Abstract
This Selected Issues paper examines social spending reform and fiscal savings in Slovenia. Rising expenditure has been at the root of Slovenia’s fiscal deterioration since the onset of the crisis. The paper explores reform options to reduce Slovenia’s social spending over the medium and long term. It discusses key features of the pension system, and analyzes the evolution of pension spending in the absence of reforms. The paper also examines the health and education spending and provides a framework to assess their efficiency relative to other countries.
Legal and Institutional Challenges in Corporate Insolvency1
A. Introduction
1. Corporate debt overhang is one of the legacies of the economic crisis in Slovenia, which needs to be addressed. Apart from the use of other debt restructuring techniques, formal insolvency processes will play an important role in the process of deleveraging the corporate sector. Reforms of the insolvency legislation in recent years have brought the framework closer to international best practices. However, debt restructuring and deleveraging is proceeding slowly, suggesting that there may be impediments, including legal and institutional factors that could hinder the implementation of the insolvency legislation.
2. This paper assesses remaining challenges to the insolvency framework. The next section summarizes the main changes implemented in recent years and the progress with corporate debt restructuring. The following sections discuss in detail issues related to the legal, institutional, and the environment for credit. The paper concludes with some policy recommendations.
B. Background
3. The crisis exposed a large corporate debt overhang, which requires the use of all restructuring tools. Numerous companies suffer from over indebtedness and have difficulty in repaying their loans, which has led to an increase in corporate NPLs to around 20 percent of total loans (even after substantial transfers to the state owned asset-management company). This indicates that a number of firms in Slovenia require substantial debt restructuring or even need to exit the market through liquidation, highlighting the importance of effective corporate insolvency procedures2.
Leverage of firms in Slovenia
(percent, 2013)
Citation: IMF Staff Country Reports 2015, 042; 10.5089/9781484310601.002.A003
Source: Financial Stability Review (2014) of Bank of Slovenia.4. To address this problem, two reforms of the Slovenian legal insolvency regime were introduced in 2013. The reform—representing the 5th and 6th time the insolvency law was amended since its implementation in 2007—brought the legal framework closer to international best practice and it was done largely in line with the rationale of the Recommendation of the European Commission (Boxes 1 and 2). The Slovenian system is based on the following insolvency procedures:
Compulsory settlement is a reorganization procedure applicable to companies and entrepreneurs, with special rules for mid-sized and large companies;
Simplified compulsory settlement offers a reorganization option for micro-companies, small companies and individual entrepreneurs and is similar to compulsory settlement.
Pre-insolvency restructuring proceedings offer a tool for distressed mid-sized and large companies to restructure their financial claims before becoming insolvent.
Bankruptcy is designed to liquidate insolvent, non-viable enterprises.
5. On this basis, corporate debt restructuring has begun, but it is proceeding only slowly. During 2013–14, about 30 compulsory settlements were completed per year. Simplified compulsory settlements have increased significantly since its introduction in late 2013 to 90 cases in the first ten months of 2014. And in 2014, some 8 pre-insolvency restructuring proceedings were concluded for the first time in Slovenia. By comparison, corporate bankruptcy procedures remain widespread, amounting to close to 1000 per year in 2013–14, double their level of 2012.
Reorganization and restructuring procedures in Slovenia, 2013–14
(number)
Citation: IMF Staff Country Reports 2015, 042; 10.5089/9781484310601.002.A003
Corporate bankruptcies in Slovenia, 2012–14
(number)
Citation: IMF Staff Country Reports 2015, 042; 10.5089/9781484310601.002.A003
The Reform of Corporate Insolvency Law in Slovenia, 2013
The reform introduced pre-insolvency restructuring proceedings for large and medium-sized firms to restructure financial claims (including secured claims) more efficiently and speedily, with a stay on creditor actions and majority voting. The introduction of these proceedings, together with the reform of the compulsory settlement procedures, is largely consistent with the principles of the European Commission Recommendation (see Box 2).
Important changes to reorganization procedures (compulsory settlement) were introduced, including:
• Increased control of the proceeding by financial creditors, including the ability to initiate proceedings, to introduce a plan that takes precedence over the debtor’s plan, and to take management control in certain cases;
• An absolute priority rule to ensure that if the value of equity is zero, debtor equity will be eliminated;
• Corporate restructuring features, including debt/equity swaps and corporate spin-offs to facilitate viable firms continuing as a going concern;
• Secured creditors are included in the compulsory settlement process and can pool collateral under a settlement plan;
• The write-down of collateral to market value with a corresponding conversion of the now unsecured portions of collateralized loans into unsecured claims is permitted; and
• The process recognizes the possibility that requisite majorities of creditors can agree to reduce principal on unsecured debt, and to extend maturity and/or to reduce the interest rate for both secured and unsecured debt.
The 2013 reform also introduced the simplified compulsory settlement as a streamlined reorganization procedure for micro and small enterprises, although with limited options for the restructuring of their debt.
These changes have brought the framework closer to international best practices. In addition, the Slovenian system has adopted solutions similar to those used in other European economies, and has joined some emerging trends in this area, such as the facilitation of debt/equity swaps as a debt restructuring tool.
| Countries following a similar approach to Slovenia | Alternative models | |
|---|---|---|
| Debtor in Possession | Ireland, Germany | UK The debtor is removed from management |
| Different procedures for reorganization and liquidation | Italy, Ireland, France | Germany, Spain There is a unitary insolvency process |
| Different procedures (or procedural rules) for small enterprises and large companies | Italy, Germany, Spain | UK, France Same procedural rules apply to all enterprises |
| Facilitation of debt/equity swaps | Germany | France, Italy Debt/equity swaps need to comply with all requirements of company law |
| Countries following a similar approach to Slovenia | Alternative models | |
|---|---|---|
| Debtor in Possession | Ireland, Germany | UK The debtor is removed from management |
| Different procedures for reorganization and liquidation | Italy, Ireland, France | Germany, Spain There is a unitary insolvency process |
| Different procedures (or procedural rules) for small enterprises and large companies | Italy, Germany, Spain | UK, France Same procedural rules apply to all enterprises |
| Facilitation of debt/equity swaps | Germany | France, Italy Debt/equity swaps need to comply with all requirements of company law |
The Recommendation of the European Commission and Pre-Insolvency Proceedings
The European Commission issued a non-binding Recommendation on a New Approach to Business Failure and Insolvency on March 12, 2014. One of the main themes in the Recommendation is the establishment of pre-insolvency proceedings supported by minimal court intervention. According to the Recommendation, pre-insolvency proceedings should be available to distressed entrepreneurs as early as possible, leave the debtor in control (debtor in possession) during the restructuring process, and, be streamlined to reduce costs:
• The Recommendation envisages a stay of all creditor actions, based on the intervention of the court, and limited to 4 months (extendable to no more than 12 months). Court appointed mediators could be used if necessary.
• The Recommendation suggests that all creditors are bound by a restructuring plan if approved by a majority of creditors’ claims (as determined under national law) divided into separate classes (at a minimum, secured and unsecured creditors). The procedure should include protective measures for dissenting creditors, namely the provision that dissenting creditors may not receive less under the plan than what they would receive in a liquidation of the enterprise.
• The Recommendation underlines the importance of protecting new financing during debt restructuring, especially against the risk of avoidance actions in a subsequent insolvency process, and of protecting the debtor’s management against potential criminal or civil liabilities.
6. The limited progress with corporate restructuring suggests that legal and institutional impediments may be at play. Despite the substantial progress made with the recent reform of the insolvency legal framework, the Slovenian insolvency system faces the pressure of a rising number of insolvency cases, the burden of administering a complex legal framework, and the difficulties of participants in adapting to the new framework. The following sections assess potential bottlenecks to the implementation of the framework, covering legal and institutional issues, as well as some issues affecting the legal environment for credit.
C. Legal Issues
7. Despite the recent reforms, the procedure to approve insolvency plans remains complex. It is necessary to obtain supermajorities to adopt insolvency plans, and the rules to calculate the voting power of creditors are intricate: for instance, the voting power of secured creditors in compulsory settlement is calculated by adding 20 percent to the value of the collateral in order to determine whether there is an unsecured portion of the claim for voting purposes. There are also complex rules to calculate the voting power of creditors when a debt/equity swap is part of a reorganization plan. There is no voting of insolvency plans by classes of creditors.3
8. The options to restructure the debt of companies under simplified compulsory settlement are limited. The availability of simplified compulsory settlement for SMEs is important, given the prevalence and importance of small firms in the economy. However, unlike in reorganizations of larger enterprises under compulsory settlement, for smaller firms under simplified procedures, secured claims may not be affected by the reorganization plan. Moreover, debt/equity swaps are not allowed in simplified compulsory settlement procedures. This makes it difficult for small firms to renegotiate an effective reduction in their debt burden under the simplified regime.
9. The recognition of claims is slow and litigious. One of the main bottlenecks in compulsory settlements and in bankruptcy relates to the recognition of claims. The procedure is based on an initial recognition by the insolvency administrator (basic list of claims), which may be objected by interested parties. A supplemented list of claims may also be challenged, until a final list of claims is approved by the court, Decisions on recognition of claims are frequently appealed by the debtor or by creditors. The result is that the insolvency process is often delayed until challenges or actions regarding claims are decided. This problem is common to numerous insolvency systems. 4
10. The sale of assets also presents difficulties. These difficulties can be attributed not only to the scarcity of investors willing to acquire distressed assets, but also to the rigid controls over the sales and the lack of flexibility of the process. Recent reforms have introduced more flexibility in asset sales, setting the price for the initial auction of asset at 70% of the market price, with an additional auction at 50% of the market price. These reforms need to be tested in practice, and they rely on the quality of the work of valuators.
11. The high number of liquidations suggests that insolvency proceedings are initiated too late. Bankruptcy may be the only option when the financial difficulties of enterprises are addressed too late. The law includes rules that establish the personal liability of directors for not acting in time in the event of corporate debt distress, but these provisions do not seem to be applied or enforced in practice. As a result, there are numerous bankruptcy cases where there are no assets to liquidate. The law also recognizes the possibility of recovering assets illegally transferred before insolvency, by way of avoidance actions, but there is little experience with these actions.
12. Finally, the perception of users of the insolvency system is that the legal framework is extremely complex. The law is extremely detailed, ripe with procedural details, and often difficult to understand and apply. For example, the law includes aspects of company law, apart from rules on insolvency law, and incorporates slightly different rules for procedural situations which are substantially similar (for instance, voting, contents of insolvency plans, or effects of the procedures on creditors). This complexity hinders its implementation and results in the delays mentioned above.
D. Institutional Issues
13. The complex legal framework requires an intensive use of judicial resources. The application of the law requires the constant intervention of the court to authorize each significant action and to decide every dispute within the procedure. In other words, the legislative model is based on the idea of a “hands-on” judge that takes an interventionist approach to the insolvency process. However, users of the system note that judges sometimes lack sufficient understanding of the economic realities of insolvency. Moreover, appeal judges lack specialization, although recent amendments of the law have concentrated the appeal jurisdiction nationally in the appellate court of Ljubljana. This should offer the opportunity for a de facto specialization of the appeal judges.
14. The increase in cases has overburdened the courts. Although Slovenia has a higher number of judges than the European average, the number of judges specialized in commercial matters and insolvency is small. For example, there are only six judges in the commercial division of the District Court of Ljubljana, the most important first instance court for insolvency matters in Slovenia. Apart from the very substantial increase in corporate insolvency cases, the courts are also experiencing the enormous increase in personal insolvency cases: the number of personal bankruptcies has jumped from 880 in 2013 to 4006 in 2014.5 The same judges are responsible for corporate and personal insolvency cases, and their role in the personal insolvency cases requires that they devote a considerable amount of time to them, detracting from corporate cases, which could be of a macro critical nature. Indeed, while aggregate household debt is small, the most indebted 100 companies are responsible for between 52 and 56 percent of the estimated debt overhang of 9.6 to 134.2 billion Euros in Slovenia.6
15. The collaboration between judges and insolvency practitioners is limited. The assumption of the law is that the insolvency administrator is an official of the court, under the court’s supervision, and assisting the court in the fulfillment of its functions. In practice, there is barely any communication, let alone any cooperation, between the insolvency administrator and the court. The judges don’t benefit of any expertise that insolvency administrators may bring for the better treatment of insolvency cases. The supervision of the court concentrates only on the formal aspects of the work of the insolvency administrator, such as the timely submission of reports.
16. The number of insolvency administrators is insufficient relative to the number of insolvency cases. The number of insolvency administrators is too small for the number and complexity of corporate insolvency cases in the jurisdiction. According to the official lists, which are publicly available, there are 145 insolvency administrators in Slovenia,7 of which it is estimated that only 80-90 are active. In order to qualify as insolvency administrator, it is necessary to pass as special exam and to have 3 years of experience publicly available; there are 145 insolvency administrators for insolvency matters. The qualification exam is demanding, and very few candidates (typically, only 2 or 3 of them) qualify every year. This does not guarantee the provision of services for the stock of cases currently outstanding, nor the continuity of the profession itself.
17. The role and skills of insolvency administrators present shortcomings. In Slovenia, insolvency administrators tend to have a legal background, as in many other countries in Central Europe, and their knowledge and skills in the areas of accounting and finance are limited. Moreover, the role of the insolvency administrators in the restructuring process is not as relevant as suggested by best international practices: the scope of action of the insolvency administrators is limited and, as noted above, they require approval of the court for most of their actions. The regime of insolvency administrators is based on their selection at random, in most cases, and their remuneration is not based on performance. Indeed, according to the EBRD, Slovenia is in the group of countries with the weakest score (50 percent or below) for the appointment of administrators, given a lack of matching of administrators based on previous experience to the insolvency case.
Assessment results: Development of insolvency office holder appointment systems
(Percent)
Citation: IMF Staff Country Reports 2015, 042; 10.5089/9781484310601.002.A003
Note: This bar chart indicates the results achieved in the assessment benchmark “Appointment Process” for each of the countries assessed. The average score aggregates the scores for each of the key indicators examined under this benchmark. These include whether the prospective insolvency office holders can be selected on the basis of professional experience and whether the creditors have an influence on appointment of a particular insolvency office holder. The result 100 percent is intended to signal the existence of a “comprehensive” regulatory and/or professional framework.Source: 2012-14 EBRD insolvency office holder assessment.Assessment results: Framework for regulation, supervision and discipline of insolvency office holders
(Percent)
Citation: IMF Staff Country Reports 2015, 042; 10.5089/9781484310601.002.A003
Note: This bar chart indicates the results achieved in the assessment benchmark “Regulation, Supervision and Discipline” for each of the countries assessed. The average score aggregates the scores for each of the key indicators examined under this benchmark. These include whether the regulatory body actively monitors the performance of insolvency office holders and operates a complaints system. The result 100 percent is intended to signal the existence of a comprehensive regulatory and/or professional framework.Source: 2012-14 EBRD insolvency office holder assessment.18. There are weaknesses in the supervision of insolvency. Supervision over the administrators is divided among the courts, the Chamber of administrators (a self-regulatory organization) and the Ministry of Justice. The division of supervisory competences leads to a situation in which none of them exercises a truly effective supervisory role. As a result, the EBRD ranks Slovenia among countries with deficiencies in the supervision of insolvency administrators as a result of no regular statutory monitoring of their activity.8
E. The Legal Environment for Credit
19. The legal environment for credit in Slovenia presents additional challenges. The insolvency system rests on the general system for individual enforcement of claims. However, the enforcement of claims, particularly mortgages, is slow and cumbersome. The enforcement regime allows ample possibilities for the use of delaying tactics by recalcitrant debtors. It is estimated that enforcing a mortgage can take between two and four years. To address this, the authorities have introduced a number of changes, including a reduction of appeals for several acts within the enforcement process, and the assignment of functions to judicial clerks in order to rationalize the use of judicial resources. Moreover, the regime for auctions, both in insolvency and outside insolvency procedures, has been streamlined. But the most important reform, consistent in the possibility of enforcing mortgages by way of a notary sale, has been suspended by the Constitutional Court, pending a final judgment.
20. The legal system does not offer effective mechanisms to support lending to SMEs such as receivables-based financing. Financing of enterprises requires the use of assets different from real estate, and receivables are among the most reliable collateral. The current law does not offer creditors assurances in the use of receivables as collateral for loans, and this diminishes the opportunities in obtaining fresh financing for numerous enterprises.
F. Recommendations and Conclusions
21. While the insolvency legislation of Slovenia has experienced several important amendments, bottlenecks to its implementation remain. The current paper highlights issues related to the legal, institutional, and the environment for credit. Given the frequent changes to the legal framework in recent years and the assessment that the framework has been brought closer in line with international best practice, it will be important to maintain legal stability in the short run to ensure that recent changes can be absorbed by economic and legal operators. This will be crucial in ensuring that all existing legal tools can be used to facilitate much needed corporate restructurings.
22. The priority in the short term should be placed on implementation and reinforcement of the institutional framework of the insolvency system. Reinforcing the courts and allowing their specialization of judges in insolvency matters are essential steps for the effective implementation of the insolvency regime. At the same time, efforts need to be focused on ensuring a deeper professionalization of insolvency administrators, including by revisiting the system of qualification, designation and remuneration of insolvency administrators. In addition, their supervision needs to be strengthened, as a precondition to eventually granting more powers and responsibilities to insolvency administrators and alleviate the responsibilities of the courts in the process. Finally, insolvency administrators need to improve their skills and have adequate resources to be able to implement the new law effectively and pursue enforcement actions against corporate directors, and avoidance actions of antecedent transactions, when needed.
23. The legal environment for credit also needs to be strengthened. Mechanisms for the enforcement of mortgages need to be improved to afford speedy recovery of claims. It will be crucial to implement a system in which makes enforcement faster and more efficient, while remaining in line with Constitutional requirements. This would benefit access to credit and would provide a solid foundation for debt restructuring activities. Rules for security over movable assets, especially receivables, also need to be strengthened. A system based on the registration of security interests over movable assets, especially receivables, easily accessible to the public, would afford the necessary certainty to develop new lending practices, improving access to finance for SMEs.
24. Over the medium term, the insolvency law could be made simpler and more flexible. For example, differences between simplified and ordinary compulsory settlement could be based on the reduction of cost and complexity rather than on the size of firms. Moreover, full respect of the principle of absolute priority and the best interest of creditors’ test would be sufficient safeguards for all restructuring and reorganization plans, without limitation to their contents. This would allow the full integration of secured creditors in the process, and afford more aggressive and sustainable possibilities of corporate restructuring for viable companies. Voting on insolvency plans should be based on the value of the claims, with creditors grouped in classes according to their respective positions in the creditors’ hierarchy.
References
Bruckmueller, M., and Struc, L., 2014, “Slovenia”, in Hoeni/Hammerl (eds.), Insolvency and Restructuring law in Central & Eastern Europe, Vienna.
CEPEJ (Council of Europe), 2014, Report on European Judicial Systems: Efficiency and Quality of Justice, http://www.coe.int/t/dghl/cooperation/cepej/evaluation/2014/Rapport_2014_en.pdf
Damijan, J. P, May 2014, “Corporate Financial Soundness and its Impact on Firm Performance: Implications for Corporate Debt Restructuring in Slovenia”, EBRD, Working Paper No. 168.
Ermenova, M., Liu, Y., and Saxegaard, M., 2011, “Corporate and Household Debt Distress in Latvia: Strengthening the Incentives for a Market-based Approach to Debt Resolution” IMF Working Paper, WP/11/85.
EBRD, 2014, Assessment of Insolvency Office Holders, http://assessment.ebrd.com/insolvency-office-holders/2014/report.html
European Commission, 2014, Commission Recommendation on a New Approach to Business Failure and Insolvency (12.3.2014), C (2014) 1500 final, http://ec.europa.eu/justice/civil/files/c_2014_1500_en.pdf
European Commission, 2014, Impact Assessment Accompanying the Document. Commission Recommendation on a New Approach to Business Failure and Insolvency, http://ec.europa.eu/justice/civil/files/swd_2014_61_en.pdf
Garrido, J. M., Out-of-Court Debt Restructuring, 2011, World Bank, Washington DC.
Hagan, S., 2010, “Restructuring Corporate Debt in the Context of a Systemic Crisis”, 73 Law and Contemp. Probs., 1.
INSOL Europe, 2014, Study on a New Approach to Business Failure and Insolvency – Comparative Legal Analysis of the Member States’ Relevant Provisions and Practices, http://ec.europa.eu/justice/civil/files/insol_europe_report_2014_annexes_en.pdf
International Monetary Fund, 1999, Orderly & Effective Insolvency Procedures, Washington DC.
Laryea, T., 2010, “Approaches to Corporate Debt Restructuring in the Wake of Financial Crises,” IMF Staff Position Note.
Liu, Y. and Rosenberg, C., 2013, “Dealing with Private Debt Distress in the Wake of the European Financial Crisis: A Review of the Economics and Legal Toolbox,” IMF Working Paper WP/13/44.
OECD, 2014, Slovenia. Reforms for a Strong and Sustainable Recovery.
Rajak, H., Horrocks, P., and Bannister, J. 1995, European Corporate Insolvency, Chichester.
UNCITRAL, 2005, Legislative Guide on Insolvency Law, New York.
Westbrook, J.L., Booth, C. D., Paulus, C. G., and Rajak, 2010, H., A Global View of Business Insolvency Systems, The World Bank, Washington DC.
World Bank, 2011, Principles for Effective Insolvency and Creditor/Debtor Regimes, Washing.
Prepared by José M. Garrido (LEG).
On the role of insolvency procedures in addressing the problems of debt distress, both by direct application and also as a backdrop for out-of-court negotiation, see generally UNCITRAL, Legislative Guide on Insolvency Law, p. 22; IMF, Orderly & Effective Insolvency Procedures, Secc.2; World Bank, Principles for effective Insolvency and Creditor/Debtor Regimes, Principle B3.6;. On the relationship between formal insolvency frameworks and out-of-court restructuring, see Hagan, “Restructuring Corporate Debt in the Context of a Systemic Crisis”; Laryea, “Approaches to Corporate Debt Restructuring in the Wake of Financial Crises,” Garrido, Out-of-court debt restructuring.
Approval of insolvency plans by classes of creditors is considered best international practice: see UNCITRAL Legislative Guide on Insolvency Law, p. 218. It is the system followed by most of the advanced economies, including the USA, Japan, and Germany.
“When coupled with rights of appeal and the difficulties associated with processing types of claim requiring valuation, the complexity of the process has the potential to significantly interrupt the conduct of the proceedings and cause delay that will affect other steps in the proceedings. For these reasons, it is highly desirable that formalities be minimized and that decision-making be as streamlined as possible” (UNCITRAL Legislative Guide on Insolvency Law, p. 257).
The remarkable increase in personal bankruptcies seems to be connected to a change of rules of procedure that exempts the petitioner from advancing the costs of the procedure.
See Damijan, J. P. “Corporate financial soundness and its impact on firm performance: Implications for corporate debt restructuring in Slovenia”,
See the list of insolvency administrators at www.ajpes.si (website of the Agency of the Republic of Slovenia for Public Legal Records and Related Services).
