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In an ideal economy, the healthy businesses stay alive – and the sick ones go under. Good bankruptcy laws help discern which is which
In the film Wall Street, the ruthless trader Gordon Gekko harangues a group of timid shareholders saying »Greed, for lack of a better word, is good. Greed is right. Greed works«.
I ask Ulrik Rammeskow Bang-Pedersen, professor at the Faculty of Law at the University of Copenhagen and chairman of the Danish Bankruptcy Law Council, whether the same applies to bankruptcy.
»Bankruptcy is good!«, he is all too eager to respond, smiling, »and some insolvent businesses should indeed close«.
»But there are basically healthy enterprises that come into difficulty through: Maybe they have been the object of fraud. Maybe they have suffered a loss from a bad business decision. You don’t want these to collapse if the business is basically healthy«, he says.
Bankruptcy law cannot in itself save these enterprises, but a good bankruptcy law can improve the chances of rescue.
We are in the midst of a deep recession, and politicians and businessmen look in desperation to the law experts, hoping against all odds that they can show the way out of the mess.
It may be too late for new laws to work this time round. But according to Ulrik Bang-Pedersen, changes in bankruptcy law can soften the impact the next time the economy hits the wall.
An amendment to bankruptcy law could for example better protect the value and assets of troubled companies, Ulrik Bang-Pedersen explains.
»As it is now, the legal fact of going into bankruptcy can drag the value of the company’s assets down into a black hole. Customers disappear and the good workers start looking for new jobs. But if we can we do something to improve the possibility of preserving the assets in the company and uphold it as an ongoing enterprise, this can be better for all parties,« he says.
Other amendments could speed up the legal proceedings, he adds, because a company, »like a patient, dies if it stays in the hospital for too long.«
In practice an amendment to bankruptcy law will change the rights of those who lend the company money.
If lenders allow the company a temporary stay on repayments, for example, the lenders can be compensated by being given a first take on the company’s assets if things turn out bad after all and the company must declare bankruptcy.
Last autumn, falling demand grounded the car giant General Motors to a halt. Managers and analysts on TV made ‘filing for Chapter 11 bankruptcy’, almost a household word, even outside the US.
Chapter 11 is that part of the US bankruptcy code that allows a troubled company time to restructure the business, giving new lenders a first priority on future earnings.
»Our code will never be that famous« admits Ulrik Bang-Pedersen.
»But Chapter 11 has been criticised for being too lenient, and for saving companies that shouldn’t be saved. And remember, saving a company from bankruptcy by giving it too long a moratorium can get the lenders into trouble and allow the insolvent company to compete unfairly with solvent enterprises.« he says.
For Ulrik Bang-Pedersen the law can ultimately help flatten the waves and troughs of the economic cycle.
»Now this is the question: Should we use laws to restrict lending in the good times, and promote lending in the bad times? Or should we let things run their course. I am not an economist, but the economic crisis gives a whole new meaning to the combination of law and economics,« Ulrik Bang-Pedersen says.
The recent economic trough has put a premium on financial law experts, with politicians only now, and too late, heeding their advice.
This was brought home to Ulrik Bang-Pedersen before the crisis when he advised the Ministry of Economic Affairs to further regulate the lending of Danish mortgage credit institutions.
Their loans to home-owners had skyrocketed partly as a result of newly available mortgages that were exempt from repayment.
The ministry did not heed his advice.
The trouble with global financial markets is that risks multiply, with one group of risks correlating with another group, building up into a massive wave of risk.
»To some extent this is just a consequence of the global economy, but law has a role to play in preventing these risks from flowing together,« Ulrik Bang-Pedersen explains.
The economy is apparently, slowly, regaining its balance.
In the meantime, Ulrik Bang-Pedersen, when not doing research and teaching, spends his weekends and evenings working for the Bankruptcy Council, »a kind of law laboratory«, he says, where new ideas are floated before ending in recommendations for legislators.
Some types of bankruptcy are better than others, but bankruptcy itself is here to stay, he says. Remember, bankruptcy is good:
»Without bankruptcy there would be a hot-dog stand on every corner«.