Responding to the Needs of Micro and Small Entities (MSE) in Financial Distress: Time for New International Recommendations
Professor Irit Mevorach*
The United Nations Commission on International Trade Law (UNCITRAL) has recently adopted a text of Legislative Recommendations on Insolvency of Micro-and Small Enterprises. Deliberations by Working Group V - Insolvency Law on an instrument concerning MSE insolvency commenced in 2018 and proceeded primarily through the Working Group’s bi-annual meetings in New York and Vienna (the 53rd to 58th sessions) and in a hybrid format during the pandemic (in 2020-21). Indeed, although the work on an instrument for MSE insolvency, in recognition of the importance of addressing the unique circumstances of small entities in distress began prior to the Coronavirus outbreak, the pandemic and its effect on business gave this initiative greater prominence.
The importance of a special regime for MSE insolvency
Small businesses are the backbone of the economy, and they are the most vulnerable and the least resilient, especially in times of economic crisis. In many jurisdictions, small businesses have a higher failure rate than larger businesses, but often insolvency regimes focus more on the larger enterprises. In Micro, Small, And Medium Enterprise Insolvency A Modular Approach (OUP 2018) I have argued with co-authors** that policy makers and legislators should make a concerted effort to design laws that are tailored for the smaller entities. Small businesses are not only abundant, thus deserving most of insolvency policy attention, they also demand a specific approach. Whether they operate as sole traders or companies, they tend to lack the types of physical assets that are acceptable to financial lenders as collateral; they tend to be relatively undiversified; and most of their creditors are disinterested in the insolvency process as there is little or no value available for distribution. We proposed a ‘modular approach’ that is premised on these assumptions and that is aimed to preserve and maximize value, to distribute that value fairly, to ensure accountability for wrongdoing, and to enable discharge of over-indebted natural persons. The modularity of the approach provided default solutions and additional modules (tools) for the parties to choose from, so that the process can best fit the circumstances and interests of the key stakeholders. It also provided existing legal systems with certain options especially in terms of the level of supervisory intervention and court involvement in the different processes.
Key features of the UNCITRAL Legislative Recommendations
The UNCITRAL Legislative Recommendations on MSEs Insolvency draws on such assumptions as well and provide simplified procedures for MSEs, considering the special circumstances and specific issues that small entities face when they are in financial distress. The Recommendations address a broad range of aspects related to the design of an MSE insolvency regime and will be accompanied by explanatory commentary. I highlight six key aspects below.
- Inclusivity – it is recommended in the UNCITRAL instrument that the insolvency law for MSEs should apply to all MSEs no matter what business structure they utilise. It should thus cover both individual entrepreneurs (operating as sole traders, or in partnerships) and legal entities (small companies).
- Comprehensive set of procedures – there is currently much focus in insolvency law reform on reorganisation and on preventive measures, namely on avoiding insolvency. Reorganisation of MSEs is undoubtedly important and should be facilitated, but many struggling MSEs will not be viable. The Recommendations propose that the insolvency regime should provide streamlined, simplified, and expedited reorganisation as well as liquidation procedures with reduced formalities, to minimize their complexity, length, and associated costs. The aim is to expeditiously liquidate and discharge non-viable MSEs from debts, while assisting viable MSEs to reach a workable solution with their creditors.
- Easy access –both debtors and creditors should be able to access and commence the simplified proceedings. Importantly, debtors should easily initiate simplified proceedings at an early stage. It is therefore recommended that MSE debtors may start the simplified insolvency procedures without the need to be in actual insolvency or to prove that they are insolvent. This easiness of access is balanced and complemented by measures to prevent improper use of the simplified procedures, by debtors or by creditors.
- Debtor in control – the Recommendations suggest that the default rule in the MSE insolvency regime should be that the debtor remain in control in a simplified reorganisation proceeding. But the debtor should also be required to cooperate with the authority and provide accurate information about their financial position, among other rights and obligations.
- Mechanisms to address creditor passivity – the Recommendations propose to consider mechanisms to facilitate approvals of solutions and matters which require creditors’ approval in the context of the simplified proceedings, including based on ‘deemed approval’ whereby creditors may not need to actively vote on a proposed matter but rather in the absence of objection or sufficient opposition and subject to proper notification, approval is deemed to be obtained.
- Institutions – it is recommended that the insolvency regime designate a competent authority to oversee the simplified procedures. It may not necessarily be a court as it could be that an administrative authority may oversee the process more cost effectively while ensuring that due process is observed. That authority, including through delegation of certain functions to an independent professional, may also assist MSEs to prepare reorganisation plans or a liquidation solution.
Guidance for domestic reform
The UNCITRAL Legislative Recommendations on MSEs Insolvency is a ‘soft’ instrument – it is not binding, and it is not designed as a ‘model law’ for uniform adoption. It supplements the UNCITRAL Legislative Guide on Insolvency Law (the Recommendations together with the accompanying commentary are published as part five of the Legislative Guide, and as part of the UNCITRAL texts series on micro, small and medium-sized enterprises (MSMEs)). The Insolvency Guide including the part, which focuses on MSEs, is aimed at assisting countries when they consider reforming or modernising their laws. As countries are determined to improve their insolvency regimes with a specific focus on issues faced by MSEs in the aftermath of the pandemic, the Legislative Recommendations on MSEs Insolvency will offer valuable guidance.
March 2022
* Professor Mevorach participated in the deliberations on the UNCITRAL Recommendations discussed in this post as a UK delegate but the comments here are provided in her independent academic capacity. The post also draws on Professor Mevorach’s talk at the UNCITRAL and St. Petersburg International and Comparative Law Research Centre discussion session on ‘MSE Debtors and Creditors in Trouble: is a Simplified Insolvency Regime the Solution?’ 19 May 2021.
** Ronald Davis, Stephan Madaus, Alberto Mazzoni, Riz Mokal, Barbara Romaine, Janis Sarra, Ignacio Tirado.