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Early warning and the restructuring directive: could directors learn from insolvency practitioners? TaxRebate.org.uk

Early warning and the restructuring directive: could directors learn from insolvency practitioners?

Could the contribution of insolvency practitioners in creating early warning tools help company directors identify the moment in time when they should take measures to avoid insolvency?

The rescue of viable businesses has become a focal point on the worldwide insolvency law agenda. In June 2019, the European directive on preventive restructuring frameworks was adopted to enhance the rescue culture in the European Union. One of the most important aspects in pursuing and promoting restructuring is ensuring that debtors take early action. The earlier a debtor can detect its financial difficulties, the higher the probability of avoiding insolvency. Therefore, article 3 of the restructuring directive states that early warning tools should be put in place to warn of impending insolvency. These tools will most probably be based on financial indicators, such as signs that the debtor has not made certain payments.

However, an insolvent situation cannot be fully explained by financial indicators. To what extent other factors can explain an insolvent situation is unknown. Credible explanations for the cause of a bankruptcy require a more scientific approach to causality. Only when there is a more complete understanding of why the bankruptcy has emerged, can the causes of the bankruptcy be accurately identified. If early warning tools focus merely on financial indicators, the effectiveness of early warning systems may be impeded. Therefore, including additional non-financial information in early warning tools could be of great importance.

Notwithstanding the importance of identifying credible explanations for bankruptcies, useful research into causes of bankruptcies lags behind. Most studies focus on compiling so-called bankruptcy prediction models. Such models, however, mainly focus on financial ratios and are not able to detect financial difficulties at an early stage. In order to more thoroughly understand the emergence of insolvency, we need additional and more specific data on investigations into the causes of bankruptcies. This is where the insolvency practitioner could and should play an important role.

The recent amendment of the Dutch Bankruptcy Act obliges the insolvency practitioner to investigate the causes of a bankruptcy by reason of public interest (“insolvency cause investigation” or “oorzakenonderzoek”) and to investigate a possible directors’ liability claim (“assessment investigation” or “rechtmatigheidsonderzoek”). In practice, the ultimate goal of insolvency cause investigations is to generate additional income for the estate (e.g. adjudication of liability). However, it has been argued that objective fact-finding should be separated from the adjudication of liability. In addition to the usual debate on separating the investigations to avoid tunnel-vision, in the context of early warning tools, another argument comes into play. When consensus exists amongst insolvency practitioners on the importance of publishing objective insolvency cause investigations, (a lot of) reliable information on the causes of bankruptcies would be available in the form of research reports. Based on that information, researchers could identify the most common causes of bankruptcies and could provide for early warning tools based on actual causes of bankruptcies. In that case, the aim of the insolvency cause investigation would not so much be generating additional income, but more learning from failure. This approach is common and successful in, for example, the area of airplane disaster studies. In addition, company directors could use early warning tools to identify the moment in time when they should take measures to avoid insolvency and thereby such early warning tools could be helpful in defining the concept of vicinity of insolvency.

From my perspective, it should be noted that learning from failure should not be a justification for conducting an insolvency cause investigation in every bankruptcy. Nevertheless, the importance of insolvency cause investigations should not be impaired by financial arguments such as recourse possibilities. In order to start learning from failure, we need insolvency practitioners to provide existing information on the causes of bankruptcies. Therefore, - if an objective insolvency cause investigation is conducted - I invite insolvency practitioners to publish their research reports.

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