Subordination of Shareholder Loans between Creditor Protection and Rescue Culture

An Escapable Tension?

Abstract

In financially distressed companies, shareholders have the tendency, as recorded throughout all major jurisdictions, to provide finance by way of loans for purposes of accomplishing a better position in the prospective insolvency proceedings to the detriment of the external creditors while “gambling” on the company’s resurrection. Insolvency Law seeks to intervene to limit such practices by subordinating this type of shareholder loans to the claims of the other creditors, thus upholding its nature of “creditor protection law”.
This paper provides a critical overview of the existing legal framework concerning the subordination of shareholder loans and, in doing so, examines the function of Insolvency Law when dealing with it. In the first place, this paper describes the conflict in corporate law between shareholders and creditors brought about by the practice of shareholder loans. Secondly, it discusses and examines some of the rules that US Bankruptcy Law and German Insolvency Law developed in this area. Thirdly, in light of the resulting findings, the paper will focus on the issue raised concerning the lack in the norms with respect to the role that shareholder loans could efficiently perform in rescuing companies on the eve of their insolvency.
It is argued in this paper that an unselective subordination of shareholder loans and the unconditioned protection of creditors should not be persistently regarded as the “panacea” . It is rather the opinion of this paper that the function of Insolvency Law in the context of shareholder loans should be reviewed by policymakers to encompass the benefit of the company as a whole.