Financial Distress and Bank Restructuring of Small to Medium Size UK Companies*

Abstract

We use a unique data set to study how U.K. banks deal with financially distressed small and medium-sized companies under a 'contractualist' bankruptcy system. Unlike in the U.S., these procedures limit the discretion of courts to strict enforcement of debt contracts, without any dilution of creditors' claims. We show that lenders and borrowers select a debt structure that avoids some of the market failures often attributed to a contractualist system. Collateral and liquidation rights are highly concentrated in the hands of the main bank, giving it a dominant position in restructuring or liquidating a defaulting firm. There is little litigation, and no evidence of co-ordination failures or creditors' runs. However, there is some evidence that the bank's dominance makes it 'lazy' in monitoring, relying heavily on the value of its collateral in timing the bankruptcy decision.

Contractual Resolutions of Financial Distress

“…In line with this possibility, Franks and Sussman (2005a) document that in the U.K. floating charge financing works very well, mitigating the problems usually associated with creditor control. In particular, there are no inefficient runs and the controlling creditor's typical response to financial distress is an attempt to rescue the firm rather than to liquidate it automatically.…”

“…This view sheds some light on the use of bankruptcy procedures in many countries, but it does not explain why in many other countries firms instead choose to resolve financial distress by way of ex ante contracts when they are given the contractual freedom to do so (Djankov et al 2008a). 1 For instance, Franks and Sussman (2005a) document that in the U.K. one common way to resolve financial distress is to use floating charge financing. In its basic version a large creditor, typically a bank, lends under both a "fixed charge" (i.e.…”

Factors of a Successfully Implemented Compulsory Settlement

“…Important external factors in successful financial restructuring of a company are also insolvency legislation (Armour, 2003;Ayotte & Skeel, 2009;Pindado, Rodrigues, & de la Torre, 2008;Succurro, 2008;Tarantino, 2009) and the role of the banking system (Brunner & Krahnen, 2001;Davydenko & Franks, 2006;Franks & Sussman, 2003;Huang & Huang, 2009;Levine, 1998;Senbet & Seward, 1995).…”

Government Involvement in Corporate Debt Restructuring: Case Studies from the Great Recession

“…Country experiences with wide-scale corporate debt restructuring in the past have been mixed and have involved lengthy and difficult processes 6 . While outcomes varied by country, the past experience indicates that a properly designed strategy would generally make the best use of limited fiscal resources, target interventions where needed most, leverage market-based solutions and private resources, bolster credit enforcement and insolvency laws, and preserve credit culture.…”