Certainty in a country’s insolvency system is a vital building block in the wall of investor confidence because well-developed systems enhance predictability.

“Insolvency regimes are important to investment because they contribute to lender confidence in loan recovery upon default, which encourages more lending and leads to financial access for more businesses,” said Mahesh Uttamchandani, Global Product Leader - Debt Resolution and Business Exit at World Bank Group.

He was speaking in Cape Town today at the 6th Annual National Conference on Restructuring and Insolvency, hosted by the South African Restructuring and Insolvency Practitioners Association.

Adam Harris, Partner at pan-African law firm Bowman Gilfillan said that, given its importance in attracting foreign investment, South Africa’s insolvency and business rescue system is in urgent need of reform.

“With our Insolvency Act still creaking along after almost 80 years and a new Companies Act that had some 120 sections requiring amendment before it was brought into effect, some investors may fear there is fruitful ground for litigation. As a result, they may be inclined to allocate their capital to a jurisdiction where they feel more comfortable.”

Citing the World Bank Group’s Viewpoint publication, (prepared jointly with the Oxford University Law & Finance Program), Mr Uttamchandani said the willingness of banks and investors to support new businesses depends a great deal on the rules that govern failing businesses.

“Effective insolvency regimes save struggling firms where possible, or they reallocate the assets of failing firms more productively. Banks and investors are more willing to lend when they know they can recover at least some of their investment. Entrepreneurs are more willing to enter the market when they are not putting their entire personal fortunes at risk”.

Mr Harris noted that effective insolvency reform is associated with a lower cost of credit, increased access to credit, improved creditor recovery, strengthened job preservation, the promotion of entrepreneurship, and other benefits for small businesses.

One aspect lenders and investors look out for is how a country’s insolvency system affects the willingness of financial institutions to grant credit to borrowers. Also, the terms upon which credit is made available are dependent on the lender’s view of the insolvency system. 

Simply put, will they be able to get their money back, how long is this likely to take, and what sort of return on their investment would they get in terms of “cents in the rand”?

A study done in Europe showed that banks price their lending based on their rights in case of default by the debtor, with loans priced higher to deal with what are described as creditor unfriendly aspects of bankruptcy law. In France, considered the least creditor friendly of the three, there was a significantly lower rate of business recovery than in Germany or the UK.The study also showed that effective insolvency regimes are associated with an increased availability of credit. Weak systems inhibit access to credit. 

Citing Viewpoint, Mr Uttamchandani said: “Insolvency law provides an orderly process for the reorganisation or liquidation of insolvent entities. It serves as an important safety net for business activity, ensuring that when businesses face financial difficulties, mechanisms are available to either rescue them or maximise the value realised from their assets through their deployment to more productive firms”.

Mr Harris said that one of the other principle aims of insolvency legislation is to ensure an orderly payment process, providing a balance between debtor protection and creditor recovery.

“Effective insolvency regimes preserve jobs by facilitating the survival of distressed but viable businesses, while reducing credit risk.”