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It is clear that in a modern developed economy, numbering many thousands of stakeholders - creditors, employees, suppliers, etc., i.e., all those participants whose material interests are directly linked to the functioning of a given corporation, the formalization of such contacts would have required unimaginably high transaction costs. And the law on bankruptcy, which implies the existence of certain methods for uni form centralized settlement of financial problems arising as a result of a companyТs insolvency, can be regarded, according to one of the most eminent experts in the field of economics and law, simply as a standard contract, whose very existence would mean economizing on transac tion costs6.

The existence of externalities in this sphere results in a search for appropriate terms to be stipulated in credit contracts that would ensure a relatively greater protection of property rights. For this purpose, in particular, mortgage notes have already been applied for a long time, when a loan is secured by certain real assets or securities. In the event of a violation of the credit contract, the creditor, in the majority of cases, Posner R. Economic Analysis of Law. 5 th ed. - A Wolters Kluwer Company, 1998, p. 442.

could appropriate these assets in lieu of compensation (or the pro ceeds of their sale); in some countries, such claims to property have been put forth even irrespective of whether the registration of a bank ruptcy procedure is effectuated.

Still, the development of the market for securities and bank credits can by no means be limited to mortgage notes. The role of УsecurityФ for liabilities being formed within various sectors of the financial market in the modern situation is being played primarily by a regular cash inflow to a company.

It is in the situation of a considerably worsened financial status of a given company that the priority for the fulfillment of obligations by a borrower is playing an especially significant role. This, as has been noted earlier, represents an important aspect of those externalities that influence the functioning of the credit relations which reveal the links existing between different markets.

When a company is making use of the services of only one creditor, has no obligations to any other stakeholders, and an appropriate credit contract provides a sufficiently clear statement of property rights ex post, an efficient solution, in fact, could be achieved through the УCoa seanФ processes (described by R. Coase7) of market bidding which util ize side payments. However, the uncertainty as to the subsequent dis tribution of property rights8, still further augmented by the presence of numerous creditors and other stakeholders, makes the overall picture look entirely different9.

The following circumstance is also worth considering. A creditor with certain claims presents these claims in respect to a part of property owned by the debtor, whereas the debtor company, even when capable of continuing its activity, can do so only if it utilizes all its assets (sup See, e.g., Coase R. The Problem of Social Cost. - УJournal of Law and EconomicsФ, 1960. Vol. 1, pp. 1Ц44.

Stressing this aspect of the problem is seen as especially important due to the enormous transaction costs required in such a situation.

One, a simplest, example will suffice. Assume that a companyТs liquidation value amounts to 300 million roubles, while the amount of its liabilities to Creditor X is 250 mil lion roubles, that to Creditor Y is 350 million roubles, etc. Then, by resorting to appropriate УcompensationalФ incentives, Bank X would be able to achieve an agreement with the debtorТs CEOs concerning a complete repayment of its credits; the other creditors would then have to get reconciled to only a small proportion of the bankruptТs assets.

posedly, the difficulties befallen to a company may represent an evi dence that it has exhausted all its liquid, as well as all the other, re serves). And even if the company suspends its activity and makes an attempt to sell a part of its property in order to settle those liabilities in respect to which payments are due, this procedure of УpartialФ sale would result in a substantial reduction in its assetsТ total value.

Let us now discuss in more detail the relations developing between creditors, on the one hand, and the borrower company, on the other, during the period when the company begins to experience serious troubles. In a situation of growing financial tension and УsetbacksФ in fulfilling the terms of credit contracts, each creditor utilizes, when de veloping an appropriate strategy, the widest possible range of market УsignalsФ. When discussing the issue as to a possible interpretation of these signals in face of information asymmetry, P.Milgrom and J. Rob erts convincingly demonstrated that given sufficiently plausible prereq uisites, the only sequential equilibrium that can be possible within their model is based on an assumption that each of the decision making par ticipants is oriented to the most pessimistic interpretation of the signals being received. This principle is formulated as Уassume the worstФ10.

At a certain stage in the development of this process (when many creditors have the possibility to petition the court concerning a violation of a credit contract), the phenomenon of spontaneous realization of pessimistic prophecies inevitably occurs. In face of the expected at tack, the most cautious (or active) creditors urgently present their claims to payment, and this, in its turn, induces other creditors to act, at the same time dramatically reducing the possibilities for refinancing the liabilities for which payments are due by means of new credits11.

The strategy of preemptive actions is an indispensable component of the zero sum game. (From the point of view of efficiency in terms of See Milgrom P., J. Roberts. Relying on the Information of Interested Parties. - УRand Journal of EconomicsФ, 1986. Vol. 17, pp. 18Ц32.

In some theoretic papers, models of depositorsТ attack on a bank were built, describing in detail the logic of evolving Уbanking panicФ and Уmob behaviorФ in a situation of informa tion asymmetry - see, e.g., Bryant J. Bank Collapse and Depression. - УThe Journal of Money, Credit, and BankingФ, 1981 Vol. 13, pp. 454Ц464; Diamond D., P. Dybwig Bank Runs, Deposit Insurance, and Liquidity. - УJournal of Political EconomyФ, 1983 Vol. 91, pp. 401Ц419; Von Thadden УOptimal Liquidity Provision and Dynamic Incentive Compati bilityФ. - 1995.

society as a whole, the game in question represents a negative sum game, because the participantsТ strategies require substantial efforts and material resources). The competition in caution among the credi tors, especially if one considers the random enough choice of УsignalsФ and discrepancies in their interpretation, as well as the looming threat of attack on the company, must undermine any stability of production and financial operations being conducted by the borrower company.

In a situation of increasing financial troubles, the behavior of owners (holders of the main bulk of shares), as well as of the top managers of a borrower company would also display dramatic changes. The threat of a companyТs total collapse, coupled with limited liability of the share holders in respect to its property, will promote a switchover to more risky operations.

This switchover is dictated by a certain logic. In face of a looming threat, entrepreneurs seemingly abandon their former caution and, in fact, attempt to utilize every opportunity for survival and recovery of in come, including Уtoo riskyФ ones12.

This trend is even more distinctly outlined in those actions of share holders and CEOs that directly contradict the principles of efficient functioning of private property. Here we mean the strategy that involves the liquidation Уfrom insideФ of a company which is nearly bankrupt and a gradual withdrawal of a part of its assets from the company. The evolving operations are also characteristic of a negative sum game: the resources and efforts of a companyТs owners and/or CEOs are spent on УrecombiningФ - a redistribution of the actual ownership rights - thus resulting in destruction of the informational and organizational capital embodied in the economic structures that are being undermined.

Thus, the functioning of decentralized market mechanisms can en sure only a partial protection of the creditorsТ property rights. At the Since the 1970s, economic theory has been commonly applying option models of an insolvent company (among the most well known publications in this field, a Nobel Prize winnerТs work can be mentioned - see Merton R. On the Pricing of Corporate Debt: The Risky Structure of Interest Rates. - УThe Journal of FinanceФ. 1974. Vol. 29, pp. 449Ц470.

Within the framework of theoretic models like MertonТs model, the transition to investment projects with a comparatively wide dispersion of expected incomes and losses can be easily explained by the growing value of the corresponding call option, which supposedly belongs to a companyТs owners (the price of the execution of such an option is equal to the nominal value of a companyТs debt liabilities).

same time, while the structure of property relations is becoming more complex, the УexplosiveФ trends also become more evident, of an oppo site orientation.

As a companyТs financial status worsens, the scope of destructive processes also inevitably grows, which - in absence of efficient bank ruptcy procedures - would logically follow the decentralized solutions to the problems resulting from insolvency. In such situations, the corre sponding costs would also be increasing in leaps - the costs of insol vency resulting from the behaviors of both the creditors, who are trying to ensure the salvation of their loaned money, and the shareholders, as well as of the CEOs who are in charge of the borrower company. All this sets the boundaries for potential internalization of the abovesaid exter nal effects, and more clearly reveals not only the functions of the cen trally established bankruptcy procedures, but also the special (Уprior ityФ) character of appropriate legislation.

The system of laws on bankruptcy establishes, in a mandatory pro cedure, unified criteria of a companyТs insolvency, regulates the proce dure of registration in bankruptcy, as well as the procedures implying simultaneous consideration of all the liabilities of a debtor company to all interested parties. Thus, the existence of unified State standards, norms and procedures eliminates the possibility for constructing any special terms of settlement with one or other participant - the terms that could have been envisaged in individual contracts with regard to the event of a companyТs insolvency.

In this connection, the criteria of insolvency may originate not only from the fact of a failure to make payments against those liabilities whose time for redemption is approaching, but also from the overall indices of a companyТs financial status. Thus, in the USA, a companyТs Уinsolvency in a bankrupt senseФ is determined on the basis of regis tered accounting records: the evidence of such insolvency can be pro vided, in accordance with the established definitions, by a negative net present value (in the document in question, the situation is being dis cussed when a companyТs liabilities are higher than its fair market value). Therefore, even companies that have never used loans may be come insolvent in terms of bankruptcy13.

It should be noted that legislation on bankruptcy designed to over come the limitations associated with the incompleteness of individual contracts, is also incomplete to a significant degree. An outcome of the proceedings in bankruptcy also largely depends upon the way the lawТs provisions can be interpreted in respect of a certain specific situation.

Vivid evidence as to the incompleteness of the laws on bankruptcy can be provided by the huge amounts of money spent by interested parties on attracting УexpertsФ - lawyersТ companies specializing in bankruptcy proceedings, payment for the services of investment banks, etc.

Since bankruptcy norms and procedures must be uniform, the cor responding laws are usually adopted at the federal (national) level.

However, the law enforcement practice, as a rule, varies considerably depending on a particular region. The variable degree of creditor pro tection represents one of the factors that determine, in particular, the uneven distribution of non payments and unequal development of credit and insurance operations in different administrative entities (states, republics, provinces, oblasts).

1.2. The forms of bankruptcy: liquidation or reorganization A theoretical analysis of the problem proceeds from the assumption that bankruptcy procedures must ensure the following:

Х firstly, maximization of the current value of a company undergoing a liquidation or a reorganization procedure (efficiency conditions be ing realized ex post), and Х secondly, an optimal distribution (redistribution) of the said value among interested parties.

It is the latter condition, that is, the norms determining the propor tions of income (or property) redistribution among interested parties, that influences the pre bankruptcy actions of borrowers, creditors and Thus, a joint stock company without any debts may find itself, in accordance with the abovesaid definition, Уinsolvent in terms of bankruptcyФ in those instances, when, e.g., its average aggregate costs are higher than its average revenues (gross incomes).

other participants in this relationship (stakeholders) (efficiency condi tions being realized ex ante).

By setting certain standards in the sphere of property rights protec tion in the event of a companyТs insolvency, and thereby determining the Уdegree of reliabilityФ of various liabilities, legislation on bankruptcy serves as a starting point for settlements effected between the partici pants in the economic process. Thus, specially determined terms and procedures of bankruptcy to a substantial degree influence the choice made by the owners (or CEOs) of a debtor company - either to sell the company, or to make a private agreement with creditors, or to officially declare the company bankrupt. The degree of protection of the ownerТs interests, as determined by bankruptcy procedures, is directly taken into consideration by creditors when estimating their investment risks.

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