(view graph ) Negative Supply Shock 2. Compared to its original state, the economy in the short-run equilibrium at point 2 has output that is_____and inflation that is_____ 3. At the new short-run equilibrium, the output gap (Y*-Yp) is 4. The positive output gap means that the aggregate supply curve (AS2) will shift 5. Background A case filed under chapter 11 of the United States Bankruptcy Code is frequently referred to as a "reorganization" bankruptcy. An individual cannot file under chapter 11 or any other chapter if, during the preceding days, a prior bankruptcy petition was dismissed due to the debtor's willful failure to appear before the court or comply with orders of the court, or was voluntarily. Study Chapter 34 flashcards from Jessica Brittle's class online, Bankruptcy Bar Exam Business Law Civil Procedure Constitutional Law Contract Law Corporate Law Unit 4 Mechanisms Of Evolution Chapter 27 Learning Curve Chapter 28 Chapter 34 Chapter 44 Chapter 29 Chapter 32 Home;.
In a Chapter 11 case, a creditor is not required to file a proof of claim that is, a proof of claim is "deemed filed" if the creditor's claim is listed on the debtor's bankruptcy schedules, unless the claim is scheduled as "disputed, contingent, or unliquidated".
The bankruptcy trustee may reject certain executory contracts and unexpired leases. If the Trustee or debtor in possession, in many chapter 11 cases rejects a contract, the debtor's bankruptcy estate is subject to ordinary breach of contract damages, but the damages amount is an obligation and is generally treated as an unsecured claim.
Under some chapters, notably chapters 7, 9 and 11, committees of various stakeholders are appointed by the bankruptcy court.
In Chapter 11 and 9, these committees consist of entities that hold the seven largest claims of the kinds represented by the committee. Other committees may also be appointed by the court. Committees have daily communications with the debtor and the debtor's advisers and have access to a wide variety of documents as part of their functions and responsibilities.
Although in theory all property of the debtor that is not excluded from the estate under the Bankruptcy Code becomes property of the estate i. An individual debtor may choose between a "federal" list of exemptions and the list of exemptions provided by the law of the state in which the debtor files the bankruptcy case unless the state in which the debtor files the bankruptcy case has enacted legislation prohibiting the debtor from choosing the exemptions on the federal list.
Almost 40 states have done so. In states where the debtor is allowed to choose between the federal and state exemptions, the debtor has the opportunity to choose the exemptions that most fully benefit him or her and, in many cases, may convert at least some of his or her property from non-exempt form e.
The exemption laws vary greatly from state to state. In some states, exempt property includes equity in a home or car, tools of the trade, and some personal effects. In other states an asset class such as tools of trade will not be exempt by virtue of its class except to the extent it is claimed under a more general exemption for personal property.
One major purpose of bankruptcy is to ensure orderly and reasonable management of debt. Thus, exemptions for personal effects are thought to prevent punitive seizures of items of little or no economic value personal effects, personal care items, ordinary clothing , since this does not promote any desirable economic result.
Similarly, tools of the trade may, depending on the available exemptions, be a permitted exemption as their continued possession allows the insolvent debtor to move forward into productive work as soon as possible. Most states have property laws that allow a trust agreement to contain a legally enforceable restriction on the transfer of a beneficial interest in the trust sometimes known as an "anti-alienation provision".
The anti-alienation provision generally prevents creditors of a beneficiary from acquiring the beneficiary's share of the trust. Such a trust is sometimes called a spendthrift trust. To prevent fraud, most states allow this protection only to the extent that the beneficiary did not transfer property to the trust. Also, such provisions do not protect cash or other property once it has been transferred from the trust to the beneficiary.
Under the U. Bankruptcy Code, an anti-alienation provision in a spendthrift trust is recognized. This means that the beneficiary's share of the trust generally does not become property of the bankruptcy estate.
In a Chapter 7 liquidation case, an individual debtor may redeem certain "tangible personal property intended primarily for personal, family, or household use" that is encumbered by a lien.
To qualify, the property generally either A must be exempt under section of the Bankruptcy Code, or B must have been abandoned by the trustee under section of the Bankruptcy Code. To redeem the property, the debtor must pay the lienholder the full amount of the applicable allowed secured claim against the property.
Key concepts in bankruptcy include the debtor's discharge and the related "fresh start". Discharge is available in some but not all cases.
For example, in a Chapter 7 case only an individual debtor not a corporation, partnership, etc. The effect of a bankruptcy discharge is to eliminate only the debtor's personal liability,  not the in rem liability for a secured debt to the extent of the value of collateral.
The term " in rem " essentially means "with respect to the thing itself" i. This liability can presumably be satisfied by the creditor taking the asset itself.
An essential concept is that when commentators say that a debt is "dischargeable", they are referring only to the debtor's personal liability on the debt.
To the extent that a liability is covered by the value of collateral, the debt is not discharged. This analysis assumes, however, that the collateral does not increase in value after commencement of the case. If the collateral increases in value and the debtor rather than the estate keeps the collateral e. In situations where the debtor rather than the creditor is allowed to benefit from the increase in collateral value, the effect is called "lien stripping" or "paring down".
Lien stripping is allowed only in certain cases depending on the kind of collateral and the particular chapter of the Code under which the discharge is granted.
The discharge also does not eliminate certain rights of a creditor to setoff or "offset" certain mutual debts owed by the creditor to the debtor against certain claims of that creditor against the debtor, where both the debt owed by the creditor and the claim against the debtor arose prior to the commencement of the case.
Not every debt may be discharged under every chapter of the Code. Certain taxes owed to Federal, state or local government, student loans , and child support obligations are not dischargeable. Guaranteed student loans are potentially dischargeable, however, if debtor prevails in a difficult-to-win adversary proceeding against the lender commenced by a complaint to determine dischargeability. Also, the debtor can petition the court for a "financial hardship" discharge, but the grant of such discharges is rare.
The debtor's liability on a secured debt , such as a mortgage or mechanic's lien on a home, may be discharged. The effects of the mortgage or mechanic's lien, however, cannot be discharged in most cases if the lien affixed prior to filing. Therefore, if the debtor wishes to retain the property, the debt must usually be paid for as agreed.
See also lien avoidance , reaffirmation agreement Note: there may be additional flexibility available in Chapter 13 for debtors dealing with oversecured collateral such as a financed auto, so long as the oversecured property is not the debtor's primary residence.
Any debt tainted by one of a variety of wrongful acts recognized by the Bankruptcy Code, including defalcation , or consumer purchases or cash advances above a certain amount incurred a short time before filing, cannot be discharged. However, certain kinds of debt, such as debts incurred by way of fraud, may be dischargeable through the Chapter 13 super discharge. All in all, as of , there are 19 general categories of debt that cannot be discharged in a Chapter 7 bankruptcy, and fewer debts that cannot be discharged under Chapter Banks and other deposit institutions, insurance companies, railroads , and certain other financial institutions and entities regulated by the federal and state governments, and Private and Personal Trusts, except Statutory Business Trusts, as permitted by some States, cannot be a debtor under the Bankruptcy Code.
Instead, special state and federal laws govern the liquidation or reorganization of these companies. In the U. The terms "insolvent", "in liquidation", or "in receivership" would be appropriate under some circumstances. Under this provision, the unpaid mandatory pension contributions must exceed one million dollars for the lien to arise. In bankruptcy, PBGC liens like Federal tax liens generally are not valid against certain competing liens that were perfected before a notice of the PBGC lien was filed.
In , 91 percent of U. The U. Bankruptcy Court also charges fees. The amounts of these fees vary depending on the Chapter of bankruptcy being filed. In the United States, criminal provisions relating to bankruptcy fraud and other bankruptcy crimes are found in sections through of Title 18 of the United States Code.
Bankruptcy fraud includes filing a bankruptcy petition or any other document in a bankruptcy case for the purpose of attempting to execute or conceal a scheme or artifice to defraud.
Bankruptcy fraud also includes making a false or fraudulent representation, claim or promise in connection with a bankruptcy case, either before or after the commencement of the case, for the purpose of attempting to execute or conceal a scheme or artifice to defraud. Bankruptcy fraud is punishable by a fine, or by up to five years in prison, or both.
Knowingly and fraudulently concealing property of the estate from a custodian, trustee, marshal, or other court officer is a separate offense, and may also be punishable by a fine, or by up to five years in prison, or both. The same penalty may be imposed for knowingly and fraudulently concealing, destroying, mutilating, falsifying, or making a false entry in any books, documents, records, papers, or other recorded information relating to the property or financial affairs of the debtor after a case has been filed.
Certain offenses regarding fraud in connection with a bankruptcy case may also be classified as "racketeering activity" for purposes of the Racketeer Influenced and Corrupt Organizations Act RICO. Bankruptcy crimes are prosecuted by the United States Attorney , typically after a reference from the United States Trustee , the case trustee, or a bankruptcy judge.
Bankruptcy fraud can also sometimes lead to criminal prosecution in state courts, under the charge of theft of the goods or services obtained by the debtor for which payment, in whole or in part, was evaded by the fraudulent bankruptcy filing. Katz , declined to apply state sovereign immunity from Seminole Tribe v.
The Court ruled that Article I, section 8, clause 4 of the U. Constitution empowering Congress to establish uniform laws on the subject of bankruptcy abrogates the state's sovereign immunity in suits to recover preferential payments. In , there were 1,, bankruptcy filings in the United States courts.
Of those, , were chapter 7 bankruptcies, while , were chapter Personal bankruptcies may be caused by a number of factors. Although the individual causes of bankruptcy are complex and multifaceted, the majority of personal bankruptcies involve substantial medical bills.
Personal Chapter 11 bankruptcies are relatively rare. The American Journal of Medicine says over 3 out of 5 personal bankruptcies are due to medical debt. There were , individual bankruptcies filed in the United States during the first quarter of Some Critical illness insurance Association report June 2, Corporate bankruptcy can arise as a result of two broad categories—business failure or financial distress. Business failure stems from flaws in the company's business model that prohibit it from producing the necessary level of profit to justify its capital investment.
Conversely, financial distress stems from flaws in the way the company is financed or its capital structure.
Continued financial distress leads to either technical insolvency assets outweigh liabilities, but the firm is unable to meet current obligations or bankruptcy liabilities outweigh assets, and the firm has a negative net worth. A company experiencing business failure can stave off bankruptcy as long as it has access to funding; conversely, a company that is experiencing financial failure will be pushed into bankruptcy regardless of the soundness of its business model.
The actual causes of corporate bankruptcies are difficult to establish, due to the compounding effects of external macroeconomic, industry and internal business or financial factors. However, some studies have indicated that financial leverage and working capital mismanagement are likely two of the major causes of corporate failure and bankruptcy in the US.
When "cash collateral" is used spent , the secured creditors are entitled to receive additional protection under section of the Bankruptcy Code. The debtor in possession must file a motion requesting an order from the court authorizing the use of the cash collateral. Pending consent of the secured creditor or court authorization for the debtor in possession's use of cash collateral, the debtor in possession must segregate and account for all cash collateral in its possession.
A party with an interest in property being used by the debtor may request that the court prohibit or condition this use to the extent necessary to provide "adequate protection" to the creditor. Adequate protection may be required to protect the value of the creditor's interest in the property being used by the debtor in possession.
This is especially important when there is a decrease in value of the property. The debtor may make periodic or lump sum cash payments, or provide an additional or replacement lien that will result in the creditor's property interest being adequately protected.
When a chapter 11 debtor needs operating capital, it may be able to obtain it from a lender by giving the lender a court-approved "superpriority" over other unsecured creditors or a lien on property of the estate. Before confirmation of a plan, several activities may take place in a chapter 11 case. Continued operation of the debtor's business may lead to the filing of a number of contested motions.
The most common are those seeking relief from the automatic stay, the use of cash collateral, or to obtain credit. There may also be litigation over executory i. Delays in formulating, filing, and obtaining confirmation of a plan often prompt creditors to file motions for relief from stay, to convert the case to chapter 7, or to dismiss the case altogether.
Frequently, the debtor in possession will institute a lawsuit, known as an adversary proceeding, to recover money or property for the estate.
Adversary proceedings may take the form of lien avoidance actions, actions to avoid preferences, actions to avoid fraudulent transfers, or actions to avoid post-petition transfers. At times, a creditors' committee may be authorized by the bankruptcy court to pursue these actions against insiders of the debtor if the plan provides for the committee to do so or if the debtor has refused a demand to do so.
Creditors may also initiate adversary proceedings by filing complaints to determine the validity or priority of a lien, revoke an order confirming a plan, determine the dischargeability of a debt, obtain an injunction, or subordinate a claim of another creditor. The Bankruptcy Code defines a claim as: 1 a right to payment; 2 or a right to an equitable remedy for a failure of performance if the breach gives rise to a right to payment.
Generally, any creditor whose claim is not scheduled i. But filing a proof of claim is not necessary if the creditor's claim is scheduled but is not listed as disputed, contingent, or unliquidated by the debtor because the debtor's schedules are deemed to constitute evidence of the validity and amount of those claims. If a scheduled creditor chooses to file a claim, a properly filed proof of claim supersedes any scheduling of that claim.
It is the responsibility of the creditor to determine whether the claim is accurately listed on the debtor's schedules. The debtor must provide notification to those creditors whose names are added and whose claims are listed as a result of an amendment to the schedules. The notification also should advise such creditors of their right to file proofs of claim and that their failure to do so may prevent them from voting upon the debtor's plan of reorganization or participating in any distribution under that plan.
When a debtor amends the schedule of liabilities to add a creditor or change the status of any claims to disputed, contingent, or unliquidated, the debtor must provide notice of the amendment to any entity affected.
An equity security holder is a holder of an equity security of the debtor. Examples of an equity security are a share in a corporation, an interest of a limited partner in a limited partnership, or a right to purchase, sell, or subscribe to a share, security, or interest of a share in a corporation or an interest in a limited partnership.
An equity security holder may vote on the plan of reorganization and may file a proof of interest, rather than a proof of claim. A proof of interest is deemed filed for any interest that appears in the debtor's schedules, unless it is scheduled as disputed, contingent, or unliquidated.
An equity security holder whose interest is not scheduled or is scheduled as disputed, contingent, or unliquidated must file a proof of interest in order to be treated as a creditor for purposes of voting on the plan and distribution under it. A properly filed proof of interest supersedes any scheduling of that interest.
Generally, most of the provisions that apply to proofs of claim, as discussed above, are also applicable to proofs of interest. A debtor in a case under chapter 11 has a one-time absolute right to convert the chapter 11 case to a case under chapter 7 unless: 1 the debtor is not a debtor in possession; 2 the case originally was commenced as an involuntary case under chapter 11; or 3 the case was converted to a case under chapter 11 other than at the debtor's request.
A debtor in a chapter 11 case does not have an absolute right to have the case dismissed upon request. A party in interest may file a motion to dismiss or convert a chapter 11 case to a chapter 7 case "for cause. Alternatively, the court may decide that appointment of a chapter 11 trustee or an examiner is in the best interests of creditors and the estate.
Section b 4 of the Bankruptcy Code sets forth numerous examples of cause that would support dismissal or conversion. For example, the moving party may establish cause by showing that there is substantial or continuing loss to the estate and the absence of a reasonable likelihood of rehabilitation; gross mismanagement of the estate; failure to maintain insurance that poses a risk to the estate or the public; or unauthorized use of cash collateral that is substantially harmful to a creditor.
Cause for dismissal or conversion also includes an unexcused failure to timely compliance with reporting and filing requirements; failure to attend the meeting of creditors or attend an examination without good cause; failure to timely provide information to the U. Additionally, failure to file a disclosure statement or to file and confirm a plan within the time fixed by the Bankruptcy Code or order of the court; inability to effectuate a plan; denial or revocation of confirmation; inability to consummate a confirmed plan represent "cause" for dismissal under the statute.
In an individual case, failure of the debtor to pay post-petition domestic support obligations constitutes "cause" for dismissal or conversion. Section c of the Bankruptcy Code provides an important exception to the conversion process in a chapter 11 case. Under this provision, the court is prohibited from converting a case involving a farmer or charitable institution to a liquidation case under chapter 7 unless the debt or requests the conversion.
Generally, the debtor or any plan proponent must file and get court approval of a written disclosure statement before there can be a vote on the plan of reorganization.
The disclosure statement must provide "adequate information" concerning the affairs of the debtor to enable the holder of a claim or interest to make an informed judgment about the plan.
In a small business case, however, the court may determine that the plan itself contains adequate information and that a separate disclosure statement is unnecessary. After the disclosure statement is filed, the court must hold a hearing to determine whether the disclosure statement should be approved.
Acceptance or rejection of a plan usually cannot be solicited until the court has first approved the written disclosure statement. An exception to this rule exists if the initial solicitation of the party occurred before the bankruptcy filing, as would be the case in so-called "prepackaged" bankruptcy plans i. Continued post-filing solicitation of such parties is not prohibited. After the court approves the disclosure statement, the debtor or proponent of a plan can begin to solicit acceptances of the plan, and creditors may also solicit rejections of the plan.
Upon approval of a disclosure statement, the plan proponent must mail the following to the U. In addition, the debtor must mail to the creditors and equity security holders entitled to vote on the plan or plans: 1 notice of the time fixed for filing objections; 2 notice of the date and time for the hearing on confirmation of the plan; and 3 a ballot for accepting or rejecting the plan and, if appropriate, a designation for the creditors to identify their preference among competing plans.
As noted earlier, only the debtor may file a plan of reorganization during the first day period after the petition is filed or after entry of the order for relief, if an involuntary petition was filed. The court may grant extension of this exclusive period up to 18 months after the petition date. In addition, the debtor has days after the petition date or entry of the order for relief to obtain acceptances of its plan. The court may extend up to 20 months or reduce this acceptance exclusive period for cause.
In practice, debtors typically seek extensions of both the plan filing and plan acceptance deadlines at the same time so that any order sought from the court allows the debtor two months to seek acceptances after filing a plan before any competing plan can be filed. If the exclusive period expires before the debtor has filed and obtained acceptance of a plan, other parties in interest in a case, such as the creditors' committee or a creditor, may file a plan.
Such a plan may compete with a plan filed by another party in interest or by the debtor. If a trustee is appointed, the trustee must file a plan, a report explaining why the trustee will not file a plan, or a recommendation for conversion or dismissal of the case.
A proponent of a plan is subject to the same requirements as the debtor with respect to disclosure and solicitation. In a chapter 11 case, a liquidating plan is permissible. Such a plan often allows the debtor in possession to liquidate the business under more economically advantageous circumstances than a chapter 7 liquidation.
It also permits the creditors to take a more active role in fashioning the liquidation of the assets and the distribution of the proceeds than in a chapter 7 case. Section a of the Bankruptcy Code lists the mandatory provisions of a chapter 11 plan, and section b lists the discretionary provisions. Section a 1 provides that a chapter 11 plan must designate classes of claims and interests for treatment under the reorganization.
Generally, a plan will classify claim holders as secured creditors, unsecured creditors entitled to priority, general unsecured creditors, and equity security holders. Under section c of the Bankruptcy Code, an entire class of claims is deemed to accept a plan if the plan is accepted by creditors that hold at least two-thirds in amount and more than one-half in number of the allowed claims in the class. Under section a 10 , if there are impaired classes of claims, the court cannot confirm a plan unless it has been accepted by at least one class of non-insiders who hold impaired claims i.
Moreover, under section f , holders of unimpaired claims are deemed to have accepted the plan. Under section a of the Bankruptcy Code, the plan proponent may modify the plan at any time before confirmation, but the plan as modified must meet all the requirements of chapter When there is a proposed modification after balloting has been conducted, and the court finds after a hearing that the proposed modification does not adversely affect the treatment of any creditor who has not accepted the modification in writing, the modification is deemed to have been accepted by all creditors who previously accepted the plan.
If it is determined that the proposed modification does have an adverse effect on the claims of non-consenting creditors, then another balloting must take place.
Because more than one plan may be submitted to the creditors for approval, every proposed plan and modification must be dated and identified with the name of the entity or entities submitting the plan or modification. When competing plans are presented that meet the requirements for confirmation, the court must consider the preferences of the creditors and equity security holders in determining which plan to confirm.
Any party in interest may file an objection to confirmation of a plan. The Bankruptcy Code requires the court, after notice, to hold a hearing on confirmation of a plan. If no objection to confirmation has been timely filed, the Bankruptcy Code allows the court to determine whether the plan has been proposed in good faith and according to law.
Before confirmation can be granted, the court must be satisfied that there has been compliance with all the other requirements of confirmation set forth in section of the Bankruptcy Code, even in the absence of any objections. In order to confirm the plan, the court must find, among other things, that: 1 the plan is feasible; 2 it is proposed in good faith; and 3 the plan and the proponent of the plan are in compliance with the Bankruptcy Code.
In order to satisfy the feasibility requirement, the court must find that confirmation of the plan is not likely to be followed by liquidation unless the plan is a liquidating plan or the need for further financial reorganization.
Section d 1 generally provides that confirmation of a plan discharges a debtor from any debt that arose before the date of confirmation. After the plan is confirmed, the debtor is required to make plan payments and is bound by the provisions of the plan of reorganization. The confirmed plan creates new contractual rights, replacing or superseding pre-bankruptcy contracts. In addition, cooperation among a number of major creditors involved in a negotiation can be more readily achieved than aligning the diverse incentives of all conflicting claimholder classes as attempted under the insolvency procedures.
While noting the merits, the demerits of informal rescues are also obvious. A fundamental difficulty for the contract-based mechanism is the need to secure a consensus; usually the agreement of all parties whose rights are affected. Informal rescues are based on the contractual variation of existing rights by way of compromise, waiver or deferment of debts or alteration of priorities.
They can only bind parties to the contract, therefore any dissenting creditors have the power to halt informal rescues by triggering formal insolvency procedures. This renders the informal rescue a fragile device which is dependent on a high degree of cooperation among a disparate range of parties.
The process generally involves four phases. The relative informality provided by the London Approach allows security interests to be adjusted, a process that may prove far less complex and expensive than receivership where a number of banks are involved. Such additional funding is normally accorded priority over existing loans requisite creditors.
It has been questioned how far the lead bank can, or has the standing to, intervene in the absence of regulatory powers. It has been argued that the main difficulty of the London Approach is the lack of any formal moratorium and the need for unanimity of support from relevant creditors. The globalisation of financial markets and the emergence of markets for distressed corporate debt also put strains on the London Approach.
The statutory rescue procedures respond to the inherent and severe coordination problems and the holdout risks associated with the informal route. Essentially they offer a collective way in which all the affected parties are participating equally and treated according to the size and seniority of their credits.
In the UK, corporate rescue procedures were first introduced through the administration order procedure and company voluntary arrangements CVA in the Insolvency Act and were re-enacted in the Insolvency Act IA , as recommended by the Cork Committee Report on Insolvency Law and Practice.
The Enterprise Act EA introduced a streamlined administration model to replace the original procedure. Under the new regime, the administration may function either as a gateway to winding up, a CVA or a scheme of arrangements, or as a stand-alone procedure, which may lead directly to dissolution. Both countries take a view that corporate rescues can be justified by the fact that assets used by a going concern company are more valuable than if the company was liquidated piecemeal, but the legal rescue procedures in the two jurisdictions are very different in terms of orientation and institutional arrangements.
For an administration procedure, the rescue of the ailing company or the whole or part of its undertaking as a going concern is preferred, but it is not an overriding objective.
The decision on which statutory purpose should be pursued is made by an outside insolvency practitioner who acts as the administrator. In contrast, the overriding objective of a Chapter 11 case, at least in theory, is the formulation and confirmation of a reorganisation plan agreed between creditors and shareholders.
As already mentioned, incumbent management may remain in office and run the business as usual during the reorganisation process and are in charge of proposing a reorganisation plan.
Accordingly, statutory rescue procedures are designed as a collective and inclusive rescue process under which all the parties-in-interests are equally participating and treated according to the size and seniority of their credits.
In order to provide adequate protection for various groups of creditors, as well as checks and balances on the conflicting incentives among different stakeholders, the legal proceedings often involve complicated documentary accountability requirements and rounds of negotiations to conclude the approval of the rescue plan.
This renders the formal approach a complex proceeding that is lengthy and costly, often eventually leading to unnecessary or premature corporate liquidations.
The wider economic disruption generated gives claimholders the incentive to look for alternative restructuring strategies.
Pre-packaged bankruptcies were first introduced in US insolvency practice. They provided a feasible option for financially distressed companies, which allowed them to avoid the significant expense and relatively complicated negotiation process under traditional US Chapter 11 proceedings. The claims of other creditors particularly ordinary employees and trade creditors may be left unimpaired to be paid in full under the restructuring plan.
The holdout problem can be further minimised by filing for protection under a formal procedure, which has the legal power to bind dissenting creditors to the restructuring terms accepted by the majority of voting creditors, that is, two-thirds in amount and more than one-half in number of those voting.
This can greatly reduce the time spent in bankruptcy, because the principal remaining tasks are the approval of the disclosure statement and confirmation of the plan by the court. Similarly on the UK insolvency scene, there has been a considerable increase in the number of pre-packs in recent years. A pre-pack administration therefore refers to the situation where arrangements for the sale of an insolvent business have been negotiated with prospective purchasers and agreed by the major creditors prior to the commencement of the administration procedure, with the sale being completed almost immediately after the appointment of an administrator.
The differences in their institutional arrangements governing insolvency and corporate rescue reflect the differences in their culture, economic environment and political constraints. As explained earlier, corporate rescues are very different in orientation from many aspects of the liquidation process.
Rather than relatively static distribution proceedings in a strict order of priority, corporate rescues are more of a negotiating and thus bargaining proceedings focusing on ongoing commercial viability.
They are accompanied by the uncertainty of the valuation on the financially distressed company. Theoretically, the rescue process is all about preserving the so-called going concern surplus in those businesses that are financially distressed but still economically viable, and identifying and liquidating those economically distressed ones in a timely manner. However, it is empirically difficult to distinguish between financial and economic distress.
It is often not obvious whether a troubled company with financial difficulty is still economically viable or not and the judgement varies with different parties due to their possession of information about the company and their private interests. Furthermore, the process is accompanied by significant uncertainty with regard to what the value of the company turns out to be. On the one hand, it needs to accommodate different stakeholders with dispersed interests bargaining with each other; on the other hand, it calls for trust among those participants as well as compromise, and possibly even necessary sacrifice from some stakeholders, in order to reach the successful rescue outcomes.
As we have seen, corporate rescue includes formal activities provided by legislation and informal activities. The key challenge to efficient negotiation in the informal rescue process is the creditor coordination problem, especially for companies with a large number of creditors and complex debt structures often a mix of public, private and bank debt.
These companies are likely to suffer from creditor holdout problems, in which a minority of claimholders refuse to accept a restructuring plan, and are better off restructuring under the less stringent voting requirements of statutory procedure. Formal rules for a collective rescue procedure, on the other hand, are designed to reduce information asymmetries and wasteful strategic behaviour and to promote cooperation in order to facilitate the achievement of the most efficient outcome.
For this reason the automatic stay provision and the voting rules under a statutory rescue procedure are devised to overcome the holdout problems. Formal rescue-oriented proceedings have their advantages in providing a forum for structured negotiations among competing and diverse interests to avoid the unnecessary collapse of businesses in the chaos of financial distress. Nevertheless, the role of insolvency law is primarily, although not merely, a response to the problem of collecting debts.
The formal rules in this context impose considerable limits on departing from the pre-insolvency entitlements of claimholders and on how far they can go in response to the substantial obstacles caused by the inherent uncertainty in the progression of rescue work.
Pre-pack restructuring is a hybrid form of corporate rescue and it does present an innovative approach to overcome the holdout problem in informal workouts by providing a formal procedure to solidify the outcome of private negotiations.
Yet pre-pack rescue also face challenges in capturing the going concern surplus in an uncertain state of corporate distress. In particular, how should the competing interests and various goals that underlie the insolvency system e. This problem could be more acute in a pre-pack restructuring, where trade-offs are often pre-determined and market-led, but not always in line with the statutory objectives of a particular insolvency law. These challenges are key to the successful use and completion of pre-pack arrangements and they are extensively discussed in subsequent chapters.