Theoretical foundation for a debtor friendly bankruptcy law in favour

Eur J Law Econ (2007) 24:201–214
DOI 10.1007/s10657-007-9033-7
Theoretical foundation for a debtor friendly
bankruptcy law in favour of creditors
Philippe Frouté
Published online: 25 October 2007
Ó Springer Science+Business Media, LLC 2007
Abstract Although many works support creditor friendly bankruptcy laws, an
evolution towards debtor friendly systems is at work. This paper proposes a theoretical ground to meet this paradox. It reconsiders the economic role of bankruptcy
law by stressing on the courts’ production of information. It reveals that the
transmission of a lenient signal by judges makes it possible to reduce the hazard that
bad risks seek to avoid going on trial. Thus, it shows that debtor friendly bankruptcy
laws are not systematically opposed to creditors’ interests. They reduce the risk of
the economy and contribute to the improvement of the global efficiency.
Keywords
Law and economics Bankruptcy law Judges
JEL Classifications
D82 G33 K41
1 Introduction
One of the first economist to have considered failures as a key component of its
economic analysis is Joseph Schumpeter. According to Schumpeter, economic
growth results from a creative destruction process where obsolescent companies
go bankrupt replaced by companies whose founders have designed new products
corresponding to consumers tastes (Schumpeter 1912). Bankruptcy law influences
the conditions under which the transition between expansion and depression
phases is carried out. The more effective reallocation of capital is, the less will
the economy suffer from depression phases. Thus, the adoption of a bankruptcy
P. Frouté (&)
Centre d’Économie de la Sorbonne, MATISSE, CNRS et Université Paris 1,
Programme Doctoral ESSEC, Bureau 101, 106-112, boulevard de l’Hôpital,
75647 Paris Cedex 13, France
e-mail: [email protected]
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law was one of the important aspects for the transition of the Eastern European
countries towards market economies (see Mizsei 1994; Hashi 1997; Lowitzsch
2004). Thus, Schumpeter’s economic evolution analysis stresses a subject which
was forsaken during a long time by economists: the costs of driving out the
activity. It suggests that the design of the law influences the economic
performances of a country. However, at the international level, force is to note
that there hardly exist as many different bankruptcy laws as there are different
countries in the world. Nevertheless, the various rights can be filed according to
a binary typology which distinguishes creditor friendly laws from debtor friendly
ones (Chopard 2005). For instance, among the first category there are countries
like Canada, Switzerland or Great Britain, among the second one, the United
States or France. These two systems come up against the trade-off met by the
judges when they enforce the law. Indeed, either they can rescue a company
which is not viable, or they can unduly liquidate a company. The first risk is the
more feared by creditors. A great number of bankruptcy laws favour its
reduction, for instance the English bankruptcy law, in order not to induce
creditors to ration credit by raising interest rates. The reduction of the second
risk favours the rescuing of debtors. On the social level, the aim is to reduce the
liquidation costs. Although many works, largely supported by financial institutions as the IFS1 or rating agencies (Standard and Poors Moody’s,
FitchRatings...), highlight the benefits of creditor friendly laws, recent reforms
seem to reveal the existence of a new trend in favour of debtor friendly
bankruptcy laws (Brouwer 2006). This evolution contrasts with the theoretical
results previously mentioned and appears quite paradoxical. The contribution of
this paper is to bring an element of explanation to this paradox. It reconsiders
the economic role of bankruptcy law by stressing on the courts’ production of
information. The analysis proposes a conceptual framework advocating the
adoption of debtor friendly systems. The argument considers the debtor friendly
characteristics as a lenient signal sent by the judges. This lenient signal makes
possible to reduce the hazard that bad risks companies impose on good ones by
seeking to avoid going on trial by, for instance, trying to conceal their real
situation to their creditors. The central feature of the argumentation is the
capacity of interpretation of the law possessed by judges. Indeed, silences of the
law or its incompleteness give judges a certain freedom which can have very
important economic consequences. Thus, this paper shows that debtor friendly
bankruptcy laws are not systematically opposed to creditors’ interests. On the
contrary, they reduce the risk in the economy and contribute to the improvement
of global efficiency. The article is organized as follows. Second section presents
the traditional opposition between debtor friendly bankruptcy laws and creditor
friendly ones. Third section expounds the role of bankruptcy law in the credit
relationship. Fourth section presents finally a conceptual framework which
reconciles creditors and debtors interests through the enforcement of a debtor
friendly law.
1
For instance, in the series of reports called Doing Business, and more particularly the chapters devoted
to the closing of companies ‘‘closing a business’’.
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203
2 The opposition between creditor friendly and debtor friendly
bankruptcy laws
Creditor friendly laws are traditionally opposed to debtor friendly ones.2 The main
stream, largely backed by international financial institutions and rating agencies,
seems to be rather in favour of creditor friendly laws. This position is called into
question by recent reforms which reveal a new trend in favour of the adoption of
debtor friendly elements within bankruptcy law. The first two sections will be
devoted to the characterization of the creditor friendly laws (2.1) and debtor friendly
ones (2.2). Then recent reforms calling into question the supremacy of creditor
friendly laws will be presented (2.3).
2.1 Creditor friendly laws’ characteristics
The main characteristic of a creditor friendly law is to advocate creditors interests
against debtors ones. One of the main characteristic of creditor friendly law is the
particular treatment granted to securities. For instance, in the UK, a creditor can take
security over a company’s assets through fixed charges. In this case, the company is
unable to sell these assets without the creditor’s permission. Another key feature is
the treatment granted to priorities. For instance, the only expenses paid before
secured creditors in the UK are those of the insolvency proceedings contrary to
countries like France or the United States where new creditors can be granted super
priority if they contribute to refund the distressed company.
Theoretically, the enforcement of a creditor friendly law is justified by the
promotion of ex ante effectiveness. Advocates of these systems (Aghion et al. 1992)
refer to the incentive effect for managers, through the threat of liquidation, or their
replacement. This means that capital’s ownership is allocated to creditors in case of
failure. The argument is thus that of good corporate governance. This design is at
the origin of very severe laws against debtors. Managers generally lose the control
of the company for an administrator who represents creditors’ interests.3
Nevertheless, elements which moderate the previous conclusions can be found in
the economic literature. The line of argument is twofold.
On one hand, if creditor friendly laws have the advantage of avoiding ineffective
reorganizations, yet, the risk of undue or premature liquidations is bigger (White
1994; Mooradian 1994). Moreover, creditor friendly laws privilege reorganization
of credits through their liquidation, partially or totally, against reorganization of
debts. However, liquidation can be defective in particular if the secondary market is
narrow in case of specific credits, or if the whole sector is itself in difficulty, or if
information asymmetries prevent from selling credits at their right price (Shleifer
and Vishny 1992).
2
A good synthesis of the stakes of the debate can be found in the article of Gilles Recasens (Recasens
2003).
3
The receivership procedure in Great Britain illustrates this dispossession of the debtors.
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On the other hand, bankruptcy law influences investment decisions. Two failures
are traditionally evoked: the risks of under- or over-investment. The first risk refers to
an entrepreneur who would refuse to undertake a project which would offer
insufficient profit expectation to cover the company’s debts in spite of presenting a
positive net actualised value.4 Thus, projects economically profitable could not be
undertaken. On the opposite, the risk of over-investment consists in undertaking
projects whose positive net actualised value is negative but whose short run profits are
important.5
The main result is that a severe law spreads the underinvestment problems (Myers
1977). Indeed, the manager, whose position is weakened, will seek to obtain the
highest profits rather than to adopt a pater familias behaviour. By doing this, it will
privilege risky projects to safe ones. Concerning the over-investment problems,
conclusions are more complex. Manager’s behaviour before and after the financial
distress has to be distinguished. Before the failure, a severe law gives manager
responsibility and thus does not encourage them to over-invest (Jensen and Meckling
1976; Eberhart and Senbet 1993). Once the financial distress has appeared, they may
find beneficial to over-invest since they will be dismissed whatever they have done in
case of failure. They will focus on short run profits rather than long run deficits6 in
order to preserve their jobs.
Thus, the incentive’s structure created by a severe law generates opposed
behaviours according to the health of the company. This leads to a paradoxical
situation.
Indeed, when the health of the company is good, a severe law improves the
incentives for good corporate governance. On the contrary, when the situation
worsens, the severity of the law accelerates the deterioration of the assets through
unwise investment decisions. The severity of the law can thus be qualified of being
procyclical.
2.2 Debtor friendly laws’ characteristics
The main characteristics of debtor friendly laws are to privilege debt renegotiation
and companies’ reorganization. These laws often maintain the manager in position
4
Calling I0 the amount of projected investment and FTi the associated treasury flows for each period i,
n
P
FTi
let s be the capital opportunity cost, then the net actualized value is
I0 . If we consider a
ð1þsÞi
i¼1
company whose uncovered debt is equal to 400 and if we assume that capital opportunity cost is equal to
0, underinvestment can occur, for instance, in the following situation. Let us consider a two period project
with I0 equal to 100 FT1 and FT2 to 200. The net present value of this project is positive, equal to 300, but
insufficient to cover company’s debt.
5
Let I0 be equal to 100, FT1 to 500 and FT2 to –500. The net present value of this project is negative
equal to –100. This project should not be implemented. Nevertheless, at the first period profit expectation
is 400, which is sufficient to cover the company’s debt. Thus, the manager of this company will have
incentives to conceal the negative profit expectations of the second period in order to negotiate a loan for
the first period.
6
It is the case for instance if first actualized treasury flows covers the initial investment and became
negative after reaching this point.
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205
and let him the possibility to initiate a reorganization plan as for Chapter 11 in the
United States. The aim is the minimization of the social consequences of the
financial distress by preserving employment and avoiding systemic risks. There are
authors who advocate the introduction of more leniencies into the formal procedures
(Berkovitch et al. 1994) in order to avoid abusive liquidations and to deliver optimal
incentives to managers, in particular for specific assets acquisition. This leniency
entails, for instance, in the existence of a provisional suit suspension against the
debtors or the granting of privileged guarantees for potential new creditors.7
Concerning the investment decisions, the effects of leniency are perfectly
symmetric to the ones for severity. Thus, a lenient law reduces the under-investment
problems because the position of the manager is threatened. Concerning overinvestment problems, before the financial distress occurred, the leniency of the law
encourages the managers to over-invest since their responsibility is not involved. On
the contrary, once the distress appears, leniency disciplines them by providing hope
to stay in business. The effects of leniency are thus of a countercyclical nature.
2.3 Convergence’s elements
Thus, creditor friendly laws and debtor friendly ones appear to be largely opposite.
Severe laws seem nevertheless to have the favours of international financial
institutions or rating agencies (FitchRatings 1999, 2006; Moody’s Investors Service
2001; Standard and Poors 2005). However, many countries have chosen to reform
their bankruptcy law to adopt systems more favourable to debtors: it was the case
for the United States in 1978 or France in 1985. More recently, countries whose
bankruptcy law was traditionally creditor friendly also adopted elements in favour
of debtors, it was the case for the Netherlands in 1992, Germany in 1994, or more
recently Great Britain in 2004 (Brouwer 2006). This recent trend complexifies the
distinction between creditor and debtor friendly law: there exists a continuum of
bankruptcy law systems between these two polar cases. To clarify the distinction
one can consider the distinction inspired by works of La Porta, Lopez-de-Silanes,
Shleifer and Vishny,8 made by FitchRatings rating agency (FitchRating 2006).
A pure creditor friendly law is a law where priority and security are mainly given to
secured creditors and where managers are replaced during the proceedings. These
three elements can be found together as for the UK bankruptcy law and with
different degrees. At the opposite a pure debtor friendly law maintains managers in
position during the proceedings and enables judges to alter priority and security
given to secured creditors in order to raise new money to rescue the enterprise. This
latter idea is the key characteristic of recent bankruptcy laws. Debtor friendly
bankruptcy laws propose proceedings enabling to alter credit contracts between
creditors and debtors in favour of the latter.
7
This kind of procedure exists for instance in the United States and France.
8
La Porta R., Lopez-de-Silanes F., Shleifer A. and Vishny R. (1998), ‘‘Law and Finance’’, Journal of
Political Economy, vol. 106, 1131–1150.
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Alternative hypothesis explaining the need to change law can be found in the
literature. For instance, some authors argue that American 1978 reform was due to
the action of lawyers who created a new field of competence for bankruptcy because
‘‘bankruptcy was became at that time a lucrative territory’’ (Carruthers and Halliday
1998). Functionalist arguments explain legal change by an evolution toward
efficiency. First bankruptcy laws were mainly punishing devices destined to
promote cooperation among merchants. They evolve mainly during the 19th century
to become debt collection devices in order to protect investors’ interests. The end of
the golden age and the emergence of massive unemployment induced the integration
of a new aim in the bankruptcy law: to maintain activity. We share the view that
recent great enterprises bankruptcies highlighted the macroeconomic consequences
of bankruptcy law design. Nevertheless, the new trend in favour of the adoption of
more lenient laws can appear paradoxical, in particular with regard to the
recommendations of the financial institutions.
To solve this paradox, the role played by bankruptcy law within the credit
relationship will be reconsidered in the following section.
3 A bankruptcy law supplier of financial information
Failure is mainly an event of financial nature. The failed company is indeed
characterized by the fact of not being able to fulfil its commitments any more.
Framing this situation, bankruptcy law is thus at the core of the credit relationship.
First, Sect. 3.1 will characterize this relationship by focusing on its main
characteristic, namely uncertainty.9 Stressing this characteristic enables to consider
the often occulted role of courts and judges which is to be information producers
(3.2).
3.1 The inherent uncertainty of the credit relationship
The credit relationship implies two actors: debtors and creditors. Debtors face two
difficulties. On the one hand, they must go through an economic project. On the
other hand, they must finance the investments necessary to achieve the project.
Creditors face the difficulty to assess the projects’ profitability in order to propose
financing solutions. Their proposals are then evaluated by debtors who assess the
financing conditions profitability.
These relationships are ruled by information asymmetries which oppose creditors
to debtors. For a long time, the majority of works offered an asymmetrical treatment
of these information problems by mainly focusing on the borrower’s opportunism
(Diamond 1984, 1991; Boyd and Prescott 1986; Fama 1985; Stiglitz and Weiss
1981). The latter may conceal the risks of its project in order to benefit from
advantageous financing conditions.
Few works dealt with the threat of informational capture of the borrowers. This
risk comes from lenders’ opportunism (Sharpe 1990; Guigou and Vilanova 1999;
9
This section refers mainly to the work of Jean Daniel Guigou and Laurent Vilanova (Guigou, Vilanova,
1999).
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207
Berlin et al. 1996; Rajan and Winton 1995; Vilanova 1997, 1999). Their works
show that within the framework of a long term relationship between a debtor and a
creditor, this latter can use the acquired informational revenue at the detriment of
the other creditors to fix an interest rate higher than the interest rate without risk but
low enough to exclude its competitors. By doing this, the debtors does not benefit
from the optimal financing conditions.
Each situation is based on the existence of an information asymmetry of the kind
of Principal-Agent models insofar as a part is better informed than the other.
However, the information imperfection can be symmetrical. Thus, one has to keep
in mind that the difficulties encountered by the creditors to evaluate the risks of the
debtors can also bear on borrowers who cannot possess all the information to assess
their own profitability. This is particularly true for small companies (Allen 1993;
Rivaud-Danset 1995; Blazy 2000). Imperfection of information can thus be borne
simultaneously by debtors and creditors.
If the two players fail to find an agreement, the debtor must give up carrying out
his project. The only settling are courts, in particular if the only way to fulfil the
commitments is to maintain activity. Then, the aim of courts is to reveal hidden
information. Courts become then a key actor of the credit relationship whose aim is
to provide information.
3.2 Bankruptcy law as a screening device
Formulated in a general way the objective of corporate bankruptcy law is to enable
companies which must survive to survive (H0) and that those which should not to do
not survive (H1) (Aghion 1998). Hence, the existence of two errors of selection
(White 1994): to refuse H0 while it is true, error of type I, which consists in
liquidating an effective company; to accept H0 while it is false, error of type II,
which consists in rescuing an ineffective company.
Thus, enterprise’s type is hidden information and bankruptcy law aims at
revealing it publicly (Webb 1987). However, this revelation of information is not
costless. These costs make preferable for profitable companies to avoid courts and
negotiate directly with their creditors. Meanwhile, non profitable companies which
have a weaker probability to be profitable would impose extra costs on good
companies if they imitate them. Indeed, to secure risks, creditors will tend to
increase the interest rates (Altman 1984; Wruck 1990). Then it is socially optimal to
operate a selection between the different kinds of companies (Mooradian 1994;
White 1994). Some authors studied the devices at the disposal of the courts to carry
out this selection (Blazy 2002; Besancenot and Vranceanu 2005). For instance, in
the French legal system, Régis Blazy studied the sanction for abusive continuation
of activity.10 The existence of this sanction should prevent bad companies from
negotiating directly with creditors. Acting like a filter, this sanction avoids creditors
10
This sanction consists in filling for assets insufficiency and aims at sanctioning a faulty manager.
The fault can be either an omission or a simple imprudence. This sanction consists in the payment by the
manager partially or totally of this insufficiency.
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dealing with bad companies which enable them to fix lower interest rates and
facilitate the financing of economic activity. Thus, if the screening capacity of the
various devices at the disposal of judges is sufficient, they should be able to
distinguish good companies from bad ones.
If the filtering role played by courts is recognized by economic theory, the question
of the link between the nature of the system (the creditor or debtor friendliness of the
law), and the effectiveness of the screening remains largely unexplored.
In the following section a framework of modelling advocating the adoption of a
debtor friendly system which makes it possible to solve the paradox evoked in the
preceding section is proposed.
4 A debtor friendly law in favour of creditors’ interests
In this section, the debtor friendliness of law is modelled as a signal sent by courts to
debtors (4.1) and creditors (4.2). The model shows that the debtor friendly signal
reinforces the effectiveness of the screening operated by the courts which makes
possible, at the optimum, to decrease the global risk borne by creditors, who can then
reduce their risk premiums which improves in turn the financing conditions of the
economy.
4.1 Influence of a debtor friendly signal on debtors
The economy is made up of SME which do not have any equity. To be financed, they
must borrow funds from a single creditor. There are two types of firms. For a given
project, good companies obtain X with a probability pb and 0 with the probability
(1 – pb). Bad companies obtain the same X with a probability pm and 0 if not. Let
assume that pb [ pm. Companies’ type is private information held by each of them.
This situation of information asymmetries is common for SME since creditors often
do not audit the companies to reveal this information. The proportion of good
companies in the economy is supposed to be known. It is equal to c, with c [ [0,1].
Whatever companies’ type, the manager does not know with certainty if the project
will succeed or fail. Thus, this situation described the symmetry of information
imperfection evoked in Sect. 3.1. The uncertainty on the success of the project is
indeed borne at the same time by creditors and debtors. The objective of the manager
is assumed to be to ensure the survival of the company which is its single source of
income.11 Under this assumption the survival of the company is equivalent to a
wealth maximization program. At each period, the company faces a liquidity
problem. The debtor has then two choices. Either it negotiates a loan of an amount D
for a rate r, this strategy is denoted by Sn, or it decides to go directly to suit, strategy
denoted by Sp. The negotiation can lead to the debt reorganization or, in case of
11
Fraudulent bankruptcies are kept apart from the analysis in order to concentrate only on the allocative
aspects of the law.
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209
failure, the opening of collective proceedings. These proceedings end in turns either
by the liquidation of the company (denoted by LD), or by its reorganization (denoted
by Red). The existence of courts expenses makes sub-optimal for a good company to
reveal its type by going to suit. A good company thus has a pure strategy: direct
negotiation. On the contrary, for bad companies, the decision is a trade off between
the probability of obtaining a positive profit which depends on pm and the probability
of being sanctioned for abusive continuation of activity.
The figure below summarizes debtors’ choices when suffering from financial
difficulties to avoid the company closure (Fig. 1).
Legend:
Nature
Enterprise
Creditor
Frequency: y
Pb
N
Frequency: 1-y
Debt reorganization Liquidation
Trial
Reorganization
Sn
Debt reorganization Liquidation
Trial
Sn
Liquidation
Pm
Sp
Reorganization
Trial
Reorganization
Fig. 1 Debtors’ choices
Theoretically, a company must be reorganized if profit expectations enable to
fulfil its commitments. Once a proceeding is opened, this decision lies on judges’
hands. However, most of the financial models dealing with this issue disregard the
legal context. When a judge takes his decision, the previous section shows that he
arbitrates between two risks: to refuse wrongly the rescuing of a company or to
accept wrongly its survival. Let call the judges who privilege the reduction of the
first risk by lenient (Len), and those who privilege the reduction of the second one
by strict (Str). The leniency or strictness can be regarded as signals sent to
the companies. The model shows that this signal influences the probability of
reorganization beyond the purely financial factors.
Let d be the proportion of strict judges in the economy. A court is made of
several judges. While making his mind, a debtor integrates the signal emitted by the
court in its decision rule knowing that he has a probability PLen to be judged by a
lenient judge and PStr to be judged by a strict one, the true type being hidden
information.
To simplify calculations, let us consider only bad types’ companies with, X,
debtors initial beliefs. If the judge is strict the company will be immediately
liquidated, if she is not, the company is liquidated immediately in (1 – g)% of the
cases. g can be regarded as the proportion of lenient judges in the economy.
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Legend:
Nature
Judges
Immediate liquidation
Frequency: δ
P Str
N
Frequency: 1 - δ
P¬ Str
1- η
η
Reorganization proceeding
Fig. 2 Judges’ behaviours
One has:
(
X¼
p(LDjStr) ¼ 1
p(LDj:Str) ¼ 1 g, with g 2 [0,1]
ð1Þ
One can represent the situation the following way (Fig. 2):
12
Debtors
8 will revise their initial beliefs according to the signal sent by courts.
>
< p(StrjLD) = d
ð2Þ
p(LDj :Str)p:Str
ð1 gÞð1 dÞ
>
=
: p( :StrjLD) =
p(LDj :Str)p:Str + p(LDjStr)pStr
1 gð1 dÞ
and
p(LD) = P(StrjLD)PStr + P( :StrjLD)PLen ¼ dPStr þ
ð1 gÞð1 dÞ
PLen
1 gð1 dÞ
ð3Þ
Þ
Thus, o PðoLD
\0. As, P(LD)=1 – P(Red), the sign of derivatives from P(LD) and
g
P(Red) are opposed.
Hence,
opðRedÞ
[0
og
ð4Þ
Thus, when the number of judges who send a lenient signal increases, the
reorganization probability increases and companies from the bad type are incited to
go directly to suit.
12
The signal can consist in the survival rates of companies provided by the Justice ministry in the justice
statistical directory for instance.
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211
4.2 Influence of the debtor friendly signal on interest rates
The managers’ decisions can then be considered as a signal sent to creditors. Let l
be the proportion of bad companies choosing to go directly to the lawsuit. Taking
(4) into account, it comes that
ol
ol
[ 0 or
[0
oPðRedÞ
og
ð5Þ
The bigger the proportion of lenient judges in the economy is, the less bad
companies will hesitate to go on trial. Let H be the following initial beliefs of
creditors:
(
p(Sn jb) ¼ 1
H¼
ð6Þ
p(Sn jm) ¼ 1 l , avec l 2 [0,1]
Creditors revise their beliefs according to the signal sent by the companies. Then,
they fix an interest rate r. More precisely, creditors’ decision rule results from an
arbitration between a riskless credit whose interest rate is q and the perceived risk of
the project. There is the following relation:
(
1 þ r, p(X) with p(X) the probability of success for the project
1þq¼
ð7Þ
0, 1 p(X)
Taking (7) into account, at the optimum, the nonarbitration condition is the
following:
ð1 þ rÞp(X) ¼ 1 þ q
ð8Þ
Thus, the bigger p(X), the smaller is r.
Knowing that p(X) = p(bjSn )pb + p(mjSn )pm . p(X) depends on the creditors’
beliefs revision according to the signal sent by companies.
8
>
< p(bjSn ) = c
ð9Þ
p(Sn jm)pm
ð1 lÞð1 cÞ
>
¼
: p(mjSn ) =
p(Sn jm)pm + p(Sn jb)pb
1 lð1 cÞ
Thus, it comes that
d pðXÞ
dl
is negative. Hence, considering two portfolios, since
pðmjSn Þ
pb [ pm, one portfolio is said to be safer than an other if the ratio pðb S Þ ¼ Rassoj b
ciated to this portfolio is smaller. Then, the interest rate associated to this portfolio
will be smaller. If d pðXÞ is negative, then oR is also negative and or is too.
dl
ol
ol
The less bad companies negotiate directly with creditors, the easier is the access
to credit for good companies. Moreover, this relation is equivalent to:
opðXÞ
[ 0:
og
ð10Þ
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This result can appear rather surprising. The more lenient the signal sent by
courts to debtors is, the bigger the probability that the project submitted to creditors
be profitable is. On the one hand, courts’ behaviour has a direct impact on the
profitability of economic projects. On the other hand, it is by privileging debtors that
the situation of creditors improves. Thus, this model goes beyond the antagonism
described in Sect. 3. The lenient signal ‘‘unstigmatizes’’ the trial. Thus, bad
companies are not incitated to go to suit which, at the optimum, reduces the risk
borne by creditors insofar as they negotiate only with good companies. The global
risk decreases, which improves the effectiveness of the whole economy.
5 Conclusion
This paper proposes a model which justifies the adoption of characteristics in
favour of debtors for bankruptcy law. It calls into question the preference of some
financial institutions for creditor friendly systems. The model shows that the
adoption of debtor friendly characteristics is favourable not only to debtors but
also to creditors. Thus, it goes beyond the traditional opposition between the two
bankruptcy law systems. The analysis brings bankruptcy courts at the chore of the
credit relationship. They are key actors whose aim is to be information’s
producers. Indeed, by taking the decision to liquidate or reorganize a company,
the judge reveals debtor’s type of risk and allows separating good from bad
companies. The model shows that this screening activity is reinforced if judges
send a lenient signal towards debtors which allows preventing bad companies
from seeking to flee the lawsuit. By doing this, uncertainty faced by creditors is
reduced which makes possible to avoid credit rationing behaviours prejudicial to
the economic activity.
The evolution towards debtor friendly bankruptcy law recently observed in
Europe is thus justified both in terms of economic fairness and efficiency through
the share of risks between creditors and courts.
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