Implementing an insolvency framework for micro and small firms

• Published date: 01 September 2021
• Author: Aurelio Gurrea‐Martínez
• Date: 01 September 2021
• DOI: http://doi.org/10.1002/iir.1422

RESEARCH ARTICLE

Implementing an insolvency framework for

micro and small firms

Aurelio Gurrea-Martínez

Yong Pung How School of Law,

Singapore Management University,

Singapore

Correspondence

Aurelio Gurrea-Martínez, Singapore

Management University, Yong Pung How

School of Law, Singapore.

Email: aureliogm@smu.edu.sg

Abstract

Micro-, small-, and medium-sized enterprises (MSMEs)

represent the vast majority of businesses in most coun-

tries around the world. Despite the economic relevance

of these firms, most insolvency jurisdictions do not pro-

vide adequate responses to MSMEs. Moreover, with a

few exceptions, the academic literature on insolvency

law has not traditionally focused on the treatment of

MSMEs in insolvency. This article seeks to contribute

to the debate by exploring the primary features and

problems of MSMEs in insolvency as well as the weak-

nesses of the ordinary insolvency framework to deal

with MSMEs. It also provides a general overview of the

primary reforms and policy recommendations taking

place around the world to deal with MSMEs in insol-

vency. The article concludes by suggesting several strat-

egies to design an efficient insolvency framework for

MSMEs.

1|INTRODUCTION

Micro-, small-, and medium-sized enterprises (MSMEs) represent about 90% of businesses and

more than 50% of employment worldwide.

1

Therefore, they play an essential role in most

For valuable comments and discussions, the author is very grateful to Jason Harris, Michael Murray, Nydia Remolina,

Kathleen Van der Linde, and the World Bank Group Insolvency & Debt Resolution Team. For excellent research

assistance, the author would like to thank Samantha Lim and Hui Min Chiow.

Received: 28 October 2020 Revised: 13 January 2021 Accepted: 3 July 2021

DOI: 10.1002/iir.1422

This is an open access article under the terms of the Creative Commons Attribution License, which permits use, distribution and

reproduction in any medium, provided the original work is properly cited.

© 2021 The Author. International Insolvency Review published by INSOL International and John Wiley & Sons Ltd.

S46 Int Insolv Rev. 2021;30:S46–S66.wileyonlinelibrary.com/journal/iir

countries around the world and even more in emerging markets.

2

Despite the economic impor-

tance of small firms, most insolvency jurisdictions do not provide adequate responses to

MSMEs. Moreover, with a few exceptions, the academic literature on insolvency law has not

traditionally focused on the treatment of MSMEs in insolvency.

The lack of an adequate insolvency framework for MSMEs can generate various costs for

society. Ex post, value can be destroyed if viable firms end up in a piecemeal liquidation or the

assets of non-viable firms are not quickly reallocated toward more productive activities.

3

From

an ex ante perspective, an inefficient allocation of assets in insolvency can lead to an increase in

the cost of debt, harming firms' access to finance.

4

Moreover, the lack of an attractive exit for

MSMEs may prevent many entrepreneurs from even starting a business. Therefore, an ineffi-

cient insolvency framework can also be harmful for entrepreneurship.

This article seeks to explore the features and problems of MSMEs and insolvency. It also

suggests various policy recommendations to design an efficient insolvency framework for

MSMEs. For that purpose, Section 2 starts by analyzing the concept and features of MSMEs, as

well as the problems these firms generally face in a situation of financial distress. Section 3 ana-

lyzes the weaknesses of the ordinary insolvency system to deal with small firms. Section 4

explains the harmful economic effects generated by the lack of an adequate insolvency frame-

work for MSMEs. Section 5 provides an overview of the primary reforms and policy recommen-

dations suggested or adopted to enhance the insolvency framework for MSMEs. Section 6

suggests a new insolvency framework based on various pillars, including the promotion of

workouts, the adoption of a simplified insolvency process using a system of auctions, a coordi-

nated treatment of personal and corporate insolvency, and various strategies to reduce the

stigma traditionally associated with insolvency proceedings. Section 7 concludes.

2|UNDERSTANDING THE PROBLEMS AND FEATURES OF

MSMEs

2.1 |Concept and features of MSMEs

The definition of MSME differs across jurisdictions.

5

In fact, countries may even adopt different defi-

nitionsofsmallfirmsdependingonthepurpose.

6

Despite these divergences, however, most MSMEs

around the world share some common features. First, they have very simple organizational struc-

tures. In many cases, MSMEs consist of just a single entrepreneur without any employees.

7

Second,

mostMSMEshavesimplefinancialstructures.

8

Indeed, small businesses often have just a few credi-

tors, and they mainly rely on bank finance as their primary source of external finance.

9

Third, many

small businesses are not incorporated. Hence, entrepreneurs do not enjoy the benefits associated

with the corporate form, including the existence of limited liability.

10

Even if incorporated, the

MSME's shareholder/manager often acts as a guarantor for the company's debts.

11

As a result, the

life and welfare of the individuals behind MSMEs are inevitably tied to the business' fate.

12

2.2 |Problems arising in financially distressed MSMEs

A situation of insolvency leads to various economic problems that are relatively similar across

companies and industries.

13

For example, when debtors are unable to pay their debts, creditors

become entitled to enforce their claims and ultimately seize the debtor's assets. Therefore, their

GURREA-MARTÍNEZ S47