Malta has the most inefficient insolvency proceedings of all the EU member states, a damning report by the European Commission has revealed.

The report coincides with new EU rules on business insolvency, aimed at increasing the opportunities for companies in financial difficulties to restructure early on so as to prevent bankruptcy and avoid laying off staff.

At present, many viable companies in financial difficulties are steered towards liquidation – which the EU report described as “the most likely outcome” in Malta – rather than early restructuring, with too few entrepreneurs getting a second chance.

Indeed, there does not seem to be much chance of a ‘second chance’: Malta is one of eight member states where bankrupt entrepreneurs cannot shed their ‘bankrupt’ status as no discharge exists, while 11 countries have a discharge period of three years or less.

The report estimates that Malta could increase its SMEs by five per cent if it were to offer a discharge period of three years, creating 428 jobs.

The impact could be significant: Malta is one of nine member states where SMEs account for over three-quarters of employment.

SMEs in only just over half of member states can achieve bankruptcy in three years or less, and only half of member states treat restarters on an equal footing with new start-ups.

Second change policies laid out in the Small Business Act have been implemented in less than half the member states – and has been the principle showing least progress since 2008.

In Malta, only 40.7 per cent of secured creditors recover their debts following insolvency, compared to 65 per cent in the EU

The report shows that the average length of insolvency proceedings in Malta is three years, compared to the EU average of two years.

This all has a spill-over effect on the rest of the economy. In Malta, only 40.7 per cent of secured creditors recover their debts following insolvency, compared to 65 per cent in the EU.

Conrad Portanier, a partner at Ganado Advocates, who has lobbied for changes to Malta’s insolvency proceedings, said that these statistics, although alarming, were not surprising.

“I will mention one case with significant commercial ramifications where the First Hall of the Civil Courts decided (swiftly and ably) that a large company owing millions to Maltese creditors is now insolvent since it was unable to pay its debts.

“The company has now appealed, as is its right under law, and the creditors need to wait for three to four years just for the Court of Appeal case to be appointed for the first hearing.

“I will not venture into proposing amendments. There are structural problems which necessitate a comprehensive national strategy to address the underlying problems in the medium term. Unfortunately, piecemeal tweaks to the system do not address the root of the issue. Lack of decisive action will lead to making Malta less attractive for investment, at a time when many other competing jurisdictions have made radical overhauls to their systems and laws,” he warned.

The Finance Ministry did not respond to questions sent by The Business Observer.

The European Commission’s annual report for SMEs for 2014/2015 stressed that many start-ups fail in their early years and that public policies offering a second chance would improve the environment.

“Often a business cessation is involuntary and results from creditor action to recover partially and fully debts owed to them,” it said.

“Bankruptcy procedures and similar involuntary business cessation procedures provide the legal framework for winding down such failing business.

“The characteristics of the bankruptcy regimes vary considerably in terms of how punitive the regime is for honest entrepreneurs whose business failed and went bankrupt … Economies with more punitive bankruptcy regimes forego the value-added and employment which would have been created by the business and which would have been created by entrepreneurs actually deterred or prevented from doing so.”

If all the member states where the discharge period exceeds three years reduced it to three years, the EU’s GDP would be one per cent higher each year, in the long run. Although this figure cannot be precise, the EU said that it nonetheless highlighted the fact that the opportunity cost, in terms of foregone output and employment, of punitive bankruptcy regimes was “far from insignificant”.

EU SMEs seem to be recovering from the fallout of the financial crisis and value added grew for the second year in a row, reaching 5.7 per cent in 2015, while employment grew by 1.5 per cent.

In 2015, there were just under 23 million SMEs in the EU, which generated €3.9 trillion of value-added.

They employed 90 million people – two out of every three – with growth in 27 out of the 28 member states, almost all of which was due to an increase in the number of SMEs. Nevertheless, every year, 200,000 firms go bankrupt, resulting in over 1.7 million people losing their jobs.

What will the new rules improve?

The situation today in Malta With the new rules
In restructuring proceedings, companies and entrepreneurs are prevented from controlling their own assets and the day-to-day operation of their businesses. ✓ The companies and entrepreneurs will be in control of their businesses which will avoid unnecessary costs and better ensure the continuation of the business. An insolvency practitioner will be appointed when necessary.
Access to restructuring procedures is too late, leading companies into formal insolvency proceedings. ✓ Viable enterprises in financial difficulties will have access to restructuring tools at an early stage where their chances of survival are higher.
A “breathing space” from enforcement of actions is automatically provided to the debtor, but it is too long (12 months with two possible extensions of two months). ✓ Viable companies in financial difficulties can have access to a time-limited “breathing space” from enforcement actions of no more than four months, renewable until a maximum duration of 12 months under strict conditions. This will not only facilitate negotiations and reduce the length of procedures, but also provide further predictability and legal certainty for creditors.
New financing for companies in the process of early restructuring is not sufficiently encouraged or protected. ✓ Access to fresh money is vital for the rescued company. New financing will be specifically protected increasing the chances that restructuring will be successful.
The framework of debt discharge does not provide for a time limit, thus lacking legal certainty. ✓ Honest insolvent entrepreneurs will have access to a full discharge of their debt after a maximum period of three years, without prejudice to adequate safeguards put in place to prevent possible abuses.

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