Insolvency Law in Emerging Markets

By Aurelio Gurrea-Martínez (Singapore Management University)

Corporate insolvency law can serve as a powerful mechanism to promote economic growth. Ex ante, a well-functioning insolvency framework can facilitate entrepreneurship, innovation and access to finance. Ex post, corporate insolvency law can perform several functions, including the reorganization of viable companies in financial distress, the liquidation of non-viable businesses in a fair and efficient manner, and the maximization of the returns to creditors. Therefore, having an efficient insolvency framework becomes essential for any economy, and even more for emerging markets due to their potential for growth and their greater financial needs.

Unfortunately, the academic literature has generally paid more attention to the regulation of corporate insolvency in developed countries. Thus, it has largely omitted the debate about the optimal design of insolvency law in jurisdictions that, in addition to requiring a more active policy debate, amount to 85% of the world’s population and 59% of the global GDP, since they include some of the world’s largest economies such as China, India, Brazil, Russia and Indonesia.

In my new article, entitled ‘Insolvency Law in Emerging Markets’, I seek to partially fill this gap in the academic literature by analyzing the problems and features of insolvency law in emerging markets. For that purpose, the paper starts from the promise that, even though, in an ideal scenario, any improvement of the insolvency framework in these countries should start by enhancing the judicial system and the sophistication of the insolvency profession, these reforms usually take time, resources and political will. In fact, due to a variety of factors, including corruption, lack of awareness about the importance of insolvency law for the promotion of economic growth, and the lack of political incentives to engage in complex institutional reforms whose benefits will only be shown in the long run, they might never occur. For this reason, my paper develops a new corporate insolvency framework for emerging economies taking into account the current market and institutional features of these countries. If these conditions change over time, or they do not exist in a particular emerging economy, my proposals would need to be adjusted accordingly.

My proposed regime for corporate insolvency in emerging markets is based on three fundamental pillars. First, pre-insolvency and out-of-court proceedings should be promoted as a way to avoid an insolvency system that is usually value-destroying for both debtors and creditors. As it is detailed in the paper, this goal should be achieved by allowing debtors to use some 'restructuring tools' outside of formal insolvency proceedings, and by creating a variety of legal and institutional initiatives to promote workouts.

Second, insolvency proceedings should be reformed to respond more effectively to the problems and features existing in emerging markets, which generally include the prevalence of MSMEs and large controlled firms, as well as the existence of inefficient courts and unsophisticated insolvency practitioners. For that purpose, my paper suggests various policy recommendations to reduce the costs associated with insolvency proceedings in the context of MSMEs, and it also proposes new rules to deal with the particular features and problems of large controlled firms. Additionally, as a way to minimize the use of the unsophisticated judicial system generally existing in emerging markets, my paper argues that the discretion of bankruptcy courts should be reduced, and insolvency proceedings should rely more on contractual and market-based mechanisms. Finally, I argue that the statutory priorities generally enjoyed by public authorities in these countries should be abolished. Namely, it is pointed out that, if the preferential treatment of public creditors is controversial in any insolvency system, it is particularly harmful in emerging markets. On the one hand, the problems of corruption often existing in these countries hamper the efficient allocation of resources collected by public authorities through their statutory priorities in insolvency. On the other hand, since private actors (especially MSMEs) have trouble having access to finance, reducing their recoveries in bankruptcy can be particularly painful, even leading them to a situation of insolvency if they are very exposed to the debtor. Therefore, if abolishing the preferential treatment of public creditors may make sense in advanced economies, it will be more desirable in emerging markets.

Finally, my paper suggests that emerging economies should adopt a more contractual approach to deal with a situation of cross-border insolvency. Thus, by facilitating the choice of insolvency forum, debtors, creditors and society as a whole will be able to enjoy the benefits associated with having access to more sophisticated insolvency frameworks. Therefore, this contractual approach to cross-border insolvency can serve as an additional tool to promote entrepreneurship, access to finance and economic growth in emerging markets. Besides, since many debtors and creditors would be using foreign insolvency proceedings, this value-creating forum shopping may incentivize many Governments to invest the resources needed to improve the market and institutional environment in these countries. Thus, hopefully my suggested approach to corporate insolvency in emerging markets will no longer be needed, or it would need to be significantly adjusted.

(*) A modified version of this post was published on the Oxford Business Law Blog.