The Creditor Concern
Ashima Sehgal
The Corporate has established itself as the strongest business form. And yet, the age-old debate on its
core – limited liability – continues as the global creditor protection laws come under the scanner.
As common knowledge goes, a Company
(or corporate) is “a voluntary association of
persons formed for the purpose of doing
business, having a distinct name and limited
liability”. This is an incredibly singular
definition, as the corporate form of
business ownership sees different structures
in jurisdictions across countries. Business
has traversed boundaries, and legal
compatibility across nations should aim to
facilitate this process of globalisation,
providing a framework for a worldwide
unison of commerce. And the uniformity in
the corporate form, even the underlying
divergence, is quite encouraging.
Notwithstanding the differences, the
numerous definitions of a business
corporation given by the statutes worldwide
comprise of five essential elements – legal
personality, limited liability, transferable
shares, delegated management under a
board structure, and investor ownership.
Legal personality and limited liability are
the defining characteristics, and give this
form most of its advantages, including lower
cost of capital and creditor protection.
That said, a quick scan of the company law
of different countries shows that corporate
creditors are the only non-shareholder
stakeholders that are protected by the law
globally. Although the legal need for the
same can be dispensed by providing
contractual security, owing to the
characteristic “limited liability”, corporate
creditors face a risk specific to this business
form. Despite this common base, the
common-thread view is violated when we
categorize the countries into two types of
jurisdictions: creditor-friendly and debtor-
friendly. Conventional wisdom suggests that
US is debtor-friendly, UK and EU are
creditor-friendly, while Japan lies midway
between the extremes. These facts are
portrayed by several stances of the law in
these countries. For instance, Germany,
Switzerland and France have a statutory
requirement to initiate bankruptcy
proceedings at its onset. A harsher stand is
taken by UK, where the directors, having
failed to act timely in the event of
insolvency, are liable for damages. In
contrast, neither US nor Japan impose any
legal liability on the boards of insolvent
companies. The US Bankruptcy Code
undertakes a more liberal position, giving
the failing board the first chance to devise
revival strategies and reorganisation.
Supplementing this argument, EU and
Japanese laws require the „larger‟
companies to be audited professionally,
while the closely held business (private
companies) in the USA have limited
obligation of maintaining financial accounts,
which they are not compelled to disclose to
the public. (On the contrary, despite the
rather loose regulations for closely held
companies, disclosure by public companies
is more emphasised on in the US than in
any other jurisdiction. Well, the irony of a
capitalist economy.) Many more such
examples can be cited to exhibit the
variance in the approach towards protection
of corporate creditors – both voluntary and
involuntary – under different statutes.
Creditor protection laws in different
countries deviate because of the uneven
levels of importance attached to this
concept. And so it is no surprise that the
UK, having the most creditor-friendly
jurisdiction, has the best record in enforcing
effective creditor protection, while the
implementation in Japan has been a little
slack. But in a globally competitive business
environment, the focus remains on
convergence of these legal provisions, and
when taken in a macro context, the
divergence seems less significant. And
here‟s why.
Different legal strategies, adopted and
enforced to different extents, and in a range
of combinations, may conclude in similar
results. For example, the markets in USA,
because of high level of integration, are able
to sustain many credit rating organisations.
And so, even in the absence of stringent
disclosure norms, when the information is
available through the channels of credit
rating, it seems implausible that an entity
will extend credit to another without
evaluating its legal capital, investment
capital and capital maintenance. Hence, the
leeway given by some jurisdictions is
compensated by other complimentary
factors in play, effecting a regulated,
workable business scenario.
The growing integration of product and
capital markets gives rise to a need to
bridge the jurisdictional differences in
creditor protection. Stronger creditor
protection laws are witnessed in economies
with fragmented markets. As exhibited by
the recent global developments, it would be
in the best interest of international as well
as domestic business if the pro-creditor
jurisdictions toned down a little, initiating
better market integration, and similarly,
slight stiffening of the debtor-friendly laws,
improving the creditor protection norms in
countries like USA, leading the path to
secular convergence.