Definition: Bankruptcy is a system for ensuring the equitable payment of debts when a debtor is no longer able to meet its debt obligations, either by reorganizing the debtor or liquidating the debtor and its assets.
The fundamental goal of Bankruptcy Law is two-fold: first, to allow for both the fair and efficient dissolution of businesses that are not viable and, second, for those businesses that have a chance at achieving viability, the opportunity to extend, reduce, or wipe our debt and protect themselves from pursuit by creditors.
Although Bankruptcy Law, also known as the Law of Insolvency, tends to attract interest mainly when enterprises face difficult times or even certain failure, the very existence of a clear and enforceable Bankruptcy Law has an important role to play in fostering economic growth.
Insolvency systems provide economic benefits beyond the firm in a variety of ways:
- Bankruptcy Law can provide businesses and their management with incentives for maintaining fiscal discipline and acting prudently with respect to corporate governance.
- The manner in which creditors and debtors are treated under a particular insolvency law can also influence the perceptions of investors.
Insolvency reform can be relevant for economies in transition, where it can play a crucial role in addressing the problems of insolvent state-owned enterprises and for failing enterprises in need of a rescue or exit strategy. In addition, the investment community and international financial institutions examine a transitioning country’s insolvency laws, as the quality of the Bankruptcy Law (and its enforcement) may influence the extent to which parties are willing to extend credit to businesses.
To be effective, the content and implementation of the Bankruptcy Law must be compatible and coordinated with other aspects of a country’s legal system. Moreover, to be properly implemented, an insolvency system’s procedural and substantive rules must be in step with the capacity of the relevant courts or agencies. A clear and enforceable Bankruptcy Law allows for efficient reallocation of the debtor’s resources, which itself leads to greater confidence in the security of investments.
