An international bankruptcy code: Has the time arrived?
Salter, Leonard M
In the Spring 1991 issue of the Commercial Law Journal an essay appeared entitled “Can the Soviet Union Use a Chapter 11? Would It Be Effective?” by this author. The argument was that the U.S.S.R. had serious financial problems that seemed insuperable, that the war in Afghanistan had proved to be the Soviet Union’s Vietnam and that a Chapter 11, or some similar artifact, should be available to assist the Soviet Union and other countries in the parlous state that Moscow found itself in in the late 1980s. Unfortunately, there was no forum for a national entity in the plight of the U.S.S.R.; the country imploded. It is the gravamen of this plea that as more and more countries–whether as a result of prodigality, poor judgment, failing crops, inability to compete in the global marketplace or any other deficiency–should have a haven where, protected from the onslaught of badgering creditors, a respite could be achieved. During such an interim period, improvements could be devised, set in place, a new program for running the country could be introduced.
The new international legislation–perhaps promulgated by the G-7, the largest industrialized nations in the world–offered the countries that needed it an opportunity to meet with their creditors, perhaps with the World Bank and the International Monetary Fund serving as consultants. There may be a long-standing problem that affects the economy of the country or it may well be a temporary set-back–a drought, a severe earthquake, a physical problem.
It could be a fiscal problem, as when the Bombay Stock Exchange closed for nearly a week in March 1995 because of price rigging and a broker’s default.(1) This is not the first time a problem has paralyzed Indian stock exchanges. The country’s trading and regulatory systems are rather primitive and quite inadequate in competing with more sophisticated emerging markets.
The dominant fiscal problem among the various nations today is the meteoric fall in the value of the Mexican peso in the Spring of 1995. The value of the currency has been in a free-fall for a considerable period; the financial pundits have suggested some plans which may be effective in reviving the debilitating downward trend.(2) Financial analysts have promulgated a plan calling for large tax increases and spending cuts designed to rein in inflationary pressures and restore some strength to the peso. It is conceded by these officials close to the situation that these ukases will add new burdens on a population already beleaguered by widespread layoffs and credit shortages. There is no question that, in the short run, these developments will increase business failures and create social instability.
Paul B. Carroll and Craig Torres, writing from Mexico City, report on what the government proposes to do in order to produce a $4.4 million budget surplus for 1995: An increase in the value-added tax to 15 percent from 10 percent. The state oil company will raise gasoline prices 35 percent immediately and .8 percent each month for the rest of the year. Electricity prices will rise 20 percent initially and .8 percent each month during 1995. New spending cuts, in addition to previous cuts, will reduce federal spending to 1.6 percent of GDP in 1995. So-called program projects will decline 9.8 percent in inflation-adjusted terms; this means there will be no new infrastructure projects. Government employees will not receive raises. There will also be staff cuts and possibly some mergers of departments,
Argentina is suffering from shock waves as a result of the economic crisis in Mexico. The government is presently (March 1995) requesting an additional $2 million more from the IMF than the $420 million Argentina had sought in the previous week to replenish an emergency fund affording liquidity to its troubled banking sector. Since Mexico’s devaluation of the peso on December 20, 1994, $4.2 billion of deposits have been withdrawn from Argentine banks. Just two weeks previous to this new request, the Economic Minister Domingo Cavallo had stated that the country would not need any funding from the IMF. However, the substantial decline in bank deposits and a persistent outflow of hard currency reserves had seriously affected the economy. The country has a convertibility system, under which the peso is traded one-for-one to the U.S. dollar; each peso in circulation is backed by a dollar of reserves. By the first week in March 1995, the government had used all but $200 million of the reserve fund; there was no end in sight to the banks’ problems.(3)
There is another serious fiscal problem that arises when commercial banks face liquidity problems. In Argentina, such a bank is permitted to borrow at a much lower rate from the central bank than from other local banks by hypothecating their holdings of government bonds as collateral.
The central bank now also allows banks to draw on funds for up to 120 days rather than just 30 days. Instead of calling on the IMF for periodic disbursements of funds, Dr. Cavallo is requesting that the IMF allocate all or most of the $2 billion immediately; Argentina’s Congress has already approved the first elements of the economic authority package that is a prerequisite for IMF participation. Here are two examples of how necessary it is to comply with the suggestions of the IMF in order to qualify for these loans. A previous reform package was opposed by the Argentine Congress in March 1995, which decree was necessary to keep the federal budget in balance. As a result of the IMF report, a variety of appropriate options by Argentina were available; the stock market, strengthened by the news rose 1.4 percent.
Brazil is another country that, although it has $36 billion in hard currency reserves and a robust export economy, has moved to avoid the kind of progressive economy that overvalued the currency, as did Mexico. According to the Moffett-Friedland report, the markets have been confused by the Central Bank as to the shifting exchange rate. As a result of this uncertainty, the Central Bank was forced to intervene in local currency markets five times on one day in March 1995, and 32 times on March 9, 1995. The currency confusion has caused consternation in the national stock market; it fell 30 percent in the first week in March and 9 percent in one day alone.
In Venezuela, 18 private banks have failed since June 1994.(4) As a result of this debacle, the government was forced to pump $7.5 billion into the banking sector, or the equivalent of 13 percent of the country’s total economic income for the year 1994. Despite price controls, this has contributed to a doubling of inflation to 71 percent in 1994. Venezuela seems to have the dubious distinction of having South America’s highest inflation and deepest recession. This is not troubling to Venezuelans, since many countries in South America are doing no better than they have in years. Although this country of 31 million people–the second largest supplier of oil to the U.S. after Saudi Arabia–thought that the bank failures had become history, they still ran into an economic crisis that only initiated social and political tensions that are always just below the surface in Venezuela.
Some 100 individuals have been issued complaints so far by the Venezuelan government in connection with the plethora of bank failures; no banker is on trial and none is in jail. One of the many problems that the government encountered in tracking these malefactors is that the putative defendants have access to computers; the government does not: David versus Goliath. The total losses in the bank collapses amounts to $7 billion. Obviously, there is a credibility gap that makes it all but impossible to persuade the public to accept the draconian measures necessary to restore credibility and responsibility.
According to James Brooke, reporting from Caracas, Rafael Caldera, the President of Venezuela, has already gone through two finance ministers, two Central Bank presidents, three bank superintendents, three development ministers, four planning ministers and eight economic plans in just his first 14 months in office. The collapse of investor confidence in the Caracas Stock Exchange has brought the daily trading to $1.4 million, just one-tenth of the level of 1994. In that year, the only important investors in Venezuela have been Latin American multi-nationals attempting to expand their research at bargain basement prices.
We have examined, albeit briefly, some of the current fiscal problems that are besieging various countries around the world. The question is: in the present interconnectedness between the finances, peoples and cultures should there be some International Bankruptcy Code to undergird and support the economies and currencies of various countries that have, for one reason or another, found themselves beleaguered?
In accord with the suggestion made above, that the world needs an International Bankruptcy Code for countries in fiscal trouble, we have Representative Jim Leach (R-IA), Chairman of the House Banking Committee, calling for a new “international bankruptcy regime” to deal with countries threatened with insolvency, such as Mexico.(5) Representative Leach noted that most Americans did not want the U.S. Treasury to become the global banker of last resort anymore than they wanted U.S. troops to police the world. There should be a procedure, he opined, for a country to have protection under a bankruptcy “umbrella” in which “an orderly reduction of liabilities could be negotiated.” A comparable regime to the U.S. Chapter 11 could be promulgated which would prevent individual or national creditors from taking action until a formal plan had been negotiated with a group of creditors, who would form a creditors’ committee.
It is obvious that by hindsight, the financial moguls (certainly those whose countries were creditors) recognized in 1994, that Mexico’s Central Bank was inflating the money supply, thereby putting downward pressure on the peso. Although, as Rep. Leach points out, many of the individual creditor countries were complacent about Mexico’s activities, the U.S. expressed concerns about that country’s build-up of short-term debt, its growing current-account gap and its dependence on foreign financial loans. Thomas L. Friedman points out that on the customs forms signed by a visitor to Mexico today, there are nine boxes in which one can insert his occupation. One of the nine, along with “driver of vehicle” or “livestock rancher” is “bond holder.” This is an instance of how significant foreign bond holders were to the Mexican economy.(6)
According to Friedman, foreign bond holders are cashing in their bonds for pesos as soon as they mature; upon receiving the pesos, they take them to the bank to exchange for dollars and take them north as fast as they can. The Mexican government is obtaining the dollars on loans from the U.S. Treasury. As Friedman phrases it, the peso’s decline would look like the EKG of someone having a heart attack. The reason that foreigners are not persuaded to bring their investments back to Mexico is that the government has not yet provided a feasible plan for restructuring its budget. Overlooking, for the moment, the murky political situation (the brother of the former President stands accused of ordering the assassination of the former ruling party’s Secretary-General, then conspiring to cover up the murder with the help of the former Chief Investigator, who happens to be the brother of the dead man), there is the danger that the rescue plan may not work.
The fear among potential investors is that there will be a recession. In exchange for the bailout, the U.S. has demanded 60 percent interest rates, tax increases and curbs on government spending. It is feared that these draconian terms will produce not just a cleansing recession, but a revolutionary despair. It may be that this budget package will save the Mexican Government but will destroy the private sector; that is supposed to be the elixir of Mexico’s renaissance. Friedman suggests that a rescue program that focused on securing the private sector with more money and fewer impossible conditions would never have been passed by the U.S. Congress.
Small and medium-sized Mexican businesses are caught in a Catch-22. They must be modernized and consolidated since they are one of the major sources of employment in Mexico. Not only are they significant in their contribution to the GNP, but also because they expand Mexico’s entrepreneurial base and assist in the development of a majority middle class. However, in order to modernize, these companies must re-engineer their technologies and adopt modem administration and accounting procedures, all of which require heavy capital investments. They cannot expect to modernize without access to additional loans; they cannot obtain access to such loans until their accounting and financial standards are in accord with those of our modernizing banking regimen. Most of these companies have borrowed at high, short-term rates, to service long-term debt.(7)
It is always interesting and profitable to analyze the results of the initiation of a new concept so that one can learn whether wending off the beaten path was a good idea.
Let us examine the benefits and demerits of a Chapter 11, for example, to determine whether, in application to a country afflicted with heavy and debilitating debts, this new creation of an International Bankruptcy Code would be useful? We read in the current press about the need to internationalize the rules about drug trafficking, that the abuses are so rampant that the only solution would be to have the various countries collaborate in their activities so that a grower in Columbia and a dealer in Brooklyn would have to submit to the same principles of international law, although their countries may be thousands of miles apart and have no common bonds, except comity and a common interest in protecting each other’s citizens and the world against the evil depredations of narcotics.
In the fluid and integrated world we inhabit, the instability of a major country like Mexico can have repercussions and reverberations around the world, as we have seen above. Therefore, it would appear necessary to coordinate our forces if only on the basis of comity, of one nation to another. We must find a method of working out fiscal problems, especially when illiquidity and insolvency are involved.
Recurring to Argentina, following the Mexican crisis, the government proffered a revised tighter budget. January and February 1995 tax receipts were far below the 1994 levels, while the program projects a 7 percent increase in such revenue. Since 1991, the government had paid interest obligations out of the budget surplus it had gained from raising tax revenues and heavy privatization proceeds.(8) What to do when there is no surplus?
It is urged here that a uniform system of bankruptcy and insolvency be instituted on a global basis so that a systematic method and structure for helping countries in a cash and liquidity bind can be formulated. Be reminded that the Group of Seven members gathered in Madrid in October 1994 and pledged to fight inflation and support world lending to needy nations. The G-7 ministers agreed to call on the IMF to create additional reserves of as much as $23.4 billion.(9) This money would be used to help finance imports, principally by former Communist countries. There is an element in their reciprocal loan package that must be national; the donee country must have erected a sound system of accounting. One of the reasons why the PLO has not received all of the money promised by the international consortium, willing to help that new entity establish itself in the West Bank as Arafat has promised, is that the leader has claimed that as a sovereign, no one has the right to ask him to account for funds received. When Moscow requested billions of dollars before it turned over some of its nuclear weapons to be dismantled and the various chemicals and metals preserved to be recycled, one wag in Washington suggested that the U.S. insist that a good accountant be included in the package to Moscow as absolutely necessary.
Here are a few lines from an important book on international bankruptcy which gives us a foothold on this problem. “From the earliest days of the trading communities,” writes Louis Jacques Blom-Cooper, “such as existed in the Greek city states, government authorities have been faced with the problem of the debtor who failed to meet the demands of his creditors. Disposal of the available assets remaining and subsequent division among all the creditors was as urgent a consideration of those times as it is today. Every modern state recognizes the concept of bankruptcy but to the chagrin of those seeking international agreement this uniformity ceases at its inception; the divergence of legal systems is apparent at the very moment of initial agreement. French law, for example, states that every trader who terminates his payments is in the state of bankruptcy. Italian law, on the other hand, decrees that only a trader who ceases to honor his commercial obligations is in a state of bankruptcy.”(10) We are not talking about business entities, but national entities. We have seen examples of beleaguered countries which have fallen on evil days. Would the proven structure of the U.S. bankruptcy system, with judges, U.S. Trustees and private trustees, in-house accountants and appraisers, be in a position to assist those countries that have fallen behind in the payment of their foreign or domestic obligations?
We have observed situations where a country may apply to the IMF for a loan; it is speaking for itself to some hardheaded bankers. Some requests are turned down or the amount greatly diminished. If a creditors’ committee composed, as in the United States, of the largest unsecured creditors, relying on a report of the accountants for the committee, claimed that the plan promulgated is feasible, the plea for the loan would be blessed with the imprimatur of a second group of creditors’ representatives. As in the U.S., this group of creditor representatives would be interested in helping the debtor country get back on its feet. A creditor who was not interested in rehabilitating the debtor, and announced so publicly, could be objected to and removed from the
There are cases where the debtor in Chapter 11 required certain specific goods to fill a contract. Often, the only source of supply, a large creditor, refuses to deliver any more merchandise unless on a C.O.D. basis and the debtor doesn’t have the cash. There are cases where a member of the creditors’ committee will intervene, discuss this problem with the recalcitrant supplier and obtain the requisite goods.
The apparatus of the International Bankruptcy Code would give the debtor and its problems some more creditability. The fact that either Uganda or Sierra Leone (for example) was under the jurisdiction of the court would make the World Bank or the IMF feel more comfortable, it is suggested. If these bureaus knew that there is someone official supervising the store, so-to-speak, the loans, in many cases, would have a better chance of being approved. Yassir Arafat would not dare to offend the Bankruptcy Trustee in the employ of the International Bankruptcy Court. The price of disobedience would be the cancellation of the loan, or the discontinuance of further discussions on the subject.
Now, one might ask, does the writer’s suggestion of a international bankruptcy facility to take care of fiscal problems as they arise–Mexico, Italy, France, Argentina, Venezuela–really help the course of world financial stability? We recognize that Section 304 of the U.S. Code allows proceedings in the U.S. to be initiated which are connected with proceedings already pending in foreign bankruptcy courts.(11) That problem has already been taken care of by present legislation.
What is here urged is an impartial representative and spokesman for the debtor country who can speak authoritatively about the present plans and future prospects of the debtor country with some credibility. The committee would be composed of representatives of states who have seen similar problems, now being encountered by the debtor, overcome by their own country or other nations. There will be a wealth of experience available to assist the debtor in proposing its plan and disclosure statement. It may be that after a proper interval, the committee may file its own plan. A freeze on litigation will, of course, be of inestimable value as a breathing space for the bedeviled state.
Question: The world is moving toward consolidation and integration in the fiscal area, among others. Can an International Bankruptcy Code be far behind?
1. “Bombay Fiasco,” Business Week, (April 3, 1995) p. 76.
2. Paul B. Carroll and Craig Torres, “Mexico Unveils Program Of Harsh Fiscal Medicine,” Wall Street Journal, March 10, 1995.
3. Jonathan Friedland and Matt Moffett, “Argentina Is Seeking More IMF Funding As Fallout From Mexico Crisis Continues,” all Street Journal, March 10, 1995.
4. James Brooke, “Venezuela Bank Failure Undercuts Government,” New York Times, March 30, 1995.
5. “Rep. Leach Urges Process For Nations’ Insolvencies,” Wall Street Journal, March 7, 1995.
6. Thomas L. Friedman, “Mexican Malfunction,” New York Times, March 8, 1995.
7. Jacques Rogozinski, “A Plan to Resuscitate Mexico’s Entrepreneurs,” Wall Street Journal, December 2, 1994.
8. Matt Moffett, “Debt Payments Put Squeeze On Argentina,” Wall Street Journal, February 28, 1995.
9. “G-7 Nations Bank Inflation Fight, More Loans,” Boston Globe, October 2, 1994.
10. Louis Jacques Blom-Cooper, “Bankruptcy In Private International Law,” The Eastern Press, (London, 1954) p. 3.
11. 11 U.S.C. Sec 304 (1982).
Leonard M. Salter is a partner in the Boston law firm of Wasserman & Salter. He is Chairman of the Board of Associate Editors of the Commercial Law League of America and served as President of the CLLA in 1970-71.
Copyright Commercial Law League of America May/Jun 1995
Provided by ProQuest Information and Learning Company. All rights Reserved