In the context of the Bank’s ongoing work under the International Financial Architecture Program, the Legal VPU hosted, together with UNCITRAL and the EBRD, a conference on secured transactions and insolvency law reform, on May 5 – 6, 2008. The modernization of legal regimes and institutions relating to creditors rights and insolvency is an integral part of the IFA initiative. The purpose of the conference was to examine the choices that policy makers face in designing effective legal frameworks for responsible access to finance. The conference brought together several of the world’s leading experts in that field. The conference participants came from a number of developed and developing nations, as well as many inter-governmental and non-governmental organizations.
By addressing the intertwined areas of insolvency and secured transactions, the conference highlighted many of the key issues that policymakers face in designing such a legal framework. These include:
How to promote increased lending by financial institutions without undercutting the legal remedies for unsecured trade suppliers;
How to balance the need for efficient and effective means of creditor enforcement with legal mechanisms to protect an ailing business from creditors while it restructures; and
How to build the necessary institutional and regulatory support required to make secured transaction and insolvency legislation operationally effective.
As participants delved deeper into these issues, a number of critical questions emerged from the conference, including:
1. Is the relationship between law and finance adequately understood?
The prevailing wisdom in much of the contemporary law and finance literature holds that greater access to finance, at all levels of a domestic market, is best facilitated by legal systems which create efficient and effective means of granting, acquiring and enforcing rights in movable property. Facilitating secured credit, it is argued, will not only lead to more abundant, and less expensive, credit availability, it will also have a positive effect on unsecured lending. Some of the presenters at the conference, however, presented arguments which forcefully counter this wisdom. A case study from India was shown to illustrate that a marked increase in secured creditor rights actually resulted in less secured lending because, it was argued, borrowers were reluctant to enter into commercial relationships which they viewed their rights as being a priori constrained by the legal framework. Another presenter demonstrated that the argument in favor of giving secured creditors ‘absolute priority’ in bankruptcy (generally favored in existing literature), creates an environment in which lenders are disincentivized from conducting the appropriate due diligence with regard to their borrowers. This, in turn, can lead both to predatory lending and, as exemplified by the current credit crisis, systemic problems triggered by ‘too much access to finance’. Finally, one presenter argued that much of the existing literature places a premium on respecting the contractual bargain between borrower and lender, with the latter typically obtaining security as part of this bargain. Preserving this bargain in insolvency, however, often requires interfering with the contractual bargain between the borrower and other stakeholders, such as suppliers and employees. The economic and social effects, therefore, of preserving secured creditor rights need to be well understood by policymakers.
2. How should legal rights be apportioned in insolvency?
Proponents of strong creditor rights mechanisms argued that gains made by countries that have adopted efficient and predictable enforcement mechanisms for enforcement of security interests risked being undone by insolvency rules that introduced too much uncertainty, particularly by allowing courts and debtors to have greater control of insolvency proceedings By contrast, many argued in favor of the debtor-in-possession system (common in France, the United States, Canada and elsewhere) –a mechanism designed to encourage successful business turnaround, while minimizing creditor involvement. To support the reorganization process, such systems often create incentives for creditors to provide financing after the commencement of insolvency proceedings by providing post- commencement creditors with a “super priority” security interest, which introduces greater uncertainty for existing creditors.
The traditional logic for giving secured creditors ‘deal-breaking’ rights in insolvency was also challenged in an innovative paper by Professor Henry Hu of the University of Texas. Professor Hu looked at the issue of the ‘decoupling’ of voting rights of secured creditors from their economic interest, through the use of relatively new derivative instruments such as credit default swaps. He argues that legal and regulatory structures in most developed and developing countries recognize secured creditors as having a critical role, and corresponding rights, in the insolvency process. These creditors, however, can – and often do – hedge their financial exposure as holders of debt instruments through the use of derivatives. In some cases, a secured creditor can sit as a debt holder of a troubled company, while at the same time being in a position to benefit financially (through these derivatives) if the company fails. Professor Hu’s paper argues that there are potentially systemic risks where creditors may not have an interest in maximizing the value of the debtor’s estate, nor a corresponding duty to disclose their financial interests. Potential solutions to this problem were discussed, including the introduction of disclosure obligations for secured creditors in insolvency proceedings. Professor Hu’s work has received extensive coverage over the past few months in the Wall Street Journal, Financial Times and the Economist.
Below, you will find the agenda for the conference. The title of each session will link you to a brief paper on the session’s outcomes, as well as the papers and presentations delivered.
Secured Transactions and Insolvency: Reforms at a Crossroads
Joint EBRD/UNCITRAL/WORLD BANK
MONDAY, MAY 5, 2008
8:00 – 8:45 AM
8:45 – 9:20 AM
Keynote Address and Opening Remarks
PART I - ARE THE TWO SIDES TALKING TO EACH OTHER?
9:20 – 11:00 AM
|SESSION I: SECURED CREDITORS IN INSOLVENCY: SHARING THE RISK OF INSOLVENCY?|
Would attempts to spread the risk of insolvency across all stakeholder groups restrict access to credit and drive up the cost of financing? Why do the contractual rights of secured creditors receive different treatment than those of other stakeholders? Is the issue of the “Stay” resolved and is priority ranking a false issue when compared to preservation and protection of collateral?
11:00 – 11:20 AM
11:20 – 1:00 PM
SESSION II: PRIVATE PARTIES IN PUBLIC PROCEDURES
Secured transactions law should facilitate the contractual freedom of parties to the transaction and ensure a high level of certainty that the terms of the contract will be enforced. Yet, in insolvency, issues of public policy intrude into the otherwise private relationships of parties. What is the role of courts in maintaining this balance? Do current US experiences suggest a need for regulatory protections to proceed hand-in-hand with reforms of legal infrastructure or is that an unnecessary muddling of two distinct issues?
1:00 – 2:15 PM
PART II - FROM THEORY TO PRACTICE
2:15 – 4:00 PM
SESSION III: WHAT DOES EMPIRICAL RESEARCH HAVE TO SAY ABOUT THE REFORM AGENDA?
In the last few years, a great deal of research on law and finance has been conducted, emphasizing the importance of secured transactions and insolvency. Has this led to a consensus? How are data collected? What could be improved? How are the findings transferred into the field? What are the respective roles of academia and international organizations?
4:00 – 4:20 PM
4:20 – 5:30 PM
SESSION IV: WHAT DOES IT ALL MEAN FOR THOSE DOING REFORM?
The gap between best practices, policy advice and the reform work conducted on the ground can be big: why? Is the advice not given in the right format? Are advisers focusing on the wrong aspects? Do the recipients have enough of a voice? What can be achieved today and what will have to wait for tomorrow?
5:30 – 7:30 PM
TUESDAY, MAY 6, 2008
PART III - EMERGING ISSUES
9:00 – 10:30 AM
SESSION V: INSOLVENCY OF GROUPS
Enterprise groups are ubiquitous in trade and commerce, but when one or more group members become insolvent, insolvency laws generally focus on individual legal entities. What can be done to facilitate the conduct of insolvency in a group context, both domestically and internationally, in a manner that ensures predictability and certainty for secured lenders? This session will identify the issues and explore possible solutions.
10:30 – 11:00 AM
11:00 – 12:30 PM
SESSION VI: WHO’S MINDING THE STORE IN INSOLVENCY? CREDITOR CONTROL VS. DEBTOR IN POSSESSION
Does a debtor-in-possession system really create more efficiencies or is it an invitation to litigation? Is post-commencement financing really worth promoting in counties where: (a) judicial discretion to grant such orders is anathema to the legal system; and (b) such financing products do not exist in the marketplace? What rules, if any, do we need to address the issues associated with the changing nature of actors in insolvency and the changing incentives that result from the use of instruments such as credit default swaps and other derivatives?
12:30 – 1:00 PM