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Three strikes and out

Leigh W Sparrow, Publisher
Leigh W Sparrow, Publisher

September 2, 2012 - We are currently seeing a number of business failures and liquidations caused mostly by a lack of cash flow finally crippling companies that have been limping along for some time.

Some of them are unfortunate examples of several pieces of bad luck coming along at the same time, while others are decent companies that just do not know their way around the bankruptcy ‘system’ or have simply left it too late to restructure.

However among them are, as usual, a number of serial bankrupts who should never be allowed near the controls of a company, while others or are out-and-out crooks. The incompetents are highly educated, highly plausible individuals that just do not understand the basics of business, although they can usually manage to run decent lifestyles while they destroy the company.

The crooks are bright individuals, also highly plausible, but they essentially set out or soon decide to run a scam. They set up a company run it for two or three years then towards the end of the cycle, register a new company with almost the same name, if you didn’t already do that at the start, then stop paying suppliers, while they give the business one last ‘milking’ for old times’ sake, as they shift the operations to the new company and let the old one go bust.

It is amazing how many times some of these people get with this one. Sadly if such people applied themselves to running a business properly they would/could do exceptionally well.  

In many countries an executive director is stripped of and barred from holding any directorships if one of his companies fails during his watch. There are many ways around this of course, resign and appoint a stooge in the final days, work as a puppet master of a new company through relatives etc….

Now there is nothing particularly wrong with going bankrupt, not everything works out as expected and unforeseen events can devastate a young business. Failure is a key part of the capitalist system and encourages innovation. Overly onerous regulation can stifle enterprise and risk-taking, both of which are required in a vibrant economy. A key element is what caused the bankruptcy – was it utter incompetence or fraud, did the managers/directors add to the company’s debts when they should have known full well that the creditors would never get paid? The former is very hard to prove, the latter is supposed, in many jurisdictions, to get you struck off as a director for trading while insolvent, but apart from the most scandalous cases it rarely does.

So what’s the answer?

I think there should be a rule, rigidly enforced, that those responsible for more than two bankruptcies where creditors are left unpaid, are banned from being a director, a controlling shareholder or a senior manager for 10 years. If a doctor kept killing patients he is struck off, if a pilot has a number of near misses he is fired, why then are senior managers/directors owners allowed to carry on with their incompetence, while having limited liability?

The first job of the administrator should be to check what has happened and report any cases of unusual fund transfers or trading while insolvent to the public prosecutor. After all the largest non- secured creditor is often the government for unpaid tax. Incumbent management/owners should also have to ‘jump through more hoops’ than independent bidders to take over the assets of a failed business.  

So that’s it - fail once and OK that can happen, fail twice and that’s borderline irresponsibility and individuals starting or managing new businesses should be closely monitored. They should also not automatically be given prime opportunity to buy the failed business assets. Fail a third time and you should be barred from any position of influence of controlling ownership for a very long time as well as heavily fined.

Such failures distort the market they can bring down good, well managed companies which are left unpaid, while in some cases the failures start up again in competition with fewer debts. The secret is to find a system that is fair yet still encourages entrepreneurial risk taking.

The ‘three strikes and you are out’ has apparently been good for cutting crime in New York I think it could help make Western insolvency processes fairer, better for business and good for the economy.

 

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