The work revolves around the value capture, or distruction of value instead, that surrounds various instances of bankruptcy arrangements.
With my colleagues at Leiden University we came to the following insigts:
Firms that find themselves in dire circumstances can improve their situation by proactively implementing strategic change to stem survival-threatening performance decline. Asset restructuring is a way to initiate such strategic change and to respond to imminent threats and opportunities in the business environment. As an alternative to conventional bankruptcy proceedings, pre-packed bankruptcy has received much attention in recent years. Pre-packed bankruptcies have been hailed by some for facilitating a debtor-driven restructuring of a distressed business and—compared to conventional bankruptcy proceedings—creating more value for all stakeholders. At the same time, they have been strongly criticized by others for failing to ensure adequate protection of the interests of all of those stakeholders.
In recent years, there has been growing interest in the question whether pre-packed bankruptcy can be a mechanism through which firms facing imminent insolvency can preserve value. Although an extensive body of predominantly legal literature exists on ‘pre-packs’, whether such techniques really preserve value remains ambiguous.
In the strategic management literature, the filing for a type of bankruptcy proceeding is referred to as ‘strategic bankruptcy’. It refers to the use of bankruptcy as a mechanism to enable firms to implement strategic changes to relationships with customers, suppliers, or other stakeholders. It aims to positively alter the firms’ likelihood of sustainable performance and to improve the chances of survival.
On the one hand, strategic bankruptcy is considered an option of last resort, after exploring the out-of-court options. As the ‘downward-spiral decline’ literature suggests, when a firm’s decline is left unchecked, its performance worsens over time and tends to become self-reinforcing, further depleting a firm’s available financial resources (also: ‘resource slack’). On the other hand, bankruptcy can also prove a ‘bridge over troubled water’. This is the core thesis of strategic bankruptcy: financially distressed firms are enabled to restructure and adapt to their changing environments through a bankruptcy proceeding, whilst at the same time limiting bankruptcy costs and public scrutiny. Therefore, a strategic bankruptcy is expected to preserve firm value and—not unimportantly—retain the firm’s employment and other key (intellectual) resources.
In our paper, we contribute to this literature on streamlining the bankruptcy process, taking a Dutch perspective. Using a strategic management research perspective, we focus on the retention rates of employment in two reorganisation-driven scenarios, analysing whether a pre-packed bankruptcy is more efficient and effective in preserving value for employees in terms of employment retention than in a conventional going-concern sale bankruptcy proceeding.
The Dutch Pre-Pack Revisited
In the Netherlands, the informal Dutch pre-packed bankruptcy has seen a strong uptake since 2012, but slowed down in 2017. The rise was in part due to the implementation of Article 5 of the Transfer of Undertakings Directive (TOU Directive) which provides an exemption from employee protection granted by Articles 3 and 4 of the TOU Directive in the case of insolvency proceedings. It introduced the feature for the pre-packed bankruptcy, that when the business is transferred post-bankruptcy—which is different from for instance the UK—employees could be dismissed by the transferee. In the cases of Smallsteps (2017) and Plessers (2019), the Court of Justice of the European Union decided that for these transfers of undertakings in bankruptcy proceedings, the exception of Article 5(1) TOU Directive did not apply. Instead, the main rules of the TOU Directive are applicable, which safeguard employees’ rights, including preventing that the transfer itself can constitute a ground for dismissal.
In the context of our empirical case study, we analysed the Dutch experience with pre-packed bankruptcy proceedings and conventional bankruptcy proceedings. By analysing bankruptcy proceedings filed with Dutch courts in the period 2012–2018, through the lenses of real options theory and debt overhang theory, we examined employment retention post-bankruptcy. We tested employment retention both as a consequence of the type of bankruptcy proceeding (pre-packed bankruptcy and conventional bankruptcy) and the severity of pre-bankruptcy financial distress.
Value creation by opting for a (Dutch) pre-pack
In our paper, we set out to contribute to a discussion on bankruptcy procedures as a mechanism for strategic change, and the type of bankruptcy proceeding that best serves that change. Drawing from real options theory and debt overhang theory, we argue that strategic bankruptcy limits bankruptcy costs, causes less value destruction in bankruptcy, and subsequently preserves a higher ratio of employees, post-bankruptcy.
The results of the study show that in the Netherlands, a pre-packed bankruptcy—when compared to a conventional bankruptcy proceeding—positively impacts employment retention rates after bankruptcy. This finding takes the amount of resource slack into account, as well as the differences in firm size, industry employment trend, and annual GDP growth rate.
Another finding is that the severity of financial distress before bankruptcy does not affect employment retention rates post-bankruptcy. This implies that despite resource slack, the preservation of employees is better served under a pre-packed bankruptcy than a conventional bankruptcy proceeding. This finding is important for insolvency practice as, up to June 2017, employee rights in the Netherlands (including redundancy) were— although not without critiques—not considered to be automatically transferred to the firm acquiring the bankrupt debtor’s assets when a pre-packed bankruptcy was applied.
The management of the distressed debtor plays a pivotal role in choices of strategic bankruptcy. Here we note that the debtor’s management is formally neither tasked with maximising value for the body of creditors nor considering employee retention in their strategic use of bankruptcy proceedings to pursue continuation of the business. However, the debtor-driven pre-packed bankruptcy still results in higher employee retention than going concern sales pursued by a liquidator in conventional bankruptcy. This is in line with real option theory, suggesting that the firm’s management aims for the strategic bankruptcy option that will result in the most beneficial alternative to successfully continue the business in a new legal entity. While only accounting for the impact on employee retention, contrary to current policy making, our empirical analysis highlights that employees can benefit from flexibility, and that flexibility thus can support policy goals in this area.
The underlying version of our paper has been published in the International Insolvency Review 2019(28) as well.
This project has been joint work by:
Rick Aalbers, Associate Professor in Strategy and Innovation at Radboud University.
Jan Adriaanse, Professor of Turnaround Management at Leiden University.
Gert-Jan Boon, Researcher on f Insolvency Law at Leiden University.
Reinout Vriesendorp, Professor of Insolvency Law at Leiden University.
Jean-Pierre van der Rest, Professor of Business Studies at Leiden University.
Frank van Wersch, an affiliated researcher of The Radboud Centre for Organization Restructuring