VOLUME 166, ISSUE 7 December 2018


This Symposium marks the fortieth anniversary of the enactment of the 1978 Bankruptcy Code (the “1978 Code” or the “Code”) with an extended look at seismic changes that currently are reshaping Chapter 11 reorganization. Today’s typical Chapter 11 case looks radically different than did the typical case in the Code’s early years. In those days, Chapter 11 afforded debtors a cozy haven. Most everything that mattered occurred within the context of the formal proceeding, where the debtor enjoyed agenda control, a leisurely timetable, and judicial solicitude. The safe haven steadily disappeared over time, displaced by a range of countervailing forces and a cooperative bankruptcy bench. Lenders, especially debtor‐in‐possession (DIP) financers, gradually began to shape the trajectory of many proceedings. They today determine the course of most of the cases. More recently, additional players such as hedge funds and equity funds have also entered the scene, altering the bargaining dynamic. New financial instruments complicate debtors’ capital structures and creditor incentives. Even the sites and modes of decisionmaking have shifted, as today’s key decisions are negotiated and embedded in contracts concluded even before the debtor files for bankruptcy. The changes, which continue to accumulate, are fundamental.

Congress has given a gentle assist to a few of these changes. Sometimes this has followed from direct intervention, as when Congress amended the Code to diminish the debtor’s agenda control of judicial reorganization proceedings. At other times the effect is indirect, as when Congress encouraged the use of derivatives and other new financial instruments by largely exempting them from key bankruptcy provisions such as the automatic stay that requires other creditors to halt any collection efforts. Whether direct or indirect, most of the legislative interventions have been of minor importance and the statutory framework is largely identical to that enacted in 1978. The changes have been driven by innovations in reorganization practice and judicial interpretation. It is a dynamic situation. Some of the most important and controversial of these new developments, such as the use of restructuring support agreements to lock up votes for a potential reorganization, will likely have seen further evolution by the time this Foreword appears in print.

This Foreword provides context for the Symposium’s academic contributions by recounting the historical developments that have brought us where we are. After chronicling the origins, New Deal redirection, and recent evolution of corporate reorganization, we describe some of the remarkable and often counterintuitive insights the articles in this Symposium offer for the current moment. We conclude by venturing a few thoughts about the future. As we shall see, the Nietzschean vision of history as eternal recurrence has surprising explanatory power in the bankruptcy context.

Bond workouts are a famously dysfunctional method of debt restructuring. The process is so ridden with opportunistic and coercive behavior by both bondholders and bond issuers as to make success intrinsically unlikely. Yet since 2008 bond workouts have quietly started to work. A segment of the restructuring market has shifted from bankruptcy court to out‐of‐court workouts by way of exchange offers made only to large institutional investors. The new workouts feature a battery of strong‐arm tactics by bond issuers, and aggrieved bondholders have complained in court. There resulted a new, broad reading of the primary law governing workouts, section 316(b) of the Trust Indenture Act of 1939 (TIA), which prohibits majority‐vote amendments of bond payment terms and forces bond issuers seeking to restructure to resort to exchange offers.

This Article exploits the bond market’s reaction to the shift in law to reassess a longstanding debate in corporate finance regarding the desirability of TIA section 316(b). Section 316(b) has attracted intense criticism, with calls for its amendment or repeal because of its untoward effects on the workout process and tendency to push restructuring into the costly bankruptcy process. Yet section 316(b) has also been staunchly defended on the ground that mom‐and‐pop bondholders need protection from sharp‐elbowed issuer tactics.

We draw on a pair of original, hand‐collected data sets to show that many of the empirical assumptions made in the debate no longer hold true. We show that markets have learned to live with section 316(b)’s limitations, denuding the case for repeal of any urgency. Workouts generally succeed, so that there is no serious transaction cost problem stemming from the TIA; when a company goes straight into bankruptcy there tend to be independent motivations. We also show that workout by majority amendment would not systematically disadvantage bondholders. Indeed, the recent turn to secured creditor control of bankruptcy proceedings makes direct amendment all the more attractive to unsecured bondholders.

Based on this empirical background, we cautiously argue for the repeal of section 316(b). Section 316(b) no longer does much work, even as it prevents bondholders and bond issuers from realizing their preferences regarding modes of restructuring and voting rules. We do not know what contracting equilibrium would obtain following repeal, but think that the matter is best left to the market. Still, we recognize that markets are imperfect and that a free‐contracting regime may result in abuses. Accordingly, we argue that repeal of section 316(b) should be accompanied by the resuscitation of the long‐forgotten doctrine of intercreditor good faith duties, which presents a more fact‐sensitive and targeted tool for policing overreaching in bond workouts than the broad reading of section 316(b).

Many current bankruptcy debates—from critical vendor orders to the Supreme Court’s decision last year in Czyzewski v. Jevic Holding Corporation—begin with bankruptcy’s distributional rules and questions about how much discretion a judge should have in applying them. It is a mistake, however, to focus on distributional questions without first identifying the bankruptcy partition and ensuring it is properly policed. What appear to be distributional disputes are more often debates about the demarcation of the bankruptcy partition and the best way to police it.

Once the dynamics of establishing and policing the bankruptcy partition are taken into account, there is little room for departures from bankruptcy’s distributional rules. There might be a few rare cases in which maximizing the value of the estate requires it, but these inhabit an exceedingly narrow domain so small and so hard to navigate that they are sensibly handled with a per se rule that prohibits them.

Spend a day in a busy bankruptcy court and your research agenda could be set for life. Bankruptcy is crisis management for individuals, business entities, and even governments. The entities that file for bankruptcy come in all shapes and sizes, as do their troubles. In addition to basic capital structure problems, bankruptcy dockets and courtrooms contain allegations of sexual harassment, race discrimination, systemic financial risk, First Amendment issues, toxic and defective products (medical devices, airplanes, and automobiles), global warming litigation, and pyramid schemes. This catastrophist’s dream has the potential to provoke engagement from scholars spanning the law school curriculum.

That breadth of engagement, however, is missing. In a public lecture, commercial law scholar and teacher Jay Lawrence Westbrook lamented the lack of “public interest” concerns in corporate bankruptcy scholarship. That term signals something more than the aggregation of individual rights‐based interests and arguments, to encompass the system’s broader effects—matters that cannot simply be waived by creditors when they settle their own claims. In addition, the scholarship insufficiently attends to claimants whose rights against a bankrupt company arise through pathways other than the fine print of a contract.

In short, the field of corporate bankruptcy has been redistricted to wealth maximization, voluntary lenders, and investors. Academic careers have flourished characterizing Chapter 11 as a mere corporate control transaction among investors, shuffling pieces of the company’s capital structure. Whether due to this framing, the lack of a popular alternative, or both, the redistricters tend to ignore scholarly contributions that construe the field more broadly.

This Article is an invitation to explore an alternative model: corporate bankruptcy as a public–private partnership. In this model, allocating responsibilities to private parties can improve regulatory functioning, but parties cannot redefine system goals purely for their own benefit. The application of this framework is supported by an institutional analysis of the bankruptcy system, drawing on privatization and administrative law scholarship that has received too little attention in bankruptcy debates. Scholars of the regulatory state understand that efficiency is not the exclusive objective: “the public law perspective asks not whether privatization is efficient, but whether it erodes the public law norms that these constitutional and statutory limits are designed to protect.” Private contributions to a system must be solicited and managed in ways that improve, not undermine, public regulatory objectives.

In addition to enlivening academic debates, the public–private partnership model sheds new light on real‐world problems. And problems abound. The American Bankruptcy Institute Commission on Chapter 11 recently released a report cataloging the ways in which Chapter 11 no longer functions in accordance with its original legislative mandate. The public–private partnership model not only helps diagnose shortcomings in Chapter 11 as it operates on the ground, but expands the range of options for addressing them.

The Bankruptcy Code deals first and foremost with the cash flow rights of the debtor’s various investors. The immediate cause of most corporate bankruptcy filings is a company’s pending inability to pay off its obligations that are becoming due. The firm has made promises to pay various parties, and it does not have the financial wherewithal to live up to those obligations. It lacks the liquidity necessary to continue to service its debt and has either defaulted on its obligations or faces imminent default. In short, there is a mismatch between the company’s capital structure and its future revenues.

Restructuring the business’s balance sheet under Chapter 11 is designed to address this mismatch between obligations and available resources. The goal is to create a capital structure that better reflects the future revenues of the firm. The heart of Chapter 11 is the absolute priority rule. It sets forth the conditions that must be met for an investor to see her cash flow rights changed over her objection. Those holding secured debt can see their principal reduced, the interest rates on the debt trimmed, and the term of the loan extended. Unsecured debt can be reduced, paid off at pennies to the dollar, or converted to equity. Equity can be drastically diluted or even wiped out in full. Specifying the extent to which the various parties’ rights can be adjusted over their objection structures the bargaining process that leads to a plan of reorganization.

Over the decades, much ink has been spilled over the extent to which there are deviations from absolute priority in practice and the extent to which other mechanisms could be implemented that would vindicate the rule. Recently, there has been serious questioning of the wisdom of the Code’s strict adherence to absolute priority, with the suggestion that we return to the world of relative priority. Regardless of which flavor of priority one prefers, in every reorganization case the central issue that is the focus of reorganization law is how cash flow rights are adjusted—what claims will the prebankruptcy investors have against the restructured company?

The Code deals with cash flow rights in other ways besides adjusting investors’ rights to cash flow at the end of the proceeding via a plan of reorganization. For example, all rights to receive payments based on prepetition debts are stayed by the filing of a bankruptcy petition. Some transfers of money made on the eve of bankruptcy can be undone. Transactions of the last few years can be scrutinized to see whether the debtor received an adequate return for property that it has transferred to others. The debtor can decide whether to continue with transactions in progress. All of these situations adjust outside parties’ legal rights to receive money from the debtor.

Bankruptcy law, in contrast, has little to say about control rights over the running of the business. It by and large allows the existing management to remain in charge of the debtor. State law vests the ultimate authority over a company’s operations with the firm’s board of directors, and bankruptcy law leaves that structure in place. Boards, in turn, delegate the running of the company to the CEO and the executive team, and the Code takes this allocation of authority as the baseline for operating the debtor, both during the case and afterwards.

A generation ago, the Creditors’ Bargain theory provided the first comprehensive normative theory of bankruptcy. Not least of its innovations was the fact that it put bankruptcy theory on a contractual footing for the first time. Earlier commentators had recognized that bankruptcy law can prevent a “grab race” or “race to the courthouse” by creditors of a financially troubled debtor as they attempt to collect what they are owed, and that bankruptcy can provide a less chaotic and more even‐handed distribution of the debtor’s assets than might otherwise be the case. The articles that introduced the Creditors’ Bargain were the first to suggest that bankruptcy’s solution to these concerns was resolutely contractual in nature.

According to the Creditors’ Bargain theory, bankruptcy can be seen as the product of an implicit—or hypothetical—bargain among the creditors of a debtor. In practice, the argument went, creditors are too dispersed to effectively contract with one another over the best response to a debtor’s financial distress. But if they were able to contract, they would agree to provisions that put a halt to the race to the courthouse and provide for a collective solution to financial distress. Although a few creditors might fare better in a grab race, creditors as a whole would suffer because the creditors’ collection efforts could dismember an otherwise viable business. By preempting the race, bankruptcy law supplies the terms of a contract that the parties would agree to if they could contract directly.

In addition to justifying the collective proceeding, the hypothetical contract had important implications for every other feature of bankruptcy as well. As Baird and Jackson envisioned it, the hypothetical contract would pursue a “sole owner” standard—that is, the approach that a sole owner of all of the debtor’s assets would favor—and thus would seek to maximize the value of the debtor’s assets without regard to the effect of the resolution decision on any particular constituency. The hypothetical contract would protect the parties’ nonbankruptcy entitlements—especially property rights—except to the extent necessary to achieve a collective solution to financial distress that would preserve the debtor’s value as a going concern. If bankruptcy were to alter rights otherwise, the reasoning went, the debtor and its creditors would engage in costly efforts to maneuver disputes toward their preferred fora.

As the hypothetical bargain terminology suggests, the Creditors’ Bargain theory focused on implicit rather than actual contracting and did not conceive of bankruptcy as a set of default rules that the parties would be free to contract around. This was because the theory was addressing a world of creditors so dispersed that they were unable to contract. The most dramatic development in the decades since the model was devised has been the increasing use of actual contracts to shape the bankruptcy process. Some of the increase in contracting is due to the rise in relative prominence of secured creditors since the inception of the Creditors’ Bargain theory. Unsecured creditors are less likely to be the key constituency in current cases than they were a generation ago, and the traditional collective action problems are correspondingly less relevant in many cases.9 Another important change has been the rise of sophisticated activists who purchase and aggregate bankruptcy claims or provide new financing with a view toward influencing the course of the bankruptcy. The body of creditors is far more dynamic than a generation ago and tilted toward creditors that can and do contract.

Prior scholarship points to valuation disputes and valuation error as key drivers of Chapter 11 outcomes. Avoiding valuation disputes and errors is also the underlying driver of most proposed reforms, from Baird’s auctions to Bebchuk’s options. In this paper, we undertake a detailed examination of bankruptcy court opinions involving valuation disputes. Our paper has two goals. The first is to understand how parties and their expert witnesses justify their opposing views to judges, and how judges decide between them. The second is to provide practical guidance to judges in resolving valuation disputes. We document surprisingly pervasive (and often self‐serving) errors in expert testimony. This is particularly true when valuation experts apply the discounted cash flow (DCF) method. With respect to key elements of that method, such as the discount rate, we observe stark inconsistency between expert testimony and finance theory and evidence. We propose simple strategies based in finance theory that judges can employ (such as avoiding the use of company‐specific risk premia in discount rates) to reduce the scope for valuation disagreements in Chapter 11. We also recommend that judges rely on the peer‐reviewed finance and economics literature to assess the scientific reliability of discount rates.

Thirty‐six years ago, Tom Jackson suggested that corporate bankruptcy law can best be explained and defended as the terms of an implicit bargain among creditors. This assertion is founded on a belief that creditors, as a group, prefer bankruptcy’s collective process to a grab race among themselves, particularly when such a race may cause the demise of a viable going concern.

Since Jackson’s article, scholars have discussed and debated whether creditors need to rely on bankruptcy’s bargain for collective action. Some have contended that creditors could in fact contractually arrange for a collective process and that the law should permit them to do so. Others have argued that the impediments to such a contractual arrangement would be too daunting. With rare exception, though, participants in this dialogue assumed that creditors desire some form of collective process, whether provided by statute or contract. That is, while implementation was debated, the collectivization premise went mostly unchallenged.

The recent transformation of the bankruptcy process from a forum of reorganization to, largely, an auction block further supports the collectivization premise. A collective process may not seem attractive when it features the contests inherent in reorganization, described colorfully by Sol Stein as a feast for lawyers. But the bankruptcy process may appear in a more favorable light when it is used simply to conduct an orderly sale of the debtor’s assets, including a sale as a going concern if that configuration of assets garners the highest bid.

All may seem well, then, in the world of bankruptcy, where the apparent confluence of theory and practice led Douglas Baird and Robert Rasmussen to declare the end of bankruptcy, by which they meant that bankruptcy has evolved to its ideal. But there is a fly in the ointment.

At a series of recent conferences attended by academics and practitioners, the latter have suggested, sometimes expressly, that if freed from legal constraint, creditors they know would not only contract out of bankruptcy but out of any collective proceeding. That is, at least some practicing lawyers—presumably not immersed in Jacksonian orthodoxy—seem to believe that their clients would like to engage in a grab race after all, consequences be damned.

Do these lawyers, who represent sophisticated lenders, simply mean that their clients favor a competition in which they would occupy a privileged position? Perhaps. But this seems unlikely because in a functioning capital market, creditors are mere stakeholders who are forced by the market to pay for any privilege in the form of lower interest rates. Sophisticated lenders, along with their lawyers, well understand this.

But perhaps a better explanation for why lenders might forgo collectivization exists: debtors would insist on interest rates possible only if the debtor obtained funds within a capital structure designed to throw the firm to the creditor wolves in the event of an uncured default. This conjecture is not new. I first raised the idea years ago in dissent to the collectivist hegemony. What is new, and the focus of this Article, is the extent to which the conjecture is supported by recent developments in bankruptcy practice and creditor activism.

It is something between awkward and an honor to be asked, as the creators of this Symposium did, to be the keynote speaker at a gathering called “Bankruptcy’s New Frontiers.” The Symposium, by its very title, is—wholly appropriately—about where bankruptcy is going, and investigating, as well as celebrating, the enormous creativity, hard work, and genius of those who are at the cutting edge of helping bankruptcy law evolve to its “new frontiers.” In that, I am at best a minor player from the perspective of 2017, notwithstanding my recent work in a side area dealing with bankruptcy and SIFIs—systemically important financial institutions—and despite a couple of energizing (for me, at least) pieces with David Skeel over the past half‐dozen years. That doesn’t account for the honor.

So, I am resigned (at least in part) to the idea—and hence the awkwardness—that my invitation here, as the keynote speaker, has less to do about my role in the future than the past—although one of my guiding beliefs as an academic has always been that all scholarship is never definitive, but is about moving the ball forward so that others, with new and different insights, can pick the ball up and run with exciting, pathbreaking scholarship. The best of the past is a part of the future. In that, I have significant pride in thinking my work moved the ball forward, inviting a host of new, and creative, people to become involved. I am “keynote” in the sense of “let’s start with how we got to where we are, in a world in which we could reasonably talk about ‘Bankruptcy’s New Frontiers’ and gather such an incredible group of academics, practitioners, and judges.”

And, in doing this, it is, I think, important to remember that not only normative frameworks change with time but, equally, so does the world to which the frameworks are responding. The “creditors’ bargain” may have been the first comprehensive normative framework for thinking about bankruptcy law, as this Symposium postulates, but it was a product not only of the emerging scholastic work at that time, but also of the actual world—of firms, capital structures, and players—that existed at that time. In a recent piece that I resonate with (cogently entitled Three Ages of Bankruptcy), Mark Roe suggested that

we see core provisions emerging in practice, dominating for a time, and then fading in importance. Each decision‐making method has had its heyday. Each method’s rise and fall usually fit with underlying market conditions and basic bankruptcy goals, sometimes mapped to political ideology currents, and often reflected the influence of powerful groups, such as well‐organized creditors.

That is, I believe, true not just of practice but of normative frameworks that respond to the world as we see it. It is an appropriate time to take stock of changes in organizations and practices, as well as theory and new analytical tools, to see to what extent what was novel, perhaps revolutionary, and perhaps normatively persuasive, thirty to forty years ago, needs ongoing adjustment and reform—exactly the work that those gathered here tonight have been so engaged in over the past twenty years.

But as this Symposium, so appropriately, does exactly that, it is at least interesting, and perhaps worthwhile, to travel back forty years in time when, I dare say, there wouldn’t have been such a star‐studded conference about “Bankruptcy’s New Frontiers.”

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