Citation(2008) 20 SAcLJ 396
Published date01 December 2008
Date01 December 2008

This article looks at some of the main features of Chapter 11 of the US Bankruptcy Code and considers their appropriateness for adoption in the Singaporean context. Chapter 11 deals with the reorganisation of ailing businesses though there is no formal insolvency requirement before a company can file for Chapter 11 protection. The nearest statutory equivalent to Chapter 11 in Singapore is perhaps judicial management under s 227 of the Companies Act or perhaps judicial management coupled with a s 210 scheme of arrangement. The article begins by endeavouring to explore the underlying objectives of corporate rescue law. This is followed by a look at the main features of Chapter 11. Some specific features of Chapter 11 are then considered with a view to their possible adoption in the Singaporean context.

I. The objectives of Chapter 11 and corporate rescue law in general

1 Many countries now have corporate rescue or restructuring laws which seek to preserve the going concern value of an ailing enterprise. The underlying principle behind restructuring or reorganisation proceedings is that a business may be worth a lot more if preserved, or even sold, as a going concern than if the parts are sold off piecemeal.1 In

other words, there is a surplus of going concern value over liquidation value.2

2 In the US, as one court put it “the purpose of [Chapter 11] is to provide a debtor with the legal protection necessary to give it the opportunity to reorganize, and thereby to provide creditors with going-concern value rather than the possibility of a more meagre satisfaction of outstanding debts through liquidation”.3 Influential US commentators have reduced the liquidation versus reorganisation question to a quasi-mathematical formula. It has been suggested that whether a firm should be kept together as a going-concern is answered by estimating the income stream that the assets would generate if they were kept together, taking into account the risk of reorganisation failure, discounting that stream to present value, and comparing it to the amount that the assets would realise if they were sold off in separate pieces.4 Since going concern value may be a lot more that break-up value, reorganisation proceedings are designed to keep a business alive so that this additional value can be captured.5

3 This objective is itself controversial for there is a widely held view that if a company encounters economic difficulties the simplest and most effective solution is to put it out of its misery, so to speak, by terminating its existence. If a business is no longer viable, then the most sensible solution may be to shut it down. If a company is producing goods and services for which there is no ready market, then why not liquidate it? For example, take the case of a dog food company that is producing food that dogs do not like. There seems little gain in keeping such a company alive.6 Moreover, preserving dying companies or putting them on a life support and resuscitation machine may do little to benefit the industry in which they operate. Instead, it may hurt

competitors by forcing them to compete with debt-reduced and restructured companies, but ultimately inefficient companies, in a crowded market place. The US airline industry may be an example of this.”7

4 One of the principal characteristics of a market economy is that some companies fall by the wayside. Forcing investors to keep their assets locked up in what is at best a marginal enterprise may prevent the same investors from making more productive use of the assets in a more efficient enterprise. It also may reduce their incentive to invest these assets in the first place.8

II. Going concern value and the modern service sector oriented economy

5 Certain commentators have put forward the thesis that because of changes in the economy and, in particular, technological advances, globalisation and the rise of the service sector, we are witnessing the end of corporate reorganisations as traditionally understood.9 They point to the decline of heavy industry and make the point that successful companies today are not very much like the US railways of the 19th century which were the historical prototype for Chapter 11. In the case of a railroad company, the assets had very little value when sold off individually — nothing but “a streak of rust iron in the prairie” to use a memorable phrase. In the case of a modern company, the most valuable resource may be human capital who can walk out the door at five o’clock in the evening. The accoutrements of the modern office may have just as much value if sold off to another company than if kept by the debtor.

6 In the real world, however, transaction costs cannot be ignored.10 Transaction costs are all around us. They exist in almost every

move of daily life. Going concern value resides principally in various relationships “among people, among assets, and between peoples and assets”.11 It is tough to start a business from scratch. Networks of relationships are at the heart of a modern business. Costs incurred in creating most of these necessary relationships will inevitably be lost if the business is scattered to the winds through a piecemeal sale of assets. Substantial additional costs will be incurred in the establishment of new relationships and the starting up of a business afresh. Moreover, centralised management and other benefits from economies of scale can be the source of going concern value.12

7 These points have been well made by the Legal Department of the International Monetary Fund (“IMF”) who go so far as suggesting that changes in the nature of the economy has meant that reorganisation and restructuring of ailing firms has become more important than ever before:13

[I]n the modern economy, the degree to which an enterprise’s value can be maximized through liquidation of its assets has been significantly reduced. In circumstances where the value of a company is increasingly based on technical know-how and goodwill rather than on its physical assets, preservation of the enterprise’s human resources and business relations may be critical for creditors wishing to maximize the value of their claims.

8 Simply stated, some companies are worth more as going concerns run by existing managers and with existing shareholders than if sold to third parties and managed by new teams.14 The going concern surplus may result from the informational advantages of existing management or from the sunk costs of arranging assets in strategic blocks. The surplus has to be substantial, however, to justify the very substantial administrative, negotiating and legal costs of the reorganisation proceedings themselves.

III. Economic distress versus financial distress

9 In commenting on the value of corporate rescue laws, it is common to draw a distinction between economic distress and financial

distress. Economic distress implies that the business plan is not working. The economic model on which the company is based suffers from some flaws. Companies in economic distress are not good candidates for reorganisation unlike companies in financial distress. Financial distress implies liquidity problems of some sort and where a company cannot meet its current liabilities. This may have been caused by some short-term dislocations in market conditions. The bankruptcy of a customer may have affected the company’s capacity to honour its commitments to its own suppliers. The company may have been trading across national frontiers and been badly caught out by currency fluctuations. Alternatively, debt-servicing costs may have risen sharply beyond the company’s capacity to service them.15 In the latter scenario, an obvious solution (if difficult to achieve in practice) would be to convert some or all of the company’s debt into equity. The necessary consent from creditors may not be forthcoming, however, and so recourse to formal procedures is necessary to concentrate minds sufficiently.

IV. Wider purposes served by corporate rescue laws

10 In many jurisdictions, including the US, discussion of the purposes served by corporate rescue laws has ranged beyond a narrow focus on the going concern surplus. For instance, in the US Congress, it has been stated that:

The purpose of a business reorganization case, unlike a liquidation case, is to restructure a business’s finances so that it may continue to operate, provide its employees with jobs, pay its creditors and provide a return for its stockholders.16

11 Outside the congressional context, Chapter 11 has even been spoken of as bound up with the preservation of the American way of life in that it provides the opportunity for the small business debtor to survive economic upheaval. If jobs in small business enterprises

disappear, then competition and convenience may disappear with them.17

12 Similar themes have also been taken up by the IMF in its paper “Orderly & Effective Insolvency Procedures: Key Issues”.18 The IMF has spoken of corporate rehabilitation procedures as serving a broader societal interest in that business debtors are given a second chance and this encourages the growth of the private sector and an entrepreneurial class. More generally, the IMF has acknowledged that:19

[E]conomic efficiency is not the only consideration when designing insolvency laws. There are social and political factors that are served by the existence of formal rehabilitation provisions and, in particular, the protection of employees of a troubled enterprise. These considerations explain why the design of rehabilitation provisions varies from country to country. When countries evaluate and reform their insolvency laws, the key question will often be how to find the appropriate balance between a variety of social, political, and economic interests that will induce all actors in the economy to participate in the system.

13 To sum up, apart from maximising returns to creditors, corporate...

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