The subordination of shareholder loans in bankruptcy

The efficiency of the Italian preventive agreement: a legal, economic and organizational perspective

“…Similarly, the financial support of the shareholders before the preventive agreement presents a signal of credible commitment and should be appreciated by the company's creditors, and thus positively linked to the outcome of the preventive agreement (Jostarndt and Sautner, 2010). In addition, rescue attempts by owners to impede bankruptcy by increasing their capital or informally extending a loan should have a positive effect on the outcome of the procedure, as the owners show a commitment to the rescue (Gelter, 2006). The replacement of the key figures of the leadership is frequently mentioned in the literature as a precondition for timely initiation and solution of the company crisis (Bibeault, 1982;Slatter, 1984;Arogyaswamy et al, 1995).…”

Valuation of the Firm's Liabilities When Equity Holders Are Also Creditors

“…Notice that those who buy the firm would just be willing to pay for the after‐tax value of the firm. According to a widespread judicial orientation, reported for example, in Gelter (2005), in bankruptcy D ( V ) is regarded as senior to D s ( V ), despite the lack of explicit subordination covenants. Gelter reports that courts, both in the US and Europe, typically tend to treat equity holders' loans as equity and thus as subordinated to those of arm's length creditors.…”

“…In particular section 547 of USC gives the trustee the right to avoid repayments of loans to controlling equity holders, who are qualified as insiders, provided such repayments take place within one year of bankruptcy filing. Gelter (2005) reports similar rules in Germany, Austria and Italy, whereby equity holders' loans are treated as equity by the bankruptcy court, at least when the loan was given in the relative proximity of distress.…”

“…Controlling equity holders of closely held private companies often lend to the very firm they own. For example, Gelter (2005) studies this phenomenon in the US and in various European jurisdictions. Alternatively equity holders often offer personal guarantees to banks that concede loans to the firm they control.…”

“…As for the economics literature, Gelter (2005) studied the social welfare effects of the subordination of controlling equity holders' loans in bankruptcy, a provision envisaged in both continental Europe and the US, which goes under the name of ‘equitable subordination’. Gelter concentrates on loans given by equity holders to the firm when the firm is already in the relative proximity of financial distress.…”