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The issue at the heart of Rolef de Weijs’ inaugural lecture “All in Disarray? How bankruptcy legislation is threatening to turn against creditors” has once again provoked questions in parliament, this time from the Socialist Party, on changes to bankruptcy law.

The Minister of Security and Justice had already announced plans to modernise bankruptcy law as far back as 2012, and while certain adjustments have been implemented, various other legislative amendments concerning topics including bankruptcy fraud and bankruptcy proceedings have either not been finalized or have not yet received the approval of both Houses of Parliament.

Publication

The Socialist Party (SP) recently posed questions concerning corporate financing with so-called ‘secured shareholder loans’: shareholder loans for which the company grants a security interest in its assets.

The SP has specifically requested the government’s reaction to Rolef de Weijs’ inaugural lecture “All in Disarray? How bankruptcy legislation is threatening to turn against creditors” (published in abridged form in Ondernemingsrecht 2016/123) in which De Weijs analyses this type of financing. If a company manages to be a success, its shareholder is rewarded with the profits. If the company fails, however, the shareholder can invoke his security interest, thus recovering his investment - ahead of the remaining creditors.

“Do you think this is a desirable form of financing, and if so, would you still think it was a good idea if bankruptcy ensued?” The SP was also curious to know whether the Minister considers it generally advisable for companies to rely on loans rather than equity for their financing, and if it is true that a lack of equity greatly increases a company’s vulnerability.

At the back of the queue

According to De Weijs, such concerns are justified. “Bankruptcy is a procedure for settling, inasmuch as possible, with creditors such as suppliers. In principle, however, whereas shareholders are the first to reap the benefits when a company is profitable and successful, in the event of bankruptcy they should move to the back of the queue.” However, according to De Weijs, these fundamental principles are increasingly being violated. “When shareholders are less inclined to finance with capital, and instead increasingly choose to extend shareholder loans - that are then secured by collateral – entrepreneurship becomes an increasingly low-risk venture. In the event of bankruptcy, shareholders waste no time asserting priority over the claims of ordinary creditors.”

The Solution

The solution is obvious, according to De Weijs, and has already been implemented in many countries (Germany, Spain, Austria and Italy). Any money a shareholder provides to a company pre-bankruptcy must be treated as equity in the event of bankruptcy. In other words, the claims of the external creditors must first be settled before the shareholder sees a penny.

De Weijs: “Shareholder security rights should not be enforceable. If such schemes are allowed to continue, we will continue to be faced with excesses such as in the McGregor case, in which one and the same shareholder was allowed to take his place at the front of the bankruptcy-claims-queue for the second time within the space of a year – after simply continuing the business following the first insolvency. This is more akin to pickpocketing than to doing business or engaging in venture capitalism.”