Abstract

http://ssrn.com/abstract=963337
 


 



Trading in Times of Crisis: Formal Insolvency Proceedings, Workouts and the Incentives for Shareholders/Managers


Horst Eidenmueller


University of Munich; University of Oxford


European Business Organization Law Review (EBOR), Vol. 7, 2006

Abstract:     
Conventional economic reasoning suggests that formal insolvency proceedings should commence once the greater of the going concern value or the liquidation value of a firm falls below the value of its liabilities. Since this test is difficult to apply in practice, an additional cash flow test is needed: formal insolvency proceedings should commence if a firm is not able to pay its due debts. Two factors complicate this analysis: risk-shifting incentives of shareholders/managers in the vicinity of insolvency and the (rapid) decline of a firm's going concern value once it approaches insolvency. The former problem should be addressed by a liability rule for wrongful trading. Based on a review of the current legal position in the United States, the United Kingdom and Germany, a uniform European rule is proposed that imposes liability on managers of insolvent companies for trading while they knew or should have known that insolvency was more probable than not, unless they can show that they took all reasonable steps to avoid insolvency. The decline of a firm's going concern value once it approaches insolvency provides all stakeholders with an incentive to try a workout to save as much of the going concern value as possible. However, workouts often fail in practice due to free-rider effects. Cooperation duties are proposed as a means to support workouts. Such duties should be triggered once a workout is initiated. It is suggested that bankruptcy rules, in general, and rules on the initiation of bankruptcy proceedings, in particular, should in principle be enabling rather than mandatory.

Keywords: company insolvency, trigger mechanisms, liquidation, reorganisation, formal insolvency proceedings, out-of-court restructuring, workout, cooperation duties, wrongful trading, manager liability, mandatory v. enabling nature of bankruptcy law, free choice of bankruptcy rules

JEL Classification: K20

Accepted Paper Series


Not Available For Download

Date posted: February 19, 2007  

Suggested Citation

Eidenmueller, Horst, Trading in Times of Crisis: Formal Insolvency Proceedings, Workouts and the Incentives for Shareholders/Managers. European Business Organization Law Review (EBOR), Vol. 7, 2006. Available at SSRN: http://ssrn.com/abstract=963337

Contact Information

Horst G. M. Eidenmueller (Contact Author)
University of Munich ( email )
Institute for International Law
Veterinärstraße 5
Munich, 80539
Germany
+49 89 2180 3306 (Phone)
HOME PAGE: http://www.horst-eidenmueller.de
University of Oxford ( email )
Mansfield Road
Oxford, Oxfordshire OX1 4AU
United Kingdom
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