Two centuries after the United States introduced tolerant treatment for bankrupt companies to keep its railroads rolling, Europe is copying that lenience, with Spain adopting a new bankruptcy law on Wednesday and more to follow.
The United States invented corporate reorganisation in the nineteenth century as a way of keeping bankrupt railroads on track, and in 1978 it formalised a more lenient approach with the Chapter 11 bankruptcy procedure.
Chapter 11 allows managers to stay in charge of bankrupt companies, and one effect of management continuity has been more company rescues and better returns for creditors. Bankruptcy has become a tool for rescuing debt-laden companies.
Faced with a spate of recent crises at big employers such as Parmalat and Cirio in Italy and Alstom in France, as well as a tougher European Commission stance on state aid, Europe is now borrowing from Chapter 11.
Spain adopted a new bankruptcy law on Wednesday, and reforms are underway in France and Italy.
"One of the stated aims is to reduce the stigmatisation of bankruptcy by letting management stay in charge and giving creditors confidence the company will survive," said Javier Gomez-Acebo, insolvency partner at the Madrid office of international law firm Freshfields, of the new Spanish law.
"The old law was driven towards liquidation, compounding the failure of the management. It was neither debtor nor creditor friendly; it was useless."
The new law, which Parliament passed last year, has had a year to establish the specialised bankruptcy courts that will administer the new procedure.
Corporate rescue is a live issue across Europe. Britain, the Netherlands and Germany have also changed their laws recently.
"There was a view in Britain that the pendulum had swung too far in favour of secured creditors," said Dominic Crawley, head of Standard & Poor's Leveraged Finance team in Europe. "The new Enterprise Act (introduced in 2003) places greater emphasis on re-establishing the insolvent company as a going concern."
In Italy 95 percent of bankruptcies result in liquidation, and recovery rates for creditors are less than 20 percent, according to Stefano Aversa, Milan manager at turnaround consultants AlixPartners. "The whole Italian insolvency system is a mess," said Vincenzo Morelli, Italian managing director at international turnaround firm Alvarez & Marsal, and recently installed as CEO of Italian port firm Fantuzzi to turn the company around.
"It doesn't provide the basis for a restructuring, and companies usually end up in protracted liquidations." The result is an avoidance of bankruptcy. Italian carrier Alitalia has flirted with bankruptcy for months, for example, while US airline United Airlines is protected from creditors while it works on a plan of reorganisation under Chapter 11.
Italy is currently in the throes of bankruptcy law reform, but progress has been slow with no law this year, lawyers say.
France has had more progress, and the government plans to submit a draft insolvency law to Parliament this autumn, a source close to the French Justice Ministry said on Wednesday.
The new law will encourage management to ask for help early by introducing a new, pre-insolvency stage - termed Sauvgarde.
There are critics of the Chapter 11, however, who point out the danger of leaving inadequate managers in place, and who cite the example of US companies that have made a series of Chapter 11 filings as evidence the process does not always work.
Also, changing the law is no panacea. Germany amended its insolvency law in 1999 to allow management to stay in charge of companies in trouble - so-called debtor-in-possession - and also introduced negotiated company rescue as an exit option.
But the bankruptcy courts have hardly used the new measures.
"Courts are used to appointing receivers, so they go to that default option," said Matthias Horbach, a Frankfurt-based insolvency lawyer at international law firm Skadden Arps Slate Meagher & Flom LLP. "They don't like debtor-in-possession, because they trust receivers more than existing management."
The result is a chicken-and-egg situation in which management avoids an insolvency filing until the last moment, the firm is then less likely to survive when it does file, and bankruptcy continues to be a last resort.
"In the United States companies say, 'We're in difficulty; let's enter Chapter 11 and clean up our balance sheet.' But in Germany they still leave filing to the last moment, which means the company is more run down and creditors less likely to trust the chances of a turnaround."
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