Journal of Legal, Ethical and Regulatory Issues Volume 26, Special Issue 3, 2023

BANKRUPTCY: A LEGAL COMPARISON

Atharyanshah Puneri, International Islamic University Malaysia
ABSTRACT

Bankruptcy is public information on the economic status of its liabilities have exceeded
the assets. Thus, bankruptcy is a declared state of insolvency pronounced by a court. This
informational difference has economic consequences whereby a hint of a possible insolvency of a
financial firm can lead to its bankruptcy. This Paper tries to explore and compare how
Bankruptcy is governed by Western Law, Indonesian Law and Islamic Law.

Keywords: Insolvency, Bankruptcy, Indonesian Law, Western Law, Islamic Law.

INTRODUCTION

The term insolvency and bankruptcy carries a respective meaning but sometimes used
interchangeably. Insolvency is a state of private information whereby the total assets have fallen
short of total liabilities. Meanwhile, Bankruptcy is public information on the economic status of
its liabilities have exceeded the assets. Thus, bankruptcy is a declared state of insolvency
pronounced by a court. This informational difference has economic consequences whereby a hint
of a possible insolvency of a financial firm can lead to its bankruptcy (Sharma & Vyas, 2017).
A state of less than public information can result in rumors, expectations and a different
kind of behavior from the counterparties of the distressed individual or institution than that in a
state of public information. In the former case creditors try to take advantage of their own
information unsure if others have same or different information. While in later case everyone is
approaching the issue with same knowledge without any asymmetry of information.
This paper are trying to explore more regarding bankruptcy in the terms of pertains to
negative net worth. A shortfall in cash-inflows compared to the planned cash-outflows required
to meet the present obligations can create an event of default but it does not necessarily create an
insolvent state i.e., negative net worth or bankruptcy. Furthermore, this paper is trying to
compare on how bankruptcy are govern and regulated under Western Law (in this paper focus on
American Law), Indonesian Law and Islamic Law. To be able to see the differences, this paper
also conducting a case study based on the bankruptcy of Arcapita Group in Malaysia.

Bankruptcy in Western Law Perspective

Bankruptcy is a constitutional right of protection against creditors. It allows consumers

and businesses to make a fresh start when they owe so much money relative to their income that
they cannot afford to pay their debts. Depending on the specific type of bankruptcy that is filed,
most of the debts owed by a consumer or a business will be wiped out or the debts will be
reorganized so that the consumer or business can afford to pay them. In exchange for the
financial fresh start that bankruptcy provides, however, the consumer or business may have to
give some of their assets back to their creditors. Furthermore, the bankruptcy will remain in the

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consumer’s credit history for up to ten years and during that time, if the consumer is approved
for new credit, the cost of that credit will be high. If you are like most consumers who are
struggling to pay their bills, even though you know that filing for bankruptcy will help you deal
with your financial situation, you may not be sure that you want to take that step. After all, you
have worked hard throughout your life and you have been willing to make sacrifices to pay your
bills. As a case in point, when your financial troubles began, you probably tried everything you
could think of to turn your financial situation around. In the United States, bankruptcy is
governed by federal law. The United States Constitution (Article 1, Section 8, and Clause 4)
authorizes Congress to enact uniform Laws on the subject of Bankruptcies throughout the United
States. Congress has exercised this authority several times since 1801, most recently by adopting
the Bankruptcy Reform Act of 1978, as amended, codified in Title 11 of the United States Code
and commonly referred to as the Bankruptcy Code (Aghion et al., 1992). The Code has been
amended several times since, with the most significant recent changes enacted in 2005 through
the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA). Some law
relevant to bankruptcy is found in other parts of the United States Code.
Article I, Section 8, of the United States Constitution authorizes Congress to enact
uniform Laws on the subject of Bankruptcies. Under this grant of authority, Congress enacted the
Bankruptcy Code in 1978. The Bankruptcy Code, which is codified as title 11 of the United
States Code, has been amended several times since its enactment. It is the uniform federal law
that governs all bankruptcy cases (Kimhi, 2010).
The procedural aspects of the bankruptcy process are governed by the Federal Rules of
Bankruptcy Procedure (often called the Bankruptcy Rules) and local rules of each bankruptcy
court. The Bankruptcy Rules contain a set of official forms for use in bankruptcy cases. The
Bankruptcy Code and Bankruptcy Rules (and local rules) set forth the formal legal procedures
for dealing with the debt problems of individuals and businesses. There is a bankruptcy court for
each judicial district in the country. Each state has one or more districts. There are 90 bankruptcy
districts across the country. The bankruptcy courts generally have their own clerk’s offices. The
court official with decision-making power over federal bankruptcy cases is the United States
bankruptcy judge, a judicial officer of the United States district court. The bankruptcy judge may
decide any matter connected with a bankruptcy case, such as eligibility to file or whether a
debtor should receive a discharge of debts. Much of the bankruptcy process is administrative,
however, and is conducted away from the courthouse. In cases under chapters 7, 12, or 13, and
sometimes in chapter 11 cases, this administrative process is carried out by a trustee who is
appointed to oversee the case. A debtor’s involvement with the bankruptcy judge is usually very
limited. A typical chapter 7 debtor will not appear in court and will not see the bankruptcy judge
unless an objection is raised in the case. A chapter 13 debtor may only have to appear before the
bankruptcy judge at a plan confirmation hearing.
Usually, the only formal proceeding at which a debtor must appear is the meeting of
creditors, which is usually held at the offices of the U.S. trustee. This meeting is informally
called a 341 meeting because section 341 of the Bankruptcy Code requires that the debtor attend
this meeting so that creditors can question the debtor about debts and property. A fundamental
goal of the federal bankruptcy laws enacted by Congress is to give debtors a financial fresh start
from burdensome debts. The Supreme Court made this point about the purpose of the bankruptcy
law in a 1934 decision: It gives to the honest but unfortunate debtor a new opportunity in life and
a clear field for future effort, unhampered by the pressure and discouragement of pre-existing
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debt. Local Loan Co. v. Hunt, 292 U.S. 234, 244 (Brown, 2014). This goal is accomplished
through the bankruptcy discharge, which releases debtors from personal liability from specific
debts and prohibits creditors from ever taking any action against the debtor to collect those debts.

Chapter 7 Liquidation under the Bankruptcy Code

A chapter 7 bankruptcy case does not involve the filing of a plan of repayment as in
chapter 13. Instead, the bankruptcy trustee gathers and sells the debtor’s nonexempt assets and
uses the proceeds of such assets to pay holders of claims (creditors) in accordance with the
provisions of the Bankruptcy Code. Part of the debtor’s property may be subject to liens and
mortgages that pledge the property to other creditors. In addition, the Bankruptcy Code will
allow the debtor to keep certain “exempt” property; but a trustee will liquidate the debtor’s
remaining assets. Accordingly, potential debtors should realize that the filing of a petition under
chapter 7 may result in the loss of property.
To qualify for relief under chapter 7 of the Bankruptcy Code, the debtor may be an
individual, a partnership, or a corporation or other business entity. 11 U.S.C. §§ 101(41), 109(b).
Subject to the means test described above for individual debtors, relief is available under chapter
7 irrespective of the amount of the debtor’s debts or whether the debtor is solvent or insolvent.
An individual cannot file under chapter 7 or any other chapter, however, if during the preceding
180 days a prior bankruptcy petition was dismissed due to the debtor’s willful failure to appear
before the court or comply with orders of the court, or the debtor voluntarily dismissed the
previous case after creditors sought relief from the bankruptcy court to recover property upon
which they hold liens. 11 U.S.C. §§ 109(g), 362(d) and (e). In addition, no individual may be a
debtor under chapter 7 or any chapter of the Bankruptcy Code unless he or she has, within 180
days before filing, received credit counseling from an approved credit counseling agency either
in an individual or group briefing. 11 U.S.C. §§ 109, 111. There are exceptions in emergency
situations or where the U.S. trustee (or bankruptcy administrator) has determined that there are
insufficient approved agencies to provide the required counseling. If a debt management plan is
developed during required credit counseling, it must be filed with the court. One of the primary
purposes of bankruptcy is to discharge certain debts to give an honest individual debtor a fresh
start. The debtor has no liability for discharged debts. In a chapter 7 case, however, a discharge is
only available to individual debtors, not to partnerships or corporations. 11 U.S.C. § 727(a)(1).
Although an individual chapter 7 case usually results in a discharge of debts, the right to a
discharge is not absolute, and some types of debts are not discharged. Moreover, a bankruptcy
discharge does not extinguish a lien on property.

Chapter 13 Individual Debt Adjustment

A chapter 13 bankruptcy is also called a wage earner’s plan. It enables individuals with
regular income to develop a plan to repay all or part of their debts. Under this chapter, debtors
propose a repayment plan to make installments to creditors over three to five years. If the
debtor’s current monthly income is less than the applicable state median, the plan will be for
three years unless the court approves a longer period for cause. If the debtor’s current monthly
income is greater than the applicable state median, the plan generally must be for five years. In
no case may a plan provide for payments over a period longer than five years. 11 U.S.C.

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§1322(d). During this time the law forbids creditors from starting or continuing collection
efforts.
Any individual, even if self-employed or operating an unincorporated business, is eligible
for chapter 13 relief as long as the individual’s unsecured debts are less than $360,475 and
secured debts are less than $1,081,400. 11 U.S.C. § 109(e). These amounts are adjusted
periodically to reflect changes in the consumer price index. A corporation or partnership may not
be a chapter 13 debtor. Id. An individual cannot file under chapter 13 or any other chapter if,
during the preceding 180 days, a prior bankruptcy petition was dismissed due to the debtor’s
willful failure to appear before the court or comply with orders of the court or was voluntarily
dismissed after creditors sought relief from the bankruptcy court to recover property upon which
they hold liens. 11 U.S.C. §§ 109(g), 362(d) and (e). In addition, no individual may be a debtor
under chapter 13 or any chapter of the Bankruptcy Code unless he or she has, within 180 days
before filing, received credit counselling from an approved credit counseling agency either in an
individual or group briefing. 11 U.S.C. §§ 109, 111. There are exceptions in emergency
situations or where the U.S. trustee (or bankruptcy administrator) has determined that there are
insufficient approved agencies to provide the required counseling. If a debt management plan is
developed during required credit counseling, it must be filed with the court.

Bankruptcy in Indonesian Law

Munir Fuady (2002), one of Indonesian Law Scholar defines bankruptcy as a general
confiscated over Debtor’s assets so that there will be settlement being made between the debtor
and creditor or so that assets can be divided equally between all the creditors. R. Subekti, the
other Indonesian Law Scholar said that bankruptcy is a joint effort to getting an equal payment
by all of those is owed. Meanwhile, Purwosutjipto (1978) defined bankruptcy is everything that
has connection with the action of bankruptcy. Bankruptcy is a condition where someone or some
institution stops paying (all of their debts).
Black’s Law Dictionary defines bankruptcy as the state or condition of a person (can be
individual, partnership, corporation, municipality) who is unable to pay its debt as they are, or
become due. The term includes a person against whom a voluntary petition has been filed, or
who has been adjudged a bankrupt (Garner, 2004). According to that definition, we can see that
the definition of bankruptcy is being connected with the inability of a debtor to pay their already
matured debts, and that inability must be followed by a real action by filing a sue to the court to
be declared as bankrupt. That file a suit can be done voluntarily by the debtor itself or by the
request from the third party.
Meanwhile, in Indonesian Bankruptcy Law, according to the Indonesian Act Number 37
Year 2004 on Bankruptcy and Suspension of Obligation for Payment of Debts Article 1
Paragraph (1), Bankruptcy shall mean general confiscation of all assets of a bankrupt debtor that
will be managed and liquidated by a curator under the supervision of Supervisory Judge as
provided for herein.

Principle of the Law of Bankruptcy:

Equality: It means there must be equal treatment to both the debtor and creditor. It means
that in one party there are rules that can preventing the misuse of the authority by dishonest

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debtor and at the other hand there are some rules that can preventing the misuse of the authorities
by dishonest creditors.
Business Continuity: It means that even though the debtor already is sued to the court to
be declared as bankrupt, but they still can runs their profitable business as usual.
Justice: Rules about bankruptcy must be fulfilling the sense of justice to all parties. This
principal also being used to preventing arbitrary creditors who imposing the payment for theirs
claim without thinking about the other creditors who have the same intention.
Integration: It means that the formal legal system must be according with the material
legal system which is an integral unity from its national civil law and civil procedural law.

Requirements for Debtor to be Filed a sue as Bankrupt

If the debtor wants to be declared as bankrupt, they must meet with the requirements
which stated on Indonesian Bankruptcy law. Indonesian Act Number 37 Year 2004 Article 2
Paragraph (1) said:
“A debtor having two or more creditors and failing to pay at least one debt which has matured ad
became payable, shall be declared bankrupt through a court decision, either at his own petition or at the
request of one or more of his creditors.”

According to the article above, we can conclude that the requirements for the debtor to be
declared as bankrupt are:

1. Debtor must having at least two creditors: This requirements also being mentioned in Indonesian Civil
Code (Burgerlijk Wetboek/BW) Article 1132 which stated that generally the distribution of debtor’s
assets must done by all of the creditors according to their portion. Or in legal terms it should be
distributed by pari passu pro rata pare.
2. Debtor must at least didn’t pay one of their debts to one of their creditor: Didn’t pay in this situation
means that the debtor didn’t pay the debt that they should pay. If the debtor didn’t pay their debt only for
once, then they can’t be considered as the condition that they didn’t pay their debts.
3. The debt that the debtor didn’t pay must be matured and can be collected: The debt that already mature
means that debt has reach its maturity and debtor must pay off that debt. Can be collected means that
even though that the debt hasn’t reach it’s maturity yet, but maybe the creditor can be asking to collect
that debt to the debtor because the debtor commit default or breach of contract.

Parties who may file a Bankruptcy Petition

Not everyone can file a bankruptcy petition to the court. According to Indonesian
Bankruptcy law, parties who can be filing a Bankruptcy petition to the court are:

1. The Debtor itself: The Debtor who is filing a petition for their self must be able to explain and prove that
they have at least one creditor and also they have at least one debt that they didn’t pay to at least one of
their creditor.
2. Creditors: One or more creditors can filing a petition to the court to declaring that their debtor is bankrupt,
as long as their debtor having at least 2 or more creditors and didn’t pay their debts.
3. Attorney General: attorney General can file a bankrupt petition for reasons of public interest. Which means
by public interests in here are: Debtors run away; Debtor embezzling their assets; Debtor having debt to
State-Owned enterprises or other institution that collecting funds from people; Debtor having debt that
comes from collecting people’s money; Debtor didn’t have the good intention or didn’t cooperate to solving
their already mature debts; On any other things that the attorney general thinks it was a public interests.

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4. Bank Indonesia (Indonesian Central Bank): Bank Indonesia can filing a bankruptcy petition to the court if
the debtor is a Bank. But it must be based on the evaluation of financial condition and the banking
condition in general.
5. BAPEPAM (Indonesian Capital Market and Financial Institution Supervisory Board): BAPEPAM having
the full authority to filing a Bankruptcy petition in case that the debtor is a securities company, stock
exchange, etc.
6. Ministry of Finance: Ministry of Finance can filing a Bankruptcy petition if the debtor are insurance
company, re-insurance company, State-Owned enterprises that have the activities in public interests.

Procedures and Time Frame

The following are the relevant procedures and time frame for a Bankruptcy proceeding
based on Indonesian Bankruptcy law (Mandala, 2007):

1. A bankruptcy petition will be submitted by the court registrar to the chairman of the commercial court
within two days after the date of registration.
2. Within three days after the date on which the bankruptcy petition was registered, the court will review the
application and determine the date of hearing.
3. The bankruptcy decision must be felled within 60 days from the date the bankruptcy petition was
registered.
4. The bankruptcy decision must be sent by express registered mail to: the debtor, the applicant, the curator,
and the supervisor judge, within three days of the date on which the decision was read.
5. A petition for cassation (appeal to the Supreme Court) or civil review (by the Supreme Court of its
decision); can be submitted only to the court registrar who will forward it to the counterparty within two
days of the date the petition was registered.
6. The counter appeal must also be distributed by the court registrar to the applicant within two days of the
date on which it was received.
7. The appeal hearing must be conducted within 20 days of the date the application was received.
8. The decision must be made within 60 days from the date the application was received.
9. A copy of decision must be delivered by the registrar of the Supreme Court to the registrar of the district
court within three days after the date on which the decision was read.

In bankruptcy proceedings, a summon issued by the court registrar will be deemed to be

validly received by the debtor if the summons has been issued by registered express mail at least
seven days before the first hearing is to be conducted.

The Effect of Bankruptcy on the Debtor

As the Debtor has been declared bankrupt based on a court decision, therefore according
to Article 22 of Indonesian Bankruptcy law he has lost by the power of law of theirs right to
master and manage theirs assets. And as of that time the Debtor’s assets shall be included in the
bankrupt’s assets, managed by the Curator appointed by the Commercial Court. To manage that
bankrupt’s assets, in accordance with Article 13 of the Indonesian Bankruptcy law, the Curator’s
duty is among others to list the Debtor’s debts and the Creditor’s claim. This duty precedes his
duty to pay claims of each creditor. The Curator must beforehand list whomever to be the
Creditors, check the authenticity of the claim of each Creditor, ascertaining the amount or value
any claim.

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The bankruptcy decision by the court does not mean that the Debtor would lose his
competence to conduct legal acts in general, but only lose theirs power or authority to manage
and transfer theirs assets. Thereby, the Debtor is still able to conduct legal acts.

The Curator and Supervising Judge

Article 13 paragraph (1) of Indonesian Bankruptcy Law stated that in the bankruptcy
decision, the judge should appoint:

1. The Supervising Judge.

2. The Curator.

According to Article 63 of Indonesian Bankruptcy Law, the Supervising Judge’s duty is

to monitor the management and settlement of the bankrupt’s assets conducted by the curator.
Still according to the same Article, The Curator conducts the management and settlemet of the
bankrupt’s assets, and being monitored by the Supervising Judge.
The position of the Supervising Judge is one of the vital importance, because according to
Article 64 of Indonesian Bankruptcy Law, in prior of taking a decision regarding something
connected with the management and settlement of the bankrupt’s assets, the Commercial Court is
obliged to listen beforehand to the opinion of the Supervising Judge.

Efects of Bankruptcy on the Creditors

Different Effects for Different Types of Creditors: The creditors affected by the
bankruptcy are not all in the same position. Preferred or secured creditors have a priority claim
on the proceeds of the sale of any assets that have been pledged as security in their favor,
whether a pledge, fiducia, mortgage or privilege. Unsecured/concurrent creditors, on the other
hand, share in the division of the remaining assets and obtain satisfaction of their debts in a
proportionate percentage. Unsecured/concurrent creditors will share the money proportionately,
rather than having a situation where the first creditor to apply will be the first to receive payment.
From the date of the declaration of bankruptcy, the unsecured/concurrent creditors can obtain
satisfaction of their claims only in bankruptcy procedure and not through individual enforcement
proceedings (McKenzie, 2017).
It is important to note that only creditors having a claim against the bankrupt debtor at the
time of the bankruptcy declaration may claim payment from the proceeds of the bankrupt’s
assets. Also note that the payment obligations of the debtor that arise after the bankruptcy
declaration cannot be paid from the proceeds of the bankrupt’s assets, unless the fulfillment of
the payment obligation brings benefits to the bankrupt’s assets.
Indonesian Bankruptcy Law and Indonesian Civil Code (BW) provide general protection
to the interests of creditors. Under those laws, a creditor has the right to request the court to
annul any voluntary legal acts of a debtor if the creditor can show that the debtor and its
counterparty, when doing those voluntary acts, had knowledge that the action would jeopardize
the creditor’s interest. This protection is known as Actio Pauliana.
The burden of proof in the action would rest on the debtor if the voluntary act that
jeopardizes the creditor’s interest was carried out within one year before the date of the

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bankruptcy declaration. If the act was done earlier than one year before the date of the
bankruptcy declaration, the burden of proof in the action would rest on the creditor.

Legal Efforts against the Commercial Court Decision

Against the Commercial Court decision, either related to the bankruptcy petition or the
Petition for Suspension of Debt Payment, a legal effort could be conducted. Such direct legal
effort can be in the form of submitting Cassation petition to the Supreme Court. Such is provided
in Article 8 Paragraph (1) and Article 282 Paragraph (2) in Indonesian Bankruptcy law. In other
words, against the Commercial Court decision no appeal efforts can be conducted at the high
court.
Besides cassation, another legal effort available to the unsatisfied party is the Civil
Review. The possibility of filling the civil review petition is stipulated in the provision of Article
11 and Article 286 Paragraph (1) in Indonesian Bankruptcy Law. According to Article 11 in
Indonesian Bankruptcy Law, against the Supreme Court decision on the cassation petition,
having obtained permanent legal force, a civil review can be filled at the Supreme Court.
As provided in Article 286 Paragraph (2) in Indonesian Bankruptcy Law, the request for a
civil review can be filled if:

1. Important new written evidence are found, which if had been known previously at the court proceeding,
would have resulted in a different decision.
2. The Commercial Court has made a major flaw in applying the law.

Indonesian Bankruptcy Law does not determine what is meant by a major flaw in
applying the law as referred to in Article 286 paragraph (2) point b in Indonesian Bankruptcy
Law. The elucidation of this article does not indicate anything. The absence of the definition of
major flaw in applying the law in Indonesian Bankruptcy Law may provoke unsatisfied parties to
file easily a civil review against any court decision having obtained permanent legal force. This
matter shall only cause a delay to the proceeding obtaining a court decision.

Bankruptcy in Islamic Law

Islamic law lays down rules for iflas, the condition of being unable to pay one’s debt
(insolvency), and for taflis, the official act or procedure of declaring the person muflis or
insolvent. Debt restructuring, defaults, triggers for events of default, ross default, debt
acceleration and debt suspension mechanism such as US Chapter 11 proceedings are all
relatively new concepts to Islamic law.
Insolvency happens when debtor is unable to pay the liabilities. The probability of
insolvency increases with the increase in debt in the capital structure of firms. Islam give us
guidelines in insolvency and bankruptcy (Farahni, 2020). According to Salman Syed ALI (2013),
to understand the theory of bankruptcy and to develop models for bankruptcy resolution in
Islamic finance clarity on the following aspects is essential:

1. Islam prohibits interest.

2. Money is recognized as medium of exchange and a facilitator with no intrinsic potential to grow or increase
in value by time.

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3. Debt is not prohibited but not encouraged. It does not mean a neutral stance towards debt. Debt is rather
discouraged.
4. Debt cannot be extinguished except by payment in full (ada) or by its forgiveness (ibra) from the creditors.
There is no other way to discharge debt.
5. Justice (adal) and Benevolence (ihsan) are fundamental in all dealings. In debt contracts, it translates into
insisting the debtor to keep his promise of timely repayment and encouraging the creditors to show
leniency is case debtor is in financial difficulty to extend time and/ or forgive full or part of the debt.

The words insolvency and bankruptcy are sometimes used alternatively, however there is
a difference. Insolvency is a state of private information (known to the individual agent himself)
or at most common knowledge (known to some others around) that total assets have fallen short
of total liabilities.
Bankruptcy is public information of this fact when everyone knows that everyone knows
about an economic agent that its liabilities have exceeded the assets. That is why bankruptcy is a
declared state of insolvency pronounced by a court.
On face, this appears to be only a philosophical difference or splitting the hair, however
this informational difference has economic consequences. A state of less than public information
can result in rumors, expectations and a different kind of behavior from the counterparties of the
distressed individual or institution than that in a state of public information. In the former case
creditors try to take advantage of their own information unsure if others have same or different
information. While in later case everyone is approaching the issue with same knowledge without
any asymmetry of information.
Allah said in Quran, “If, however (the debtor) is in straightened circumstances, (grant
him) a delay until a time of ease; and it would be for your own good-if you but knew it-to remit
(the debt entirely) by way of charity”. Indeed, if the creditors forgive the debtor, it will be the act
of charity for them.
However Islamic banks are not charitable body, but commercial institutions with
shareholders who are seeking dividends and capital gains, and depositors, including those with
investment accounts, who are expecting profit sharing pay-outs. There is a conflict of interest
between those being financed and an Islamic bank’s owners and depositors. Debt forgiveness on
a large scale will result in declining shareholder value and zero profits for investment account
holders. Regulators will also be concerned with excessive debt forgiveness, as if the bank fails,
in most jurisdictions governments will be obliged to bail out the bank using taxpayers’ money
(Mayer et al., 2012).

Islamic Approach towards Insolvency and Bankruptcy

There are two main characteristics on Islamic approach towards insolvency for both
parties; debtor and creditor. First approach is they have rights for each party. This means that
Islamic law emphasizes balance approach to creditors and debtors in the case of insolvency and
bankruptcy. Therefore, it cannot be said that Islamic law is protecting the rights of debtors only;
it also protects the rights of creditors. On the part of debtor, Islamic law puts guidelines:

1. The debt, either created through loan (qard), credit purchase, lease, partnership and etc., must be paid.
2. Debt settlement is considered as obligation to fulfill the covenant in which the Quran said many times and
of of them is “O you who believed, fulfill (all) contracts…” (Quran 5:1).

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3. A debtor delaying paying a debt or an obligation without a valid excuse, even to a wealthy person, is unjust
(ẓulm). For this reason, some sort of punishment and penalty is allowed.
4. In the case of default and inability to pay back debt due to economic hardship, he should consult the
creditor asking for more time and facilities to settle the debts.

On the part of the creditor:

1. The debt created from him essentially emerged from his social responsibility and moral commitment of
benevolence.
2. He has the right to get back the debt from debtor, but this does not mean he has the authority or power to
exploit the debtor by threatening or by increasing the amount of debt.
3. In the case of default, the creditor is expected to ease debtor by giving more time or other ways in which
the debtor could reduce and hence settle the debt accordingly. This is based the Quran (2: 280) which says
if a person is in difficulties, let there be respite until a time of ease. And if you give freely (i.e., if you
forgive the debt voluntarily) it would be better for you, if only you knew.
Second, that balance approach and position of debt settlement and bankruptcy comes
from the Islamic values expected to be hold by both the creditor and debtors. In this regard, both
the debtor and creditor are expected to have the prescribed norms and values in debt creation,
settlement also in case of insolvency as guided by the Islamic principles. Some of the guidelines
are as follows:

1. Debt due to delayed payment, under Islamic law, will not increase over time. It is unlawful in Islam to
either lend or borrow a sum of money at interest. This is in contrast with a draconian system (i.e. riba
jahiliyyah) which strongly favored creditors whereby if the debtor sought a reprieve, it came at the price of
a doubling of the debt. This make the debtor has a lifetime opportunity to reduce it down. In other word, the
amount of debt can only go down over time, whereby the debtor can eventually settle it back any time in
his life.
2. Islam requires a fair treatment and avoidance of punishment for an inability to pay back debt due to
economic hardship.
3. In Islamic framework for debt settlement in the case of insolvency and bankruptcy, the debt settlement is
done through recourse to the assets. Debtor’s asset could be utilized to pay off his debts. In recent
development of sukuk, an asset-backed sukuk whereby the sukuk holders had claims to specific assets.
4. Under Islamic concept of settlement (sulh) a creditor could accept a compromise or reduction of the debt.
The moral theory for such reduction is that creditor would make a donation or charitable forgiveness of the
remaining balance as propagated in the Quran (2: 280).
5. Judge (qadi) also plays very central in finding appropriate resolution to the cases brought before him. A
bankruptcy proceeding is commenced by the creditor. The burden, in Islamic law, is on the creditors to
show proof of the debt and that the debt had become due.

One important point need to be stress here is that every step and planning have to be
taken before an entity falls into trouble. The maxim which says harm shall be eliminated shall be
the guiding principle here. Islam always stresses the importance of planning and avoiding any
harm from happening. Insolvency, no doubt is considered as harm not only to individual but also
to society and the economy in general.
Therefore, it is the role of the regulator and governments to ensure all mechanisms are
intact in order to prevent insolvency. If, despite all the measures, it happened, then there must
also be the mechanism to ensure minimal impact of such happening to individual, society and
economy. It is important to note that such planning become mandatory and compulsory if
without it may harm the nation and ummah.

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Finally, Islam emphasis the principle of justice to all parties related when there is case of
insolvency. What is important is the role of the court to ensure that justice is done to everyone
and no one party should be given preference over the others. Islam does not rank the rights of the
parties involve when claiming their rights; rather it is left to the wisdom of the court to determine
the rights of all are protected.

Case Study: Bankruptcy of Arcapita Group in Malaysia

Arcapita Bank was incorporated in November 1996 as a Bahrain Joint Stock Company,
and operates under an Islamic wholesale banking license issued by the Central Bank of Bahrain
(CCB).
Arcapita, through its debtor and non-debtor subsidiaries is a global manager of Shariah-
compliant investments and operates as an investment bank. Arcapita was privately owned by
approximately 360 shareholders, with approximately 70% of its equity held by prominent
individuals and institutions based predominantly in the Gulf region and the remaining
approximately 30% beneficially held by Arcapita’s management.
The Arcapita Group operated primarily as an investment company that provided
investment opportunities to high net worth individuals, family offices, institutions and sovereign
wealth funds whom wishes to conform to Islamic Shariah rules and principles.
The Arcapita Group sponsored its first investment in 1997 as private equity investments
in assets based in the United States. In 2001, the Arcapita Group expanded its investment
portfolio to include real estate assets.
Arcapita Group was an unable to obtain liquidity as a result of the 2007 global economic
downturn and debt crisis. This affected the Group’s ability to refinance a US$1.02 billion
Syndicated Murabahah Facility that was due on March 28, 2012. The company was obliged to
seek protection from the courts after hedge funds that had bought into the secondary market
refused to agree to a consensual out-of-court debt restructuring.
In lieu of the bankruptcy petition, the group management is considering a voluntary
bankruptcy filing under Chapter 11 of the United States Bankruptcy Code. They could use the
Chapter 11 framework since it had assets in the United States and this framework presented the
most appropriate and efficient vehicle for a comprehensive restructuring for all debtors. The
principal objective of Chapter 11 proceeding is creating and implementing a plan of
reorganization. Thus, a debtor fall in this category may continue its business and remain in
possession of its property as a “debtor in possession” during the proceeding.
Arcapita’s plan will transfer its assets into a new holding company which will dispose of
them over time to pay off creditors, effectively a gradual wind-down of the firm. Under the
court-approved restructuring plan, Arcapita is to be split into two entities: one which will hold
the existing company assets as they are sold down to pay creditors, with a second in charge of
the process’ management. On the other hand, the U.S. court also had to approve a rare $350
million debtor-in-possession financing from Goldman Sachs, arranged to fund Arcapita’s wind-
down operations.
The primary financing arrangements under the Plan are two new Murabaha facilities and
a sukuk issuance. The “New Murabaha Facilities” are comprised of an “Exit Facility” and a
“New SCB Facility”. The Exit Facility is used to provide working capital which takes out the
existing SCB Facility with a first lien (highest priority debt) on the obligors’ assets into junior-

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liens (second mortgage) on the New SCB Facility. The “New SCB Facility” is a new Murabaha
facility. The Sukuk Facility is a newly issued unsecured sukuk facility that is subordinate to the
New Murabaha Facilities. These are repaid primarily from the proceeds of asset dispositions.
Arcapita has become the first GCC Company to emerge from U.S. bankruptcy under
Chapter 11 rules, in a move that could help clarify how Islamic finance is treated in Western
courts. The case could prove to be a step forward for the Islamic finance industry by offering a
degree of certainty as to how Western courts treat contracts and disputes that make reference to
Shariah (Singh & Sheng, 2011). While Chapter 11 process, also the first to use a debtor-in
possession financing which complied with Islamic finance principles such as a ban on interest,
ensured Arcapita’s existing portfolio could be sold without a firesale.
The regulators and the courts have adopted and approved the economic substance
approach to legal issues of relevance to Islamic finance since the forms of the Shariah-compliant
transactions are not disruptive of the analysis.
In the case of U.S, Islamic principles are not actually codified in law. Thus the absence of
Shariah law makes notoriously difficult for Western courts to deal with. The complexities of
addressing Arcapita bankruptcy issues in the context of Shariah-compliant debtors are the second
of its kind, after the East Cameron oil and gas sukuk. It is gratifying to note that the Bankruptcy
Courts in the United States have striven to adhere to Shariah principles in both of these
bankruptcy proceedings, including the financial and corporate restructurings and reorganizations.
True debt restructuring is somewhat of an alien concept in the Middle East. The region’s
bankruptcy laws are largely untested especially the bankruptcy law in Bahrain, where Arcapita is
based in, has never been used. Instead, such situations tend to be worked out through privately
negotiated deals, typically involving a so-called amend and extend, whereby a company amends
its credit agreement and extends the debt maturities to avoid a default.

CONCLUSION

Bankruptcy declaration process is initiated by the creditors and a settlement would be

initiated by the action of the court itself. Shariah Laws of insolvency and indebtedness allows a
finely balanced resolution towards the dispute of rights between creditors, debtors as well as
other stakeholders. A strict ration of capital and debt to be observed when it comes to windup
and insolvency.
Although there is a lot of different perspective and definition on bankruptcy as discussed
in the Western as compared to particularly on the Indonesian Law point of view, Shariah Laws
may find a universal solution towards this matter at hand.
A key element to the success of Shariah compliant restructurings is the involvement, and
ongoing dialogue with, the relevant Shariah boards from the outset. It is clear from recent
Shariah compliant restructurings that Shariah boards are willing to revisit the fundamental
principles of current Shariah compliant financing arrangements and are open to considering other
innovative structures. The key to all of them has been balancing the interests of multiple Shariah
boards with sometimes competing interests of a diverse creditor group.

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Received: 22-Mar-2022, Manuscript No. JLERI-22-11576; Editor assigned: 24-Mar-2022, PreQC No. JLERI-22-11576(PQ); Reviewed: 05-
Apr-2022, QC No. JLERI-22-11576; Revised: 25-Jan-2023, Manuscript No. JLERI-22-11576(R); Published: 01-Feb-2023

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Citation Information: Puneri, A. (2023). Bankruptcy: A legal comparison. Journal of Legal, Ethical and Regulatory Issues, 26(S3),
1-13.