Saturday, March 10, 2012

Why Spain needs bankruptcy reform

Since many enterprises in Spain are suffering under ever higher levels of debt, it is becoming much more important for Spain to have a less destructive bankruptcy law. In the old days, most industries were very capital intensive. It was likely that a significant value of the company consisted of physical assets, and in the case of bankruptcy, creditors stood to gain some recovery as these assets were liquidated.

In the new world, corporations have much less in assets, and almost everything physical the company has is leased rather than owned.  For example, Spainair didn’t own any of its aircraft, which in the old world would have been sold off. Now, the prime asset of a corporation are its customer base, business method and employee know-how. Since none of these assets are tangible (unless you can sell the employees into slavery), liquidating the company is in many cases the worst possible solution to trying to pay off creditors.

Instead, a better course of action is similar to what the US has in “Chapter 11” bankruptcy. A court appointed receiver examines the business to see if it is still viable, or could be made viable by converting debt into equity, renegotiating labor contracts, etc. The court then has the power to enforce a deal between the creditors, employees and the company, which in many cases allows the company to be sold or exit bankruptcy with the business intact. In addition, while in bankruptcy protection, a company has the ability (with court approval) to take on additional debt to keep operations going and preserve the value of the enterprise.

In the Spainair case, I never saw a single analysis questioning whether the business itself was viable (how much money was the company losing before interest and taxes? would the employees have taken a paycut to keep their jobs? would the aircraft leasing company lowered their rates?), and whether the entire business (assuming the debt was turned into equity) had any of positive value. Is there any airline that would have been interested in acquiring the customers, know-how and routes of Spairair for a couple million dollars (which is probably more than the creditors got in liquidation)? Everyone would have been better off, the creditors would have gotten more cash, the employees would have kept their jobs, and passengers would have not had their vacations ruined.


Anonymous said...

Yet spanish bankruptcy law does allow for a "Concurso de Acreedores a viabilidad" with many of the implications that US Chapter 11 bankruptcy protection implies.

The problem is cultural. Most customers and vendors will flee from a company in bankruptcy protection like the plague. The short-termism that infects a company in this protection is amazing, and there is talk of corrupt judicial administrators basically stripping bankrupt companies of their assets for their "coleguillas". I've personally lived through at least one bankruptcy where the game was played with the various courts and the judicial system banking and forthing on jurisdictional issues
for so many months that by the time bankruptcy was declared, the owners had stripped assets from the company in such as way as to make it impossible to prove or prosecute.

Also, there is a huge stigma attached to being in a directorial role in a bankrupt company. The fear of the personal and career effects on the executives and directors of a bankruptcy is so huge that many otherwise sane executives will try to muddle on as best they can without the protection that can be afforded to them with this sort of move.

The legal reform may not be necessary, but there is certainly a cultural reform that needs to happen

santcugat said...

Thank you for the comment! The fact that existing management is immediately disqualified from any role in running the company really makes it a corporate death sentence. I get that you want someone keeping an eye on things, but giving full power to a court appointed administrator who knows nothing about the business...

Add the personal disqualification from running any kind of business until you make a separate appeal to declare you are not "socially dangerous" after everything is wrapped up, then there is the distinct possibility of personal liability, even if you acted in good faith as a director, you are basically screwed nine ways to Sunday.

This is also really important if you are investing in a startup. Really think about whether you want to have directorial responsibility if things get screwed up.