Last week, here, I wrote about various strategies for restructuring debt. One of those–specifically for businesses–involved a court ordered restructuring as part of the bankruptcy procedures. This week I want to examine that process in more detail. Though instead of going through the entire process I’m going to highlight bits and pieces that are important to understand if you are thinking about initiating bankruptcy for yourself or for a business with which you are involved.
First, I need to clarify a confusion from last week. In discussing the concept of bankruptcy I mistakenly imputed at least once that it was a possibility for individuals to go through this process. That is incorrect. Only enterprises or cooperatives (or groups of cooperatives) are subject to the law on bankruptcy. Individuals cannot declare bankruptcy like in some jurisdictions around the world. Any misunderstanding is my fault as I relied on research notes in drafting last weeks article and didn’t actually read the law. So be aware, there is no option for individuals to get out of their debt other than through means of restructuring as discussed last week.
(I’m briefly going to discuss some policy issues here. The Vietnamese government has missed an opportunity to minimize bad debt on bank’s books by not providing some form of bankruptcy for individuals. It has engaged the fiction of personality for enterprises and grants them the opportunity to have their assets sold off to satisfy their debts to the degree of wiping out their debt. Though, in fairness, the enterprise itself ceases to exist at the end of a bankruptcy. This option is not available for individuals who continue to live and can, conceivably, enter into future debt relationships even after a bankruptcy. Additionally, it is difficult to deter individuals from bank hopping to obtain loans even after they might go through bankruptcy–something that is not the case for enterprises who, again, cease to exist–as there is no comprehensive credit reporting agency in existence in the country. There is nothing, therefore, to prevent an individual from wiping out his debts in a theoretical bankruptcy procedure and then going to a non-involved bank and taking out another loan. Finally, the government has a desire to see that its citizens remain housed and that land is at least roughly distributed in an equitable manner.
By allowing housing and land to be sold in a bankruptcy procedure out from under an individual and his family the government would be reallocating land used as a residence to land used as a profit making device, thus creating inequity in the system and negating the concepts of the country’s constitution. From this, banks can still foreclose on properties used as security for loans. Should a borrower use his land and house to secure a loan from a bank and then default on that loan, the bank is allowed to foreclose on that land and house and sell it off in an attempt to recoup its losses. This problem could, conceivably, be mitigated through an individual bankruptcy program that would limit the ability of lenders to attach primary residential housing to obtain relief. As existing, the law does not protect an individual’s land and housing and, thus, its citizens ability to maintain themselves in a given location. This affects livelihoods that are bound by geographical proximity to the workplace, their ability to pay taxes, and adds numbers to unemployment rolls and burdens to social security programs.
Thus, in addition to protecting the equitable distribution of land, it is also in the government’s interest to protect the homes of individuals. This requires both a bankruptcy procedure for individuals, and limits on banks for their imposition of security over residential property. A third prong is the development of creditable and comprehensive credit rating agencies who can keep track of individual credit transactions, payments, and defaults. With those three in mind, the government would be able to better control the redistribution of land from citizen to credit institution protect tax rolls, prevent unemployment and preserve the fine customs and traditions of Vietnam.)
Second, an enterprise needs to be aware of the parties who can institute a bankruptcy proceeding involving the enterprise. This is a knowledge that should exist from the beginning as the treatment of relevant parties should be taken into account to prevent bankruptcy as a general rule. The parties who can file for bankruptcy in relation to a given enterprise are:
- A creditor, unsecured or partially secured, who has remained unpaid for three months from maturity of the debt owed it by the enterprise;
- Employees and trade unions if they have not been paid for three months;
- The legal representative of the enterprise (here the filing is obligatory if he becomes aware that the enterprise is insolvent);
- Chairman of the board of management or owner (depending on the type of enterprise) upon learning of the enterprises insolvency (again, this is an obligation, not an option);
- Shareholder(s) controlling at least 20% of the shares of the enterprise for at least six months when the enterprise becomes insolvent.
It is important to know who can and has to initiate bankruptcy in relation to an enterprise. First, it informs the enterprises behavior towards creditors and employees, and, second, it imposes obligations on the management of the enterprise for which they can be held accountable if they fail to perform. Thus, the legal representative and chairman of the board of management both have the responsibility, legally, to initiate bankruptcy upon discover of insolvency of their enterprise. Failure to do so opens them to civil and possibly criminal liability.
Third, once bankruptcy procedures have been initiated it is important to understand that the enterprise, and subsequently its management, are essentially at the whim of the judge in the case. Judges overseeing bankruptcy proceedings have a very large degree of discretion in determining each step in the legislated procedure and they are responsible for overseeing the implementation of the decisions of the meeting of creditors (the meeting held between creditors and the enterprise to determine whether to proceed with bankruptcy or to try to recover the enterprise). They are also responsible for determining what actions need to be taken by the enterprise and its management to proceed to the finalization of bankruptcy or the resumption of business in a restructured form. Essentially, every decision of the enterprise comes under the jurisdiction of the assigned judge once a bankruptcy filing has been submitted. Beware, therefore, of trying to avoid responsibility as assigned by the judge for once the situation goes to court, management is not only subject to the penalties laid out for violations of the enterprise law, but also the civil procedures law.
Fourth, the payment of bankruptcy costs is the senior debt of the enterprise entering bankruptcy proceedings. The individual initiating the bankruptcy procedure is responsible for paying the bankruptcy fee and some initial costs, but the court has the power to sell assets of the enterprise in order to pay bankruptcy costs. These include the costs for the courts supervision of the process, notifications and public announcements, costs incurred in the hiring and operations of the asset manager who controls the enterprise and the bankruptcy investigation once bankruptcy has been initiated and before a decision as to a declaration of bankruptcy or recovery of the business is made. And other fees as may be legally incurred by the court, enforcement officers, and other administrators involved. This comes first. So depending on the size of the enterprise and the debts owed, this could eat a sizeable chunk out of the remaining assets of the company and thus make satisfaction any but the most senior debts possible. Dissatisfied shareholders who thus receive little to no value on their investments could then make life difficult for management who failed to foresee and forestall the bankruptcy in the first place. They could question management’s decisions and bring derivative suit against them, thus creating a personal liability on management’s part for any bad decisions that may have led to the bankruptcy.
Fifth, between the filing of a petition to initiate bankruptcy procedures and the initiation of bankruptcy procedures, the enterprise has the option to request negotiations between the creditor and the enterprise so as to avoid bankruptcy proceedings. The court will allow no more than 20 days for the enterprise to negotiate with the creditor in an attempt to come to an understanding and thus avoid bankruptcy proceedings. If the parties come to an understanding they can notify the court and the proceedings will be canceled, failure to come to an agreement within the 20 day time limit will recommence proceedings. This is the first in several opportunities throughout the bankruptcy procedures for the enterprise to negotiate with creditors. As discussed last week, a negotiated settlement is most often preferred by creditors over foreclosure or bankruptcy because they are more likely to receive a higher percentage of satisfaction for their debt that way. Management of an enterprise entering bankruptcy procedures should therefore be cognizant of those opportunities and seek every opportunity to come to a negotiated resolution so as to preserve the enterprise’s assets, operations, and the goodwill of shareholders and other stakeholders. Only if the enterprise is unable to reasonably satisfy creditor demands should management go willingly into a declaration of bankruptcy.
Sixth, once bankruptcy procedures have been commenced, the enterprise will continue to operate under the supervision of the judge and the asset manager. In all likelihood the legal representative and managing director will remain the same, however, the court may replace them if they deem management incapable or likely to commit an act prohibited under bankruptcy. Once bankruptcy proceedings have been initiated, the enterprise is prohibited from the following acts:
- to conceal, dispose of, or donate any assets;
- to pay any unsecured debts except those arising out of the bankruptcy itself or employee wages;
- to abandon any right to claim a debt;
- to convert any unsecured debt into a debt secured by any asset of the enterprise.
Any of these actions after bankruptcy has been initiated will put the enterprise in violation of the law and subject management responsible to legal repercussions.
Seventh, the relationship between shareholders and management is very important during the operations of a company and comes into stark lighting during the bankruptcy process. This is emphasized by the seniority of debt to be paid by the sale of assets of the enterprise. Secured debts are settled by sale of the secured assets. Any remaining assets will go to pay creditors in the following order:
- bankruptcy costs;
- labour costs including wages and social insurance payments;
- debts that arose as a result of efforts to recover the business during bankruptcy proceedings;
- unsecured debts, government payments, secured debts that were not satisfied completely by the sale of the secured assets.
- shareholders of the enterprise.
As you can see, shareholders are the last to receive any payment through the bankruptcy procedures. They can be reasonably upset at this state of affairs. Management, who they may deem responsible, is vulnerable here. See the case of the Mon Hue restaurant chain who went bankrupt last year. Their management was arrested and sued by numerous stakeholders for their actions in contributing to the bankruptcy. Again, here, management must beware that it fulfills its obligations under the law lest it become liable for shareholder losses.
Eighth, enterprises who are approaching insolvency and bankruptcy proceedings may additionally be liable to third parties because of the potential invalidity of transactions conducted during the six months prior to initiation of bankruptcy. Certain transactions conducted during that time period will be declared invalid by the court in order to preserve the assets of the enterprise for the repayment of creditors. The transactions deemed to be under threat of invalidity are as follows:
- asset assignments not at market price;
- conversion of unsecured debt into debt secured by the assets of the enterprise;
- payment of a debt which has not yet become due, or of value greater than the amount which was due;
- donations of assets;
- transactions outside the business purposes of the enterprise;
- other transactions for the purpose of disposing assets of the enterprise.
This list allows the court, and the asset manager, to retroactively preserve assets of the enterprise. The theory here is that management of a nearly insolvent enterprise may take actions to preserve assets from the creditors by donating, trading, or benefiting related parties over unrelated creditors. This will balance the payments across creditors by law rather than blood and creates a level playing field for all creditors of the enterprise. In addition, contracts that are currently under performance by the enterprise may be temporarily suspended by the court to prevent unnecessary loss of assets or funds.
I’ll close with that. The process itself is lengthy and detailed and I won’t go into it. Suffice it to say that while the court may appear to be on the side of the creditors, they are also inclined to take all reasonable measures to ensure the continuation of the enterprise as to do so is in the interest of all parties. It should not be considered a necessarily antagonistic process, therefore, but rather a legally constituted procedure for making sure everyone is dealt with fairly. Ultimately, the parties least well served are management. Their liabilities accrue, though admittedly this is likely due to bad decisions they made leading up to the bankruptcy, and they may be held responsible for their actions by shareholders or other stakeholders who feel dissatisfied with the results of any bankruptcy proceeding. Regardless of whether the business is rehabilitated or declared bankrupt, management will be held liable, and as such, needs to be aware of its duties in operating an enterprise.
Previous posts about management liability include this post on derivative suits against management, this post on management liability, and this post examining Vietnam’s “business judgment” rule. There are specific responsibilities that management must meet if they are to avoid facing liability with their personal time and assets and as such it is important to understand them before entering into a management position in a Vietnamese enterprise.
As always, if you have questions about the bankruptcy process or about management liability please feel free to contact your lawyer on staff or get in touch through our website at www.indochinecounsel.com.