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The Future of Failure

alexiahenglStart-ups growing everywhere and hundreds of young people committed to become entrepreneurs? Not really. At least not in Europe.

Starting a business can be scary and complicated. A good idea, some money and loyal partners alone are often not sufficient. Legislation is becoming more and more complex and fragmented, especially when it comes to work in the online environment or trading across borders.

Numbers are clear: the European Commission's Eurobarometer 2012 reported that under a fifth of people surveyed declared they had already started, taken over or taken steps to start a business in the near future. More than four out of ten respondents say that what scares them the most about setting up a new business is the possibility of bankruptcy; while more than a third say the risk of losing their property/home would concern them the most. In comparison, less than one third of US adults considering starting a new business would be dissuaded by the fear of failure.

One does not start a business with with the aim of going bankrupt. Failure is normally not an option! But more than one third of the 50 percent of enterprises who fail within the first five years in the EU hit bankruptcy. The numbers are impressive. In 2009, the business failure rate grew by 46 percent with a further rise of five percent in 2010. Studies have demonstrated that re-starters perform better in terms of turnover and jobs created: simply because they have learned from previous mistakes.

But the difference between EU and US entrepreneurs' approach to failure does not depend only on the cultural or psychological attitude! It also depends on the law.

Indeed what makes the difference between the two systems is Chapter 11 of the US Bankruptcy Code.

Chapter 11 (as we will call it from now onwards) is designed to reorganise and not to liquidate companies in financial distress by maximising the opportunity for the debtor and the creditors to keep the company as a going concern. It is essentially organized around two major axes when it comes to creditors (maximise the debtor's assets and their distribution, as well as ensure that similarly-situated creditors are equally treated within the distribution process) and three major axes with regard to the debtor (rehabilitate viable businesses, discharge the debtor from debt for a ‘fresh start’ and provide her/him with time and ability to restructure the balance sheet and business). The very simple principle underpinning Chapter 11 is: a business that restarts its own activities will better pay off its creditors and shareholders.

At the European level something similar to the US Chapter 11 is missing and, on the contrary, insolvency law is mostly organized around the liquidation of debtor's assets, rather than on rescuing the company and is highly fragmented among different national legislations.

In 2000 the problem has been addressed in Europe by adopting Regulation 1346/2000 on insolvency proceedings, and by establishing common rules on conflict of law for insolvency proceedings across Europe. Central to the Regulation is the so called COMI (Centre of Main Interest) of the debtor that determines, with universal effect, competent jurisdiction to open the main insolvency proceeding and, consequently, the applicable national law.

So simple! But not really!

COMI is not defined by the Regulation and it is presumptively assumed to be located in the Member State where the registered seat of a company is located. Since differences among national laws are huge, both with regard to available legal remedies for creditors, time to discharge, out of court and pre-insolvency proceedings available etc, jurisdiction rules based essentially on the definition of the company's COMI have opened for forum-shopping though abusive or, at least, doubtful COMI-relocations.

To give an example, Italy, Sweden and Poland allow insolvency proceedings to be opened only against debtors that are already facing financial difficulties and are insolvent. Under the Spanish, German and French insolvency laws, insolvency proceedings can be commenced even against currently solvent debtors, that are expected to be insolvent in the imminent future (equitable insolvency). As a consequence, in the second case, debtors are admitted to protective measures from their creditors that in other Member States are only reserved to companies that meet the insolvency test.

Moreover, huge differences in the insolvency tests adopted across Europe create a situation where companies considered insolvent in one member state, are perceived as solvent in another Member State. So why not to shift your COMI to a sunnier place that holds less risk?

However reorganisation plans are available in Europe as well, albeit only under national laws, with a consequent fragmentation that creates further appetite for COMI forum shopping.

Under Chapter 11 there is no shift of managerial power from the debtor to any liquidator or ‘insolvency representative’, but it remains on the debtor that, indeed, is referred to in the law as the 'debtor in possession' or DIP. He/she has the exclusive right, lasting 120 days and extensible up to 18 months, from the court, to propose a reorganisation plan. Rules are clear when it comes to the adoption of the plan (that can be confirmed by the court) when all parties to the proceedings accept the plan. This occurs when it considers the plan has to be 'crammed down' or, finally, when the court adopts it over the objection of a dissenting class of claims.

So, if you even consider failure as a very remote possibility within your entrepreneurial life, don't give up!!

The European Union is currently working on the modernisation of its insolvency law and it really seems this time bankruptcy will no longer be considered a stigma. Second chance and early warning systems to support businesses in recognising a situation of financial distress at an early stage and a more US-like approach to failure is under way.

Further information about insolvency proceedings in Europe is available at: rcial/insolvency/index_en.htm
Published on 21-10-2013 13:49 by David Tee. 1101 page views

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