Rethinking the Role of the Law of Corporate Distress in the Twenty-First Century

Thomas Jackson famously described the role of all bankruptcy law as reducing the incentive for individual enforcement against the assets of a distressed company.[1] Although scholars have debated other aspects of Jackson’s thesis, most have continued to identify with this as a central tenet of bankruptcy law. In a recent working paper, Rethinking the Role of the Law of Corporate Distress in the Twenty-First Century, I propose a new taxonomy: the law of corporate distress comprised of insolvency law and restructuring law. I suggest that Thomas Jackson’s description remains apt for part of that taxonomy but draw a distinction between the constituent parts. I reframe the unifying aim of the law of corporate distress as the facilitation of the reallocation of resource in the economy to best use and draw a distinction between insolvency law’s role in reducing the incentive for individual enforcement and restructuring law’s role in providing a deadlock resolution procedure.[2]

In the paper,  I briefly chart the story of the early railroad restructurings in the US, concentrating on what David Skeel has called the ‘irresistible’ logic of restructuring the railroads,[3] the problems with creditor coordination given dispersal of the creditor group and the existence of many separate liens on individual assets. I argue that these elements, collectively, led to a focus in railroad restructuring on restricting the ability of individual creditors to take action against particular assets and I show how this concern with reducing incentives to pursue enforcement and sale rather than a debt restructuring carried into modern US bankruptcy law. I compare this with the historical roots of insolvency law in the UK, concentrating on the dominance of deposit-taking or ‘clearing’ banks, the role of ‘The London Approach’ as a market, as opposed to legal, mechanism to solve creditor coordination problems and the almost non-existent role of the law in promoting debt restructuring as opposed to facilitating insolvency sales.

In the paper, I explain how the finance markets in the UK and the US have begun to resemble each other more closely. First, the UK finance market is becoming more dispersed and more diversified, giving rise to greater coordination challenges. At the same time, it is becoming more common for a senior class to have security over substantially all of the assets of a US business, giving creditors greater control through the security interest. Finally, distressed debt trading has becoming a regular feature of the landscape in both jurisdictions. I argue that each of these developments has had a significant impact on the role of the law of corporate distress in the twenty-first century.

I have already explained the historical background to modern US bankruptcy law which led to a single gateway for an asset sale or a debt restructuring and in which a moratorium against creditor action is imposed. In contrast, I explain in the paper that multiple procedures exist in the UK which senior creditors in modern, complex capital structures have adapted to promote a restructuring (where they are willing to remain invested in the company) or to force a sale of the business and assets to a third party (where they are not). This highlights one of the most profound differences between US bankruptcy law and UK insolvency and restructuring law: the extent to which the law seeks to influence the choice between restructuring on one hand and enforcement and sale to a third party on the other. I explain how, in recent times, this distinction has seemed to be waning given the rise of a senior secured class in US bankruptcies which can effectively control decision-making through its security interest. In due course, I will update the paper to show why some of recommendations in the report of the American Bankruptcy Institute Commission to Study Reform of Chapter 11 (published after the paper was sent to print)  may reignite the issue  – and why I continue to maintain the argument advanced in the paper that the distressed debt market ought, in any event, to render the debate, and any legal response to it, redundant at least for large and mid-cap companies. [4]

The distressed debt market seeks to identify any distressed company where the value of the company if it continues to operate exceeds the value of the business and assets if they are sold at the time of the restructuring. It therefore provides an exit for existing creditors who might otherwise have preferred enforcement and sale by buying them out at a price which reflects their expected return on enforcement, leaving the distressed debt trader with the potential to capture the restructuring upside (and with  the downside risk). I argue that this means restructuring law need not concern itself with the incentive for enforcement but instead stands ready to provide a deadlock resolution procedure where unanimous consent for a new bargain cannot be achieved. Where the market sees insufficient value in a restructuring, on the other hand, insolvency law must continue to concern itself with reducing the incentive for individual creditors to take action so that a sale of the business and assets as a going concern may be attempted, improving the prospects for maximising the value at which the assets are realised and the amount of capital flowing back into productive use in the economy.

Having argued that we can now consider the role of insolvency law and the role of restructuring law separately, the final part of the paper discusses some of the key concerns, which arise for both branches of the law of corporate distress, in responding to the State’s desire to promote the allocation of resource in the economy to highest and best use. The paper argues that both insolvency law and restructuring law must respond to these issues but that each branch of the law of corporate distress responds in a distinct way. This part of the paper includes some technical discussion but, at its heart, the paper remains a clarion call to bankruptcy scholars everywhere to reassess the roles of insolvency law and restructuring law in modern markets without too much blurring of the lines between the two.

ENDNOTES

[1] T Jackson, ‘Bankruptcy, Non-Bankruptcy Entitlements, and the Creditors’ Bargain’ (1982) The Yale Law Journal 857; TH Jackson, ‘Translating Assets and Liabilities to the Bankruptcy Forum’ (1985) 14 The Journal of Legal Studies 73; T Jackson, The Logic and Limits of Bankruptcy Law (Harvard University Press 1986); TH Jackson and RE Scott, ‘On the Nature of Bankruptcy: An Essay on Bankruptcy Sharing and the Creditors’ Bargain’ (1989) 75 Virginia Law Review 155.

[2] A central part of Thomas Jackson’s philosophy but not often put up front and central in the account which traditionally focuses on the need to stop the so-called ‘race to the courthouse door’ or (more technically) the common pool problem.

[3] DA Skeel, Jr., Debt’s Dominion: a History of Bankruptcy Law in America (Princeton University Press 2001).

[4] Commission to Study the Reform of Chapter 11 2012-2104 Final Report and Recommendations available at http://commission.abi.org/.

 

The preceding post comes to us from Sarah Paterson, Assistant Professor of Corporate Insolvency Law at The London School of Economics and Political Science. It is based on her recent paper entitled “Rethinking the Role of the Law of Corporate Distress in the Twenty-First Century,” which is available here.