Hungary's Bankruptcy Experience, 1992-93
| Author | Cheryl Gray; Sabinery Schlorke; Miklos Szanyi |
| Profession | Policy Research Department The World Bank; The Institute for World Economics Hungarian Academy of Sciences |
| Pages | WPS1510 |
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As policy makers in transition economies look for policies and processes to spur enterprise restructuring, they should take a close look at Hungary's experience with bankruptcy1 reform since 1992. It is indeed unique in the post-socialist world. Hungary adopted a tough new bankruptcy law in late 1991 that took effect January 1, 1992. It required managers of all firms with arrears over 90 days to any creditor to file for either reorganization or liquidation within 8 days (the so-called "automatic trigger") and provided a rather sympathetic framework for them to do so. The law immediately resulted in a wave of filings, with some 3500 filings in April, 1992, alone (after the 90 day "grace" period covered by the law) and over 22,000 filings in 1992-1993. Since January 1992, over 25,000 cases have been filed under the law (Table 1), a level far beyond the expectations of policy makers when the law was adopted.
Although the level of activity has been enormous, detailed information on how the bankruptcy process has actually worked in Hungary has been scarce. Many views -- both positive and negative -- have been put forward regarding the impact of the law on enterprise restructuring in particular and economic growth more generally, but they have been supported by very limited reliable data. This study helps to fill this information vacuum by providing detailed data on a randomly selected stratified sample of actual cases filed in the first two years after the enactment of the law. These data are supplemented with information obtained in numerous interviews with judges, liquidators, and firms involved in the bankruptcy process to give an overall picture of the process in practice in the first two years of its implementation.
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[NO INCLUYE TABLA]
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Bankruptcy law plays at least three important roles in market economies. First, it provides ailing frmns with an orderly means of exit. Second, it helps to reallocate assets to better uses through a combination of restructuring and liquidation. These two roles work together: The threat of exit spurs restructuring, and the impossibility of restructuring spurs exit. The bankruptcy process should ideally be able to discriminate between unviable firms and potentially viable ones that can be saved through restructuring. For enterprises able to cover operating costs out of current revenues but unable to cover debt service, reorganization provides an avenue to restructure debt burdens and thus continue in operation. It may promote such restructuring formally, as in the Hungarian reorganization procedure, or through informal debtor-creditor workouts undertaken to avoid formal bankruptcy. Firms unable to cover even operating costs are clear candidates for exit unless fundamental operational restructuring can be achieved via reorganization.
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In their emphasis on preserving jobs and production, policy makers in many transitional countries focus on these first two roles for bankruptcy law. However, a third role is at least as important for economic growth: The bankruptcy regime should promote the flow of credit in an economy by protecting creditors and serving as a final stage of debt collection. A well-designed bankruptcy process takes control over financially-distressed firms before all assets have been misused or dissipated, and it gives creditors the information and power to direct the use of the remaining assets to maximize the potential for debt recovery (either by improving the firm's performance via reorganization or by liquidating the firm and satisfying creditors' claims to the extent possible out of sale proceeds). By thus giving creditors the confidence that debts can be collected, bankruptcy processes (and collateral laws prior to bankruptcy) facilitate the role of banks and other creditors in funding and monitoring investment in an economy and in exerting influence over enterprise managers. Without the ability to collect debts, banks will either refuse to lend at all and thereby become peripheral players in both resource allocation and corporate governance, or they will turn to the state for support when loans turn bad. Thus, bankruptcy legislation is an important complement to, not a substitute for, disciplined macroeconomic policies and privatization (and the "hard budget constraints" and corporate governance possibilities they create).
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Considering these various roles, the major questions to be addressed below include the following:
- What types of firms enter reorganization and/or liquidation in Hungary, and why?
- How cumbersome are these processes in practice?
- What direct effects do these processes have:
- on restructuring of problem firms?
- on exit of problem firms?
- on privatization?
- on institution building?
- What are the roles of the various actors in these processes (i.e. debtor managers and owners, creditors, judges, liquidators/trustees), and why?
- Does the process serve reasonably well as a debt collection mechanism for creditors?
- Considering the answers to the above questions, what is the overall impact of the process on the economy, and how can the process be improved?
The Hungarian bankruptcy law of 1991 replaced earlier legislation adopted in 1986 and provided Hungary for the first tine with a modern legal framework, quite similar in structure to the U.S. bankruptcy regime. Debtor finms could file for either reorganization or liquidation, Page 6 while creditors could file for liquidation only. If debtors filed for reorganization, incumbent management could stay in place, and the firm received automatic relief from debt service and asset foreclosures for three months (further extendable by one month). During this three-month period, debtor management was supposed to develop a reorganization plan and present it to creditors. Unanimous approval by all creditors was required for the plan to be adopted; otherwise the case reverted automatically to liquidation. A firm with a successful plan could not file again for bankruptcy for at least three years. Trustees' and creditors' committees were not required in reorganization cases but could be organized at the discretion of creditors.
The liquidation process provided in the 1991 law was also in line with international norms. It provided for a liquidator be appointed once the court reviewed and decided to proceed with a filed case. The liquidator was supposed to notify creditors, draw up a list of assets, sell the assets, and divide the proceeds among creditors in order or priority (with liquidation costs first, followed by creditors secured by mortgage2 , other creditors, and equity holders, in that order). The entire process was supposed to be completed within two years. The law set compensation levels for liquidation and trustees, and regulations adopted concurrently with the law provided an annual licensing procedure for liquidators, setting out minimum capital requirements and professional qualifications.
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Numerous important changes were made to the law in September, 1993, drawing ostensibly from the first one and a half years of experience with the 1991 law. The unanimous creditor approval requirement was considered too tough, so it was replaced by a requirement of creditor approval by one-half in number and two-thirds in value of outstanding claims. The automatic three-month stay on debt service was considered too generous and easy to abuse, and it was replaced by a discretionary stay that required the same level of creditor approval within 15 days from the date of filing3 . Liquidators' compensation was considered too low and was increased. To stem the unanticipated flood of cases, both the "automatic trigger" and the automatic reversion of failed reorganizations to liquidation were eliminated. Finally, trustees were made mandatory in all reorganization cases.
Since the passage of the 1993 amendments, the number of reorganization cases has declined dramatically, to a level of only about five cases per month by end-1994. There are several likely reasons for this decline. First, the 1993 amendment removed both powerful "carrots" (the automatic stay) and powerful "sticks" (the "automatic trigger"), and the trustee requirement increased the costs and introduced potentially undesired outside controls into the process.4 Furthermore, end-1993 also saw the introduction of a new out-of-court workout Page 8 process, called "debtor consolidation", into the Hungarian scene. While description of this process is beyond the bounds of this paper,5 suffice it to say that debtor consolidation could well have been seen by many debtors and creditors as a substitute for reorganization under the bankruptcy law. Finally, the general economic conditions of Hungary improved in 1994, and many of the worst firms may well have already been included in the flood of cases in 1992-93.
To gain insight into many of the questions raised above, we undertook a survey of 117 bankruptcy cases filed between April 1992 and September 1993. All were covered by the unamended 1991 law.6 They were filed in one of...
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