Current Legal Issues Affecting Central Banks, Volume IV.

21C. Bankruptcy Law and Bank Insolvency Law in Eastern Europe

Robert Effros
Published Date:
April 1997
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Bankruptcy Law

This chapter first addresses aspects of bankruptcy law in Eastern Europe.1 Key provisions of bankruptcy or insolvency law focus on administrative efficiency, the stay of related proceedings, priorities in the distribution of assets, the degree of finality of the proceedings, enterprise rehabilitation, and the voidance of certain prebankruptcy transfers.

Regarding the efficiency of the administration of insolvency proceedings, the law of the Czech Republic contains a model provision granting appropriate discretion to the court in supervising the trustee2 and affirming that there is no right of appeal against the court supervision of the proceeding.3 A difficult question in this connection involves the effect of bankruptcy proceedings on enterprises that are to be privatized. The Czech Republic has attempted to come to grips with this question in proposing some amendments to the bankruptcy law. However, the amendments are complicated and may be impractical in some cases. There does not appear to be a full consideration of the sale of assets, as distinguished from the sale of an enterprise, or of how an impending bankruptcy proceeding would affect the prospective investors and the company to be privatized. A request for initiating a bankruptcy proceeding against a company involved in privatization may be stayed for different periods of time, according to this proposal, depending upon the stage of the privatization process.

The stay of collection actions against a debtor, a process described as the “rush to the courthouse,” may be the most important provision in a bankruptcy law. Under Hungary’s law, however, a stay does not automatically arise when a reorganization petition is filed.A debtor must meet with creditors within 15 days of filing a reorganization proposal, and a certain percentage of the creditors must agree to the stay.4

With respect to the distribution of assets, a train of thought in European bankruptcy law reform suggests that setting priorities in the distribution of assets among unsecured creditors should be minimized. This line of thought is apparently based on the belief that, as there really is no “natural law” governing the appropriate distribution of assets, few priorities should be set, so that the creditors in a collective proceeding can share the assets pro rata. This approach would probably facilitate the granting of unsecured credit. Among unsecured claims, the Czech, Hungarian, and Polish laws give priority in the payment of claims to the administrative expenses of the bankruptcy proceedings, which is appropriate. Indeed, if a trustee is not assured that the costs and fees of administering the estate will be paid, the bankruptcy proceeding will not be administered by responsible persons. Employee and government claims are generally next in payment priority. In this connection, the new thinking is that priority should not be given to workers’ claims if there is a system of social security. Tax claims’ priority may be somewhat illusory because granting such priority means that creditors who receive no dividends will have tax-deductible losses that will reduce their tax payments. None of the laws appear to give priority to those who provide credit after the commencement of bankruptcy proceedings. This omission will diminish the prospects of restructuring some enterprises because they will have to curtail business activities that depend on new credit.

With respect to the degree of finality of the resolution of claims against debtors in insolvency proceedings, one of the important goals in some countries is providing a debtor with an opportunity for a fresh start. In a market economy, entrepreneurial risk is to be encouraged because successful new business ventures benefit the economy and society. The penalty of failure should not be so great as to discourage risk taking. If a businessperson were to be barred for life from engaging in business or never to be free of business debts, risk taking would be limited. In Eastern European countries, many businesses are in the form of unincorporated single proprietorships. Consequently, involvement in bankruptcy proceedings has more consequences for future business activities than in countries in which limited liability corporate businesses are more prevalent.

Under Hungarian law, if a certain percentage of creditors in a reorganization proceeding approve the plan, all creditors are bound by it, as long as those not accepting the plan receive treatment equal to or better than that accorded those who approved it.5 Under Poland’s law, liquidation proceedings do not finally settle all claims against the debtor.6 Claims not recognized in the bankruptcy action may be brought against the debtor after the bankruptcy proceedings are concluded.7

Regarding enterprise rehabilitation, Hungarian law tends to encourage financial reorganization of insolvent enterprises as a serious alternative to liquidation. Bankruptcy laws that do not have comprehensive provisions to encourage financial reorganization, such as those in the Czech Republic and Poland, embody a policy that, in effect, promotes the liquidation of enterprises when their current liabilities cannot be met, regardless of their degree of negative net worth or the remediability of the situation.

It is too early to say whether the discretion given to courts under the insolvency laws of Poland and the Czech Republic to reject settlements on reorganization agreed to by debtor and creditors will significantly limit the utility of reorganization provisions; nevertheless, this is a possibility. Clearly, the arbitrary provisions in the laws of the Czech Republic setting a minimum of claims payments by the debtor to conclude a settlement will restrict the use of reorganization as an alternative to liquidation. Similarly, with respect to the confirmation of settlements, courts in both the Czech Republic and Poland may refuse to confirm settlements agreed to by the creditors and the debtor if they determine that the proposal is too disadvantageous to dissenting creditors. Again, the court should be careful about substituting its own judgment for that of the parties to the proceeding, especially on such indefinite criteria, as the alternative in many cases will be liquidation.

Regarding the voidance of prebankruptcy transfers and payments, the law should as a matter of fairness—and to encourage creditors not to be unduly concerned about extending credit—provide that payments made by a debtor to creditors during some period before bankruptcy be null and void. These funds would then become part of the estate, to be apportioned among all creditors in the reorganization. Debtors should not be able to choose who will get paid in full and who in part or not at all; this is a general principle in bankruptcy law—equitable treatment of all creditors similarly situated. However, none of the laws under consideration contain general provisions that void preferences given to creditors within a certain time period before bankruptcy. Some laws void transfers made gratuitously, while others void transfers made to family members, for security interests, or as payments.

Bank Insolvency Law

In the complex area of bank insolvency and involuntary bank liquidation, the laws are rather diverse in Eastern Europe. Under one country’s banking law, no special provisions are made for the insolvency of a bank, which means that the issue is left to the general bankruptcy law.

There is an important question of whether a general bankruptcy law would be appropriate for a bank. Because regulatory considerations are paramount in the reorganization—as opposed to the liquidation—of a bank, it would seem that a bankruptcy law may not be adequate. Of course, when it comes to liquidating a bank, a good bankruptcy law could be applicable because liquidation is a much more mechanical process, comprising essentially receiving and verifying claims, selling assets, and distributing the proceeds. However, when it comes to finding new shareholders for a troubled bank, getting new equity capital, or taking out bad assets, the banking authorities should be involved to a significant extent; their judgment on such matters as the suitability of new principal shareholders or the feasibility of merging a strong bank with a weak bank should be determinative.

Under another country’s law, insolvency proceedings can be initiated either by the central bank or by creditors of the bank. The desirability of creditors’ action in this area is questionable. Initiating an insolvency proceeding for a bank is such a delicate matter that perhaps it should be left only to the bank supervisor, as the formal questioning of a bank’s financial integrity by private parties could exacerbate a difficult financial situation.

Another country’s law sets forth a two-stage procedure. In the first stage, when there is a marked reduction in capital, the central bank becomes involved and tries to find a buyer for the bank. The law is rather arbitrary on this point, as it requires that the acquiring bank must assume all of the liabilities and purchase all of the assets of the troubled bank. Experience has shown that this kind of sale is very difficult to accomplish, because troubled banks’ credit files are sometimes in such bad condition that no prospective purchaser wants to acquire such questionable assets. From the point of view of insolvency law theory, to effect the sale of a bank—or the purchase of substantially all its assets and the assumption of all its liabilities—the receiver should be allowed to reduce the value of liabilities, provided that, in the receiver’s opinion, no depositor or other creditor would receive less than would be received in a liquidation of the banks assets, which is the relevant alternative.

In the second stage of this law, if the bank declares—or the central bank determines—that it is insolvent, a court takes over and initiates bankruptcy proceedings. In these proceedings, a bankruptcy judge tries to settle the claims. If a settlement is not reached, the bank is sold free of certain liabilities, except deposits. The assets can then be sold piecemeal. This law, however, makes no mention of whether it is consistent with, or takes priority over, the existing bankruptcy law; also, it is inconsistent regarding the setting of priorities to distribute assets to satisfy the different classes of claims, and with respect to the role of creditors in reorganizing the bank. In general, a later law should supersede an inconsistent earlier law, but this is not always a clear rule of legislative interpretation and not the best way to determine the applicable law to manage a bank insolvency.

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