Public Finance in China by The World Bank

Author:The World Bank
Language: eng
Format: epub
ISBN: 9780821369272
Publisher: The International Bank for Reconstruction and Development / The World Bank

Debt Restructuring

Debt restructuring lies at the heart of any insolvency framework. In administrative interventions, the higher level of government often restructures the subnational’s debt obligations into longer-term debt instruments. The 1997 debt agreements between the Brazilian federal government and 25 states, though strengthened by ex ante regulations, might be seen as an ex post mechanism as well, because the agreements were imposed on a case-by-case basis as a condition for debt restructuring.

Debt discharge represents a major departure from the principle that contracts ought to be honored.48 A mature judicial mechanism is well placed to ensure that discharges are fair and equitable. Discharges are thus typically limited to judicial mechanisms. Ex post modification of contracts needs to be tightly circumscribed. If creditors feel that they have been treated unfairly, there is a substantial risk that they will stop lending. Perceptions of “equitable” are likely to differ across countries, as distributional judgments are involved.

Debt restructuring and debt discharge are complex. One basic question is who holds the cram down power—that is, confirmation of bankruptcy plans despite the opposition of certain creditors.49 Under the U.S. Chapter 9, the municipal debtor controls the debt-adjustment plan and modifies the terms of existing debt instruments. To the critical question of what the debtor is able to do over the objection of creditors, Chapter 9 incorporates basic Chapter 11 requirements: at least one impaired class of claims approves the plan, secured creditors receive at least the value of the securitized property, and unsecured creditors often lose out.50

In Hungary the Debt Committee is chaired by a court-appointed financial trustee, who is required by the debt law to be independent of the local government under proceeding. The Committee is charged with preparing a reorganization plan and debt-settlement proposal.51 The plan and proposal are decided by majority vote of the Committee and presented to creditors. A debt settlement is reached if at least half of creditors whose claims account for at least two-thirds of total undisputed claims agree to the proposal. Creditors within the same group must be treated equally.52 The Act also stipulates the priority of asset distributions. If disagreements arise on distribution, the court makes the final decision, which cannot be appealed.53

South Africa’s legislation stipulates that debt discharge and settlement of claims must be approved by the court. The settlement of claims follows the following order: secured creditors, provided that the security was given in good faith and at least six months before mandatory intervention by the provinces; preferences provided by the 1936 Insolvency Act; and nonpreferential claims, which are settled in proportion to the amount of each claim.

The rescaling of debt obligations represents a major intervention in contract rights. Insolvency law reconciles this clash of creditor rights and inability to pay. It formalizes the relationship between creditors and a subnational debtor in financial distress. Insolvency law preserves the legal order by superseding contractual violations with a new legal act.54 A procedure for subnational insolvency recognizes that resolving financial distress through mechanisms guided by law is preferable to muddling through repeated, costly, and often unsuccessful negotiations.

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