5 Institutions and Participants
- International Monetary Fund
- Published Date:
- August 1999
Given that creditors are key beneficiaries of the insolvency process, the law should be designed and implemented in a manner that enables them to play an active role in this process. They should normally be the decision makers in a number of key areas. For example, during liquidation proceedings, it is advisable that creditors be given the authority to dismiss the liquidator (discussed below), approve the temporary continuation of the business by the liquidator, and approve a private sale. In rehabilitation proceedings, they should normally have the authority to dismiss the administrator and propose and approve a rehabilitation plan. In addition, the law should give them a role in requesting or recommending action from the court, including, for example, a recommendation that the rehabilitation proceedings be converted to liquidation. Giving creditors an active role in the process is particularly important when the institutional framework is relatively underdeveloped. Creditors will lose confidence in the process if all of the key decisions are made by individuals that are perceived as having limited expertise or independence.
Whatever role is provided for creditors under the law, they will only be able to fulfill this role in an effective manner if the proceedings are actually conducted in a transparent manner. It is therefore imperative that they receive adequate notice of important meetings and decisions and that they receive sufficient information to make fully informed decisions. Given the increasing number of insolvency proceedings involving nonlocal creditors, it is advisable for the law to allow for voting to take place by mail or proxy.
In cases where there are a large number of creditors, the creation of a creditors’ committee that will act on behalf of creditors provides for coherence and efficiency in the process. The law should normally allow for the creation of such committees and provide that their costs will be borne by the estate. For the benefit of all participants, it is advisable for the court to have the authority to limit excessive costs incurred by the committee so as to preclude any abuse by or proliferation of professional advisors.
Although a creditors’ committee plays only an advisory role in the decision-making process (they normally are not given the legal authority to take major decisions on behalf of all creditors), such a role can, as a matter of practice, be very important. The creditors’ committee will normally make recommendations to creditors on how to make key decisions (e.g., approval of a plan) and will also make recommendations to the court as to how it should decide on important matters. Although the court should listen to all creditors before making its decision, considerable weight will normally be given to the committee’s views.
In addition to facilitating the decision-making process, an effective creditors’ committee can play an important role in the negotiation of a rehabilitation plan. Experience demonstrates that, in circumstances where there are a large number of creditors with divergent interests, one of the critical stumbling blocks is the resolution of inter-creditor issues. The creation of a creditors’ committee with a single financial advisor can greatly facilitate the resolution of those issues. One of the financial advisor’s principal roles will be to forge creditor agreement on the features of the plan. A committee can also assist in increasing the flow of information. Debtors may be much more willing to provide particularly confidential information to a small committee rather than the full body of creditors, particularly where the committee members have signed confidentiality agreements.
For a creditors’ committee to play the above role, it is important to avoid creating a multiplicity of committees. At the same time, it will be difficult to create a small and manageable committee if there are many creditors with divergent interests. Although the value of a creditor’s claim should be taken into consideration for the purpose of determining who should serve on the committee, that should not be the exclusive consideration. The chances of a successful rehabilitation increase to the extent that a plan attempts to capitalize on the different economic interests of creditors. For this reason, it is important that the makeup of the committee reflect these interests. Thus, for example, it may be useful to include in the committee creditors such as bond holders, employees, financial institutions, and trade creditors.10
The law should enable creditors to play an active role in the insolvency proceedings. To that end, it should allow for the formation of a creditors’ committee, with the cost of such a committee being an administrative expense.
The Liquidator and the Administrator
The liquidator and the administrator play a central role in the effective implementation of the law. Although their respective roles differ substantially, they are similar in one important respect. As court-appointed officials, they have an obligation to ensure that the law is applied effectively and impartially. Moreover, since they normally have the most information regarding the circumstances of the debtor, they are in the best position to make informed decisions. That does not mean, however, that they are a substitute for the court: due process requires that a dispute between the liquidator and an interested party be adjudicated by a court of competent jurisdiction. Even in countries where there are serious problems with the capacity of the judiciary, there is a limit to the amount of authority that the law can confer upon these officers.
Qualifications and Appointment
To what extent should the liquidator and the administrator be required to have different qualifications? On one level, their roles would appear different: a liquidator manages, collects, and distributes assets, which may require an accounting background, while an administrator supervises the operation of a business, making recommendations on viability and, perhaps, preparing a plan, which may require a management/business background. In fact, however, the qualifications are essentially the same: a knowledge of the law, impartiality, and adequate experience in commercial and financial matters. If specialized knowledge is needed in the management of a particular business, the administrator can always hire experts. To ensure expertise and integrity, consideration can be given to establishing qualifications on the basis of a self-regulatory licensing system.
Both the liquidator and the administrator should be appointed by the court. It is generally recommended that this appointment be derived from a list of eligible candidates, which can be provided by the self-regulatory organization if one exists. To avoid collusion, appointment should be precluded when there is any evidence of a conflict of interest arising from a preexisting relationship with the debtor, a creditor, or a member of the court.
The law should permit the liquidator or administrator to be dismissed on the basis of either a decision taken by a majority of unsecured creditors or a decision of the court, acting on its own motion or at the request of any party in interest. In the latter case, the court’s decision should normally be based upon a determination that the liquidator has violated its legal duties. In contrast, dismissal by the creditors should not normally require any justification, although the law may specify that such removal without cause be made within a specified period after commencement.
A variety of approaches can be used when calculating fees—for example, on an hourly basis or as a percentage of the distribution to unsecured creditors (in liquidation) or assets of the enterprise (in rehabilitation). Whichever approach is followed, it is critical that it be transparent and that creditors be made aware of the method of calculation from the beginning of the proceedings. Leaving the determination of fees to the exclusive discretion of the court should be avoided.
As a court-appointed official, the liquidator and the administrator owe a duty of care to all parties in interest and therefore can be liable to all these parties for a violation of this duty. What standard of care is owed to these parties? As a general matter, the standard should not be stricter than that of negligence, a standard that will take into consideration the difficult circumstances in which a liquidator or administrator finds itself when it is fulfilling its duties. A stricter standard would make it difficult to attract qualified professionals. It should be noted that a liquidator or administrator’s liability can be effectively reduced by obtaining advance approval of creditors before the making of any key decisions (e.g., the continuation of the business during liquidation).
Given the central role that a liquidator and an administrator play in insolvency proceedings, it is important that they have an adequate knowledge of the law and sufficient experience in commercial and financial matters. To ensure that these officials have adequate integrity and expertise, countries may wish to consider establishing some form of self-regulatory licensing system.
The court should have the authority to appoint the liquidator or administrator. The law should determine the conditions under which these officials can be dismissed by either the court or a majority of unsecured creditors.
While a variety of methods can be used to determine the remuneration of a liquidator or administrator, it is important that the method chosen be transparent and that creditors be made aware of this method from the beginning of the proceedings.
As court-appointed officials, liquidators and administrators have an obligation to ensure that the law is applied effectively and impartially. Accordingly, they owe a duty of care to all parties in interest and should be personally liable to all these parties for a violation of this duty. As a general matter, the duty of care should be considered violated only in cases of negligence.
Throughout this report, it has been noted that an insolvency law will be effective only if the judiciary has sufficient capacity to implement it. Although discussion of the means by which this capacity can be enhanced is beyond the scope of this study, set forth below are several issues that are of general relevance when considering the relationship between the capacity of the judiciary and the design of an insolvency law.
Exercise of Discretion
Irrespective of the quality of the judiciary, all insolvency laws should provide adequate guidance as to how a court should exercise its discretion when making a determination on matters that involve economic or commercial issues. This is essential if the law is to be predictable. When the capacity of the judiciary is limited, consideration may also need to be given to actually eliminating the role of the judge entirely when determinations are made regarding the viability of the enterprise. For example, any authority of the court to overrule the creditors’ views on such matters should be treated very cautiously. Moreover, consideration can also be given to allowing the specified period of the rehabilitation proceedings to be extended only upon a vote of the creditors.
Because an insolvency proceeding is a judicial proceeding, there are, however, important limits to how much the court’s role can be diminished. A party in interest cannot be denied an opportunity to appear before the court if it feels that its rights are not being adequately protected. Moreover, there are certain key decisions (e.g., the decision to commence proceedings) that can only be made by the court. Accordingly, if the capacity of the court system is constrained, efforts will need to be made to improve it; one cannot design an insolvency law in a manner that circumvents the judiciary.
An insolvency proceeding is a dynamic process. Unlike many other adjudicative proceedings, which involve an inquiry into historical events, an insolvency proceeding takes place in “real time”: delays in a court’s adjudication can have an adverse effect on the value of the assets or the viability of the enterprise. It is therefore critical that procedures be put in place to ensure that hearings can be held quickly and that decisions are rendered soon thereafter. Similarly, it is critical that an accelerated appeal process be available. In any event, during the period of appeal, the lower court’s decision should normally continue to be binding.
In light of the need to ensure efficiency and the proper exercise of discretion, a number of countries have established specialized courts, in the form of either bankruptcy courts or commercial courts. The judges appointed to these courts often have received special training and, in some cases, these judges are actually selected from the business world. If such an approach is followed, it is important that the relevant law give the court exclusive subject matter jurisdiction over all or most of the matters that may have an impact on the estate, for example, the liquidator’s pursuit of a contractual claim of the debtor against a third party. If there are exceptions to this general rule they should be limited and specified—for example, disputes over ownership of real property and tort claims.
To ensure that an insolvency law is applied with predictability, the law should provide adequate guidance on how the court should exercise its discretion, particularly when the court’s decision involves an assessment of economic and commercial issues.
Since insolvency proceedings give rise to a dynamic process, it is important that procedures be put in place to ensure that court hearings are held quickly and that decisions, including appeals, are rendered soon thereafter. During the period of appeal, the lower court’s decision should normally continue to be binding.
Given the need to ensure efficiency and the proper exercise of discretion, countries may wish to consider the establishment of specialized courts, in the form of either bankruptcy courts or commercial courts. Whether or not a specialized court system is adopted, it is important that the judges have adequate training and experience in commercial and financial matters.