Business rescue summarised

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CHAPTER An introduction to the commencement standard

How did the invisible hand lose its grip?

The “invisible hand” is a term coined by Adam Smith (2016) during the 18th century in his book The Wealth of Nations, which invoked an enduring piece of imagery to describe the unintended social benefits of individual self-interested actions within the economy. As the invisible hand would have it, there is an incentive for third parties to seize control of a failing entity in order to salvage their claims. The notion of free market exchange automatically directing selfinterest toward socially desirable ends is a core validation of the laissez-faire economic philosophy. However, as Baird (1991) explains, the collective interests of the group can be jeopardised when a single creditor exercises their rights over an insolvent estate. It is customary to expect the party that benefits from a particular legal rule to invoke it accordingly; however, insolvency is different. The beneficiaries of insolvency law are the creditors as a whole and not the individual creditors within the group. This is the so-called “common pool problem”, which arises where more than one person has rights over the same, finite fund of resources (Fletcher, 2005:9).Insolvency law thus transforms what were initially multiple relationships between each creditor and the debtor into a unified whole, with the aim of administering and deriving maximum value from the debtor’s estate. To do so, insolvency laws place various protective and disciplinary mechanisms upon the ill debtor in reorganisation. The aim of these is to allow the debtor to overcome its financial difficulties and resume or continue normal commercial operations (United Nations Commission on International Trade Law, 2005:27). These mechanisms in effect introduce synthetic rules for the benefit of society in order to facilitate the rapid recovery of the firm in distress and ultimately maximise its return –violating the benign view of self-interest that the invisible hand embodies. Insolvency serves the economic function of screening and eliminating only those firms that are economically inefficient and whose resources could be better used in some other activity (White, 1989:129). For reorganisation proceedings, this rule is fundamental, while it seeks to rehabilitate a distressed firm. Keep in mind that the same mechanisms that are intended to support a viable, financially distressed firm can also serve to give shelter to an injuriously uneconomical firm.Baird (1987) and Jackson (2001) have argued that market-based insolvency procedures are more efficient, and that financially distressed firms should be “auctioned” in the open market instead of attempting reorganisation. Rajan and Zingales (2003) suggest that market-based systems also seem to be more effective at forcing companies in declining industries to shrink and release capital.However, studies have shown there to be a net gain to creditors from reorganisation (Alderson & Betker, 1995; Eisenberg & Tagashira, 1994). It is important therefore to distinguish between business failure and the economic function of insolvency. Insolvency is not intended to prevent the failure of inefficient firms. A firm can fail in the sense that its assets (resources) would be better used elsewhere, and this would be deemed acceptable (Boraine & Wyk, 2015:236). Business failure, however, does not necessarily mean that reorganisation has failed, but rather represents the desired outcome of an efficient process. Famous economist Joseph Alois Schumpeter reiterated this through the term “constructive destruction”, which sees the reallocation of investments as “constructively” destroying or replacing the old physical economy with the new (Omar, 2008:61). Pol and Carroll (2006), citing Schumpeter, state“[constructive destruction] could provide better results than the invisible hand and price competition”. One must keep in mind, though, that failure is itself constituted out of an assemblage of calculative technologies, expert claims and modes of judgement (Miller & Power, 2005). Professionals will undoubtedly perceive corporate events in distinctive ways.This is where it gets interesting. It is an extension of finance theory that a firm’s financial health (its ability to pay its debts) is different from the firm’s economic health (its ability efficiently to provide goods or services) (Adler, 1997:334). This means that a firm riddled with debt can suffer financial distress while remaining economically viable. Conversely, a financially distressed firm could also be economically unviable, in which case there would be no benefit from its entering reorganisation proceedings, which would simply erode its value. This issue is easily concealed in the rather nebulous area where law and economics intersect.As King (1975:306) unravels it from an economic point of view, “failure” means nothing more than an excess of average costs (in the historical sense) over average earnings.

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Declaration Regarding Plagiarism 
Table of Contents 
List of tables 
List of figures 
List of abbreviations 
CHAPTER 1  Introduction
Business rescue summarised
Importance of the study
Problem definition
Research ethics
Referencing technique
Research methodology
Arrangement of chapters
CHAPTER 2  How did the invisible hand lose its grip? 
The commencement standard
Reorganisation triggers
Commencement gateway
Gap period for commencement decision
Good faith test
The commencement standard for business rescue
Commencement standards in major jurisdictions
CHAPTER 3  Introduction
Key Concepts
Value maximisation principle
Stakeholder theory perspective
Legal analysis
Discussion and conclusion
Defining reasonable prospect
Value maximisation
Likelihood of Liquidation (LOL)
Research methodology
Proposed framework
Limitations and future research
The Likelihood of Liquidation Framework
The Delphi Method
Proposed framework
Assigning values to the LOL indicators
LOL Score
Limitations and Future research
Summary of main findings
Implications for further research (limitations)
Implications for practitioners
Implications for policy-makers
List of references


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