BizCLIR

Bankruptcy law and practice are at a curious crossroads in Serbia, with one system ending, and the other not quite underway. The collapse of the former centrally-planned economic system has left numerous companies insolvent or failing, from systemic problems leading to commercial failure. On the other hand, new investment based on commercial lending and free-market practices has not fully begun in earnest, so that there are not yet any “normal” bankruptcies taking place. The bankruptcy law, fashioned in part on capitalist principles, is expected to handle both systems.

Bankruptcy, fundamentally, is a system for dealing with commercial debt, and especially with competing commercial claims to encumbered property of the debtor. Historically, little lending in the former Yugoslavia was been based on normal commercial practices and safeguards. Moreover, the last ten years have seen increased misuse of the banking and finance sector to provide loans based on influence, political patronage, ideology, and other non-commercial bases. In addition, existing law has not permitted priority claims on movable property within the debtor’s possession, so that priority disputes relate to the overall bankrupt estate on a cash value basis (that is, only claims to money).

Much of the debt now owed by insolvent companies was extended based on such non-commercial practices. As a consequence, there is something of a mismatch in using the commercial mechanism of bankruptcy to clean up a political mess. Courts are very reluctant to assist with this process, fearing the socio-economic and even personal impact of shutting down companies and eliminating laws. Many feel that the situation needs political solutions as much as legal ones.

One solution moving forward under the privatization program is to place bankruptcy claims related to privatized companies within a different system. Some legal professionals have expressed concerns about the existence of parallel systems with potentially different rules operating simultaneously. We believe that the concerns are overstated. First, privatized companies form a special breed. They were created by the state, financed under non-commercial practices, and are now being sold to private investors. The “baggage” they carry is substantially different than the circumstances in new and recent investments in private-sector enterprises. Second, this type of company will disappear. If the privatization plan works according to schedule, they will all be sold or liquidated within three years. In other words, the old game is ending and a new one is starting – although there are similarities, there are new rules, new players and new expectations. Third, any new bankruptcies of companies under the new legal regime are likely to be several years off because it usually takes a new or newly capitalized business two or three years to fail. Finally, a separate system for privatized companies might be more effective at addressing the political and social concerns that bankruptcy court judges do not feel qualified to confront.

Clearly, a modern bankruptcy law is needed as the country moves into a new era of commercial lending. For the short-term, the law is needed to define the rules of priorities among creditors as a basis for commercial lending practices for future bankruptcies that are likely to begin in a few years, especially as regards security interests in movable property. It is therefore essential that the two laws be considered together to ensure compatibility. With plans to have a new draft Bankruptcy Law ready by mid-September, it is possible that the new law will need to be amended thereafter to be consistent with the eventual collateral law. It might be prudent to take a less expedited approach to the bankruptcy law to avoid such conflicts, and to obtain sufficient feedback from the financial and lending community to ensure local ownership by those most affected.