## _wp1155

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---

### Introduction and scope
- Study focus: implications of differences in national legislations for corporate bankruptcy and secured transactions on the credit riskiness of corporate loans and potential credit losses faced by banks (usually senior creditors).
- Countries analyzed: Germany, the UK, and the US.
- Exclusions: effects on credit supply and demand, economic growth and innovation, role of other creditors, and bank bankruptcy legislation.

### Theoretical framework and hypotheses
- Core theoretical predictions:
  - Market participants adjust lending behavior (credit prices, demand for collateral) to applicable legislation to maximize efficiency and minimize costs.
  - Creditor-friendly environments lead to more advantageous credit terms for creditors (lower interest rates, longer maturities).
- Main hypotheses:
  - Hypothesis 1: Duration and formality are crucial factors for costs of bankruptcy proceedings.
  - Hypothesis 2: Creditor-friendly systems see more formal bankruptcies; debtor-friendly systems see more out-of-court restructurings.
  - Hypothesis 3: Legal preconditions for initiating formal bankruptcy affect credit risk; initiation at an earlier stage leaves more assets for distribution.
  - Hypothesis 4: Country-specific differences in standard security types are relatively limited; market participants adjust only to a minor degree.

### Method and analytical approach
- Conceptual decomposition:
  - Empirically observed Credit Risk = Credit Risk driven by Legislation + Credit Risk not driven by Legislation.
- Three dimensions neutralized to isolate legislation effects:
  - (i) The type/nature of default events.
  - (ii) The credit environment (through-the-cycle parameters; assume no long-run country differences in credit supply).
  - (iii) Market participants’ behavioral adjustment (residual after neutralizing non-legal effects).
- Data: legal proceedings and firm default data, including firms financed through capital markets (to account for US less bank-based system).
- LGD workout formula referenced: LGD = 1 - (sum_{t=1}^T C_t / (1+R)^t) / EAD (variant shown as equation (1) in source).

### Frequency and characterization of default procedures (empirical frequencies)
- Portion of successful informal voluntary defaults (successful voluntary defaults as percent of total defaults):
  - Germany: 13 percent
  - UK: 25 percent
  - US: 47 percent
- Conditional likelihoods for firms entering formal bankruptcy (liquidation vs going-concern):
  - Germany: 69 percent liquidated, 31 percent going-concern.
  - UK: approximately 62 percent liquidation, 38 percent going-concern.
  - US: 74 percent liquidation, 26 percent going-concern.
  - Note: about 16 percent of Chapter 11 filings can mute into Chapter 7 cases at a later stage.
- Empirical evidence on restructuring attempts:
  - Gilson et al. (1990): 85 percent of investigated US firms tried to restructure outside formal bankruptcies; 55 percent of those trying to stick to informal renegotiations (or 47 percent of all firms) were successful.
  - German experts (Euler Hermes Kreditversicherungs-AG, 2007) SME expectations: 10 percent “real” going-concern, 56 percent reorganization via sale, 34 percent liquidation.

### Procedure-specific LGD assumptions and simulation parameters
- LGD assumptions:
  - Informal default events: LGD = 22 percent (uniform across DE/UK/US).
- Gross undiscounted proceeds assumed:
  - Going-concern: 90 percent of EAD.
  - Liquidation-type: 80 percent of EAD.
- Discounting and duration:
  - Discount rate used: 12 percent.
  - Country-specific durations used (see results below); for Germany, assumed going-concern duration = 1 year (robustness check at 1.5 years).
- Country-specific direct legal costs subtracted from gross proceeds; proceeds assumed net of expenses not subject to legal differences.

### Procedure-level discounted LGDs (12 percent discount rate)
- Liquidation LGDs:
  - DE = 56.7
  - UK = 38.3
  - US = 36.8
- Going-concern LGDs:
  - DE = 32.9
  - UK = 29.2
  - US = 28.0
- Informal LGD:
  - DE = 22
  - UK = 22
  - US = 22
- Drivers:
  - High German liquidation LGD (56.7 percent) reflects comparably high duration of the bankruptcy process.
  - Differences in direct legal costs are less decisive than durations for total LGD differences.

### Country-level Total LGDs (conceptual framework, Table 6)
- DE:
  - Formal Mean LGD = 49.3
  - Frequency (formal) = 87
  - Informal Mean LGD = 22
  - Frequency (informal) = 13
  - Total LGD = 45.8
  - Footnote: Formal Germany LGD computed as 69 percent * 56.7 percent + 31 percent * 32.9 percent.
- UK:
  - Formal Mean LGD = 34.9
  - Frequency (formal) = 75
  - Informal Mean LGD = 22
  - Frequency (informal) = 25
  - Total LGD = 31.7
- US:
  - Formal Mean LGD = 34.5
  - Frequency (formal) = 53
  - Informal Mean LGD = 22
  - Frequency (informal) = 47
  - Total LGD = 28.6
- Basel II reference:
  - Basel II Foundation IRB approach sets LGD for senior unsecured debt at 45 percent.

### Empirical PD and total default evidence (through-the-cycle averages and per-capita measures)
- Through-the-cycle average bankruptcy rates (2000–2008):
  - US: 0.53 percent (US Court Press)
  - UK: 0.88 percent (CreditReform)
  - Germany: 1.2 percent (CreditReform)
  - Relative level: 0.44:0.73:1 (US:UK:DE)
- Formal corporate bankruptcies per 1 million inhabitants (1980–2005, Osterkamp (2006)):
  - US: about 200
  - UK: about 250
  - DE: about 300
  - Relative terms: 0.67:0.84:1 (US:UK:DE)
- Total defaults including informal defaults (per 1 million inhabitants):
  - DE: Formal = 300; Informal = 44.8 (=300/0.87-300); Total = 344.8
  - UK: Formal = 250; Informal = 83.3 (=250/0.75-250); Total = 333.3
  - US: Formal = 200; Informal = 177.4 (=200/0.53-200); Total = 377.4
- Implications:
  - Conceptual formal PDs (US:UK:DE = 0.69:0.84:1) closely resemble empirical evidence (0.67:0.84:1).
  - Total default rates: UK and Germany similar; US total default rate about 10 percent higher (relative 1.10:0.97:1 US:UK:DE).
  - Hypothesis: higher US total defaults partly due to voluntary default events not directly related to solvency (about 20 percent of informal defaults in the US are of this nature).

### Empirical LGD evidence and robustness (Tables 8 and 9)
- Undiscounted net proceeds and discounted (sources and sample sizes):
  - DE (Grunert and Weber (2009), 1992-2003, 120 defaults):
    - Liquidation-Type Net Proceeds = 75.1 (49.8)
    - Going-Concern = 85.8 (76.6)
  - UK (Davydenko and Franks (2008), 1994-2003, 1,418 defaults):
    - Liquidation-Type = 68.9 (62.5)
    - Going-Concern = 78.0 (70.8)
  - US (Bris et al. (2006), 1995-2001, 303 defaults):
    - Liquidation-Type = 27.4 (24.1)
    - Going-Concern = 76.6 (68.5)
- Empirically observed LGDs (Discount Rate: 12 percent) vs conceptual:
  - DE:
    - Formal Mean LGD = 39.5
    - Frequency (formal) = 87
    - Informal Mean LGD = 22
    - Frequency (informal) = 13
    - Total LGD = 37.2
    - Conceptual LGD = 45.8
  - UK:
    - Formal Mean LGD = 36.7
    - Frequency = 75
    - Informal Mean LGD = 22
    - Frequency = 25
    - Total LGD = 33.0
    - Conceptual = 31.7
  - US:
    - Formal Mean LGD = 64.5
    - Frequency = 53
    - Informal Mean LGD = 22 (80) and 0 (20) [reflecting that 20 percent of informal defaults assumed truly voluntary with LGD = 0]
    - Frequency (informal) = 47
    - Total LGD = 42.5
    - Conceptual = 28.6
- Interpretations:
  - UK: empirical LGD closely matches conceptual LGD.
  - Germany: empirical total LGD (37.2) is below conceptual (45.8), suggesting behavioral adjustments by banks (e.g., more collateral, conservative valuation).
  - US: empirical formal LGD is very high (64.5) driven by Chapter 7 outcomes, producing empirical total LGD (42.5) substantially above the conceptual estimate (28.6).

### Recovery comparisons and collateral composition
- Collateral composition (most widespread credit risk mitigants):
  - UK: Real estate 47 percent; Guarantees 22 percent; Accounts receivables 16 percent; Stocks 5 percent.
  - Germany: Real estate 49 percent; Guarantees 27 percent; Accounts receivable 7 percent; Stocks 7 percent.
  - US (Araten et al. 2004): Real estate 55 percent.
- Recovery comparisons (undiscounted basis and relative statements in source):
  - German banks recover approximately 10 percent more collateral (as percentage of EAD) in formal bankruptcy proceedings than UK banks, in both liquidation and going-concern proceedings.
  - US banks recover about 45 percent less than UK banks in case of liquidation (Chapter 7) and about 4 percent less in case of a going-concern (Chapter 11).
- Adjustments required to equalize recoveries with UK banks:
  - Liquidation proceedings in Germany would have to be shortened by about one half.
  - US banks would need more than twice as much collateral in Chapter 7 proceedings (or one third of all Chapter 7 events would have to become Chapter 11 cases) to be at par with UK banks.

### Portfolio credit risk implications (EL and capital requirements)
- PDs used (empirically derived long-run alignment):
  - DE PD fixed at 1.37 percent.
  - UK PD = 1.32 percent.
  - US PD = 1.5 percent.
- Portfolio credit risk results (Table 10; percent of exposure):
  - DE:
    - Expected Loss = 0.51
    - Basel II capital requirements = 6.79
  - UK:
    - Expected Loss = 0.44
    - Basel II capital requirements = 5.96
  - US:
    - Expected Loss = 0.64
    - Basel II capital requirements = 7.97
- Ranking and interpretation:
  - Legislation-driven portfolio credit risk highest in the US (both EL and UL/Basel II capital), followed by Germany, then the UK.
  - Differences can be rationalized only if credit prices or other factors differ; empirical observation: German banks ask lower credit spreads than US banks.

### Policy-relevant conclusions and recommendations
- Legal design matters for financial stability: bankruptcy and secured transactions legislation materially affect banks’ expected losses.
- Trade-offs for policymakers:
  - Balance efficiency, fairness, creditor- versus debtor-friendliness.
  - Debtor-friendly features that promote preemptive restructuring reduce formal defaults but do not necessarily offset low recovery rates in formal procedures.
- Potential bank responses in debtor-friendly systems (US):
  - Implement margin calls once firms’ solvency deteriorates.
  - Demand more collateral upfront.
- Structural policy options to reduce LGDs:
  - Shorten duration of formal proceedings (Germany would need to shorten liquidation proceedings by about one half to match UK recoveries).
  - Encourage informal restructurings and reduce stigma of default (as seen in the US), noting potential trade-offs for creditor recoveries if formal proceedings follow.
- Observations on legal convergence:
  - US law reformed in 2005 to be less debtor-friendly.
  - UK has become more debtor-friendly post-receivership reform; Germany has a Draft Law on Restructuring Insolvent Companies moving toward less creditor-friendly rules.
- Data limitations and research needs:
  - Need for more granular data on collateral types, revaluation timing, and creditor composition to refine behavioral adjustment estimates and interactions with credit prices and competition.

### Illustrative example of liquidation distribution (Appendix 3 highlights)
- Example setup:
  - Debtor assets = 1,000,000; outstanding debt = 1,000,000.
  - Debt split into 10 credits of 100,000 each: 2 unsecured, 2 guaranteed, 6 secured (two creditors share same collateral).
  - Collateral sale assumptions: each sale at market value; costs per sale = 10,000.
- Outcomes and implications:
  - Security rights enforced prior to general distribution; sale costs materially reduce net collateral proceeds.
  - After secured enforcement and procedural costs of 100,000, remaining assets = 340,000 to satisfy remaining claims of 570,000 (pro rata distribution).
  - Recovery rates vary strongly by priority, collateral coverage, and foreclosure clauses; unsecured claims face significant dilution.
- Reported table entries preserved verbatim in source (examples: Creditor 1 recovery listed as 059,60059.6; average recoveries and aggregated figures reported as in source).

*Source: _wp1155*

### References .............................................................................................................

### _wp1155 - References

### Introduction
- Study focus: implications of differences in national legislations for corporate bankruptcy and secured transactions on the credit riskiness of corporate loans and potential credit losses faced by banks (usually senior creditors).
- Countries analyzed: Germany, the UK, and the US, representing civil law (Germany) and common law (UK and US) law families.
- Scope exclusions: effects on credit supply and demand, economic growth and innovation, role of other creditors, and bank bankruptcy legislation.

### Theoretical background and empirical context
- Theoretical predictions:
  - Market participants (banks) adjust lending behavior (credit prices, demand for collateral) to applicable legislation to maximize efficiency and minimize costs (Coase Theorem).
  - In creditor-friendly environments, creditors are assumed to grant credit on more advantageous terms (lower interest rates, longer maturities) per Agion and Bolton 1992; Hart and Moore 1994, 1998.
- Empirical findings cited:
  - Behavioral adjustments in assessment of creditworthiness and use of collateral and work-out duration (Djankov et al. 2007; Acharya et al. 2006; Qian and Strahan 2007).
  - Adjustments of credit prices (Bae and Goyal 2004; Qian and Strahan 2007).
  - Davydenko and Franks (2008): banks adjust lending practices to bankruptcy codes but cross-country differences in credit risk persist and are not fully offset by credit prices.

### Method and analytical approach
- Concept: disentangle legal effects on credit risk from market participant behavior and credit environment influences (e.g., credit prices and credit supply).
- Data: legal proceedings data including firms financed through capital markets (to account for US less bank-based financial system).
- Consideration of both formal bankruptcy procedures (in-court liquidation or going-concern) and informal default/bankruptcy measures (out-of-court restructuring).

### Key empirical findings and quantitative results
- Informal restructuring and formal default:
  - Approximately 20 percent of informal restructurings in the US are preemptive measures not observable in the other two countries.
  - These 20 percent represent 10 percent of the overall default events in the US.
  - Conclusion: US legislation that allows early/preemptive restructuring reduces the number of formal defaults compared to the UK and even more so compared to Germany.
- Recovery and loss-given-default (LGD) comparisons:
  - German banks recover approximately 10 percent more collateral (as a percentage of the Exposure at Default) in formal bankruptcy proceedings than UK banks, in both liquidation and going-concern proceedings.
  - US banks recover about 45 percent less than UK banks in case of liquidation (Chapter 7).
  - US banks recover about 4 percent less than UK banks in case of a going-concern (Chapter 11).
- Relative credit risk ranking (other things equal):
  - US banks face the highest credit risk.
  - Germany is next highest.
  - The UK faces the lowest credit risk among the three.
- Drivers of cross-country differences:
  - US advantage from higher incidence of informal restructurings (yielding low or zero loss levels) is outweighed by low recovery levels in formal US procedures.
  - Germany’s long duration of proceedings reduces recoveries substantially.

### Policy-relevant implications
- Legal design matters for financial stability: differences in bankruptcy and secured transactions legislation affect banks’ expected losses and thus financial stability.
- Trade-offs for policymakers:
  - Efficiency and fairness in proceedings must be balanced with whether legislation should be creditor- or debtor-friendly.
  - Debtor-friendly features that promote preemptive restructuring can reduce formal defaults but may not offset low recovery rates in formal procedures.
- Bank behavior:
  - Banks respond to legal environments by demanding different credit risk mitigants (e.g., more or different types of collateral in Germany), consistent with economic theory, but such adjustments do not fully neutralize legal impacts on losses.

*Source: _wp1155 - References*

### Chapter 7 proceedings, and liquidation proceedings in Germany would have to be shortened

### _wp1155 - Chapter 7 proceedings, and liquidation proceedings in Germany would have to be shortened

### Organization of the study
- The rest of this study is organized as follows: Sections II and III identifies relevant dimensions, which can account for differences in credit risk from a legal perspective and an economic perspective, respectively. Section IV looks at the previous findings and analyzes and interprets the legal differences between Germany, the UK, and the US. Section V, compares the model-based result with empirical evidence. Section VI concludes.

### Legal perspective to credit risk — general aspects and notions
- Language and notion differences complicate cross-jurisdictional comparison (e.g., “bankruptcy” and “insolvency” have different scope in UK, US, and Germany).
- Under the German Bankruptcy Code (“Insolvenzordnung”, 1999), the notion of “Insolvenz” covers both individual and corporate cases; “Bankruptcy” (“Bankrott”) is not a legal term in Germany.
- The study adopts the US sense of “bankruptcy” for legal context within this analysis.
- Legal versus economic meanings differ (example: “default”): legally, non-performance of an obligation in due time; economically, often equated with financial breakdown or bankruptcy.
- Legal prerequisites for initiation of bankruptcy proceedings do not necessarily require economic bankruptcy (see Hypothesis 3).
- The study focuses on legislation effects relevant for economic analysis and leaves detailed comparative legal doctrine aside.

### Credit risk and bankruptcy legislation — core mechanisms and hypotheses
- Bankruptcy proceedings aim to equitably distribute debtor’s remaining assets among creditors and typically suspend out-of-court enforcement once proceedings commence.
- Outcomes: liquidation or going-concern (reorganization).
- Procedural costs (PC) reduce creditor recoveries; recovery rate formula noted as [(value of the assets - PC) / total outstanding debt] (stylized example in Appendix 3).
- Hypotheses highlighted:
  - Hypothesis 1: Duration and formality are crucial factors for costs of bankruptcy proceedings.
  - Hypothesis 2: Creditor-friendly systems see more formal bankruptcies; debtor-friendly systems see more out-of-court restructurings (informal proceedings).
  - Hypothesis 3: Legal preconditions for initiating formal bankruptcy (bankruptcy/default definitions) affect credit risk; initiation at an earlier stage leaves more assets for distribution.
  - Hypothesis 4: Country-specific differences in standard security types are relatively limited; market participants adjust to national conditions only to a minor degree.

### Credit risk and security interests — personal vs real security
- Two main groups of security interests:
  - Personal security (guaranties): value depends on guarantor solvency; loss only if both debtor and guarantor default (double default).
  - Real security (collateral): value depends on rank and market value; creditor can sell/use collateral independently of ownership.
- Fundamental determinants: market risk and priority are similar across jurisdictions.
- Security interests do not confer superior rights to the principal claim; secured creditors participate in bankruptcy proceedings like unsecured creditors.
- Country-specific differences in the procedures for creating, perfecting and enforcing security can differ widely (not included in the “standard security types” assertion).
- Additional detail in Appendix 2 and numerical example in Appendix 3.

### Economic perspective to credit risk — PD, LGD, EAD
- Focus on two key parameters: probability of default (PD) and recovery rate / loss-given-default (LGD); also exposure-at-default (EAD).
- PD modeling:
  - Main challenges: predicting default likelihood and, for guaranteed exposures, joint PD of debtor(s) and guarantor(s).
  - Default definition is crucial for PD estimation.
  - Economic default triggers: past due credit and/or unlikely-to-pay events (see BCBS 2006).
  - After default: creditor can be cured or liquidation occurs during workout.
  - Determinants table (Table 1) summary:
    - Default definition: Country Dependent — Effect on the PD: "The more conservative the default definition, the lower the PD."
    - Guaranty as a security title: No — Effect: "The higher the (likelihood of a positive) value of the guarantor’s assets, the lower the PD."
- LGD modeling (workout LGDs focus):
  - Workout LGD formula (Schuermann 2004):
    - LGD = 1 - (sum_{t=1}^T C_t / (1+R)^t) / EAD  (variant shown as equation (1) where tC denotes cash flow at time t, R is discount rate, and EAD is exposure at default)
  - Recovered cash flows comprise proceeds and expenses.
  - Determinants table (Table 2) summary:
    - Duration of work-out time: Country Dependent — "The longer the duration of the work-out process, the higher the LGD."
    - Costs of bankruptcy procedure: Country Dependent — "The higher the costs, the higher the LGD."
    - Default Definition: Country Dependent — "The more conservative the default definition, the higher the LGD."
    - Value, quality and seniority of security titles: Rather no — "The higher the value, quality and seniority of the security titles, the lower the LGD."
    - Discount Rate: No — "The higher the discount rate, the lower the LGD."
  - Stylized Merton-type framework: asset value follows diffusion; mandatory (formal) default when asset value falls below default barrier; voluntary defaults or preemptive reorganizations also possible.
  - Empirical note: For early US bankruptcy procedures medians reported — Chapter 7 cases median of 168 percent and Chapter 11 cases median of 123 percent (asset value relative to debt at the beginning of bankruptcy procedures).

### Determinants and modeling notes
- Workout cash flows include proceeds (e.g., liquidation of collateral) and expenses (e.g., legal costs, collection costs).
- Discounting procedures: Macaulay duration or value-weighted average duration mentioned as possible approaches; bottom-up decomposition by collateral categories may be appropriate for heterogeneous exposure classes.
- Basel II references:
  - PD substitution approach and double-default framework discussed for modeling joint debtor-guarantor PDs (BCBS 2006, paras. 141, 284, 303).
  - LGD estimation guidance: focus on economic loss, include material discount effects and direct/indirect collection costs (BCBS 2006, para. 460).

### Comparison of Germany, the UK, and the US (legal determinants mapped to hypotheses)
- Legal systems:
  - Germany: uniform federal legal system (Insolvenzordnung); procedure mainly administered by public administrator.
  - UK: focus on English law; Scottish Insolvency Code (2007) noted as regional exception; prior existence of receivership gave creditors greater control historically.
  - US: common law structure similar to English law but with substantial state-level legislative variation; Chapter 11 allows debtor participation.
- Summary outcomes related to Hypotheses (Table 3 and Appendix 4 referenced):
  - Duration of workout:
    - Tends to be rather lengthy in Germany and comparably short in the UK and in the US.
    - Differences particularly substantial for liquidation proceedings.
  - Legal costs of bankruptcy:
    - Follow similar ordering as duration — higher in Germany, lower in UK and US.
  - Creditors’ control rights:
    - Order differs: UK had many control rights before receivership vanishing; balance between creditors and debtors now relatively neutral and similar to Germany (procedure handled mainly by an administrator).
    - US: creditors have limited control rights because debtors have a say (Chapter 11).
- The study notes potential future changes anticipated in the German Draft Law on Restructuring Insolvent Companies (discussed in conclusions).

*Source: _wp1155 - Chapter 7 proceedings, and liquidation proceedings in Germany would have to be shortened*

### section V.

### V. NET IMPACT OF LEGISLATION ON CREDIT RISK

### Proceedings, control rights, and creditor-friendliness (comparative findings)
- Comparative qualitative differences:
  - UK: creditors’ control rights remain broader than in Germany, but with the cessation of the receivership procedure (pre-2003 September) UK law has become more debtor-friendly; formal proceedings can be initialized voluntarily by debtors in England (an option not existent in Germany).
  - Germany: bankruptcy proceedings are the most formal; no separate formal procedure explicitly aiming at restructuring a firm as a going-concern; administrators are generally appointed by the court; equality and short duration objectives require time-consuming assessment of claims.
  - US: legislation tends to be more balanced between debtors and creditors (with Chapter 11 being debtor-friendly), voluntary default is a real alternative, and control rights of banks in formal bankruptcy procedures are substantially lower than in the UK and Germany; US law is characterized as comparably informal.
- Public perception and stigma:
  - There is a negative public perception of bankruptcy in both European countries, where failing debtors are stigmatized.
  - Both European countries are at par with the EU average to allow firms a second chance (Small Business Act (2009) evidence).
  - EU-level policy measures have been introduced to diminish stigmatization rooted in European traditions.
- Out-of-court restructurings:
  - Informal, out-of-court restructurings are more common in the UK than in Germany; in the US voluntary out-of-court restructuring is a common and effective alternative.
- Security interests:
  - Commonly used security interests—personal security and real security—are, in shape and practical effects, relatively similar across the three countries; differences are expected to be triggered more by behavioral adjustment than by the underlying legal framework.

### Methodology to isolate legislation-driven credit risk
- Conceptual decomposition:
  - Empirically observed Credit Risk = Credit Risk driven by Legislation + Credit Risk not driven by Legislation.
- Three dimensions neutralized to isolate legislation effects:
  - (i) The type/nature of default events (use findings documented in Section IV).
  - (ii) The credit environment:
    - Credit prices not directly relevant in first step but considered for final conclusions.
    - Assume no country-specific differences in credit supply in the long run.
    - Use through-the-cycle credit risk parameters to account for cyclical effects.
  - (iii) Potential adjustment of market participants’ (banks’) behavior; residual after neutralizing non-legal effects is assumed behavioral adjustment.
- Outcome: implied (quasi-theoretical) PDs and LGDs are determined and compared with empirical evidence; residuals interpreted as behavioral adjustment.

### Frequency of different bankruptcy proceedings (empirical frequencies)
- Three default categories distinguished:
  - (a) Informal voluntary default
  - (b) Formal bankruptcy of a going-concern type
  - (c) Liquidation-type procedures
- Portion of successful informal voluntary defaults (successful voluntary defaults as percent of total defaults):
  - Germany: 13 percent
  - UK: 25 percent
  - US: 47 percent
- For firms entering formal bankruptcy procedures, conditional likelihoods of liquidation vs going-concern:
  - Germany (conditional on entering formal bankruptcy): 69 percent liquidated, 31 percent kept as a going-concern (proxy figures from Grunert and Weber (2009)).
  - UK (formal bankruptcies): approximately 62 percent liquidation (liquidations and ex-receivership), 38 percent going-concern (administrations).
  - US (formal bankruptcies): 74 percent liquidation, 26 percent going-concern.
  - Note: about 16 percent of Chapter 11 filings can be assumed to mute into Chapter 7 cases at a later stage (Bris et al. 2006).
- Additional empirical points:
  - Gilson et al. (1990): 85 percent of investigated US firms tried to restructure outside formal bankruptcies; 55 percent of those trying to stick to informal renegotiations (or 47 percent of all firms) were successful.
  - German experts (Euler Hermes Kreditversicherungs-AG, 2007) expecting SME outcomes: 10 percent “real” going-concern, 56 percent reorganization via sale, 34 percent liquidation.

### Theoretical credit risk parameter decomposition and PD implications
- PD decomposition:
  - PD = PD(Formal Bankruptcy) + PD(Voluntary Default).
- Debtor-friendliness influences frequency of voluntary default (Hypothesis 2).
- Comparative implied formal PDs (relative to Germany):
  - Relative PDs reported: US: UK: DE = 0.53:0.75:0.87 = 0.61:0.86:1 (reflecting that PD for formal bankruptcy events in the US is by 39 percent lower than in Germany; in the UK the figure is by 14 percent lower than in Germany).
- Empirical success of early/voluntary restructurings:
  - Survey among German liquidators: early restructurings successful in 44 percent of cases (Euler Hermes Kreditversicherungs-AG, 2006).
  - Internal restructuring success in formal bankruptcy procedures: 10 percent (Euler Hermes Kreditversicherungs-AG, 2007).
  - Gilson et al. (1990): portion of voluntary defaults kept as going-concern is 55 percent in their US sample.

### Theoretical Loss-Given-Default (LGD) simulation assumptions and structure
- LGD decomposition formula (procedural components and probabilities):
  - Overall LGD depends on LGD for liquidation (“Liq”), going-concern type bankruptcy (“GC”), informal restructuring (“Informal”), and probabilities Pr1, Pr2, Pr3 for their occurrence; net proceeds in case of liquidation and going-concern are adjusted by legal costs and a duration-weighted discount factor.
  - Specific functional form reported in source (equation (3)).
- Key parameter assumptions used in simulations:
  - Gross undiscounted proceeds:
    - Going-concern procedures: 90 percent of the EAD.
    - Liquidation-type bankruptcy: 80 percent of the EAD.
    - These figures correspond to Davydenko and Franks (2008) for the UK.
  - Proceeds are assumed net of expenses not subject to legal differences (e.g., expenses for collection of security titles).
  - Country-specific direct legal costs are subtracted thereafter.
  - Discounting:
    - Discount rate used: 12 percent.
    - Cash flow weighted average duration of the work-out process is used to discount net proceeds.
  - Duration assumptions:
    - For Germany, no data for duration of going-concern procedures; assume 1 year (closely corresponding to the length in the UK and the US); robustness checks show similar outcomes for a conservative duration of 1.5 years.
  - For the UK and Germany, where data are missing on legal costs for certain procedure types, the same parameters are used for both procedures in the simulation.
  - For voluntary default events LGD is assumed the same across all three countries and substantially lower than for formal default events (backed by Davydenko and Franks (2008): UK informal LGD 22 percent vs Germany 24 percent; Araten and Karagozoglu (2007) provide US corporate sample LGD evidence).
- Key modeling assumptions:
  - Hypothesis 4: average gross proceeds P for formal bankruptcies are assumed the same in all three countries, reflecting similar security titles and that the cohort of firms is the same across countries.

*Source: _wp1155 - section V.*

### 23.8 percent, which closely matches the figures for the UK and Germany. We use LGDs of

### _wp1155 - 23.8 percent, which closely matches the figures for the UK and Germany. We use LGDs of

### Procedure-specific LGD assumptions and results
- LGDs of 22 percent for informal default events in all three countries.
- For liquidation (Liq) type bankruptcy (Table 5):
  - DE: Undiscounted Proceeds P = 80 (1, Percent); Direct Legal Costs (LCost) = 14.8 (2, Percent); Undiscounted Net Proceeds = 65.2 (3); Duration = 3.62 (years) (4); LGD Based on Discounted Cash Flows at 12 Percent = 56.7 (5).
  - UK: P = 80; LCost = 12; Net Proceeds = 68; Duration = 0.86; Discounted LGD = 38.3.
  - US: P = 80; LCost = 8.1; Net Proceeds = 71.9; Duration = 1.14; Discounted LGD = 36.8.
- For going-concern (FGC) type bankruptcy (Table 5):
  - DE: P = 90; LCost = 14.8; Net Proceeds = 75.2; Duration = 1; Discounted LGD = 32.9.
  - UK: P = 90; LCost = 12; Net Proceeds = 78; Duration = 0.86; Discounted LGD = 29.2.
  - US: P = 90; LCost = 9.5; Net Proceeds = 80.5; Duration = 0.98; Discounted LGD = 28.0.
- Informal LGD (Table 5):
  - DE: 22
  - UK: 22
  - US: 22
- Notes on drivers:
  - High LGD for Germany in liquidation (56.7 percent) reflects comparably high duration of bankruptcy process.
  - LGDs for going-concern type bankruptcies are around 30 percent in all three countries.
  - Differences in direct legal costs (administrative costs) do not appear decisive for total LGD differences.

### Overall LGD results (Table 6: Total LGDs Calculated Based on Analytical Concept)
- Country-level formal vs informal frequencies and resulting Total LGD (Figures in Percent):
  - DE: Formal Mean LGD = 49.3; Frequency (formal) = 87; Informal Mean LGD = 22; Frequency (informal) = 13; Total LGD = 45.8.
    - Footnote: The LGD for formal procedures in Germany is 69 percent * 56.7 percent + 31 percent * 32.9 percent.
  - UK: Formal Mean LGD = 34.9; Frequency = 75; Informal Mean LGD = 22; Frequency = 25; Total LGD = 31.7.
  - US: Formal Mean LGD = 34.5; Frequency = 53; Informal Mean LGD = 22; Frequency = 47; Total LGD = 28.6.
- Basel II comparison:
  - Basel II Foundation IRB approach sets LGD for senior unsecured debt at 45 percent, indicating estimated parameters are realistic in general terms.

### Empirical evidence — Probability of Default (PD)
- Through-the-cycle average bankruptcy rates (2000–2008) used:
  - US: 0.53 percent (source: US Court Press)
  - UK: 0.88 percent (source: CreditReform)
  - Germany: 1.2 percent (source: CreditReform)
  - Relative level: 0.44:0.73:1 (US:UK:DE).
- Cross-check using formal corporate bankruptcies per 1 million inhabitants (1980–2005, Osterkamp (2006)):
  - US: about 200
  - UK: about 250
  - DE: about 300
  - Relative terms: 0.67:0.84:1 (US:UK:DE).
- Total defaults including informal defaults (Table 7):
  - DE: Formal Defaults per 1 Million Inhabitants = 300; Informal Defaults per 1 Million Inhabitants = 44.8 (=300/0.87-300); Total Defaults per 1 Million Inhabitants = 344.8 (1).
  - UK: Formal = 250; Informal = 83.3 (=250/0.75-250); Total = 333.3 (0.97).
  - US: Formal = 200; Informal = 177.4 (=200/0.53-200); Total = 377.4 (1.1).
- Implications:
  - Conceptual formal PDs (US:UK:DE = 0.69:0.84:1) closely resemble empirical evidence (0.67:0.84:1).
  - Total default rates: UK and Germany similar; US total default rate about 10 percent higher (relative 1.10:0.97:1 US:UK:DE).
  - Hypothesis: higher US total defaults attributable to voluntary default events not directly related to solvency (about 20 percent of informal defaults in the US are of this nature).

### Empirical evidence — LGD comparisons and robustness (Tables 8 and 9)
- Empirical studies used:
  - UK: Davydenko and Franks (2008)
  - Germany: Grunert and Weber (2009)
  - US: Bris et al. (2006) (adjusted to reflect bank recoveries)
  - Additional comparisons: Araten et al. (2004), Carey and Gordy (2004), Araten and Karagozoglu (2007).
- Undiscounted net proceeds and discounted (Table 8):
  - DE: Liquidation-Type Net Proceeds = 75.1 (49.8); Going-Concern = 85.8 (76.6); Source: Grunert and Weber (2009), 1992-2003, 120 defaults.
  - UK: Liquidation-Type = 68.9 (62.5); Going-Concern = 78.0 (70.8); Source: Davydenko and Franks (2008), 1994-2003, 1,418 defaults.
  - US: Liquidation-Type = 27.4 (24.1); Going-Concern = 76.6 (68.5); Source: Bris et al. (2006), 1995-2001, 303 defaults.
- Empirically observed LGDs (Discount Rate: 12 Percent) (Table 9):
  - DE: Formal Mean LGD = 39.5; Frequency (formal) = 87; Informal Mean LGD = 22; Frequency (informal) = 13; Total LGD = 37.2; LGDs Based on Conceptual Framework = 45.8.
  - UK: Formal Mean LGD = 36.7; Frequency = 75; Informal Mean LGD = 22; Frequency = 25; Total LGD = 33.0; Conceptual = 31.7.
  - US: Formal Mean LGD = 64.5; Frequency = 53; Informal Mean LGD = 22 (80) and 0 (20) [reflecting that 20 percent of informal defaults assumed truly voluntary with LGD = 0]; Frequency (informal) = 47; Total LGD = 42.5; Conceptual = 28.6.
- Key comparisons and interpretations:
  - For the UK, empirical LGD closely matches the conceptual LGD.
  - For Germany, empirical discounted LGD for formal procedures = 39.5 percent, total LGD = 37.2 percent.
  - For the US, empirical formal LGD = 64.5 percent, leading to total LGD = 42.5 percent once informal default adjustments applied; this empirical total LGD is about 50 percent higher in relative terms than the conceptual one (42 percent vs. 28 percent).
  - Low recoveries in US Chapter 7 cases drive high formal LGDs; many zero-recovery senior creditor cases observed.
  - Araten et al. (2004) reports average LGD for US bank debt ≈ 38.5 percent (same discount rate), about 4 percentage points lower than LGD based on framework.
  - Carey and Gordy (2004) finding: for each percent more of bank debt (as portion of total debt), the recovery of a firm increases by approximately 0.35 percentage points (used as context for recovery sensitivity to creditor composition).

### Summary of substantive findings
- Procedure-level discounted LGDs (12 percent discount rate) show:
  - Liquidation LGDs: DE = 56.7; UK = 38.3; US = 36.8.
  - Going-concern LGDs: DE = 32.9; UK = 29.2; US = 28.0.
  - Informal LGD (uniform assumption): 22 for DE/UK/US.
- Total LGDs (conceptual framework, Table 6):
  - DE = 45.8
  - UK = 31.7
  - US = 28.6
- Empirically observed total LGDs (Table 9):
  - DE = 37.2
  - UK = 33.0
  - US = 42.5
- Evidence indicates legal framework and procedure durations materially affect LGDs and PD composition across DE, UK, and US; US shows higher empirical formal LGD driven by Chapter 7 outcomes and a higher share of voluntary informal defaults.

*Source: Authors.*

### Chapter 11 recovery on an undiscounted basis would be 87 percent and the one for Chapter 7

### _wp1155 - Chapter 11 recovery on an undiscounted basis would be 87 percent and the one for Chapter 7

### Empirical recovery and LGD benchmarks
- Chapter 11 recovery on an undiscounted basis would be 87 percent and the one for Chapter 7 cases 23.9 percent, yielding a formal LGD of 59.6 percent and a total LGD of 40.9 percent.
- Overall, these two empirical benchmarks confirm the robustness of the study's results.
- With the vanishing of receiverships in the UK, formal (liquidation) LGDs might have increased since 2002; successful early restructuring could become more common as creditors’ incentives weaken. Investigation of reform effects requires more recent UK data that is not available in this source.
- For Germany:
  - Empirical LGDs are substantially lower than the implied ones, suggesting behavioral adjustment by German banks to obtain more favorable credit terms.
  - Final LGDs in percentage points remain higher than in the UK (37 percent vs. 34 percent), driven by a higher number of liquidation-type bankruptcy cases and longer work-out processes.
  - LGDs are about 5 percentage points lower than in the US, unlike 17 percentage points higher as suggested by implied parameters.
- Cross-study and within-country differences:
  - Grunert and Weber (2009) report more favorable figures for Germany than Davydenko and Franks (2008).
  - Differences reflect German banking pillars (private banks, savings banks, cooperative banks), competition intensity, and creditor–debtor relationship intensity (relationship banking).
  - Grunert & Weber (2009) sample contains larger firms and finds a positive relationship between firm total assets and LGD (larger firms recover less), making that dataset more conservative and deemed adequate for Germany.

### Behavioral adjustment dimensions considered and data limitations
- The analysis sought to eliminate identified relevant dimensions except for behavioral adjustment by market participants, which depends on:
  - (i) Frequency of "choice" of different default procedures (liquidation-type formal bankruptcy, going-concern formal bankruptcy, informal default).
  - (ii) Use of credit risk mitigation instruments (portion of exposure covered by security titles, type of security title, security realization).
- The first dimension (frequency of procedures) was incorporated. Use of credit mitigation instruments was assessed indirectly through level of proceeds due to scarce disaggregated data.
- Caveat: valuation conservatism and timing/frequency of collateral revaluation by banks affect secured lending fractions; country-specific differences are assumed limited due to lack of data.

### Collateral types and cross-country comparisons
- UK collateral composition (most widespread credit risk mitigants):
  - Real estate 47 percent
  - Guarantees 22 percent
  - Accounts receivables 16 percent
  - Stocks 5 percent
- Germany collateral composition:
  - Real estate 49 percent
  - Guarantees 27 percent
  - Accounts receivable 7 percent
  - Stocks 7 percent
- US collateral (Araten et al. 2004):
  - Real estate 55 percent (most frequent)
- Undiscounted proceeds and recovery comparisons:
  - German banks recover approximately 10 percent more than UK banks in both liquidation and going-concern procedures.
  - US banks recover about 45 percent less than UK banks (and 55 percent less than German banks) in liquidation cases, and 4 percent less in going-concern cases.
  - Interpretation: German banks demand most collateral, followed by UK banks; US banks have less collateral to be liquidated (at least in Chapter 7 cases).
- Adjustments required to equalize recoveries with UK banks:
  - Liquidation proceedings in Germany would have to be shortened by about one half.
  - US banks would need more than twice as much collateral in Chapter 7 proceedings (or one third of all Chapter 7 events would have to become Chapter 11 cases) to be at par with UK banks.

### Implications for portfolio credit risk (EL and UL)
- PDs and LGDs used:
  - PD for Germany fixed at 1.37 percent (in line with empirical long-term evidence).
  - Corresponding PDs: UK 1.32 percent; US 1.5 percent.
  - LGDs used are empirically derived (displayed in Table 9 of source).
- Portfolio credit risk based on theoretical credit parameters (Table 10):
  - DE: Expected Loss 0.51 (Percent of Exposure); Basel II capital requirements 6.79 (Percent of Exposure)
  - UK: Expected Loss 0.44 (Percent of Exposure); Basel II capital requirements 5.96 (Percent of Exposure)
  - US: Expected Loss 0.64 (Percent of Exposure); Basel II capital requirements 7.97 (Percent of Exposure)
- Ranking and interpretation:
  - Portfolio credit risk originating from legislation is highest in the US (both EL and UL/Basel II capital requirements), followed by Germany (capital requirements about 15 percent lower than in the US) and the UK (capital requirements 25 percent lower than in the US).
  - From an arbitrage/theoretical perspective, such differences can only be justified if additional factors (most importantly credit prices) vary.
  - Empirical observation: German banks ask lower credit spreads than US banks, consistent with US banks pricing additional risk from debtor-friendly legislation.
  - UK anomaly: UK banks charge similar or slightly higher interest rates than German banks for comparable firms despite slightly lower credit risk; lower competition in the UK may explain higher interest rates.

### Conclusions and policy-relevant observations
- Informal out-of-court restructurings are integral in the US and used by the majority of firms to avoid formal bankruptcy, reflecting absence of stigma and more debtor-friendly proceedings relative to European law.
- Advantage of early informal restructurings: fewer formal procedures and prevention of bankruptcy in some cases.
- Disadvantage: very high losses if informal proceedings and Chapter 11 procedures fail—deterrent is strong but costly when formal proceedings are used.
- Potential bank responses to increase recovery in the US:
  - (a) Implement margin calls once firms’ solvency deteriorates, balancing recovery and firm survival.
  - (b) Demand more collateral upfront.
- Post-crisis dynamics: less ample market funding could make banks more successful in enforcing such strategies but at costs to the real sector.
- Legal convergence:
  - Potential credit losses are highest in the US; US law was reformed in 2005 to be less debtor-friendly.
  - European bankruptcy systems are gradually becoming less creditor-friendly (UK law already changed; Germany has a draft act aiming in that direction), indicating convergence aimed at spurring innovation and growth.
- Additional notes:
  - Longer workout durations shrink overall recovery substantially.
  - For German banks to match UK recoveries, formal proceedings would have to be shortened by about one half—this conflicts with German legal traditions favoring "equality".
  - An alternative is increased frequency of informal proceedings (as in the US), which would require stigma of default to diminish; referenced policy measures include the Small Business Act for Europe and the German Draft Law on Restructuring Insolvent Companies.
  - The study underscores the need for more data to further assess complex links between legislation, credit risk, credit prices, and competition.

*Source: IMF working paper content provided.*

### Appendix 3. Illustrative Example of Bankruptcy Proceedings with Credit Risk

### Appendix 3. Illustrative Example of Bankruptcy Proceedings with Credit Risk Mitigants

### Setup of the illustrative example
- Debtor assets and outstanding debt both amount to 1,000,000 currency units.
- Outstanding debt split into 10 credits of 100,000 currency units each:
  - 2 unsecured credits.
  - 2 credits secured by guaranties.
  - 6 credits secured by collateral.
  - Two creditors have security interests in the same collateral (double-charged).
  - One creditor (beneficiary) included a foreclosure clause in the security agreement.
- Collateral ownership and values:
  - Four pieces of collateral (including the double-charged one) are owned by the debtor; one by someone else.
  - One of the debtor’s belongings is burdened by a security interest (amount: 100,000) of a beneficiary who is not a creditor.
  - Two of the debtor’s collaterals (including the double-charged one) have a market value of 150,000; the others have market value of 100,000.
- Table 11 summary (as presented):
  - Total: 1,000,000; 600,000 + Collateral 5

### Asset realization and enforcement in liquidation
- At the start of bankruptcy proceedings beneficiaries of security interests in collateral owned by the bankrupt debtor can enforce their titles prior to distribution.
- Assumptions for sales:
  - Each collateral sale can be made at market value.
  - Costs of each sale amount to 10,000 currency units.
- Sale outcomes described:
  - Revenue of sale of Collateral 1: 140,000 — 100,000 used to satisfy Creditor 5; surplus 40,000 falls to debtor’s assets.
  - Collateral 2: 140,000 — first used to satisfy Creditor 6 (1st rank) by 100,000, second to satisfy Creditor 7 (2nd rank) by 40,000.
  - Collateral 3: 90,000 disbursed to Creditor 8.
  - Collateral 6: 90,000 disbursed to the beneficiary (non-creditor).
  - Collateral 4 (foreclosure clause) alienated to Creditor 9.
- Resulting remaining assets after enforcement: total market value 440,000 units.
- Procedural costs (administrator wages, court fees, taxes, cost of sales) assumed to amount to 100,000 units, leaving 340,000 units to satisfy remaining claims totaling 570,000 units.
- Distribution assumption: pro rata distribution among remaining creditors (neglecting preferential political treatments such as employees’ wages).
- Further enforcement options post-distribution:
  - Creditors 3 and 4 can seek recovery from guarantors (bearing default risk).
  - Creditor 10 can enforce security interest against the third owner and seek foreclosure or affect sale, depending on agreement terms.
  - Creditor 8 receives ownership over forfeited collateral instead of the credit.

### Distribution and recovery outcomes (Table 12 summary)
- Recovery outcomes depend on:
  - Recovery rate specific to types of security titles.
  - Pertinent coverage of the exposure (column 3 in the source table).
  - Overall unsecured recovery rate in bankruptcy proceedings (column 4 in the source table).
- Table 12 entries (preserved verbatim as in source):
  - Creditor 1 — 100,000 — 059,60059.6
  - Creditor 2 — 100,000 — 059,60059.6
  - Creditor 3 — 100,000 — 059,60059.6
  - Creditor 4 — 100,000 — 059,60059.6
  - Creditor 5 — 100,000 — 100,0000100
  - Creditor 6 — 100,000 — 100,0000100
  - Creditor 7 — 100,000 — 40,00035,80075.8
  - Creditor 8 — 100,000 — 90,0006,00096.0
  - Creditor 9 — 100,000 — Forfeited collateral0(Forfeited collateral)
  - Creditor 10 — 100,000 — 059,60059.6
- Averages reported (verbatim):
  - Average — 100,000 — 82,500 (Creditors 5–8)
  - 48,500 (Creditors 1–4, 7, 8, 10)
  - 74.4 (Creditors 1–8, 10)

### Key implications from the stylized simulation
- Security rights are enforced prior to general distribution; sale costs materially reduce gross collateral values (10,000 per sale).
- Priority structure and coverage determine full or partial satisfaction:
  - Fully satisfied secured creditors with adequate collateral coverage (e.g., Creditors 5 and 6 in the example).
  - Partially satisfied secured creditors where coverage is insufficient (e.g., Creditor 7).
  - Beneficiaries with security interests but not creditors can be paid from specific collateral (Collateral 6).
  - Foreclosure clauses can result in immediate alienation of collateral to a creditor (Creditor 9).
- Remaining unsecured claims face significant dilution in pro rata distribution after procedural costs are paid (340,000 available vs. 570,000 remaining claims in the example).
- Recovery via guarantors or enforcement against third-party owners remains possible for certain claims, but entails additional default risk and legal processes.

### Appendix 4 — Country-specific evaluation: bankruptcy proceedings, control rights, characterization, and default initiation
- Hypothesis 1: duration, costs and degree of formality of bankruptcy proceedings vary across legal systems and affect control rights.
- Germany:
  - Legal framework: German Bankruptcy Code (“Insolvenzordnung” [InsO], 1999).
  - Proceedings initiate by court decision following request by debtor or creditor.
  - Liquidation and conserving business as going-concern possible; public administrator appointed.
  - Important decisions require approval by meeting of all creditors and/or court.
  - Automatic stay in pending proceedings.
  - Overall creditor influence low; proceedings highly formalized, long duration, comparably high administrative costs.
- England:
  - Legal framework: “Insolvency Act” (IA, 1986) and “Enterprise Act” (EA, 2002).
  - Two main forms: liquidation and administration.
  - Liquidation executed rather informally and as fast as possible; voluntary liquidation: debtor nominates liquidator subject to creditor confirmation; compulsory liquidation requires court decision after creditor winding-up petition.
  - Administration: administrator appointed by court; requires approval of all creditors for action; administrator must propose reorganization plan within three months.
  - Automatic stay while administration order is outstanding; administrator can stay additional claims.
  - Receivership largely restricted by EA (2002); receivership entailed creditor-appointed receiver with sole representation of that creditor.
  - English proceedings overall less formal and substantially less lengthy than German ones (evidence from EU Small Business Act).
- United States:
  - Legal framework: Bankruptcy Code; reformed by “Bankruptcy Abuse Prevention & Consumer Protection Act” (2005).
  - Two basic types: Chapter 7 (liquidation) and Chapter 11 (preserve business as going-concern).
  - Chapter 7: liquidation similar to English IA; trustee appointed by court to oversee liquidation.
  - Chapter 11: debtor may retain control and exclusive right to propose reorganization plan for a limited period; court may appoint new management or trustee; strong automatic stay provisions.
  - US system viewed as informal, short, and less costly relative to Germany and England; creditors have overall less influence on procedure.
- Hypothesis 2 (characterization and perception):
  - German legislation tends to be protective, creditor-friendly (favoring employees); bankruptcy carries negative public perception and stigma; criminal sanctions for wanton bankruptcy (s283 Strafgesetzbuch).
  - English legislation comparatively liberal but attitude toward debtor is negative; employees’ wages enjoy priority (IA s19 s. [6–10]); voluntary agreements commonly used to restructure without legal proceedings.
  - US legislation considered debtor-friendly; bankruptcy viewed as misfortune rather than misbehavior; reorganizations often occur outside formal proceedings.
- Hypothesis 3 (default definition and initiation of proceedings):
  - Germany: formal proceedings can be initiated by court order on application by debtor or creditor; court initiates only in case of economic bankruptcy (debtor cannot pay claims when due); imminent bankruptcy and insolvency defined by asset value lower than liabilities (ss 17 to 19 InsO).
  - England: none of the proceedings requires economic bankruptcy as necessary condition; voluntary liquidation does not depend on economic bankruptcy; compulsory liquidation may be initiated under various grounds (IA, Part IV, ss122 to 124); administration requires inability or likely inability to pay debts (IA, Part II, s8).
  - US: rules for initiation set out uniformly in the Bankruptcy Code (further details follow in the source).

*Source: Appendix 3 and beginning of Appendix 4 from the provided IMF content unit.*

### Chapter 3 of the Bankruptcy Code which distinguishes voluntary and involuntary initiation.

### _wp1155 - Chapter 3 of the Bankruptcy Code which distinguishes voluntary and involuntary initiation.

### Voluntary vs. involuntary initiation (Bankruptcy Code, Chapter 3 / Chapter 6 references)
- Voluntary initiation:
  - Requires only the filing of a petition by the debtor (Chapter 6, s301).
  - The court does not audit the soundness of the filing.
- Involuntary initiation:
  - Initiated by creditors and does not depend on the economic bankruptcy of the debtor.
  - Permitted only against certain persons, particularly business or commercial corporations (Chapter 6, s303, Franks et al. 1996: 93).
- Observed implication:
  - The notion of economic bankruptcy (as defined in the US Bankruptcy Code, Chapter 1, s101 (32)) plays a far less important role in US bankruptcy law than in the other legislations covered and is, by and large, not a prerequisite for formal bankruptcy proceedings.

### Security interests in comparative perspective (Hypothesis 4)
- Hypothesis 4:
  - There are no fundamental differences in national legislations concerning credit risk mitigation instruments; legal patterns for standard security interests are similar.

### Personal security interests — structure and cross‑jurisdictional mapping
- Key distinguishing criterion:
  - Level of accessoriness (degree of dependence on the principal title).
- Standard/accessory form in all three systems:
  - Called “guaranty” in English and US law and “Bürgschaft” in the German Civil Code (Bürgerliches Gesetzbuch [BGB], ss765 ss.).
- Non-accessory forms:
  - English law: “indemnity” (Andrews/Millett 2005: 10ss.).
  - US law: “suretyship” (Elder 1972: 6, Clarkson et al. 1992: 627); an indemnitor in US law is only liable for loss or damage, not for perfection.
  - German law: no definite non-accessory personal security instrument; “Schuldbeitritt” (co-signing as a second primary debtor) induces similar legal consequences.
- Variation:
  - All legal systems allow variations of these standard forms by security agreement.
- Tabular mapping (verbatim entries from source Table 13):
  - DE: Accessory “Bürgschaft”; Non-Accessory “Schuldbeitritt”; Variation possible Yes
  - UK: Accessory Guaranty; Non-Accessory Indemnity; Variation possible Yes
  - US: Accessory Guaranty; Non-Accessory Suretyship; Variation possible Yes

### Real securities — comparative issues and criteria
- Major valuation and distinction criteria used in the comparison:
  - (i) Whether the security interest can attach to intangibles (titles, particularly stocks and shares), mobile (e.g. vehicles) or immobile items (land).
  - (ii) Whether the interest only attaches to and remains on a certain item specified in the security agreement (fixed title) or covers floating assets (floating title).
  - (iii) Whether the security interest requires publicity (public filing) or possession (possessory security).
  - (iv) Whether realization is only possible by exploitation (sale) of the collateral or whether foreclosure is possible.

- German law (BGB):
  - (a) Recognizes “Pfandrechte” on immobile, mobile items and intangibles (ss1113, 1273, 1204 BGB); additional instruments: “Sicherungsabtretung” and “Sicherungsübereignung” (ss398, 929, 158 BGB).
  - (b) No legal distinction between fixed and floating security interests; collateral must be specifically described but descriptions like “all the stock in a specific warehouse” can create interests similar to floating charge (Oechsler 2004: mn. 5 ss.).
  - (c) Publicity central: real security interests in land listed in a public register (s1115 BGB); security interests in moveable collaterals can only be possessory (s1205 BGB). Use of transfer of property and assignment of titles adopted to enable non-possessory security in practice.
  - (d) Foreclosure is disallowed; standard exploitation is sale of collateral and distribution of proceeds (ss1147, 1228 BGB).

- English law:
  - (a) Multiple real security types: mortgage (land, goods, titles), charges and debentures, pledges and liens limited to movables, assignment for titles. “Hypothecation” used in banking documents but not a distinct form (Ali 2002: 89).
  - (b) Mortgages and charges can be fixed or floating; fixed covers fixed assets (land), floating covers floating assets (stocks, raw materials).
  - (c) Common law requires public filing for mortgages on land or sometimes movables; equitable mortgages under seal exist in practice. Mortgages and charges non-possessory; pledges and liens effective only if creditor has possession.
  - (d) Standard satisfaction: sale of collateral and distribution of proceeds; foreclosure allowed under certain circumstances (Ali 2002: 104ss.). Some interests (lien) may only authorize detention.

- United States (UCC and State law):
  - (a) UCC (1962, Art. 9) unified law of real securities other than land; adopts universal concept of security interest in movables and intangibles and introduced “collateral” as a term. Land security remains State law and varies.
  - (b) UCC does not distinguish fixed vs floating; collateral must be specifically described and specifications like “all the stock in a specific warehouse” can create floating-like interests (§ 9–204 UCC). Descriptions like “all the debtor’s assets” or “all the debtor’s personal property” are insufficient (s9–108 UCC).
  - (c) UCC principle: public notice of the security interest must be given (s9–308). US State law is not uniform.
  - (d) US law allows foreclosure under certain circumstances (s9–620ss. UCC); common form of exploitation is sale and distribution of proceeds (ss9–609, 9–610 UCC). Some security interests allow only detention of collateral. State law for land security interests is non-uniform.

### Comparative summary of real securities (Table 14 — key patterns)
- The provided tabular summary (Table 14) categorizes instruments by:
  - Security types (Mobiles, Immobiles, Intangibles) and by Possessory / Public filing / Non-possessory and Fixed / Floating.
- Foreclosure:
  - Marked as existing in UK and US (legend: ‘x’ denotes existence).
- Overall conclusion from tables and narrative:
  - Differences between DE, UK, and US legislations on real securities are relatively limited in structure; distinctions concentrate on publicity requirements, possessory versus non-possessory forms, and state-level variation for land in the US.

### Practical implications for credit risk mitigation and recovery
- All systems provide accessory personal securities (guaranty/Bürgschaft) as the baseline creditor protection.
- Non-accessory personal securities or equivalents differ in name and mechanics (indemnity, suretyship, Schuldbeitritt).
- For real securities, practical lending solutions (e.g., use of assignments, transfer of property, specific collateral descriptions) have evolved to overcome formal limitations (e.g., German possession requirement) and to create floating-like security despite doctrinal differences.
- Publicity and registration regimes (public filing, registries) are critical for establishing priority and enabling creditors to check existing charges; approaches vary across jurisdictions and between movables/intangibles/land.
- Foreclosure rights vary: permitted under certain conditions in UK and US; disallowed in Germany where sale and distribution of proceeds is the standard remedy.

*Source: _wp1155 - Chapter 3 of the Bankruptcy Code which distinguishes voluntary and involuntary initiation.*

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