Our paper investigates a comprehensive sample of 574 English corporate insolvency cases, including direct liquidation cases. In contrast to other insolvency procedures, liquidations perform poorly on average and fail to produce satisfactory repayments to creditors. We run multinomial Logit regressions to explain the choice between liquidation and reorganization. We obtain three main results. First, we confirm that size matters: distressed firms owning low assets have higher chances of being liquidated immediately. Second, the presence of secured creditors decreases the risk of direct liquidation. This provides a clue that in England, the most-informed creditors adapt their strategies and turn away from the less-performing procedures. Third, we find that the likelihood of administration—which appears nowadays as the main alternative to direct liquidation—significantly depends on the proportion of fixed/current assets owned by the firms.
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The terms insolvency/bankruptcy will be used interchangeably throughout the paper. Yet, it is noteworthy to mention that in the UK, corporate default is referred to as insolvency, not bankruptcy.
From the debtor’s point of view, such screening should not be biased systematically towards liquidation, provided that the NPV of the firm’s project remains positive. From the creditors’ point of view, the choice of one insolvency procedure against another mostly depends on how their repayment rights are protected under such procedure.
Germany, for instance, offers only two main procedures (or outcomes) after insolvency filing: one corresponds to direct liquidation, and the other aims at preparing a plan (Insolvenzplan). The latter remains scarce in practice (Angele 2008).
Simply named “receivership” in the rest of the paper. Actually, receivership procedures fall into two categories: Administrative Receivership (AR) and Receivership (R). Under AR, the receiver is appointed wide management control over the whole firm’s property. Under R, this control is limited to specific property.
Receivership was restricted by Enterprise Act 2002, but open receivership cases will continue past this date until they are closed.
Depending on the legislation, the decision to trigger insolvency can be made by: (i) the debtor, (ii) the creditors, or (iii) both. Fundamentally, however, this remains a constrained decision: legal provisions can force the firm to enter a procedure under particular circumstances (e.g., excessive liabilities, suspended business). Moreover, the perceived attractiveness of the rules prevailing under bankruptcy, when compared to informal renegotiation, is likely to influence the debtor/creditors’ volition to file for a specific procedure.
According to Van der Schans (2012), English SMEs use bank overdrafts (29%), credit cards (19%), bank commercial & mortgage loans (11%), directors & family equity (11%), leasing (7%), and others (6%). Of these, 51% do not use external finance but exclusively finance their activities with trade credit and/or internal reserves (the total exceeds 100%, as a corporation can use several financing sources at the same time).
Subject to certain exceptions (Law of property Act 1925), the right to appoint an administrative receiver in all cases where a floating charge was created on or after the commencement of the provisions on 15th September 2003.
It has commonly been suggested in the law and economics literature that court control (a lesser form of which is found in the US Ch.11 procedure) could be costly and inefficient, despite a careful study by Morrison (2007) presenting an opposite finding.
Refer to the Insolvency Service© website for the latest statistics of filings under different insolvency procedures.
Our approach focuses on bankrupt firms only. This allows us to identify the factors explaining the outputs of procedures that provide different legal environments to solve financial distress. Other studies focus on the various ways of closing business (sale vs. liquidation, compulsory vs. voluntary exit) for both profitable and distressed firms (see Wennberg et al. 2010, for Sweden, Boyer and Blazy, 2012, for France). These studies complement our approach by encompassing a broader set of situations, but without distinguishing between the types of insolvency procedures.
The Insolvency Service is a government agency of the Department of Business Innovation and Skills, with headquarters in London. The Insolvency Service administers compulsory liquidations and personal bankruptcies, and it verifies misconduct and discrepancies if required.
For CVL, we obtain information through Begbies Traynor©, a UK leading professional consultancy service composed of insolvency practitioners, professional advisors, consultants, accountants, etc.
Such choice lies in the hands of the debtor and/or the creditors (depending on the firm’s actual situation and on the type of procedure engaged).
We measure “size” in terms of total assets (market value) and of overall due claims.
Throughout our analysis, we split the firms’ creditors into five categories: preferential, employee, secured, new money, and unsecured claims.
We find in the literature little empirical evidence of the determinants of the choice between liquidation and reorganization procedures. Armour et al. (2008) studied costs and duration under administration and receivership procedures (UK). Bris et al. (2006) studied costs under the US liquidation procedure, and many authors studied costs under Chapter 11 (Ferris and Lawless 2004, Lubben 2012, Weiss 1990). Thorburn (2000) studied costs and recovery rates under the liquidation procedure in Sweden.
The process remains quite the same for directors and creditors. However, some rules have been simplified with the objective of increasing creditor engagement, reducing unnecessary administrative burdens and costs that reduced returns to creditors. For example: (i) officeholders can make payment for small dividends without formal claim; (ii) abolition of physical creditor meetings by electronic voting and virtual meetings; (iii) termination of the requirement to hold certain meetings, as considered unnecessary and time-consuming process (final meetings of creditors in liquidation and bankruptcy are no longer required. Instead the liquidator or trustee must file a final report); (iv) when the officeholder writes to creditors with a proposal, and fewer than 10% by value of creditors object, the proposal is deemed to be approved and these deemed consents can be given email correspondences, electronic voting or virtual meetings; (v)the new framework fosters website and electronic communication for notification to creditors. These new insolvency rules follow the objective to increase creditor participation in the process.
Receivership was suspected of excessively favoring secured creditors, leading too often to piecemeal liquidation.
Let us note that, on this period, some appointers (mostly banks) made the positive choice to appoint an administrator, even though they could have appointed an administrative receiver.
An administrative receiver primarily owned fiduciary duties towards the party (bank) making appointment and did not consider for seeking repayment for general body of creditors as a whole.
The exceptions are highly specific to certain large-scale financial arrangements or particular entities and still permit the appointment of an administrative receiver in highly prescribed circumstances.
EA2002, §251 (1) states that the Crown preference shall cease to exist.
The EA2002, §252 introduces a new Sect. 176A into the IA1986, which introduces the ring fence fund.
See appendix Table 12 for more details on the structure of our template.
In England, insolvency practitioners are liquidators, administrators, receivers, etc. They are private companies (except for the CL liquidators, who are appointed by the State).
Here, the duration of the procedure (in months) corresponds to the entire process (i.e. the time interval from the beginning of the procedure till the end, when the firm is sold or liquidated). Thus, in case of piecemeal liquidation, duration includes the time it takes to liquidate the assets.
The year of insolvency corresponds to the triggering date. Recent years have more incidences in the time distribution of our sample. The reason for this is that it is not easy to trace firms that defaulted years ago, because information related to them is barely available.
We may also measure size by considering the total number of employees. Unfortunately, this information is often missing in insolvency files, especially those attached to liquidation procedures. In addition, such information on employees becomes volatile prior to default. Considering the total assets and/or the total due claims appears as an interesting alternative to measuring the firm size.
This information was not reported for some files, which we treat as missing data.
Blazy and Combier (1997) suggested that one factor may not be sufficient to generate default but that a combination of causes might be involved. Although we do not include these combinations in our study, we do acknowledge that subsequent dominant causes for default significantly differ from one procedure to the other, as shown by Fisher tests.
Due to missing values, the sample used for descriptive statistics (Sects. 3.2, 3.3 and 3.4) slightly differs from the one used for econometrics (Sect. 4). The difference comes mostly from CVLs: 24 CVL files (out of 66) contain information on the causes of default, and thus could be used in Sect. 4. To decrease the heterogeneity between both sections, we provide here (mean) statistics on the subsample of CVL files that were actually used in Sect. 4: total assets (140 K€), %intangibles (0%), %tangibles (33%), %financial assets (0%), %inventory (6%), %receivables (48%), %cash (13%); total due claims (524 K€), %due preferential (8%), %due employees (1%), %due secured (17%), %due new money (4%), %due unsecured (64%), %due bankruptcy costs (6%), total recovery rate (14%), secured rec. rate (19%), preferential rec. rate (19%), employees rec. rate (32%), new money rec. rate (100%), unsecured rec. rate (7%), duration of the procedure (59 months), bankruptcy costs, in % of total assets (39%), bankruptcy costs, paid value (29 K€).
The directors are obliged by law to provide such documents to the court-appointed official.
For both procedures, the median proportion of cash is however lower than the average: e.g., 4% (CVL) and 13% (CL).
The owners of such charges are given the exclusive right to trigger receivership by appointing a receiver.
Note that after EA2002, the State lost its preferential status and now falls under the unsecured category for administrations.
See Schedule 6 of IA1986.
Except for CLs that do not generate new money. That new money claims mostly repaid in full is a noteworthy feature of English procedures that effectively protect the post-default creditors and, thus, provide a suitable framework to prepare a sensible legal solution to financial distress.
Insolvency Act 1986, SchB1,§76.
Armour et al. (2008) also find that administrations are costlier than receiverships.
One dummy variable only (cf. “production”) significantly decreases the probability of receivership under multinomial PROBIT, while it is not significant under multinomial LOGIT.
The weight of new money creditors also increases the chances of receivership. Indeed, under receivership, new money is often raised by the existing secured creditors in order to reach an outcome maximizing their chances of recovery.
Interestingly, the holders of floating charges can appoint the administrator out-of-court without having to demonstrate that the company is unable to pay its debts. On the other hand, directors of the company need to demonstrate that the company is unable to pay its debts to materialize out-of-court appointment (§27(2) Schedule B1 Insolvency Act). Previously, administrators could only be appointed on the order of the court.
The proportion of new money claims also significantly enhances the chances of reorganization: here again, the availability of post-petition financing plays a critical role for the implementation (and acceptance) of a reorganization plan.
Note: including the State.
Remind that the debtor cannot initiate receivership.
When considering receivership and administration altogether (vs. direct liquidation).
One may notice the negative influence of the coverage rate (i.e. total assets out of due claims) onto the probability of triggering receivership /administration versus liquidation. The interpretation follows: ceteris paribus, a high coverage rate at the time of default increases the likelihood of satisfactory recovery rates, whatever the procedure initiated. Thus, opting for faster procedures (CLs) has some advantage for the creditors.
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Agence Nationale de la Recherche (ANR) financed this research (EURODEF program: http://www.agence-nationale-recherche.fr/Project-ANR-12-BSH1-0013). We are grateful to the journal’s referees. Any remaining errors are ours.
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Blazy, R., Nigam, N. Corporate insolvency procedures in England: the uneasy case for liquidations. Eur J Law Econ 47, 89–123 (2019). https://doi.org/10.1007/s10657-018-9599-2
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