chapter 5

Question 1

tarnsactions w creditors

Answer 1

based on legal personality and limited liability
-make sure yk which asset is available when and why

usually creditors arejust contractual paties but become owners of the assets in case firm defaults on payme nt obbligations

Question 2

asset partitioning and corporate creditors

Answer 2

2 aspects:
1 entity shielding (priority of firms creditors over sh and their creditors)
2 limited liability (owner shielding)

hence, creditors can receourse just to corporate assets

for corporate group structures (multiple corporations under the same umbrella) it makes sense to partiton the diferent assets in different companies - helps w creditcause if one part goes down not the whole has to

Question 3

sh-creditor agency problem

Answer 3

ex ante: sh might misrepresent the assets (by saying that the firm owns sh’s or other ent8ties’ assets=
ex post: incentive of sh to take actions that eneit them instead of the creditors (asset dilution, substitution or debt dilution)

influences: managerial risk aversion, sh control over decision making
esp when managers and sh are aligned there’s a higher chance of them taking sh interest at expense of credtors

these conflicts can reducethe firms’ assets value - hence restrictions to divert or substitute assets
+potectionx entity shielding: certain valuable assets into a separate subsidiary (a smaller company it controls), those re used to back up financial debts (they are protected by the other creditors

Question 4

the vicinity of insolvency

Answer 4

when lose to insolvency, management might take higher risks (at risk of creditors)
law will shift the focus to creditors again, trying to renegotiate terms or starting the procedure of bankrupcy

Question 5

groups

Answer 5

multiple companies controlled by the same person or same group of people (sh o managers even)
They use asset partitioning: dividing assets among subsidiaries within the group.
This helps allocate credit risk more efficiently — creditors who understand or monitor specific assets can lend to the subsidiary that owns those assets.

bu agency problems (sh creditors), opacity (we dont know ehre money and assets are) allowing for hidden or unfair assets transfers at cost of creditors

Question 6

exernalities

Answer 6

Externalities here refer to costs or harms caused by a corporation that affect others outside the company.
1 nn adjusting credtor (thd party): tehy owe u money but u cant adjust the terms to reflect the risk tehy bear (victims of corporate tort)
2 limited liability shield: sh a.re responsible only for amount invested (no personal assets can be touched) - hence less protection for third party

solution is a mandatory insurance

Question 7

solvent firms (firms able to pay their debts)

Answer 7

1 affiliation strategy - mandatoyr disclosure
(applied to closely held corp to publicly trade corp and to groups)
+gatekeepers making sure thats reliable

2 rules strategy:legal capital - you keep an amount of capital on hand to protect creditors and other sh
+distribution restrictions )reduce dividends paid to sh esp if below mincapital)
+if u loose too much capital u either stop distributng or start insolvency procedings

Question 8

distressed firms

Answer 8

companies that are in financial trouble (close to being insolvent, or already are).

To deal with this, the law uses a standards strategy — meaning it sets rules and duties for how key players must behave in this situation, to protect creditors and other stakeholders.

For now, it focuses on:

✅ Directors — they must start thinking about the interests of creditors (not just shareholders anymore), because the company is in trouble and creditors are at risk.
✅ Shareholders — next week, you will study how shareholders’ rights/duties change in distress.
✅ Creditors and other third parties — next week too, you will study their role and protections.

Question 9

creditor-creditor and coordination problems

Answer 9

entity shielding leads to the avoidance of creditors’ claims over sh’s personal assets

henece if firm defaults, te creditors become owners of firms’ assets but if te firm has debts w more creditors: coord problem

creditors can act as individuals: break te business, msot likely recover less cause assets worth less in fire sale
together: retsructue the debt (more time, new terms= or go throuh bankrupcy process

the coord problem stands cause all creditors wanna act individually (the first who gets there gets paid, the others get crumbs) but oveerall everyone loses more

Question 10

bankruptcy: basics

Answer 10

right for procedure for all firms that are insolvent
individual entitlement to right?entitlements to collectiveprocedure
the 5 core characteristics of corporations are preserved: limited liabilities, claims of creditors (just as shares) are tradeable, delegated management (associated w crisis managemnt), crisis manager accountable to creditors

Question 11

ifferent kind of bankruptcy

Answer 11

1 liquidation procedure: close down, sell all the firm’s assets
2r reorganization procedure: renegotiate the terms creditor-corporation

Question 12

how to chose the procedure

Answer 12

creditors have a say
few allow corporation to contract with creditors
no cjurisdiction allows corporation to design its own bankruptcy procedure (+judicial pecedent?certainty of approach, hence easier to understand background on whic they are negotiating)

Question 13

solvency

Answer 13

sbility of a corporatio to pay its debt and financial obligations

Question 14

solvent firm: affiliation strategy

Answer 14

mandatory disclosure: in order to contract, suuallycreditors ask for perormance

larer creditors have more protections:
1 accelleration clauses x breach of obligation - early exit
2 security interests x assets - if fails to pay, creditor takes teh asset that was the collateral

informations disclosed: type of corporation, file charter in public register +manadatorydisclosure to creditors (depending on type of company and not on jurisdiction)

Question 15

beneficiaries of mandatory diclosures

Answer 15

1 investors in public markets: hard to get private infos, smaller investors, coordination is hard, no private relationship with the company - much ore elance on mandatory dislosure

2 banks: chek and screens risks before lending, builds a re w company, monitors after lending, demands private infos - good at protecting itself, eevenw/ mandatory disclosure

Question 16

solvent closely held corp (mandatory disclosure)

Answer 16

banks= principal suppliers
us: no obbligation to disclose unless sh
other jurisdictions: equire financial statements, make them available x public inspections, bu softer urules since smalleer firms

Question 17

solvent publicly traded corporations

Answer 17

extenively regulated in all jurisdictions
us security law: registration statement filed with securities and exchange commisison (checks if full and fair infoss)
eu also quite similar

Question 18

solvent groups (mandtaory disclosure)

Answer 18

vulnerable to shareholder opportunism - listed groups are required to prepare consoliidated accounts

Question 19

gatekeepers’ role in mandatory disclosure for solvent firms

Answer 19

verification via third party
auditors being universally employed x accoubting disclosures (required to be external by all jurisdictions, many also for largely close held companies)
credit bureaus: infod ab borrower’s credit histories
credit rating agencies: assess bond and debt’s default risks

• those can reduce borrowers’p cost of capital by lending their own credibility (based on the rating the lendr will trust more or less the corporation)

Question 20

legal capital for solvent firms

Answer 20

The most important rules relate to legal capital. These can apply to at
least three separate aspects of corporate finance:
a. Prescribing a minimum initial investment of equity capital
b. Restrictions on payments out to shareholders
c. Triggering actions that must be taken following serious depletion of
capital

Question 21

minimum initial investment of capital

Answer 21

only in eu e only for publicly traded ones, 25000

Question 22

distribution restrictions

Answer 22

in order to avid asset dilution
most common is: restricton on payment of dividend that exceed the difference between the book value (cost-depreciation) of the company’s assets and the amount of its legal capital (capital that needs to be maintained by law)

if legal captal ias above min requred, firm must follow a set of standard terms that restrict not only dividends but also any unfair transaction benefitting shareholders to rpotect creditors and maintain company stability )germany, us and uk=
+us might even lower the firms’ legal capital

Question 23

loss of capital rules

Answer 23

eu: sh’s meeting x dissolution if net assets fall under 1/2 legal capital
france: liquidation if assets below legal capitaò and sh fail to remedy
italy: liquidation if assets fall under 2/3 legal capital /below statutory min legal capital and sh fail to remedy
germany: when value assets is below 0

Question 24

distressed firms

Answer 24

assets probably insufficient to pay debt, hence gov strategy in 2 phases: 1 transiction into bankrupcy, 2 bankruptcy procedure
Appointment rights for a “crisis manager”:
Creditors can appoint someone (like a special manager) to take control and try to save the company or manage its affairs during the crisis.

Decision rights on the bankruptcy or restructuring plan:
Creditors get a say (and sometimes a vote) on how the company’s debts will be handled and repaid in the bankruptcy plan.

These rights are supported by:

Standards: Legal rules that directors and managers must follow during distress.

Trusteeship: A trustee (often a court-appointed official) oversees the process to make sure everyone’s interests are protected.

Question 25

standard srategy (distressd firm)

Answer 25

Standards are legal rules used to protect creditors when a company is distressed. impose ex post liability on peope linked to the company (directors, controling sh, favored creditors) if smth goes wrong +only applied if there was mismanagement or improper conduct

Question 26

directors

Answer 26

an be held personally liable for net inceases in losses to creditors xboard negligence or fraud to creditors whne company is almost insolvent different levels of intensity: fraud (-); activites that make u questio good faith negligence (+): worsened financial position of company trigger for duty's imposition only when thereis a certain level of financial distress (the igher the distress, the most specificthe implications) enforcement i easier if duties are owed directlyto creditors (creditors take actons themselves) if the company has rights to the duty enforcemnet is weaker oer less direct us: lower intensity standard - duty of loyalty shift to corporation and not creditors, so creditors cant sue directors directly, ending up being less proected uk: middle stanard - directors duties still owed to company byt can still be personally liable for wrongful trading (when directors dont rake reasonable steps to protect creditos) eu (fra ita): directors x liability for negligence, incentive to think ba creditors when in distess japan. creditor can sue directors evene if firm is still solvent

Question 27

public enforcement

Answer 27

gov can unish bad behavior 1 director disqualification: ban from manaing aftere misconduct 2 crminal liability: when things are made illegaly

Question 28

sh

Answer 28

all jurisdictions have tools toh hold sh liable for debts of insolvent corporation - controllin or managing sh who abuse corporate firms 3 tools: 1 shadow directors 2 equitable subordination 3 piercing the corprate veil

Question 29

shadow directors

Answer 29

peson who acts as a member of the board/exercises control over the board w/ being appointed as such france: sh directing managment to violate fiduciary duty, he'll be considered as a shadow director and pay compensation dor losses caused works more or less everywhere, except us and brazil

Question 30

equitable subordination

Answer 30

subordination of debt claims brought by controlling sh against the estates of bankrupted companies germany and brazl: automatic subordination ita and us: subordination depends on circumstances france, uk: no try to balance deterring overinvestment 8preveenting abuse from sh) an d legitiate trial to save

Question 31

piercing the corporate veil

Answer 31

to hold controlling shareholders (or the controllers of corporate groups) personally liable for the company’s debts ▪ Is always done by a court ▪ Permitted in all our jurisdictions but not done easily us: when controlling sh disregard the integrity of companies by failing to observe formalities, dont put enough captal, mix their own money and the corporate money + fraus and unfair harm to creditors or third parties same for eu and japan ex of france whenevr integrity of company is not respected brazil also w/ fraus or abuse, for benefit of non adjusting creditors

Question 32

veil piercing also for groups

Answer 32

us substantive consolidation: assets and liablities of 2 corporations in a single pool same for brazil - avoids teh chance of hding assets but can hurt the creditors who thouht that the assets were "safe" !less common in groups, and some jurisdictions (germany) have special sets o creditor standard covers for these cases

Question 33

creditors and other third partes

Answer 33

use of stndard strategies: 1 third parties as gatekeepers 2 preventing a creditor from getting a better position than the other 3 both

Question 34

third parties as gatekeepers

Answer 34

sh might take actions that hurt the company (stripping assets out of a failing company), courts can undothese after the facr (third parties will give back what they received) eu and brazil: acto pauliana us and japan: fraudulence conveyance uk: undervalue transactions third party might supprt these actions, but will only be able to rely on transactions if it can show they were done in good faith and reasonable to belive they would be beneficial at the time

Question 35

preventing one debtor from egtting into a better position

Answer 35

insider creditors (banks) may misuse tehi position at the expense of other creditors In the UK, anyone who knowingly continues business intending to defraud creditors can be held liable. Italy and the U.S. have various laws to stop lenders from exploiting their position with insolvent firms.

Question 36

preferential transactions

Answer 36

2. Preferential transactions A preferential transaction happens when a creditor gets paid back or benefits ahead of others just before bankruptcy. Laws exist to reverse these unfair deals to keep creditor treatment equal: Europe & Brazil: The “actio pauliana” requires proving bad faith. Japan: The benefiting creditor must know the company is insolvent. US & UK: No need to prove the creditor knew or acted in bad faith — the transaction can be reversed anyway.

Question 37

governance strategy

Answer 37

appintment rights to crisis manageres or starting bankruptcy procedures The law tries to stop insiders (creditors or shareholders) from abusing the situation to get unfair advantages or strip assets, while also giving creditors tools to intervene and protect their money if a company is failing.

Question 38

gov appointment rights

Answer 38

single creditor can triger bankruptcy procedure (in us 3 creditors at least) u can also proactively start it once triggered, bod loses control ovr company assets, crisis manager apointed by creditors or y the court itself ven to manage company

Question 39

decision rights

Answer 39

plan to exit bankrupcy proposed by crisis managere but vetoed by creditors (exc fra it and us: debtors management propises the plan first) +intercreditor conflict: -senior most likely to recover sinxe safest claims, hence low risk plan -junir less likely to rceover so high risk plans to avoid conflct there is limited veto

Question 40

incentive strategy

Answer 40

trusteeship: crisis manager oversees or runs a bankrupt firm: custody of assets, ot for own ain but for benefit of creditors or curt acting as arbitter between claimers reward strategy: creditor's max pay defined by cotract, rewards strategy that relies on participation in upsides