In the absence of well-developed financial markets, bankruptcy procedures provide useful mechanisms to ease and organize the capital transfers of distressed businesses. From an investor’s perspective, such court-supervised ways of solving financial distress are part of the attractiveness of the post-transition economies that eventually integrated the European Union. This article originally analyzes the content of bankruptcy files handled by the courts operating in three Eastern European countries: Hungary, Poland, and Romania. Our approach mostly focuses on the two fundamental issues that bankruptcy courts must solve when the question of repayments arises: (1) maximizing and (2) sharing the debtor’s value. We first find that the investors’ recovery power strongly depends on the local rules prevailing after bankruptcy filing (legal indexes) and on the type of procedure engaged (reorganization vs. liquidation). Second, total recoveries do not benefit from the presence of public claims suggesting some passivity from the state, in the context of post-transition. Conversely, junior creditors exert a positive influence on total recoveries despite their poor legal protection, which contrasts with secured creditors (confirming the bad incentives that collaterals may generate). In addition, as in Western Europe, the Eastern European bankruptcy systems provide stronger protection for private secured claims than for public claims.
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Both names can be used, depending on the considered legislation. In this article, we use the terms bankruptcy or insolvency when referring to collective procedures for corporations (i.e. excluding individuals).
The Doing Business report—published annually by the World Bank—covers a wider range of countries, including Eastern Europe: 185 countries are ranked by their ability to design and foster an attractive business environment (“ease of doing business”), which includes bankruptcy law (“resolving insolvency”). The 2013 Doing Business report (World Bank 2013) shows a high discrepancy within Eastern Europe: Poland is ranked 37th, Hungary 70th, and Romania 102nd. One of the benefits of the World Bank’s approach is to provide recurrent and comparable indicators for countries that differ regarding the design of their institutions. However, the manner in which the Doing Business report measures bankruptcy attractiveness has limitations because the three indicators used in this ranking (time, costs, and recoveries) mainly rely on rules of thumb. The recovery rates are assessed by local experts who are asked to evaluate the likely figures in a case study (a restaurant with 201 employees and 50 suppliers that is financed by one bank), but there is no guarantee that such profile adequately represents the companies operating within each country. In fact, bankruptcy analyses require empirical research based on real data that is extracted from real cases as they are managed by the bankruptcy courts. However, the question remains as to what variables should be considered when assessing the attractiveness of bankruptcy.
Poland and Hungary joined the European Union on May 1st, 2004. Romania joined the EU on January 1st, 2007.
Sajter (2010, p. 140) posits with respect to Croatia: “When in the position of creditor, in many cases the government fails to take responsibility, and does not take a stand in the processes. In some cases, The State Tax Administration Office tolerates non-payment of taxes for many years, and government institutions sometimes look the other way for even a decade of non-payment of taxes and other debts.”
The SLR index measures to what extent collateral and bankruptcy laws facilitate credit by protecting both the lenders’ and borrowers’ rights. It ranges from 0 (low) to 10 (strong protection). Some countries with better designed laws may have scores superior to 10 (up to 12).
The ranking of every country depends on three criteria: time to close a business, cost of resolving default, and creditors’ recovery rates.
In Poland, the SLR index has increased from 4 (2008) to 9 (2013). It now equals 7 (2018). The Polish bankruptcy system is also better ranked by the World Bank: from 88th (2008) to 37th (2013). Poland is now ranked 22nd (2018).
Our sample does not encompass informal restructurings, and thus restricts to the two first procedures.
The Polish APO follows: First, bankruptcy costs, employees’ claims and farmers’ claims (1) are satisfied. Second, taxes and other public financial obligations (2) are satisfied (if category (1) is fully covered). Third, the liquidator uses the remaining value to satisfy claims associated with interest due in the year prior to the bankruptcy petition (3). Fourth, the other claimants: judicial and administrative fines (4). Since May 2009, the priority rule of the Polish bankruptcy law was modified. Category (1) was divided into two categories. The liquidation values are first used to cover bankruptcy costs. After full payment of the bankruptcy costs, the second category corresponds to employee’s claims and farmers’ claims. The priority of the other categories remains unchanged.
Nevertheless, the stay of payment does not apply to employees’ wages and to public claims such as taxes or social insurance contributions. If the bankruptcy petition is filed by creditors, the moratorium is not enforced.
Minimum and maximum thresholds are 5000 forints (around 16 euros) up to 100,000 forints (around 327 euros).
The liquidation procedure can also be opened after a composition agreement fails.
In general, the court considers a debtor to be insolvent if the value of assets is insufficient to repay liabilities. If the petition is filed by creditors, the court checks the existence of the conditions stated in the petition. A liquidation petition will be dismissed by the Court in the absence of any proof of the debtor’s insolvency.
The legal feature of liquidator selection was introduced in 2010 at the request of judges and liquidators.
The Hungarian APO follows: (1) claims of secured creditors (net of costs related to the collaterals: maintenance costs, selling costs of the pledged assets…), (2) bankruptcy costs and employees’ claims, (3) claims secured up to the remaining value of the pledged property, (4) alimony and life-annuity payments, (5) claims of small and micro firms, (6) taxes and social insurance debts, (7) other claims, (8) default interests and debt penalties, (9) shareholders.
45,000 lei equal approximately 10,200 euros.
A debtor is “insolvent” if the payment of its debts has a delay longer than 90 days due to insufficient funds.
The plan contains a set of proposals to restructure the debtor’s activities and/or to liquidate certain assets.
The Romanian APO follows: (1) claims of secured creditors that arose before and during the procedure, and bankruptcy costs associated with the preservation of pledged asset(s), (2) bankruptcy costs, (3) employees’ claims, (4) credit lines granted after the opening of the procedure, (5) public claims, (6) alimony, (7) claims set by the judge for the survival of the debtor’s family, (8) claims from deliveries and services, (9) unsecured claims, (10) shareholders.
Yet, if a creditor is willing to satisfy the uncovered costs, the procedure can go on.
Poland, Hungary, and Romania also differ regarding their financial/entrepreneurial development. First, according to the World Bank, their financial markets differ in size. The 2003–2011 average market capitalization of listed companies represented 32% of Poland's GDP, 24% of Hungary's GDP and only 12% of the Romania's GDP. However, such percentages are below the ones registered in France (76%), U.S.A. (116%), or U.K. (114%). Second, Hungarian firms are using banks to finance investments more often than Polish and Romanian firms. Almost half of Hungarian firms had a debt contract with banks in 2009. Third, during the post-transition era, the creation of new firms between was much more intense in Romania: between 2006 and 2011, in Romania, the average annual number of new businesses was respectively 2 times and 5 times higher than in Hungary and in Poland.
From an empirical perspective however, the level of recoveries may be attributable to factors unrelated to bankruptcy law, such as the firm’s specific attributes and the national macroeconomic environment. Thus, controlling for such factors is a required step, so that any remaining effects on recoveries can be related to how the bankruptcy procedures are designed, regulated, and managed.
Romanian Law n°85/2006 art. 11 (1) c.
Romanian Law n°85/2006 art. 11 (1) e.
Regulatory Quality is an index that ranges from − 2.5 to 2.5. A high value is associated with governments efficient in formulating regulations that can promote the private sector development. According to the World Bank, the average value for the 2002–2012 period was equal to 1.13 for Hungary, 0.85 for Poland and 0.40 for Romania.
The World Bank provides data about Government Effectiveness that assesses the quality of public and civil services, their independence from political pressures, the quality of policy implementation, and the government’s credibility to commit to such policies. That index ranges from − 2.5 to 2.5. The average value of Government Effectiveness for the 2002–2012 period was 0.78 for Hungary, 0.52 for Poland and − 0.28 for Romania.
Marginally, residual claimants’ interests and efficiency align with one another. One may argue that residual claimants also have an interest in invoking cumbersome and expensive procedures to delay the termination of their option value. Yet, as shown by Baird and Bernstein (2005), such incentives arise only if the value of the bankrupt firm remains uncertain. Moreover, the rationale of such strategy is questionable in practice, as the bankruptcy costs (direct and indirect) are paid out of this value.
Both approaches are not strictly equivalent, but the second one can be easier to implement empirically.
At the beginning of the procedure for example, some creditors may expect no repayment at all.
In theory, a claimant is “residual” if his/her expected recovery rate strictly lies between zero (no repayment) and one (full repayment): then, any marginal increase in the debtor’s value is expected to increase his/her repayment. In practice however, the situations under which the observed recovery rate equals 100% are rare. This leads us to consider “incentivized creditors” whose expected recovery rate is strictly positive.
For example, when the debtor’s value is high (ex-ante) and the amounts due to senior creditors are moderate, junior creditors may expect substantial recoveries. In this context, the procedure should also protect the interests of the junior creditors because they are incentivized to expand the overall firm’s value. Of course, such incentives may disappear with lower assets and/or different claim structures, giving junior creditors no hope of recovery.
Yet, being “involved” implies monitoring and verification costs. To be effective, those creditors must be in position to recover something from the debtor (and even correspond to the residual claimants). Otherwise, it is unlikely that (private) claimholders spend the requisite time and energy to improve total recoveries.
We can also mention two other counterarguments. The first is related to (private) bankruptcy practitioners who may lack incentives to behave efficiently. Their claims differ from the others because, at an early stage of the procedure, the practitioners have not yet spent money (or effort). In such a situation, they might invest substantial effort in the procedure if and only if they expect to be paid in full: from the practitioners’ point of view, being partially paid may not provide enough incentives to increase repayment for the entire set of creditors. The second counterargument is related to the outcome of the procedure (liquidation vs. reorganization), which may change the nature of the incentives. Suppose, for example, that the value of a bankrupt firm is higher under liquidation than under reorganization. Here, a creditor, even in the position of being “residual”, may promote reorganization for reasons that extend beyond the sole question of immediate repayment: a bank may decide to abandon part of its claim in the hope of pursuing business with the reorganized company or because the bank fears negative externalities that might arise from the firm’s liquidation (loss of reputation, domino effect, etc.).
This is true for our countries of interest (Poland, Hungary, and Romania).
Obviously, creditors do not manage the procedure directly: they are represented by a liquidator who works under the supervision of a court. Nonetheless, they can influence the procedure from the beginning to its end.
For instance, in the United-Kingdom, the Crown’s preferential status was abolished by the Enterprise Act (2003).
3 Romanian and 4 Hungarian practitioner companies.
During this process, we noticed that the recovery rate of the creditors' debt ranged from 25 to 30% to 80–85%, and that the structure of claims differed among the cases (cases with unsecured claimants only, cases with secured claimants and unsecured claimants, etc.). Hence, we decided to add those cases to our sample.
Namely: A-Conto(o)-Roll Kft., Csabaholding Zrt., Credit-Audit Kft., Interit Kft., Juris-Invest Kft., Pro-Creditor Kft., Tm-Line Zrt.
Namely: Észak-Magyarország, Észak-Alföld, Dél-Alföld, Közép-Magyarország, Közép-Dunántúl, Nyugat-Dunántúl, Dél-Dunántúl.
These local firms include the following: Casa de Insolvență Transilvania, Euroinsol, Global Money Recovery IPURL, Pavel Management, Rominsolv, Rovigo, Rominsolv, Solvendi, MRL - Management Reorganizare Lichidare Iași.
We have more observations on Romania for the most recent years due to the recent implementation of the reformed Romanian Law.
This is an average proportion between 2006–2011.
This figure encompasses reorganizations and arrangement procedures.
We compute two measures of duration. First, a lower estimate from the beginning of the procedure to the date when the file is officially closed (i.e. when liquidation is terminated or when the plan is fully validated by the court). Second, an upper estimate, adding to the previous one the planned duration of reorganization, under the assumption that the plan does not fail before its scheduled end. The actual duration lies between both estimates.
In Hungary, nearly 100% of bankrupt firms are liquidated.
Appendix 3 does not display the recovery rate on year 2003, as we have less observations for this year.
At this date, Romania (that integrated the EU later, in 2007) seems less affected than the other two countries.
This finding on employees applies to Poland and Romania only (the Hungarian sample does not contain unpaid employees). For both countries, bankruptcy systems seem to favor social claims, which might reflect some willingness to compensate for the weaker level of social system development in these countries.
The employees as well, which appears quite logical for companies being reorganized though a plan.
The corresponding codes are: strategy, production, finance, management, accident, outlets, and environment.
As mentioned above, there are no reorganization cases in Hungary.
See also FNR report n°06/31/17 (VIVRE2 research program, Luxembourg, 2010).
The legal sources are as follows: Sect. 57 of the 1991 XLIX bankruptcy act (Hungary), article 342 of the 2003/2009 bankruptcy laws (Poland), and the bankruptcy law n°85/2006 (Romania).
On our analyzed countries, the bankruptcy files contain reliable information on this value, and provide verified estimates of the market value of the debtor’s assets, when (s)he enters the procedure.
Thanks to the practitioner’s verification work, our files contain both types of information.
Model 1b includes seven times dummy variables, covering the time period, from 2005 to 2011 (in reference to years 2003/04—the omitted dummies—that correspond to the beginning of the covered period). To avoid multicollinearity issues, model 1b does not include the annual economic growth (DGDP).
For space constraints, Variance Inflation Factors (VIF) are not displayed here. Those are available on request.
These values exclude model (1b). The inclusion of time-dummies logically increases VIF statistics, with a maximum VIF of 4.36 on this model (which remains satisfactory, as all the VIFs remain inferior to 5).
A bankruptcy procedure can be viewed as a treatment against disease (financial distress), leading to an outcome (recovery rate). Confounding issue arises when the traits of a subject predetermine the treatment (s)he receives.
Those probabilities originate from a PROBIT regression. The propensity scores are then reversed and used to (re)weight the sample to make the firms more comparable (whatever the procedure they file for). Contrary to the other propensity scores matching methods, there is no loss of observations with IPTW regressions.
This is mostly true is they own residual claims (Daigle and Maloney 1994).
That is, the initial value of assets (market value) out of the total claims due.
Assessing the actual impact of both crises onto creditors recoveries would require expanding the covered time-period.
The sources of data and computations are available on demand.
Yet, under reorganization, secured creditors were slightly outranked on average by public creditors.
The labels “recov” and “due” represent “recovered amounts” and “due debts”.
The first-step OLS regression is computed on several instruments to obtain the predicted values of the endogenous variable (here, the logarithms of the recovered amounts). Then, the predicted values are returned to the initial equations, which are estimated again. The resulting residuals are used to estimate the variance–covariance matrix of the errors. Finally, generalized least squares are used to estimate the entire system.
To save space, this table does not display i) the second step of the 3SLS regression, nor ii) the second equation within each system (i.e. the equation explaining the amounts recovered by the “other” classes of creditors, compared to class “J”). Complete estimates are still available on request.
Remind that the Hungarian sample does not contain employees’ unpaid claims.
The French bankruptcy procedures protect quite well the employees (OSEO, 2008). France is nonetheless characterized by a strong social protection system.
This last interpretation is rather supported by the figures shown in the paper: depending on the country and procedure, the average direct costs associated with every bankruptcy case is between 29,000€ and 103,000€, which is higher than similar average figures computed by OSEO (2008) for France (5,000€), the U.K. (21,000€), or Germany (47,000€). This specificity remains true when comparing these costs to total claims due.
Appendix 1 provides the corresponding legal sources for each country.
On Poland and Romania, such deviations are slightly bigger under reorganization than under liquidation. Indeed, a plan offers more opportunities to readjust the agenda of repayment. On the Polish subsample of reorganized firms, the difference between observed and theoretical recovery rates equals -13.3 and -5.4 points for secured and public claims respectively. On Romanian reorganizations, these figures become − 6.9 and +14.8 respectively.
One should distinguish the initial choice of a bankruptcy procedure (liquidation vs. reorganization filing) from the final decision made at the end of the procedure (liquidation vs. reorganization of the debtor, Morrison 2007).
Obviously, this risk of endogeneity exists at the country level only: our companies are mostly SMEs, so they are not in position to choose between two different national bankruptcy systems.
Appendix 7 provides the correlation matrixes on our sample. On Poland and Romania, the instruments are more correlated to the type of procedure (i.e. liquidation, vs. reorganization) than to the overall recovery rate.
The most noticeable difference is found on Poland: the negative influence of “Incentived creditors: employees” is not significant anymore. On Romania, the negative influence of claims’ concentration and of assets (log) becomes significant (10% level) with Heckman regressions.
IPTW approach is widely used in medical research as well, that face similar confounding issues.
The propensity scores are estimated through a PROBIT model (like the selection function discussed above).
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We are grateful to the journal’s reviewers. This article is a revised version of a paper presented at EALC 2018, EALE 2017, SFA 2015, MFS 2015, EFMA 2015, Infiniti 2015, AFFI 2015, SIDE-ISLE 2014. This research was financed by ANR (EURODEF program). We thank our network, the judges, liquidators, and administrators involved in the data collection process. Any remaining errors are ours.
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Blazy, R., Stef, N. Bankruptcy procedures in the post-transition economies. Eur J Law Econ 50, 7–64 (2020). https://doi.org/10.1007/s10657-019-09634-5
- Legal indexes
- Transition economies