Focus: Insolvency Law in the EU Member States and Candidate Countries

Problems of Insolvency Law in Transition Economies  

The transformation of property ownership and the “revolutionary establishment of an entrepreneurial class”

In the transition economies of Central, Eastern and South Eastern Europe, a fundamental social economic change has occurred simultaneously to the process of political and constitutional modernisation: the transformation of property ownership. Here, "the revolutionary establishment of an entrepreneurial class" – as a category of agents which was alien to the socialist planned economy and which is now participating in the free competition on the basis of property ownership titles – leads to entirely new demands on the concept of system transformation. The transformation of property as a (re-)introduction of private property is seen as being crucial in reaching a "point of no return" in the process of privatisation of the legal and economic organisations of former socialist states.

The position of insolvency law in the transformation of property ownership 

Hand in hand with the establishment of private entrepreneurship, a private law system is being introduced, in which the economy and the state exist as separate entities and the basic conditions for the participation of the new agents in the common market are created. For this to succeed, an unequivocal allocation of risks and responsibilities – especially in the field of commercial law – is absolutely necessary. The insolvency law, complementing the juridical institutions of private property and private entrepreneurship, is a core element here and in order to correctly fulfill its mission, it must, like all laws, include all subjects involved in economic exchange – both public and private.

However, the basic difference in the role of the insolvency law in the transformation of property ownership is that unlike in the developed West European economies, it is not a matter of a well-functioning economic system searching for an instrument for self-adjustment, but that this order is only currently emerging in the context of the denationalisation process. 

Lack of personnel as a "transformation handicap"

Unlike in East Germany, the transformation of the system in former East Bloc countries has not been marked by a "permanent replacement of the Eastern elite by the Western elite", but by a renewal of the old nomenklatura by the succeeding generations. Due to the fact that adequate education and practical experience in the new market system have only been available since the political turnaround, there is a lack of personnel with experience in the market economy system on all levels. So while in East Germany, Western experience in the private economy was available for the task of transformation, this was not and still is not the case in Eastern Europe. 

For this reason the lack of specialised chambers and court personnel, and competent administrators organised in professional associations, is not an institutional deficiency but a structural one.

Exit processes as a market-driven process of optimal asset re-allocation

From a macroeconomic point of view, insolvency can be seen as one of many possibilities through which productive capacity can be assigned to a better and more efficient use. The characteristic of this process of resource re-allocation is the temporary withdrawal of productive capacity from the market at the early stages of this process. Consequently – beside the optimal re-allocation of the assets – the duration until the re-entrance of the resources into the market is decisive for the success of the whole process.

Beside the "classic" mechanisms of insolvency law (in particular bankruptcy and reorganisation), the "non-classic" procedures covered by the general rules of civil, company and commercial law (downsizing/restructuring/asset sale) should also be mentioned. They are of great importance in transition economies, due to their flexibility, rapidity, and most importantly because unlike classic methods, which are usually conducted by the creditors, they are conducted by the debtors (owners) and therefore have a lower level of conflict potential. 

State influence and industrial policy

It seems that consistent application of the insolvency law depends very much on enterprise size and on the decisions of the relevant government. This has also been found to be the case in Western economic systems, where the bankruptcy of large enterprises is often only avoided by state financing, reduction of taxes or other suitable means of direct or indirect subsidies. Thus in a paradoxical way, after reaching a "critical size", the relationship between deficient management and its consequences is reversed: the more employees are affected by possible bankruptcy, the milder are the consequences for the managing staff should they fail to avoid insolvency by prudent management.

Restrictive application of the insolvency law affects the development of the private sector, as financing the state sector, e.g. in the form of generous credits or direct support, impedes competition and disadvantages private enterprise. In addition, there are the losses from enterprises which are neither dissolved nor privatised but continue to muddle along, losing eco-nomic potential and in some cases negatively effecting the environment due to increasing decay and failure to modernise.