The dominant shareholder primacy model of corporate governance makes shareholder wealth maximization both the purpose of a corporation and the only legitimate consideration for decisions by corporate directors. Yet that single-stakeholder model is under attack on several fronts. Numerous scholars and leading business figures assert that corporations have a broader purpose and that the interests of constituencies other than shareholders can and should be considered by corporate directors.
This debate plays out as a legal matter in the context of the “business judgment” rule. That is the test courts use to determine which interests are legitimate for consideration by the corporation’s decisionmakers and the extent to which directors must investigate and consider the consequences of corporate decisions. However, the judicial review provided by the business judgment test is so weak that a shift from shareholder primacy to stakeholderism will have minimal impact. Further, the process provides no effective mechanism to raise or force consideration of other stakeholder consequences.
That is not true in bankruptcy. Although bankruptcy courts purport to apply the business judgment rule, the bankruptcy variant is very different from its corporate cousin. In a recent paper, I conclude that bankruptcy provides meaningful opportunities for stakeholder involvement in the decision-making process and permits stakeholders to add information and challenge decisions before they are made final.
Sustainability is about consequences, and a sustainable approach to bankruptcy requires consideration of the interests of all, both present and future, who may be affected by the process. It is a light-touch approach. It does not impose any metric on the outcome of the decision-making process and does not elevate the interests of other stakeholders over those of the financial stakeholders. It merely requires that the interests of all affected parties be considered.
Adopting a sustainable approach will make no difference in the vast majority of bankruptcy cases because they affect only the debtor, its creditors, and its shareholders – interests already fully considered and addressed by the process. However, some bankruptcy cases impose significant costs on other constituencies. Others involve major issues of public interest that affect society as a whole.
While few in number, bankruptcy cases raising serious sustainability concerns are of great importance. Bankruptcy has become a principal forum for important public policy debates. National industrial policy often plays out in the bankruptcy system. For example, most decisions involving the government-financed bailout of the American automotive sector took place in bankruptcy court, not in the legislative arena. Similarly, the bankruptcy courts played a major role in the global financial crisis, handling the resolution of systemically important institutions such as the Lehman Brothers. The bankruptcy system handles numerous mass tort issues, including such pervasive problems as industry-wide asbestos exposure and the fallout from the opioid addiction crisis. And it handles innumerable environmentally sensitive cases.
Like corporate law, bankruptcy theory has tilted strongly toward a single-stakeholder model in recent decades. Although not all bankruptcy debtors are insolvent, in most bankruptcy cases the shareholder primacy model morphs into a creditor primacy model because creditors replace shareholders as the residual claimants upon insolvency. This is reflected in the currently dominant “creditors’ bargain” theory of bankruptcy. Full adoption of the creditor primacy model would squeeze out consideration of the consequences imposed on others by the decisions made in a bankruptcy case.
As in corporate theory, there is mounting pressure to shift away from the single-constituency model. But, in any event, the U.S. Bankruptcy Code adopts a much broader stakeholder approach and already incorporates a more robust sustainability approach than would a shift to stakeholderism in corporate law.
In contrast to corporate decisions, almost all bankruptcy decisions that might have significant stakeholder consequences either require court approval or can be challenged before they are implemented. Unlike corporate decisions, advance notice must be provided and affected parties have a right to be heard. That right in Chapter 11 reorganization cases is extended to virtually all parties who might be affected by a decision, not just parties with a financial stake in the enterprise.
Unlike in the corporate context, the court is involved in decision-making and does not merely review the process after the fact. Indeed, for most bankruptcy decisions, the court is the ultimate decision maker. The bankruptcy business judgment rule serves a function very different from its corporate cousin. Rather than a shield protecting most corporate decisions from challenge, it determines how much deference the bankruptcy judge gives to the proposed decision of the bankruptcy manager, who usually is the debtor corporation acting as a debtor-in-possession. The test operates on a sliding scale, with judges giving almost complete deference to proposals involving ordinary business decisions and far less to those that affect important stakeholder interests.
Bankruptcy is not simply a forum for effectuating a creditors’ bargain, or even a hypothetical creditors’ bargain. It is a coercive process that can impose significant costs on non-creditors and even on society as a whole. Sustainability should be part of that process, and the decisions made should balance the interests of all who are affected by them and not serve only the interests of a select few. The bankruptcy business judgment rule is the tool for incorporating sustainability principles into bankruptcy.
This post comes to us from Professor G. Ray Warner at St. John’s University School of Law. It is based on his recent paper, “Sustainable Bankruptcy,” available here.