Tutorial 1

Prof. Tibor Tajti & Monika Prusinowska

Insolvency Law Tutorial

TUTORIAL 1

The role and limits of discretion in insolvency proceedings

• BANKRUPTCY JUDGE

• BANKRUPTCY TRUSTEE

Source: http://www.duhaime.org/LegalDictionary/B/BankruptcyTrustee.aspx

To warm up:

Why is it a solution: appointing a trustee instead of letting

the company's management continue proceeding?

The trustee's duties (US)

1. Collection, reduction to cash and distribution of the assets of the estate;

2. Operating of the debtor’s business with court approval (if that is

appropriate to preserve value);

3. Making periodic reports to the court on the financial status of the estate;

4. Investigating the debtor’s financial affairs;

5. Examining proofs of claims and objecting to improper ones

… (etc.)

In China

A bankruptcy administrator shall perform the following functions and duties:

(1)Taking over the assets, seals as well as the account books and documents of the debtor;

(2)Investigating into the financial status of the debtor and formulating the financial

statements;

(3)Deciding the internal management of the debtor;

(4) Deciding the daily expenditure and other necessary expenditures of the debtor;

(5) Deciding, before the first creditors' meeting is held, to continue or suspend the

debtor's business;

(6)Managing and disposing of the debtors' assets;

(7)Participating actions, arbitrations or any other legal procedures on behalf of the debtor;

(8)Proposing to hold creditors' meetings; and

(9)Performing any other functions and duties that the people's court believes it should

perform.

Kmart Case

What do you think about the role of bankruptcy judge?

- What does the judge need to balance?

Do you agree with the decision/position of the Court of Appeals? Why?

Which standpoint do you support - the first instance court's or the Court of Appeal's? Which argumentes do convince you?

Who should be „critical vendors”? Who should designate them?

Debtor? Are there any risks you can think of?

- Is it fair that some of the creditors get paid back 100%

whereas some 10%?

What level of discretionary powers should be given to bankruptcy

trustees and bankruptcy judges? Why?

Who should control/review the actions of trustee?

Discretionary powers may easily lead to arbitrariness.

What alternative could you think of? Would it be possible to formulate

exact formulas instead?

DEPENDS

Doctrine of Necessity

„A fancy name for the power to depart from the Code”?

Is it easy to obtain statements from the critical vendors that they will

refuse to continue to provide goods on a postpetition basis, unless

they are paid in full for outstanding prepetition invoices?

- Fleming case?

INTERDEPENDENCE

Insolvency trustee remuneration

1) What is, in general, the relation between

trustee’s remuneration and effective proceeding?

Poland is recently at the stage of amending its Bankruptcy and Reorganization Law.

Since trustee’s adequate remuneration is believed to be one of the most important

factors influencing the time and effectiveness of bankruptcy proceeding, there has

been a wide discussion around trustee’s situation.

Recently trustees’ remuneration may not exceed 3 % of the bankruptcy estate

funds or 140 times the average monthly salary in the enterprise sector.

There is no minimum sum provided.

Basically, legislator claims that too big remuneration decreases the amount of money

left for the creditors.

On the other hand, trustees emphasize that their situation is often very difficult to

predict, and it happens that proceedings are not only very long (even couple of

years), but also that eventually they are not paid much.

What is your opinion?

2) What is the optimal solution for trustee’s remuneration?

Should there be minimum amount of remuneration provided?

When should the money be paid - partially or after the whole proceeding is

completed? Which solutions can increase trustee’s effectiveness at the same time not

running to over-rewarding?

Polish legislator points to careless procedural expenses of trustees since their

remuneration is a percentage rate of the bankruptcy estate funds. Thus, there is a

discussion on the optimal method of payment:

Fixed percentage of realizations (bankruptcy estate funds) vs. Fixed percentage of

distribution to creditors (after the costs are reduced).

What are the differences in terms of motivating trustee? Which system works

better? Any other ideas of improvements in the area of method of remunerating?

“For example, in the UK, if there is a creditors’ committee, the

committee will determine the basis of the remuneration.

If there is no creditors’ committee, the remuneration can be fixed by the

general body of creditors or by the court. In the latter case, a creditor can challenge the remuneration.”

What do you think about this solution?

Do you think that creditors should be involved in making the decision of

what trustee’s method of remuneration/amount to be paid should be?

Why?

Can you see any dangers in case trustee’s remuneration is dependent on

the creditors?

3) Recently, involvement of creditors in the procedure of appointing/

dismissing trustee is very limited in Poland.

What do you think – what is the optimal involvement of the creditors

in regard to this matter?

Can you see any dangers?

What is the situation in China?

The new Enterprise Bankruptcy Law of the PRC came into force in

2007.

Administrator who will act much like bankruptcy trustees do in

U.S. The administrator’s role is to help the creditors and to assist in

assuring the bankruptcy runs smoothly.

The law provides for clear provisions on who may serve as

an administrator and it is expected most administrators will come

from the ranks of lawyers, accountants.

Article 22 A bankruptcy administrator shall be designated by the people's court.

Where it is decided at the creditors' meeting that a bankruptcy administrator fails to perform or fulfill its duties and functions in a lawful and impartially manner, the creditors may apply with the people's court for alteration.

The measures for designating bankruptcy administrators and deciding the remunerations of bankruptcy administrators shall be made by the Supreme People's Court.

Article 28 [...] The remunerations of a bankruptcy administrator shall be

decided by the people's court. In case the creditors' meeting has any different opinion to the remuneration of a bankruptcy administrator, it has the right to file demurral with the people's court.

Pyramid and Ponzi schemes as bankruptcy crimes

Whate are pyramids / Ponzi schemes?

Shortly speaking, mechanism by which money paid by later investor is

used to pay artificially high returns to earlier investors.

Sharp definition form Investopiedia: "[...] unsuspecting individuals are

fooled by unscrupulous investors who promise extraordinary returns".

Albanian case

Albania case: "Kriza piramidale" 1997 Transformation - Albania becoming a liberalized economy after years under a controlled

economy

↓ Limited ways of investing money (inadequacy of the formal financial system) - creation of

financial pyramids - financial system dominated by Ponzi schemes

↓ 1996: signals about the risks from outside experts neglected - parlimentary election -

uncomfortable topic not picked

↓ By January 1997, Ponzi schemes were finally not able to make more paymentys and the

people of Albania, who had lost $1.2 billion (out of a small population of three million), took their protest to the streets - 2/3 of Albanians affected!

↓ Citizens launched daily protests demanding reimbursement by the government, which they

believed was profiting from the schemes

↓

Unrests all around the country

What could have been done to prevent it? Supervisory?

(IMF & World bank playing their roles better?)

Chinese case

From 2002 to 2005 ten thousand Chinese investors fantasizing of 40 and 60% returns made of investment in $1,300 ant-breeding

boxes with a street value of $ 25

↓ The buyers were supposed to return the

boxes after a few months so the company could process them into aphrodisiacs and

other remedies

↓ Some early investors were paid off by those

who got sloppy seconds, but eventually the Ponzi scheme collapsed

↓

Failing for bakruptcy (approx. 1% recovered)

↓

The "father of business" sentenced to death

Hungarian case Saga of Hungarian real estate investment cooperative (REIC)

A public offer to investors: buying "membership right" or "membership share" in the cooperative in exchange for their

money (investment in first class immovables and covering some operational costs - boost in the market expected).

The promise: cooperatives to repurchase the shares at a predetermined future date, price, and interest rate.

High interest rates offered.

Buying membership interests (shares) in the cooperatives the investors actually became "owners" of the cooperatives according to the law -

what is the bankrupcy-related problem you see here?

↓

Warnings and Investigations: The Association of Fund Management Companies in Hungary (warning regarding high

interest rates), National Security Agency (money laundering), the Parliamentary Commissioner for Civil Rights, accusations

in media (the profit is not made legally)

↓

The police have launched investigations (investment fraud, money laundering, forgery of documents).

Prohibition: no advertisemet of REIC, REIC change the element "ccoperatives" to "funds"

↓

REIC collapses one by one

↓

Numerous protests of "shareholders (Baumag) in front of the Hungarian Parliament in Budapest

↓

No governmental body willing to take action to seize the remaining assets of to preserve something for the investors

What is the difference between Ponzi scheme and pyramid

scheme (if any)?

Pyramid scheme:

“A property-distribution scheme in which a participant pays for the chance to receive compensation for introducing new persons to the scheme, as well as for when those new persons themselves introduce participants.”

Also termed: endless-chain scheme; chain-referral scheme; multilevel-distribution program; pyramid distribution plan.

Black’s Law Dictionary (Deluxe, 7th ed., 1999)

Ponzi scheme:

“A fraudulent investment scheme in which money contributed by later investors

generates artificially high dividends for the original investors, whose example attracts even larger investments.

Money from new investors is used directly to repay or pay interest to old investors, usually without any operation or revenue-producing activity other than the continual raising of new funds.”

Black’s Law Dictionary (Deluxe, 7th ed., 1999)

Why are pyramid and Ponzi schemes inherently linked to

insolvency law?

How long can the Ponzi/pyramid scheme function?

Who should protect the investors?

Who should be liable (like in Hungary case - government?

Because of allowing for such a situation?)

How do you perceive people investing in this sort of

business? Shouldn't their naivety be taken into consideration?

Why is often detecting of pyramid and Ponzi schemes difficult?

What is the difference, for example, between a multi-level

marketing and a Ponzi scheme?

Multi-level marketing (MLM)

is a marketing strategy in which the

sales force is compensated not only

for sales they personally generate,

but also for the sales of the other

salespeople that they recruit.

AVON, Oriflame, Amway

Could you identify segments of economy where Ponzi schemes

tend to arise more frequently?

What do you think?

"Some victims make out pretty well in a Ponzi scheme. Although later investors certainly lose money, the early investors can come out ahead. Their testimonials are exactly what help perpetuate the scheme. Some unscrupulous characters invest with the full knowledge that they're funding a Ponzi scheme - they cross their fingers that they aren't in the bottom rung. Of course, any money they make is at the expense of other investors.

Legal questions abound as to whether these lucky initial investors should be forced to help recoup losses for later investors".

from CLARK, Josh & McGrath, Jane, How Ponzi Schemes Work, http://money.howstuffworks.com/ponzi-scheme3.htm

Create your own Ponzi/pyramid scheme…

THANK YOU!