No easy fix for ineffective bankruptcy laws
With the old system shattered, bankruptcy judges are left, often without law clerks let alone computers, to sort through the shards alone, piecing together what has happened and what should happen next, they said.
The bankruptcy laws from 1934 are inadequate for the "processing of huge numbers of companies undergoing bankruptcy in Central and Eastern Europe," said Arlene Mirsky, a specialist on bankruptcy whose 13-country study was partly subsidized by USAID.
In the West, Mirsky said, bankruptcy laws are used "for a very small number of the overall companies," unlike here where huge state factories tied to the past system are technically bankrupt. But these giants can't be dealt with, partly because the bankruptcy mechanisms are too flawed, and partly because of potential political outcries.
Most bankruptcy and liquidation activity has occurred under a 1993 bank restructuring law set up principally to force banks to deal with bad debts on their books from state enterprises. That law expires next year, however, and there is much concern that Poland build on the 1993 framework to lay down a contemporary legal and financial structure for the future. That goal seemed to be supported by Justice Minister Jerzy Jaskiernia, who said bankruptcy
"can't be seen as an economic ill or a way to eliminate the weakest from the market ... but it has to be seen as one of the tools that will lead to adjustment." The bankruptcy proceedings must go forward, if for no other reason than "to make the best possible use of debtors' assets." U.S. Ambassador Nicholas Rey, who said he spoke as a businessman more than as a diplomat, echoed Jaskiernia's view that "capital in a bankruptcy needs to be released for more productive uses."
But he warned that the enterprise bankruptcies also should be looked at closely "for the impact on banks." New rules should be adopted to permit quick action by the National Bank of Poland or the Guarantee Fund if there are bank failures due to debt overload.
"They should be given the power to take failing banks into trusteeship, without waiting for appointment of a receivership," Rey said, adding that "the collapse of a bank would be calamitous."
Until recently, some legal scholars had contended that the 1934 laws could suffice once lawsuits were filed and post-World War II case law was developed, but that is no longer seen as feasible.
The 1930s laws were mainly "a weapon to use against bad debtors" in prewar Poland's small-business economy, said Supreme Court Justice Zbigniew Strus. "Unfortunately the 1934 situation doesn't correspond to the situation we inherited from the communist era," where ownership is unclear, assets are overvalued and enterprises are being bled of anything that moves well before any bankruptcy is declared.
"It took a while for the courts to understand what was happening," Strus said, and to realize that debtors were "trying to hide and secrete away their assets."
Judges are learning on the job, he said. They are ill-equipped to handle these complexities, coming from an era "where there were no bankruptcies in actual fact ... The wisdom was that state-owned enterprises could not fail, just like the state cannot fail," he said.
A bankruptcy judge in Poland today "is like an archeologist trying to unearth beautiful jugs after an earthquake," Strus said.
The existing bankruptcy provisions hurt more than help in many tangible ways, Mirsky said. "There is quite a gap between the need for and the actual use of bankruptcy proceedings."
This keeps valuable assets tied up indefinitely, with the country being the loser, along with the creditors. Some of the problems include:
Proving insolvency. This can be done by determining that debts exceed assets - but balance sheets are notoriously inaccurate - so that leaves cash flow, and a test of whether debts are paid as they come due. But even that doesn't do the job because the definition of when bankruptcy actually occurs is unclear. For example, does it occur when a company is not able to meet debt payments "for a protracted period of time," or when it is "overburdened by debt"? Judges are flying blind in deciding what that means.
Deciding on restructuring versus liquidation. This is another judgment call. But some judges are over their heads in weighing the merits of either option and have very few experts available to call upon.
Selling off assets. The rules require that assets cannot be sold "below the book value of 75%." That means many won't be sold at all because "if there is a glut of these assets, you can't sell them off under the law. It becomes impossible," said Mirsky, who called for harmonization of the numerous sets of auction laws.
Unlike in the West, where pressure from creditors forces such options as debt forgiveness and the actual filing for bankruptcy, the law discourages creditors in Poland. They have to pay the court 12% of the amount of the debt they are trying to collect, before the court will move forward to enforce their rights.
"This is a tremendous disincentive," Mirsky said. "If that's not changed, credit won't be extended."
The bankruptcy laws from 1934 are inadequate for the "processing of huge numbers of companies undergoing bankruptcy in Central and Eastern Europe," said Arlene Mirsky, a specialist on bankruptcy whose 13-country study was partly subsidized by USAID.
In the West, Mirsky said, bankruptcy laws are used "for a very small number of the overall companies," unlike here where huge state factories tied to the past system are technically bankrupt. But these giants can't be dealt with, partly because the bankruptcy mechanisms are too flawed, and partly because of potential political outcries.
Most bankruptcy and liquidation activity has occurred under a 1993 bank restructuring law set up principally to force banks to deal with bad debts on their books from state enterprises. That law expires next year, however, and there is much concern that Poland build on the 1993 framework to lay down a contemporary legal and financial structure for the future. That goal seemed to be supported by Justice Minister Jerzy Jaskiernia, who said bankruptcy
"can't be seen as an economic ill or a way to eliminate the weakest from the market ... but it has to be seen as one of the tools that will lead to adjustment." The bankruptcy proceedings must go forward, if for no other reason than "to make the best possible use of debtors' assets." U.S. Ambassador Nicholas Rey, who said he spoke as a businessman more than as a diplomat, echoed Jaskiernia's view that "capital in a bankruptcy needs to be released for more productive uses."
But he warned that the enterprise bankruptcies also should be looked at closely "for the impact on banks." New rules should be adopted to permit quick action by the National Bank of Poland or the Guarantee Fund if there are bank failures due to debt overload.
"They should be given the power to take failing banks into trusteeship, without waiting for appointment of a receivership," Rey said, adding that "the collapse of a bank would be calamitous."
Until recently, some legal scholars had contended that the 1934 laws could suffice once lawsuits were filed and post-World War II case law was developed, but that is no longer seen as feasible.
The 1930s laws were mainly "a weapon to use against bad debtors" in prewar Poland's small-business economy, said Supreme Court Justice Zbigniew Strus. "Unfortunately the 1934 situation doesn't correspond to the situation we inherited from the communist era," where ownership is unclear, assets are overvalued and enterprises are being bled of anything that moves well before any bankruptcy is declared.
"It took a while for the courts to understand what was happening," Strus said, and to realize that debtors were "trying to hide and secrete away their assets."
Judges are learning on the job, he said. They are ill-equipped to handle these complexities, coming from an era "where there were no bankruptcies in actual fact ... The wisdom was that state-owned enterprises could not fail, just like the state cannot fail," he said.
A bankruptcy judge in Poland today "is like an archeologist trying to unearth beautiful jugs after an earthquake," Strus said.
The existing bankruptcy provisions hurt more than help in many tangible ways, Mirsky said. "There is quite a gap between the need for and the actual use of bankruptcy proceedings."
This keeps valuable assets tied up indefinitely, with the country being the loser, along with the creditors. Some of the problems include:
Proving insolvency. This can be done by determining that debts exceed assets - but balance sheets are notoriously inaccurate - so that leaves cash flow, and a test of whether debts are paid as they come due. But even that doesn't do the job because the definition of when bankruptcy actually occurs is unclear. For example, does it occur when a company is not able to meet debt payments "for a protracted period of time," or when it is "overburdened by debt"? Judges are flying blind in deciding what that means.
Deciding on restructuring versus liquidation. This is another judgment call. But some judges are over their heads in weighing the merits of either option and have very few experts available to call upon.
Selling off assets. The rules require that assets cannot be sold "below the book value of 75%." That means many won't be sold at all because "if there is a glut of these assets, you can't sell them off under the law. It becomes impossible," said Mirsky, who called for harmonization of the numerous sets of auction laws.
Unlike in the West, where pressure from creditors forces such options as debt forgiveness and the actual filing for bankruptcy, the law discourages creditors in Poland. They have to pay the court 12% of the amount of the debt they are trying to collect, before the court will move forward to enforce their rights.
"This is a tremendous disincentive," Mirsky said. "If that's not changed, credit won't be extended."
