At the moment insolvency law is experiencing fundamental transformations to counter the negative economic effects caused by the outbreak of COVID-19, to support businesses and to promote their restructuring. On 20 May 2020, the UK Government published the much anticipated draft legislation (Corporate Insolvency and Governance Bill). It seeks to provide new rescue opportunities for struggling companies and to introduce greater flexibility into the insolvency regime. As the number of insolvency cases is rising in the Netherlands, on 26 May 2020 the Dutch House of Representatives expeditiously adopted the Act on Confirmation of Private Plans (WHOA), which modernises Dutch insolvency law and introduces fast and flexible restructuring options.
Can insolvency law address economic instability to minimize the negative externalities and social harm stemming from the wide-ranging shocks and grand-scale business failures? Should insolvency law safeguard the public interest and embrace the macroprudential vision, going beyond the microprudential goal of solving coordination problems between creditors of a single entity? What can it learn from bank failures and bank resolution? These are the questions that I discuss in my new paper ‘Insolvency of Significant Non-Financial Enterprises: Lessons from Bank Failures and Bank Resolution.’
Insolvency law and bank resolution
Insolvency law has traditionally been: (i) microprudential—single entity-focused and designed to protect individual companies and their creditors, (ii) contractarian—implementing the idea of creditors’ bargains, and (iii) reactive—centred around the post-crisis liquidation of assets and the allocation of proceeds among creditors. Insolvency law may, therefore, be ill-fitted to serve the public interest of mitigating negative externalities of large-scale (systemic) corporate collapses (eg Chrysler, GM, British Steel, Carillion) or handling the economy-wide instability experienced nowadays.
In contrast, as a response to the global financial crisis of 2008 (GFC), bank resolution has increasingly embraced the macroprudential vision, recognizing the value and the need for advance preparation and speedy intervention to ensure the continuity of critical functions performed by banks, the preservation of financial stability and the avoidance of bailouts. This vision has resulted in specific proactive and reactive resolution strategies, established by the Bank Recovery and Resolution Directive (BRRD). Such strategies include, inter alia, the preparation of single-entity and group recovery and resolution plans, the application of early intervention measures and the use of an administrative resolution procedure with a variety of special tools, including bail-in.
Admittedly, unlike bank failures, corporate insolvencies usually do not pose systemic risk. However, in practice this may not hold true for significant non-financial enterprises (SNFEs)— companies like Chrysler, GM and Carillion. SNFEs oftentimes play a major role in national economies and serve important public functions. Their failure may trigger contagion and cause disruptive consequences. To the extent that the collapse of an SNFE could lead to socially unacceptable results, far exceeding the boundaries of a single entity, the role of insolvency law may need to shift towards safeguarding the public interest, thus aligning it with bank resolution. This conceptual alignment should permit the inquiry into whether the recovery and resolution strategies applicable to financial institutions may be feasible and useful in dealing with corporate insolvencies.
When private insolvency goes public: the collapse of Carillion
Carillion was once the UK’s second-largest construction company. When it applied for liquidation in January 2018, its activities ranged from supplying school dinners and maintaining about half of the UK’s prisons to engagement in various construction projects, including works on the HS2 rail network and the Royal Liverpool Hospital. This makes it a promising case study for exploring whether the strategies used for bank recovery and resolution may have a role to play in preventing the insolvency of an SNFE or diminishing the negative effects of such an insolvency.
The collapse of Carillion has shown that the reactive approach to crisis resolution, centred around post-crisis liquidation, poses major risks not only for creditors but also for other stakeholders and communities at large. Carillion had around 43,000 workers and a supply chain of more than 30,000 companies, including direct and indirect subcontractors and suppliers. Despite the fact that the signs of financial distress were present long before Carillion filed for liquidation, these early warning signals were largely ignored. The failure of Carillion had substantial implications for the provision of public services, raising environmental, health and safety concerns. It ultimately led to state intervention backed up by taxpayers’ money. However, the actual economic and social cost of Carillion’s insolvency are hard to quantify. The financial distress of such a significant contractor required timely state intervention. Nevertheless, its profit warnings came as a surprise to the Cabinet Office, which did not even have a complete list of Carillion’s government contracts.
Application of bank recovery and resolution tools to SNFE insolvency
The insolvency of Carillion had three important features: (i) a failure to intervene at an early stage to resolve distress and ensure business viability, (ii) a genuine threat of public disruption, and (iii) vast complexity determined by both the debtor’s organizational structure (ie more than 320 group members) and the nature of its activities. The administration of such proceedings required industry knowledge, fast responses and extensive resources.
Many of the same features were observed in the failure of banks and banking groups at the time of the GFC. As a response, both the EU (BRRD) and the USA (Title II of the Dodd-Frank Act) have embraced a proactive and precautionary approach focused on preparation and early response. This approach has more recently been supported by the Restructuring Directive (2019/1023), which promotes early restructuring of viable debtors in financial difficulties.
The proactive approach can manifest itself in granting state authorities certain intervention powers as a reaction to the escalation of financial problems. Such powers could entail instructions to the debtor’s management to address identified problems or require debtors to implement specific changes to their legal, operational or financial structures. This can be done to reduce the complexity of a corporate group, to decrease the interdependence of group members, and to improve corporate governance practices and the overall business model by addressing funding structures, earning asymmetries and financial volatility.
Such effective early intervention is inconceivable without adequate and complete information about the debtor’s financial and operational status. This is why I advocate for the introduction of a requirement for SNFEs to prepare and regularly update (group) recovery plans. Taking this ex ante preparatory step might improve corporate discipline and uncover economic weaknesses. As a result, it can serve as a warning indicator and a catalyst for action.
A more controversial issue concerns the role of public authorities in the insolvency process. While an administrative-led procedure, prevailing in bank resolution, has certain advantages, it may be difficult and unnecessary to replicate in or transpose to non-financial enterprises. The Italian example of extraordinary administration procedures with heavy state involvement proves this point. Instead, a transparent court-supervised process with active involvement of creditors and debtors, as well as a limited and targeted engagement of state authorities on matters of public interest, should be encouraged.
Ilya Kokorin is the Meijers PhD candidate at the Department of Financial Law, Leiden University.