The global auto giant General Motors (GM) filed for the Chapter 11 bankruptcy protection in New York at 7:57 am on June 1, in an electronics submission. The largest failure for a manufacturer in the U.S. history required only 24 pages of document for the filing. 

But the landmark case has drawn strong interest from worldwide. Without the court's approval, no creditors can make any of their claims from the moment of the filing and all the rights owned by traders, lenders, corporate bond holders, and shareholders are to be postponed or reduced. The existing ownership and financial structure at the carmaker will be overhauled and a new GM will be created consequently. 

In Korea, "bankruptcy filing" can be taken as the beginning of the liquidation procedures but it has different meaning in the U.S. First, the word of "bankruptcy" contains both liquidation and reorganization. GM filed for the reorganization step. The filing is also called as "bankruptcy relief" as creditors cannot exercise their rights and a debt rescheduling program starts at the very moment of filing for the Chapter 11.

Why does a failed company apply for the court protection although there are other ways of debt restructuring, such as voluntary agreement among interested parties? This means the failure of a voluntary deal. For a unhealthy firm to regain the financial strength, it needs a sharp cut to its debt but creditors refuse to make any concessions. Or shareholders may not want to make more sacrifices. In any case, the company comes to a conclusion that it needs a compulsory court procedure to restructure its debt to a needed level. 

Many countries, including South Korea, have similar debt restructuring procedures but not as strong as those in the U.S. For example, the filing for the court protection itself cannot freeze creditors' claim in Korea. The court should issue an order for the asset preservation or comprehensive ban on asset disposal. Unlike the U.S., a debtor cannot choose the timing to stop the creditors' exercising their rights.

In Korea, a debtor should prove its inability to repay the debt when filing for the bankruptcy protection but the U.S. is not the case. Under the Chapter 11, a debtor can resort to the legal support whenever it needs a debt rescheduling for its future even though it has no problem in repaying the debt at now. 

Furthermore, since the right to draw and submit a restructuring plan is granted to the debtor for a certain period of time in the U.S., the debtor has the initiative over the program. For this reason, the U.S. Chapter 11 bankruptcy protection is the most powerful weapon for a debtor's revival. Sometimes, a debtor can manage to obtain creditors' agreement over a debt rescheduling scheme even before resorting to the legal protection. 

The reasons behind Obama's choice over GM 

What's noticeable over the GM's bankruptcy filing is the U.S. President Barack Obama's choice. The automobile industry is the heart and hallmark of the U.S. industry. And the auto labor union has been a key political constituency for Obama. But he rejected a direct support and instead chose a court protection. The choice could become a political risk for him but it seems the U.S. public opinion regard it as a right decision. It's probably because they don't trust a government intervention in a corporate restructuring process for several reasons.

First, they believe the debt rescheduling is not a job for the government. It is an outcome of a fierce negotiation where you can get more from the others' concessions. If the government intervenes, people may criticize that the authorities' power has been overused or politicians may yield to such a heavy pressure that they could not drastically undercut the debt.

Second, to revive a company requires not only debt restructuring but also a new business plan, which is not a job for the government. Only private-sector professionals can see market demand and figure out how to cope with the changing demand and win the competition. And it is the company that should be responsible for the outcome. 

Third, it is more important for the government to stay fair. With the U.S. largest company faltering, no other companies are free from a possible bankruptcy. There would be more and more companies asking for the government help and the case of GM would become a precedent for the followers. The U.S. government came to a conclusion that they could maintain a fair and objective stance only through legal procedures. 

Implications for South Korean corporate restructuring efforts

Even without external shocks such as the recent global financial market meltdown driven by the subprime loan crisis, companies can collapse at any time. They should win endless throat-cut competition with rivals and constantly satisfy consumers with better products and services. Otherwise, they would be isolated from consumers and forced out of the market. In order to survive the competition and keep its market share, a company should do its best all the time. We all know this is not easy. Therefore, it's critical to draw up and run an efficient bankruptcy procedure.  

Since the second half of last year, the debate about the corporate restructuring has gained force in South Korea. Some non-viable builders and shippers have been weeded out and even large business groups have been going through restructuring. The bankruptcy filing by GM has several implications on our corporate restructuring drives. 

First, the government should avoid its direct intervention with the corporate restructuring process. We have a long history of direct government intervention in handling with non-viable companies.  A good example is the so-called industry rationalization policy evolved from the state-led industry reorganization in1969. The action taken on August 3, 1972 was one of the strongest government interventions hardly seen around the world. Even after the 1997 Asian financial crisis, the government continued to intervene in the form of default delay, big deals, and debt workout programs.

Although the debt workout program has been promoted as a deal based on voluntary agreements among creditor financial institutions, everyone knows the financial watchdog has been the real mastermind behind the scheme. Then was it an effective restructuring method? An empirical study based on a survey of listed companies shows that the voluntary debt workout program has been less effective than the legal liquidation procedures in terms of the recovery pace after the end of the credit support. The reason is that there have been some limitations in creditors' efforts to cut the debt on their own.

A government intervention inevitably brings about corruption. There is no way to stop the interested parties' desperate efforts to approach the policymakers and obtain favourable outcomes. Hence comes a saying that a recession breeds corruption. In Korea, the financial watchdog is in charge of corporate restructuring plans, which should be changed as soon as possible. The authorities should hand over the decision to the private sector and set up a political neutral agency to implement the reform if the issue requires some public judgement. The task of restructuring the corporate secotr is not a job for a committee within the financial watchdog.  

Second, a procedure that can reduce the debt drastically should be introduced. Non-viable companies require two supports: a cut to the debt and an access to new lifeline. Both are very critical to their survival but we've been very slow in debt reduction. Creditors have been reluctant to writing down the loans in their books and shareholders have been loath to share cancellations. Without a drastic cut to the debt, it's hard to revive a financially weak company how much new money is injected. A number of past rescue projects have failed since the new fund has been used to repay the debt rather than to create new revenue.

Third, the government should follow the market principles when deciding to extend bloodline. When the government directly supports a company, it should take over the fairly evaluated stake in the company to keep it afloat as seen in the case of GM.  Or, it can set up a joint fund with private investors while letting them decide over how to use the money. The latest government move to rely on such a fund is highly welcomed.

It's desirable to restructuring a non-viable company through legal means or a private debt rescheduling deal based on legal procedures. But international bankruptcy exports have been recently seeking countermeasures in case the crisis escalates beyond the capability of the existing systems. They have been talking about a new public body that can lead the worldwide corporate restructuring. We should pay a close attention to the global development and prepare for a  far worse scenario.

By Oh Su-keun / Professor of the Graduate School of Law at Ewha Womans'University