East Europeans tackle mess of business failure

Bankruptcy usually signals the end of a business. In the nascent economies of central Europe, the poor state of bankruptcy legislation means a lot of business never gets done in the first place.

When countries in the region emerged from Communism more than a decade ago, they opened the door to private business.

Once past the welcome mat, however, businesses have found a bewildering set of rules and ill-equipped courts.

On top of that, many governments simply opted to make bankruptcies difficult in the early 1990s in a bid to keep massive and non-viable Communist-era firms afloat and avoid a surge in unemployment.

The result has been a mess which the region`s group of European Union candidates are now trying belatedly to tackle as they work to catch up with their richer Western neighbours.

"Bankruptcy here is one of the biggest obstacles to doing business. It prevents business from being done," said Weston Stacey, head of the American Chamber of Commerce in the Czech Republic, which is campaigning for a legislative revamp.

In the Czech Republic, slow and inefficient bankruptcy procedures have allowed billions in assets to vanish and made banks and companies extremely cautious about lending and dealing with business partners. This limits economic growth.

Many state-run companies have been bailed out repeatedly rather than allowed to fail - including most major banks, whose non-performing loans to ailing industrial firms have been taken over by state debt vehicles at the cost of billions of dollars.

A poor legal framework means businesses that do go bust return very little to creditors.

"The return in bankruptcies is up to three percent on average. That is an awfully small fraction," said Alexander Vacek, a bankruptcy administrator working on the largest Czech business failure to date, chemicals group Chemapol.

Elsewhere, companies that have hit hard times face similar difficulties. Polish firms find themselves caught in a tangled bankruptcy web when a court orders a freeze on their assets, making it impossible for them to regain a level footing.

In Romania, where laws are often interpreted in a discretionary manner, international institutions have urged the government to implement more efficient bankruptcy procedures.

One central European country which had the will to tackle the problem was Hungary, which paid the price for a series of failures in the early 1990s and now serves as a model for reform.

"The Hungarian government had the courage," said Ramiro Cibrian, the head of the European Union`s delegation to the Czech Republic. "This was a painful process which was undertaken in the early 1990s...The Czech Republic has been trying to catch up since then."

The Czechs have amended their bankruptcy legislation 17 times over the past 10 years, but it still doesn`t work.

The law only knows two forms of ending a bankrupt firm`s life: liquidation and debt settlement. But parameters for composition and procedural drags have made protracted liquidation the way in which nearly all bankruptcies go.

Proceedings are lengthy - 40 per cent of cases last more than three years - and creditors have little chance of influencing the process, especially in the early stages, which often destroys the value left in the ailing companies.

At the end of 2000, the Czechs had a backlog of 10,560 cases which needed to be dealt with. Poland had 3,835 in mid-2001.

Seeing that partial changes make no sense, the Czechs started writing an entirely new law, looking to Germany and the United States for inspiration. The EU sent two experts to help.

Working proposals have won praise from lawyers and investors, but the lack of a final draft ahead of the June 14-15 election has irritated the business community.

"It is a great shame that the parliamentary debate has not already occurred, and that the bill has not been signed by the president," the American Chamber of Commerce wrote in a report.

The Justice Ministry now says the final version will be submitted to the next cabinet in the autumn.

In Poland, where business failures have jumped in recent years amid a slowing economy, lawyers and businessmen have also called for new laws that would avoid the lethal freeze on assets of firms declared insolvent.

"After a decade of growth, the economy needs to reorganise, to trim the fat, and a new bankruptcy law is essential for this reorganisation," said one lawyer at a US firm in Warsaw.

But investors should not hold their breath, say analysts, as the new bill is not expected to be passed by parliament until late 2002.

The new Czech law is big in its introduction of restructuring - the possibility to revamp a company under creditors` oversight and keep it alive.

"The reorganisation section corresponds in many respects to the theory and intentions underpinning US and German legislation and offers an effective alternative to bankruptcy," lawyers White & Case, Feddersen said in a report.

Creditors` rights will be increased, mainly in choosing administrators, and rules for partial debt settlement will be made more flexible so more insolvencies can be handled that way. Bankruptcy administrator Vacek is optimistic about the changes:

"If there are no administrative troubles, and there is reorganisation, the return may be 80 per cent, or 30 per cent, but certainly not three per cent."