Privatized bankruptcy: a study of shipping financial distress

The current trend in bankruptcy legislation is to follow the US model of Chapter 11, whereby the courts have the authority to ‘stay’ the liquidation rights of the secured creditors. The alternative approach of freedom of contracting, whereby the courts limit themselves to strictly enforcing the rights of all parties, is largely ignored, for fear that such a system would be plagued by coordination failures among creditors. We study the resolution of financial distress in shipping, where the ex territorial nature of assets have distanced the industry from on shore bankruptcy legislation. We have three main findings. First, we demonstrate how financial distress can be effectively resolved by way of a contract and other private institutional arrangements. Second, that the economic cost of financial distress is low. Moreover, the cost seems to be driven by dysfunctional owners rather than uncoordinated creditors. Third, we estimate the fire sale discount, and demonstrate that much of the estimated discount is due to low maintenance of vessels and is largely concentrated in low valued vessels and corrupt ports. The shipping industry with its multitude of jurisdictions might be expected to provide for disorderly defaults; whereas in fact we find an industry close to Hayek’s ‘spontaneous order’. “There is only one law in shipping: there is no law in shipping”. Sami Ofer (shipping magnate)