Recent Reforms in US and UK Market and effect on overall Insolvency Regime

Insolvency laws in the US and UK have undergone significant reforms in recent years to improve the insolvency regime’s efficiency and effectiveness. These reforms have been driven by a range of factors, including changing economic conditions, technological advancements, and evolving attitudes toward corporate responsibility.
In the US, one of the most significant reforms in recent years has been the adoption of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA). This legislation introduced a range of changes to the bankruptcy process, including imposing stricter eligibility requirements for debtors filing for Chapter 7 bankruptcy, also known as “liquidation” bankruptcy.

The BAPCPA also introduced the means test, determining a debtor’s ability to repay their debts. This test considers the debtor’s income, expenses, and other financial obligations and is used to determine whether the debtor is eligible for Chapter 7 or Chapter 13 bankruptcy, also known as “reorganization” bankruptcy.

Another significant reform in the US has been the adoption of the Small Business Reorganization Act of 2019 (SBRA). This legislation created a new subchapter of Chapter 11 bankruptcy, specifically designed for small businesses with debts of less than $3.0 million. The SBRA aims to streamline the bankruptcy process for small businesses. The provisions like ownership retention and use of disposable income for plan payment make the exit process under SBRA faster, less expensive, and more accessible.

In the UK, the Corporate Insolvency and Governance Act 2020 has introduced a range of measures aimed at supporting businesses during the COVID-19 pandemic, including temporary suspension of wrongful trading provisions, making it easier for businesses to access new finance, and introducing a new restructuring process called the “moratorium.” This allows companies in financial distress to obtain a 20-day breathing space from creditors to seek advice and prepare a restructuring plan. This payment holiday prevents forfeiture of lease by landlord, enforcement of security over company property, and restriction on disposal of floating charge assets.
In addition to these measures, the Insolvency (England and Wales) Rules 2016 has introduced new rules governing the administration of insolvent estates, improving the efficiency of the insolvency process in the UK. These recent reforms have significantly impacted the insolvency regime in both the US and UK, introducing new measures to support businesses and improve the adequacy of the insolvency process.

Easy exit is vital to increase aggregate productivity, as it removes the unsuccessful ones. Through market selection, productivity can be enhanced as, on average exiting firms have lower productivity than surviving firms. This phenomenon has strong effects in the United States, where low-productivity firms find it more difficult to survive. Moreover, the gains to aggregate productivity are magnified if the scarce resources once trapped in inefficient firms, such as capital, labor, skills, and ideas, are reallocated to more productive uses.

Evidence suggests that firm exit creates space for new varieties to emerge and that new entrants productively recycle the assets of defunct firms across a range of activities. For example, the collapse of Lehman Brothers completely changed the landscape of banking ultimately leading to creation of new kinds of financial institutions like FinTechs. Additionally, by reducing the cost of failure, efficient insolvency regimes can spur firm creation, draw more talented individuals into entrepreneurship and incentivize radical innovation over conservative business strategies.

Overall, the recent reforms in the US and UK insolvency laws have been driven by a range of factors, including improving the efficacy and strength of the insolvency regimes. An effective and efficient insolvency regime can increase aggregate productivity and free up engaged skill and capital for more productive and successful firms.