Hungary's bankruptcy experience, 1992-93

Hungary adopted a tough new bankruptcy law in late 1991 that took effect on January 1, 1992. It required managers of firms with arrears over 90 days to any creditor to file for either reorganization or liquidation within eight days (the so-called"automatic trigger") and provided a rather sympathetic framework in which to do so. The result: since January 1992, more than 25,000 cases have been filed - far beyond lawmakers'expectations. Both positive and negative views about the law have been expressed, but details about how the process has actually worked have been scarce. The authors help fill this information gap by providing detailed data on a randomly selected stratified sample of actual cases filed in 1992-93, supplemented by information gained through interviews with judges, liquidations, and firms involved in bankruptcy. Their conclusions are as follows. First, the bankruptcy process appears to have had some degree of economic logic in 1992 and 1993. Better firms were more likely to enter and emerge"successfully"from reorganization, while worse firms were more likely either to fail in reorganization or to file directly for liquidation. Second, judicial reorganization need not be slow and costly. The first wave of reorganizations was handled surprisingly quickly, especially considering the sheer number of cases, the novelty of the process, and the shortage of trained judges. This quickness was possible largely because of the decentralized design of the process. Once the court approved a case, the court had little role. (Amendments added in 1993 may have made the process more bureaucratic and expensive). Third, in this sample, major delays occurred not in reorganization but in liquidation. Creditors will do almost anything to avoid filing for liquidation, and once firms enter liquidation they are still likely to be kept alive indefinitely. In the end, this lack of a viable creditor-led"exit"and debt collection mechanism harms firms by increasing the cost and reducing the flow of credit. Fourth, although the bankruptcy process displays some degree of economic logic, one should not assume that it operates as a similar law would in a market economy. In particular, a likely source of private gain in Hungary appears to be asset or other value diversion (or"value-stripping) before bankruptcy. Fifth, the main need is to strengthen the incentives of creditors to monitor the process closely and to improve their ability to do so.