The alternative to bankruptcy is not payment, but waste, uncertainty and chaos

The only people who complain about insolvency proceedings more bitterly than creditors . . . are creditors’ lawyers. The recent case of the developer Al-Murjan points to a revival of the bankruptcy law in the United Arab Emirates, and even though that law is not known to be “debtor-friendly”, the predictable laments of claimants’ lawyers soon followed.

One lawyer for a series of claimants against Al-Murjan was reported as complaining that the bankruptcy “filing may remove their ability to file legal claims in court” and thus “has the potential of taking away any protection” for these investors. As Asia moves boldly forward with an accelerating pace of insolvency law reforms, policymakers would do well to evaluate such comments critically.

Behind most criticism of insolvency law lies an unstated and usually quite false assumption about the alternative. The notion that insolvency procedures deprive creditors of their right to payment is in most cases wrong. It is not the insolvency procedure that deprives creditors of payment; it is the fact of the debtor’s financial distress. We all know the old saying about the futility of trying to squeeze blood from a stone, but creditors seem to forget this when insolvency law steps in to prevent them from trying.

Creditors too often pursue claims because the legal system sustains their illusion that a legally established claim is an enforceable claim. This is true only if the debtor has assets or some other source of value production and with the abandonment of indentured servitude as a formal matter in most of the world, the ability to seize the fruits of the debtor’s future labour is all but worthless when the debtor cannot be forced to labour.

Against an insolvent debtor, legal proceedings to establish and enforce claims generally benefit only one person: the lawyer pressing those claims. The right to pursue a lawsuit against a factually insolvent debtor is a liability for the claimant, who continues to finance fruitless litigation efforts; it is an asset only for the pursuing lawyer, whose fees are paid by the debtor and the solvent claimant. When it becomes apparent that the harsh reality of the situation is that the debtor lacks sufficient assets to satisfy all claims, most creditors’ “rights” to payment are revealed to be a fantasy propped up by an elaborate legal mechanism that remains comfortably aloof from reality.

When factual insolvency reveals the icy sting of reality for claimants, the procedure of insolvency forces an acknowledgment of reality and attempts to ameliorate it by minimising or at least equalising inevitable creditor losses. Insolvency procedures curtail – they do not cause – such losses. Barring official corruption or procedural ineptitude or fraud, the loss to creditors is a matter of fact, created not by insolvency procedures, but by whatever economic or other factors led to the debtor’s factual insolvency.

Yet insolvency procedures, especially those viewed as “debtor-friendly”, are constantly scapegoated for causing claims to be uncollectible and for preventing creditors from realising their rights in court. This inaccurate distraction is fuelled by constant criticism by creditors’ lawyers of the fact that insolvency law prevents creditors from pursuing their claims in court, which it goes without saying must be bad – but bad for whom?

Bad for creditors’ lawyers. Without a functioning insolvency system, the mere fact of the debtor’s actual insolvency does not prevent lawyers’ pursuit of claims in court, since virtually every legal system is all but completely unconcerned with the claimant’s ultimate (in)ability to collect payment on money claims. When lawsuits are allowed to proceed unchecked against a factually insolvent debtor, lawyers are free to divert value (to themselves) from an insolvent debtor’s dwindling patrimony that might otherwise be available to increase the share distributed to creditors, and constant harassment by lawyers can effectively prevent a distressed debtor from regaining economic vitality and returning to productivity. Insolvency law aims in part to minimise redistribution of value to lawyers and to maximise and distribute real value fairly among creditors (disabusing them of the illusion of supposed value).

Indeed, even when not formally invoked, a well-structured bankruptcy law is often the sine qua non of preserving value in a successful informal restructuring, as the recent workout pact involving Dubai World demonstrates. Without a hastily announced new law that allowed the government-owned entity to use the relatively effective Dubai International Financial Centre’s insolvency law framework, creditors were uncertain against what alternative to measure the restructuring proposal. Without the insolvency law backdrop, what ultimately proved to be a successful creditor-approved workout might well have ended up as a chaotic and spectacular collapse of vital business entities, with heavy losses for all involved and reverberations far beyond the Gulf region.

Pakistani regulators have taken a similar approach to viewing insolvency law as part of the solution rather than the problem3. Legislators throughout Asia should follow this lead and beware of resistance to meaningful insolvency law reform from those with vested interests in the wasteful status quo. When the law ignores reality, insolvency inevitably reminds us, and well-designed insolvency procedures create the conditions for a law-reality compromise to support economic recovery for the greatest possible benefit.

Endnotes:

  1. Kevin Brass, “Al Murjan’s bankruptcy to blaze new UAE legal gr  ound,” The National (27 Nov. 2010), online at www.thenational.ae/business/al-murjans-bankruptcy-to-blaze-new-uae-legal-ground.  
  2. See Leigh Kamping-Carder, “Dubai’s New Restructuring Law Aims to Calm Creditors,” www.law360.com (2 June 2010) (subscription required). 
  3. Naween A. Mangi, “Pakistan to Introduce Insolvency Law Amid ‘National Emergency,’” Bloomberg (29 April 2010), www.bloomberg.com/apps/news?pid=20670001&sid=a_SwTCuoWfgA.
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Jason Kilborn

Professor Jason Kilborn teaches business and commercial law at John Marshall Law School in Chicago.  His primary focus is on the comparative analysis of insolvency systems for individuals, though his interest extends to international bankruptcy as well. He recently co-authored a book on international co-operation in cross-border insolvency cases, published by Oxford University Press.

Jason Kilborn
Professor of Law
John Marshall Law School, Chicago
315 S. Plymouth Court
Chicago, IL 60604
USA

T: +1 (312) 386 2860+1 (312) 386 2860
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