Leiden Law Blog

In the new economy we do not need new more debtor-friendly regulations on insolvency proceedings

In the new economy we do not need new more debtor-friendly regulations on insolvency proceedings Photo: Flickr

European Parliament Report A7-0355/2011A concludes: “With recommendations to the Commission on insolvency proceedings in the context of EU company law” that the approach in relation to insolvency proceedings is now centred more on corporate rescue as an alternative to liquidation. The basic presumption for rescuing companies is that a loss of value occurs when a company is liquidated. In the old economy with stable positions, niches and industries that could be the case. A firm is a wealth-generating entity; it can create wealth if it is able to fulfill customer needs – create customer value. In capturing a part of that customer value the company generates its own wealth. This is called the business model. In a very stable economy the business model does not change much. If a company is insolvent the business model can still have a wealth-generating potential. The premise of the corprate rescue trend is that in principle the insolvent firm has a wealth-creating potential – can create customer value. This was not the case however in the old economy, and will definitely not be the case in the new economy.

True competitive advantage is (and was) rare and short lived. Invisible sources may not represent a source of value, but the source of failure. In the old economy positions were not stable either. Schumpeter wrote about this tendency in the 1940s. Positions and niches are frequently destroyed, creative destruction – finding new ways of organising, producing and creating new products -  is the central force of the economy. So the basic premise that insolvent firms contain customer value is doubtful. Usually an insolvent firm is not well adapted to the changing market. The market selects poorly performing firms with low wealth potential. This force of creative destruction – that undermines the basic premise of debtor-friendly insolvency regulations –  will be even stronger in the new economy.

The chance that an insolvent firm has no customer value potential  will sharply increase in the new economy. In the new economy knowledge and innovations will be more important. Competition intensifies and innovations are accelerating. Knowlede is very fluid; everybody can use it. Because of the universal application (digital convergence) of bits, knowledge can be easily combined and copied. There will be an increased pressure to experiment and innovate. In a world with accelerating innovations and shorter product life cycles failure is a common phenomenon. In this dynamic, complex and uncertain economy it is usually the case that an insolvent firm has no prospect of generating customer value – it no longer fulfils customer needs. We should turn our attention to innovation, not to sustaining the past. In the Netherlands, attempts to adapt the old Insolveny Law to become more debtor friendly did not succeed; it is a blessing in disguise.

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