tag:theconversation.com,2011:/us/topics/creditors-22323/articlescreditors – The Conversation2022-10-10T07:37:49Ztag:theconversation.com,2011:article/1918772022-10-10T07:37:49Z2022-10-10T07:37:49ZGhana and the IMF: debt restructuring must go hand-in-hand with managing finances better<figure><img src="https://images.theconversation.com/files/488725/original/file-20221007-14-cp946.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Ghana is engaging the IMF over a bailout</span> <span class="attribution"><span class="source">Wikimedia Commons</span></span></figcaption></figure><p>Ghana is struggling with managing its <a href="https://theconversation.com/ghanas-return-to-the-imf-within-three-years-underscores-its-deeper-economic-problems-187041">debt</a>, 20-year high inflation, a weak currency, and rising inequality.
For example, <a href="https://statsghana.gov.gh/cpigraph.php?graphindicators=MTI0MDM5Njc1Ny42OTU1/cpigraph/n1r7pr567p">inflation</a> rose to 33.9% in August 2022 from 9.7% a year earlier, while the cedi has <a href="https://www.google.com/finance/quote/GHS-USD?sa=X&ved=2ahUKEwi_gMry88T6AhVoSEEAHfAVAoAQmY0JegQIAxAb&window=YTD">depreciated</a> by 41% year-to-date against the US dollar. These vulnerabilities have been worsened by the aftershocks of the ongoing Russia–<a href="https://theconversation.com/ukraine-war-how-ghana-is-vulnerable-and-what-can-be-done-178528">Ukraine war</a> and the COVID-19 pandemic.</p>
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<a href="https://theconversation.com/ghanas-return-to-the-imf-within-three-years-underscores-its-deeper-economic-problems-187041">Ghana’s return to the IMF within three years underscores its deeper economic problems</a>
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<p>These challenges have forced Ghana’s government to <a href="https://mofep.gov.gh/press-release/2022-09-26/ghana-starts-imf-negotiations">approach</a> the International Monetary Fund (IMF) for an economic support package. Part of the engagement will involve a new <a href="https://www.imf.org/external/pubs/ft/dsa/">assessment</a> of the sustainability of the country’s debt. </p>
<p>Debt sustainability analysis <a href="https://www.imf.org/en/About/Factsheets/Sheets/2016/08/01/16/39/Debt-Sustainability-Framework-for-Low-Income-Countries">classifies</a> countries into four bands: low risk, moderate risk, high risk, and in debt distress. This is based on certain thresholds for key public debt indicators. Ghana’s last <a href="https://documents.worldbank.org/en/publication/documents-reports/documentdetail/973971632340489819/ghana-joint-world-bank-imf-debt-sustainability-analysis">analysis</a>, conducted in mid-2021, classified the country as being at high risk of external debt distress and overall debt distress. The assessment was carried out jointly by the IMF and the World Bank. </p>
<p>If the new assessment concludes Ghana’s debt levels aren’t sustainable, the country will have to take steps to restructure its debt to qualify for IMF assistance. The Fund <a href="https://www.imf.org/en/About/FAQ/sovereign-debt">states</a> that it won’t lend to countries that have unsustainable debts unless the member takes steps to restore debt sustainability, which can include debt restructuring.</p>
<p>Recently, Zambia had to <a href="https://www.theguardian.com/global-development/2022/sep/02/crisis-hit-zambia-secures-13bn-imf-loan-to-rebuild-stricken-economy">negotiate</a> with all its external lenders, including bilateral and commercial creditors, as a pre-condition for accessing IMF funding. The process lasted almost two years.</p>
<p>Ghana needs to address its current crisis by tackling two issues. </p>
<p>Firstly, the restructuring of its debt. Here a good option would be to restructure its external debt as well as some limited domestic debt restructuring. </p>
<p>And secondly, it needs urgently to take six steps on the domestic front to get its financial house in order. This includes putting an end to <a href="https://imaniafrica.org/wp-content/uploads/2022/05/2ND-IMANI-FISCAL-RECKLESSNESS-INDEX-2020.pdf">profligacy</a> in government spending and ensuring it lives within its means.</p>
<h2>Ghana’s public debt dynamics</h2>
<p>A country’s debt dynamics includes both external and domestic debt, and debt accruing to <a href="https://www.imf.org/en/Publications/fandd/issues/2020/09/what-is-debt-sustainability-basics">state-owned enterprises</a> and its maturity structure. All need to be considered when considering any debt restructuring. </p>
<p>Ghana’s total public debt as of June 2022 was US$54.4 billion (GHS393 billion or 78.3% of GDP) from US$32.3 billion (GHS143 billion or 55.5% of GDP) in 2017, according to <a href="https://www.bog.gov.gh/wp-content/uploads/2022/08/Summary-of-Economic-and-Financial-Data-July-2022_1.pdf">central bank</a> and <a href="https://mofep.gov.gh/sites/default/files/reports/economic/2021-Annual-Public-Debt-Report.pdf">finance ministry</a> data. </p>
<p>Of this, external debt was US$28.1 billion (GHS203.4 billion or 40.5% of GDP), while domestic debt issued in cedis was US$26.3 billion (GHS190 billion or 37.8% of GDP). </p>
<p>Regarding external debt, the portfolio includes debt owed to multilaterals such as the IMF and World Bank, bilaterals, commercial loans such as Eurobonds, and other export credits. The external debt also comprises of fixed (86.5%), variable (13.1%) rate and some interest-free (0.4%) debt. As of 2021, about 72% of the external debt was also dollar-denominated.</p>
<p>In 2021, the government <a href="https://mofep.gov.gh/sites/default/files/reports/economic/2021-Annual-Public-Debt-Report.pdf">spent</a> US$2.2 billion in total external debt service, including principal repayments, interest payments and charges.</p>
<p>Of the domestic debt, Ghana’s government sourced as much as 85% of its domestic debt in 2021 via the market. This included financial securities and instruments traded on the secondary market. This means that Ghanaian banks, individuals and institutional investors, such as pension funds, buy and sell government securities such as treasury bills and other fixed deposits. </p>
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<img alt="" src="https://images.theconversation.com/files/488031/original/file-20221004-16-l3wqpl.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/488031/original/file-20221004-16-l3wqpl.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=178&fit=crop&dpr=1 600w, https://images.theconversation.com/files/488031/original/file-20221004-16-l3wqpl.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=178&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/488031/original/file-20221004-16-l3wqpl.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=178&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/488031/original/file-20221004-16-l3wqpl.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=223&fit=crop&dpr=1 754w, https://images.theconversation.com/files/488031/original/file-20221004-16-l3wqpl.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=223&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/488031/original/file-20221004-16-l3wqpl.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=223&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="attribution"><span class="source">Theo Acheampong</span></span>
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<p>In 2021, Ghana’s banking sector cumulatively held 50% of the total domestic debt stock comprising commercial banks (30%) and the Bank of Ghana (20%). The non-bank sector comprised firms and institutions (22.6%), individual investors (9.2%), rural banks (1.1%), insurance companies (0.6%) and the Social Security and National Insurance Trust (0.3%). Foreign investors held 16% of the remaining domestic debt.</p>
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<img alt="" src="https://images.theconversation.com/files/488033/original/file-20221004-12-xljudb.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/488033/original/file-20221004-12-xljudb.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=233&fit=crop&dpr=1 600w, https://images.theconversation.com/files/488033/original/file-20221004-12-xljudb.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=233&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/488033/original/file-20221004-12-xljudb.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=233&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/488033/original/file-20221004-12-xljudb.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=292&fit=crop&dpr=1 754w, https://images.theconversation.com/files/488033/original/file-20221004-12-xljudb.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=292&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/488033/original/file-20221004-12-xljudb.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=292&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="attribution"><span class="source">Theo Acheampong</span></span>
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<h2>Restructuring ideas</h2>
<p>There have been <a href="https://www.bloomberg.com/news/articles/2022-09-20/ghana-set-to-start-debt-restructuring-talks-for-local-bonds?srnd=premium-africa">suggestions</a> that Ghana would prioritise restructuring its domestic debt. But this begs the question: what does a debt restructuring entail and where does the burden fall especially if <a href="https://www.investopedia.com/terms/h/haircut.asp">haircuts</a> – which can include a reduction in outstanding interest payments – are part of the policy mix?</p>
<p>Ghana’s commercial banks held about <a href="https://mofep.gov.gh/sites/default/files/reports/economic/2021-Annual-Public-Debt-Report.pdf">30%</a> of the domestic debt and 31% of the total <a href="https://www.bog.gov.gh/wp-content/uploads/2022/08/Summary-of-Economic-and-Financial-Data-July-2022_1.pdf">banking sector assets</a> in 2021. Thus, any attempt to restructure the domestic debt without a compensating policy action could leave the banking sector highly vulnerable to further distress. </p>
<p>Restructuring domestic debt focused solely on haircuts would severely affect asset quality and increase non-performing loans much higher than the <a href="https://www.bog.gov.gh/wp-content/uploads/2022/08/Summary-of-Economic-and-Financial-Data-July-2022_1.pdf">current</a> 14.1%. </p>
<p>It would also reduce private sector lending, already under severe strain from 20-year high inflation. Pensions and other institutional investments are also likely to suffer.</p>
<p>When it comes to external debt, Ghana must first seek to restructure it under the principles of the <a href="https://saiia.org.za/research/africas-covid-19-recovery-challenge-how-the-g20-can-bridge-the-development-financing-gap/">G20 Common Framework</a>. Ghana delayed in applying to join the Framework during the pandemic for <a href="https://academic.oup.com/book/38922/chapter-abstract/338098258?redirectedFrom=fulltext">fears</a> of losing market access. </p>
<p>The country was eventually locked out of the international capital markets anyway after several <a href="https://www.fitchratings.com/research/sovereigns/common-framework-access-could-lead-to-sovereign-debt-default-16-02-2021">sovereign</a> rating downgrades. </p>
<p>Ghana has an opportunity to remedy this and offer a collaborative and constructive platform to engage on external debt restructuring. </p>
<p>Zambia’s recent restructuring <a href="https://www.atlanticcouncil.org/blogs/econographics/zambia-a-template-for-debt-restructuring/">exercise</a> offers valuable <a href="https://jubileedebt.org.uk/wp-content/uploads/2022/02/Zambia-debt-restructuring-needs-calculation_02.22.pdf">lessons</a>. All creditors must be treated evenly as any hints of arbitrary treatment will delay the process, as <a href="https://odi.org/en/insights/four-lessons-from-zambias-emerging-debt-default/">happened</a> in this case. </p>
<h2>Way forward</h2>
<p>There are six steps Ghana must urgently take to get government finances in order.</p>
<p>Firstly, it must enforce the <a href="http://ir.parliament.gh/bitstream/handle/123456789/1831/FISCAL%20RESPONSIBILITY%20ACT%2c%202018%20%28ACT%20982%29.pdf?sequence=1&isAllowed=y">law</a> when it comes to fiscal responsibility and impose hard sanctions on the finance minister and other ministries who flout it. Ultimately, Ghana must ensure that it lives within its means and hold politicians to account to provide funding plans for their <a href="https://blogs.worldbank.org/africacan/will-procyclicality-override-ghanas-new-fiscal-responsibility-law">political</a> campaign promises. </p>
<p>Secondly, Ghana must implement the Integrated Financial Management System as part of the broader public financing management reforms and ensure that every transaction is fully captured in the main accounting system. Media <a href="https://www.myjoyonline.com/auditor-generals-reports-are-hollow-bright-simons/">reports</a> indicate that only about a third of government transactions are fully captured. This creates many avenues for collusion and corruption.</p>
<p>Thirdly, the government must limit borrowing from the domestic market to compensate for the lack of access to the international capital markets. </p>
<p>Fourthly, President Nana Akufo-Addo must cut down the size of the government through a reshuffle to remove many of those who are not performing and reduce public expenditure. The President does not need to tell Ghanaians that his ministers are <a href="https://citinewsroom.com/2022/08/my-ministers-have-been-outstanding-akufo-addo-shoots-down-calls-for-reshuffle/">“outstanding”</a>, as the citizens would know it if cost of living is indeed improving.</p>
<p>Fifth, the government must urgently convene a broader national stakeholder forum on the economy with all key representative groups including labour, civil society, inter-faith groups, political parties, and business associations, among others.</p>
<p>In 2014 the then opposition <a href="https://www.graphic.com.gh/news/politics/npp-boycotts-national-economic-forum.html">ridiculed</a> the idea of a forum. But platforms like this can be valuable for generating new ideas for economic reforms. It will also ensure stakeholder buy-in of any proposed reform programmes.</p>
<p>Lastly, the government must be transparent in its dealings with Ghanaians and the IMF. All data must be fully and transparently disclosed, especially the indebtedness or exposure of the state-owned enterprises and other parastatals.</p><img src="https://counter.theconversation.com/content/191877/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Theophilus Acheampong is affiliated with the IMANI Centre for Policy and Education, Accra, Ghana.</span></em></p>Ghana’s sovereign risk has been downgraded to near junk status by ratings agencies in recent times.Theophilus Acheampong, Associate Lecturer, University of AberdeenLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1849312022-06-22T14:52:55Z2022-06-22T14:52:55ZTriple punch of shocks threatens to upend debt sustainability and recovery in Africa<figure><img src="https://images.theconversation.com/files/469180/original/file-20220616-18-b32fy8.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Children queue for porridge in Harare, the capital of Zimbabwe during the height of the COVID pandemic.</span> <span class="attribution"><span class="source">Photo by Tafadzwa Ufumeli/Getty Images</span></span></figcaption></figure><p>Food and fuel price increases and the aftermath of the COVID pandemic are really just the start of the story when it comes to fiscal shocks which have exacerbated government debt vulnerabilities in Africa.</p>
<p>Tightening global financial conditions present a third shock that will cause debt-servicing costs to climb dramatically. This is because central banks around the world are hiking interest rates to <a href="https://www.bloomberg.com/news/articles/2022-05-01/global-economy-faces-410b-financial-shock-as-central-banks-pull-back">rein in inflation</a> that’s running at the fastest pace not seen in recent decades. </p>
<p>After the 2008 financial crisis, borrowing costs had been reduced to relatively low levels due to lower interest rates in developed countries. This enabled African governments to borrow at relatively lower rates.</p>
<p>The triple punch of rising interest rates, rising food and fuel prices and the COVID aftermath will significantly squeeze government budgets, threatening the continent’s fragile post-pandemic recovery. </p>
<p>The strain on government finances will vary across countries. Net importers of essential food items (such as wheat) and fuel have to pay more for imports, and are thus experiencing a much bigger drain on their fiscal resources. </p>
<p>On the other hand, net exporters of oil like Nigeria and Angola are likely to benefit from rising oil prices, and will have more budgetary room for responding to policy demands. </p>
<p>Not all African countries are experiencing the same squeeze on their public finances. But the triple punch of shocks has markedly increased the number that are at high risk of – or are already in – debt distress that require sovereign debt restructuring. Unfortunately, the only system in place for debt restructuring – the <a href="https://blogs.imf.org/2021/12/02/the-g20-common-framework-for-debt-treatments-must-be-stepped-up/">G20’s Common Framework for Debt Treatment</a> – has proved ineffective for a number of reasons. These include the absence of clear procedures and timelines for debtors and creditors, a lack of clarity on how different creditors will be treated, and the growing geopolitical rift between the US and EU on one side and China and Russia on the other. </p>
<p>This is why an alternative system to the framework must be put in place without delay to alleviate the debt problems faced by African countries. Failure to do so will make it difficult to restrain Africa’s debt and imperil its fragile post pandemic recovery.</p>
<h2>The shocks</h2>
<p>According to the <a href="https://www.imf.org/en/Publications/REO/SSA/Issues/2021/04/15/regional-economic-outlook-for-sub-saharan-africa-april-2021">International Monetary Fund</a>, African countries spent only about 2.6% of GDP on average in 2020 to cushion the impact of COVID-19 on firms and households. And as government revenues plummeted in response to the sharp economic downturn induced by the pandemic, budget deficits widened. This added considerable strain on government debt which was already elevated. </p>
<p>As shown in Figure 1, fiscal balances further deteriorated when the pandemic struck, which constricted fiscal space and drove up government debt burdens in Africa. </p>
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<img alt="" src="https://images.theconversation.com/files/469592/original/file-20220618-22-fqj9mg.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/469592/original/file-20220618-22-fqj9mg.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=313&fit=crop&dpr=1 600w, https://images.theconversation.com/files/469592/original/file-20220618-22-fqj9mg.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=313&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/469592/original/file-20220618-22-fqj9mg.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=313&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/469592/original/file-20220618-22-fqj9mg.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=393&fit=crop&dpr=1 754w, https://images.theconversation.com/files/469592/original/file-20220618-22-fqj9mg.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=393&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/469592/original/file-20220618-22-fqj9mg.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=393&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<p>Between 2019 and 2021, government debt as a percent of GDP spiked from a pre-pandemic level of 51% to a pandemic-era of 61% for the median country in <a href="https://www.imf.org/en/Publications/WEO/weo-database/2022/April">Sub-Saharan Africa</a>. Zambia’s <a href="https://www.cnbc.com/2020/11/23/zambia-becomes-africas-first-coronavirus-era-default-what-happens-now.html">default on its sovereign debt in 2020</a> was a harbinger of trouble ahead. </p>
<p>The <a href="https://www.imf.org/en/About/Factsheets/Sheets/2016/08/01/16/39/Debt-Sustainability-Framework-for-Low-Income-Countries">IMF and World Bank</a> now consider 23 low-income African countries to be at high risk of, or already, in debt distress. This calls into question whether they will be able to keep up with their debt repayments.</p>
<p>Seven countries – Chad, Congo Republic, Mozambique, São Tomé and Príncipe, Somalia, Sudan and Zimbabwe – are in debt distress, meaning that they are having trouble servicing their public debt. The other 16 African countries are at high risk of debt distress. Cabo Verde and Zambia stand out as the only two where public debt exceeded 100% of GDP in 2021. </p>
<p>A handful of others including Ghana, Guinea-Bissau and Gambia are at risk. Ghana’s sovereign debt jumped from <a href="https://www.imf.org/en/Publications/WEO/weo-database/2022/April">63% in 2019 to 82% in 2021</a>, while Guinea-Bissau’s sovereign debt edged up from <a href="https://www.imf.org/en/Publications/WEO/weo-database/2022/April">66% to 81%</a> over the same period. Gambia’s debt showed no signs of easing, and has remained elevated at an average level of about <a href="https://www.imf.org/en/Publications/WEO/weo-database/2022/April">84% since 2019</a>. </p>
<p>IMF and World Bank assessments of a country’s risk of experiencing public debt distress are based on two main types of debt sustainability analyses. The first considers a country’s projected debt burden and its vulnerability to shocks. The second assesses the risk of external and overall public debt distress using a country’s macroeconomic environment and other country specific factors.</p>
<p>For this reason, a country with a relatively lower public debt ratio could also still be vulnerable. For example, Ethiopia was deemed to be at high risk of debt distress even though its sovereign debt of <a href="https://www.imf.org/en/Publications/WEO/weo-database/2022/April">53% of GDP in 2021</a> was relatively lower. </p>
<h2>Restructuring</h2>
<p>Given this state of affairs, sovereign debt restructuring has become inevitable. The G20’s Common Framework has not been effective amid growing mistrust among the different parties involved. Any optimism that it could be improved has been dented further by escalating geopolitical tensions between the US and EU on one side and China and Russia on the other.</p>
<p>Therefore, expecting both sides to sit down and coordinate with other G20 members to negotiate new debt terms with African governments and other sovereign debtors in the developing world is a long stretch. This casts further doubt on the G20 as a negotiating forum. </p>
<p>This is why an alternative system must be put in place without delay to alleviate Africa’s debt problems in a timely manner.</p>
<p>Failure to do so will make it difficult to restrain Africa’s debt and will weaken its post pandemic recovery.</p>
<p>In the past, sovereign debtors relied on the <a href="https://marketbusinessnews.com/financial-glossary/paris-club-definition-meaning/">22-member Paris Club</a> of wealthy creditor nations to negotiate debt restructurings. However, this time around, the Paris Club can no longer be used as the lead forum for debt treatments. This is largely because China is now one of Africa’s largest creditors, but is not one of the Paris Club’s members. </p>
<h2>Policy responses</h2>
<p>A return to debt sustainability will create fiscal room for African policy makers to stave off risks to the post-pandemic recovery in the face of multiple shocks that are teaming up to elevate sovereign debt pressures. But fiscal policy must be carefully targeted to avoid adding to debt vulnerabilities. This can be done in several ways.</p>
<p>First and foremost, policy makers should direct fiscal resources to protect the most vulnerable households affected by the cost-of-living crisis being wrought by the war in Ukraine. </p>
<p>Second, policy makers should use any budgetary room created by restraining debt to heal pandemic scars that are holding back the economic recovery. This includes supporting companies that can survive or recover, but are saddled with debt or cannot raise the financing to support themselves. </p>
<p>Support should also target new productive companies that are innovative and contribute to growth, jobs, and overall economic development. Additionally, workers set back by the pandemic should be given assistance to learn in-demand skills and adjust to new careers. </p>
<p>One of the deep scars of the pandemic was the severe disruption to schooling which led to a surge in teen pregnancies. Re-enrolling girls in classes by supporting community-based programs like <a href="https://www.projectelimu.org/">Kenya’s Project Elimu</a> will help limit the loss in human capital, and should be a top priority for policy makers.</p>
<p>Finally, African governments should use technical assistance support from multilateral lenders (IMF and World Bank) in areas that strengthen debt sustainability. These include debt management reforms, improved government revenue collection, smarter public investment programs, and debt sustainability analysis.</p><img src="https://counter.theconversation.com/content/184931/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Jonathan Munemo does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>A return to debt sustainability will create room for African policy makers to stave off risks to the post-pandemic recovery.Jonathan Munemo, Professor of Economics, Salisbury UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1579512021-04-26T19:42:05Z2021-04-26T19:42:05ZCanada should embrace Québec’s simple incorporation system for small businesses<figure><img src="https://images.theconversation.com/files/397081/original/file-20210426-21-1grf4au.jpg?ixlib=rb-1.1.0&rect=0%2C441%2C5265%2C2908&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Canada should take cues from Québec on how it incorporates small businesses.</span> <span class="attribution"><span class="source">(François Gha/Unsplash)</span></span></figcaption></figure><p>The federal government’s 2021 budget is significant in at least two respects. </p>
<p>First, it affirms that small businesses are <a href="https://www.canada.ca/en/department-finance/news/2021/04/budget-2021-address-by-the-deputy-prime-minister-and-minister-of-finance.html">“the vital heart of our economy.”</a> Government support in times of extreme economic stress is therefore critical. </p>
<p>Second, the budget looks to policy innovation at the provincial level as inspiration for nationwide reform — Québec’s universal child-care system being the latest example. </p>
<p>While parliamentarians and provincial legislatures debate unprecedented fiscal measures to support Canada’s small businesses, they should also consider how to embrace another Québec innovation: <a href="https://law.queensu.ca/sites/default/files/Robert%20M.%20Yalden%20PDF%20QBCA%20Article%202021.pdf">its simplified incorporation model for small businesses</a>. With some minor refinements, Québec’s system of <a href="https://www.thebalancesmb.com/incorporation-2948235">incorporating businesses</a> can and should be deployed across the country. </p>
<p>The pandemic has reinforced the need to advance reform in an area where we lag behind the United States and many other members of the Organization of American States (OAS).</p>
<p>Small businesses employ <a href="https://www.ic.gc.ca/eic/site/061.nsf/eng/h_03114.html#a01">two-thirds of Canadian workers</a> and account for about half of Canada’s <a href="https://www150.statcan.gc.ca/n1/pub/11f0027m/2011070/part-partie1-eng.htm">private sector economy</a>. Yet some neglect to incorporate <a href="https://fbc.ca/blog/pros-and-cons-incorporating-small-business/">due to concerns about costs and paperwork</a>, even though constant regeneration of small business is critical to long-term prosperity. </p>
<h2>Access to capital</h2>
<p>Incorporation helps with this process. When businesses legally become corporate entities or companies, they increase their access to capital because they separate assets in a way that is attractive to those who finance early stage businesses. Business assets are set apart from personal assets that can be subject to claims from other creditors. </p>
<p>Incorporation also encourages entrepreneurs to keep creating new businesses. The limited liability that comes with incorporation caps a founding shareholder’s losses to the amount they invested in the business. This better enables a founder to manage insolvency risks.</p>
<p>Importantly, some of the newest providers of capital to small businesses now rely on algorithms to evaluate credit risk. They’re also increasingly prepared to invest in a corporation without asking <a href="https://www.theglobeandmail.com/business/article-michele-romanows-clearbanc-hits-unicorn-status-raising-us100-million/">for personal guarantees</a>. The ability to contain losses to what was already invested is critical to an entrepreneur’s ability to build other businesses. </p>
<figure class="align-center ">
<img alt="Two women stand in front of a bakery." src="https://images.theconversation.com/files/397107/original/file-20210426-15-1fuaz1q.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/397107/original/file-20210426-15-1fuaz1q.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/397107/original/file-20210426-15-1fuaz1q.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/397107/original/file-20210426-15-1fuaz1q.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/397107/original/file-20210426-15-1fuaz1q.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/397107/original/file-20210426-15-1fuaz1q.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/397107/original/file-20210426-15-1fuaz1q.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">The co-owners of a bakery in Hamilton, Ont., pose outside of their store in October 2020.</span>
<span class="attribution"><span class="source">THE CANADIAN PRESS/Tara Walton</span></span>
</figcaption>
</figure>
<p>But more than that, the pandemic has taught many small businesses that there are advantages to moving from the informal to formal economy. Incorporation can greatly assist in getting access to government support. </p>
<p>Demonstrating that a business satisfies eligibility criteria is easier when it is a distinct legal entity with financial statements. Government delivery of funds is also facilitated when dealing <a href="https://ceba-cuec.ca/">with corporations that already have business numbers and business bank accounts</a>. </p>
<p>Québec was especially focused on helping small business when it adopted a <a href="http://legisquebec.gouv.qc.ca/en/showdoc/cs/S-31.1">new Business Corporations Act (QBCA) in 2010</a>. To this day, the QBCA’s simplified incorporation structure remains highly innovative, allowing a sole shareholder to dispense with:</p>
<p>• Establishing a board of directors</p>
<p>• Adopting by-laws (for example, rules about internal governance)</p>
<p>• Appointing an auditor</p>
<p>• Holding shareholder meetings</p>
<p>• Keeping records of board and shareholder meetings</p>
<h2>Reduces costs</h2>
<p>More than 25 years as a business lawyer taught me that removing redundant administrative burdens would simplify incorporation for many small businesses. It would also reduce costs that can serve as a barrier to incorporating.</p>
<p>But it is one thing to innovate, and another for innovation to be embraced. To date, only a few hundred companies have opted into Québec’s <a href="http://www.finances.gouv.qc.ca/documents/Autres/en/AUTEN_loiSocieteActions.pdf">simplified regime</a>. In contrast, several OAS countries have adopted simplified incorporation systems, many of which have met with extraordinary success. Colombia alone <a href="http://revistas.pucp.edu.pe/index.php/agendainternacional/article/download/19368/19486/">has seen the creation of hundreds of thousands</a> of simplified corporations. </p>
<figure class="align-center ">
<img alt="A man stands in an empty ballroom." src="https://images.theconversation.com/files/397114/original/file-20210426-21-z111j5.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/397114/original/file-20210426-21-z111j5.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=398&fit=crop&dpr=1 600w, https://images.theconversation.com/files/397114/original/file-20210426-21-z111j5.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=398&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/397114/original/file-20210426-21-z111j5.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=398&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/397114/original/file-20210426-21-z111j5.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=500&fit=crop&dpr=1 754w, https://images.theconversation.com/files/397114/original/file-20210426-21-z111j5.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=500&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/397114/original/file-20210426-21-z111j5.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=500&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Colombian event organizers speak in their business’s ballroom in October 2020. Thousands of businesses in Colombia have been created after the country adopted a simplified corporation system.</span>
<span class="attribution"><span class="source">(AP Photo/Fernando Vergara)</span></span>
</figcaption>
</figure>
<p>The benefits have been significant and include increased employment and social security contributions and benefits and <a href="https://dx.doi.org/10.2139/ssrn.2357578">enhanced tax revenue for governments</a>.</p>
<p>What accounts for the difference in uptake? Québec’s approach could certainly be more user-friendly. For example, it could give a founder the option to dispense with a board and other formalities by ticking a box when incorporating, rather than the current practice of requiring more legal documents to be filed after incorporation. </p>
<h2>Efforts need to be publicized</h2>
<p>But the OAS and countries like Colombia have also put substantial effort into ensuring that the option is well known and its use actively encouraged. In contrast, Québec has done little to publicize its regime. Unfortunately, a strategy that relies on word of mouth is no strategy. </p>
<p>What is required is a sustained government communications plan that alerts small businesses to the system’s advantages, encouraging them to embrace it from the moment they go online to incorporate.</p>
<p>The QBCA’s adoption marked an important step in recognizing the value inherent in simplified incorporation processes. But more needs to be done for that value to be fully realized. </p>
<p>Other jurisdictions in Canada need to follow Québec’s lead, adjusting and perfecting its model. They then need to deploy communications strategies that will resonate with small businesses — all inexpensive but consequential steps that would help drive economic recovery for small businesses in the post-pandemic era.</p><img src="https://counter.theconversation.com/content/157951/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Robert Yalden does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The federal government should embrace Québec’s simplified incorporation model for small businesses. With some minor refinements, Québec’s regime can and should be deployed across the countryRobert Yalden, Stephen Sigurdson Professor in Corporate Law & Finance, Queen's University, OntarioLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1555792021-02-19T13:40:44Z2021-02-19T13:40:44ZWhen companies go bust, the law does little to help suppliers get repaid – here’s a possible solution<p>Insolvency is stalking many UK businesses in the wake of coronavirus and Brexit. This has been particularly visible in retail, with <a href="https://www.retailresearch.org/whos-gone-bust-retail.html">2021 already seeing</a> stationery chain Paperchase in administration and former high-street leaders Debenhams and Topshop <a href="https://theconversation.com/future-of-high-streets-how-to-prevent-our-city-centres-from-turning-into-ghost-towns-154108">being mopped up</a> by online upstarts Boohoo and Asos. </p>
<p>Meanwhile, pubs and restaurants are <a href="https://www.theguardian.com/uk-news/2021/feb/18/budget-to-provide-fresh-covid-rescue-package-as-tax-rises-deferred">lobbying hard</a> to be allowed to open sooner rather than later, while Chancellor Rishi Sunak is signalling that the March budget will give more support to businesses and workers. </p>
<p>But when the support measures <a href="https://www.gov.uk/coronavirus/business-support">finally stop</a>, we can expect an <a href="https://www.accountancyage.com/2020/12/01/tsunami-of-insolvencies-likely-as-retail-faces-collapse/">insolvency tsunami</a>. According to a <a href="https://www.begbies-traynorgroup.com/news/business-health-statistics/news/firm-news/630000-uk-businesses-now-in-significant-financial-distress-as-new-lockdown-comes-into-effect">recent report</a>, the number of UK businesses in “significant distress” rose 27% year on year in the final quarter of 2020 to 630,000, with increases across all sectors. </p>
<p>Business collapses will obviously be painful for a lot of people involved. But thanks to the law that governs insolvency, some stakeholders in these companies will come off a lot worse than others. </p>
<h2>The battle for priority</h2>
<p>Perhaps the best example of the imbalance in insolvencies is on planet football. <a href="https://www.r3.org.uk/stream.asp?stream=true&eid=22099&node=190&checksum=141F3D891B3A4811F289ED8BE69BF679">Nearly half</a> of clubs in top four tiers of the English leagues have gone through an insolvency since 1992.</p>
<figure class="align-right zoomable">
<a href="https://images.theconversation.com/files/385030/original/file-20210218-23-1hq1t1f.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Punctured football on grass" src="https://images.theconversation.com/files/385030/original/file-20210218-23-1hq1t1f.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/385030/original/file-20210218-23-1hq1t1f.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=685&fit=crop&dpr=1 600w, https://images.theconversation.com/files/385030/original/file-20210218-23-1hq1t1f.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=685&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/385030/original/file-20210218-23-1hq1t1f.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=685&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/385030/original/file-20210218-23-1hq1t1f.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=860&fit=crop&dpr=1 754w, https://images.theconversation.com/files/385030/original/file-20210218-23-1hq1t1f.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=860&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/385030/original/file-20210218-23-1hq1t1f.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=860&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Millionaires get paid first.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/deflated-soccer-ball-1053297158">Javier Crespo</a></span>
</figcaption>
</figure>
<p>When a club enters administration, for example, the “<a href="https://www.brabners.com/blogs/effect-football-creditors-rule-staff-wages-event-efl-clubs-insolvency">football creditor rule</a>” kicks in. This gives certain creditors priority status in getting their money back, including players, clubs and the football league authorities. It can lead to perverse outcomes: for instance, a multi-millionaire footballer might get paid ahead of a cleaner who is paid by an outside cleaning company that is owed money by the club.</p>
<p>The league authorities maintain that this rule exists for the financial integrity of the league. But it clearly creates losers, too. </p>
<p>In the insolvency world, this is known as the “waterfall” because value trickles down a pre-determined hierarchy of all the groups of creditors. Jockeying for position is the name of the game. </p>
<p>Once insolvency practitioners have been paid, the law prioritises “secured creditors” over all others. These are creditors who have lent money in exchange for collateral – usually in the form of a mortgage over property or plant or machinery. These are known as fixed charges, and these creditors will normally be banks. They have manoeuvred into this priority position in the hierarchy over many decades. </p>
<p>Next comes “preferential creditors”, whose <a href="https://www.legislation.gov.uk/ukpga/1986/45/part/IV/chapter/VIII/crossheading/preferential-debts">status has been granted</a> by parliament. This includes employees, who can claim outstanding holiday pay and some unpaid wages. <a href="https://www.r3.org.uk/press-policy-and-research/r3-blog/more/29492/page/1/royal-assent-for-the-finance-bill-but-r3-s-opposition-to-crown-preference-continues/">Very controversially</a>, tax authorities were also <a href="https://www.gov.uk/government/publications/introduction-of-changes-to-protect-your-tax-in-insolvency/introduction-of-changes-to-protect-your-tax-in-insolvency">recently re-added</a> to the list of preferential creditors after an absence of two decades. </p>
<p><strong>The hierarchy of creditors</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/385036/original/file-20210218-20-td0ewv.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/385036/original/file-20210218-20-td0ewv.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/385036/original/file-20210218-20-td0ewv.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=186&fit=crop&dpr=1 600w, https://images.theconversation.com/files/385036/original/file-20210218-20-td0ewv.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=186&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/385036/original/file-20210218-20-td0ewv.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=186&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/385036/original/file-20210218-20-td0ewv.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=233&fit=crop&dpr=1 754w, https://images.theconversation.com/files/385036/original/file-20210218-20-td0ewv.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=233&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/385036/original/file-20210218-20-td0ewv.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=233&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
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<p>After preferential creditors comes another type of bank lending in exchange for collateral, known as floating charges. These loans are secured against things like stock and raw materials, but could include any asset. Last comes “unsecured creditors”, which refers to the likes of customers and suppliers. This could be customers who have ordered a coat that is being tailor made, or suppliers who sell bread to a sandwich shop. </p>
<p>Some unsecured creditors do manage to increase what they can recover in insolvencies. Some suppliers take out credit insurance. Others <a href="https://www.oxfordreference.com/view/10.1093/oi/authority.20110803100416557">cleverly use</a> contractual provisions that mean that they continue to own goods until their customer pays for them. </p>
<p>Some customers who have become creditors of failed companies have been protected by the law of trusts in the past. This means that the money they use to purchase a sofa, or a Christmas hamper, is specially reserved for them in a dedicated bank account. Those funds go straight back to the consumers, bypassing the insolvency process. We have seen this with <a href="https://youtu.be/wCr_HJWBiTA">Christmas savings clubs</a> and some <a href="https://www.kingschambers.com/assets/images/news/meh_article.pdf">home-furnishing companies</a>. </p>
<h2>The crumbs</h2>
<p>Various studies have shown that <a href="https://webarchive.nationalarchives.gov.uk/20140402172033/http://oft.gov.uk/shared_oft/reports/Insolvency/oft1245">unsecured creditors get</a> lamentably little in an insolvency. Forty years ago, the emeritus Oxford law professor Roy Goode <a href="https://www.qmul.ac.uk/ccls/media/ccls/docs/research/TCLR-1-Fundamental-Concepts-of-Commercial-Law-The-Development-of-Transnational-Commercial-Law-Reviews.pdf">questioned</a> whether the law was too favourable to secured creditors. As far back as 1897 Lord Macnaghten, one of the most senior judges of the era, <a href="https://www.nytimes.com/1913/02/18/archives/englands-great-judge-dead-lord-macnaghten-was-the-most-eminent.html">expressed</a> “some sympathy for unsecured creditors”. </p>
<p>That sympathy was well placed, then and now – particularly in view of coronavirus and Brexit. This is despite numerous attempts to improve their lot, such as the <a href="https://uk.practicallaw.thomsonreuters.com/Cosi/SignOn?redirectId=rt_b1a92c71-f889-4767-8756-c2b5043a0f6a">“prescribed part” rules</a>. These entitle unsecured creditors to a small proportion of whatever the floating-charge creditors are able to extract from an insolvency process – though it only applies to floating charges agreed from September 15 2003, which leaves quite a large proportion of them. </p>
<p>Should the system be reformed? This depends on your position in the waterfall. Banks would say their priority ranking is necessary to allow them to provide the lending required for economic growth. Tax authorities and employees would also say they deserve their preferential treatment as they did not become creditors by choice. </p>
<p>Unsecured creditors would probably say we need to do more to help them. The relevant legislation around the “prescribed part” was <a href="https://www.legislation.gov.uk/uksi/2020/211/contents/made">recently amended</a> to increase the portion of value in each insolvency reserved just for these creditors. This was a step in the right direction, and it could be further reformed in certain ways to give these creditors a slightly greater share of the pie, including extending the entitlement to floating charges pre-2003. </p>
<p>To help these creditors more than that, business associations such as the Institute of Directors could take more responsibility for educating smaller businesses about the ways in which some haul themselves up the hierarchy by using contractual provisions over who owns the goods they supply. These businesses might also protect themselves in the same way as Christmas clubs by requiring the customers they supply to ring-fence the money they owe before it is settled. These solutions may not be perfect, but as ways of improving the bargaining position of unsecured creditors, they are worth considering.</p><img src="https://counter.theconversation.com/content/155579/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>John Tribe does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Under insolvency law, there’s an order in which creditors get paid from whatever is left of a company.John Tribe, Senior Lecturer in Law, University of LiverpoolLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1230602019-09-12T13:10:03Z2019-09-12T13:10:03ZHow corporate bankruptcy works<p><a href="https://s3.amazonaws.com/abi-org/Newsroom/Bankruptcy_Statistics/Total-Business-Consumer1980-Present.pdf">More than 20,000 companies</a> file for bankruptcy every year. </p>
<p>Although companies follow many different paths to bankruptcy, each one encounters a process that is carefully designed to balance the rights of debtors and creditors. </p>
<p>As I’ve learned from <a href="http://www.law.uga.edu/profile/lindsey-simon">studying and practicing bankruptcy law</a>, the system is not perfect, and sometimes outcomes seem unfair. But bankruptcy is definitely not a “get out of jail free” card for companies deep in debt. </p>
<h2>Making the best of a grim situation</h2>
<p>To most people, bankruptcy <a href="https://hbswk.hbs.edu/item/how-chapter-11-saved-the-us-economy">has a negative image</a>. And for good reason: A filing almost always means there’s not enough money to go around. </p>
<p>But the system makes the best of a grim situation by imposing an orderly and open process that preserves value and encourages negotiation. Bankruptcy reorganizations by well-known brands such as <a href="https://www.reuters.com/article/us-delta-bankruptcy/delta-exits-bankruptcy-after-19-month-restructuring-idUSWNAS850820070430">Delta</a> and <a href="https://ssrn.com/abstract=3252104">General Motors</a> show that it can bring parties together and resurrect struggling companies. </p>
<p>At the most fundamental level, the Bankruptcy Code creates an estate to collect all assets in one place, identify and categorize claims against the debtor in terms of priority and then distribute the assets accordingly. </p>
<p>Exactly how this plays out depends largely on what type of bankruptcy case the debtor files.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/264725/original/file-20190319-60964-f92spd.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/264725/original/file-20190319-60964-f92spd.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/264725/original/file-20190319-60964-f92spd.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/264725/original/file-20190319-60964-f92spd.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/264725/original/file-20190319-60964-f92spd.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=502&fit=crop&dpr=1 754w, https://images.theconversation.com/files/264725/original/file-20190319-60964-f92spd.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=502&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/264725/original/file-20190319-60964-f92spd.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=502&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Delta went public after emerging from bankruptcy in 2007.</span>
<span class="attribution"><a class="source" href="http://www.apimages.com/metadata/Index/Delta-Stock/18e8c3a4e01748f190d454f514311bf3/8/0">AP Photo/Mark Lennihan</a></span>
</figcaption>
</figure>
<h2>Chapter 7 vs. Chapter 11</h2>
<p>Large business debtors have two bankruptcy options: liquidation or reorganization. </p>
<p><a href="https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/chapter-7-bankruptcy-basics">Chapter 7 cases are designed</a> to liquidate the company, meaning it will no longer exist, and any remaining value is divided up and distributed to creditors. </p>
<p>In contrast, a <a href="https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/chapter-11-bankruptcy-basics">Chapter 11 reorganization</a> allows a debtor to sell some or all of its assets or propose a reorganization plan that aims to resolve and satisfy enough creditors to re-emerge as a going concern. </p>
<p>For example, airlines United, Delta and American <a href="https://www.vox.com/the-goods/2019/3/11/18259894/bankruptcy-business-chapter-11-close-stores">all filed for Chapter 11</a> protection in the mid-2000s and managed to unload enough debt to stay aloft. More recent filings seeking reorganization include those by <a href="https://www.investopedia.com/news/downfall-of-sears/">Sears</a>, <a href="https://www.reuters.com/article/us-pg-e-us-bankruptcy/pge-bondholders-propose-competing-bankruptcy-plan-worth-up-to-30-billion-idUSKCN1TQ21D">Pacific Gas and Electric Company</a> and <a href="https://www.dailyrepublic.com/all-dr-news/wires/business/toys-r-us-is-back-from-the-dead-but-its-new-stores-are-unrecognizable/">Toys R Us</a>. </p>
<p>Once a Chapter 11 plan of reorganization is finalized and approved, a debtor emerges from bankruptcy and continues operating, usually in a stronger position than before. </p>
<h2>Benefits of bankruptcy for debtors</h2>
<p>Bankruptcy provides at least two valuable benefits to all debtors: time and space. </p>
<p>The moment a debtor files its petition, an automatic stay is imposed on creditors, which operates like a pause button on any collection efforts, litigation or similar actions. Creditors can ask the court to lift the stay under certain circumstances, but the standard for doing so is often difficult to meet.</p>
<p>The bankruptcy court has broad authority to control all matters involving the debtor’s estate, including claims that are distantly related to the main bankruptcy case. The debtor may ask the court to pause other lawsuits outside of the bankruptcy case if they affect the estate. By bringing together all those with a stake in the company’s assets in one place, a debtor can more efficiently deal with all claims against it.</p>
<p>Debtors then evaluate their problems and make the necessary changes to succeed after reorganizing. This includes deciding which contracts they want to carry forward and which to abandon. </p>
<p>To avoid a contested process, savvy debtors seek a global settlement with as many stakeholders as possible and offer “sweeteners” to sway undecided creditors to support their plan.</p>
<h2>Benefits for creditors</h2>
<p>Clearly, bankruptcy provides debtors with significant power to rearrange their business affairs.</p>
<p>What many people misunderstand, however, is that this power is balanced by <a href="https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/chapter-11-bankruptcy-basics">strong creditor protections</a> For example, the Bankruptcy Code requires a debtor to publicly file information about all of its assets and liabilities, sit for a bankruptcy deposition with creditors and seek the court’s permission before taking many actions outside of the ordinary course of business. </p>
<p>The code provides for additional checks on the debtor, including the unsecured creditors’ committee and the <a href="https://www.justice.gov/ust">U.S. Trustee</a>. Creditors that are concerned about the debtor’s ability to preserve the estate’s value may ask the court to appoint an examiner or trustee to take possession of the estate, and creditors may even move to dismiss the case if they believe the debtor is abusing the bankruptcy process. </p>
<p>These and other features add a degree of fairness to an inherently unjust situation. The debtor may be sitting in the driver’s seat, but numerous other stakeholders have the power to make sure that the company follows the rules of the road. </p>
<p><em>This is a shortened version of an <a href="https://theconversation.com/why-companies-file-for-bankruptcy-and-how-it-protects-both-debtors-and-creditors-113101">article originally published</a> on Aug. 29, 2019.</em></p>
<p>[ <em>Deep knowledge, daily.</em> <a href="https://theconversation.com/us/newsletters?utm_source=TCUS&utm_medium=inline-link&utm_campaign=newsletter-text&utm_content=deepknowledge">Sign up for The Conversation’s newsletter</a>. ]</p><img src="https://counter.theconversation.com/content/123060/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Lindsey Simon does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>A bankruptcy filing always means there’s not enough money to go around, but the process ensures both debtors and creditors are protected.Lindsey Simon, Assistant Professor of Law, University of GeorgiaLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1131012019-08-29T12:20:40Z2019-08-29T12:20:40ZWhy companies file for bankruptcy – and how it protects both debtors and creditors<figure><img src="https://images.theconversation.com/files/289919/original/file-20190828-184217-85d8hm.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Critics have worried Purdue might use bankruptcy to avoid accountability. </span> <span class="attribution"><a class="source" href="http://www.apimages.com/metadata/Index/Opioid-Crisis-Purdue-Bankruptcy/59244806d067425bba37138857b93bc9/62/0">AP Photo/Jessica Hill</a></span></figcaption></figure><p><a href="https://www.nytimes.com/2019/08/27/health/sacklers-purdue-pharma-opioid-settlement.html?action=click&module=Top%20Stories&pgtype=Homepage">Reports have emerged</a> that Purdue Pharma is in settlement talks to resolve thousands of federal and state lawsuits over its role in fueling the <a href="https://theconversation.com/us/topics/opioid-epidemic-26182">opioid epidemic</a>. As part of the reported settlement, the company would file for bankruptcy. </p>
<p>Earlier this year, Insys Therapeutics <a href="https://www.npr.org/2019/06/10/731363225/insys-files-for-chapter-11-days-after-landmark-opioid-settlement-of-225-million">became the first opioid drugmaker</a> to enter bankruptcy following its US$225 million settlement with the Department of Justice. In recent months, <a href="https://www.commondreams.org/news/2019/03/04/when-we-say-pharma-greed-kills-what-we-mean-critics-respond-possible-purdue">there’s been speculation</a> that drugmakers might use bankruptcy as a way to escape accountability and avoid billions of dollars in litigation costs. </p>
<p>Fortunately, that’s not how bankruptcy works. Rather, as <a href="http://www.law.uga.edu/profile/lindsey-simon">I’ve learned in my experience</a> studying and practicing bankruptcy law, the process is designed to not only protect debtors like Insys or Purdue but also creditors such as states and other opioid litigants. </p>
<p>Bankruptcy is not perfect, and sometimes outcomes seem unfair. But it’s definitely not the “get out of jail free” card that many fear. </p>
<h2>Making the best of a grim situation</h2>
<p>To most people, bankruptcy <a href="https://hbswk.hbs.edu/item/how-chapter-11-saved-the-us-economy">has a negative image</a>. And for good reason: A filing almost always means there’s not enough money to go around. </p>
<p>But the system makes the best of a grim situation by imposing an orderly and open process that preserves value and encourages negotiation. Bankruptcy reorganizations by well-known brands such as <a href="https://www.reuters.com/article/us-delta-bankruptcy/delta-exits-bankruptcy-after-19-month-restructuring-idUSWNAS850820070430">Delta</a> and <a href="https://ssrn.com/abstract=3252104">General Motors</a> show that it can bring parties together and resurrect struggling companies. </p>
<p>At the most fundamental level, the Bankruptcy Code creates an estate to collect all of the debtor’s assets into one place, identify and categorize claims against the debtor in terms of priority and then distribute the assets accordingly. </p>
<p>Exactly how those three core tasks play out in a given case will vary depending on what type of bankruptcy case the debtor files and specific facts about the debtor.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/264725/original/file-20190319-60964-f92spd.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/264725/original/file-20190319-60964-f92spd.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/264725/original/file-20190319-60964-f92spd.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/264725/original/file-20190319-60964-f92spd.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/264725/original/file-20190319-60964-f92spd.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=502&fit=crop&dpr=1 754w, https://images.theconversation.com/files/264725/original/file-20190319-60964-f92spd.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=502&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/264725/original/file-20190319-60964-f92spd.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=502&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Delta went public after emerging from bankruptcy in 2007.</span>
<span class="attribution"><a class="source" href="http://www.apimages.com/metadata/Index/Delta-Stock/18e8c3a4e01748f190d454f514311bf3/8/0">AP Photo/Mark Lennihan</a></span>
</figcaption>
</figure>
<h2>Chapter 7 vs. Chapter 11</h2>
<p>Large business debtors have two bankruptcy options: liquidation or reorganization. </p>
<p><a href="https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/chapter-7-bankruptcy-basics">Chapter 7 cases are designed</a> to liquidate the company, meaning it will no longer exist, and any remaining value will be divided up and distributed to creditors. </p>
<p>In contrast, a <a href="https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/chapter-11-bankruptcy-basics">Chapter 11 reorganization</a> allows a debtor to sell some or all of its assets or propose a reorganization plan that aims to resolve and satisfy enough creditors to re-emerge as a going concern. </p>
<p>For example, airlines United, Delta and American <a href="https://www.vox.com/the-goods/2019/3/11/18259894/bankruptcy-business-chapter-11-close-stores">all filed for Chapter 11</a> protection in the mid-2000s and managed to unload enough debt to stay aloft. More recent filings seeking reorganization include those by <a href="https://www.investopedia.com/news/downfall-of-sears/">Sears</a>, <a href="https://www.reuters.com/article/us-pg-e-us-bankruptcy/pge-bondholders-propose-competing-bankruptcy-plan-worth-up-to-30-billion-idUSKCN1TQ21D">Pacific Gas and Electric Company</a> and <a href="https://www.dailyrepublic.com/all-dr-news/wires/business/toys-r-us-is-back-from-the-dead-but-its-new-stores-are-unrecognizable/">Toys R Us</a>. </p>
<p>Companies sometimes initially file under Chapter 11 to reorganize but later decide to shut down after they fail to confirm a plan or find a suitor. Recent examples of this include <a href="https://money.cnn.com/2018/04/19/news/companies/bon-ton-liquidation/index.html">Bon-Ton Stores</a>, <a href="http://www.nbcnews.com/id/28691963/ns/business-us_business/t/circuit-city-liquidate-remaining-us-stores/#.XPWBgS2ZNTY">Circuit City</a> and <a href="https://dealbook.nytimes.com/2011/02/16/borders-files-for-bankruptcy/">Borders</a>.</p>
<p>For companies looking to survive, the <a href="https://uscode.house.gov/view.xhtml?path=/prelim@title11&edition=prelim">Bankruptcy Code</a> requires either creditor support or payment in full. If even one class of impaired creditors votes against a plan, the company must go through a demanding “cramdown” process for court approval to proceed.</p>
<p>Once a Chapter 11 plan of reorganization is finalized and approved, a debtor emerges from bankruptcy and continues operating, usually in a stronger position than before. </p>
<h2>Benefits of bankruptcy for debtors</h2>
<p>Bankruptcy provides at least two valuable benefits to all debtors: time and space. </p>
<p>The moment a debtor files its petition, an automatic stay is imposed on creditors, which operates like a pause button on any collection efforts, litigation or similar actions. Creditors can ask the court to lift the stay under certain circumstances, but the standard for doing so is often difficult to meet.</p>
<p>The bankruptcy court has broad authority to control all matters involving the debtor’s estate, including claims that are distantly related to the main bankruptcy case. The debtor may ask the court to pause other lawsuits outside of the bankruptcy case if they affect the estate. By bringing together all those with a stake in the company’s assets in one place, a debtor can more efficiently deal with all claims against it.</p>
<p>While the stay is in place, debtors use the bankruptcy process to evaluate their problems and make the necessary changes to succeed after reorganizing. This includes deciding which contracts they want to carry forward and which to abandon. </p>
<p>To avoid a contested process, savvy debtors seek a global settlement with as many stakeholders as possible – which is what <a href="https://www.cnbc.com/2019/08/27/purdue-pharma-offers-10-12-billion-to-settle-opioid-claims.html">Purdue is likely trying to do</a> – and include “sweeteners” to sway undecided creditors in favor of the plan.</p>
<h2>Benefits for creditors</h2>
<p>Clearly, bankruptcy provides debtors with significant power to rearrange their business affairs.</p>
<p>What many people misunderstand, however, is that this power is balanced by <a href="https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/chapter-11-bankruptcy-basics">strong creditor protections</a>. The Bankruptcy Code requires debtors to disclose significant information about their operations and imposes strict checks on debtor actions. </p>
<p>For example, the debtor must publicly file information about all of its assets and liabilities, sit for a bankruptcy deposition with creditors and seek the court’s permission before taking many actions outside of the ordinary course of business. </p>
<p>Under Chapter 11, the debtor is allowed to remain in possession of its estate and continue operating. Creditors that are concerned about the debtor’s ability to preserve the estate’s value may ask the court to appoint an examiner or <a href="https://www.justice.gov/ust">trustee</a> to take control. Creditors may even move to dismiss the case if they believe the debtor is abusing the bankruptcy process. </p>
<p>The Bankruptcy Code creates a committee of unsecured creditors – those without assets backing their claims – to advocate on behalf of claimants who are likely not involved in the case. The court may also form a special committee representing tort claimants in cases where debtors face litigation or future claimants whose injuries are not yet known. The court overseeing the bankruptcy of Imerys, for example, <a href="https://www.law.com/delbizcourt/2019/03/07/11-lawyers-named-to-tort-claims-committee-in-talc-suppliers-bankruptcy/">appointed plaintiffs</a> to represent cancer victims with <a href="https://www.bloomberg.com/news/articles/2019-02-13/imerys-sa-unit-seeks-bankruptcy-protection-over-talc-lawsuits">claims against the talc supplier</a>. </p>
<p>These and other features add a degree of fairness to an inherently unjust situation. The debtor may be sitting in the driver’s seat, but numerous other stakeholders have the power to make sure that the company follows the rules of the road.</p>
<p>With such protections in place, creditors and the general public need not fear the worst if bankruptcy plays a bigger role in the unfolding opioid saga.</p><img src="https://counter.theconversation.com/content/113101/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Lindsey Simon does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>While critics accuse companies facing lots of lawsuits of using bankruptcy as a sort of ‘get of jail free card,’ the reality of the legal procedure is more complicated.Lindsey Simon, Assistant Professor of Law, University of GeorgiaLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/528212016-01-12T19:34:19Z2016-01-12T19:34:19ZReforming bankruptcy laws is the first step - next, remove the stigma<figure><img src="https://images.theconversation.com/files/107876/original/image-20160112-6996-1nvtvhv.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Changes to Australian bankruptcy laws have led to fear that people will be let off easily - but is that warranted?</span> <span class="attribution"><span class="source">Image sourced from www.shutterstock.com</span></span></figcaption></figure><p>In Australia, there is a lingering belief that bankruptcy should not be “too easy”.</p>
<p>The federal government’s plan to reduce the period of bankruptcy from a minimum of three years to one year, announced in December’s <a href="https://theconversation.com/innovation-statements-significant-insolvency-changes-are-well-overdue-51908">Innovation Statement</a>, has been criticised for allowing debtors to avoid the consequences of their misconduct.</p>
<p>But this view misunderstands the role of bankruptcy law in a modern economy and arguably conflates the role of bankruptcy and criminal law. In fact, what is needed in addition to legal changes is a shift in the way Australians think about bankruptcy.</p>
<p>Modern personal bankruptcy law attempts to balance competing public interests of rehabilitating debtors and allowing them a fresh start, with the need to discourage reckless borrowing and spending and abuse of the credit and insolvency system.</p>
<p>But bankruptcy as a crime has had a long history, arising out of an early need to allay the violence and mayhem occurring through Roman debtors not paying their creditors, by imposing some order and authority on the warring parties. </p>
<p>This authority sought to divide up the debtor’s assets among the creditors; but the idea of protection of the unfortunate debtor did not arise until later. The first modern bankruptcy laws developed in the 16th century in England and sought to provide administrative order to commercial debt recovery. </p>
<p>Non-business bankruptcy was treated as a crime, with debtor’s prisons existing until the late 19th century. The growth of middle classes after the industrial revolution and the drive to encourage and broaden entrepreneurial risk taking helped change society’s treatment of all bankrupts (both business and non-business) and the goal of protection and rehabilitation became more important. </p>
<p>At the same time, bankruptcy continues to involve the bankrupt losing most of their property, including the family home, and any cash, shares or other property, including their passport, and anything other than household furniture and a cheap car. </p>
<p>There are requirements to repay creditors through contributions from income, above a certain level; restrictions imposed on obtaining credit and with credit agencies reporting the bankruptcy; and restrictions on being a company director and on retaining licenses to work in certain trades and professions. </p>
<p>A failure of a bankrupt to comply with their obligations can result in the extension of their bankruptcy to five or even eight years. Failure to file a list of their assets and liabilities can result in the bankruptcy continuing indefinitely, at least until the bankrupt complies.</p>
<p>Most of these impacts are expected to remain whether bankruptcy is one year or longer. </p>
<p>Our 21st century laws even connect bankruptcy with serious crime, and treason, and impose criminal sanctions, including imprisonment, for breaches by bankrupts of many of these obligations. And there is still the stigma of bankruptcy, of being labelled as someone who could not manage their finances and left their creditors unpaid, and who otherwise might be seen as morally suspect. </p>
<p>The government doesn’t propose to lessen these rules. Those who suggest that bankruptcy is an easy option are ignoring the range of penalties and limitations that apply to bankrupts. Given the fact that bankruptcy can release a debtor from debts of $20,000, or $20 million, the law - and society - acknowledges that some accountability and consequence be imposed. It is a matter of degree and of balance.</p>
<p>But the government has opted for a fresh approach to unpaid debt in personal insolvency, given it is a more emotive area than the relative anonymity of corporate losses.</p>
<p>Australia is seen internationally as having a rather harsh view of unpaid debt. But punishment and deterrence can only achieve so much when it comes to discouraging reckless borrowing or profligate spending. </p>
<p>A person might well not pursue their innovative business idea if the consequence of it not working were jail, or at a less extreme outcome, a long period of bankruptcy and the loss of most if not all of their property. Creditors also need a predictable, transparent and fair system for collecting their debts. </p>
<p>For that reason, many other countries are refocusing their insolvency laws more on rehabilitation and a constructive approach to business rescue. </p>
<p>The government is trying to shift the balance in favour of risk and innovation, with its potential for promoting economic growth, and to move the language away from retribution and failure, an important aspect of cultural change. But merely reducing the period of bankruptcy won’t be enough. </p>
<p>The public narrative and perception around financial failure and insolvency, both personal and corporate, need to change if we are to embrace an entrepreneurial and innovative business culture. </p>
<p>Changing the law is perhaps the easier part, with initial public support needed, followed by a shift in public perception in order to allow the law to be fully effective.</p><img src="https://counter.theconversation.com/content/52821/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Australians still have lingering beliefs about bankruptcy as a crime. This has to change if we want to foster business innovation.Jason Harris, Associate Professor in corporate, commercial and insolvency law, University of Technology SydneyMichael Murray, Visiting Fellow, QUT, Queensland University of TechnologyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/501622015-11-05T03:55:45Z2015-11-05T03:55:45ZObligations, repayments and regulations: the debt conundrum in the global South<figure><img src="https://images.theconversation.com/files/100733/original/image-20151104-21232-11t9z4c.JPG?ixlib=rb-1.1.0&rect=0%2C305%2C4000%2C2329&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Retailers offer 'rewards' programs and loyalty cards that can trap customers into a debt cycle.</span> <span class="attribution"><span class="source">Deborah James</span></span></figcaption></figure><p><em>This is part of <a href="https://theconversation.com/africa/topics/financial-inclusion">a series</a> of articles The Conversation Africa is running on financial inclusion and micro credit and their role in economic development.</em></p>
<p>Why should we repay our debts? Why do we borrow in the first place? And why do some people, despite intense feelings of obligation and shame, default?</p>
<p>Worldwide, and especially in the global South where, as researchers Mosa Phadi and Claire Ceruti <a href="https://www.academia.edu/3206445/Multiple_meanings_of_the_middle_class_in_Soweto_South_Africa_Mosa_Phadi_and_Claire_Ceruti_">have said</a>, “everyone is now middle class”, and people are not willing – as they once might have been – to think of themselves as belonging in a low and stigmatised social bracket, these questions have taken on particular relevance. </p>
<p>Although there are commonalities across different settings – people in India, Mongolia, and Guatemala have all experienced a sudden rise in indebtedness – the answers also vary depending on context.</p>
<p>In South Africa, a concerted attempt to abolish all apartheid’s facets coincided with a massive rise in expectations. This demand was met with a burgeoning supply. As members of a rising black middle class replaced the mostly white incumbents of the previous civil service, these newly redundant public servants started lending money to those replacing them – and others – at high rates of interest. They did so without incurring risk: they were using their borrowers’ salaries as a form of collateral.</p>
<p>Other micro-lenders soon joined them. Salaries deposited in people’s bank accounts thus started circulating around the system, with a considerable proportion – plus interest – ending up in the pockets of lenders. Is it any wonder that debtors began to despise and mistrust these <a href="http://wiredspace.wits.ac.za/handle/10539/10143">mashonishas</a> (loan sharks), and seek ways to avoid payment?</p>
<h2>Why get into debt in the first place?</h2>
<p>The answers are complex. The expectations of the newly upwardly mobile took the form not only of a desire for an increase in material wealth, but for investment in education.</p>
<p>Householders borrow from the future in order to secure the present – but they often do so, in turn, with a view to investing in that future. Many black South African parents, their own education options having been severely restricted under apartheid, are now expected to send four or five children to university. </p>
<p>Often the only way to do so is by borrowing against future earnings, even for those who abhor doing so. The Kekanas, a Sowetan family, have two parents working for a parastatal company. The mother, a frugal person, dislikes all forms of credit.</p>
<p>But the spouses disagree about their priorities. Should their daughter go out to work after finishing high school, or attend university? She does the latter, but extra financial pressures plus the parents’ arguments over budget priorities mean that the university is obliged to wait until the mother gets an annual bonus before the fees are paid. </p>
<p>Here, as is often the case, present day debt repayments need to be weighed up against other obligations. Luckily, the Kekanas’ daughter ends up getting a good job. </p>
<p>But recent student protests in South Africa show that, while such aspirations for higher education are ubiquitous, many parents – unlike the Kekanas – lack a regular income. Debts to banks and short-term/high-interest microlenders are incurred, and non-repayment can result. </p>
<h2>Credit apartheid</h2>
<p>For decades before this, however, borrowers mostly did keep up their repayments on the small loans they were able to incur for less substantial things. This was the only way that credit apartheid – a highly exclusionary system which had lent money to those in disadvantaged groups, but only in unequal ways – was able to maintain its business model and develop its characteristic features.</p>
<p>People disallowed from land or house ownership, and with few credit options, bought furniture or appliances on instalments, usually at more than twice the cash price, and paid them off item by item. Although most responded assiduously to the invoices that arrived monthly in brown envelopes, a complex system of procedures evolved to “catch” the defaulters.</p>
<p>Retailers, granted permission by clerks of the court, took what was owed to them directly out of debtors’ bank accounts, via the <a href="http://www.fin24.com/Money/Debt/State-tackles-the-civil-servant-debt-trap-20150222">now-infamous</a> ‘garnishee order’ system.</p>
<p>In recent times, given the steep rise in aspirations and expenditure, many employees – especially civil servants, but also train drivers, factory workers and supermarket employees – were having substantial parts of their salaries reclaimed by creditors before they were able even to see the money. This was, in effect, a system of legal regulation skewed to the advantage of lenders and lamentable in its lack of protection to borrowers.</p>
<p>Creditors rarely lost out or received a sanction for failing to check if clients were able to repay, and they had ways of getting their money back against all the odds. The negative consequences of debt, from people resigning from their jobs to escape creditors through cashing in their pensions, were here being intensified by illegal and unregulated collection practices.</p>
<p>This “advantage to creditor” culture has not gone unchallenged. A class action court case eventually <a href="http://www.bdlive.co.za/business/financial/2015/07/09/court-ruling-reins-in-attachment-orders">ruled against</a> some of these practices in 2015.</p>
<h2>Escape routes</h2>
<p>Besides this legal challenge, people were finding other means to escape from creditors. Some employees were regularly changing their bank accounts. Some employers were resorting to paying wages directly in cash to avoid creditors’ getting their hands on their employees’ money.</p>
<p>But truly effective regulation has been difficult to put in place, not least because borrowers are reluctant to stop accessing credit, or accept the strictures that bankruptcy would impose.</p>
<p>Anthropologist Parker Shipton is <a href="https://books.google.co.za/books/about/Credit_Between_Cultures.html?id=cMsjk2DV_0EC&redir_esc=y">critical</a> of the “self-evident truth” that</p>
<blockquote>
<p>… all loans and repayments should cancel each other out.</p>
</blockquote>
<p>Local ideas and values that underpin relations of debt, he says, are usually irreconcilable with financiers’ and bankers’ priorities.</p>
<p>David Graeber <a href="https://libcom.org/files/__Debt__The_First_5_000_Years.pdf">criticises</a> similar assumptions that lie at the heart of the global capitalist order. Something originally thought of as “reciprocity”, in which gifts are returned only after long delays or are transferred onwards over the generations, has been transformed by the modern financial system into a relationship of unequal power and of enduring hierarchy – between creditor and debtor, first world and third world nations, rich and poor.</p>
<p>To reject the power of that system is also, implicitly, to question the obligations that require borrowers to repay their loans.</p>
<hr>
<p><em>Deborah James is <a href="http://www.sup.org/books/title/?id=21858">the author</a> of <a href="https://www.facebook.com/MoneyFromNothingSUP?ref=hl">Money from Nothing: Indebtedness and Aspiration in South Africa</a>.</em></p><img src="https://counter.theconversation.com/content/50162/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Professor Deborah James has received funding from the ESRC (Economic and Social Science Research Council).. </span></em></p>In the global South, where some argue that “everyone is now middle class”, people are reluctant to acknowledge that they need to borrow money – and the stigma drives them to dodge their debts.Deborah James, Professor of Anthropology, London School of Economics and Political ScienceLicensed as Creative Commons – attribution, no derivatives.