EU must relax rigid bankruptcy laws to encourage entrepreneurs

By Peter Chapman

Date: 13/11/03

CHARLES Dickens - who as a child saw his father languish in a debtors' jail, providing inspiration for the character of Mr Micawber in David Copperfield - proved that bankruptcy can be a stimulus for great literature.

But rigid legal systems, some little changed since the 19th century, combined with distinctly Victorian social attitudes, are not so great for the EU's much-vaunted attempt to become the world's leading economy.

Enterprise Commissioner Erkki Liikanen says the contrast with the entrepreneur-friendly United States is compelling. In the US, one or two business failures at the "University of Life" are as important as an MBA. In Europe, they mean you are likely to be shunned by society.

EU citizens, says Liikanen, are "on average less inclined to become entrepreneurs and are more risk-averse than their US counterparts. The fear of going bankrupt is a key obstacle to entrepreneurship and business creation in the EU", he laments.

Unfortunately for the EU, most of the responsibility for change rests with member states. That means the scope for action in Brussels is limited.

The Finnish commissioner, however, says member states are able to learn from what others are doing to change the "one chance last chance" mentality. "If the legal consequences of bankruptcy are too severe, they can deter entrepreneurs from starting afresh. Best practice examples have a vital role to play in inspiring legal reform."

He asked a panel of legal experts from across Europe to identify the key problems and to suggest solutions. Their report, unveiled last week, is a simple blueprint for change. It examined a range of issues, such as the need for an early warning system to sound the alert that firms are in difficulty before it is too late. The need to set up cheap, easy and quick systems to allow smaller companies in trouble to restructure rather than go into liquidation was also given priority.

But most striking was the urgent need to unlock the legal shackles on bankrupt entrepreneurs - often saddled with personal loans to get their businesses off the ground - so that they can make a fresh start.

Most of the member states - Greece is considered to be the worst example - often make it well-nigh impossible for bankrupts, in the short term at least, to set up a new business, act as a director, or carry out a profession.

Such restrictions, frequently in place for years and often only removable by courts, "create an environment that deters entrepreneurs from making a fresh start". Moreover, they are patently unfair against the "honest but unlucky" bankrupts - perhaps the victim of late paying creditors, illness or an unpredicted downturn in the economy.

One answer, the experts say, is to also ensure courts make a legal distinction between those bankruptcies and fraudulent ones - making it less difficult for the merely unlucky to bounce back.

At the same time, courts or other bodies who declare that a bankruptcy is "excusable" should make strenuous efforts to publicize the fact to the sceptical European public. Unless this is done, "honest bankrupts will be stigmatized through association with the dishonest", the experts say. Then, there is the question of what to do with bankrupt entrepreneurs' remaining debts once the bailiffs have done their work.

The US Bankruptcy Code provides for a complete discharge of the entrepreneurs' debt, which allows them to enter freely into other business ventures thereafter - provided they were not convicted of fraud or any other serious offence.

In stark contrast, most EU countries have long discharge periods - such as the six or seven years respectively that German or Austrian entrepreneurs must wait, linked with special administrative procedures. "Early discharge from remaining debts is crucial to promote fresh starts and entrepreneurial activity," the experts conclude.

But the report is not all doom and gloom. The UK, Spain and Finland have pushed for reform on bankruptcy, and insolvency rules are being modernized in Italy and Portugal.

Most countries have put in place some reforms. But a legal patchwork remains. If the new 25-state EU hopes to overtake the US, it needs to sort it out. Perhaps Europe needs less Dickens and more Adam Smith.

Erkki Liikanen, European Commissioner for Enterprise, believes the fear of going bankrupt is a key obstacle to entrepreneurship and business creation in the European Union. The legal ramifications of bankruptcy can deter entrepreneurs from starting again.