A Synthetic View of Different Concepts of Creditor Protection, Or: A High-Level Framework for Corporate Creditor Protection
Peter O. Mülbert
University of Mainz - Center for German and International Law of Financial Services and Faculty; European Corporate Governance Institute (ECGI)
European Business Organization Law Review (EBOR), Vol. 7, 2006
Protection of corporate creditors has become an important topic within the European Union. At EU level, discussion has been sparked by widespread dissatisfaction with some very rigid and cumbersome provisions, and even with the whole concept of the Second Company Law Directive. At EU Member State level, three landmark decisions by the European Court of Justice - Centros, Uberseering, and Inspire Art - opened the way for an all-out competition between the different company forms provided for by national company laws. At both levels, albeit for different reasons, British company law - and in particular the absence of any legal capital in the private limited company - acts as the main driving force putting pressure on the concept of legal capital as enshrined in the Second Directive, which in turn was modeled on German company law notions.
The High Level Group of Company Law Experts provided the appropriate starting point for the present discussion by dealing not only with the raising and maintenance of capital, but by also taking up the wrongful trading remedy (s. 214 British Insolvency Act) and the equitable subordination remedy. This present article builds upon this broader approach, seeking to develop a conceptual framework for an efficient creditor protection regime within a purely national setting, i.e., leaving aside the additional problems created by pseudo-foreign companies and the impact of the provisions of the EU Treaty for the free movement of companies on national company laws.
Given the rich variety of creditor protection mechanisms within EU Member States, any attempt at developing even a high-level framework has to start by identifying the relevant risks against which creditors need protection and the required extent of such protection. Against this backdrop, any jurisdiction has to make a choice whether to rely mostly on creditor self-help or on mandatory protection rules. In principle, since all mechanisms for creditor self-help are inherently costly and fail to protect involuntary (tort) creditors and weak contractual creditors as effectively as they do strong contractual creditors, there is a case for mandatory protection rules. The article then goes on to review the different well-known mechanisms for mandatory creditor protection. In line with earlier findings and the criticism mostly from English scholars, the case for a German-style legal capital regime turns out to be weak, at best.
On the other hand, since shareholders' incentive to act to the detriment of creditors increases with the company becoming financially distressed, it is important to provide for mechanisms that will work to effectively control any opportunistic behavior on the shareholder's part. In this respect, equitable subordination of a shareholder's right as well as the wrongful trading remedy may serve important roles. The article concludes by taking a brief look at the resultant high-level framework for an efficient creditor protection regime.
Keywords: High Level Group, creditor protection, limited liability, financial covenants, legal capital, minimum capital requirement, capital maintenance, undercapitalization, wrongful trading, equitable subordination, recharacterization
JEL Classification: K20
Date posted: February 19, 2007