to creditors, and most MSMEs facing natural person MSMEs, with the possibility insolvency lack such value. The Report’s current for creditors or an insolvency administrator to focus is on proposing a hybrid regime as a model request transition to corporate reorganization that might effectively work in jurisdictions where proceedings in complex cases; and purely out-of-court restructurings are unlikely and/ or unfamiliar. • Institutions specifically skilled in and dedicated to MSME insolvency should administer the The following sets forth a proposal for a MSME-specific process. framework for effective treatment of MSME Each of the following sections explains one aspect insolvency, regardless of the legal form of the of this proposal and is supported with historical and business, for possible incorporation into the ICR empirical research. Principles. The basic aspects are as follows: • Access to a process of liquidation and discharge of the natural person entrepreneur’s unserviceable debt is the essential foundation for rehabilitating MSMEs facing insolvency; 2 CHAPTER 1. INTRODUCTION CHAPTER 2. Discharge for the Natural Person Entrepreneur as a Primary Goal of MSME Insolvency Without intimating a policy preference for this The majority of MSMEs facing insolvency option, liquidation-and-discharge proceedings are most likely to be liquidated for a variety should be a primary feature of MSME insolven- of reasons specified in the MSME Insolvency cy in light of the fact that so many MSMEs are Report, and discharge relief for natural person natural persons, have different goals and needs debtors should be the automatic result of a in comparison to juridical entities, and are most simple and low-cost liquidation process. As effectively rescued by an expeditious discharge was observed by the Task-Force, only a small and business fresh start. Currently corporate fraction of MSMEs are likely to be able to take insolvency’s goal is to provide a maximum return advantage of a restructuring regime. Accordingly, to creditors, whether through restructuring or for natural person MSMEs, discharge relief should liquidation. Whilst this remains a goal for MSME be systematically delivered, and the quid pro quo insolvency, policy-makers are increasingly rec- for this extraordinary relief collected, in bankruptcy ognizing that offering relief to entrepreneurs is a liquidation proceedings. Such a liquidation process parallel goal that most effectively reinvigorates might even be considered a necessary prerequisite MSME business. The bulk of MSMEs are in fact to discharge. Whilst arguments might be advanced natural persons with unlimited liability, operating, today in favor of conferring a discharge without for instance, as sole proprietorships.4 Even for asset liquidation and distribution, there is also entrepreneurs operating via limited liability legal a widely held perception that it is unjustified to entities, the liability shield is often porous, espe- discharge a debtor’s unpaid obligations without at cially for MSMEs. Voluntary creditors often re- least giving creditors the value to which they had quire individual entrepreneurs to bind themselves access when the debtor sought relief; i.e., non- to their business entities’ contractual debts, usually exempt property. Which items of property should via personal guarantees. Likewise for involuntary be exempted from liquidation (or protected from the creditors (tort/delict/tax), doctrines for pierc- enforcement efforts of secured creditors, especially ing through the liability shield expose individual home mortgagees) is beyond the scope of this report entrepreneurs to liability for corporate obligations, and varies widely among modern states seeking to and such doctrines are especially likely to apply achieve various policy objectives.5 in the case of closely held MSME entities. Thus, country experiences have shown that the best eco- Providing MSME natural person debtors access nomic result in the case of these MSMEs is to free to a simple, liberal discharge regime seems to the individual entrepreneur of debilitating debt to be the most common denominator among states restore him or her as an economically productive that have recently considered how to address actor. Cabining the risk of failure and reinvigorat- MSME insolvency specifically and reinvigorate ing debtor energies for the many-faceted benefit of entrepreneurs. The Anglo-American bankruptcy society has become one of the principal goals of systems, and many others modelled on them around best practice standards in insolvency law, and the the world, have long allowed former entrepreneurs liberal discharge is the primary and indispensable a simple and efficient discharge in the context of instrument for achieving this. SAVING ENTREPRENEURS, SAVING ENTERPRISES: PROPOSALS ON THE TREATMENT OF MSME INSOLVENCY 3 liquidation proceedings, often with no expropriation over time have had with MSME rescue and of future income and few restrictions on future individual entrepreneur rehabilitation, the following activity. In the past three decades, new “debt central elements are proposed, and discussed in adjustment” proceedings have developed, primarily detail below: in Europe, to provide a discharge to individuals, • Open access; usually in exchange for a liquidation of their non- exempt assets and a multi-year plan for turning over • Discharge of both personal and business debts; income beyond defined exempt limits. Similarly, • Specific, substantiated challenges to debtors’ reforms in Asia and South America have extended good faith in exceptional cases; liberal discharge relief to both consumers and • Controlled costs by reducing formalities; small business debtors. Recent experiences with countries’ efforts to offer natural person MSME • Carefully constrained expropriation of current debtors access to an effective discharge regime are wealth and future income; and discussed further in the empirical review section • Limited civil restrictions and stigma. below. This empirical research focuses on those jurisdictions with available data and accessible Open Access information on the implementation and operation An MSME natural person should have open of discharge regimes specifically targeting small access to a personal discharge regime that is not business debtors, and for this reason is unable to limited to the debtor’s status as a “merchant” assess many emerging markets which lack such or “consumer”, but instead based on the regimes or publicize insufficient data. simple criterion of personal financial distress Despite disagreements over detail, the trajectory of some identifiable degree (e.g., durable around the world in jurisdictions that have overindebtedness). The gate to such a procedure recently considered these issues seems to be should not be barred by cost barriers or enhanced decidedly moving in the direction of broader, technical obstacles, such as requiring private less restricted access to a discharge process, negotiation in advance, hopeless insolvency, and swifter, less burdensome requirements for qualified insolvency, or other access hurdles such honest debtors to obtain that discharge. The idea as minimum dividends offered to creditors. The of creditor control has taken a backseat to social burdens of revealing one’s debts, identifying and engineering by courts and policymakers to decide turning over non-exempt assets, and facing the on the requirements for discharge relief, even in natural stigma of bankruptcy all serve to deter the business context. And discharged debtors are abuse, and solvent debtors seldom, if ever, seek a increasingly regarded not as fiends to be marked and bankruptcy discharge simply to evade claims they restricted, but as casualties of the modern, volatile are able to pay.6 Efforts to remove barriers to access global economy, to be renewed and set back upon personal discharge regimes in Scandinavia and the road to productivity. elsewhere throughout Europe have been particularly concentrated on allowing freer access to (former) THE ELEMENTS OF AN EFFECTIVE entrepreneurs, as discussed in the empirical review DISCHARGE REGIME FOR INDIVIDUAL below, and legislators in Eastern Europe have MSME DEBTORS recently shaken off their original concerns with potential abuse, removing access restrictions for The key question is how to structure discharge all individual debtors.7 Even in regimes that have relief to balance the legitimate interests moved to restrict access by “consumers” to a liberal of creditors and maximize the reasonable discharge, entrepreneurs have been exempted from rehabilitation success for MSME natural persons these restrictions.8 This is a welcome trend that and the societies that benefit from their renewed has not led to widespread abuse or public disdain. efforts. Based on experiences that various countries 4 CHAPTER 2. DISCHARGE FOR THE NATURAL PERSON ENTREPRENEUR AS A PRIMARY GOAL OF MSME INSOLVENCY Limitations on repeat access or serial filing may be efficient tax collection. Particularly egregious cases appropriate to prevent abuse, but debtors should of tax evasion and fraud can be dealt with by denying enjoy open access at least the first time they seek such debtors discharge entirely upon the request by relief in an insolvency procedure. a creditor or insolvency administrator. Such cases are rare exceptions and should not overshadow the Discharge of Both Personal and Business vast majority of honest MSME debtors. Debts The discharge proceeding should encompass all Specific, Substantiated Challenges to debts, whether related to business activity or not. Debtors’ Good Faith in Exceptional Cases It is difficult if not impossible to accurately categorize At the entry and exit points of a discharge process, debts as business or personal in many cases, given the standard path should lead to automatic the fungible nature of money and credit, in addition rehabilitation and a fresh start, but allowance to the inevitable commingling of the personal and should be made for insolvency administrators business affairs of an MSME individual debtor. It is or creditors to raise affirmative objections and preferable and likely unavoidable to treat consumers substantiated assertions of debtors’ fraud or and entrepreneurs in one and the same procedure, malfeasance. It is unnecessary and unconstructive allowing all individual debtors access to discharge to impose an affirmative obligation on debtors to relief.9 prove their “good faith” to gain access to relief. Experience has shown that instances of debtor fraud Exceptions from discharge should be limited. and other misbehavior are exceptional and should The claims of creditors intentionally omitted from not cast a pall over the overwhelming majority of the debtor’s list to avoid their receiving notice, honest debtors. Similarly, it is counterproductive for example, can be and often are excluded from and contrary to modern notions of insolvency discharge. Exceptions for secured debts, as well and relief to impose restrictions on debtors’ post- as specific debts arising from fines and penalties discharge business or non-business activities, for and family support obligations, are also common.10 example, presuming that debtors who received These exceptions should be carefully limited and discharge relief are not suited to serve in public specifically identified, however, to avoid undue office or to manage business enterprises. erosion of the reinvigorating effect of the discharge on debtors’ future entrepreneurialism. If a creditor or insolvency system administrator has a reasonable basis for suspecting fraud If a society expects private creditors to or other misbehavior, they should be allowed compromise their claims in order to reinvigorate to oppose the debtor’s discharge, and some debtors for public benefit, tax creditors should investigation into the debtor’s affairs can and lead by example and do the same. Tax debt and should be facilitated. Experience has shown that, other public debt presents particular challenges, even in the absence of positive financial incentives and it is often among the largest burdens on MSME for creditor participation, there are sufficient individuals and sometimes the main precipitator numbers of disgruntled former business partners of insolvency. On the one hand, because tax debt and former spouses willing to reveal most instances represents a debt to society and not simply to an of debtors’ financial skullduggery. If the standard individual creditor, such obligations have often for abuse is sufficiently defined, the administrative been exempt from discharge in many systems. On disruption of the few exceptional cases would be the other hand, denying a discharge for such debts far less than a cumbersome entry criterion that risks sacrificing the many benefits of a personal must be applied and established in every case. It insolvency system. These benefits in the long run is inefficient to require such investigation in every likely greatly exceed the foregone tax revenue and case. A proper system of checks and balances is may eventually produce greater future and more SAVING ENTREPRENEURS, SAVING ENTERPRISES: PROPOSALS ON THE TREATMENT OF MSME INSOLVENCY 5 based on an initial expectation that debtors are When the return is likely to be low, the expense and honest but unfortunate, backed by the ability of time in organizing creditors’ committees does not a creditor or insolvency administrator to pursue justify the return. Creditors will rationally decide evidence to the contrary (an approach that might to let small debts owed by MSMEs go, especially if be called “trust but verify—when specifically there are no assets, or so few that the return will be warranted”). The UK abandonment of general low. If creditors have a basis for a specific objection, restrictions and the development of specific they can be given a voice in matters to which they Bankruptcy Restrictions Orders, customized to so object. Waiting for objections by creditors will the few cases where some malfeasance warrants be more efficient in MSME cases than assuming restrictions, under the Enterprise Act, is a model their willingness to participate in decision-making. worthy of consideration, particularly in states In the average MSME case, a system administra- whose bankruptcy laws mirror former English law. tor will quickly determine that insufficient In countries where fraud is of serious concern, value is available for significant distribution jurisdictions may opt to limit discharge to first- to creditors to warrant any consideration of time bankruptcies. Heightened requirements or the validity of their claims. Unless a significant restrictions may be imposed on debtors seeking a distribution is expected, the investment of time and discharge in a second or subsequent bankruptcy. resources in evaluating claims (and investigating pre-insolvency transactions) should be carefully Controlled Costs by Reducing Formalities monitored and minimized to avoid destroying The principal problems MSMEs face with what little value is available. It makes little sense insolvency proceedings today are complexity to evaluate whether claims are valid, as those and expense. These go hand in hand, and subject to discharge will be discharged quickly and both can and should be carefully contained in efficiently with no payment. If the administrator discharge proceedings. Costs imposed on former discovers value, creditors can be invited to make entrepreneurs in insolvency are essentially a their claims, and the administrator can evaluate tax on future innovation and productivity. Such them and proceed with the case, still assuming costs should be minimized or eliminated, in that the creditors will only contribute to decision- large part simply by reducing or eliminating making through objections, not as a matter of formalities. In the relatively simple cases of most course. MSME entrepreneurs, the historical formalities The liquidation process should not be protracted. associated with liquidation proceedings have been If a search for assets is to extend beyond a short demonstrated to have little purpose in the great period, the discharge should be entered while the majority of cases. Elaborate rules on public notices search continues. Time is of the essence in returning (especially in newspapers), meetings of creditors, MSME debtors to productive activity. Time is and claims verification procedures achieve very equally of the essence in providing whatever little in the context of most cases where little or no distribution of value might be made to creditors, value is available for distribution, or so little value who particularly in this context might also be micro that creditors rationally decide that pursuing it is not and small enterprises dependent on quick resolution worth the expense. In such cases, recent experience of outstanding receivables. demonstrates that these formalities can and should be scrapped or replaced with much more efficient Carefully Constrained Expropriation of electronic noticing and submission practices. Current Wealth and Future Income Creditors’ committees are unnecessary in most If debtors are to have an effective fresh start to MSME cases, and generally creditors will not continue their business activities, they must be find participation economically worthwhile. left with sufficient current wealth and future 6 CHAPTER 2. DISCHARGE FOR THE NATURAL PERSON ENTREPRENEUR AS A PRIMARY GOAL OF MSME INSOLVENCY income to support their personal and perhaps more quickly.12 Discharge proceedings should no business expenses. The range of property exempt longer be regarded as quarantine for those suspected from the claims of creditors is generally the same of having the disease of financial irresponsibility outside and within an insolvency procedure, and the or fecklessness, but rather quick treatment for the widely varying approaches to this issue are beyond inevitable casualties of a modern, volatile economy the scope of this Report and a matter of public and encouragement for entrepreneurs to continue to policy.11 Tools of the debtor’s trade are commonly take the risks that redound to the benefit of all of exempted from an insolvency estate, illustrating society. the already common acceptance of the notion that If future income is to be collected for creditors preserving the debtor’s income-producing capacity as a prerequisite for discharge relief, it should be has long been regarded as trumping the claims of limited in time and carefully constrained in scope creditors to the value of those assets. to a predictable and consistent method of assessing The extent to which future income should disposable income beyond reasonable support be expropriated for the benefit of creditors needs for debtors, their families and perhaps their has been a divisive policy issue and deserves businesses. The term of such payments should be especially sensitive consideration. It is quite carefully limited to get entrepreneur-debtors back on common for modern personal insolvency systems their feet with incentives for maximizing productive to require debtors to apply some portion of their activity. Extended repayment terms depress debtors’ future disposable income to pay a portion of their incentives and rob society of their entrepreneurial legitimate debts. The determination of which cases contributions. Payment expectations during this and which amounts should be implicated have term should be calculated as a function of debtors’ challenged modern legislators in recent years. actual disposable income in excess of a reasonable English bankruptcy practice, for example, seems budget for debtors and their dependents and perhaps to have settled on a sensible compromise following a buffer for unexpected expenses. No arbitrary the Enterprise Act. The practice requires payments minimum payment should be required, and budgets from future income as a quid pro quo for the should be objectively and predictable determined. automatic discharge of unpaid debt, but only from To avoid lack of consistency and a heightened a few debtors (averaging about 20 percent in recent administrative burden in gauging the scope of years) with fairly clear excess income, and largely disposable income, this determination should not by agreement with those debtors based on an be left to the discretion of an administrator, be it a evaluation by the Official Receiver of the debtors’ court or otherwise. Rather, predictable and uniform reasonably assessed disposable income. expense allowances should be developed and applied as consistently as possible across cases.13 It is counterproductive to depress debtors’ incentives with ongoing payment obligations and Limited Civil Restrictions and Stigma administrator oversight, especially considering a principal goal of MSME insolvency treatment Insolvency proceedings or discharge should not is to mobilize societal resources and reinvigorate result in restrictions on economic or professional debtors quickly into economic productivity. activity, or other restrictions on movement. Practices in Europe, such as those discussed below in When insolvent individuals are viewed as Germany, the Netherlands, Denmark, and Sweden, malfeasant actors, the law may restrict them from that require a long-term plan involving income activities such as starting new businesses, obtaining supervision and expropriation, have a negative credit, or holding public office. These restrictions impact on current and future entrepreneurial run counter to the goal of discharge, which is to activity. Denmark and Sweden have reduced the facilitate renewed, productive economic activity by payment term in cases involving entrepreneurs the debtor-entrepreneur. Such restrictions should be specifically to get these debtors back to productivity eliminated in the absence of fraud and malfeasance. SAVING ENTREPRENEURS, SAVING ENTERPRISES: PROPOSALS ON THE TREATMENT OF MSME INSOLVENCY 7 Similarly, stigma should be minimized. If debtors not MSMEs have access to a liberal discharge in know that their failure will be broadcast to the cases of extreme distress, lenders know that many community and that they will be branded with MSMEs experience significant distress during their judgmental labels like “bankrupt” or, as in one lifecycle, which interrupts the repayment process unique system, “beggar without friends,” they are and requires expensive individualized account less likely to engage the protective system, and maintenance. Indeed, even in cases of successful its benefits will be lost. Publicity of liquidation loan servicing, individual loan origination costs, cases should be limited to the degree necessary even if small, represent a larger proportion of small to administer the case and provide sufficient loans than larger ones, leading many lenders to information to enable future creditors to behave conclude that it is not sufficiently economically prudently in extending credit to debtors after efficient to exploit the MSME market. In light of discharge. Care should be taken to apply procedures the potential costs and the relatively small volume and choose statutory language that acknowledges of profit to be gained from these loans—even if the entrepreneurial risk, the rarity of debtor fraud and potential profit margins are thick—many lenders misbehavior, and the positive goals to be achieved simply refuse to deal with these small borrowers. by a discharge system. For the segment of the lending community willing to deal with MSMEs, the remote possibility that EFFECT ON AVAILABILITY OF CREDIT FOR some temporary defaults might turn into permanent MSMEs discharge is unlikely to represent a salient additional deterrent to lending to this already high- Discussions of liberally available discharge risk segment of borrowers. often prompt concerns about the effect this will have on the already constrained availability of Second, the risk proposition is similar with and unsecured credit, especially to MSMEs. These without a discharge regime, as a small subset of concerns have less long-term impact than might debtors will default in any case. Whether or not a be expected. In the short term, following adoption conclusive discharge is available, many defaulting of a more liberal discharge regime, some lenders debtors will return to financial health and pay, but may retrench and be more circumspect in extending many will not. Lending losses arise from the fact that credit, particularly unsecured credit to MSMEs, these perpetual defaulters will languish in factual whose defaults would now be more certain to insolvency indefinitely, not from the operation of a allow a defaulting debtor freedom from payment legal discharge system that conclusively establishes following a discharge. However, especially as the these debtors’ durable inability to pay. These risks immediate emotional impact of a new discharge are already built into the underwriting and pricing regime fades with time, at least three considerations model that institutional creditors use in their should mitigate this concern. lending decisions, and the addition of conclusive, legal discharge relief is unlikely to have any notable First, the presence or absence of a liberal impact on this calculus. While some even smaller discharge regime for MSME natural persons fraction of debtors might pay something eventually should have little effect on the institutional if their debts are not discharged, this remote and lending environment, as most institutions do isolated possibility likely has very little impact not lend to MSMEs due to structural concerns on the decisions of lenders willing to lend to the and risk aversion.14 The scarcity of credit to MSME segment, at least in an economy with a MSMEs is a function not only of creditworthiness, sufficient volume of competitive lending activity. but of institutional lenders’ desire to avoid risk Anglo-American regimes have extended generous in general, not only risk of ultimate loss, but discharge relief to MSMEs for decades, yet these risk of default and expensive and distracting states enjoy a robust market for lending to MSMEs. administration of distressed accounts. Whether or 8 CHAPTER 2. DISCHARGE FOR THE NATURAL PERSON ENTREPRENEUR AS A PRIMARY GOAL OF MSME INSOLVENCY Finally, a discharge could benefit lenders in collective insolvency proceedings developed as predicting losses and could result in greater, or a single creditor executing his own judgment more stable, availability of credit to MSMEs. was forced to represent the collective of creditors By conclusively establishing that some debts will to avoid depriving them of their share of the never be repaid, a discharge allows institutional presumptively insolvent debtor’s assets.16 Only creditors to clear nonperforming loans (NPLs) an insolvent debtor would refuse to satisfy a from their books by recording and moving past judgment if he had the means to avoid the negative recognized losses. When regulated lenders are able consequences (infamy, enslavement, prison) of to record default losses as final and remove NPLs these early enforcement proceedings. from their books, they are able to stop provisioning The notion of offering insolvent debtors legal relief for these eventual losses and redirect those freed- from the consequences of unpaid debt arose later up resources for more lending. As the volume of and in limited form. Augustus Caesar instituted a available resources rises, competition should rise proceeding (cessio bonorum) by which insolvent alongside, putting pressure on creditors to search debtors could turn over their assets voluntarily and further and deeper into the market for profitable avoid infamy and potential imprisonment.17 Caesar’s borrowers, including MSMEs. procedure recognized and preserved the debtor’s human dignity and future potential for productive HISTORICAL APPROACH AND THE contribution to society, though it left the debtor’s DEVELOPMENT OF DISCHARGE future value production/acquisition available to For more than two millennia, bankruptcy as creditors. Some later European polities in northern a legal proceeding took one form and had one Italy, France, and Spain embraced the cessio major purpose: liquidation of the (individual) bonorum approach, allowing honest but unfortunate debtor’s valuable assets in order to maximize debtors some measure of respite, though still not a distribution of that value among creditors. Where permanent discharge of debt. Nonetheless, even the word “bankruptcy” was born, early practice in these relatively more humane authorities subjected medieval Italian city states, especially in the south, insolvent debtors to humiliating rituals, such as set a tone that would persist in Europe and beyond striking their naked posteriors on a public stone or for centuries to come, treating insolvent debtors wearing a stigmatizing green cap.18 as scoundrels, breaking their trading benches, and banning them from engaging in productive Historical insolvency regimes treated entre- activity.15 This process usually did not provide any preneurial risk as an evil to be avoided, financial relief to the debtor, leaving future income and assets failure a (divine) sign of character weakness subject to creditors’ ongoing claims enforcement. or other flaw in the entrepreneur. Between the Debtors were subjected to restrictions on activities, 16th and early 19th centuries, Caesar’s minimally such as being barred from commerce or positions in forgiving attitude toward debtors waned in Europe. government. This represented a continuation of a Elsewhere, while Islamic Law had earlier instituted trend throughout most of recorded history, treating cessio bonorum-type procedures for freeing failed entrepreneurs as irresponsible sinners, hopelessly insolvent debtors from jail, imprisonment sometimes as criminals, rather than victims of rather than this limited relief remained the principal financial misfortune. reaction to bankruptcy, and laws in Imperial China additionally subjected defaulting debtors to public The first insolvency proceedings in early Roman beatings, as bankruptcy continued to be regarded law developed as little more than an early throughout the world more as a crime than a collections procedure for unpaid judgment misfortune befalling the pitiable debtor.19 Even as creditors — a tradition that many countries a more forgiving approach to debtors was revived followed into the 21st century. The earliest SAVING ENTREPRENEURS, SAVING ENTERPRISES: PROPOSALS ON THE TREATMENT OF MSME INSOLVENCY 9 and discharge incorporated into bankruptcy law first by shielding debtors from the adverse effects of in England and later in the new United States in the measured (rational) risk-taking.21 18th and 19th centuries, debtors were still largely A similar process of liberalization of the discharge framed as malefactors deserving of suspicion if not for individual entrepreneurs began slowly but punishment. Creditor satisfaction rather than relief surely in continental Europe in the late 1900s. to the individual remained the goal of insolvency Denmark led the way with the adoption in 1984 of systems, and creditors remained in charge of a new Gældssaneringslov (Debt Adjustment Law), discharge for individuals, resulting in its sparing which introduced into the Danish Bankruptcy Law application. the first liberal personal discharge law in Europe.22 In the 20th century, legislators in the U.S. shifted Soon thereafter, a merchant discharge appeared the emphasis to relief, striving to encourage risk in the French insolvency laws in 198523, followed rather than punish it, to promote economic by an explosion of liberal discharge laws for both growth. The bankruptcy law played a major role in business and consumer individuals in continental that effort. The idea of a court-imposed, automatic Europe and elsewhere in the world in the 1990s discharge for individual entrepreneurs began in and after.24 The shift toward favoring rescue and earnest with the adoption of the U.S. Bankruptcy rehabilitation for both individuals and business Act of 1898, which extended the discharge to all entities received renewed impetus recently in the natural person debtors following completion of European Commission’s proposed directive on asset liquidation. The “Old World” took another restructuring and a second chance.25 century to come around to accepting liberal discharge, spurred by the same desire to encourage Outside the Anglo-American world, the first risk-taking and entrepreneurial engagement. step toward reinvigorating failed individual entrepreneurs has most often involved a separate In the UK, discharge relief expanded significantly liquidation-and-discharge procedure geared as the Enterprise Act 2002 was adopted toward individuals, rather than modifying the expressly to encourage greater entrepreneurial business restructuring regime, which offered no activity, encourage productive risk-taking, and discharge.26 In the past three decades, new “debt allow small business actors to learn from their adjustment” proceedings have developed, primarily mistakes.20 Effective April 1, 2004, the Enterprise in Europe, to provide a discharge to individuals, Act reduced the discharge waiting period from three usually in exchange for liquidation of their non- years to one, and enhanced the “fresh start” effect of exempt assets and a multiyear plan for turning the discharge. It lifted the most punitive restrictions over income beyond defined exempt limits. These on debtors’ post-bankruptcy activities, other new regimes were not controlled by creditors or than in isolated cases where proof of specific bad voting, and they involved less complex procedures conduct might warrant a Bankruptcy Restrictions for determining which debtors would receive Order. English lawmakers endorsed this liberalized discharge relief and on what terms. These systems discharge as an indispensable aspect of insolvency were therefore less expensive and more accessible policy that directly contributes to enhanced to individual entrepreneurs, at least those who had entrepreneurial activity and readiness to embrace terminated their businesses. Lawmakers have made productive risk-taking. The growing economic concerted efforts in recent years to expand access literature on the beneficial effects of insolvency to these procedures and reduce future obligations, law on entrepreneurship has a clear core message: particularly for small businesspeople. It is the discharge for individuals, more than any other aspect of insolvency procedure, that spurs Currently, among modern insolvency systems, entrepreneurship and individual productivity (among cabining the risk of failure and reinvigorating past, present, and future potential entrepreneurs) debtor energies for social and economic benefit 10 CHAPTER 2. DISCHARGE FOR THE NATURAL PERSON ENTREPRENEUR AS A PRIMARY GOAL OF MSME INSOLVENCY have become primary goals of insolvency law, While consensus is building among policymakers especially for natural person debtors like MSME worldwide as to the benefits of a liberal discharge, entrepreneurs. The legislative histories of these considerable controversy continues to surround laws and proposals reflect modern policymakers’ the notion of freeing individual debtors from recognition of the value of the personal discharge their obligations without either the consent of, in achieving the goals of the system. While or a significant benefit to, creditors. Most of the maximizing recovery on creditors’ legitimate benefits of discharge relief systems will flow to claims remains an aim of modern insolvency law, debtors and society rather than creditors. Creditors rehabilitating debtors and enabling their economic are understandably unlikely to agree voluntarily to reemergence are concurrent goals.27 Decades of internalize the costs of the negative externalities of experience has shown that debtors laboring under their lending and collections activities. In light of an unserviceable debt burden generally will not the disciplinary effect described above, it has been continue to expend significant effort to maximize clear to many modern policymakers that putting value for their creditors. In particular, such creditors in control of the debtor’s discharge through debtors are robbed of incentive to engage in new a negotiation is counterproductive. Unfortunately, entrepreneurial activity to produce new sources of many other world regimes have not acknowledged value. They remain debilitated and immobilized, this evolution of insolvency goals and the beneficial depriving not only creditors but also society of the effects of encouraging reasonable risk-taking. In benefits of their entrepreneurial, creative, and other particular, many bankruptcy regimes around the productive energies. Surveys reveal that when world that are based on the English model have not lifelong overwhelming debt is a risk, it powerfully followed England’s (and later, Ireland’s) lead in suppresses entrepreneurial incentive and willingness liberalizing the individual discharge process. This to engage risk, depressing entrepreneurship28 and powerfully undermines the effectiveness of these stunting economic growth. The orderly, liberal regimes in many parts of Africa, for example, in discharge of overwhelming debt is the primary offering solutions to failed entrepreneurs.32 instrument for providing a release from lifelong debt and promoting the goals of entrepreneurship EMPIRICAL REVIEW OF MODERN and individual economic rehabilitation.29 DISCHARGE REGIMES FOR MSMES In addition, modern policymakers have The Netherlands increasingly recognized that insolvency law has an important role to play not only in benefitting The Dutch began offering open access creditors, but in disciplining them to behave more to both business entrepreneurs and responsibly in extending and collecting on credit. consumers in 1998 through the new As both MSME entrepreneurs and consumers have Wet schuldsanering natuurlijke personen (Law on gained access to both traditional and, most often, debt adjustment for natural persons), or Wsnp. less regulated sources of credit, their insolvency has The Dutch bankruptcy law (Faillissementswet or often been hastened, exacerbated, or even caused FW) does not offer discharge of debt not covered by by the high-risk and high-pressure tactics of some the proceeds of bankruptcy liquidation,33 so when lenders. A well-structured insolvency system with the Wsnp was adopted in 1998, it became a third liberal discharge forces these creditors to consider title of the FW, offering any natural person a path to the possibility of a loss in advance of extending court-conferred (not creditor-conferred) discharge credit, and acknowledge a loss for hopelessly of both business and personal liabilities, with no unserviceable debts.30 It also limits the ability of limit on the volume or nature of the debtor’s assets these lenders to externalize the negative effects of or debts.34 In recent years, about 20 percent of high-cost credit onto the families and societies of the impacted debtors.31 SAVING ENTREPRENEURS, SAVING ENTERPRISES: PROPOSALS ON THE TREATMENT OF MSME INSOLVENCY 11 Wsnp cases have involved former entrepreneurs,35 productive energies of these debtors, both during with higher incomes and significantly higher debt and perhaps long after the three-year process. levels than their “consumer” counterparts.36 These MSME debtors have fared quite well under the new Spain relief law, obtaining a discharge after complying Spain provides a simple discharge with the standard three-year repayment plan in over to entrepreneurs, though it is 75 percent of cases, slightly more often than in subject to long-term obligations consumer cases.37 that potentially stifle entrepreneurialism. A One drawback of the Dutch approach, however, discharge procedure specifically for merchants is that it stifles renewed entrepreneurial activity was established in a 2013 law “on Support for by burdening debtors with an extended period Entrepreneurs,” modified in 2015 to apply to of oversight and restriction. Like most European non-merchant consumers as well.42 It confers debt adjustment laws, the Wsnp requires both an immediate discharge on individual debtors if liquidation of assets, most likely including those a liquidation of their non-exempt assets covers used in the debtor’s failed business, and a three- administrative expenses, privileged claims year payment plan complying with statutory (including 50 percent of tax claims), and a 25 requirements for turning over all “disposable” percent dividend to unsecured creditors. This income.38 The debtor is forbidden from incurring dividend is waived following the 2015 reform if substantial new debt during that three-year term. the debtor attempted an out-of-court negotiation Thus, entrepreneurs are effectively prohibited from with creditors. However, if administrative and continuing to operate their pre-Wsnp business privileged claims cannot be satisfied in full from while undergoing the relief procedure.39 the liquidation proceeds, the debtor can obtain a discharge only by complying with a payment plan The possibility of a Dutch entrepreneur-debtor of up to five years.43 starting a new business during the three-year repayment period is expressly recognized, but such an action requires the explicit approval Germany of the judge-supervisor (rechter-commissaris).40 Germany adopted an individual A rare, recent empirical survey of former Dutch discharge regime to accommodate entrepreneurs in the Wsnp process reveals that the former entrepreneurs, as well, three-year supervision process in general, and the though with complex (and expensive) procedures requirement to obtain permission for new business and sometimes stricter limitations on the nature in particular, can dampen entrepreneurial spirit. One of the debtor’s income or liabilities. The first entrepreneur complained that he was “not allowed discharge provision became effective in 1999,44 but to start up anything new thanks to the WSNP, but access was limited in two ways. First, the German I’m constantly thinking about it.” Another reported Insolvency Act calls for dismissal of insolvency cases he had attempted to gain permission from the judge- when the debtor lacks available assets sufficient to supervisor to launch another venture “months ago, cover the substantial administrative costs.45 Along but I’ve heard nothing since.” This same respondent with consumers, even MSME entrepreneurs often expressed feelings of being “made to feel incredibly lack sufficient funding for a formal insolvency small and terribly distrusted.” One final former procedure on the heels of a business collapse. The entrepreneur lamented that, while he thought he German legislature fixed this problem in a 2001 could cope with the three-year supervision period, reform, allowing all natural person debtors to “the idealism had gone, and that’s what was receive a postponement of these fees until after the worst.”41 These comments reveal lost potential and end of their discharge proceedings.46 The second missed opportunities for societal benefit from the limitation is that the discharge procedure must be 12 CHAPTER 2. DISCHARGE FOR THE NATURAL PERSON ENTREPRENEUR AS A PRIMARY GOAL OF MSME INSOLVENCY preceded by an insolvency process, either ordinary former entrepreneurs with “straightforward” or simplified.47 As in the Netherlands and Spain, a liabilities, who thus qualified for simplified simplified (and much less complex and expensive) proceedings. And as in the Netherlands, all of process was created for consumers. It is available to these former German entrepreneurs are explicitly former businesspeople, but in Germany, it is further permitted to launch a new business venture during restricted to former businesspeople whose financial the three- to six-year discharge period (to enhance condition is straightforward (überschaubar, lit. creditor returns).53 No data indicate the incidence oversee-able, comprehensible); that is, fewer than of such serial entrepreneurship during the course of 20 creditors and no debts to (former) employees.48 the payoff period, but the Dutch experience suggests For small business people with 20 or more creditors, that German entrepreneurs face the same emotional a full-blown ordinary insolvency proceeding is limitations in launching a new venture during—and required. Such proceedings are generally more perhaps after—this long insolvency period. probing, more expensive, and much longer (lasting two to four years, as opposed to one year in Denmark simplified proceedings), which significantly delays The Danish regime was reformed the beginning of the already protracted statutory specifically to embrace more former payment-plan period. entrepreneurs. The 1984 Danish The most significant hurdle standing between personal debt adjustment law was the first in Europe, a failed entrepreneur and discharge relief is an starting a movement that would eventually lead to extended period of behavior control and income personal discharge laws in almost every European expropriation. The German so-called “Good state. Entering new territory, Danish lawmakers Behavior Period” (Wohlverhaltensperiode) is among were hesitant to throw open the gates too widely the longest discharge terms in Europe, beginning at and undermine individual payment morality, so they a standard six years.49 After a recent reform, this imposed strict access controls on the new process. period is shortened to five years for debtors able to The most important one for former entrepreneurs pay administration costs in full, and three years for is the requirement that debtors seeking access to debtors also able to pay 35 percent of unsecured discharge proceedings must exhibit “qualified creditors’ claims,50 but such cases have been rare insolvency.” That is, it must be objectively clear exceptions, as debtors in fewer than 20 percent of that the debtor’s foreseeable income is insufficient German personal insolvency cases have any income to service and/or retire business and personal debts legally available to creditors.51 No empirical data in full. Entrepreneurs who intend to manage their indicate the prevalence of one or another income (perhaps unpredictable) debts with unpredictable level or payment term among former entrepreneurs business income were thus regularly barred from as opposed to consumer debtors. the procedure.54 Despite the limitations of the regime, significant After nearly 20 years of frustration with an access numbers of (former) German entrepreneurs have process that in practice rejected applications by benefitted from these new discharge proceedings. entrepreneurs and inhibited them from starting About 21,000 individual small business debtors again,55 the Danish government launched a (and about 80,000 consumers) have sought reform process that culminated in 2005 and discharge relief each year from 2014 to 2016.52 The eased the entryway for former entrepreneurs great majority (about 14,000 per year) were former and shortened the plan period. A new chapter entrepreneurs who did not qualify for simplified 29 of the Bankruptcy Law relaxed the “qualified proceedings and therefore had to endure the longer, insolvency” criterion for access to the personal more expensive, ordinary insolvency process. A discharge procedure expressly providing for rising number, about 6,000 – 7,000 per year, were admission of debtors with primarily business-related SAVING ENTREPRENEURS, SAVING ENTERPRISES: PROPOSALS ON THE TREATMENT OF MSME INSOLVENCY 13 debts whose economic situation is “unclear.”56 private reports from the court in Copenhagen and Moreover, the payment term for a court-confirmed estimated that about 25 percent of Danish personal discharge plan (established by Justice Ministry debt adjustment cases involved entrepreneurs.63 regulation) is three years for former entrepreneurs, rather than the standard five years for consumers.57 Finland This shorter plan period was designed to encourage Elsewhere in Scandinavia, law- entrepreneurs to start a new venture sooner makers have experimented with following a debt adjustment proceeding.58 offering entrepreneurs discharge As in the Netherlands, Spain, and Germany, that interrupts their business activities less, at the Danish entrepreneur-access provisions are least in cases where the debtor will retain only de expressly limited to former entrepreneurs. The minimis business property. The Finnish personal former business must be closed and the debtor debt relief law was among the first, adopted in 1993. or the enterprise must be either in or preferably It is unique in that it contains specific provisions on just emerging from the end of a bankruptcy entrepreneur-debtors, including those who remain proceeding.59 This restriction was specifically active in continuing businesses. Such debtors are imposed to avoid the system’s losing legitimacy admitted to the discharge regime if one of two in the eyes of the public.60 As in Germany, Danish conditions is met: either (1) the debtor has no (or entrepreneur-debtors are not legally inhibited from only a few) personal debts emanating from the starting a new business venture once the discharge continuing business, and the property the debtor plan has been confirmed and is underway, though uses in that continuing business is “insignificant,” the strictures of the multiyear repayment plans very or (2) debts relating to the continuing business have likely stifle both the incentive and practical ability not yet come due, and the debtor reasonably expects to plan a new venture. these debts to be covered by the income generated by the business. The debtor need not liquidate assets The Danish entry restrictions still invite courts reasonably necessary for use in the business, once to undertake a “reasonableness” evaluation again as long as their value is commensurate with and reject cases where “other circumstances the income expected to be generated from business … speak decisively against” admission. This activities. A working group estimated in 2013 that has resulted in rejection of over half of all around 300 small-businesspeople seek personal debt applications.61 The Danish courts have taken these relief each year in Finland, and a reform process is access restrictions quite seriously, and admissions underway to make the Finnish regime more effective figures have remained low over the years, though for this group.64 no data reporting distinguishes between personal MSME versus consumer cases. From 2006 to Sweden 2016, fewer than half of all petitions for admission to the personal discharge procedure were granted Sweden was the last Scandinavian (fewer than 40 percent in each of 2009 and 2010). country to adopt a personal debt Moreover, of an average of just over 5,000 cases adjustment law, in 1994,65 and closed per year from 2006 to 2016, only about for the same access-restriction reasons as for 30 percent (average about 1,680) concluded with Denmark, entrepreneurs have struggled to gain an approved plan (though, excluding the cases entry to the procedure ever since.66 Reviewing rejected at the entryway, this represents a 70 percent the Danish reform process, Swedish policymakers confirmation rate for admitted cases).62 Though no concluded that “serious” entrepreneurs should be public statistics report the number of applications allowed and encouraged to continue their businesses filed by entrepreneurs as opposed to consumers, while undergoing a personal debt adjustment a Swedish reform commission in 2014 obtained to strengthen their second chance and “benefit growth-promoting entrepreneurship.”67 Since 14 CHAPTER 2. DISCHARGE FOR THE NATURAL PERSON ENTREPRENEUR AS A PRIMARY GOAL OF MSME INSOLVENCY system administrators had not responded positively conduct are offered in the legislative history, to incremental reforms to the primary personal debt including poor bookkeeping and evasion of adjustment law, reformers decided to enact a new, taxes and withholding obligations “to a greater separate law just for small entrepreneurs. Thus, than minimal degree.”73 Time will tell how the new “F-Skuldsanering”68 procedure became these restrictions are interpreted, but these are available as of November 1, 2016, for individual precisely the types of problems that tend to lead debtors with primarily business-related debt. The small entrepreneurs to bankruptcy court in other procedure is in almost all respects exactly the same countries. Judging by past experience, the Swedish as an ordinary consumer debt adjustment, leading Enforcement Agency is likely to take a fairly rigid to an Enforcement Agency-confirmed payment stance on admission of entrepreneur cases under plan, with a few key modifications.69 the new law. After the Enforcement Agency was directed to launch a public information campaign Swedish entrepreneurs are required to on the availability and benefits of a liberalized demonstrate that they will be able to make personal debt adjustment process in 2013,74 the minimum payments of around SEK6,50070 number of annual applications increased by 10 (about US$780 or EUR650) each calendar percent each year from 2014 to 2016, but the quarter71, that they are “serious” entrepreneurs, percentage of approved cases has hovered around and that they have not conducted their business 60–65 percent for the past decade, at around 5,000 in an “irresponsible” way.72 In addition, as in per year (spiking to over 7,500 in 2016).75 One Denmark, the payment term for administrator- also wonders if the minimum payment threshold approved entrepreneur discharge plans is three will deter some entrepreneurs from seeking or years, as opposed to the ordinary five in consumer obtaining relief. cases. Examples of “irresponsible” business SAVING ENTREPRENEURS, SAVING ENTERPRISES: PROPOSALS ON THE TREATMENT OF MSME INSOLVENCY 15 CHAPTER 3 Creditor-Controlled, Simplified Restructuring as part of an MSME Insolvency Regime For viable MSME businesses, a simplified, but exceptional, relying heavily on the expertise creditor-negotiated restructuring procedure of dedicated bankruptcy courts and a complex should be available in an insolvency law alongside statutory structure. Most of the world seems liquidation-and-discharge. For individual MSME resistant to the notion of allowing courts to impose debtors that wish to retain significant non-exempt compromise arrangements on creditors without assets, a simplified, largely out-of-court creditor- significant creditor participation and voting on negotiated restructuring model seems to have a plan, and enlisting the courts in a negotiated enjoyed notable success around the world. In restructuring process for MSMEs risks injecting combination with a proper foundation of a freely unnecessary complexity and cost into a process accessible liquidation-and-discharge procedure, where experience suggests this is not necessary or this alternative restructuring process aims to strike helpful. The statutory requirements of court-based an optimal balance of interests. This alternative is models also require courts to engage in speculative ultimately available only if both the debtor and a valuation of assets to ensure that the restructuring majority of creditors agree that the venture has value plan offers creditors no worse treatment than the worth preserving, and the debtor has the capacity liquidation alternative. Many countries in the to do so. Putting creditors in charge of evaluating world today lack the robust and insolvency-focused the debtor’s plan entrusts this decision to actors who institutional structure to bear these burdens. Recent are best situated to perform an accurate analysis and research on insolvency system efficiency concludes who will face the consequences of miscalculations. that in underdeveloped states in particular, court Requiring support only from a majority of voting involvement invites formality, which has been a creditors ensures that apathetic creditors, a common major contributing factor in failure to preserve problem in MSME insolvency cases, cannot enterprise value.76 Leaving these decisions to undermine an otherwise acceptable restructuring, creditors both avoids complexity and respects the and minority holdouts are prevented from interfering historical prerogatives accorded to creditors of a with a generally acceptable compromise. failed enterprise. Court involvement and other formalities in Especially if court involvement is limited, the the MSME restructuring process can and institutional infrastructure for a rescue regime should be limited. The principal process-related is vitally important. MSME debtors clearly need contributors to MSME restructuring failure stem special support in developing and implementing from court procedures and other formalities that restructuring proposals, and some intermediary is seem unjustified in the vast majority of MSME likely needed to screen cases for both viability and cases. The court-based approach of imposing obvious signs of fraud. These issues merit separate restructuring plans on creditors, like in the U.S. discussion and further examination. They are and Republic of Korea, seems to be successful therefore presented separately in the penultimate section of this Report. SAVING ENTREPRENEURS, SAVING ENTERPRISES: PROPOSALS ON THE TREATMENT OF MSME INSOLVENCY 17 THE ELEMENTS OF A SIMPLIFIED only to court approval; or relatedly, (3) to substitute RESTRUCTURING PROCEDURE for the incursion into creditor prerogative through a reduction of the required majorities, especially by As in the liquidation-and-discharge context, way of negative approval processes (for example, the challenge here lies in identifying the key not counting non-voting creditors). characteristics of a negotiated, out-of-court In the great majority of individual MSME regime that maximize reasonable restructuring cases, none of these concerns seems to justify the opportunities for MSMEs. The specific rules of imposition of either minimum dividends or debt this restructuring alternative may vary from state to limits. The Canadian debt limits on Division II state, but a few issues warrant special consideration. Proposals have been criticized as too low to facilitate Based on a comparative review of existing regimes restructurings for small business.77 The English that allow individual debtors to retain non- IVA process has had success without either of exempt assets and continue their ongoing business these inhibitions, and where creditors have decided operations, the following elements are proposed, as to demand “hurdle rate” minimum payments, discussed in detail below: they have exercised their prerogative to do so • Open access, no maximum debt limits or by voting against plans that do not promise such minimum dividend requirements; payment, for better or worse. Formal limitations • Plan adoption by affirmative agreement of on what creditors can or cannot accept by way secured creditors (to the extent their claims of compromise restructuring arrangements seem are impacted) and majority vote of unsecured unnecessary in light of creditors’ power to gauge creditors; what they feel is acceptable in any given case. As for the shift in power to smaller and smaller groups • Exclusion or deemed consent of creditors not of creditors to impose a “majority” decision on the participating; minority, this is either a problem of creditor apathy, • Plan confirmed absent specific objection for which is likely a rational decision on the part of carefully defined abuse. creditors, or a logical progression in facilitating a still democratic process of group decision-making. Open Access, No Maximum Debt Limits or Individual countries might experiment with larger Minimum Dividend Requirements or smaller majority thresholds, but restricting access Individual MSME debtors should have open by reference to debt limits and minimum dividends access to the simplified restructuring process seems in most cases to be unnecessary, unjustified, unless the case involves significant complexity. and counterproductive. Most of the restructuring systems described in the empirical review below restrict access to debtors Particularly complex cases might be converted with total debts under prescribed limits, generally to corporate reorganization proceedings the equivalent of a few hundred thousand dollars in upon substantiated demand by an insolvency unsecured debt and perhaps a million or so in secured administrator or creditor, though such cases are debt. Some court-driven systems also require a likely to be very limited. If the circumstances of minimum dividend to unsecured creditors (an absolute an individual case exhibit such complexity that a amount or a percentage of the debt) as a formal or minority of creditors believe a formal corporate informal condition of plan approval. Presumably, process should be the only restructuring option, both of these access limits were imposed for one they might be allowed to move for conversion of three reasons: (1) as a proxy for complexity and from the simple MSME procedure to the corporate the need for more elaborate procedures to root out restructuring procedure. The appropriate grounds debtor fraud; (2) to substitute for the deprivation of for such a request are difficult to delineate in creditors’ right to vote in systems that subject plans advance. They may include the availability of 18 CHAPTER 3. CREDITOR-CONTROLLED, SIMPLIFIED RESTRUCTURING AS PART OF AN MSME INSOLVENCY REGIME recovery of preferential or fraudulent transfers to purposes with ordinary unsecured creditors. If insiders or others, a challenge to the secured status significant MSME restructuring success is desired, of a large creditor, or a cause of action to be pursued priority unsecured claimants cannot be allowed to against an insider or affiliate of the debtor. Mere destroy compromises considered reasonable by a volume of debt or asset value involved seems majority of creditors. Tax debts in particular raise today to be an unjustified manner of marking the crucial concerns for restructuring plans. If the appropriate division between simple and complex consent of priority claimants such as tax authorities restructuring methods for individual debtors. That is required to confirm a plan, this veto power gives being said, a request for conversion to corporate priority unsecured creditors the power to invalidate proceedings would require an assessment of the reasonable restructuring plans even if they are in case’s complexity from a fairly sensitive and the best interests of the parties involved. If public sophisticated court or administrator. Relatively authorities expect private creditors to compromise few states have the institutional capacity, judicial their rights in support of reasonable restructuring or administrative, to properly administer such proposals, then so too should public authorities be a conversion-request system. Nonetheless, the prepared to compromise their rights in connection incidence of such excessively complex MSME with such plans, as long as (1) the requisite majority cases is likely minuscule and largely confined to supports the plan; and (2) priority claims are treated high-income states. no worse in the plan than ordinary unsecured creditors and receive at least as much as they would Plan Adoption by Majority Vote of Unsecured in a liquidation. Variations on this approach have Creditors been used (or can be designed), such as limiting While secured creditors are generally given free priority by amount or time incurred (such as two reign to negotiate with debtors individually, years of taxes) or percentage (of overall debt, or unsecured creditors adopt restructuring plans of the claim itself), or in certain countries where by majority vote. The most common position compromise of the principal amount is illegal, with respect to secured creditors requires their comprise of the interest. affirmative consent to any plan that restructures their secured claims while the debtor retains the Exclusion or Deemed Consent of Unsecured collateral securing those claims. As for unsecured Creditors Not Participating creditors, in contrast, only a majority need support The practice of calculating the majority based a restructuring plan for it to be imposed legally on only on claims actually voted is widespread and dissenters. The more difficult question concerns should be standard. Creditor apathy has been a the requisite majority: should it be 70 percent, two- significant hindrance for MSME restructuring, thirds, a bare majority? The progression over the and excluding absentees from the plan approval long sweep of history has been gradual, but there process seems eminently reasonable. Limited has been notable reduction in the volume of creditor resources in MSME insolvencies lead to very support required to adopt a compromise plan. A limited expectations for unsecured creditors simple majority (in both number of creditors and regarding any substantial distribution in respect of value of claims) of votes actually cast should serve their claims. Thus, unsecured creditors often have as a sufficient safeguard of creditors’ rights. Voting little incentive to incur further costs (for example, should be encouraged by allowing electronic or attorneys’ fees, travel costs, communication costs, other convenient methods of communication, investment of time) with regard to the insolvent rather than requiring a formal, physical meeting of debtor by participating actively in negotiations or creditors where votes are cast. proceedings. Overall, it is rational for a creditor not to participate, but creditors who make that Priority (preferred, preferential) creditors should rational choice should not be allowed to prevent be treated equally for voting and distribution SAVING ENTREPRENEURS, SAVING ENTERPRISES: PROPOSALS ON THE TREATMENT OF MSME INSOLVENCY 19 the establishment of a plan, so long as the plan EMPIRICAL REVIEW OF RESTRUCTURING offers objectively reasonable treatment to absent REGIMES FOR INDIVIDUAL creditors (i.e., pro rata distribution with claims of ENTREPRENEURS – CREDITOR- similar priority, not unfairly discriminating against CONTROLLED absent creditors or certain kinds of claims). Indeed, creditors who do not vote might be deemed to be England, Canada, Australia (IVAs, Proposals, just as satisfied with the debtor’s proposed plan Agreements) as without it, so the common practice of deeming When English creditors to consent to the debtor’s proposal unless lawmakers they explicitly object is also reasonable. liberalized the bankruptcy and discharge regime in 1986, they also adopted a restructuring alternative for Plan Confirmed Absent Specific Objection For individual debtors. The Individual Voluntary Carefully Defined Abuse Arrangement (IVA) procedure largely carried In instances of fraud or abuse, individual through the 19th century composition model, with creditors or an insolvency administrator can small but important enhancements. and should be allowed to challenge a majority- The court plays only a backup role, with the debtor’s approved plan. Even if a majority of creditors chosen “nominee,” a mandatory licensed Insolvency supports a plan, if individual creditors are treated Professional (IP), playing the gatekeeping and unfairly, such concerns should be able to be aired and facilitating role in what is essentially an unrestricted addressed, within reasonable limits. The concept of negotiation with creditors. The terms of an IVA are “abuse” or “unfairness” should be carefully defined exceptionally flexible, with the outer boundaries and circumscribed, but if detractors can point to marked only by what unsecured creditors are willing evidence of a system-undermining instance of to accept (secured creditors must affirmatively misbehavior or abuse, they should have an avenue agree to any modification of their rights), though a for pursuing such challenges. Intervention by the five-year payment term has emerged as the standard judiciary is appropriate in these cases to address in practice, with certain creditors setting “hurdle concerns about due process, but the courts should rates” of minimum acceptable percent payment, be engaged only if and to the extent that judicial sometimes as high as 45 percent.78 The nominee intervention is invoked. Creditors bring ordinary must report to the court and creditors whether she/ collections actions to the courts, and so should they he believes the debtor’s plan to be viable, and if be expected to bear the burdens of bringing to the (invariably) so, the nominee presents the plan to courts any challenge to the negotiated (out-of-court) the creditors for their controlling vote: if the IVA restructuring process. Here again, if creditors do is accepted by the creditors who hold 75 percent not regard the expense of lodging such challenges of the value of claims for which a vote is cast to be warranted, they can and should reasonably (non-voters’ claims are excluded from the tally), be deemed to accept the natural result of failing to the IVA becomes binding on all affected creditors object. This is not an additional burden faced by (voting or not), and the nominee reports this creditors; rather, it is the natural continuation of the success to the court and becomes a “supervisor,” burden they would otherwise face in pursuing their guiding the debtor through the implementation claims if no restructuring process were initiated, and of the compromise arrangement and distributing creditors can enjoy the benefits of this procedure payments among the creditors.79 without any expenditure. The IVA was initially intended to be a bankruptcy alternative for small traders and guarantors of business debt, though consumer debtors have 20 CHAPTER 3. CREDITOR-CONTROLLED, SIMPLIFIED RESTRUCTURING AS PART OF AN MSME INSOLVENCY REGIME come to dominate the IVA landscape since the Australia has a regime of bankruptcy- early 2000s.80 The IVA rules specifically envision alternative arrangements similar to that in the possibility of the debtor’s continuation of a Canada. So-called Debt Agreements (Part IX) business.81 A study of creditor-accepted IVAs in and Personal Insolvency Agreements (Part X) 1994–95 reported primarily business use, with 81 both allow an entrepreneur-debtor to continue to percent (118/145), indicating a business-related operate a business, and both are creditor controlled, reason for the filing.82 With IVA filings ranging much like IVAs, though they have slightly differing from 5,000 to 8,000 per year before the consumer requirements. For example, Part IX agreements spike in 2004,83 it is likely that at least 4,000 to have income and debt limits (post-tax income 6,000 entrepreneurs currently enter an approved less than AUS$83,000, unsecured debt less than IVA each year. AUS$111,000) and require pro rata payment to affected creditors, while Part X agreements have Because the negotiation stage of an IVA is no such limits and allow for differential payments largely private, no data track approved versus to similar unsecured creditors.91 The flexibility rejected IVA proposals, but the study of of Part X agreements leads inevitably to greater 1994–95 IVAs indicated a 67 percent rate of administrative costs, making this a more expensive successful completion of accepted IVAs, with solution for debtors.92 In 2015–16, only 175 Part creditor distributions ranging from less than X (unrestricted) agreements were registered, GBP10,000 to more than GBP100,000, and a while statistics reflect 12,150 Part IX (restricted) heavy concentration between GBP20,000 and agreements.93 Judging by the ratios of business-to- GBP50,000.84 Official statistics indicate a global personal insolvencies in the first quarter of 2017, “termination” (failure) rate for approved IVAs of about 25 percent of the 175 Part X (unrestricted) about 30 percent from 1990 to the consumer spike agreements were likely business related, while in 2004, which is consistent with the 1994–95 only 7 percent of the 12,150 Part IX (restricted) study’s finding of 67 percent success.85 agreements involved business debtors, for a total, The Canadian equivalent of an IVA is called as in Canada, of about 900 individual entrepreneur a Proposal, either Division I (unrestricted) or cases in fiscal year 2015–16. Division II (restricted).86 Division II proposals Aggregate data on Australian Part IX agreements are restricted in that they may be presented (mostly non-business related) indicate a high rate only by individuals with unsecured debt less of creditor acceptance (in excess of 80 percent on than CAN$250,000. Division II Proposals are average), though given an average distribution to communicated to creditors without a meeting creditors of more than 60 percent on unsecured and are deemed accepted unless creditors holding claims, there appears to be a significant degree of at least 25 percent of claims demand a creditors’ self-sorting of particularly strong cases into the meeting, a quorum appears at that meeting, and agreements process.94 The ultimate completion a majority by dollar value rejects the proposal. rate is difficult to establish, as raw numbers of Division I Proposals, in contrast, are not subject completed and terminated agreements are reported to a debt restriction and must be affirmatively annually without tying them to the original, varying accepted by a majority of voting creditors holding start years. The number of successfully completed two-thirds of the value of all voted claims.87 Only agreements continues to climb in recent years, 972 and 965 business-related Proposals in both however, approaching 7,000 in 2016, though more divisions88, respectively, were registered in the than 40,000 agreements remained underway in 2016, years ending March 31, 2016 and March 31, 2017, with a predominant agreed term of five years.95 in contrast to about 60,000 consumer Proposals.89 The completion rate for business Proposals is about 70 percent.90 SAVING ENTREPRENEURS, SAVING ENTERPRISES: PROPOSALS ON THE TREATMENT OF MSME INSOLVENCY 21 Japan (Civil Rehabilitation for Individuals with Chile (Renegotiation Procedures for Individual Small-Scale Debts) Debtors) The Japanese Civil Rehabilitation In 2014, Chile overhauled its Act of 1999 (CRA) is discussed bankruptcy process with Law in greater length later, as it was no. 20.720 “on Insolvency and adopted specifically to offer a streamlined Re-entrepreneurship,”104 introducing a four- procedure for rehabilitating small business quadrant structure of reorganization and entities.96 As amended in 2001, however, it also liquidation for enterprises and individuals. One of provides an even further simplified (and less these quadrants implements a process similar to costly) procedure for individuals with “small- a quite liberalized English IVA. The simplified re- scale debts” (SSD).97 This SSD procedure is similar organization procedure for natural persons provides to the Canadian Division II Proposal process,98 with a context, facilitated by the new Superintendent of two significant differences. First, the debt limit in Insolvency and Re-entrepreneurship,105 in which Japan is almost double that in Canada. The SSD individuals can renegotiate their debts and preserve procedure is available only to individuals with their businesses. The process is rather formalistic, unsecured debts99 of less than JPY50 million (about requiring several meetings of creditors before the US$450,000). Second, the three-year payment plan Superintendent, but the law places no restrictions on must promise a sliding scale of minimum dividend workout plans, which are adopted by the affirmative payments to creditors, at least 10 percent, often 20 vote of at least two creditors who hold a majority in percent, and as much as 100 percent in very small value of approved (unsecured) claims.106 cases.100 If these restrictions are met, the debtor’s The Superintendent has been successful in proposed plan is circulated by the court to the striking compromise arrangements among debtor’s submitted list of creditors and is deemed creditors and debtors in the first few years of accepted unless a majority by number of creditors the new procedure. From October 2014 and value of claims affirmatively votes to reject through January 2017, just over 2,000 individual the plan. If a “rehabilitation officer” is appointed, renegotiation cases were initiated before the his/her task is limited to investigating the debtor’s Superintendent.107 Of the 1,818 cases in which affairs, reviewing claims (if anyone objects), and a plan confirmation meeting was held, creditors assisting the debtor in drafting a plan.101 approved the debtor’s plan in 1,641 cases, an The SSD procedure is the dominant choice of astounding success rate of just over 90 percent.108 business debtors seeking to restructure under The most recent data available show an acceleration the CRA. In 2005, for example, of a total of 19,401 and continuation of this success, with 451 plan business-related CRA cases, 18,567 were individual confirmation meetings from January 1 through June SSD cases (96 percent), with only 834 “ordinary” 30, 2017, and 418 approved plans, a success rate of CRA small business cases (4 percent).102 Little nearly 93 percent.109 No data report the nature of empirical data on CRA proceedings are available, these debtors or whether they were in business. but a longitudinal study of higher-value CRA cases suggests that the SSD procedure accounts for most EMPIRICAL REVIEW OF RESTRUCTURING individual CRA business restructuring debtors. REGIMES FOR ENTREPRENEURS – The study examined all of the 9,406 CRA cases COURT-IMPOSED with unsecured liabilities exceeding JPY10 million (US$90,000) filed between April 2000 and March United States (Chapter 13) 2016, and it found that 7,341 of these involved Chapter 13 of the U.S. Bankruptcy business entities; therefore, no more than 2,065 total Code permits individual entre- cases filed over a 16-year period involved individual preneurs (but not juridical entities) entrepreneurs.103 The study provides no information to seek relief from their debts while maintaining on the fate of the individual entrepreneur cases. 22 CHAPTER 3. CREDITOR-CONTROLLED, SIMPLIFIED RESTRUCTURING AS PART OF AN MSME INSOLVENCY REGIME business and non-business assets. Originally, can interrogate the debtor.121 Between 20 and 45 Chapter XIII (as it was then designated, using days later, the court is directed by statute to hold Roman numerals) provided for a traditional a confirmation hearing.122 Failure to abide by and composition process, with required approval by a be prepared for these deadlines often leads to case majority of unsecured creditors.110 However, as dismissal (or conversion to a Chapter 7 liquidation amended in 1978, the present Chapter 13 requires bankruptcy).123 System-wide, 70–80 percent of no creditor vote; the court confirms the debtor’s submitted plans are confirmed, but only about one- reorganization plan as long as it complies with a third are completed.124 few, fairly objective statutory requirements.111 The proportion of successful Chapter 13 cases Perhaps the most notable of these, consonant with that involve entrepreneurs cannot be established European debt adjustment practice, is that the accurately. The scant empirical evidence on debtor must promise to turn over to creditors for a Chapter 13 tends to focus on general usage patterns, period of three to five years (almost invariably five with little focus on entrepreneurs and distinguishing years112) the value of all of the debtor’s anticipated them from consumers.125 Academic and official “disposable income.”113 This concept is defined estimates vary. Official statistical reports are likely in a complex and often obtuse way in terms of the highly inaccurate in distinguishing business from infamous “means test” implemented in 2005,114 non-business filings.126 They suggest that less than and it must at least equal the amount that would 1 percent of Chapter 13 filings are “business” be distributed in a liquidation of the debtor’s cases, though this represents nearly 30 percent of unencumbered, non-exempt property.115 all reorganization cases filed under Chapters 11 While Chapter 13 was not designed or perhaps and 13.127 Prominent academic empirical studies, even intended to facilitate the rescue of small in contrast, conclude that a significant portion — businesses, it certainly can be and has been used at least 15 percent — of Chapter 13 filings (and in this way.116 Small business debtors are explicitly a roughly equal portion of Chapter 7 liquidation allowed to continue to conduct their business (unless filings) involve entrepreneurs,128 which is the court orders otherwise), including taking on consistent with the 20–25 percent seen in European trade debt in the ordinary course.117 In calculating personal debt adjustment systems. The specific payments to creditors, the law specifically characteristics and experiences of entrepreneurs in acknowledges the propriety of reducing disposable Chapter 13 remain largely a mystery. income “for the payment of expenditures necessary for the continuation, preservation, and operation of Republic of Korea (Individual Rehabilitation such business.”118 Proceeding) The most significant limitation on entrepreneurs’ Since a system-wide insolvency use of Chapter 13 is a pair of strict debt limits. reform process began in 2004, An individual may be a debtor under Chapter 13 Republic of Korea has had a only if he or she has non-contingent, liquidated procedure modeled on and similar to the U.S. unsecured debt less than US$394,725 and secured Chapter 13 process. The Republic of Korean debt less than US$1,184,200.119 And simply getting Individual Rehabilitation Proceeding (IRP) was in is no guarantee of successful plan confirmation designed to facilitate the rescue of wage-and- or obtaining a discharge. Chapter 13 cases proceed salary earners as well as debtor-entrepreneurs. In very expeditiously. The debtor must file a plan with particular, the IRP allows debtor-entrepreneurs to the petition or shortly thereafter, begin making continue operating their micro and small enterprises payments on that plan to the trustee within 30 to earn business income and use it to support a days of filing,120 and within 50 days of filing, the court-confirmed repayment plan.129 The process, system regulator (the U.S. Trustee) convenes timing, and product of the Korean IRP generally a meeting where the case trustee and creditors tracks the U.S. Chapter 13 process, with a similar RESPONSES TO MSME INSOLVENCY ISSUES 23 debt limitation (KRW500 million in unsecured debt, Chapter 13. In the 21 months from July 1, 2015, about US$450,000, and KRW1 billion in secured to March 31, 2017, a total of just under 15,000 debt, about US$900,000), but with one significant individual entrepreneurs with reported business difference: An IRP does not affect secured claims income applied for the IRP (along with just over (other than staying their enforcement during 144,000 applicants with reported non-business, the period between case commencement and the salary income), or about 9 percent of the total court’s approval of the plan).130 In the context of IRP applicants.132 The plan confirmation rate for small business insolvencies, this may be a minor individual debtors with business income amounted difference, since U.S. Chapter 13 does not affect to 86 percent, though this was after the courts applied debts secured by an individual entrepreneur’s a fairly rigorous screening process that led to court principal residence (or debts that require longer rejection of nearly 15 percent of all applications for than five years to pay off), and empirical research IRP.133 But most of the rejected applications involve suggests that lending to small businesses in amounts debtors who improperly provided documents. The less than US$100,000 is increasingly unsecured rate of ultimate plan completion and discharge is not (perhaps on personal or business credit cards), reported separately for business and non-business but personally guaranteed by the entrepreneur.131 debtors, but the general completion-and-discharge However, it is notable that in the Korean IRP, the rate is reported to have been an impressive 42.7 entire amount of the “disposable income” must percent. be used for payment of unsecured debt under the Both the legislature and the courts in Republic repayment plan and may not be used for repayment of Korea have responded over time with of secured debt (including debt secured by a measures to make the IRP process more effective residential mortgage). Therefore, in the Korean IRP, for individual debtors. To reduce pressure on secured claims are usually collected by foreclosure. debtors and increase their incentive to complete But, in some cases where debtors so request and it plan payments, the term of an IRP plan was reduced is deemed reasonable, the Seoul Bankruptcy Court from an original 8 years to 5 years in 2006, and then allows debtors to calculate the “disposable income” again to 3 years in 2018. In addition, although the except the interests of secured claims encumbered courts had applied a fairly rigorous case screening by frugal home (regarding the interests as a living process in the past, the Seoul Bankruptcy Court cost), so that debtors eventually can keep paying has changed this practice in the hope of better the residential secured claim’s interests without achieving the mission of rescuing financially fearing the foreclosure of their home during the IRP ailing individual debtors by enlisting individual plan period. rehabilitation commissioners to advise debtors to The plan confirmation and discharge rates draft feasible IRP plans while considering various for the Korean IRP also mirror those for U.S. living expenditures. 24 CHAPTER 3. CREDITOR-CONTROLLED, SIMPLIFIED RESTRUCTURING AS PART OF AN MSME INSOLVENCY REGIME CHAPTER 4 Juridical Persons and Natural Persons Should Access the Same Restructuring Procedure BALANCING REORGANIZATION AND debtor’s creditors by (1) maximizing the value LIQUIDATION FOR JURIDICAL ENTITY of the debtor-entity’s assets, and (2) ensuring MSMES equitable distribution of that value among the entity’s creditors in accordance with ordinary rules MSME insolvency policy shifts considerably of priority.134 The law of limited liability offered when proceeding beyond natural person this value to creditors, and it remains generally entrepreneur debtors to artificial juridical within their control how to maximize that value, person debtors. Just as the liberal discharge for through liquidation and winding-up or otherwise. individual debtors was beginning to develop in the late 1800s, another major legal innovation arose, Laws facilitating “compositions” among debtors also with the goal of encouraging risk-taking, and creditors represent the genesis of a rescue entrepreneurial activity. This effect was achieved and reorganization movement that would by allowing individuals to do business via artificial gradually evolve over the next 150 years toward entities and offering relief not after failure, but in reducing the majorities of creditors whose advance. In the mid- to late-1800s, states began support was required to impose a composition to liberalize the availability of private corporations on all creditors. Given the varying incentives (and other limited liability entities) to shield of different creditors, concern arose that holdouts individual business people from future business might demand a dismemberment and piecemeal liabilities. Now, not only major, multinational sale, derailing an otherwise viable value-preserving corporations like the East Indies companies, but restructuring. To address this potential inter-creditor also ordinary MSMEs could limit their liability conflict, a variety of mechanisms have emerged to risk in advance by concentrating and limiting risk empower a large majority of cooperative creditors exposure on a pool of invested assets. to speak for and bind a disagreeable and destructive minority. Artificial entities have already conferred a discharge-in-advance on their individual owners Whether and on what terms to facilitate a through the institution of limited liability. The company rescue by intervening in the debtor- compromise for this is to give creditors access to creditor negotiation of a restructuring of the invested and accumulated assets of the artificial juridical entity MSMEs is a key academic and entity to back the credit and other claims against policy sticking point. Insolvency best practices that entity. Bankruptcy liquidation regimes play an have long accepted the propriety of reducing important, ongoing role in coordinating creditors’ the power of holdout minorities to undermine a claims against insolvent business entities and potentially value-preserving workout. Favoring finalizing the recovery or loss on those claims restructuring of MSME companies is supported from the debtor-entity’s limited assets. Even very by societal concerns for the preservation of going recent commentary therefore continues to identify concern value, especially to employees and the primary goals of (artificial entity) business communities dependent upon the artificial entity’s insolvency proceedings as benefitting the affected activities. But the compelling force of the benefit SAVING ENTREPRENEURS, SAVING ENTERPRISES: PROPOSALS ON THE TREATMENT OF MSME INSOLVENCY 25 of MSME restructuring is often ambiguous given many “policy choices [are] involved in developing the limited size of most such entities, and it is not … solutions” to insolvency resolution systems.141 at all clear that process concerns rather than basic business weakness leads to the unsatisfying level OPTIMIZING JURIDICAL ENTITY MSME of successful entity reorganization, especially RESTRUCTURING PROCEDURE for MSME companies with limited assets and If more MSME juridical entity restructuring is liabilities (that is, less than several million local desired, an optimal procedural approach must currency units). be quick, simple, and relatively inexpensive. In While concerns about employment and an effort to remove procedural barriers and support community reliance support larger corporate more juridical entity restructuring, particularly for reorganization efforts, there is little evidence medium-sized companies, some lawmakers have that smaller MSME juridical entities have removed obstacles in the corporate restructuring sufficient community impact and going-concern rules that increase expense and complexity; e.g., value to warrant a restructuring procedure. creditor control, especially creditors’ committees, What little empirical support that does exist relies and other monitoring and oversight institutions on projections and estimates of liquidation value, (disclosure statements, court hearings). They also which directly implicate the very concern that the have imposed stricter deadlines and reporting Law & Economics world has with non-market requirements, however, in part in an effort to divert based valuation methods.135 Indeed, it is not at all the likely failures of MSME company restructuring clear that procedural complexity and cost are the to a quick liquidation. As discussed below, the cause of most MSMEs reorganization failures, as regimes in Japan and Republic of Korea have opposed to non-process related factors, such as identified corporate reorganization complexities to fundamental problems with these businesses, the be avoided (e.g., organized committees of creditors) economy, the market for finance,136 or the lack of and lowered creditor voting thresholds in a way support offered to MSME directors.137 Even the that brings MSME entity cases closer to individual most ardent supporters of business rescue have entrepreneur cases. These are not so much special identified a variety of common, business-related proceedings so much as slightly more structured reasons why, in more than half of Chapter 11 cases or demanding versions of simple arrangement for example, the debtor never even files a plan, proceedings for individual entrepreneurs. much less submits it to creditor vote.138 The complexity and cost of company Moreover, there are real opportunity costs to restructuring procedures seem to be largely favoring reorganization for all MSMEs and if not entirely a function of the complexity of locking entrepreneurs into failed businesses, these debtor-entities and the problems these rather than giving them a personal fresh start procedures are designed to work out. From this and encouraging them to move on to the next perspective, the question should be — and the venture.139 There continues to be a marked Japanese and Korean regimes seem to be asking — philosophical difference of opinion on whether whether MSME juridical entity insolvency cases to give all comers a chance, relying on sensitive are more likely to present the kinds of complexities institutions to sort out the “dead on arrival” cases present in corporate reorganization cases as from those with restructuring potential,140 or instead opposed to the relative simplicity of an individual to avoid the massive inefficiency and potential natural person restructuring case. perceived unfairness (“debtor-friendliness”) of Smaller MSME juridical entities tend to be more this approach and rather focus on redeploying the like individuals than like complex corporate discharged and rescued human entrepreneurial enterprises in relevant respects, in that they capital quickly. These observations illustrate the seldom have multiple tranches of tiered debt, truth of the statement in the ICR Principles that 26 CHAPTER 4. JURIDICAL PERSONS AND NATURAL PERSONS SHOULD ACCESS THE SAME RESTRUCTURING PROCEDURE complex multi-division business operations, that this remains a creditor-controlled process. And and numerous contractual arrangements that if the entity is “dead on arrival,” the insolvency warrant review and restructuring. Rather, a professional or administrator can establish that relatively concentrated group of creditors already quickly, express that to creditors, and guide the has an adequate grasp of the debtor’s relatively case to a quick closure if that is the right option, straightforward situation and can assess the all while minimizing cost to both debtors and the feasibility of a simple restructuring in relatively formal insolvency system. short order. If a complex, court-directed process is warranted by the complexities of the case, the ELIGIBILITY LIMITS AND REQUESTING corporate reorganization process might be engaged. TRANSITIONS FROM MSME PROCEDURES Otherwise, no more procedural complexity or TO CORPORATE REORGANIZATION higher voting margins than that imposed on The key challenge here is drawing the line individual entrepreneurs seem justified for small between artificial entities that should be offered companies, and the flexibility of the out-of-court access to the simplified process available to individual process would foster a much greater individuals, with less expensive simplified degree of MSME restructuring success while still restructuring procedures, and those that are leaving creditors in ultimate control. more appropriately relegated to the corporate The optimal compromise position thus seems restructuring process, with its largely to be treating most MSME juridical entities unavoidable complexity and cost. Experience like individual entrepreneurs with whom they in both the U.S. and Japan suggests larger entities share the key characteristics of low value, low will seek to use simplified procedures in a way sophistication, and low complexity. Given that creditors might find objectionable. Any such the similarity of the issues facing individual dividing line should be drawn not based on labor entrepreneurs and most small-scale business department employment measures or other non- entities, it seems most sensible to apply by default bankruptcy-specific metrics, but guided by the the same simplified creditor-negotiation model specific problem to be addressed: complexity. This discussed above to all MSME restructuring cases, Report takes no particular position on the precise for both natural individual and juridical business- definition or characteristics of “complexity,” but entity debtors. The restructuring option for MSME the optimal approach to juridical entity MSME juridical entities should by default mirror that offered restructuring does seem to be most appropriately to individuals: a simplified creditor-negotiation a matter of choosing such a factor by which to model, administered out of court through simple direct cases either to the procedure applicable to majority voting, in all cases where a more complex natural person MSMEs or the complex corporate corporate restructuring regime is not chosen by the reorganization regime, rather than creating yet debtor-entity or shown by an insolvency system another procedure specifically for MSME entities. administrator or creditors to be necessary. There are several approaches to distinguishing The straightforward approach of applying generally between MSMEs and larger business the individual simplified restructuring regime entities (such as numbers of employees or to most small companies can solve the main creditors, etc.), but in the specific context of problems of complexity and cost much more MSME insolvency proceedings, using liability directly and effectively than developing bespoke volume as an efficient proxy for complexity is processes or even modifying the formalities of particularly common and has been empirically in-court procedures. Objections to imposing yet justified. The American Bankruptcy Institute another compromise on creditors who have already Chapter 11 Commission chose US$10 million compromised their claims by dealing with a limited in total assets or liabilities as the ceiling/dividing liability entity are somewhat mollified by the fact line,142 the NBRC chose US$5 million in total SAVING ENTREPRENEURS, SAVING ENTERPRISES: PROPOSALS ON THE TREATMENT OF MSME INSOLVENCY 27 debt,143 while a prominent empirical study144 and large asset or liability levels might be presumed U.S. and Korean legislators favored US$2 million sufficiently complex, but most large entities will (now US$2.5 million). European authorities and likely choose corporate reorganization procedures U.S. practitioners mark the boundary between voluntarily, so conversion requests should be “small” and “medium” enterprises at US$10 relatively rare and confined to the largest medium- million in assets or debts.145 The suggestion in sized enterprises. If either the debtor-entity or the preceding cases seems to be that a medium creditors accurately perceive the need for complex enterprise with US$10 million, US$5 million, or proceedings to sort out an MSME entity’s affairs, even perhaps as little as US$2.5 million of assets greater expense appears to be inevitable. or debts most likely has the resources and needs a In disputed cases, which are likely to be a small mechanism to sort out a complex matrix of claims minority, conversion motions by creditors may and constituencies. lead to significant litigation burdens, but this Liability volume is not the best proxy for is likely an inevitable and controlled cost of a complexity, however, and it is difficult to find the maximally efficient and effective solution. The right dividing line in various jurisdictions with early 20th-century U.S. system was deluged with very different monetary values and economic such litigation involving large corporate debtors conditions of small business. It seems more who filed simplified Chapter XI cases, not wanting efficient and productive to change the starting point to undergo complex Chapter X reorganization of this analysis to a presumption that reflects the proceedings, but opposed by creditors and reality of MSMEs and the problems they face. A administrators who preferred the enhanced scrutiny. better approach would presume applicability not This litigation and other challenges to allowing of complex corporate proceedings and seek debt- companies access to the individual out-of-court volume-based exceptions, but rather presume restructuring process is likely a necessary evil. that the proper approach to small entities (defined The farther down the road one travels away from flexibly by policy-makers in accordance with careful monitoring and oversight, the more issues various domestic contexts and perspectives on of perceived unfairness are implicated, a problem complexity) is to allow them access to the same vividly illustrated by the recent debate about one taken to individual entrepreneurs and allow streamlined out-of-court administration in England challengers to rebut this presumption and move for and pre-packaged “phoenix” reorganizations of conversion to corporate reorganization procedures. MSME companies via sale back to the entrepreneurs (often in leveraged buy-outs financed with deferred If a debtor-entity chooses simplified proceedings, payments).146 The cost of court oversight of and creditors or system administrators believe conversion requests in a few larger cases should be more complex, corporate reorganization an acceptable price for smoothing the restructuring proceedings are more appropriate, such path of the great bulk of unopposed MSME entity challengers should bear the burden of justifying arrangement negotiation cases. this conversion. Perhaps closer scrutiny of fraudulent behavior is necessary, or significant This approach achieves the necessary balance transfers of value can be recovered for the benefit of flexibility and simplicity to support maximal of the estate, or some other mechanism available MSME restructuring while maintaining insolvency only in complex reorganization proceedings is system integrity and respecting creditors’ abilities highly valuable for the case. MSME entity cases to control the outcome and oppose simplified would be relegated to corporate restructuring, procedures in more complex, higher-value cases. though, only when and if the entity’s restructuring This solution is also properly oriented on the case exceptionally implicates such complexity as factual criteria — value and complexity — that are to warrant those more elaborate and therefore more the animating concerns of corporate restructuring expensive procedures. Entities with sufficiently procedures. 28 CHAPTER 4. JURIDICAL PERSONS AND NATURAL PERSONS SHOULD ACCESS THE SAME RESTRUCTURING PROCEDURE EMPIRICAL REVIEW OF RESTRUCTURING in, Chapter 11.”148 For this latter, small group, the REGIMES FOR MSME JURIDICAL ENTITIES Commission proposed a simplified disclosure and plan confirmation process. Technically, lawmakers have taken one of two approaches to MSME juridical entity The long-discussed notions of (1) developing restructuring procedures: modifying an existing a new, streamlined “Chapter 10” specifically corporate restructuring regime, or constructing for MSME restructuring; or (2) giving small a separate procedure specifically directed at enterprises access to the vastly simplified corporate entity MSMEs. Given the variety of Chapter 13 individual reorganization regime other distinctions among these regimes, it is not were rejected out of hand by the Commission, clear that the technical approach matters as much as without substantive explanation.149 The the substance of the operative provisions—which Commission’s modifications to the procedure for often resemble simplified procedures applicable to small businesses appeared to be directed more individual debtors—and even more important, the at pushing MSME cases out of Chapter 11 than support (or lack thereof) from institutional actors. facilitating reorganization. They included shorter plan filing and confirmation deadlines, additional Comparing the filing figures in existing regimes, operational reporting requirements, and probing it seems that MSMEs prefer insolvency systems oversight by the U.S. Trustee.150 intended for natural persons over modifications of the corporate insolvency process. Most A simplified and expedited plan151 process was systems designed specifically for small business adopted for MSME debtors in 2005 in the U.S. and MSME corporate entities are undersubscribed. with some requirements waived and timelines Instead, juridical entity MSMEs use the individual shortened. The usually required “disclosure procedures overwhelmingly more often, seemingly statement” and the hearing preceding the call for to good effect. the plan vote may be simplified or dispensed with in small business cases, and only the debtor may file United States (“Small Business” Chapter 11) a plan within the first 180 days of a small business In 1994, several streamlined case.152 But a plan must be filed within the first 300 modifications of Chapter 11 were days of the case, and a filed plan must be confirmed made available to MSMEs that within 45 days after filing (that is, a maximum elected to be treated as “small businesses,” but of 345 days after case commencement).153 These few companies accepted this invitation. Thus, deadlines can be extended, but only upon the when reformers returned to this issue, the dual debtor’s showing that “it is more likely than not that questions were whether to force small business the court will confirm a plan within a reasonable entities into this special treatment and what the period of [extended] time.”154 In “ordinary” Chapter goals of the special regime should be. The National 11 proceedings, in contrast, the debtor’s exclusive Bankruptcy Review Commission proposed that period for filing a plan is only 120 days, but it can the small business provisions become mandatory, be and usually is extended up to 18 months upon a and they were quite candid in their explanation of lenient showing of cause,155 and there is no deadline the reason: for most MSMEs, “the primary goal for plan confirmation. [was] to reduce the amount of time they consume These restrictive provisions apply only to “small in Chapter 11” by “identifying [weak] cases early business cases,”156 defined as Chapter 11 cases and removing them from Chapter 11.”147 For the filed by “small business debtors.” A “small “relatively small proportion of cases in which the business debtor” is any person engaged in business debtor has a reasonable likelihood of confirming a with liquidated total debt (secured and unsecured) of plan and succeeding as a going business,” the goal US$2 million or less,157 whose case does not have an was “reducing the high cost of, and time delays active official committee of unsecured creditors.158 SAVING ENTREPRENEURS, SAVING ENTERPRISES: PROPOSALS ON THE TREATMENT OF MSME INSOLVENCY 29 Since it is quite common for an insufficient number 2006 and 2008, the percentage of Chapter 11 cases of creditors to be willing to serve on an official identified as “small business cases” shrank from Chapter 11 committee,159 the US$2 million debt one-third to one-quarter.167 limit is effectively the sole determinant of “small business” status. Argentina, India, Greece, OHADA Small business debtors are scrutinized more Other regimes closely in the specialized procedure than in a mentioned standard Chapter 11 case, with a bias toward in the first early case dismissal or conversion to Chapter Report on the Treatment of MSME Insolvency168 7 liquidation. Small business debtors must file (and described in greater detail elsewhere169) pre- and post-petition financial statements and tax have instituted modifications of the ordinary returns (or a sworn statement that one or more of reorganization regime (India, the Organization for these documents does not exist) as well as detailed the Harmonization of Corporate Law in Africa reports on operations, profit projections, and (OHADA)), and they are possibly so minor as to compliance during the pendency of the case.160 have no likely positive effect (Argentina, Greece) They also must attend early intervention (viability) or are so new that no empirical evidence of their meetings with the bankruptcy system supervisor operation is available (India, OHADA). The many (the U.S. Trustee), and allow the U.S. Trustee to Greek reforms reportedly have failed to achieve investigate the debtor’s business operations at any their intended effects, and the 2014 reforms to time.161 The U.S. Trustee is directed to monitor the voluntary restructuring framework for small small business cases carefully to be prepared to businesses expired in March 2016.170 move for dismissal or conversion if it appears unlikely that the debtor can confirm a plan.162 England (Company Voluntary Arrangements) U.S. small businesses appear to be evading The rescue-oriented Cork reforms the small business Chapter 11 regime, rather of 1986 pursued parallel tracks than embracing their cost- and delay-reducing for individuals and entities. While application. In a recent nationwide study of individuals were empowered to negotiate IVAs with individual Chapter 11 debtors, while more than their creditors, entities were similarly empowered to half of the sample included debtors engaged in negotiate Company Voluntary Arrangements (CVAs) business with total debt below $2 million and with theirs. The two processes operate in nearly no creditors’ committee, only about 13 percent identical fashion, and neither is limited to small self-identified as “small business debtors,” even businesses,171 though larger business entities generally though the rules163 and forms require this self- pursue negotiated restructurings in the context of a designation.164 Another small study revealed that, scheme of arrangement under the Companies Act.172 of just under 2,300 Chapter 11 cases filed in 2007 Unlike the relative success of the IVA procedure, with primarily business debt less than $1 million, however, English insolvency professionals report only 36.8 percent identified as “small business that the CVA process is generally ill-suited to debtors.”165 One commentator explained this rescuing smaller enterprises, given the costs of the phenomenon in candid terms: “In reality, the small process, and CVAs often result in liquidation of the business Chapter 11 provision is … a bad thing for entity.173 A report on CVA outcomes found an eventual small businesses. Chapter 11 practitioners … have failure rate of over 70 percent in a sample consisting given the small business Chapter 11 provisions … a of 90 percent small companies (74 percent of which pretty universal thumbs down.”166 Official statistics were micro enterprises, with issued share capital less seem to confirm this negative perception of small than GBP100).174 The most common outcome (61 business Chapter 11 by potential filers: Between percent) was a breakup sale of the entity.175 30 CHAPTER 4. JURIDICAL PERSONS AND NATURAL PERSONS SHOULD ACCESS THE SAME RESTRUCTURING PROCEDURE Even among business cases, the CVA is a little- Unlike the U.S., Japan retained its separate used procedure in comparison to the IVA. In small business restructuring mechanism when contrast to about 5,000 business-related IVAs per it revised its insolvency law. Japan’s 1952 year,176 the number of CVAs has steadily declined Corporate Reorganization Law (Kaisya Kosei from a high of about 800 in 2011–12 to fewer than Ho) was modelled on Chapter X.184 The analogue 400 in 2016,177 and most of these were likely on to Chapter XI is the regime examined here, the their way to a breakup liquidation. Already in the Civil Rehabilitation Act (CRA) (Minji Saisei mid-1990s, one commentator characterized the Ho), adopted in 1999 not as a major innovation, CVA as “a dead letter.”178 but simply to “improve and simplify” an earlier Composition Law, which was based on the 1914 Japan (Civil Rehabilitation) Austrian model and operated very much like an in- When Japan began revising its court version of the later English CVA process.185 insolvency law in 1999, it retained Big businesses resist using the restrictive Corporate a CVA-like structure as part of Reorganization Law, preferring the less intrusive an insolvency system that by design strongly and more nimble process under the CRA.186 A resembles the pre-1978 US bankruptcy law. In broad-based study of CRA company cases filed the US, before there was Chapter 11, there was from 2000 to 2016 notes that usage by large Chapter XI. The US Bankruptcy Act of 1898, as companies is conspicuous, including, for example, reformed in 1938, divided court-based business Lehman Brothers Securities Co., Ltd.187 reorganization into two segments, Chapter X for The CRA remains the preferred restructuring large corporations with diffuse shareholdings, and option in Japan, especially for MSMEs, though Chapter XI for closely held companies.179 Chapter X filing statistics indicate that “small-scale debt” was designed for the protection of public investors, (SSD) proceedings under the CRA greatly not to smooth the reorganization process. A trustee outnumber ordinary CRA filings, indicating a ousted management in all cases, and the Securities clear preference for the procedure more geared and Exchange Commission scrutinized all Chapter toward individuals. As stated previously, in 2005, X reorganization plans. Lauding its operation, of a total of 19,401 business-related CRA cases, contemporaries noted “[i]ts ritual is more complex 18,567 were individual SSD cases (96 percent), and impressive, its substance more satisfying, its with only 834 ordinary CRA small business cases promise of protection to investors more emphatic.”180 (4 percent).188 One likely reason for this is cost. Chapter XI, in contrast, “provide[d] for a cheap Each court sets its own fee structure, and while the and practical method of settlement, based on the simplified SSD procedure requires an average filing history of composition in bankruptcy.”181 Chapter fee of only about JPY40,000–JPY80,000 (US$360– XI left the debtor’s management in place to engage US$720),189 the fee for ordinary CRA procedures a simple procedure for negotiating a compromise ranges from JPY2 million–JPY8 million, with a among majority voting groups of creditors. As median of JPY6 million (US$54,000).190 Another a result, large corporations often sought to use potential explanation is the CRA screening Chapter XI, leading to protracted litigation about mechanism that requires the court to dismiss a case the ambiguous boundaries between the “large” and when it is clear that there is no possibility that a “small” business reorganization provisions.182 The plan will be approved, or when the petition was not 1978 US Bankruptcy Code mooted these disputes filed in good faith.191 These rejections seem to be by jettisoning the bulky Chapter X and folding much rare, however.192 of its complexity into the small business Chapter About 80 percent of CRA cases concern business XI, leaving a single business reorganization vehicle entities even though individuals are also in a new Chapter 11, but with no distinct small allowed to file. Individuals understandably opt business restructuring regime.183 for the alternative SSD proceeding. The debtor- SAVING ENTREPRENEURS, SAVING ENTERPRISES: PROPOSALS ON THE TREATMENT OF MSME INSOLVENCY 31 company’s management remains in possession, and and Bankruptcy Act in 2006.199 As discussed an automatic stay prevents all but secured creditors earlier,200 the Korean Individual Rehabilitation from taking action against the debtor’s property.193 Proceeding (IRP) has been available since 2004. In contrast to the simplified SSD process, in the A new, cognate rehabilitation procedure, ordinary CRA procedure creditors are required to available to small business debtors (both natural file proof of their claim, and the debtor must prepare persons with larger debts as well as juridical and submit to court an inventory of all assets and persons), was adopted more recently, effective their value.194 The debtor has no exclusive period July 1, 2015, to reduce the cost and complexity for submitting a plan, though creditors seldom of the ordinary rehabilitation proceeding.201 submit competing plans, and rather than regulating The scope of application of this new Summary the content of plans (other than a maximum length Rehabilitation Proceeding (SRP) mirrors the of 10 years195), the law submits the plan for creditor “small business” designation in U.S. Chapter 11, approval. Plans are adopted by the affirmative and ordinary corporate reorganization rules apply vote of a majority of all scheduled creditors, unless supplanted by specific SRP provisions. The who must hold at least 50 percent of scheduled two major differences between the IRP and SRP claims. The court confirms the approved plan if it are that, in addition to being available to business believes the plan to be feasible, and the debtor is entities, the SRP has a higher debt limit and submits immediately discharged from claims not scheduled plans to creditor approval. The SRP is available to for satisfaction in the plan. The court may, and debtors (including individuals and companies), who usually does, appoint a court official as supervisor are expected to earn business income, and whose of the debtor’s execution of the plan for the first total secured and unsecured debt does not exceed three years of its operation.196 3 billion won (US$2.7 million—almost identical to the current “small business” limit under U.S. Confirmation rates for plans are high, so the Chapter 11). No trustee or creditors’ committee is system allows some rehabilitation, though many appointed, but an examiner is appointed to opine of the rehabilitated companies do fail at a later on the continued viability of the business, albeit date. The entire process takes on average only five in simplified form (and at the reduced cost of to seven months, and plan confirmation rates are US$3,000–US$5,000 for companies, vastly less high (about 80 percent).197 A longitudinal study of than the US$15,000–US$120,000 in examination post-CRA outcomes for all 7,341 company CRA fees in ordinary reorganization cases, and generally cases with debt totaling at least JPY10 million cost-free examination by a court official for (US$90,000) reveals that, as with English CVAs, individual debtors). Korean SRP plans may not more than 70 percent of these Japanese CRA exceed 10 years, and since a reform in 2015, they cases were followed by the companies’ ultimately are approved by the affirmative vote of (i) at least ceasing to do business, mostly (60 percent) by full three-fourths (by amount) of secured creditors and termination, though others by merger or transfer to (ii) at least two-thirds (by amount) of unsecured a sponsor.198 creditors (or more than one-half by amount and more than one-half by number of unsecured creditors) Republic of Korea (Summary Rehabilitation Ordinary cram-down rules apply. Plans must be Proceedings) submitted within about five to eight months of case Korea’s first bankruptcy and commencement (usually only about 70–100 days in reorganization laws were adopted in practice, as determined by court scheduling order) the early 1960s and were modelled and must be approved by creditors and confirmed on Japanese law. The Republic of Korea reformed by the court within a year after commencement its insolvency laws in the early 2000s, later (usually 100–200 days in practice) unless extended consolidated into a unitary Debtor Rehabilitation for cause up to 18 months.202 In practice, SRP plans 32 CHAPTER 4. JURIDICAL PERSONS AND NATURAL PERSONS SHOULD ACCESS THE SAME RESTRUCTURING PROCEDURE are approved by the creditors and confirmed by the consistent with a similar degree of success in court within about 100 days pursuant to the court’s ordinary rehabilitation proceedings. It should be standard scheduling. Upon the court’s confirmation noted that it is unclear how confirmed SRP plans of the plan which is immediately granted after will ultimately perform, as the earliest ones have the approval of the plan by the creditors, the pre- been in place for only a short time. Significant commencement claims (other than specified numbers of SRP applications are withdrawn (about category of debt) which are not recognized in the 20 percent), but the courts also reject a further 6-8 plan shall be irrevocably discharged. The time percent. Of those that remain, about half succeed of discharge under the SRP is more favorable to in confirming a plan.204 It is noteworthy that the the debtors than discharge under the IRP which is rate of commencement and plan confirmation in usually granted after completion of payment under the ordinary corporate rehabilitation proceedings the plan is almost identical to the SRP process, with a 10 percent rate of court rejection of applications and a As in Japan, the overwhelming majority of 52 percent rate of plan confirmation for companies MSME cases appear to be under the IRP, the (48 percent for individuals).205 Perhaps the success procedure for individuals. Official statistics from rate for MSMEs would be far smaller if they were the first 21 months of operation of the SRP (July subjected to the costly and complex ordinary 1, 2015, to March 31, 2017) reflect that the ratio regime, but the parallel in success rates among the of business-related IRP-to-SRP cases is similar to ordinary and summary procedures (for companies that in Japan, with 94 percent of potential MSME and individuals) is striking. One reason for this activity in the individual IRP process (14,973 cases) impressive rate of success seems to lie in the special and 6 percent in the SRP process (903 cases).203 attention the Korean courts have paid to MSME More surprising, the SRP cases are divided almost cases, collaborating with the Small & Medium evenly between individual and corporate cases, Business Corporation to support these companies in with 472 entity cases and 431 individual cases. consulting on and preparing rehabilitation petitions, The Korean SRP has produced an impressive and lending an air of persuasive credibility for degree of success in plan confirmation, potentially dissenting creditors. SAVING ENTREPRENEURS, SAVING ENTERPRISES: PROPOSALS ON THE TREATMENT OF MSME INSOLVENCY 33 CHAPTER 5 Institutional Structure: Specialized Professionals and/ or Institutions with Oversight, Training, and Procedures Specific to MSMEs Should Administer the Process Institutions and professionals are critical to separate agency. The English and Irish model of the success of any proposed MSME insolvency developing an entirely new infrastructure in the regime. This Report fully recognizes that the form of an Insolvency Service adds another layer successful implementation of any MSME of complexity that might not be necessary or insolvency regime will ultimately depend on appropriate for less developed states. Other models the integrity, transparency and competence of a of assigning various agencies with the responsibility country’s institutional framework and professionals. for administering discharge proceedings have been Emerging markets, in particular, might need to quite successful; for example, the Swedish approach prioritize this piece of the insolvency regime before leverages the existing expertise of the Enforcement focusing on MSME-specific concerns. For instance, Agency in dealing with defaulting debtors and the several African countries have both discharge and legal protections afforded them. These kinds of an IVA-type restructuring procedure, with minimal efficiencies should be encouraged, as it is on the practice on the ground.206 A robust discussion of whole preferable that the majority of uncontested the institutional and professional fabric needed discharge cases pass through a simple, semiformal to support an MSME insolvency regime is process. outside the scope of this Report. However, some Concerns about due process and property key considerations are set out below for future rights protection can be adequately addressed discussion. by allowing creditors open access to a judicial re-examination of challenges to first-instance DESIGNATING THE PROFESSIONALS WHO administrative determinations. This is the WILL HANDLE MSME INSOLVENCY AND solution implemented by reformers in 2007 in the DISCHARGE IS AN IMPORTANT PART OF first and most extensive reform of the Swedish DESIGNING THE SYSTEM personal insolvency system.207 In the vast majority While liquidation-and-discharge proceedings of MSME cases, if debtors cooperate with system in particular have traditionally been the administrators and do what the procedure objectively province of court processes, other institutional requires of them, they should receive an automatic structures may be superior for administration of discharge, whether or not this confers an objective MSME insolvency. States with deeply embedded benefit on creditors.208 Especially in countries with traditions of judicial involvement in insolvency weak or overburdened court infrastructure, further proceedings will likely retain this structure. But encumbering the courts with personal insolvency even longstanding and sophisticated regimes cases and MSME cases is counterproductive and like that in England have increasingly concluded unnecessary. that the judiciary can be safely unencumbered Institutional support is especially vital in the and most insolvency administration assigned to MSME restructuring context. The information an administrative agency. In the UK, Canada, deficiencies and creditor apathy that often and Australia, MSME insolvency and individual undermine MSME restructuring can be overcome discharge has been successfully designated to a SAVING ENTREPRENEURS, SAVING ENTERPRISES: PROPOSALS ON THE TREATMENT OF MSME INSOLVENCY 35 only by assigning a trusted intermediary to give direct debtors to any lawyer or accountant willing individualized attention to each debtor’s case and to provide support for negotiated debt arrangement to offer creditors a succinct, credible assessment efforts. Particularly for states with underdeveloped of the debtor’s bona fides and the feasibility of the professional infrastructure, this may be a less proffered restructuring proposal. It is vital to place effective approach than the central authority. these functions in an institution that gains and holds Careful oversight of practitioners is necessary. the trust of creditors, as the vote on restructuring The South African debt adjustment process plans will be powerfully impacted by the degree to called “administration” is considered to have which the chosen intermediary commands creditors’ suffered from a lack of oversight and regulation of trust and confidence. The proper institutional appointed administrators, a problem addressed in choices here are absolutely crucial to the success of the new personal debt negotiation process under the an MSME restructuring alternative, both in guiding National Credit Act, now led by debt counsellors and advising debtors and in interfacing credibly regulated by a new National Credit Regulator.209 with creditors. The approach of engaging a central regulatory authority is essential to ensure competency and To formulate viable restructuring plans, MSME honesty if private advisers are to be enlisted to debtors are likely to need expert business advice guide debtors through a restructuring process. in addition to the administrative support. A central authority may fill the role of counsellor and intermediary for debtors, in addition to the THE KEY ROLE OF ATTITUDES AMONG administration role, as is the case in the new PROFESSIONALS AND INSTITUTIONS Chilean regime. This approach has the potential Successful regimes such as those in Japan and added benefit of concentrating in one place both Republic of Korea seem to enjoy another crucial business advice and guidance for struggling small benefit that seems likely to be the primary businesspeople, as well as insolvency resolution driver of success: powerful institutions and a assistance when financial challenges become rescue-friendly insolvency culture. The reform overwhelming. MSME debtors often fail due to movement in Japan was especially impactful not insufficient support and guidance early in their only on procedures, but on attitudes. One longtime lifecycles, a void that becomes more difficult to commentator on Japanese insolvency law describes fill as problems mount and insolvency threatens interviews with “key players in the legal and court or sets in. If a central authority like the Chilean practice” who reported “changing attitudes among Superintendent of Re-Entrepreneurship can offer the courts and practitioners” from a “political small business support both before and after mandate from the reform movement,” leading to MSMEs experience distress, such enterprises will an environment where courts and practitioners likely have a much greater degree of success in cooperated “to make the civil rehabilitation process navigation of business challenges. Such agencies more conducive to quick, efficient and acceptable require adequate funding and staffing support, resolutions.”210 He attributes much of the success but this investment is likely to produce a much of the Japanese reforms to the fact that “the revision higher rate of return and long-term success than signified and initiated a change in the various actors’ similar investments in after-the-fact restructuring posture, that is, in insolvency culture,” ushering processes. in “a renewed interest in and commitment to proactively reforming … troubled businesses,” and A common approach, particularly in countries concluding that “the CRA was a symbolic gesture newly modernizing their insolvency systems, to a more expedient, user-friendly, and affirmative enlists the support of insolvency practitioners, reorganization scheme.”211 usually licensed by a central regulatory authority. It is a deceptively simple solution, however, to 36 CHAPTER 5. INSTITUTIONAL STRUCTURE: SPECIALIZED PROFESSIONALS AND/OR INSTITUTIONS WITH OVERSIGHT, TRAINING, AND PROCEDURES SPECIFIC TO MSMES SHOULD ADMINISTER THE PROCESS In Republic of Korea, a leading insolvency insolvency. New laws and legal structures are academic noted the embrace of a new rescue necessary but not sufficient. Supportive institutional culture by judges in the mid-2000s. One attitudes seem to be largely responsible for MSME judge described himself as “an evangelist of restructuring success on a national level. The the bankruptcy-discharge church,” and another famously rescue-friendly pioneering U.S. regime explained that “when he started to work on personal has been driven in part by legislation, but both that bankruptcy cases, he mostly worried about how to legislation and the results it has produced have been prevent the moral hazard regarding debtors, but propelled by an underlying culture that believes in after a few months of experience, he now focuses reorganization and second chances. A prominent on how to help bankrupts.”212 As in the early history of U.S. bankruptcy law observes, “Since development of the U.S. bankruptcy system, an 1898, bankruptcy professionals have been the enthusiastic insolvency culture is solidifying in single most important influence on the development Republic of Korea as the country implements a of bankruptcy law.”214.American institutions, new system of specialized tribunals with exclusive especially the dedicated Bankruptcy Courts and jurisdiction over insolvency cases, beginning with the professionals working within them, generally the Seoul Bankruptcy Court, effective March 1, truly believe in the benefits of a policy of rescue 2017.213 and fresh start. This attitude has helped to create institutions that model effective and accessible Attitudes cannot be legislated, but must be support for reorganization.215 considered in the design and reform of MSME SAVING ENTREPRENEURS, SAVING ENTERPRISES: PROPOSALS ON THE TREATMENT OF MSME INSOLVENCY 37 CHAPTER 6 Preliminary Discussion of the World Bank Group Principles for Effective Insolvency and Creditor/Debtor Regimes The Principles for Effective Insolvency and The ICR Principles as currently formulated Creditor/Debtor Regimes (the “ICR Principles”) were initially focused on large business entity are a distillation of international best practices on insolvency. While the ICR Principles can often key aspects of insolvency systems, emphasizing be read flexibly to accommodate the concerns of contextual, integrated solutions and the policy MSMEs along with large corporate debtors, this choices involved in developing those solutions. Report emphasizes the need for the ICR Principles The Principles are used in connection with the to incorporate features of insolvency regimes that World Bank Group program to develop Reports on particularly facilitate the insolvency process for the Observance of Standards and Codes (“ROSC”) MSMEs. There are two ways in which this can and the joint IMF-World Bank Financial Sector be done: (i) a new Principle could be introduced Assessment Program (“FSAP”). These assessments dealing with all the composite features of an have yielded a wealth of experience and enabled MSME insolvency regime that countries are free the World Bank Group to test the sufficiency of the to assess in the development of their insolvency ICR Principles as a flexible benchmark in a wide legislation; or (ii) alternatively, several Principles range of country systems. The ICR Principles are might be modified or expanded to take into account ultimately a collaboration of the World Bank Group the special circumstances and common treatment with UNCITRAL, IAIR, and INSOL International. of MSMEs, whether natural persons or juridical entities. It should be highlighted that this Report The ICR Principles call for an integrated is not intended to provide a full discussion on approach to reform, taking into account a wide this topic, as amending the ICR Principles will range of laws and policies in the design of creditor/ ultimately depend on the final MSME insolvency debtor regimes and insolvency systems. The ICR system recommended by the ICR Task-Force and Principles have been designed to be sufficiently UNCITRAL. For this reason, the first option is flexible to apply as a benchmark to all country most likely the clearest and most effective method systems and to embody several fundamentally for dealing with the evolving subject of MSME important propositions. First, effective systems insolvency. respond to national needs and problems. Second, transparency, accountability, and predictability Regardless of which approach is taken, the new are fundamental to sound credit relationships. focus on MSMEs should be added not just to Third, legal and institutional mechanisms must the ICR Principles, but to the Introduction and align incentives and disincentives across a broad Summary of the official text. In each Summary spectrum of market-based systems — commercial, section, a sentence or two on the relevance to corporate, financial and social. The application of MSMEs and availability of credit to them of the Principles at the country level will be influenced aspects such as enforcement of collateral and debt, by domestic policy choices and by the comparative credit information systems, and insolvency system strengths (or weaknesses) of applicable laws, components should be inserted as integration to institutions and regulations, as well as by capacity ensure understanding of the broadened scope of the and resources.216 ICR Principles. SAVING ENTREPRENEURS, SAVING ENTERPRISES: PROPOSALS ON THE TREATMENT OF MSME INSOLVENCY 39 ONE STAND-ALONE PRINCIPLE TO • Carefully constrained expropriation of current INCORPORATE MSME INSOLVENCY wealth and future income; and The benefit of adding a single Principle (Part • Limited civil restrictions and stigma. E) that addresses MSME insolvency is that A simplified, creditor-negotiated restructuring this will promote greater coherence and process should be included in insolvency legislation consideration of MSME insolvency in one place, to encourage the rescue of viable MSMEs. This separate from the corporate framework. The process should have the following features: importance of MSMEs, their number, and the percentage of economic actors would merit the • Application to both natural persons and juridical separate section if one was created. Accordingly, persons. specific considerations separate from the general • Open access, no maximum debt limits or framework could be highlighted and/or carved out. minimum dividend requirements; If this was done, then other Principles would not • Plan adoption by majority vote of unsecured need to be amended. Instead of reading through creditors; various Principles to understand the framework, • Exclusion or deemed consent of creditors not the one group of new criteria would cover all the participating; aspects of MSME insolvency as set forth here. A downside could be that other Principles that cover • Plan confirmed absent specific objection for the framework, institutions, and other relevant carefully defined abuse; aspects may be incomplete. It may also be difficult Although the institutional provisions in Part D to describe a whole MSME framework in countries should equally apply for MSMEs, Part E should set where it has not been developed as a fully separate out institutional issues that might be of particular system, where the elements of the MSME approach concern to MSME insolvency. This will include: are scattered throughout the law and institutional responsibilities overlap rather than having a • The role of the insolvency regulator in dedicated MSME-specialized administrative body. administering MSME insolvency procedures, in particular, regarding any out-of-court Although Part E cannot be completed until both procedures; the World Bank Group and UNCITRAL have • The role of any other third-party intermediary finalized their approach in addressing MSME (such as a mediator or an insolvency insolvency, based on this Report, any stand-alone practitioner) in administering MSME Principle would contain the following elements: insolvency procedures, in particular, regarding A discharge should be made available to all natural any out-of-court procedures; persons following a liquidation process. Policy- • The role of the insolvency regulator in plugging makers should decide whether this discharge various information deficiencies relating to is applicable to all natural persons, regardless MSME insolvency; and in what capacity they are operating, or only for natural persons operating as entrepreneurs or in a • The role of a centralized institution in providing commercial capacity. This discharge should have debt counseling and business advice. the following features: AMENDING EXISTING ICR PRINCIPLES TO • Open access; INCORPORATE MSME INSOLVENCY • Discharge of both personal and business debts; Amending each ICR Principle to reflect concerns • Specific, substantiated challenges to debtors’ specific to MSMEs appears to be sub-optimal good faith in exceptional cases; in so far as it weakens coherency and can lead to confusion for policy-makers implementing • Controlled costs by reducing formalities; 40 CHAPTER 6. PRELIMINARY DISCUSSION OF THE WORLD BANK GROUP PRINCIPLES FOR EFFECTIVE INSOLVENCY AND CREDITOR/DEBTOR REGIMES reforms. That said, the following twelve Principles even representation in such contexts. Experience in (or groups of Principles) stand out as having special France, Sweden, and Chile in particular (in contrast implications for MSME cases. to mass failure in this context elsewhere in the world) demonstrates that a persuasive intermediary can be Principle B2: Director Liability for Insolvent helpful, if not vital, to producing agreements in these Trading lower-value cases.218 This issue did not arise as a prominent factor in any of the systems examined in this report, but Principle C1: Key Objectives and Policies the notion of pursuing company directors for As with Enabling Frameworks, a key objective of damages for continuing to trade while insolvent, an insolvency law should be its availability and as the Modular Approach paper noted,217 “may effectiveness for MSMEs. require some relaxation in terms of the expectations from small debtors.” This Principle might be Principle C3-C4: Eligibility, Applicability and amended to address this relaxation specifically. Access MSME entrepreneurs tend to have less access to Principle C3 mentions only legal entities, and so sophisticated legal guidance that would prompt it should be expanded to include natural persons them to abide by an obligation to cease trading in engaged in business. If it does, however, Principle the face of impending insolvency. They also tend to C4 might be significantly expanded to address lack access to sophisticated accounting assistance access restrictions unique to individuals. For that would indicate impending insolvency. The example, modern personal and business insolvency personal nature of much MSME business means regimes are often quite concerned with barring proprietors are prone to overinvesting before access to debtors who have engaged in a greater or recognizing failure. A specific note of a more lenient lesser degree of fraud, or whose vaguely defined approach to MSME debtors might be appropriate. “bad faith” makes them ineligible for relief. These inhibit rescue and rehabilitation, often to the benefit Principle B3: Enabling Legislative Framework of no one if the restrictions are overly broad and if Existence of a procedure or procedures for MSMEs access criteria pose a heavy burden on debtors at and individuals merit their own mention within the outset. Other systems have been exceptionally the legislative framework. The research and restrictive on entry, especially for former or current evidence reviewed here leads to the conclusion businesspeople, who have struggled to establish that insolvency systems must serve MSMEs to be certain insolvency in the face of fluctuating, maximally effective within the economy. unpredictable future income and business liabilities. It would be helpful for this Principle to reiterate or Principle B4.1: Role of Supervisor in Informal reflect the endorsement of open access balanced by Workouts creditors’ ability to challenge individual cases of Principle B4 might miss an opportunity by failing to fraud or misbehavior. Principle C4 might also be mention the importance of a persuasive intermediary expanded, as flagged in the UNCITRAL Legislative in the context of negotiations involving MSME Guide and elsewhere,219 to address the notion of entrepreneurs. While the financial supervisor having one procedure to adjust all of an MSME should remain aloof, consistent with the regulatory entrepreneur’s debts, both business and personal. role, an insolvency supervisor like the Chilean Categories 3.1 and 3.2 should be added to Principle Superintendent mentioned in section III.B.3. may C3. C3.2 should cover MSMEs, and the questions play a more active and salutary role in facilitating asked should relate to the coverage of both workouts involving MSMEs. Small-business people individual entrepreneurs and corporate entity in particular can benefit greatly from guidance and MSMEs. C4.5 should be added to C4, which SAVING ENTREPRENEURS, SAVING ENTERPRISES: PROPOSALS ON THE TREATMENT OF MSME INSOLVENCY 41 should ask about eligibility requirements for the example, Netherlands, U.S., Japan, Republic of MSME procedure as compared to the corporate Korea). By no means in such cases “must [there] reorganization procedure for larger entities. be a rigorous system of examining claims to ensure A preference that imminent, rather than actual validity,” especially in discharge procedures where insolvency, confer eligibility can also be added to little or no value is to be distributed on such claims. C4 in C4.3. Specific reference might be made to assessing the cost-effectiveness of this process by reference to the Principle C7: Creditors’ Committees reasonably anticipated dividend to be distributed One of the key reforms to MSME regimes on claims, with the possibility of a more robust has been the consistent removal of creditors’ process in cases where substantial distributions are committees and often formal meetings of creditors anticipated. entirely. Principle C7’s focus on the centrality of (and explicit preference for) creditors as an Principle C14: Discharge following Liquidation oversight mechanism, including their role in the While Principle C14.5 addresses discharge pursuant appointment of an insolvency representative, might to a plan of reorganization, no Principle seems to be appropriate for large-company insolvency, but address the importance or terms of providing a it is seldom appropriate for MSME cases. This (court- or agency-imposed) discharge to individual is especially true in the context of individual entrepreneurs, without creditor approval or a discharge proceedings, where creditors should play reorganization plan. If individual MSMEs are to essentially no governance role. be considered along with large corporate debtors, some mention of an imposed discharge would be Principle C8: The Estate and Exemptions, appropriate here, perhaps with reference to the Disposable Income importance of maintaining debtors’ human dignity While the discussion of enforcement of unsecured in discharge proceedings and ensuring that the claims refers to footnote 2 on exemptions, there process releases their productive energy quickly. is no such reference in Principle C8. Reference Along those same lines, some mention of the quid to individual entrepreneurs should also be made pro quo for this discharge would be useful here, in Principle C8. In addition, a more substantial for example, liquidation of non-exempt assets, discussion of exempt assets and especially income payment plan, terms, assessment of disposable is warranted in Principle C8 and/or C14.1. income. These key issues warrant mention in the MSME context. C12: Treatment of Stakeholder Rights and Also, the discussion of discharge here offers very Priorities little detail, for example, on exceptions to discharge, As discussed earlier, the treatment of tax issues can which relate largely to individuals. For MSMEs determine the success or failure of insolvency cases in particular, the issue of the dischargeability (or and insolvency systems. C12.6 should be added other treatment) of tax-related debt is absolutely to determine the extent to which public/tax claims crucial to successful recovery. This Principle also are limited in ways that allow reorganization and crucially fails to address another most troublesome fairness to other creditors in liquidation. issue for individual entrepreneurs: anachronistic post-discharge restrictions on debtors’ activities, Principle C13: Claims Resolution such as acting as a company director or engaging in professional activity. If the goal is to reinvigorate Many regimes for adjusting individual debts, entrepreneurial activity, aggressive post-insolvency including business debts, have simplified or restrictions are the best method of squelching that scrapped the claims verification process (for goal. These restrictions should be avoided. 42 CHAPTER 6. PRELIMINARY DISCUSSION OF THE WORLD BANK GROUP PRINCIPLES FOR EFFECTIVE INSOLVENCY AND CREDITOR/DEBTOR REGIMES Principles D1.2, D1.5: Role of Court or systems. The Swedish Kronofogdemyndighet and Administrative Agency the Irish Insolvency Service have done especially The focus on courts in Principle D1.2 misses the impressive work in administering and advancing cost-reducing efforts of many systems to implement the development of their respective personal agency-administered insolvency processes for insolvency systems, with only minor or backup individuals (for example, Sweden, Chile). While it court involvement. Principles D1.2 and D1.5 is extremely helpful to have specialized courts and envision the possibility of agency action, but it judges, these institutions tend to be quite expensive, might be useful to accentuate this cost-saving and specialized agencies can do and have done a fine possibility, especially useful in the MSME context. job of administering well-functioning insolvency SAVING ENTREPRENEURS, SAVING ENTERPRISES: PROPOSALS ON THE TREATMENT OF MSME INSOLVENCY 43 CHAPTER 7 Summary of Main Issues Discussed at the World Bank Group 2018 ICR Task Force Meeting 4 MAY 2018 – WASHINGTON, DC • Time periods for restrictions between discharges could be longer. The 2018 ICR Task Force Members welcomed the presentation of the draft report. They also raised • Each additional discharge could become a number of topics to consider with respect to the progressively more difficult to provide a final version of the report as well as to next steps. disincentive for abuse of the discharge A number of views were expressed on how best to system. Canada was discussed as an example address those topics. Below is a summary of the of a country with this system in place (for major issues discussed at the Task Force Meeting, example, a judge is required for additional and suggestions for the final report and next steps. discharges). • To provide a strong deterrent to fraud or to Presumption of good faith providing misleading information before • Financial skullduggery exists in the developing discharge, what sanctions should be in place? world; could the proposal negatively affect • Broadly, abuse falls into three categories: access to credit? (i) non-disclosure of assets, (ii) transfer • This issue was strongly echoed by many of substantial assets to friends/relatives/ Members from developing countries. related parties, or (iii) preferential payments (payments which are intentionally made to • It was suggested that good faith could be the friendly creditors). international baseline approach. However, separate guidelines could be introduced • Overall, Task Force Members thought a for jurisdictions where dishonesty was a strong penalty should be in place for abuse major concern. This could entail including of the good faith presumption. It was a standard principle with flexibility in suggested that it could be a criminal offence implementation. if a debtor lies. • Monitoring will be challenging. Catching Discharge for the natural person entrepreneur abuse of the good faith presumption will be as a primary goal of MSME insolvency important but it is difficult. Too heavy an approach may defeat the purpose of having a • What should be the effects of the discharge? presumption. The system will not be able to • After discharge, should the framework verify that every single discharge is sought impose restrictions on the debtor for a in good faith: That would create too much certain time? For example, should future of an administrative burden and would be wealth/income be garnished? too expensive and slow. • Provision of discharge must be balanced • What happens if multiple discharges are with the possibility that the entrepreneur requested? What is the treatment of each will need to be provided with credit. The subsequent discharge? entrepreneur should be able to get back into SAVING ENTREPRENEURS, SAVING ENTERPRISES: PROPOSALS ON THE TREATMENT OF MSME INSOLVENCY 45 the market quickly and become productive Business-related v. consumer debt again. • A strong link to natural person discharge exists, • The discharge must be reliably recorded to and coordination/connection is needed between maintain a record of past discharges. Most personal and company insolvency law. developed countries have reliable credit • It is essential to ensure that the people bureaus that enable creditors to keep track discharged are really entrepreneurs and not just of debtor information (such as the number of consumers running-up credit card debts. discharges). However, developing countries often have no reliable information. This will • Some Members suggested treating business be another challenge in implementing the and consumer debt separately and differently. discharge system in developing countries. However, a number of Members did not think it would be possible in many cases to distinguish • The Task Force discussed creditor participation one from the other. They stated that it would at length. be practically very difficult and burdensome • Many Members described creditor to attempt to investigate and separate business participation as “scream or die”. Two issues from consumer debt. were discussed under this heading: (i) If • Legal jurisdiction should be considered. Some a creditor does not raise an objection, it is jurisdictions may not be able to have one assumed to have consented; and (ii) creditors law/jurisdiction deal with both consumer and who do not participate will not have a vote. business debt. This would be the case if one • If we only allow participating creditors to type of debt is in the jurisdiction of the federal vote, banks (as large creditors) will control government and the other in a state/provincial everything. Some Members suggested jurisdiction. This could lead to MSMEs in that a safeguard system for small creditors the same country receiving different treatment should be put in place (such as a gatekeeper, depending on the regional jurisdiction. addressed further below). • MSME insolvency cannot be addressed just Should the system include a gatekeeper? by discharge. A comprehensive system of • Some Task Force Members suggested a role for measures is required, including rules for a gatekeeper (for example, a trustee) who could enhanced information; the need to discuss help ensure the discharge is provided on a good issues with the banking sector, including faith basis and that creditors have a sufficient provisioning; treatment of secured creditors voice. (especially collateral and movable assets); • A gatekeeper may work better in advanced the number of procedures; and incentives for jurisdictions with established practices for debtors/creditors to use the system. insolvency practitioners. In developing • The system established must detail conditions countries, such a role could have potential for obtaining a discharge and the consequences for: (i) increase in fraud/corruption; (ii) lower of a violation. This will enhance system performing incentives if not paid sufficiently transparency and predictability. Debtors should (for example, in no asset cases); and (iii) capacity have to fully disclose financial information and issues with finding qualified practitioners. assets. • Should a system of spot audits be used in • Debtors’ ability to use the proposed discharge the absence of gatekeepers? Some Members should be capped at a certain amount of debt. suggested that spot audits have not been effective in countries where they have been required (for example, in the United States). 46 CHAPTER 7. SUMMARY OF MAIN ISSUES DISCUSSED AT THE WORLD BANK GROUP 2018 ICR TASK FORCE MEETING Institutional considerations Consult further with creditors • Members raised the issue of whether • Task Force Members suggested that further institutional support can be provided in no consultations with creditors would be useful income/no assets cases. before Principles are proposed. This would • Mediation/Alternative Dispute Resolution permit investigation into whether the Report’s techniques should play a key role. proposals could compromise access to finance. • These techniques help mitigate the issue of The MSME Report has components similar to overburdened courts. the Treatment of Natural Person Insolvency • They may help reduce stigma and be more Report culturally appropriate in some countries. • The MSME Report and the Treatment of Natural • Should they be government sponsored? Person Insolvency Report overlap in places. A It was suggested that countries in Asia suggestion was made to link/cross-reference might provide inspiration for this form of the reports where this occurs. The World Bank government support. Group team agreed, but noted that the MSME • With respect to the role of courts, Task Force Report deals with all MSMEs regardless of Members advised that procedures should take legal form and that focusing on natural persons place outside the courts as much as possible – detracts from this point. although courts cannot be avoided completely, Spectrum of application especially if fraud is alleged. • Some Task Force Members expressed concerns Importance of language/stigma that recommendations may not fit both micro • Use of terminology and language is important, as well as small and medium sized businesses. especially for MSMEs where the stigma of This is because recommendations for micro having financial difficulties and/or using an business have implications for questions of insolvency framework may limit or suppress personal insolvency. A suggestion was made to use of the framework. It was suggested stigma exclude micro businesses and to focus on the is particularly problematic with micro and other categories. small business owners. MSME World Bank ICR Principles. • Communication and education of both • The Task Force expressed a preference for one creditor and debtor communities are important or two Principles addressing MSMEs rather components in minimizing any stigma than a review/modification of many existing associated with use of an insolvency framework. Principles to address specific MSME issues. Dive deeper into country data The Members recommended that the Bank, along with its partners, should draft such • The Report provides a description of systems. A Principles for consideration at the next Task deeper discussion of country-level data would Force Meeting. The Principles should reflect be beneficial. the Report’s conclusions and the discussions of the Task Force. SAVING ENTREPRENEURS, SAVING ENTERPRISES: PROPOSALS ON THE TREATMENT OF MSME INSOLVENCY 47 Appendix 1: Acknowledgments The Task-Force Co-Conveners Antonia Menezes and Andres F. Martinez, Senior Financial Specialists, along with Mahesh Uttamchandani, Global Practice Manager, Finance Competitiveness, and Innovation, World Bank Group, would like to acknowledge the following individuals (in alphabetical order) who participated in the 2018 Insolvency & Creditor/Debtor Regimes Task-Force and provided valuable contributions: Adam Harris, INSOL International Alain Tardif, McCarthy Tétrault Ceyla Pazarbasioglu, WBG Prof. Charles Booth, University of Hawaii School of Law Chris Parker, DLA Piper Christopher Klein, U.S. Bankruptcy Court, Eastern District of California Christopher Redmond, Husch Blackwell LLP Prof. Dr. Christoph Paulus, Humboldt-Universität zu Berlin Craig Martin, DLA Piper David Burdette, INSOL International Diana Mumo, Office of Attorney General and Department of Justice, Kenya Diana Talero, UVPA Abogados Dobromir Christow, WBG  Prof. Don DeAmicis, Georgetown Law, International Law Institute Fernando Dancausa, WBG Prof. Edward Janger, Brooklyn Law School Hugo Sanchez Ramirez, Superintendencia de Insolvencia y Reemprendimiento, Chile Hyo Sun Kim, Ministry of Justice of the Republic of Korea, Commercial Legal Affairs Division Prof. Dr. Ignacio Tirado, Universidad Autónoma de Madrid Isabelle Didier, GRIP 21 James Reed, WBG Prof. Jason Kilborn, John Marshall Law School, Radboud University Jenny Clift, UNCITRAL SAVING ENTREPRENEURS, SAVING ENTERPRISES: PROPOSALS ON THE TREATMENT OF MSME INSOLVENCY 49 John Martin, Norton Rose Fulbright Joseph Lowther, Cardno International Development Prof. Juanitta Calitz, University of Johannesburg, Faculty of Law Dr. Kanok Jullamon, Bankruptcy Division of the Supreme Court of Thailand Kenneth Kraft, Dentons Canada LLP Lousie Adler, U.S. Bankruptcy Court, Southern District of California Luciano Panzani, Court of Appeal of Rome  Lucio Ghia, Ghia Law Firm Luis Mejan, Instituto Tecnologico Autonomo de Mexico (ITAM) Luiz Fernando Valente de Paiva, Pinheiro Neto Advogados Lynn P. Harrison III, Curtis Mallet-Prevost Colt & Mosle LLP  Mark Gakuru, Office of Attorney General and Department of Justice, Kenya Monica Marcucci, Banca d’Italia Murat Sultanov, WBG Neil Cooper, INSOL International Nina Mocheva, WBG Olena Koltko, WBG Patrick Potter, Pillsbury Winthrop Shaw Pittman LLP Philippe Belanger, Insolvency Institute of Canada Pooja Mahajan, Chandhiok & Associates Robert Hertzberg, Pepper Hamilton LLP Robert Thornton, Thornton Grout Finnigan LLP Scott Atkins, Norton Rose Fulbright Steven Kargman, Kargman Associates Will Paterson, WBG Wolfgang Bergthaler, IMF 50 APPENDIX 1: ACKNOWLEDGMENTS ENDNOTES 1. World Bank Group Report on the 6. See, e.g., Teresa A. Sullivan, Elizabeth Treatment of MSME Insolvency (2017), Warren & Jay Lawrence Westbrook, As https://openknowledge.worldbank.org/ We Forgive Our Debtors: Bankruptcy and handle/10986/26709. Consumer Credit In America 338 (1999). For a discussion of the rising incidence of stigma 2. A/CN.9/870 https://documents-dds-ny. among individuals seeking discharge relief, un.org/doc/UNDOC/GEN/V16/028/16/PDF/ see Michael D. Sousa, “The Persistence of V1602816.pdf?OpenElement Bankruptcy Stigma” (2017), http://ssrn.com/ 3. See, e.g., 11 U.S.C. §§ 727(a)(1), 1129(a)(10) abstract=3048422. (denying a liquidation discharge to juridical 7. See, e.g., Jason J. Kilborn, “The Rise and Fall of entities, requiring the vote of at least one Fear of Abuse in Consumer Bankruptcy: Most impaired class of non-insider creditors for Recent Comparative Evidence from Europe a reorganization plan discharging creditors’ and Beyond,” 97 Texas L. Rev. _ (forthcoming claims). 2018), http://ssrn.com/abstract=3116253. 4. That is, micro-enterprises, involving a single 8. See 11 U.S.C. § 707(b) (the (in)famous owner-entrepreneur and no formal business “mean test,” subjecting individual debtors to entity. Such businesses constitute at least an evaluation of ability to pay creditors from 93% of the market in rich areas like the EU, future income under a payment plan, but only see European Commission, Annual Report if their debts “are primarily consumer debts”). on European SMEs 2015/2016, at 4 (2016) (reporting 92.8% “micro” SMEs and 6% 9. See, e.g., World Bank, above note 5, 48; “small,” with only 1.0% “medium” and 0.2% UNCITRAL, Legislative Guide on Insolvency “large”), and probably more than 99% in Law 284 (2005) (concluding “it may not developing areas in Africa, Asia, and South be feasible to have rules on business debts America. of natural persons that differ from the rules applicable to consumer debts”). 5. See World Bank, Insolvency and Debtor/ Creditor Regimes Task-Force, Report on the 10. See World Bank, above note 5, 367-71. On the Treatment of the Insolvency of Natural Persons, particular challenge of treating or excluding 223-54 (2013). The treatment of debtor- secured debt, especially home mortgage debt, entrepreneurs’ personal residences, especially see above note 5. when such property is encumbered by a home 11. See, e.g., World Bank, above note 5, 223-254. mortgage, is particularly challenging. Only a few insolvency regimes around the world have 12. Even the reduced three-year plan in these developed solutions to this problem, with the countries inhibits entrepreneurialism and overwhelming majority approach relegating depresses long-term potential, however, as this issue to lightly or wholly unregulated indicated by interviews with entrepreneurs in debtor-mortgagee negotiation. the Dutch personal debt adjustment procedure. SAVING ENTREPRENEURS, SAVING ENTERPRISES: PROPOSALS ON THE TREATMENT OF MSME INSOLVENCY 51 See below Section II.C.1. While the European “The Chinese Bankruptcy Law of 1906-07: Commission has endorsed partial repayment A Legislative Case History,” 30 Monementa plans like the ones imposed in Scandinavia Serica 259, 263-65 (1972). and the Netherlands, it has not endorsed a 20. Donna McKenzie Skene & Adrian Walters, three-year period as a minimum standard; “Consumer Bankruptcy Law Reform in Great rather, the Commission has suggested an upper Britain,” 80 Am. Bankr. L.J. 477, 482-83 limit of “no longer than three years” in most (2006); Adrian Walters, “Personal Insolvency cases, allowing for a less inhibiting, shorter Law After the Enterprise Act: An Appraisal,” discharge period, as well. See European 5 J. Corp. L. Studies 65 (2005). Commission, Proposal for a Directive of the European Parliament and of the Council on 21. For a fairly comprehensive list of law & preventive restructuring frameworks, second economics articles supporting the proposition chance and measures to increase the efficiency that insolvency reform spurs entrepreneurial of restructuring, insolvency and discharge growth, all focusing on the effect of a liberal procedures and amending Directive 2012/30/ discharge, and ignoring or minimizing other EU, COM(2016) 723 final, 2016/0359 (COD), aspects of the insolvency regime, see Douglas at 22, 49. J. Cumming, “Measuring the Effect of Bankruptcy Laws on Entrepreneurship across 13. For a more detailed discussion of these Countries,” 16 J. Entrepreneurial Finance 80, sensitive topics, see World Bank, above note (2012) (criticizing the neglect of attention on 5, 262-309. personal bankruptcy laws, the principle if not 14. See Brayden McCarthy & Karen Gordon exclusive purpose and effect of which is to Mills, “The State of Small Business Lending: discharge unpaid debt). Credit Access During the Recovery and How 22. For the history of the Danish law, see Technology May Change the Game,” Working Jason J. Kilborn, “Twenty-Five Years of Paper 15-004, Harvard Bus. Sch., July 22, Consumer Bankruptcy in Continental Europe: 2014. Internalizing Negative Externalities and 15. Walter Pakter, “The origins of bankruptcy Humanizing Justice in Denmark,” 18 Int’l. in medieval canon and Roman law,” in Insol. Rev. 166 (2009) Proceedings of the Seventh International 23. Marie-Danielle Schödermeier & Françoise Congress of Medieval Canon Law 485, 488 Pérochon, “National Report for France,” in (Peter Linehan, ed., 1988); J.H. Dalhuisen, Principles of European Insolvency Law 237, Dalhuisen on International Insolvency and 303 (W.W. McBryde, A. Flessner, & S.C.J.J. Bankruptcy § 202[1] (1986). Kortmann, eds., 2003). 16. Max Kaser & Karl Hackl, Das Römische 24. For a history of the spread of consumer Zivilprozessrecht §§ 57-58, 76, 96 (1996). discharge laws in Europe, see Jason J. Kilborn, 17. Id. § 61. Expert Recommendations and the Evolution of European Best Practices for the Treatment 18. See Pakter, above note 14, at 488. of Overindebtedness, 1984-2010, at 18-21 19. See id. 505-06; Dalhuisen, above note 14, § (2011). 3.02[1]; Jason J. Kilborn, “Foundations of 25. See European Commission, above note 12. Forgiveness in Islamic Bankruptcy Law: Sources, Methodology, Diversity,” 85 Am. 26. Lasse Højlund Christensen, “National Report Bankr. L.J. 323 (2011); Thomas Mitrano, for Denmark,” in Principles of European 52 ENDNOTES Insolvency Law 153, 190 (W.W. McBryde, A. €l560 and debt of €90,320, double the average Flessner, & S.C.J.J. Kortmann, eds., 2003); debt level for consumers). Axel Flessner, “National Report for Germany,” 37. Id. at 37-38 & tbls. 3.6b and 3.6c (also in Principles of European Insolvency Law 313, reporting that former entrepreneurs managed 368 (W.W. McBryde, A. Flessner, & S.C.J.J. to secure agreed compromises with creditors Kortmann, eds., 2003). in an additional nearly 6% of cases). 27. For a discussion of this range of values, see 38. See Jason J. Kilborn, “The Hidden Life of World Bank, above note 5, 56-111 (2013). Consumer Bankruptcy Reform: Danger Signs 28. John Armour, “Personal Insolvency and the for the New U.S. Law From Unexpected Demand for Venture Capital”, 5 Eur. Bus. Parallels in the Netherlands,” 39 Vanderbilt J. Org. L. Rev. 87 (2004); Wei Fan, Michelle J. Transnat’l L. 77, 97-105 (2006). White, “Personal Bankruptcy and the Level 39. Noordam, above note 33, §§ 4.5-4.6, 5.1, 5.5.4 of Entrepreneurial Activity”, 46 J. L. & Econ. (noting some courts make exception for sole 543 (2003). proprietors with no employees, though the tax 29. See above note 20. authorities require business liquidation as a condition of any akkord workout). 30. For a discussion of these and related goals, see World Bank, above note 5, 79-98. 40. Id. § 5.1.3. 31. For a particularly salient example of these 41. Jennifer van Kesteren, Jan Adriaanse, & negative effects, and a context where a Jean-Pierre van der Rest, “The Story Behind personal insolvency discharge could be most Bankruptcy: When Business Gets Personal,” beneficial in disciplining unregulated lenders, 17 QUT L. Rev. 57, 66, 69 (2017). see Lerong Lu, “‘Runaway bosses’ in China: 42. See generally Matilde Cuena Casas, “La Private lending, credit crunches and the exoneración del pasivo insatisfecho,” in regulatory response,” Financial Regulation Comentarios a la Ley de Mecanismo de Int’l, issue 18.9, Nov. 2015, at 1-7. Segunda Oportunidad 65 (Matilde Cuena 32. See, e.g., Antonia Menezes & Andres Martinez, Casas et al., eds., 2016). “Micro, Small and Medium Enterprise 43. Ley Concursal art. 178 bis. [Spain]. Insolvency in Africa: a comparative study,” www.uncitral.org/uncitral/en/commission/ 44. Insolvenzordnung (InsO) §§ 286-303. On colloquia/50th-anniversary-papers.html. the development of the new German law, see Jason J. Kilborn, “The Innovative 33. Sebastian Kortmann et al., “National Report German Approach to Consumer Debt Relief: for the Netherlands,” in Principles of European Revolutionary Changes in German Law, and Insolvency Law 487, 523 (W.W. McBryde, A. Surprising Lessons for the United States,” 24 Flessner, & S.C.J.J. Kortmann, eds., 2003). Northwestern J. Int’l L. & Bus. 257 (2004). 34. Schuldsanering (ex-)ondernemers § 4.2 at 177 45. Insolvenzordnung (InsO) § 26. (A.J. Noordam, ed., 2013). 46. See Kilborn, above note 43, at 278-79 & n. 35. L. Combrink-Kuiters, S.L. Peters, and C. 129; InsO § 4a. Verkleij, Monitor Wsnp: Twalfde meting over het jaar 2015, 24-25 & tbl. 3.2 (2016). 47. InsO § 286. 36. Id. at 27-28 & tbls. 3.13 and 3.14 (reporting for 48. InsO § 304. In addition, simplified proceedings 2015 average entrepreneur monthly income of must be preceded by an out-of-court workout attempt, which usually fails. The court has SAVING ENTREPRENEURS, SAVING ENTERPRISES: PROPOSALS ON THE TREATMENT OF MSME INSOLVENCY 53 an option to attempt another, court-backed 63. SOU 2014:44, above note 57, at 329. This is workout negotiation, and a plan in this context notably consistent with Dutch and German can be approved by the acceptance (or non- data, reported above. response) of only half of creditors by number 64. Id. at 131-32. and value of claims. Courts have seldom engaged this second attempt, however, and only 65. On the history and operation of the Swedish about 1-2% of cases conclude with such a plan. law, see Jason J. Kilborn, “Out with the New, See Kilborn, above note 43, at 276-77; InsO In with the Old: As Sweden Aggressively § 306(1); Jan Heuer, Anwaltliche Schuldner- Streamlines Its Consumer Bankruptcy System, und Verbraucher-insolvenzberatung: Eine Have U.S. Reformers Fallen Off the Learning explorative Studie zur Rechtswirklichkeit Curve?,” 80 Am. Bankr. L.J. 435 (2007). anwaltlicher Insolvenzberatung im Rahmen 66. SOU 2014:44, above note 57, at 35-36 des § 305 InsO 50 (2009). (providing an English-language summary of 49. InsO § 287(2). the proposal). 50. InsO § 300. 67. Id. at 31. 51. Heuer, above note 47, at 51; Jan Heuer et al., 68. Lag (2016:676) om skuldsanering för Der aussergerichtliche Einigungsversuch företagare. The ordinary personal debt im Verbraucher-insolvenzverfahren: adjustment procedure is called Skuldsanering Inkasso-Unternehmen als Datenquelle für (debt adjustment), and the added F- stands for Verschuldungsundersuchungen 23 (2005). företagare (entrepreneurs). 52. Statistisches Bundesamt, Insolvenzen von 69. The Enforcement Agency emphasizes this Unternehmen und Übrigen Schuldnern (2017). “sameness” in its introductory comments on the new process. See Skuldsanering 53. InsO § 295(2). för företagare, www.kronofogden.se/ 54. For the history of the Danish law, see Kilborn, skuldsaneringforetagare.html; Nytt från den above note 21. 1 november 2016, www.kronofogden.se/ skuldsaneringnyttforstanovember.html. 55. Betænkning nr. 1449/2004 om gældssanering, pp. 340-42, 351-54. 70. Actually, one-seventh of the prisbasbelopp, an indexed social-benefit measure, which for 56. Konkurslov §§ 231b, 236a(2). 2017 is 44,800 kronor. Prisbasbeloppet för år 57. Gældssaneringsbekendtgørelsen § 2 (last 2017, https://www.scb.se/sv_/Hitta-statistik/ amended 2009). Statistik-efter-amne/Priser-och-konsumtion/ 58. Betänkande av Nystartsutredningen, Konsumentprisindex/Konsumentprisindex- F-skuldsanering—en möjlighet till nystart för KPI/33772/33779/Behallare-for- seriösa företagare, SOU 2014:44, at 127, 238. Press/406706/. 59. Konkurslov §§ 231, 232. 71. Lag (2016:676) om skuldsanering för företagare §§ 9(3), 36. 60. SOU 2014:44, above note 57, at 126. 72. Lag (2016:676) om skuldsanering för 61. Konkurslov § 231a(4). företagare §§ 8, 9(1). 62. Data compiled from historical official court 73. SOU 2014:44, above note 57, at 370-71 (noting statistics on probate and bankruptcy, latest in particular that shoddy bookkeeping should years online at http://www.domstol.dk/om/ generally exclude an active entrepreneur from talogfakta/statistik/Pages/skiftesager.aspx. the procedure). 54 ENDNOTES 74. Id. at 113-14. 86. These two proposal types are often referred to as “commercial” and “consumer,” 75. Kronofogden, Ärendestatistik, https://www. respectively, but they are referred to here kronofogden.se/download/18.28b9f267159 instead as unrestricted and restricted to 0d52c89baaab/ 1487148199196/detaljerad_ emphasize, as discussed in this section, that statistik_skuldsanering_2007_2016.pdf. business debts can be and are restructured in 76. See Simeon Djankov et al., “Debt Enforcement both proceedings, so long as the restrictions in Around the World,” 116 J. Pol. Econ. 1105, Division II are satisfied. 1146-47 (2008). 87. See Sarra, above note 77, at 8-11. 77. See Janis P. Sarra, Micro, Small and Medium 88. As defined by official statistics as involving Enterprise (MSME) Insolvency in Canada 45 debtors with a majority of business-related (2016), http://ssrn.com/abstract=2862039; debt; see also Sarra, id. at 9, 46 (noting use of Office of Superintendent of Bankruptcy Division II Proposal by micro-entrepreneurs). Canada, Consumer Proposals, https://www. ic.gc.ca/eic/site/bsf-osb.nsf/eng/br02051. 89. Office of The Superintendent of Bankruptcy html; Office of the Superintendent of Canada, Insolvency Statistics in Canada: First Bankruptcy Canada, Division I Proposals, Quarter of 2017 tbls 2-3. https://www.ic.gc.ca/eic/site/bsf-osb.nsf/eng/ 90. See Sarra, above note 77, at 33-34 (noting that br02052.html. some “successes” may involve going-concern 78. Adrian Walters, “Individual Voluntary sales). Arrangements: A ‘Fresh Start’ for Salaried 91. See Australian Financial Security Authority, Consumer Debtors in England and Wales?,” Compare the Formal Options, https://www. 18 Int’l Insol. Rev. 5, 18, 30 (2009). afsa.gov.au/insolvency/i-cant-pay-my-debts/ 79. Id. at 17-19; Insolvency (England and Wales) compare-formal-options. Rules 2016 , S.I. 2016/1024, § 15.34(6)(a). 92. See Vivien Chen, Lucinda O’Brien & Ian 80. See Walters, above note 78, at 17. Ramsay, “An Evaluation of Debt Agreements in Australia,” 44 Monash Univ. L. Rev. __ 81. Insolvency (England and Wales) Rules 2016 , (forthcoming 2018). S.I. 2016/1024, § 8.3(r) (requiring discussion in IVA proposal, “if the debtor has any 93. New Administrations Under the Bankruptcy business, how that business will be conducted Act 1966 Statistics (Provisional) 2015-16, during the IVA”). release no. 143 (2016). 82. Keith Pond, Investigating personal insolvency: 94. Chen et al., above note 117, figs. 4, 7 and a progression of studies into individual accompanying text. voluntary arrangements 197 (Loughborough 95. Id. figs. 9, 11 and accompanying text. Univ. PhD diss. 2003), //dspace.lboro. a c . u k / d s p a c e / b i t s t re a m / 2 1 3 4 / 3 0 3 9 / 1 / 96. Junichi Matsushita, “Japan’s Personal KeithPondPhD.pdf. Insolvency Law,” 42 Texas Int’l L.J. 765, 768 (2006). 83. See Walters, above note 78, at 9-10 & tbl. 1. 97. For a description of the SSD process, see 84. Pond, above note 82, at 218. Etsuko Sugiyama, Insolvency Proceedings 85. The Insolvency Service, Individual Voluntary for MSMEs in Japan 6-8 (working paper for Arrangements: Outcome Status and Provider UNCITRAL Working Group V 51st session, Breakdown, 1990-2015, England & Wales 4 & May 2017). fig. 3, 6 & tbl. 1 (2017). SAVING ENTREPRENEURS, SAVING ENTERPRISES: PROPOSALS ON THE TREATMENT OF MSME INSOLVENCY 55 98. It is also similar to the U.S. Chapter 13 process, 105. See http://www.superir.gob.cl/; Ley de and ironically, the SSD procedure is contained Insolvencia y Reemprendimiento No. 20.720 in Chapter 13 of the Civil Rehabilitation Act. art. 266. An alternative, court-confirmed plan procedure 106. Ley de Insolvencia y Reemprendimiento (based on disposable income) is available No. 20.720 arts. 265-267. If the plan is not for debtors with “salary or similar regular confirmed, the case is routed to a liquidation income” that has not and is not expected to proceeding, which culminates in a discharge fluctuate by 20% or more, but in light of the for the debtor. Id. arts. 268, 281. unpredictable nature of entrepreneurs’ income, this procedure will not be addressed here. 107. Superintendencia de Insolvencia y Reemprendimiento, Boletín Estadístico: 99. Secured claims are unaffected, though Procedimientos Concursales, 6 (Feb. 2017) collateral can be redeemed from secured (reporting data from 9 Oct. 2014 to 31 Jan. claims by paying a lump sum of the collateral’s 2017, on file with author). During this same value. Cf. 11 U.S.C. § 722 (available in the period, only 1605 personal liquidation cases U.S. only in a Chapter 7 liquidation). were initiated, most of which remain open, 100. The scale has five tranches of minimum likely for investigation of assets. Id. at 7. dividends: (1) 100% when claims total less 108. Id. at 16. than 1 million yen (US$9000); (2) 1 million yen (US$9000) when claims total between 1 109. Superintendencia de Insolvencia y and 5 million yen (thus, between 100% and Reemprendimiento, Boletín Estadístico: 20% of claims, declining as their total volume Procedimientos Concursales – Ley No. rises toward US$45,000); (3) 20% when 20.720, at 14 (July 2017). claims total between 5 and 15 million yen 110. Bankruptcy Act of 1898 §§ 1051-52 (repealed). (US$135,000); (4) 3 million yen when claims total between 15 and 30 million yen (thus, 111. 11 U.S.C. §§ 1322, 1325. between 20% and 10%, declining as claims 112. Scott F. Norberg & Andrew J. Velkey, “Debtor volume rises toward US$270,000); and (5) Discharge and Creditor Repayment In Chapter 10% when total claims exceed 30 million yen. 13,” 39 Creighton L. Rev. 473 (2006). Also, payments on these minimum dividends must be distributed at least quarterly. 113. 11 U.S.C. § 1322(b)(1)(B). 101. Matsushita, above note 96, at 768. 114. Criticism of the means test is abundant; see, e.g., Jason J. Kilborn, “Still Chasing Chimeras 102. Id. at 766, 769-70. An additional 8077 (29% But Finally Slaying Some Dragons in the of the total) were “salaried worker” cases, and Quest for Consumer Bankruptcy Reform,” 25 that same year saw nearly 230,000 bankruptcy Loyola Consumer L. Rev. 1, 6-9, 11-13 (2012). filings. See id. at 766. 115. 11 U.S.C. § 1325(a)(4). This is the so-called 103. See Follow-up Survey of Companies Applying “best interests of creditors” test. for “Civil Rehabilitation,” http://www.tsr-net. co.jp/news/analysis/20170113_07.html (Jan. 116. See Arthur L. Moller, “It Isn’t Only for Wage 13, 2017) (in Japanese), cited in Sugiyama, Earners Anymore: The Individual in Business above note 106, at 2. and Chapter 13 of the Bankruptcy Code,” 17 Houston L. Rev. 331 (1980). 104. Ley de Insolvencia y Reemprendimiento No. 20.720 (D.O. 9 Jan. 2014), effective 9 October 117. 11 U.S.C. § 1304. 2014. 56 ENDNOTES 118. 11 U.S.C. § 1325(b)(2) (emphasis added). 129. See Ministry of Justice, Republic of Korea, Special Rehabilitation Proceedings for 119. 11 U.S.C. §109(e). These figures are indexed MSMEs 2 (working paper for UNCITRAL for inflation every 3 years, due again in 2019. Working Group V 51st session, May 2017); 11 U.S.C. § 104. Soogeun Oh, “Personal Bankruptcy in Korea: 120. Bankr. Rule 3015(b); 11 U.S.C. § 1326. Challenges and Responses,” 7 Theoretical 121. Fed. R. Bankr. P. 2003. Inquiries in Law 597, 609 (2006). 122. 11 U.S.C. § 1324(b). A ruling on confirmation 130. Ministry of Justice, id., at 3-5; Oh, id., at 609- of the plan is often continued for as long as 611. a year as a result of ongoing negotiations or 131. See Lawless, above note 128, at 112-13. court congestion, but the potential for swift 132. Ministry of Justice, above note 129, at 11-12. plan consideration nonetheless looms. 133. Id. at 13. 123. 11 U.S.C. § 1307(c). 134. UNCITRAL, Legislative Guide on Insolvency 124. Wenli Li, Federal Reserve Bank of Law 9-14 (2005). Philadelphia, “What Do We Know About Chapter 13 Personal Bankruptcy Filings?,” 135. See, e.g., Theodore Eisenberg & Shoichi Bus. Rev., Q4 (2007), at 19, 24 & tbl. 2; Ed Tagashira, “Should We Abolish Chapter 11? Flynn, “Chapter 13 Case Outcomes by State,” The Evidence From Japan,” 23 J. Legal Stud. 8 Am. Bankr. Inst. J., Aug. 2014 at 40, 41. 111 (1994). 125. See, e.g., Li, id.; Norberg & Velkey, above 136. In a survey of Canadian trustees, 74% note 112. responded that no new source of financing for MSME insolvency should be developed; the 126. See Robert M. Lawless & Elizabeth Warren, market provides a sufficient financing vetting “The Myth of the Disappearing Business process. See Sarra, above note 77, at 58-59. Bankruptcy,” 93 Cal. L. Rev. 743, 749-68 (2005). 137. See, e.g., National Bankruptcy Review Commission, Bankruptcy: The Next Twenty 127. Admin. Office of U.S. Courts, U.S. Bankruptcy Years 612 (1997), http://govinfo.library.unt. Courts, Business and Nonbusiness Cases edu/nbrc/reporttitlepg.html (noting the view Commenced, by Chapter of the Bankruptcy of “many of the experienced individuals who Code, During the 12-Month Period Ending appeared before the Working Group,” that March 31, 2017, tbl. F-2 (indicating only the “primary reason for the low Chapter 11 2222 “business” Chapter 13 filings of a total confirmation rate is that the great majority of of nearly 300,000, but only 6003 “business” Chapter 11 debtors lack any genuine prospect Chapter 11 filings). for reorganization”); but cf. American 128. See, e.g., Robert M. Lawless, “Striking Bankruptcy Institute Commission to Study Out on Their Own: The Self-Employed in the Reform of Chapter 11, Final Report Bankruptcy,” in Broke: How Debt Bankrupts and Recommendation, 285, 299 (2014) the Middle Class 101, 104-06 (Katherine [hereinafter ABI Report] (noting the many Porter, ed., 2012); Lawless & Warren, above economic, operational reasons why many note 126, at 773 & tbl. 2, 747, 782-83 (2005); small businesses fail, and noting widespread Elizabeth Warren & Jay Lawrence Westbrook, disagreement on the causes and solutions to this “Financial Characteristics of Business in problem, but expressing a belief that “many of Bankruptcy,” 73 Am. Bankr. L.J. 499 (1999). these SMEs were failing not because of fatally flawed business models, but because they SAVING ENTREPRENEURS, SAVING ENTERPRISES: PROPOSALS ON THE TREATMENT OF MSME INSOLVENCY 57 were not receiving the assistance they needed 144. Lawton, above note 138, at 1006. in the context of a financial restructuring”). 145. See European Commission, above note 138. See Elizabeth Warren & Jay Lawrence 4, at 3 (defining “micro” as fewer than 10 Westbrook, “The Success of Chapter 11: A employees and less than €2 million in total Challenge to the Critics,” 107 Mich. L. Rev. asset value, “balance sheet total”, while 603, 618-20 (2009); see also Ann Lawton, “medium” enterprises have more than 50 “Chapter 11 Triage: Diagnosing A Debtor’s employees and between €10 and €40 million Prospects for Success,” 54 Ariz. L. Rev. 985, in total assets); Jeffrey D. Goetz & Mark S. 1004, 1025 (same, and noting that this failure Melickian, Small Chapter 11/Big Chapter may be caused not by procedural costs, but “if 11: A Tale of Two Cities 5 (presentation to it is the debtors and not some deficiency in the 32nd Annual Bankruptcy Conference of Iowa process that cause low confirmation rates, then Chapter of Federal Bar Association, Oct. 25, tinkering with the process will not improve 2013)(noting U.S. practitioners categorization success rates in Chapter 11”). of SME Chapter 11 debtors as “small” if they have assets or debts from $2 million to $10 139. See Douglass G. Baird & Edward R. Morrison, million, and mid-market (medium) if they “Serial Entrepreneurs and Small Business have assets or debts from $10 million to $50 Bankruptcies,” 105 Columbia L. Rev. 2310 million). (2005). 146. See Sarah Paterson, “Debt Restructuring and 140. See Edward R. Morrison, “Bankruptcy Decision Notions of Fairness,” 80 Modern L. Rev. Making: An Empirical Study of Continuation 600 (2017); Bolane Adebola, “An Invitation Bias in Small-Business Bankruptcies,” 50 to Encourage Due Consideration for the J. L. & Econ. 381 (2007) (finding no such Survivability of Rescued Businesses in the continuation bias and an aggressive practice Business Rescue System of England and by Chicago bankruptcy courts of dismissing Wales,” 26 Int’l. Insol. Rev. 129 (2017); Gerard likely reorganization failures early); Warren McCormack, “National Report for England,” & Westbrook, above note 128, at 626 (noting in Commencement of Insolvency Proceedings that U.S. bankruptcy courts in their sample 234, 240-41 (Dennis Faber et al., eds., 2012). terminated likely reorganization failures early, with 33% of cases dismissed within 6 147. NBRC Report, above note 137, at 610. months, about 50% within 9 months, and of 148. Id. at 609. the clearly “dead on arrival” cases, 70% were ejected from the system within 9 months of 149. Id. at 616-17. For enthusiastic discussions of filing). Both of these articles’ conclusions these other recommendations by sitting judges, are critically reliant on context, though, as see Hon. Thomas A. Small, “Small Business they study sophisticated, specialized US Bankruptcy Cases,” 1 Am. Bankr. Inst. L. Rev. bankruptcy judges. Institutions matter. 305 (1993); Hon. Thomas A. Small, “If you ‘Fix It, They Will Come – A New Playing Field 141. ICR Principles at 1 (2016); see also Warren for Small Business Bankruptcies,” 79 Am. & Westbrook, above note 128, at 625 Bankr. L.J. 981 (2005); Hon. James B Haines (“Any thoughtful evaluation of Chapter 11 & Philip J. Hendel, “No Easy Answers: Small eventually boils down to weighing the costs Business Bankruptcies After BAPCPA,” 47 and benefits.”). Boston College L. Rev. 71, 94-102 (2005). 142. ABI Report, above note 137, at 279. 150. Many of these Chapter 11 modifications had 143. NBRC Report, above note 137, at 618. been used in MSME cases since the late 1980s by individual bankruptcy judges, with notable 58 ENDNOTES success, though without elaborate reporting 165. Bob Lawless, “The Disappearing Small and oversight rules. See Small, id. Businesses (Designation) in Bankruptcy,” Credit Slips (Apr. 30, 2010, 10:26 AM), http:// 151. The point made in the first Report on the www.creditslips.org/creditslips/2010/04/the- Treatment of MSME Insolvency at p. 36, about disappearing-small-businesses-designation- the lack of a maximum duration for MSME in-bankruptcy.html. Chapter 11 plans, is a contrast with and benefit over Chapter 13 (for individuals only), which 166. Id. (comment posted by AMC on April 30, limits plans to 60 months. This is not an 2010, 1:11 PM). advantage of the “small business” provisions 167. Ed Flynn & Phil Crewson, Chapter 11 Filing over other Chapter 11 cases. Trends in History and Today 4 (2009), www. 152. 11 U.S.C. § 1125(f). The Commission justice.gov/ust/eo/public_affairs/articles/ considered the disclosure statement process docs/2009/abi_200905.pdf. a key stumbling block and venue for abuse, 168. See pp. 30-35. especially in small business cases. See NBRC Report, above note 137, at 636-37. 169. See Menezes & Martinez, above note 45 (OHADA). 153. 11 U.S.C. §§ 1121(e)(1)-(2), 1129(e). 170. Samoladas, Dorotheos, and Christina 154. 11 U.S.C. § 1121(e)(3). Kalogeropoulou. “Greece.” The Restructuring 155. 11 U.S.C. § 1121(d). Review 10 (September 2017). https:// thelawreviews.co.uk/chapter/1147024/greece. 156. 11 U.S.C. §§ 101(51C). 171. The stand-alone CVA with a moratorium has 157. This figure is indexed for inflation every been available since 2000 only for “small” three years and currently stands at US$2.556 companies, as defined in section 382 of the million. Companies Act 2006, but this procedure has 158. 11 U.S.C. § 101(51D). been all but moribund. See Adrian Walters 159. See NBRC Report, above note 137, at 642 & Sandra Frisby, Preliminary Report to (noting a committee had been appointed in the Insolvency Service into Outcomes in only 15% of Chapter 11 cases filed during Company Voluntary Arrangements 10 (2011) a recent three-year period); Ann Lawton, (unpublished manuscript on file with author) “Chapter 11 Triage: Diagnosing a Debtor’s (reporting only 1% of the sample with a CVA Prospects for Success,” 54 Ariz. L. Rev. 985, with moratorium). 1006 (2012) (noting committee formation in 172. See McCormack, above note 146, at 236. only 18% of cases in sample 2004). 173. See Sarra, above note 77, at 17 (reporting on 160. 11 U.S.C. §§ 308, 1116. interviews with UK Insolvency Service and 161. Id.; 28 U.S.C. § 586(a)(7), (8). IPs). 162. Id.; 11 U.S.C. § 1112. 174. Walters & Frisby, above note 171, at 5, 8-9. 163. Fed. R. Bankr. P. 1020. 175. Id. at 30. 164. Margaret Howard, “National Study of 176. See above note 83 and accompanying text. Individual Chapter 11 Bankruptcies,” 25 Am. 177. The Insolvency Service, Insolvency Statistics Bankr. Inst. L. Rev. 61, 92-93 (2017). – January to March 2017 (Q1 2017), at 5 tbl. 1, 9 fig. 6 (2017). SAVING ENTREPRENEURS, SAVING ENTERPRISES: PROPOSALS ON THE TREATMENT OF MSME INSOLVENCY 59 178. Keith Pond, “The Individual Voluntary 190. See Anderson, above note 184, at 367-68. Arrangement Experience,” J. Bus. L., Mar. 191. Id. at 369, Civil Rehabilitation Act art. 25(iii)- 1995, at 118 (1995). (iv) (Japan). 179. See David A. Skeel, Jr., Debt’s Dominion: A 192. A study of all CRA cases filed from 2000 to History of Bankruptcy Law in America 98-127 2016 by business entities with debt totaling at (2001). least 10 million yen (US$90,000) reported 96% 180. Eugene V. Rostow & Lloyd N. Cutler, successful case commencement. Follow-up “Competing Systems of Corporate Survey, above note 103; Sugiyama, above note Reorganization: Chapters X and XI of the 97, at 2. The rejection rate might be higher for Bankruptcy Act.” 48 Yale L.J. 1334, 1334, cases involving less debt or individual debtors. 1338-40, 1345 (1939). 193. Sugiyama, above note 97, at 3 (noting that 181. Id. at 1334. the debtor can redeem collateral by paying its value into court). 182. Id. at 1337-38, 1340-44, 1362-72; Skeel, above note 179, at 126-27, 162-65. 194. Id. at 3-4. 183. Skeel, above note 179, at 168-230. 195. See Civil Rehabilitation Act art. 155(3) (Japan). 184. See Kent Anderson, “Small Business Reorganizations: An Examination of Japan’s 196. Sugiyama, above note 97, at 4; see also Civil Rehabilitation Act Considering U.S. Anderson, above note 184, at 395 (noting that Policy Implications and Foreign Creditors’ a supervisor is usually appointed to monitor Practical Interests,” 75 Am. Bankr. L.J. 355, the debtor’s execution of the plan in Tokyo 358 (2001). and Nagoya). 185. Id. at 356, 361; see also Sugiyama, above 197. Sugiyama, above note 97, at 2. note 97, at 1 (noting the deficiencies of the 198. Follow-up Survey, above note 103. composition process); Eisenberg & Tagashira, above note 135 (describing the Composition 199. Ministry of Justice, above note 129, at 1. Law process and results). 200. See above section III.C.2. 186. See Anderson, above note 184, at 364 (noting 201. Ministry of Justice, above note 129, at 2, 6. the most significant early CRA proceeding, Sogo Department Store, with a debt load of 202. Id. at 6-12 . over US$18 billion). 203. Id. at 11. If the 144,000 IRP debtors with 187. Follow-up Survey, above note 103, see also “salary” income are included, they overwhelm Sugiyama, above note 106, at 2 (noting the the statistics, at ten times the number of same trend). “business income” IRP debtors, and 330 times the number of individual SRP cases. 188. Id. at 766, 769-70. An additional 8077 (29% of the total) were “salaried worker” cases, and 204. Id. at 13 (50.4% for corporate SRPs, 46.9% that same year saw nearly 230,000 bankruptcy for individual SRPs). filings. See id. at 766. 205. Id. 189. See Stacey Steele & Chun Jin, “Some 206. World Bank Group Insolvency & Debt Suggestions From Japan for Reforming Resolution Team country projects, which have Australia’s Personal Bankruptcy Law,” 17 not been specified for confidentiality reasons. QUT L. Rev. 74, 89 (2017). 60 ENDNOTES 207. See Kilborn, above note 64, at 460-61. 213. Ministry of Justice, above note 129, at 8. 208. See World Bank, above note 5, 207-16. 214. See Skeel, above note 179, at 34-47, 168-70 (2001). 209. See Deborah James, Money from Nothing: Indebtedness and Aspiration in South Africa 215. See id.at 229 (noting the rise of Delaware as 61, 76, 87 (Stanford Univ. Press 2014); see also a restructuring center in large part thanks to a generally M. Roestoff, F. Haupt, H Coetzee & cooperative judge). M Erasmus, “The Debt Counselling Process— 216. www.worldbank.org/insolvency Closing the Loopholes in the National Credit Act 34 of 2005,” 12 P.E.R. 247 (2009). 217. Pages 71-84. 210. Kent Anderson, “Japanese Insolvency Law 218. See, e.g., Jason J. Kilborn, “Determinants After a Decade of Reform,” 43 Canadian Bus. of Failure ... and Success in Personal Debt L.J. 2, 4 (2006); see also id. at 13 (noting that Mediation” Transnat’l Disp. Mgmt. (Winter the Tokyo and Osaka District Courts have 2017), transnational-dispute-management. “divisions dedicated to insolvency matters com. that have gained significant expertise.”). 219. See, e.g., Sarra, above note 77, at 46, 49 (noting 211. See Anderson, above note 184, at 363. the difficulty or impossibility of effectively distinguishing personal from business debt in 212. Oh, above note 129, at 621. the MSME context). 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