How Law & Economics Analysis Can Solve the Problem of Over-Indebtedness in LBO Target Companies -- Promoting Changes in French Bankruptcy Law
Revue Trimestrielle de Droit Financier N°3 - 2014
41 Pages Posted: 3 Jun 2015
Date Written: September 1, 2014
While leveraged buy-outs or "LBO" can create financial and economic value, they may also lead to over-indebtedness for target companies. The financial crisis that followed the burst of the speculative subprime bubble in 2007 revealed and exacerbated the risk of over-indebtedness that affects companies’ viability and the rights of their stakeholders. Over-indebtedness particularly exacerbates the dilution of the rights of creditor created by the use of leverage. This problem is even bigger in France as French bankruptcy law does not adequately help companies to reduce their debt.
The easing of monetary policies, initiated following the cyclical downturn of 2008, has so far helped to prevent massive corporate insolvencies, and calmed fears that LBOs have led to over indebtedness. However, monetary policies have not permanently resolved the financial difficulties of LBO target companies.
In light of empirical considerations and the theoretical lessons of law and economics analysis, this article will attempt to show that, in the short term, properly tackling over-indebtedness requires the modernization of bankruptcy law in order to facilitate corporate restructuring, and in the mid term, to adapt the legal rules governing LBO transactions, in particular those establishing liability for directors’ which currently prevent the LBO industry from developing into a positive force for economic growth.
The key to solving the over-indebtedness problem lies precisely in rebalancing the agency relationship between shareholders and creditors. In short, the article will attempt to show that because the interests of directors and shareholders are aligned in a LBO target company and because legal mechanisms governing debt are ineffective, the best way to deal with over-indebtedness remains the contractual protections put in place by creditors. It is therefore essential that Courts properly enforce these mechanisms. If this contractual approach may conflict with the traditional approach of judicial interventionism of French bankruptcy law, it does not disqualify all state intervention but rather recommends to rationalize it by requiring that state intervention be subject to a cost-benefit test, in accordance with the teachings of law & economics theory.
Keywords: LBO, leverage buy-out, French bankruptcy law, financial assistance, Coase, Pigou
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